Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements of Quidel Corporation and its subsidiaries (the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (consisting of normal recurring accruals) have been included.
The information at September 30, 2020, and for the three and nine months ended September 30, 2020 and 2019, is unaudited. For further information, refer to the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2019 included in the Company’s 2019 Annual Report on Form 10-K. Operating results for any quarter are historically seasonal in nature and are not necessarily indicative of the results expected for the full year.
For 2020 and 2019, the Company’s fiscal year will end or has ended on January 3, 2021 and December 29, 2019, respectively. For 2020 and 2019, the Company’s third quarter ended on September 27, 2020 and September 29, 2019, respectively. For ease of reference, the calendar quarter end dates are used herein. The three and nine-month periods ended September 30, 2020 and 2019 each included 13 and 39 weeks respectively.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Significant Accounting Policies
During the nine months ended September 30, 2020, there have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 except as noted below.
During the three months ended September 30, 2020, the Company entered into a contract with the National Institute of Health (“NIH”) through its newly launched Rapid Acceleration of Diagnostics - Advanced Technology Platforms initiative to support the Company’s expansion of its manufacturing capacity for its diagnostic assays that test for SARS-CoV-2 antigen. The contract provides for consideration to the Company of up to $65.0 million and has a performance period of one year beginning July 2020 with key deliverables and milestones that would directly support the upgrade and addition of new manufacturing lines as well as the outfitting of a new distribution center. The Company will also provide instruments and assays to the NIH. There are no refund provisions under the contract.
Consideration from the contract is allocated to each deliverable identified within the contract using a relative fair value allocation method and recognized when there is reasonable assurance the Company will meet the milestones and receive the consideration. Consideration allocated to the delivery of instruments and assays are recognized in accordance with the Company’s existing revenue recognition policy. Consideration that relates to capital expenditures is recorded as a reduction to the carrying value of such assets and amortized over the useful life over the assets. Consideration allocated to the remainder of the contract is recorded as reductions to the related expense. During the three months ended September 30, 2020, the Company incurred $14.3 million in capital expenditures which will be reimbursed under this contract as future milestones are met. Therefore, the Company accrued such unbilled receivables in prepaid expenses and other current assets as of September 30, 2020.
Note 2. Computation of Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average number of common shares outstanding, including restricted stock units (“RSUs”) vested during the period. Diluted EPS is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of shares issuable from stock options, unvested RSUs and the 3.25% Convertible
Senior Notes due 2020 (“Convertible Senior Notes”). Potentially dilutive common shares from outstanding stock options and unvested RSUs are determined using the average share price for each period under the treasury stock method. Potentially dilutive shares from the Convertible Senior Notes are determined using the if-converted method. Under the provisions of the if-converted method, the Convertible Senior Notes are assumed to be converted and included in the denominator of the EPS calculation and the interest expense, net of tax, recorded in connection with the Convertible Senior Notes is added back to net income.
The Convertible Senior Notes have a dilutive impact when the average market price of the Company’s common stock exceeds the applicable conversion price of the notes. The Senior Convertible Notes became convertible on March 31, 2018 and remained convertible through September 30, 2020.
The following table reconciles net income and the weighted-average shares used in computing basic and diluted earnings per share (in thousands):
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
|
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2020
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2019
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2020
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2019
|
Numerator:
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|
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|
|
|
|
Net income used for basic earnings per share
|
$
|
232,268
|
|
|
$
|
16,181
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|
|
$
|
340,157
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|
|
$
|
42,295
|
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Interest expense on Convertible Senior Notes, net of tax
|
107
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|
|
180
|
|
|
457
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|
|
1,669
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|
Net income used for diluted earnings per share, if-converted method
|
$
|
232,375
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|
|
$
|
16,361
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|
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$
|
340,614
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$
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43,964
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Basic weighted-average common shares outstanding
|
42,105
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|
41,642
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|
|
42,093
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|
40,520
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Dilutive potential shares issuable from Convertible Senior Notes
|
218
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|
|
410
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|
|
340
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|
|
1,282
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Dilutive potential shares issuable from stock options and unvested RSUs
|
1,273
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|
|
1,154
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|
|
1,149
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|
|
1,249
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Diluted weighted-average common shares outstanding, if-converted
|
43,596
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43,206
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|
|
43,582
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|
43,051
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Potentially dilutive shares excluded from calculation due to anti-dilutive effect
|
7
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|
|
223
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4
|
|
|
198
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Potentially dilutive shares excluded from the calculation above represent stock options when the combined exercise price and unrecognized stock-based compensation are greater than the average market price for the Company’s common stock because their effect is anti-dilutive.
