Company Operations and Summary of Significant Accounting Policies

Quidel Corporation (the “Company”) commenced operations in 1979. The Company operates in one business segment, which develops, manufactures and markets rapid diagnostic testing solutions. These diagnostic testing solutions primarily include applications in infectious diseases, women’s health and gastrointestinal diseases. The Company sells its products directly to end users and distributors, in each case, for professional use in physician offices, hospitals, clinical laboratories, reference laboratories, leading universities, retail clinics and wellness screening centers. The Company markets its products in the U.S. through a network of national and regional distributors, and a direct sales force. Internationally, the Company sells and markets through distributor arrangements.

The accompanying consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with generally accepted accounting principles in the U.S.

Consolidation—The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Cash and Cash Equivalents—The Company considers cash equivalents to be highly liquid investments with a maturity at the date of purchase of three months or less.

Accounts Receivable—The Company sells its products directly to hospitals and reference laboratories in the U.S. as well as to distributors in the U.S. and internationally. The Company periodically assesses the financial strength of these customers and establishes reserves for anticipated losses when necessary, which historically have not been material. The Company’s reserves primarily consist of amounts related to cash discounts and contract rebates. The balance of accounts receivable is net of reserves of $8.2 million and $5.8 million at December 31, 2014 and 2013, respectively.

Concentration of Credit Risk—Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable.

The Company invests its cash equivalents primarily in certificates of deposit and money market funds. Cash equivalents are maintained with high quality institutions.

The Company’s trade accounts receivable are primarily derived from sales to medical distributors, hospitals and reference laboratories in the U.S. (see Note 7). The Company performs credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary, but generally requires no collateral. Credit quality is monitored by evaluation of collection history. The Company believes that the concentration of credit risk in its trade accounts receivables is moderated by its credit evaluation process, relatively short collection terms, the high level of credit worthiness of its customers, and letters of credit issued on the Company’s behalf. Potential credit losses are limited to the gross value of accounts receivable.

Inventories—Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company reviews the components of its inventory on a quarterly basis for excess, obsolete and impaired inventory and makes appropriate dispositions as obsolete stock is identified. Inventories consisted of the following, net of reserves of $2.2 million and $0.6 million at December 31, 2014 and 2013, respectively (in thousands):



	December 31,
	2014		2013
Raw materials	$	10,472	$	11,938
Work-in-process (materials, labor and overhead)	6,834		9,831
Finished goods (materials, labor and overhead)	7,457		5,870
Total inventories	$	24,763	$	27,639

Property, Plant and Equipment—Property, plant and equipment is recorded at cost and depreciated over the estimated useful lives of the assets (three to 15 years) using the straight-line method. Amortization of leasehold improvements is computed on the straight-line method over the shorter of the lease term or the estimated useful lives of the assets. The total expense for depreciation of fixed assets and amortization of leasehold improvements was $10.3 million, $7.9 million and $7.3 million for the years ended December 31, 2014, 2013 and 2012, respectively. Maintenance and minor repairs are charged to operations as incurred.

Property, plant and equipment consisted of the following (in thousands):



	December 31,
	2014			2013
Equipment, furniture and fixtures	$	64,233		$	69,103
Building and improvements	32,074			25,964
Leased instruments	12,395			7,223
Land	1,080			1,080
Total property, plant and equipment, gross	109,782			103,370
Less: accumulated depreciation and amortization	(60,556		)	(55,313		)
Total property, plant and equipment, net	$	49,226		$	48,057

Goodwill and Intangible Assets—Intangible assets are recorded at cost and amortized on a straight-line basis over their estimated useful lives, except for software development costs and indefinite-lived intangibles such as goodwill and in-process research and development. Software development costs associated with software to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility has been established. After technological feasibility is established, software development costs are capitalized. The capitalized cost is amortized on a straight-line basis over the estimated product life or on the ratio of current revenues to total projected product revenues, whichever is greater. Amortization expense related to the capitalized software costs was $0.6 million, $0.3 million and $0.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. Goodwill and intangible assets consisted of the following (dollar amounts in thousands):



