Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited Consolidated Financial Statements of QuidelOrtho Corporation and its subsidiaries (the “Company” or “QuidelOrtho”) have been prepared in accordance with generally accepted accounting principles in the U.S. (“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 April 2, 2023, and for the three months ended April 2, 2023 and April 3, 2022, is unaudited. For further information, refer to the Company’s Consolidated Financial Statements and notes thereto for the fiscal year ended January 1, 2023 included in QuidelOrtho’s 2022 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.
The Company follows the concept of a fiscal year that ends on the Sunday nearest to the end of the month of December, and fiscal quarters that end on the Sunday nearest to the end of the months of March, June and September. For 2023 and 2022, the Company’s fiscal year will end or has ended on December 31, 2023 and January 1, 2023, respectively. For 2023 and 2022, the Company’s first quarter ended on April 2, 2023 and April 3, 2022, respectively. The three months ended April 2, 2023 and April 3, 2022 each included 13 weeks.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the related 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.
Reclassifications
Certain prior period amounts were reclassified to conform to the current period presentation, including the separate presentation of Amortization of intangible assets and Interest expense, net, and the combination of Selling, marketing and administrative expense. Cost of sales, excluding amortization of intangibles for the three months ended April 3, 2022 excludes $2.0 million of intangibles amortization expense, formerly included in Cost of sales, which has been reclassified to Amortization of intangible assets. Selling, marketing and administrative expense for the three months ended April 3, 2022 excludes $5.1 million of intangibles amortization expense, formerly included in Sales and marketing expense, which has been reclassified to Amortization of intangible assets. The reclassifications did not have an impact on net assets, Operating income, Net income, Basic or Diluted earnings per share, or cash flows.
Recent Accounting Pronouncements
There have been no accounting pronouncements issued or adopted during the three months ended April 2, 2023 that are expected to have a material impact on the Company’s financial statements.
Note 2. Business Combination
On May 27, 2022, pursuant to a Business Combination Agreement entered into as of December 22, 2021 (the “BCA”), by and among Quidel Corporation (“Quidel”), Ortho Clinical Diagnostics Holdings plc (“Ortho”), QuidelOrtho (formerly Coronado Topco, Inc.), Orca Holdco, Inc., Laguna Merger Sub, Inc. and Orca Holdco 2, Inc., Quidel and Ortho consummated a business combination (the “Combinations”) and each of Quidel and Ortho became a wholly owned subsidiary of QuidelOrtho. As a result of the Combinations, QuidelOrtho became the successor issuer to Quidel. The Combinations have been accounted for as a business combination using the acquisition method of accounting in conformity with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, with Quidel considered the accounting and the legal acquirer. The Combinations enhance the Company’s revenue profile and expand the Company’s geographic footprint and product diversity.
The Combinations were completed for a total consideration of approximately $4.3 billion, which included the fair value of equity issued based on the May 26, 2022 closing price of $99.60 per share of Quidel common stock. Former Ortho shareholders received $7.14 in cash and 0.1055 shares of QuidelOrtho common stock for each Ortho ordinary share. The Company funded
the cash portion of the purchase price with cash on its balance sheet and a portion of the Term Loan proceeds from the Financing (each as defined in Note 8).
The purchase price allocation is preliminary and subject to change for income tax matters. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the closing date of the Combinations. Measurement period adjustments decreased goodwill by $2.8 million in the three months ended April 2, 2023 due to a purchase price allocation increase of $3.0 million to income taxes payable and a decrease of $0.2 million to deferred tax liabilities.
Note 3. Computation of Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average number of shares of common stock outstanding. Diluted EPS is computed based on the sum of the weighted-average number of shares of common stock and potentially dilutive shares of common stock outstanding during the period. Potentially dilutive shares of common stock consist of shares issuable from stock options, unvested RSUs and restricted stock. Potentially dilutive shares of common stock from outstanding stock options and unvested RSUs are determined using the average share price for each period under the treasury stock method.
The following table presents the calculation of the weighted-average shares used in computing basic and diluted EPS:
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| | | Three Months Ended |
(In millions) | | | | | April 2, 2023 | | April 3, 2022 |
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Basic weighted-average shares of common stock outstanding | | | | | 66.6 | | | 41.9 | |
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Dilutive potential shares issuable from stock options and unvested RSUs | | | | | 0.5 | | | 0.5 | |
Diluted weighted-average shares of common stock outstanding | | | | | 67.1 | | | 42.4 | |
Potentially dilutive shares excluded from calculation due to anti-dilutive effect | | | | | 1.5 | | | 0.4 | |
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 4. Revenue
Contract Balances
Timing of revenue recognition may differ from timing of invoicing to customers. The Company records an asset when revenue is recognized prior to invoicing a customer (a “contract asset”). Contract assets are included within Prepaid expenses and other current assets in the Company’s unaudited Consolidated Balance Sheets and are transferred to accounts receivable when the right to payment becomes unconditional. The balance of contract assets recorded in the Company’s unaudited Consolidated Balance Sheets as of April 2, 2023 and January 1, 2023 was $53.4 million and $49.6 million, respectively.
