Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
We are exposed to market risk related to changes in interest rates. We invest our cash in a variety of financial instruments, principally securities issued by the U.S. government and its agencies, collateralized reverse repurchase agreements, and money market instruments. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk.
Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of interest rates, particularly because our investments are in short-term marketable securities. Due to the primarily short-term duration of our investment portfolio and the low risk profile of our investments, an immediate 1% change in interest rates would not have a material effect on the fair market value of our portfolio. Accordingly, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.
We do not believe our cash and cash equivalents have significant risk of default or illiquidity. While we believe our cash and cash equivalents do not contain excessive risk, we cannot provide absolute assurance that in the future our investments will not be subject to adverse changes in market value. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the potential instability of financial institutions, we cannot provide assurance that we will not experience losses on these deposits.
Our convertible senior notes bear interest at a fixed rate and therefore have minimal exposure to changes in interest rates; however, because these interest rates are fixed, we may be paying a higher interest rate, relative to market, in the future if our credit rating improves or other circumstances change.
Equity Price Risk
2022 Convertible Notes
Our 2.25% Convertible Senior Notes due 2022, or 2022 Convertible Notes, include conversion and settlement provisions that are based on the price of our Class A Common Stock at conversion or at maturity of the 2022 Convertible Notes. The amount of cash we may be required to pay is determined by the price of our Class A Common Stock. The fair value of our 2022 Convertible Notes is dependent on the price and volatility of our Class A Common Stock and will generally increase or decrease as the market price of our Class A Common Stock changes.
The 2022 Convertible Notes are convertible into Class A Common Stock at an adjusted conversion rate of 68.9172 shares of Class A Common Stock (subject to adjustment as provided for in the 2022 Convertible Notes that are governed by an indenture, or the 2022 Indenture) per $1,000 principal amount of the 2022 Convertible Notes, which is equal to a conversion price of approximately $14.51 per share. The 2022 Convertible Notes will mature on June 15, 2022 unless earlier converted or repurchased. We will settle conversions of the 2022 Convertible Notes through payment or delivery, as the case may be, of cash, shares of our Class A Common Stock or a combination of cash and shares of Class A Common Stock, at our option (subject to, and in accordance with, the settlement provisions of the 2022 Indenture). The 2022 Convertible Notes bear cash interest at an annual rate of 2.25%, payable on June 15 and December 15 of each year, which began on December 15, 2015. As of June 30, 2020, the fair value of the 2022 Convertible Notes was estimated by us to be approximately $126.4 million. The 2022 Convertible Notes are more fully described in Note 5, Fair Value of Financial Instruments , and Note 8, Notes Payable, in the accompanying notes to our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.
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Convertible Note Hedge and Note Hedge Warrant Transactions with Respect to 2022 Convertible Notes
To minimize the impact of potential dilution to our common stock upon conversion of the 2022 Convertible Notes, we entered into Convertible Note Hedges to acquire, subject to customary adjustments, 23,135,435 shares of our Class A Common Stock at a strike price of $14.51 per share, as adjusted. Concurrently with entering into the Convertible Note Hedges, we entered into warrant transactions whereby we sold Note Hedge Warrants to acquire, subject to customary adjustments, 23,135,435 shares of our Class A Common Stock at a strike price of $18.82 per share, as adjusted. In August 2019, in connection with the repurchase of a portion of a portion of the 2022 Convertible Notes, we partially terminated the respective portion of the Convertible Note Hedges and Note Hedge Warrants. We remeasure the remaining Convertible Note Hedges and Note Hedge Warrants to fair value at each reporting date using the Black-Scholes option-pricing model, with changes in fair value recorded as (loss) gain on derivatives in our condensed consolidated statements of operations. The Convertible Note Hedges and Note Hedge Warrants are more fully described in Note 8, Notes Payable, in the accompanying notes to our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.
2024 Convertible Notes and 2026 Convertible Notes
Our 0.75% Convertible Senior Notes due 2024, or 2024 Convertible Notes, and our 1.50% Convertible Senior Notes due 2026, or 2026 Convertible Notes, include conversion and settlement provisions that are based on the price of our Class A Common Stock at conversion or at maturity of the 2024 Convertible Notes and 2026 Convertible Notes. The amount of cash we may be required to pay is determined by the price of our Class A Common Stock. The fair value of our 2024 Convertible Notes and 2026 Convertible Notes is dependent on the price and volatility of our Class A Common Stock and will generally increase or decrease as the market price of our Class A Common Stock changes.
The initial conversion rate for each of the 2024 Convertible Notes and 2026 Convertible Notes is 74.6687 shares of Class A Common Stock (subject to adjustment as provided for in the applicable Indenture) per $1,000 principal amount of the 2024 Convertible Notes and 2026 Convertible Notes, which is equal to an initial conversion price of approximately $13.39 per share. The 2024 Convertible Notes will mature on June 15, 2024 and the 2026 Convertible Notes will mature on June 15, 2026, unless earlier converted or repurchased. We will settle conversions of the 2024 Convertible Notes and 2026 Convertible Notes through payment or delivery, as the case may be, of cash, shares of our Class A Common Stock or a combination of cash and shares of Class A Common Stock, at our option (subject to, and in accordance with, the settlement provisions of the applicable Indenture). The 2024 Convertible Notes bear cash interest at the annual rate of 0.75% and the 2026 Convertible Notes bear cash interest at the annual rate of 1.50%, each payable on June 15 and December 15 of each year, which began on December 15, 2019. As of June 30, 2020, the fair value of the 2024 Convertible Notes and 2026 Convertible Notes was estimated by us to be approximately $206.0 million and approximately $206.3 million, respectively. The 2024 Convertible Notes and 2026 Convertible Notes are more fully described in Note 5, Fair Value of Financial Instruments , and Note 8, Notes Payable, in the accompanying notes to our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.
Capped Calls with Respect to 2024 Convertible Notes and 2026 Convertible Notes
In August 2019, in connection with the issuance of the 2024 Convertible Notes and the 2026 Convertible Notes, we entered into the capped call transactions, or the Capped Calls, with certain financial institutions. Subject to customary anti-dilution and certain other adjustments, the Capped Calls cover the same number of shares of Class A Common Stock that initially underlie the 2024 Convertible Notes and the 2026 Convertible Notes. These instruments meet the conditions outlined in ASC Topic 815, Derivatives and Hedging , or ASC 815, to be classified in stockholders’ deficit on our condensed consolidated balance sheet and are not subsequently remeasured as long as the conditions for equity classification continue to be met. The Capped Calls are more fully described in Note 8, Notes Payable, in the accompanying notes to our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.
Foreign Currency Risk
We have no significant monetary assets or liabilities expected to be settled in foreign currency and we do not expect to be impacted significantly by foreign currency fluctuations.
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Effects of Inflation
We do not believe that inflation and changing prices over the three and six months ended June 30, 2020 and 2019 had a significant impact on our results of operations.
Item 4. Controls and Procedure s
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, or the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control
As required by Rule 13a-15(d) of the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation of the internal control over financial reporting to determine whether any changes occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Based on that evaluation, our principal executive officer and principal financial officer concluded no changes during the period covered by this Quarterly Report on Form 10-Q materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.