		December 31, 2014							December 31, 2013
Description	Weighted-average useful life (years)	Gross assets		Accumulated amortization			Net		Gross assets		Accumulated amortization			Net
Goodwill	Indefinite	$	84,197	$	(3,449	)	$	80,748	$	84,212	$	(3,449	)	$	80,763
Purchased technology	8.4	51,870		(28,570		)	23,300		51,870		(22,287		)	29,583
Customer relationships	7.5	7,214		(3,978		)	3,236		7,250		(2,954		)	4,296
In-process research and development	Indefinite	690		—			690		2,260		—			2,260
License agreements	5.9	34,324		(30,050		)	4,274		34,330		(21,374		)	12,956
Patent and trademark costs	12.3	10,530		(1,725		)	8,805		10,530		(861		)	9,669
Software development costs	5	2,849		(1,264		)	1,585		4,191		(693		)	3,498
Total goodwill and intangible assets		$	191,674	$	(69,036	)	$	122,638	$	194,643	$	(51,618	)	$	143,025

The Company acquired distribution rights for $0.8 million in conjunction with the March 2013 Agreement with Life Technologies Corporation (see “Collaborative Arrangement” in Note 1). The distribution rights will be amortized on a straight-line basis over the contractual term of six years.

Amortization expense was $17.4 million, $16.6 million and $15.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. Included in amortization expense for 2014, 2013 and 2012 is $8.0 million of amortization for licensed technology recorded in cost of sales. This amount is related to the purchase of a license pursuant to the Alere Amendment as discussed in Note 6. The remaining amortization expense associated with this intangible asset is expected to be $0.7 million in the first quarter of 2015.

The expected future annual amortization expense of the Company’s intangible assets is as follows (in thousands):



For the years ending December 31,	Amortization expense
2015	$	10,044
2016	9,210
2017	8,913
2018	3,342
2019	2,085
Thereafter	7,606
Total	$	41,200

The Company recorded a $1.6 million impairment loss related to a discontinued research and development named Project Stella during the third quarter of 2014. See further discussion in Note 10. The Company completed its annual evaluation for impairment of goodwill and in-process research and development as of December 31, 2014 and determined that no impairment of goodwill and no additional impairments of indefinite lived intangible assets existed.

Impairment of Long-Lived Assets—The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the total book value of an asset may not be recoverable. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and the eventual disposition are less than its carrying amount. An impairment loss is equal to the excess of the book value of an asset over its determined fair value. For the year ended December 31, 2014, the Company recorded a $1.5 million impairment loss on software development costs related to Project Stella. See further discussion in Note 10. The Company recorded no impairment losses for the years ended December 31, 2013 and 2012.

Other current liabilities—Other current liabilities consisted of the following (in thousands):



	December 31,
	2014		2013
Customer incentives	$	4,233	$	3,068
Accrued research and development costs	990		240
Other	2,820		2,303
Total other current liabilities	$	8,043	$	5,611

Convertible Debt—The Company accounts for convertible debt instruments that may be settled in cash upon conversion (including combination settlement of cash equal to the “principal portion” and delivery of the “share amount” in excess of the conversion value over the principal portion in shares of common stock and/or cash) by separating the liability and equity components of the instruments in a manner that reflects our nonconvertible debt borrowing rate. The Company determines the carrying amount of the liability component by measuring the fair value of similar debt instruments that do not have the conversion feature. If no similar debt instrument exists, the Company estimates fair value by using assumptions that market participants would use in pricing a debt instrument, including market interest rates, credit standing, yield curves and volatilities. Determining the fair value of the debt component requires the use of accounting estimates and assumptions. These estimates and assumptions are judgmental in nature and could have a significant impact on the determination of the debt component, and the associated non-cash interest expense. See Note 2 for additional discussion of the Convertible Senior Notes issued in December 2014.

Revenue Recognition—The Company records revenues primarily from product sales. These revenues are recorded net of rebates and other discounts which are estimated at the time of sale, and are largely driven by various customer program offerings, including special pricing agreements, promotions and other volume-based incentives. Revenue from product sales are recorded upon passage of title and risk of loss to the customer. Change in title to the product and recognition of revenue occurs upon delivery to the customer when sales terms are free on board (“FOB”) destination and at the time of shipment when the sales terms are FOB shipping point and there is no right of return.