The contract asset balance consisted of the following components, all of which related to agreements acquired by the Company in connection with the Combinations:
•a customer supply agreement under which the difference between the timing of invoicing and revenue recognition resulted in a contract asset of $4.3 million and $6.8 million, respectively, as of April 2, 2023 and January 1, 2023;
•contractual arrangements with certain customers under which the Company invoices the customers based on reportable results generated by its reagents; however, control of the goods transfers to the customers upon shipment or delivery of the products, as determined under the terms of the contract. Using the expected value method, the Company estimates the number of reagents that will generate a reportable result. The Company records the revenue upon shipment and an associated contract asset, and relieves the contract asset upon completion of the invoicing. The balance of the contract asset related to these arrangements was $40.8 million and $38.5 million, respectively, as of April 2, 2023 and January 1, 2023; and
•one of the Company’s contract manufacturing agreements that recognizes revenue as the products are manufactured resulted in a contract asset of $8.3 million and $4.3 million, respectively, as of April 2, 2023 and January 1, 2023.
The Company reviews contract assets for expected credit losses resulting from the collectability of customer accounts. Expected losses are established based on historical losses, customer mix and credit policies, current economic conditions in customers’ country or industry, and expectations associated with reasonable and supportable forecasts. No credit losses related to contract assets were recognized during the three months ended April 2, 2023.
The Company recognizes a contract liability when a customer pays an invoice prior to the Company transferring control of the goods or services (“contract liabilities”). The Company’s contract liabilities consist of deferred revenue primarily related to customer service contracts. The Company classifies deferred revenue as current or non-current based on the timing of the transfer of control or performance of the service. The balance of the Company’s current deferred revenue was $61.9 million as of April 2, 2023 and $76.4 million as of January 1, 2023. The Company has one arrangement with a customer where the revenue is expected to be recognized beyond one year. The balance of the deferred revenue included in long-term liabilities was $12.7 million and $9.4 million as of April 2, 2023 and January 1, 2023, respectively, and was included in Other liabilities in the Consolidated Balance Sheets. The amount of deferred revenue as of January 1, 2023 that was recorded in Total revenues during the three months ended April 2, 2023 was $50.8 million.
Joint Business with Grifols
In connection with the Combinations, the Company acquired the ongoing collaboration arrangement (the “Joint Business”) between Ortho and Grifols Diagnostic Solutions, Inc. (“Grifols”), under which Ortho and Grifols agreed to pursue a collaboration relating to Ortho’s Hepatitis and HIV diagnostics business. The governance of the Joint Business is shared through a supervisory board made up of equal representation by Ortho and Grifols, which is responsible for all significant decisions relating to the Joint Business that are not exclusively assigned to either Ortho or Grifols, as defined in the Joint Business agreement. The Company’s portion of the pre-tax net profit shared under the Joint Business was $23.6 million during the three months ended April 2, 2023. This included the Company’s portion of the pre-tax net profit of $1.2 million during the three months ended April 2, 2023 on sales transactions with third parties where the Company is the principal. The Company recognized revenues, cost of sales, excluding amortization of intangibles, and operating expenses, on a gross basis on these sales transactions in their respective lines in the unaudited Consolidated Statements of Income. The Company’s portion of the pre-tax net profit also included revenue of $22.4 million from collaboration and royalty agreements during the three months ended April 2, 2023, which is presented on a net basis within Total revenues.
Disaggregation of Revenue
The following table summarizes Total revenues by business unit:
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| Three Months Ended | | |
(In millions) | April 2, 2023 | | April 3, 2022 | | | | |
Labs | $ | 370.7 | | | $ | 13.3 | | | | | |
Transfusion Medicine | 155.9 | | | — | | | | | |
Point of Care | 308.1 | | | 943.0 | | | | | |
Molecular Diagnostics | 11.4 | | | 46.0 | | | | | |
Total revenues | $ | 846.1 | | | $ | 1,002.3 | | | | | |
Concentration of Revenue and Credit Risk
The Company had sales to individual customers in excess of 10% of Total revenues as follows:
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| Three Months Ended |
| April 2, 2023 | | April 3, 2022 |
Customer: | | | |
A | 11 | % | | — | % |
B | 6 | % | | 38 | % |
C | 6 | % | | 14 | % |
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| 23 | % | | 52 | % |
As of April 2, 2023, no customers had a balance due in excess of 10% of Accounts receivable, net. As of January 1, 2023, customers with balances due in excess of 10% of Accounts receivable, net totaled $161.9 million. For the three months ended April 2, 2023 and April 3, 2022, sales of COVID-19 products accounted for 26% and 83% of Total revenues, respectively.