Note 3. Balance Sheet Account Details
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value. Inventories consisted of the following (in thousands):
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September 30,
2020
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December 31,
2019
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Raw materials
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$
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40,430
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$
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23,294
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Work-in-process (materials, labor and overhead)
|
33,095
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20,514
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Finished goods (materials, labor and overhead)
|
21,696
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14,278
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Total inventories
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$
|
95,221
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|
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$
|
58,086
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Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
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September 30,
2020
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December 31,
2019
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Other receivables
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$
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22,978
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$
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7,857
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Prepaid expenses
|
10,150
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|
4,568
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Income taxes receivable
|
—
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|
2,560
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Other
|
1,886
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|
1,885
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Total prepaid expenses and other current assets
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$
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35,014
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|
|
$
|
16,870
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Other Current Liabilities
Other current liabilities consist of the following (in thousands):
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September 30,
2020
|
|
December 31,
2019
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Customer incentives
|
$
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4,914
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|
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$
|
7,369
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Customer deposits
|
1,873
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|
1,500
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Other
|
10,198
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|
|
5,993
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Total other current liabilities
|
$
|
16,985
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|
|
$
|
14,862
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Note 4. Income Taxes
The Company calculates its interim income tax provision in accordance with Accounting Standards Codification (“ASC”) 270, Interim Reporting, and ASC 740, Accounting for Income Taxes (together, “ASC 740”). At the end of each interim period, the Company estimates its annual effective tax rate and applies that rate to its ordinary quarterly earnings to calculate the tax related to ordinary income. The tax effects for other items that are excluded from ordinary income are discretely calculated and recognized in the period in which they occur.
The Company recognized income tax provisions of $63.5 million and $1.3 million for the three months ended September 30, 2020 and 2019, respectively, which represent effective tax rates of 21% and 8%, respectively. The Company recognized income tax provisions of $84.6 million and $2.4 million for the nine months ended September 30, 2020 and 2019, respectively, which represent effective tax rates of 20% and 5%, respectively. The Company benefited from discrete impacts of excess tax deductions from stock-based compensation, Foreign Derived Intangible Income and research and development (“R&D”) credits for all periods. For the three and nine months ended September 30, 2020, the effective tax rates were in line with the federal statutory rate as the higher pre-tax income was offset by the impact of these benefits.
The Company is subject to periodic audits by domestic and foreign tax authorities. Due to the carryforward of unutilized credits, the Company’s federal tax years from 2009 and forward are subject to examination by the U.S. authorities. The Company’s state and foreign tax years for 2001 and forward are subject to examination by applicable tax authorities. The Company believes that it has appropriate support for the income tax positions taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors, including past experience and interpretations of tax laws applied to the facts of each matter.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. The CARES Act provides for, among other things, refundable payroll tax credits, deferment of employer side social security payments and technical amendments regarding the income tax depreciation of qualified improvement property placed in service after December 31, 2017. The Company is benefiting only from the technical amendments regarding retroactive accelerated income tax depreciation on certain of our leasehold improvement assets.