A portion of product sales include revenues for diagnostic kits, which are utilized on leased instrument systems under the Company’s “reagent rental” program. The reagent rental program provides customers the right to use the instruments at no separate cost to the customer in consideration for a multi-year agreement to purchase annual minimum amounts of consumables (“reagents” or “diagnostic kits”). When an instrument is placed with a customer under a reagent rental agreement, the Company retains title to the equipment and it remains capitalized on the Company’s Consolidated Balance Sheet as property and equipment. The instrument is depreciated on a straight-line basis over the shorter of the lease term or the life of the instrument. Depreciation expense is recorded in cost of sales included in the Consolidated Statements of Operations. The reagent rental agreements represent one unit of accounting as the instrument and consumables (reagents) are interdependent in producing a diagnostic result and neither has a stand-alone value with respect to these agreements. No revenue is recognized at the time of instrument placement. All revenue is recognized when the title and risk of loss for the diagnostic kits have passed to the customer.

Royalty income from the grant of license rights is recognized during the period in which the revenue is earned and the amount is determinable from the licensee. The Company also earns income from the licensing of technology.

The Company earns income from grants for research and commercialization activities. On November 6, 2012, the Company was awarded a milestone-based grant totaling up to $8.3 million from the Bill and Melinda Gates Foundation to develop, manufacture and validate a quantitative, low-cost, nucleic acid assay for HIV drug treatment monitoring on the integrated Savanna MDx platform for use in limited resource settings. Upon execution of the grant agreement, the Company received $2.6 million to fund subsequent research and development activities and received milestone payments totaling $2.5 million in 2013. On September 10, 2014, the Company entered into an amended grant agreement with the Bill and Melinda Gates Foundation for additional funding of up to $12.6 million in order to accelerate the development of the Savanna MDx platform in the developing world. Upon execution of the amended grant agreement, the Company received $10.6 million in cash and expects to receive the remaining milestone payments of up to $2.4 million in 2015 and $2.8 million in 2016. Under the original and amended grant agreements, the Company recognizes grant revenue on the lesser of the amount recognized on a proportional performance basis or the amount of cash payments that are non-refundable as of the end of each reporting period. For the years ended December 31, 2014, 2013 and 2012, we recognized $6.3 million, $2.6 million and $0.5 million as grant revenue, respectively. The Company classified $3.1 million and $1.0 million of funds received from the Bill and Melinda Gates Foundation as restricted cash as of December 31, 2014 and 2013, respectively. In addition, the Company classified $6.3 million and $2.0 million as deferred grant revenue as of December 31, 2014 and 2013, respectively.

Research and Development Costs—Research and development costs are charged to operations as incurred. In conjunction with certain third party service agreements, the Company is required to make periodic payments based on achievement of certain milestones. The costs related to these research and development services are also charged to operations as incurred.

Collaborative Arrangement— In July 2012, the Company entered into a collaborative arrangement with Life Technologies Corporation for the development of molecular assays. ASC Topic 808, Collaborative Arrangements (“ASC Topic 808”), defines a collaborative arrangement as an arrangement where the parties are active participants and have exposure to significant risks. The Company is accounting for the joint development and commercialization activities with the third-party as a joint risk sharing collaboration in accordance with ASC Topic 808. Payments from Life Technologies Corporation totaled $0.4 million in 2014, $1.4 million in 2013 and $3.0 million in 2012. The Company does not expect additional payments in 2015, as the development efforts are complete. The reimbursement represents 50% of project development costs based upon mutually agreed upon project plans for each molecular assay. In connection with the collaboration agreement, the Company also entered into a manufacturing and supply agreement with the same third party. As part of that agreement, and upon commercialization, the Company will manufacture and sell assays to the third party at cost plus 20%. Additionally, the Company will receive 40% of the gross margin for sales from the third party to the end customer. In March 2013, the Company entered into a six year instrument supply agreement (the “March 2013 Agreement”) with Life Technologies Corporation. Pursuant to the March 2013 Agreement, the Company paid $0.8 million for distribution rights to sell Life Technologies Corporation’s QuantStudio™ DX diagnostic laboratory instrument for use in the infectious disease field, along with the assays developed under the collaborative agreement. The distribution rights are included in intangible assets on the Consolidated Balance Sheets and are being amortized on a straight-line basis over the contractual term of six years.

Product Shipment Costs—Product shipment costs are included in sales and marketing expense in the accompanying Consolidated Statements of Operations. Shipping and handling costs were $2.3 million, $2.2 million and $1.6 million for the years ended December 31, 2014, 2013 and 2012, respectively.