Note 5. Segment and Geographic Information
Total revenues by reportable segment are as follows:
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| | | Three Months Ended |
(In millions) | | | | | April 2, 2023 | | April 3, 2022 |
North America | | | | | $ | 582.8 | | | $ | 961.5 | |
EMEA | | | | | 81.3 | | | 15.2 | |
China | | | | | 70.6 | | | 8.7 | |
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Other | | | | | 111.4 | | | 16.9 | |
Total revenues | | | | | $ | 846.1 | | | $ | 1,002.3 | |
The following table sets forth Adjusted EBITDA by segment and the reconciliations to Income before provision for income taxes for the three months ended April 2, 2023 and April 3, 2022:
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| | | Three Months Ended |
(In millions) | | | | | April 2, 2023 | | April 3, 2022 |
North America | | | | | $ | 278.4 | | | $ | 713.4 | |
EMEA | | | | | 7.2 | | | 3.5 | |
China | | | | | 28.5 | | | 3.8 | |
Other | | | | | 21.8 | | | 9.5 | |
Total segment Adjusted EBITDA | | | | | 335.9 | | | 730.2 | |
Corporate (1) | | | | | (90.6) | | | (89.3) | |
Depreciation and amortization | | | | | (114.2) | | | (15.3) | |
Acquisition and integration costs | | | | | (29.7) | | | (3.0) | |
Interest expense, net | | | | | (36.7) | | | (1.0) | |
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Amortization of deferred cloud computing implementation costs | | | | | (1.6) | | | (1.0) | |
Employee compensation charges and other costs | | | | | (1.5) | | | — | |
Impairment of long-lived assets | | | | | (0.5) | | | — | |
EU medical device regulation transition costs (2) | | | | | (0.8) | | | — | |
Tax indemnification expense | | | | | (0.3) | | | — | |
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Income before provision for income taxes | | | | | $ | 60.0 | | | $ | 620.6 | |
(1) Primarily consists of costs related to executive and staff functions, including certain finance, human resources, manufacturing and information technology (“IT”) functions, which benefit the Company as a whole. These costs are primarily related to the general management of these functions on a corporate level and the design and development of programs, policies and procedures that are then implemented in the individual segments, with each segment bearing its own cost of implementation. The Company’s corporate function also includes debt and stock-based compensation associated with all employee stock-based awards.
(2) Represents incremental consulting costs and research and development (“R&D”) manufacturing site costs to align compliance of Ortho’s existing, on-market products that were previously registered under the European In Vitro Diagnostics Directive regulatory framework with the requirements under the EU’s In Vitro Diagnostic Regulation, which generally apply from May 2022 onwards.
The chief operating decision maker does not review capital expenditures, total depreciation and amortization or assets by segment, and therefore this information has been excluded as it does not comprise part of management’s key performance metrics.
Note 6. Income Taxes
The Company calculates its interim income tax provision in accordance with ASC 270, Interim Reporting, and ASC 740, Accounting for Income Taxes. 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.
For the three months ended April 2, 2023 and April 3, 2022, the Company recognized a Provision for income taxes of $11.2 million and $140.7 million, respectively, in relation to Income before provision for income taxes of $60.0 million and $620.6 million, respectively, resulting in effective tax rates of 18.7% and 22.7%, respectively. For the three months ended April 2, 2023, the effective tax rate was impacted by income tax benefits related to non-U.S. earnings being taxed at rates that are different than the U.S. statutory rate, R&D credits, foreign tax credits, and foreign exchange losses, partially offset by income taxes owed in U.S. states and Global Intangible Low-Tax Income. For the three months ended April 3, 2022, the effective tax rate was impacted primarily by income taxes owed in U.S. states.
The balance of unrecognized tax benefits at April 2, 2023, not including interest and penalties, was $39.9 million, of which $28.2 million could affect the effective income tax rate in future periods, if recognized. The Company also recognizes interest and penalties related to unrecognized tax benefits in tax expense. At April 2, 2023, the Company had approximately $8.2 million of interest and penalties accrued related to unrecognized tax benefits. The Company estimates that within the next 12 months, its uncertain tax positions, excluding interest, will decrease by $2.0 million.
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 2012 and onwards are subject to examination by the U.S. authorities. The Company’s state and foreign tax years for 2001 and onwards 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.