Note 5. Debt
Convertible Senior Notes
In December 2014, the Company issued $172.5 million aggregate principal amount of its 3.25% Convertible Senior Notes. Debt issuance costs of approximately $5.1 million were primarily comprised of underwriters fees, legal, accounting and other professional fees, of which $4.2 million were recorded as a reduction to long-term debt and are being amortized using the effective interest method to interest expense over the six-year term of the Convertible Senior Notes. The remaining $0.9 million of debt issuance costs were allocated as a component of equity in additional paid-in capital. The implied interest rate of the Convertible Senior Notes was 6.9%, assuming no conversion option. The Convertible Senior Notes mature on December 15, 2020.
The Convertible Senior Notes are convertible into cash, shares of common stock, or a combination of cash and shares of common stock based on an initial conversion rate, subject to adjustment, of 31.1891 shares per $1,000 principal amount of the Convertible Senior Notes (which represents an initial conversion price of approximately $32.06 per share) in the following circumstances and to the following extent: (1) during any calendar quarter commencing after the calendar quarter ending on March 31, 2015, if the last reported sales price of the Company’s common stock, for at least 20 trading days (whether or not consecutive) in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price of the notes in effect on each applicable trading day; (2) during the five consecutive business day period following any five consecutive trading day period in which the trading price per $1,000 principal amount of the Convertible Senior Notes for each such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such day; or (3) upon the occurrence of specified events described in the indenture for the Convertible Senior Notes. On or after September 15, 2020 until the close of business on the second scheduled trading day immediately preceding the stated maturity date, holders may surrender their notes for conversion at any time, regardless of the foregoing circumstances. If a fundamental change, as defined in the indenture for the Convertible Senior Notes, such as an acquisition, merger or liquidation of the Company, occurs prior to the maturity date, subject to certain limitations, holders of the Convertible Senior Notes may require the Company to repurchase all or a portion of their Convertible Senior Notes for cash at a repurchase price equal to 100% of the principal amount of the Convertible Senior Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the repurchase date.
During the second quarter of 2020, the Company received notices to convert $5.9 million in principal which the Company elected to settle in cash. The settlement amount is determined based on the volume-weighted average stock price during the 25 consecutive trading days beginning on, and including, the third trading day after the conversion date notice is received. The election to settle the notes in cash is irrevocable and the settlement amount is variable based on the stock price. As of June 30, 2020, this 25-day period had not been completed. Therefore, the Company reclassified the conversion feature from equity at fair value and recorded a derivative liability of $26.2 million, measured as of the respective conversion dates. As of June 30, 2020, the derivative liability for the unsettled conversions were revalued, resulting in a loss of $1.1 million included in other expense, net on the Consolidated Statements of Income. The derivative liability was valued using the Company’s volume-weighted average stock price for a 25-day trading period preceding the measurement dates. These conversions were settled for $43.4 million during the three months ended September 30, 2020, resulting in a $10.4 million loss on extinguishment of debt.
The Convertible Senior Notes are convertible as of September 30, 2020 and will remain convertible until the second scheduled trading day before maturity. The Convertible Senior Notes outstanding as of September 30, 2020 may be settled at the Company’s option in cash or a combination of cash and shares of common stock. If such Convertible Senior Notes were converted as of September 30, 2020, the if-converted amount would exceed the principal by $40.4 million.
The Company pays 3.25% interest per annum on the principal amount of the Convertible Senior Notes semi-annually in arrears in cash on June 15 and December 15 of each year. During the nine months ended September 30, 2020, the Company recorded total interest expense of $0.6 million related to the Convertible Senior Notes, of which $0.3 million related to the amortization of the debt discount and issuance costs and $0.3 million related to the coupon due semi-annually. During the nine months ended September 30, 2019, the Company recorded total interest expense of $2.1 million related to the Convertible Senior Notes of which $1.1 million related to the amortization of the debt discount and issuance costs and $1.0 million related to the coupon due semi-annually.
The following table summarizes information about the equity and liability components of the Convertible Senior Notes (dollars in thousands). The fair values of the respective notes outstanding were measured based on quoted market prices and is a Level 2 measurement.