Advertising Costs—Advertising costs are expensed as incurred. Advertising costs were $0.4 million, $0.7 million and $0.2 million for the years ended December 31, 2014, 2013 and 2012, respectively.

Deferred Rent—Rent expense is recorded on a straight-line basis over the term of the lease. The difference between rent expense and amounts paid under the lease agreement are recorded as deferred rent.

Income Taxes—Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The Company’s policy is to recognize the interest expense and penalties related to income tax matters as a component of income tax expense.

Fair Value of Financial Instruments— The Company uses the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures, that requires the valuation of assets and liabilities subject to fair value measurements using a three tiered approach and fair value measurement be classified and disclosed by the Company in one of the following three categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

The carrying amounts of the Company’s financial instruments, including cash, receivables, accounts payable, and accrued liabilities approximate their fair values due to their short-term nature. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company establishes reserves for estimated uncollectible accounts and believes its reserves are adequate.

Product Warranty—The Company generally sells products with a limited product warranty and certain limited indemnifications. Due to product testing, the short time between product shipment and the detection and correction of product failures and a low historical rate of payments on indemnification claims, the historical activity and the related expense were not significant for the fiscal years presented.

Stock-Based Compensation—Compensation expense related to stock options granted is recognized ratably over the service vesting period for the entire option award. The total number of stock options expected to vest is adjusted by estimated forfeiture rates. The Company determined the estimated fair value of each stock option on the date of grant using the Black-Scholes option valuation model. Compensation expense for restricted stock (“stock awards”) is measured at the grant date and recognized ratably over the vesting period. The fair value of stock awards is determined based on the closing market price of the Company’s common stock on the grant date.

Computation of (Loss) Earnings Per Share—For the twelve months ended December 31, 2014, basic (loss) earnings per share were computed by dividing net (loss) earnings by the weighted-average number of common shares outstanding, including vested restricted stock awards, during the period. Diluted earnings per share reflects the potential dilution that could occur if the earnings were divided by the weighted-average number of common shares and potentially dilutive common shares from outstanding stock options as well as unvested restricted stock awards. Potential dilutive common shares were calculated using the treasury stock method and represent incremental shares issuable upon exercise of the Company’s outstanding stock options and unvested restricted stock awards. For periods in which the Company incurs losses, potentially dilutive shares are not considered in the calculation of net loss per share as their effect would be anti-dilutive. For periods in which the Company has earnings, stock options are excluded from the calculation of diluted net income per share when the combined exercise price, unrecognized stock-based compensation and expected tax benefits upon exercise are greater than the average market price for the Company’s common stock because their effect is anti-dilutive. For the twelve months ended December 31, 2014, there were no differences between the number of common shares used for the basic and diluted earnings per share (“EPS”) computation as the Company incurred a net loss. For the twelve months ended December 31, 2014, 1.1 million stock options and shares of restricted stock were excluded from diluted loss per share that would have been included if the Company had been in a net income position. Additionally, stock options totaling 1.0 million for the twelve months ended December 31, 2014 were not included in the computation of diluted earnings per share as their effect was anti-dilutive. As discussed in Note 2, the Company issued Convertible Senior Notes ("Convertible Senior Notes") in December 2014. It is the Company’s intent and policy to settle conversions through combination settlement, which essentially involves repayment of an amount of cash equal to the “principal portion” and delivery of the “share amount” in excess of the conversion value over the principal portion in shares of common stock ("conversion premium"). No conversion premium existed as of December 31, 2014, therefore, there was no dilutive impact from the Convertible Senior Notes to EPS. In addition, for the twelve months ended December 31, 2014, there were no participating securities. As such, the treasury stock method was applied in calculating EPS rather than the more dilutive of the treasury stock or the two-class method, as performed in previous periods.

For the twelve months ended December 31, 2013 and 2012, diluted net income per share was reported based on the more dilutive of the treasury stock or the two-class method. Under the two-class method, net income is allocated to common stock and participating securities. For the twelve months ended December 31, 2013 and 2012, the Company’s unvested restricted stock awards and certain unvested restricted stock units met the definition of participating securities. Basic net income per share under the two-class method was computed by dividing net income adjusted for earnings allocated to unvested stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share under the two-class method was computed by dividing net income adjusted for earnings allocated to unvested stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period. The Company excludes stock options from the calculation of diluted net income per share when the combined exercise price, unrecognized stock-based compensation and expected tax benefits upon exercise are greater than the average market price for the Company’s common stock because their effect is anti-dilutive. Stock options totaling 0.5 million and 1.1 million for the twelve months ended December 31, 2013 and 2012, respectively, were not included in the computation of diluted EPS because the exercise of such options would be anti-dilutive.