Indemnification Assets
On January 16, 2014, Ortho entered into a stock and asset purchase agreement of (i) certain assets and liabilities and (ii) all of the equity interests and substantially all of the assets and liabilities of certain entities, which, together with their subsidiaries, comprised the Ortho business from Johnson & Johnson. The agreement generally provided that Johnson & Johnson retained all income tax liabilities accrued as of the date of the acquisition, including reserves for unrecognized tax benefits. The indemnification receivable from Johnson & Johnson totaled $16.2 million and $16.8 million as of April 2, 2023 and January 1, 2023, respectively, and is included as a component of Prepaid expenses and other current assets and Other assets on the Consolidated Balance Sheet. The Company recorded $0.3 million of interest and penalties during the three months ended April 2, 2023.
Note 7. Balance Sheet Account Details
Cash, Cash Equivalents and Restricted Cash
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(In millions) | April 2, 2023 | | January 1, 2023 |
Cash and cash equivalents | $ | 353.9 | | | $ | 292.9 | |
Restricted cash included in Other assets | 1.0 | | | 1.0 | |
Cash, cash equivalents and restricted cash | $ | 354.9 | | | $ | 293.9 | |
Marketable Securities
The following table is a summary of marketable securities:
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| April 2, 2023 | | January 1, 2023 |
(In millions) | Amortized Cost | | | | Gross Unrealized Losses | | Fair Value | | Amortized Cost | | | | Gross Unrealized Losses | | Fair Value |
Corporate bonds | $ | 33.4 | | | | | $ | (0.2) | | | $ | 33.2 | | | $ | 40.5 | | | | | $ | (0.5) | | | $ | 40.0 | |
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Corporate asset-backed securities | 6.1 | | | | | — | | | 6.1 | | | 6.7 | | | | | — | | | 6.7 | |
U.S. government securities | — | | | | | — | | | — | | | 2.0 | | | | | — | | | 2.0 | |
Agency bonds | 1.0 | | | | | — | | | 1.0 | | | 1.0 | | | | | — | | | 1.0 | |
Sovereign government bonds | 2.0 | | | | | — | | | 2.0 | | | 1.9 | | | | | — | | | 1.9 | |
Foreign and other | 0.5 | | | | | — | | | 0.5 | | | 0.5 | | | | | — | | | 0.5 | |
Total marketable securities, current | 43.0 | | | | | (0.2) | | | 42.8 | | | 52.6 | | | | | (0.5) | | | 52.1 | |
Corporate bonds, non-current | 23.6 | | | | | — | | | 23.6 | | | 13.3 | | | | | (0.1) | | | 13.2 | |
Corporate asset-backed securities, non-current | 8.8 | | | | | (0.1) | | | 8.7 | | | 7.9 | | | | | (0.1) | | | 7.8 | |
Agency bonds | 1.6 | | | | | (0.1) | | | 1.5 | | | — | | | | | — | | | — | |
Total marketable securities | $ | 77.0 | | | | | $ | (0.4) | | | $ | 76.6 | | | $ | 73.8 | | | | | $ | (0.7) | | | $ | 73.1 | |
Accounts Receivable, Net
Accounts receivables primarily consist of trade accounts receivables with maturities of one year or less and are presented net of reserves:
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(In millions) | April 2, 2023 | | January 1, 2023 |
Accounts receivable | $ | 356.2 | | | $ | 543.0 | |
Allowance for contract rebates and discounts | (67.8) | | | (77.1) | |
Allowance for doubtful accounts | (13.6) | | | (12.0) | |
Total accounts receivable, net | $ | 274.8 | | | $ | 453.9 | |
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value. Inventories consisted of the following:
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(In millions) | April 2, 2023 | | January 1, 2023 |
Raw materials | $ | 198.6 | | | $ | 185.2 | |
Work-in-process (materials, labor and overhead) | 95.1 | | | 82.7 | |
Finished goods (materials, labor and overhead) | 274.3 | | | 295.1 | |
Total inventories (1) | $ | 568.0 | | | $ | 563.0 | |
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Inventories | $ | 528.6 | | | $ | 524.1 | |
Other assets (2) | 39.4 | | | 38.9 | |
Total inventories | $ | 568.0 | | | $ | 563.0 | |
(1) Includes adjustment of approximately $39 million in the three months ended April 2, 2023 due to changes in estimates to decrease inventory obsolescence reserves from the prior period.
(2) Other assets includes inventory expected to remain on hand beyond one year.
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following:
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(In millions) | April 2, 2023 | | January 1, 2023 |
Prepaid expenses | $ | 101.0 | | | $ | 96.7 | |
Contract assets | 53.4 | | | 49.6 | |
Other receivables (1) | 78.1 | | | 44.3 | |
Income taxes and other tax receivables | 48.4 | | | 38.6 | |
Derivatives | 17.1 | | | 22.0 | |
Other | 0.8 | | | 0.9 | |
Total prepaid expenses and other current assets | $ | 298.8 | | | $ | 252.1 | |
(1) Includes a settlement award of approximately $41 million from a third party related to one of the Company’s collaboration agreements, of which approximately $20 million is due to the Company’s collaboration partner and is included within Accounts payable as of April 2, 2023.