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September 30,
2020
|
|
December 31,
2019
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Principal amount outstanding
|
$
|
6,761
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|
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$
|
13,131
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Unamortized discount of liability component
|
(57)
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|
|
(415)
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Unamortized debt issuance costs
|
(8)
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|
|
(55)
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Net carrying amount of liability component
|
$
|
6,696
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|
|
$
|
12,661
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Carrying value of equity component, net of issuance costs
|
$
|
1,166
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|
|
$
|
2,265
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Fair value of outstanding Convertible Senior Notes
|
$
|
41,570
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|
|
$
|
30,991
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Remaining amortization period of discount on the liability component
|
0.3 years
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|
1.0 year
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Revolving Credit Facility
The Company has a $175.0 million Revolving Credit Facility under a credit agreement expiring on August 31, 2023 of which no amounts were utilized as of September 30, 2020. Loans will bear interest at a rate equal to (i) the London Interbank Offered Rate (“LIBOR”) plus the “applicable rate” or (ii) the “base rate” (defined as the highest of (a) the Bank of America prime rate, (b) the Federal Funds rate plus one-half of one percent and (c) LIBOR plus one percent) plus the “applicable rate.” The initial applicable rate was 1.00% per annum for base rate loans and 2.00% per annum for LIBOR rate loans, and thereafter is determined in accordance with a pricing grid based on the Company’s Consolidated Leverage Ratio (as defined in the Credit Agreement) ranging from 1.75% to 2.50% per annum for LIBOR rate loans and from 0.75% to 1.50% per annum for base rate loans. In addition, the Company pays a commitment fee on the unused portion of the Credit Agreement based on the Company’s Consolidated Leverage Ratio ranging from 0.15% to 0.30% per annum.
The Revolving Credit Facility is guaranteed by certain material domestic subsidiaries of the Company (the “Guarantors”) and is secured by liens on substantially all of the assets of the Company and the Guarantors, excluding real property and certain other types of excluded assets, and contains affirmative and negative covenants that are customary for credit agreements of this nature. The negative covenants include, among other things, limitations on asset sales, mergers, indebtedness, liens, dividends and other distributions, investments and transactions with affiliates. The Credit Agreement contains two financial covenants: (i) maximum Consolidated Leverage Ratio (as defined in the Credit Agreement) as of the last day of each fiscal quarter of 3.50 to 1.00, which ratio may be increased to 4.50 to 1.00 in case of certain qualifying acquisitions; and (ii) a minimum Consolidated Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of 1.25 to 1.00 as of the end of any fiscal quarter for the most recently completed four fiscal quarters. The Company was in compliance with all financial covenants as of September 30, 2020.
Interest expense recognized, including amortization of deferred issuance cost, was $0.2 million and $0.6 million, respectively for the three and nine months ended September 30, 2020 and $0.3 million and $1.4 million, respectively, for the three and nine months ended September 30, 2019.
Note 6. Stockholders’ Equity
Issuances of Common Stock
A summary of the status of stock option activity for the nine months ended September 30, 2020 is as follows (in thousands, except price data):
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Shares
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|
Weighted-average
exercise price
per share
|
Outstanding at December 31, 2019
|
944
|
|
|
$
|
30.63
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|
Granted
|
141
|
|
|
93.15
|
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Exercised
|
(279)
|
|
|
21.07
|
|
Forfeited
|
(12)
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|
|
43.34
|
|
Outstanding at September 30, 2020
|
794
|
|
|
$
|
44.89
|
|
A summary of the status of restricted stock unit activity for the nine months ended September 30, 2020 is as follows (in thousands, except price data):
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|
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|
|
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Shares
|
|
Weighted-average
grant date fair value
|
Non-vested December 31, 2019
|
786
|
|
|
$
|
41.88
|
|
Granted
|
227
|
|
|
97.33
|
|
Vested
|
(115)
|
|
|
25.82
|
|
Forfeited
|
(18)
|
|
|
58.11
|
|
Non-vested at September 30, 2020
|
880
|
|
|
$
|
58.03
|
|
During the nine months ended September 30, 2020, the Company issued 49,972 shares of common stock in connection with the Company’s employee stock purchase plan (the “ESPP”).