The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 2013 and 2012 (in thousands, except per share amounts):



	2013			2012
Basic net income per share:
Net income	$	7,390		$	4,993
Less: income allocated to participating securities	(17		)	(28		)
Net income allocated to common stockholders	$	7,373		$	4,965
Weighted average common shares outstanding — basic	33,836			33,068
Net income per share — basic	$	0.22		$	0.15
Diluted net income per share:
Net income	$	7,390		$	4,993
Less: income allocated to participating securities	(16		)	(27		)
Net income allocated to common stockholders	$	7,374		$	4,966
Weighted average common shares outstanding — basic	33,836			33,068
Dilutive securities	1,111			634
Weighted average common shares outstanding — diluted	34,947			33,702
Net income per share — diluted	$	0.21		$	0.15

Comprehensive (Loss) Income—Comprehensive (loss) income includes unrealized gains and losses excluded from the Company’s Consolidated Statements of Operations.

Facility Restructuring— In 2013, the Company announced a plan to move its manufacturing operations in Santa Clara, California to Athens, Ohio. Termination benefits for those employees who choose not to relocate are accounted for in accordance with ASC Topic 712, Compensation – Nonretirement Postemployment Benefits, and are recorded when it is probable that employees will be entitled to benefits and the amounts can be reasonably estimated. Estimates of termination benefits are based on the frequency of past termination benefits and the similarity of benefits under the current plan and prior plans. Facility related costs are accounted for in accordance with ASC Topic 420, Exit or Disposal Cost Obligations, and are recorded when the liability is incurred. The Company recorded a charge of $1.8 million during the year ended December 31, 2013, which included employee termination benefits and impairment charges related to the facility lease. The Company recorded no restructuring charges during the year ended December 31, 2014.

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.

Accounting Periods—Each of the Company’s fiscal quarters end on the Sunday closest to the end of the calendar quarter. The Company’s fiscal year ends are December 28, 2014, December 29, 2013 and December 30, 2012. For ease of reference, the calendar quarter end dates are used herein.

Reclassifications – The Company recorded immaterial reclassifications of $0.7 million and $0.8 million for the years ended December 31, 2013 and December 31, 2012, respectively, from general and administrative expense as previously reported in the Consolidated Statements of Operations to conform to current year interest expense presentation. The amortization of debt issuance costs and loan commitment fees had previously been recorded in general and administrative expense in the Consolidated Statements of Operations and the Company reclassified the amounts to more appropriately identify them as interest expense. The reclassification did not impact net income as previously reported or any prior amounts reported on the Consolidated Balance Sheets, Statements of Cash Flows, Statements of Comprehensive (Loss) Income or Statements of Stockholders' Equity. Management evaluated the materiality of these prior year reclassifications both qualitatively and quantitatively and determined that these errors were not material to the previously reported financial statements.

Recent Accounting Pronouncements—In May 2014, the FASB issued guidance codified in ASC Topic 606, Revenue Recognition—Revenue from Contracts with Customers, which amends the guidance in former ASC Topic 605, Revenue Recognition. This guidance is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance is effective for annual reporting periods beginning after December 15, 2016, with early adoption prohibited. The Company is currently evaluating the impact of this guidance and expects to adopt the standard in the first quarter of 2017.

In August 2014, the FASB issued guidance codified in ASU 2014-15 (Subtopic 205-40), Presentation of Financial Statements - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The guidance requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable). Management will be required to make this evaluation for both annual and interim reporting periods and will have to make certain disclosures if it concludes that substantial doubt exists or when its plans alleviate substantial doubt about the entity’s ability to continue as a going concern. Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or available to be issued). The term probable is used consistently with its use in ASC Topic 450, Contingencies. The guidance is effective for annual periods ending after December 15, 2016 and for interim reporting periods starting in the first quarter 2017, with early adoption permitted. The Company is currently evaluating the impact of this guidance and expects to adopt the standard for the annual reporting period ended December 31, 2016.