Goodwill
Changes in goodwill were as follows:
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(In millions) | North America | | EMEA | | China | | Other | | Total |
Balance at January 1, 2023 | $ | 1,547.7 | | | $ | 358.6 | | | $ | 118.1 | | | $ | 452.4 | | | $ | 2,476.8 | |
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Purchase accounting adjustments | (1.6) | | | (0.4) | | | (0.2) | | | (0.6) | | | (2.8) | |
Foreign currency translation | — | | | 5.7 | | | 0.5 | | | 11.1 | | | 17.3 | |
Balance at April 2, 2023 | $ | 1,546.1 | | | $ | 363.9 | | | $ | 118.4 | | | $ | 462.9 | | | $ | 2,491.3 | |
Other Current Liabilities
Other current liabilities consist of the following:
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(In millions) | April 2, 2023 | | January 1, 2023 |
Deferred revenue | $ | 61.9 | | | $ | 76.4 | |
Accrued commissions and rebates | 57.6 | | | 55.1 | |
Deferred consideration | 39.8 | | | 39.3 | |
Operating lease liabilities | 26.1 | | | 24.4 | |
Derivatives | 17.9 | | | 19.7 | |
Accrued other taxes payable | 16.5 | | | 9.3 | |
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Other | 114.2 | | | 101.2 | |
Total other current liabilities | $ | 334.0 | | | $ | 325.4 | |
Note 8. Long-term Borrowings
The components of borrowings were as follows:
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(In millions) | April 2, 2023 | | January 1, 2023 |
Term Loan | $ | 2,595.3 | | | $ | 2,646.9 | |
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Financing lease obligation | 0.7 | | | 0.8 | |
Other long-term borrowings | 1.0 | | | 1.2 | |
Unamortized deferred financing costs | (9.9) | | | (10.6) | |
Total borrowings | 2,587.1 | | | 2,638.3 | |
Less: current portion | (207.5) | | | (207.5) | |
Long-term borrowings | $ | 2,379.6 | | | $ | 2,430.8 | |
The credit agreement, dated May 27, 2022, by and among the Company, as borrower, Bank of America, N.A., as administrative agent and swing line lender, and the other lenders and L/C issuers party thereto (the “Credit Agreement”) consists of a $2,750.0 million senior secured term loan facility (the “Term Loan”) and an $800.0 million revolving credit facility (the “Revolving Credit Facility” and with the Term Loan, the “Financing”). As of April 2, 2023, letters of credit issued under the Revolving Credit Facility totaled $13.0 million, which reduced the available amount under the Revolving Credit Facility to $787.0 million.
The Credit Agreement 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, investments and transactions with affiliates. The Credit Agreement contains two financial covenants: (i) a maximum Consolidated Leverage Ratio (as defined in the Credit Agreement) as of the last day of each fiscal quarter of (a) 4.50 to 1.00 for the first four fiscal quarters ending after the closing date of the Credit Agreement (the “Initial Measurement Period”), (b) 4.00 to 1.00 for the first four fiscal quarters ending after the Initial Measurement Period and (c) 3.50 to 1.00 for each fiscal quarter thereafter; and (ii) a minimum Consolidated Interest Coverage Ratio (as defined in the Credit Agreement) of 3.00 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 the financial covenants as of April 2, 2023.
The following table provides the detailed amounts within Interest expense, net for the three months ended April 2, 2023 and April 3, 2022.
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| | | Three Months Ended |
(In millions) | | | | | April 2, 2023 | | April 3, 2022 |
Term Loan | | | | | $ | 40.9 | | | $ | — | |
Revolving Credit Facility | | | | | 0.5 | | | 0.1 | |
Amortization of deferred financing costs | | | | | 0.8 | | | 0.1 | |
Derivative instruments and other | | | | | (4.5) | | | 1.1 | |
Interest income | | | | | (1.0) | | | (0.3) | |
Interest expense, net | | | | | $ | 36.7 | | | $ | 1.0 | |
Note 9. Stock-based Compensation
Stock-based compensation expense was as follows:
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| | | Three Months Ended |
(In millions) | | | | | April 2, 2023 | | April 3, 2022 |
Cost of sales | | | | | $ | 1.0 | | | $ | 0.6 | |
Research and development | | | | | 1.3 | | | 1.1 | |
Selling, marketing and administrative | | | | | 7.2 | | | 5.3 | |
Acquisition and integration costs | | | | | 4.5 | | | 0.4 | |
Total stock-based compensation expense | | | | | $ | 14.0 | | | $ | 7.4 | |
The table above includes $3.0 million of compensation expense related to liability-classified awards for the three months ended April 2, 2023, which has been or is expected to be settled in cash. These awards represent the $7.14 per share cash settled portion of the replacement awards issued in connection with the Combinations.