On August 28, 2020, the Board authorized an increase of additional $150.0 million to the Company’s previously announced stock repurchase program authorization. The Board also extended the repurchase authorization through August 28, 2022. During the three months ended September 30, 2020, 10,157 shares of outstanding common stock were repurchased under the Company’s share repurchase program for $1.5 million. During the nine month ended September 30, 2020, 257,329 shares of outstanding common stock were repurchased under the Company’s share repurchase program for $43.7 million. As of September 30, 2020, the Company had approximately $156.3 million available under the revised repurchase program.
Stock-Based Compensation
The expense related to the Company’s stock-based compensation plans included in the accompanying Consolidated Statements of Income was as follows (in thousands):
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|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Cost of sales
|
$
|
539
|
|
|
$
|
265
|
|
|
$
|
1,232
|
|
|
$
|
807
|
|
Research and development
|
1,032
|
|
|
573
|
|
|
2,540
|
|
|
1,682
|
|
Sales and marketing
|
1,580
|
|
|
827
|
|
|
4,218
|
|
|
2,850
|
|
General and administrative
|
2,402
|
|
|
1,459
|
|
|
6,571
|
|
|
4,745
|
|
Total stock-based compensation expense
|
$
|
5,553
|
|
|
$
|
3,124
|
|
|
$
|
14,561
|
|
|
$
|
10,084
|
|
As of September 30, 2020, total unrecognized compensation expense was $35.8 million, which is expected to be recognized over a weighted-average period of approximately 1.8 years.
The estimated fair value of each stock option was determined on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for the option grants.
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|
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|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
Risk-free interest rate
|
1.20
|
%
|
|
2.51
|
%
|
Expected option life (in years)
|
5.13
|
|
5.68
|
Volatility rate
|
40
|
%
|
|
39
|
%
|
Dividend rate
|
0
|
%
|
|
0
|
%
|
Weighted-average grant date fair value
|
$
|
35.28
|
|
|
$
|
23.67
|
|
The fair value of RSUs is determined based on the closing market price of the Company’s common stock on the grant date. The weighted-average fair value of RSUs granted during the nine months ended September 30, 2020 and 2019 was $97.33 and $59.45, respectively.
Compensation expense capitalized to inventory and compensation expense related to the Company’s ESPP were not material for the three and nine months ended September 30, 2020 or 2019.
Note 7. Industry and Geographic Information
The Company operates in one reportable segment. Sales to customers outside of the U.S. represented $140.5 million (16%) and $129.0 million (34%) of total revenue for the nine months ended September 30, 2020 and 2019, respectively. As of September 30, 2020 and December 31, 2019, net accounts receivable due from foreign customers were $18.9 million and $22.9 million, respectively.
The Company had sales to individual customers in excess of 10% of total revenues, as follows:
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|
|
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|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
Customer:
|
|
|
|
A
|
25
|
%
|
|
13
|
%
|
B
|
18
|
%
|
|
17
|
%
|
C
|
11
|
%
|
|
6
|
%
|
D
|
9
|
%
|
|
15
|
%
|
Total:
|
63
|
%
|
|
51
|
%
|
As of September 30, 2020 and December 31, 2019, net accounts receivable from customers with balances due in excess of 10% of total accounts receivable totaled $226.9 million and $53.5 million, respectively.
Consolidated total revenues by product category for the three and nine months ended September 30, 2020 and 2019 were as follows (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Rapid Immunoassay
|
$
|
337,042
|
|
|
$
|
42,534
|
|
|
$
|
513,578
|
|
|
$
|
126,800
|
|
Cardiometabolic Immunoassay
|
64,810
|
|
|
66,820
|
|
|
172,902
|
|
|
200,674
|
|
Specialized Diagnostic Solutions
|
11,213
|
|
|
12,455
|
|
|
39,452
|
|
|
40,595
|
|
Molecular Diagnostic Solutions
|
62,993
|
|
|
4,683
|
|
|
126,533
|
|
|
14,643
|
|
Total revenues
|
$
|
476,058
|
|
|
$
|
126,492
|
|
|
$
|
852,465
|
|
|
$
|
382,712
|
|
Note 8. Commitments and Contingencies
Leases
We lease administrative, research and development, sales and marketing and manufacturing facilities and certain equipment under various non-cancelable lease agreements. Facility leases generally provide for periodic rent increases, and may contain clauses for rent escalation, renewal options or early termination.
