Debt and Other Commitments

Summary of debt obligations

Debt obligations consist of the following (dollars in millions):



	December 31, 2017			January 1, 2017
Principal amount of 2019 Notes outstanding	$	633		$	633
Principal amount of 2021 Notes outstanding	517			517
Unamortized discount of liability component	(75		)	(105		)
Net carrying amount of liability component	1,075			1,045
Obligations under financing leases	113			9
Other	4			4
Less: current portion	(10		)	(2		)
Long-term debt	$	1,182		$	1,056
Carrying value of equity component, net of issuance costs	$	161		$	161
Fair value of outstanding notes (Level 2)	$	1,305		$	1,108
Weighted average remaining amortization period of discount on the liability component	2.8 years			3.6 years

0% Convertible Senior Notes due 2019 (2019 Notes) and 0.5% Convertible Senior Notes due 2021 (2021 Notes)

In June 2014, we issued $633 million aggregate principal amount of 0% convertible senior notes due 2019 (2019 Notes) and $517 million aggregate principal amount of 0.5% convertible senior notes due 2021 (2021 Notes) in an offering conducted in accordance with Rule 144A under the Securities Act of 1933, as amended. The Notes were issued at 100% of par value. The net proceeds from the issuance, after deducting the offering expenses payable by us, was $1,132 million. We used the net proceeds plus cash on hand to repurchase a portion of the outstanding 2016 Notes in privately negotiated transactions concurrently with the issuance of the 2019 and 2021 Notes.

Both the 2019 and 2021 Notes will be convertible into cash, shares of common stock, or a combination of cash and shares of common stock, at our election, based on an initial conversion rate, subject to adjustment, of 3.9318 shares per $1,000 principal amount of the notes (which represents an initial conversion price of approximately $254.34 per share), only in the following circumstances and to the following extent: (1) during the five business-day period after any 10 consecutive trading day period (the measurement period) in which the trading price per 2019 and 2021 Note for each day of such measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (2) during any calendar quarter (and only during that quarter) after the calendar quarter ending September 30, 2014, if the last reported sale price of our common stock for 20 or more trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; (3) upon the occurrence of specified events described in the indenture for the 2019 and 2021 Notes; and (4) at any time on or after March 15, 2019 for the 2019 Notes, or March 15, 2021 for the 2021 Notes, through the second scheduled trading day immediately preceding the maturity date.

As noted in the indentures for the 2019 and 2021 Notes, it is our 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. In general, for each $1,000 in principal, the “principal portion” of cash upon settlement is defined as the lesser of $1,000 and the conversion value during the 20-day observation period. The conversion value is the sum of the daily conversion value which is the product of the effective conversion rate divided by 20 days and the daily volume weighted average price (VWAP) of our common stock. The “share amount” is the cumulative “daily share amount” during the observation period, which is calculated by dividing the daily VWAP into the difference between the daily conversion value (i.e., conversion rate x daily VWAP) and $1,000.

The 2019 Notes carry no coupon interest. We pay 0.5% interest per annum on the principal amount of the 2021 Notes, payable semiannually in arrears in cash on June 15 and December 15 of each year, beginning on December 15, 2014. The 2019 and 2021 Notes mature on June 15, 2019 and June 15, 2021, respectively. If a designated event, as defined in the indentures for the 2019 and 2021 Notes, such as acquisition, merger, or liquidation, occurs prior to the maturity date, subject to certain limitations, holders of the notes may require us to repurchase all or a portion of their notes for cash at a repurchase price equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the repurchase date.

The liability and equity components of the 2019 and 2021 Notes are accounted for in accordance with authoritative guidance for convertible debt instruments that may be settled in cash upon conversion. The guidance requires the carrying amount of the liability component to be estimated by measuring the fair value of a similar liability that does not have an associated conversion feature. Because we have no outstanding non-convertible public debt, we determined that market-traded senior, unsecured corporate bonds represent a similar liability to the convertible senior notes without the conversion option. Based on market data available for publicly traded, senior, unsecured corporate bonds issued by companies in the same industry as us, and with similar maturities to the 2019 and 2021 Notes, we estimated the implied interest rates of our 2019 and 2021 Notes to be 2.9% and 3.5%, respectively, assuming no conversion option. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market interest rates, credit standing, and yield curves, all of which are defined as Level 2 observable inputs. The estimated implied interest rates were applied to the 2019 and 2021 Notes, which resulted in a fair value of the liability component in aggregate of $972 million upon issuance, calculated as the present value of implied future payments based on the $1,150 million aggregate principal amount. The $161 million difference between the cash proceeds of $1,133 million and the estimated fair value of the liability component was recorded in additional paid-in capital as the 2019 and 2021 Notes are not considered redeemable.