The Company granted 83 thousand stock options during the three months ended April 2, 2023. As of April 2, 2023, total unrecognized compensation expense related to stock options was approximately $22.6 million and the related weighted-average period over which it is expected to be recognized is approximately 1.9 years. The maximum contractual term of the Company’s stock options is ten 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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| | | Three Months Ended |
| | | April 2, 2023 | | April 3, 2022 |
Risk-free interest rate | | | 3.63 | % | | 1.63 | % |
Expected option life (in years) | | | 5.51 | | 4.91 |
Volatility rate | | | 57 | % | | 58 | % |
Dividend rate | | | 0 | % | | 0 | % |
Weighted-average grant date fair value | | | $47.83 | | $51.79 |
During the three months ended April 2, 2023, the Compensation Committee of the Company’s Board of Directors approved a modification to the vesting terms of certain stock options that were previously granted by Ortho to certain Ortho employees, such that the stock options will vest on December 31, 2023. The modification resulted in an additional $2.0 million of stock-based compensation expense recognized during the three months ended April 2, 2023. The total unrecognized expense relating to unvested shares for these stock options as of April 2, 2023 was $9.2 million and will be recognized through December 31, 2023.
The Company granted 177 thousand RSUs during the three months ended April 2, 2023. 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 three months ended April 2, 2023 and April 3, 2022 was $86.70 and $103.60, respectively. The total amount of unrecognized compensation expense related to non-vested RSUs as of April 2, 2023 was approximately $66.0 million, which is expected to be recognized over a weighted-average period of approximately 2.3 years.
Note 10. Commitments and Contingencies
From time to time, the Company is involved in litigation and other legal proceedings, including matters related to product liability claims, commercial disputes and intellectual property claims, as well as regulatory, employment, and other claims related to its business. The Company accrues for legal claims when, and to the extent that, amounts associated with the claims become probable and are reasonably estimable. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from these matters are inherently difficult to predict. 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 the Company is not able to estimate a possible loss or range of loss, the Company is not able to determine whether the loss will have a material adverse effect on its business, financial condition, results of operations or liquidity.
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.
Note 11. 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:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| April 2, 2023 | | January 1, 2023 |
(In millions) | Level 1 | | Level 2 | | Level 3 | | Total | | Level 1 | | Level 2 | | Level 3 | | Total |
Assets: | | | | | | | | | | | | | | | |
Cash equivalents | $ | 0.3 | | | $ | — | | | $ | — | | | $ | 0.3 | | | $ | 0.6 | | | $ | 2.1 | | | $ | — | | | $ | 2.7 | |
Marketable securities | — | | | 76.6 | | | — | | | 76.6 | | | 2.0 | | | 71.1 | | | — | | | 73.1 | |
Derivative assets | — | | | 17.1 | | | — | | | 17.1 | | | — | | | 22.0 | | | — | | | 22.0 | |
Total assets measured at fair value | $ | 0.3 | | | $ | 93.7 | | | $ | — | | | $ | 94.0 | | | $ | 2.6 | | | $ | 95.2 | | | $ | — | | | $ | 97.8 | |
Liabilities: | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Derivative liabilities | $ | — | | | $ | 43.0 | | | $ | — | | | $ | 43.0 | | | $ | — | | | $ | 21.8 | | | $ | — | | | $ | 21.8 | |
| | | | | | | | | | | | | | | |
Contingent consideration | — | | | — | | | 0.1 | | | 0.1 | | | — | | | — | | | 0.1 | | | 0.1 | |
Deferred consideration | — | | | 39.8 | | | — | | | 39.8 | | | — | | | 39.3 | | | — | | | 39.3 | |
Total liabilities measured at fair value | $ | — | | | $ | 82.8 | | | $ | 0.1 | | | $ | 82.9 | | | $ | — | | | $ | 61.1 | | | $ | 0.1 | | | $ | 61.2 | |
There were no transfers of assets or liabilities into or out of Level 3 of the fair value hierarchy during the three months ended April 2, 2023 and fiscal year 2022.
Cash equivalents consist of funds held in money market accounts that are valued using quoted prices in active markets for identical instruments and highly liquid corporate debt securities with maturities within three months from purchase. Marketable securities consist of investment-grade corporate and government debt securities, corporate asset-backed securities and commercial paper. Derivative financial instruments are based on observable inputs that are corroborated by market data. Observable inputs include broker quotes, daily market foreign currency rates and forward pricing curves.