Summers Ridge Lease — The Company leases three of the four buildings that are located on the Summers Ridge Property in San Diego, California with an initial term through January 2033 with options to extend the lease for two additional five-year terms upon satisfaction of certain conditions, which have not been included in the determination of the lease term. The lease is subject to must-take provisions related to one additional building, which will have the same lease term as the three buildings originally leased. The remaining building is subject to the expiration of the lease with its current tenant for which the expiration date is not yet known.
As a result of the relocation of the Company’s headquarters to the Summers Ridge Property, the Company entered into a sublease of its former headquarters building in January 2020, with minimum rent of $2.4 million under the sublease agreement. Lease income for the nine months ended September 30, 2020 was $0.7 million.
McKellar Court Lease — In 1999, the Company completed a sale and leaseback transaction of its San Diego facility at McKellar Court to a partnership for which the Company is a 25% limited partner. The partnership is deemed to be a variable interest entity (VIE). The Company is not, however, the primary beneficiary of the VIE as it does not have the power to direct
the activities of the partnership and does not have the obligation to absorb losses or receive benefits of the partnership that could potentially be significant to the partnership. The McKellar Court lease was scheduled to expire on December 31, 2020. On July 27, 2020 the Company entered into an amendment to the lease to extend the lease term through December 31, 2030. In addition, the McKellar court lease contains options to extend the lease for two additional five-year periods, with one five-year renewal option included within the lease term determination. Total minimum lease payments under the amended lease agreement is $51.2 million.
San Diego Distribution Center Lease - During the three months ended September 30, 2020, the Company entered into a lease agreement for a facility to be used as a distribution center in San Diego, California to support the expansion of the Company’s operations and recorded a right-of-use asset of $14.8 million and a corresponding lease liability. The initial lease term is through January 31, 2031, with options to extend the lease for two additional five-year periods.
Litigation and Other Legal Proceedings
In Beckman Coulter Inc. v. Quidel Corporation, which was filed in the Superior Court for the County of San Diego, California, on November 27, 2017, Beckman Coulter (“Beckman”) alleges that a provision of an agreement between Quidel and Beckman violates state antitrust laws. Our acquisition of the B-type Naturietic Peptide assay business (“BNP Business”) consisted of assets and liabilities relating to a contractual arrangement with Beckman (the “Beckman Agreement”) for the supply of antibodies and other inputs related to, and distribution of, the Triage® BNP Test for the Beckman Coulter Access Family of Immunoassay Systems. The Beckman Agreement further provides that Beckman, for a specified period, cannot research, develop, manufacture or sell an assay for use in the diagnosis of cardiac diseases that measures or detects the presence or absence of BNP or NT-pro-BNP (a related biomarker) (the “Exclusivity Provision”). In the lawsuit, Beckman asserts that this provision violates certain state antitrust laws and is unenforceable. Beckman contends that it has suffered damages due to this provision and seeks a declaration that this provision is void.
On December 7, 2018, the trial court granted a motion by Beckman for summary adjudication, holding that the Exclusivity Provision is void under California law (the “December 7 Order”). On December 18, 2018, the trial court stayed the effect of the December 7 Order pending a decision on a writ petition Quidel intended to file with the Court of Appeal. Quidel filed its writ petition on January 18, 2019, asking the Court of Appeal to review and reverse the December 7 Order. On February 7, 2019, the trial court stayed all the remaining litigation pending the outcome of the writ petition and vacated all deadlines in the case.
