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Fair Value of Financial Instruments
 6 Months Ended
Jun. 30, 2015
Fair Value of Financial Instruments

8. Fair Value of Financial Instruments

The Company applies various valuation approaches in determining the fair value of its financial assets and liabilities within a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset or liability and are developed based on the best information available in the circumstances. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:

Level 1— Quoted prices for identical instruments in active markets.

Level 2— Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3— Significant inputs to the valuation model are unobservable.

 

The availability of observable inputs can vary among the various types of financial assets and liabilities. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for financial statement disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is categorized is based on the lowest level input that is significant to the overall fair value measurement.

Cash and cash equivalents

Cash equivalents consist of highly liquid investments with original or remaining maturities of 90 days or less at the time of purchase, that are readily convertible into cash. As of June 30, 2015 and December 31, 2014, the Company held $107.2 million and $120.8 million, respectively, of cash and cash equivalents, consisting primarily of money market funds of $104.7 million and $118.5 million, respectively, and the remaining in non-interest bearing checking accounts. The fair value of these money market funds was determined by using quoted prices for identical investments in an active market, which equals carrying value (Level 1 in the fair value hierarchy).

Related-Party Arrangement

The fair value of the note payable to our principal stockholder cannot be reasonably estimated as the Company would not be able to obtain a similar credit arrangement in the current economic environment.

Senior convertible notes and facility financing obligation

The following is a summary of the carrying values and estimated fair values of the 2015 notes and the facility financing obligation (i.e., the 2019 notes and Tranche B notes) (in millions):

 

     June 30, 2015      December 31, 2014  
     Carrying
value		      Estimated
fair value		      Carrying
value		      Estimated
fair value		  

2015 notes

    $ 99.8       $ 103.2       $ 99.4       $ 102.9   

Facility financing obligation

    $ 73.8       $ 77.9       $ 73.0       $ 75.1   

The estimated fair value of the 2015 notes was calculated based on model-derived valuations whose inputs were observable, such as the Company’s stock price, and non-observable, such as the Company’s longer-term historical volatility (Level 3 in the fair value hierarchy). As there is no current observable market for the 2015 notes, the Company determined the estimated fair value using a convertible bond valuation model within a lattice framework. The convertible bond valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price volatility and recent price quotes and trading information regarding Company issued debt instruments and shares of common stock into which the notes are convertible.

Facility Agreement

As discussed in Note 14 — Facility Agreement, in connection with the Facility Agreement, the Company issued 2019 notes and certain rights to receive payments of up to $90.0 million upon the occurrence of specified strategic and sales milestones (the “Milestone Rights”) and subsequently issued Tranche B notes. As there is no current observable market for the 2019 notes or Tranche B notes, the Company determined the estimated fair value using a bond valuation model based on a discounted cash flow methodology. The bond valuation model combined expected cash flows associated with principal repayment and interest based on the contractual terms of the debt agreement discounted to present value using a selected market discount rate. At June 30, 2015 the market discount rate was recalculated at 12.0% for the 2019 notes and the Tranche B notes (Level 3 in the fair value hierarchy).

The estimated fair value of the Milestone Rights was calculated using the income approach in which the cash flows associated with the specified contractual payments were adjusted for both the expected timing and the probability of achieving the milestones discounted to present value using a selected market discount rate (Level 3 in the fair value hierarchy). The expected timing and probability of achieving the milestones, starting in 2014, was developed with consideration given to both internal data, such as progress made to date and assessment of criteria required for achievement, and external data, such as market research studies. The discount rate (15.5%) was selected based on an estimation of required rate of returns for similar investment opportunities using available market data. As of June 30, 2015, the fair value of the Milestone Rights is estimated at $43.9 million.

 

Sanofi Loan Facility

As discussed in Note 7 — the Sanofi Loan Facility, consists of a senior secured revolving promissory note and a guaranty and security agreement with an affiliate of Sanofi which provides the Company with a secured loan facility of up to $175.0 million to fund the Company’s share of net losses under the Sanofi License Agreement. As of June 30, 2015, the Company has borrowed $15.6 million, which includes $0.2 million in paid-in-kind interest, under the Sanofi Loan Facility and the estimated fair value was determined to approximate the carrying value based on the consideration of the key elements of the contractual terms of the Sanofi Loan Facility, market-based estimated cost of capital, and time value of money, namely the amount of time to settlement and the estimated discount rate appropriate for the liability (Level 2 in the fair value hierarchy).

This analysis was performed using a discounted cash flow model in which time outstanding and discount rate were the primary variables.

There were no material re-measurements to fair value during the six months ended June 30, 2015 of financial assets and liabilities that are not measured at fair value on a recurring basis. There were no transfers of assets or liabilities between the fair value measurement levels during the six months ended June 30, 2015.