In connection with the acquisition of the B-type Natriuretic Peptide (“BNP”) assay business run on Beckman Coulter analyzers (“BNP Business”) from Alere Inc., the Company paid its last annual installment of $40.0 million subsequent to April 2, 2023. The fair value of the payment was treated as deferred consideration and was calculated based on the net present value of the cash payment using an estimated borrowing rate based on a quoted price for a similar liability.
Financial Instruments Not Measured at Fair Value
The estimated fair value of the Company’s borrowings under the Term Loan was $2,562.9 million at April 2, 2023, compared to the carrying amount, excluding debt issuance costs, of $2,595.3 million. The estimate of fair value is generally based on the quoted market prices for similar issuances of long-term debt with the same maturities, which is classified as a Level 2 input.
Note 12. Derivative Instruments and Hedging Activities
The Company selectively uses derivative and non-derivative instruments to manage market risk associated with changes in interest rates and foreign currency exchange rates. The use of derivatives is intended for hedging purposes only, and the Company does not enter into derivative transactions for speculative purposes.
Credit risk represents the Company’s 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. The Company generally enters into master netting arrangements that reduce credit risk by permitting net settlement of transactions with the same counterparty. The Company does not have any derivative instruments with credit-risk related contingent features that would require it to post collateral.
Interest Rate Hedging Instruments
The Company’s interest rate risk relates primarily to interest rate exposures on variable rate debt, including the Revolving Credit Facility and Term Loan. See Note 8 for additional information on the currently outstanding components of the Revolving Credit Facility and Term Loan. The Company entered into interest rate swap agreements to hedge the related risk of the variability to the Company’s cash flows due to the rates specified for these credit facilities.
The Company designates its interest rate swaps as cash flow hedges. The Company records gains and losses due to changes in fair value of the derivatives within Other comprehensive income (loss) (“OCI”) and reclassifies these amounts to Interest expense, net in the same period or periods for which the underlying hedged transaction affects earnings. In the event the
Company determines the hedged transaction is no longer probable to occur or concludes the hedge relationship is no longer effective, the hedge is prospectively de-designated. Pre-tax unrealized gains of $20.0 million are expected to be reclassified from OCI to earnings in the next 12 months.
The following table summarizes the Company’s interest rate derivative agreements as of April 2, 2023, all of which were interest rate swaps:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Notional Amount (In millions) (1) | | Description | | Hedge Designation | | Effective Date | | Expiration Date |
$ | 500.0 | | | Pay 1.58% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | May 29, 2022 | | December 31, 2023 |
$ | 397.2 | | | Pay 3.765% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | December 30, 2022 | | May 27, 2027 |
$ | 144.4 | | | Pay 3.7725% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | December 30, 2022 | | May 27, 2027 |
$ | 216.7 | | | Pay 3.7675% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | December 30, 2022 | | May 27, 2027 |
$ | 288.9 | | | Pay 3.7575% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | December 30, 2022 | | May 27, 2027 |
$ | 252.8 | | | Pay 3.7725% fixed, receive floating rate (1-month USD-SOFR) | | Designated cash flow hedge | | December 30, 2022 | | May 27, 2027 |
(1) The notional value of interest rate swap contracts with an effective date of December 30, 2022, is expected to increase to $1.8 billion on December 29, 2023.
Currency Hedging Instruments
The Company has currency risk exposures relating primarily to foreign currency denominated monetary assets and liabilities and forecasted foreign currency denominated intercompany and third-party transactions. The Company uses foreign currency forward contracts and may use option contracts and cross currency swaps to manage its currency risk exposures. The Company’s foreign currency forward contracts are denominated primarily in Australian Dollar, Brazilian Real, British Pound, Canadian Dollar, Chilean Peso, Chinese Yuan/Renminbi, Euro, Indian Rupee, Japanese Yen, Mexican Peso, Swiss Franc and the Thai Baht.
The Company designates certain foreign currency forward contracts as cash flow hedges. The Company records gains and losses due to changes in fair value of the derivatives within OCI and reclassifies these amounts to Total revenues and Cost of sales, excluding amortization of intangibles in the same period or periods for which the underlying hedged transaction affects earnings. In the event the Company determines the hedged transaction is no longer probable to occur or concludes the hedge relationship is no longer effective, the hedge is prospectively de-designated. The pre-tax unrealized loss of $10.5 million within OCI as of April 2, 2023 is expected to be reclassified to earnings in the next 12 months.
The Company also enters into foreign currency forward contracts that are not part of designated hedging relationships and which are intended to mitigate exchange rate risk of monetary assets and liabilities and related forecasted transactions. The Company records these non-designated derivatives at mark-to-market with gains and losses recognized in earnings within Other expense (income), net.