On March 14, 2019, the Court of Appeal issued an order to show cause why the relief sought in Quidel’s petition should not be granted. The Court also stayed the December 7 Order pending a further order from the Court of Appeal. On August 29, 2019, the Court of Appeal issued a written decision ruling in Quidel’s favor and overturning the December 7 Order. Beckman challenged the Court of Appeal’s ruling with a petition for rehearing on September 10, 2019, which was denied on September 13, 2019.
On October 1, 2019, Beckman filed a petition for review of the Court of Appeal’s ruling with the Supreme Court of California (the “Supreme Court”). We subsequently filed an answer to Beckman’s petition, Beckman filed a response to our reply and on November 13, 2019, the Supreme Court granted review of the Court of Appeal ruling, with further action in this matter being deferred pending consideration and disposition of a related issue in Ixchel Pharma v. Biogen, or pending further order of the Supreme Court.
On August 3, 2020, the Supreme Court issued its opinion in Ixchel Pharma v. Biogen, holding, among other matters, that in evaluating whether a restraint in a business-to-business agreement violates California law, “a rule of reason applies to determine the validity of a contractual provision by which a business is restrained from engaging in a lawful trade or business with another business.” That is, the Supreme Court rejected the position that every contract in restraint of trade in the business context is per se void, but rather each must be evaluated based on a rule of reason.
On September 9, 2020, the Supreme Court transferred the matter back to the Court of Appeal with directions to vacate its decision and reconsider the case in light of the Supreme Court’s Ixchel Pharma v. Biogen ruling. Supplemental briefing was submitted by the parties to the Court of Appeal on October 14, 2020 and the matter is currently submitted before the Court of Appeal.
The stay remains in place at the trial court level and a status conference is scheduled for December 11, 2020
Quidel denies that the Exclusivity Provision is unlawful, denies any liability with respect to this matter, and intends to vigorously defend itself. There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that
may result from this matter including: (1) we are vigorously defending ourselves and believe that we have a number of meritorious legal defenses; (2) there are unresolved questions of law and fact that could be important to the ultimate resolution of this matter, some of which are subject to review by the Supreme Court; and (3) discovery is ongoing. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from this matter or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.
From time to time, the Company is involved in other litigation and proceedings, including matters related to product liability claims, commercial disputes and intellectual property claims, as well as regulatory, employment, and other claims related to our business. The Company accrues for legal claims when, and to the extent that, amounts associated with the claims become probable and are reasonably estimable. The actual costs of resolving legal claims may be substantially higher or lower than the amounts accrued for those claims. For those matters as to which we are not able to estimate a possible loss or range of loss, we are not able to determine whether the loss will have a material adverse effect on our business, financial condition or results of operations or liquidity. No accrual has been recorded as of September 30, 2020 and December 31, 2019 related to such matters as they are not probable and/or reasonably estimable.
Management believes that all such current legal actions, in the aggregate, will not have a material adverse effect on the Company. However, the resolution of, or increase in any accruals for, one or more matters may have a material adverse effect on the Company’s results of operations and cash flows.
The Company also maintains insurance, including coverage for product liability claims, in amounts that management believes are appropriate given the nature of its business.
Note 9. Fair Value Measurements
The following table presents the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of the following periods (in thousands):
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September 30, 2020
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December 31, 2019
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Level 1
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Level 2
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Level 3
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Total
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Level 1
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Level 2
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Level 3
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Total
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Assets:
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Derivative assets
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$
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—
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$
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3
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$
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—
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$
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3
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$
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—
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$
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321
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$
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—
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$
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321
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Total assets measured at fair value
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$
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—
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$
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3
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$
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—
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$
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3
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$
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—
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$
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321
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$
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—
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$
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321
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Liabilities:
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Derivative liabilities
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$
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—
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$
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1,799
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$
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—
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$
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1,799
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$
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—
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$
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433
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$
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—
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$
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433
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Contingent consideration
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—
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—
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11,340
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11,340
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—
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—
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16,535
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16,535
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Deferred consideration
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—
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114,408
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—
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114,408
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—
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151,382
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—
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151,382
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Total liabilities measured at fair value
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$
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—
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$
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116,207
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$
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11,340
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$
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127,547
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$
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—
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$
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151,815
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$
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16,535
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$
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168,350
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There were no transfers of assets or liabilities between Level 1, Level 2 and Level 3 categories of the fair value hierarchy during the three and nine-month periods ended September 30, 2020 and the year ended December 31, 2019.