As a policy election under applicable guidance related to the calculation of diluted net income per share, we elected the combination settlement method as our stated settlement policy and applied the treasury stock method in the calculation of the potential dilutive impact of the 2019 and 2021 Notes. Neither the 2019 nor the 2021 Notes were convertible as of December 31, 2017, and had no dilutive impact during the year ended December 31, 2017. If the 2019 and 2021 Notes had been converted as of December 31, 2017, the if-converted value would not exceed the principal amount.

0.25% Convertible Senior Notes due 2016

In 2011, we issued $920 million aggregate principal amount of 0.25% convertible senior notes due 2016 (2016 Notes) with a maturity date of March 15, 2016. The effective rate of the liability component was estimated to be 4.5%. Based upon meeting the stock trading price conversion requirement during the three months ended March 30, 2014, the 2016 Notes became convertible on April 1, 2014 through, and including, March 11, 2016. All notes were converted by March 11, 2016.

Leases

We lease office and manufacturing facilities under various non-cancellable lease agreements. Facility leases generally provide for periodic rent increases, and many contain escalation clauses and renewal options. Certain leases require us to pay property taxes and routine maintenance. We are headquartered in San Diego, California and lease facilities in San Diego and the San Francisco Bay Area in California; Madison, Wisconsin; Morrisville, North Carolina; Australia; Brazil; Canada; China; France; Japan; Singapore; the Netherlands; South Korea; and the United Kingdom.

We evaluate whether we are the accounting owner of leased assets during the construction period when we are involved in the construction of leased assets. As of December 31, 2017, we are considered the owner of two construction projects for accounting purposes only under build-to-suit lease accounting due to certain indemnification obligations related to the construction. As of December 31, 2017 and January 1, 2017, we recorded $144 million and $223 million, respectively, in project construction costs paid or reimbursed by the landlord as construction in progress and a corresponding build-to-suit lease liability.

During the year ended December 31, 2017, construction of a build-to-suit property was completed. We concluded that we do not qualify for “sale-leaseback” treatment and the lease is accounted for as a financing obligation. Accordingly, $104 million of construction in progress and build-to-suit lease liability were reclassified to building asset and obligations under financing leases, respectively.

On February 28, 2017, GRAIL was deconsolidated, as further described in note “2. Balance Sheet Account Details”, and $58 million of construction in progress and the corresponding build-to-suit lease liability were removed.

As of December 31, 2017, annual future minimum payments of our operating leases and build-to-suit leases, which include those leases accounted for as a financing obligation, were as follows (in millions):



	Operating Leases		Sublease Income			Net Operating Leases		Build-to-suit Leases
2018	$	55	$	(9	)	$	46	$	22
2019	60		(10		)	50		20
2020	58		(10		)	48		20
2021	57		(10		)	47		21
2022	54		(11		)	43		21
Thereafter	468		(16		)	452		190
Total minimum lease payments	$	752	$	(66	)	$	686	$	294

Rent expense was $46 million, $46 million, and $39 million for the years ended December 31, 2017, January 1, 2017, and January 3, 2016, respectively. As of December 31, 2017 and January 1, 2017, the deferred rent balance related to our operating leases was $115 million and $107 million, respectively, of which the long-term portion of $113 million and $104 million, respectively, were recorded in other long-term liabilities.

Facility exit obligations were recorded upon vacating our former headquarters in 2011. Changes in the facility exit obligation from December 28, 2014 through December 31, 2017, are as follows (in millions):



	Facility Exit Obligation
Balance as of December 28, 2014	$	38
Adjustment to facility exit obligation	(5		)
Accretion of interest expense	2
Cash payments	(13		)
Balance as of January 3, 2016	22
Accretion of interest expense	1
Cash payments	(4		)
Balance as of January 1, 2017	19
Accretion of interest expense	1
Cash payments	(3		)
Balance as of December 31, 2017	$	17

Purchase Obligations

In the normal course of business, we enter into agreements to purchase goods or services that are not cancelable without penalty, primarily related to licensing and supply arrangements. For those agreements with variable terms, we do not estimate the total obligation beyond any minimum quantities or pricing as of the reporting date. Licensing agreements under which we commit to minimum royalty payments, some of which are subject to adjustment, may be terminated prior to the expiration of underlying intellectual property under certain circumstances. Annual minimum payments for noncancelable purchase obligations as of December 31, 2017 are as follows (in millions):



	Minimum Payments
2018	$	27
2019	60
2020	20
Total	$	107