The following table provides details of the currency hedging instruments outstanding as of April 2, 2023:
| | | | | | | | | | | | | | |
Description | | Notional Amount (In millions) | | Hedge Designation |
Foreign currency forward contracts | | $ | 333.9 | | | Cash Flow Hedge |
Foreign currency forward contracts | | $ | 636.8 | | | Non-designated |
The following table summarizes pre-tax gains and losses from designated derivative and non-derivative instruments within accumulated other comprehensive (loss) income (“AOCI”) for the three months ended April 2, 2023:
| | | | | | | | | | | | | | | | | |
| Designated Hedging Instruments |
(In millions) | Amount of Loss (Gain) Recognized in OCI on Hedges | | Location of Amounts Reclassified From AOCI Into Income | | Amount of Loss (Gain) Reclassified From AOCI Into Income |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Foreign currency forward contracts (sales) | $ | 2.1 | | | Total revenues | | $ | (0.9) | |
Foreign currency forward contracts (purchases) | $ | — | | | Cost of sales, excluding amortization of intangibles | | $ | 0.4 | |
Interest rate derivatives | $ | 20.9 | | | Interest expense, net | | $ | (5.2) | |
Gains and losses from designated derivative and non-derivative instruments within AOCI for the three months ended April 3, 2022 were not material.
The following table summarizes the fair value of designated and non-designated hedging instruments recognized within the unaudited Consolidated Balance Sheets as of April 2, 2023 and January 1, 2023:
| | | | | | | | | | | |
(In millions) | April 2, 2023 | | January 1, 2023 |
Designated cash flow hedges | | | |
Interest rate derivatives: | | | |
Prepaid expenses and other current assets | $ | 11.8 | | | $ | 15.9 | |
| | | |
Other liabilities | $ | 25.1 | | | $ | 2.1 | |
Foreign currency forward contracts: | | | |
Prepaid expenses and other current assets | $ | 2.7 | | | $ | 4.6 | |
Other current liabilities | $ | 11.9 | | | $ | 14.3 | |
| | | |
Non-designated hedging instruments | | | |
| | | |
| | | |
Foreign currency forward contracts: | | | |
Prepaid expenses and other current assets | $ | 2.6 | | | $ | 1.5 | |
Other current liabilities | $ | 6.0 | | | $ | 5.4 | |
Note 13. Related Party Transactions
Quotient Limited
As a result of the consummation of the Combinations, the Company acquired Ortho’s Letter Agreement (the “Letter Agreement”), entered into in September 2020 with Quotient Limited (“Quotient”), in which Ortho partnered with Quotient to commercialize, when approved, Quotient’s next generation product in immunohematology, a transfusion diagnostic patient immunohematology microarray intended for use with Quotient’s MosaiQ® instruments. Under the Letter Agreement, the Company was required to make certain milestone payments to Quotient as specified milestones and benchmarks were achieved. Quotient subsequently revised its business strategy to pause development and commercialization of its MosaiQ testing solutions in immunohematology and infectious disease immunoassay screening. On January 10, 2023, Quotient filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Proceeding”). Following the completion of the Bankruptcy Proceeding, the Company’s equity interests in Quotient were canceled for no consideration. Quotient is no longer considered a related party of the Company.
Note 14. Accumulated Other Comprehensive Loss
The balance of Accumulated Other Comprehensive Loss, net of tax, was as follows for the three months ended April 2, 2023:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(In millions) | | | | | | | | | | Pension and Other Post- employment Benefits | | Cash Flow Hedges | | Available-for-Sale Investments | | Unrealized Foreign Currency Translation Adjustments | | Accumulated Other Comprehensive (Loss) Income | | |
Balance at January 1, 2023 | | | | | | | | | | $ | 0.7 | | | $ | 1.5 | | | $ | (0.5) | | | $ | (69.3) | | | $ | (67.6) | | | |
Current period deferrals (1) | | | | | | | | | | — | | | (16.9) | | | 0.2 | | | 30.7 | | | 14.0 | | | |
Amounts reclassified to net income | | | | | | | | | | — | | | (5.7) | | | — | | | — | | | (5.7) | | | |
Net change | | | | | | | | | | — | | | (22.6) | | | 0.2 | | | 30.7 | | | 8.3 | | | |
Balance at April 2, 2023 | | | | | | | | | | $ | 0.7 | | | $ | (21.1) | | | $ | (0.3) | | | $ | (38.6) | | | $ | (59.3) | | | |
(1) Includes tax impact of $6.1 million related to cash flow hedges for the three months ended April 2, 2023.
Amounts related to the three months ended April 3, 2022 were not material.