Derivative financial instruments are measured based on observable inputs that are corroborated by market data. Observable inputs include broker quotes and daily market foreign currency rates, forward pricing curves.
In connection with the acquisition of the BNP Business, the Company pays annual installments of $42.0 million each in deferred consideration through April 2023 and up to $8.0 million each in contingent consideration through April 2022. The fair value of the deferred consideration is calculated based on the net present value of cash payments using an estimated borrowing rate based on a quoted price for a similar liability. The Company recorded $1.4 million and $5.0 million, respectively, for the accretion of interest on the deferred consideration during the three and nine months ended September 30, 2020. The fair value of contingent consideration is calculated using a discounted probability weighted valuation model. Significant assumptions used in the measurement include revenue projections and discount rates that are not observed in the market and thus represent Level 3 measurements. The discount rate of 3.5% used as of September 30, 2020 was based on estimated borrowing rate for a similar liability.
Changes in estimated fair value of contingent consideration liabilities from December 31, 2019 through September 30, 2020 were as follows (in thousands):
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Contingent consideration liabilities
(Level 3 measurement)
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Balance at December 31, 2019
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$
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16,535
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Cash payments
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(6,043)
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Change in estimated fair value, recorded in general and administrative expenses
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848
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Balance at September 30, 2020
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$
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11,340
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Note 10. Foreign Currency Hedges
In the normal course of business, the Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates. As part of its strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses designated cash flow hedges in the form of foreign currency forward contracts to mitigate the impact of foreign currency translation on transactions that are denominated primarily in the Euro and the Chinese Yuan. The Company also uses non-designated forward contracts to hedge non-functional currency denominated balance sheet assets. All hedging relationships for all designated derivative hedges and the underlying hedged items, as well as the risk management objectives and strategies for undertaking the hedge transactions, are formally documented. The duration of these forward contracts is generally less than one year. The Company does not use any derivative financial instruments for trading or other speculative purposes.
Such forward foreign currency contracts are carried at fair value in prepaid expenses and other current assets or other current liabilities depending on the unrealized gain or loss position of the hedged contract as of the balance sheet date. Changes in the value of the designated derivatives are recorded to other comprehensive income (loss) until the underlying hedged item is recognized in earnings, or the derivative no longer qualifies as a highly effective hedge. Changes in the value of non-designated derivatives are recorded to other expense, net on the Consolidated Statements of Income. The cash flows from derivatives treated as hedges are classified in the Consolidated Statements of Cash Flows in the same category as the item being hedged.
The notional principal amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and do not represent the amount of our exposure to credit or market loss. Credit risk represents our gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency exchange rates at each respective date. We generally enter into master netting arrangements, which reduces credit risk by permitting net settlement of transactions with the same counterparty. We present our derivative assets and derivative liabilities at their net fair values. We did not have any derivative instruments with credit-risk related contingent features that would require us to post collateral.
The following table summarizes the fair value and notional amounts of designated and non-designated foreign currency forward contracts as of September 30, 2020 and December 31, 2019 (in thousands):
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September 30, 2020
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December 31, 2019
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Notional Amount
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Fair Value, Net
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Notional Amount
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Fair Value, Net
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Designated cash flow hedges:
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Prepaid expenses and other current assets
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$
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—
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$
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—
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$
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27,944
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$
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321
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Other current liabilities
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$
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43,325
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$
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1,657
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$
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6,219
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$
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433
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Non-designated forward contracts:
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Prepaid expenses and other current assets
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$
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6,903
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$
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3
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$
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—
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$
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—
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Other current liabilities
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$
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5,939
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$
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142
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$
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—
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$
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—
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