7. Borrowings

Borrowings consist of the following (in thousands):


	December 31,
	2016			2015
Facility Financing Obligation (2019 Notes)
Principal amount	$	75,000		$	80,000
Unamortized debt discount		(3,661	)		(5,418	)

Net carrying amount	$	71,339		$	74,582

Senior Convertible Notes (2018 Notes)
Principal amount	$	27,690		$	27,690
Unamortized premium		426			660
Unaccreted debt issuance costs		(481	)		(737	)

Net carrying amount	$	27,635		$	27,613

Note payable to principal stockholder — net carrying amount	$	49,521		$	49,521

Facility Financing Obligation (2019 Notes) — As of December 31, 2016, there were $55.0 million principal amount of 2019 notes and $20.0 million principal amount of Tranche B notes outstanding. As of December 31, 2015, there were $60.0 million principal amount of 2019 notes and $20.0 million principal amount of Tranche B notes outstanding. The 2019 notes accrue interest at annual rate of 9.75% and the Tranche B notes accrue interest at an annual rate of 8.75%. Interest is paid quarterly in arrears on the last day of each March, June, September and December. The Facility Financing Obligation principal repayment schedule is comprised of annual payments beginning on July 1, 2016 and ending December 9, 2019. Future principal payments for the years ended December 31, 2017, 2018 and 2019 are $20.0 million, $20.0 million and $35.0 million, respectively.

In conjunction with the Facility Agreement, the Company entered into a Milestone Rights Agreement with Deerfield which requires the Company to make contingent payments to Deerfield, totaling up to $90.0 million, upon the Company achieving specified commercialization milestones. The Milestone Rights were initially recorded as a short-term liability equal to $3.2 million included in accrued expenses and other current liabilities in the accompanying consolidated balance sheets and a long-term liability equal to $13.1 million included in other liabilities. During the first quarter of 2015, a milestone triggering event was achieved following the Company’s product launch on February 3, 2015, which resulted in a $5.8 million incremental charge to interest expense due to the increase in carrying value of the liability to the required $10.0 million payment made in February of 2015. During the year ended December 31, 2014, the first milestone triggering event was achieved following the Company’s entry into the Sanofi License Agreement, which resulted in a $1.9 million incremental charge to interest expense due to the increase in carrying value of the liability to the required $5.0 million payment, which was paid to Deerfield pursuant to the terms of the Milestone Agreement. As of December 31, 2016 and 2015, the remaining liability balance of $8.9 million is classified as a long-term liability.

As of December 31, 2016, the unamortized debt discount and debt issuance costs were $3.7 million and $0.1 million, respectively.

Accretion of debt issuance cost and debt discount in connection with the Deerfield financing during the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands):


	December 31,
	2016		2015		2014
Accretion expense — debt issuance cost	$	35	$	35	$	326
Accretion expense — debt discount	$	1,722	$	1,553	$	7,550

The Facility Agreement includes customary representations, warranties and covenants, including, a restriction on the incurrence of additional indebtedness, and a financial covenant which requires the Company’s cash and cash equivalents, which includes available borrowings on the note payable to principal stockholder, on the last day of each fiscal quarter to not be less than $25.0 million. As discussed in Note 1 — Description of Business, the Company will need to raise additional capital to support its current operating plans. Due to the uncertainties related to maintaining sufficient resources to comply with the aforementioned covenant, the 2019 notes and the Tranche B notes have been classified as current liabilities in the accompanying consolidated balance sheets as of December 31, 2016 and 2015. In the event of non-compliance, Deerfield may declare all or any portion of the 2019 notes and/or Tranche B notes to be immediately due and payable.

Milestone Rights — The Milestone Agreement includes customary representations and warranties and covenants by the Company, including restrictions on transfers of intellectual property related to Afrezza. The Milestone Rights are subject to acceleration in the event the Company transfers its intellectual property related to Afrezza in violation of the terms of the Milestone Agreement. The Company has initially recorded the Milestone Rights at their estimated fair value — See Note 2 — Summary of Significant Accounting Policies under Milestone Rights Liability.

In determining the fair value of the Milestone Rights, the 13 individual milestone payments were adjusted for both (i) the expected timing and (ii) the probability of achieving the milestones, and then discounted to present value using a discount rate of 14.5%. Once the initial valuation of each specified milestone payment was determined, the individual milestone payments were then aggregated to arrive at a total fair value of $18.4 million. The discount rate was based on the estimated cost of equity which was derived using the capital asset pricing model. In addition, a 5% risk premium was added to the computation of the cost of equity to adjust for non-systemic risk factors, such as the Company’s lack of product diversification and history of financial losses, which were not captured in other model inputs.

Security Agreement — In connection with the Facility Agreement, the Company and its subsidiary, MannKind LLC, entered into a Guaranty and Security Agreement (the “Security Agreement”) with Deerfield and Horizon Sante FLML SA’RL (collectively, the “Purchasers”), pursuant to which the Company and MannKind LLC each granted the Purchasers a security interest in substantially all of their respective assets, including respective intellectual property, accounts, receivables, equipment, general intangibles, inventory and investment property, and all of the proceeds and products of the foregoing. The Security Agreement includes customary covenants by the Company and MannKind LLC, remedies of the Purchasers and representations and warranties by the Company and MannKind LLC. The security interests granted by the Company and MannKind LLC will terminate upon repayment of the 2019 notes and Tranche B notes, if applicable, in full. The Company’s obligations under the Facility Agreement and the Milestone Agreement are also secured by the mortgage on the Company’s facilities in Danbury, Connecticut, which has a carrying value of $28.7 million.

Embedded Derivatives — The Company identified and evaluated a number of embedded features in the notes issued under the Facility Agreement to determine if they represented embedded derivatives that are required to be separated from the notes and accounted for as freestanding instruments. In 2014, the Company analyzed the Tranche B notes and identified embedded derivatives which required separate accounting. However, all of the embedded derivatives were determined to have a de minimis value at December 31, 2016 and 2015.

Conversion Option — During 2014, Deerfield elected to convert a total of $93.5 million of principal, which consisted of $20.0 million, $33.5 million, and $40.0 million of Tranche 1 notes, Tranche 2 notes, and Tranche 3 notes, respectively, into an aggregate 3,464,616 shares of common stock. In conjunction with the conversion by Deerfield, we recorded an aggregate expense of $6.4 million for the difference between the principal amount of the notes converted and their carrying amount (which included unamortized discount and debt issuance costs) which consisted of $1.2 million, $3.0 million, and $2.2 million related to the Tranche 1 notes, Tranche 2 notes, and Tranche 3 notes, respectively. Further, upon Deerfield converting $40.0 million of Tranche 3 notes and $20.0 million of Tranche 1 notes, Deerfield has reached the conversion limits (i.e., “Applicable Limits”) with respect to the Facility Agreement and therefore, no additional amount of the 2019 notes is convertible.

Issuance of new 5.75% Convertible Senior Subordinated Exchange Notes Due 2018 in Exchange for 2015 Notes — On July 28, 2015, the Company entered into privately-negotiated exchange agreements (the “Note Exchange Agreements”) with a select holder of the Company’s 5.75% Senior Convertible Notes due 2015 (the “2015 notes”), pursuant to which the Company agreed to issue $27.7 million aggregate principal amount of new 5.75% Convertible Senior Subordinated Exchange Notes due 2018 (the “2018 notes”) to such holders in exchange for the delivery to the Company of the same principal amount of 2015 notes. The 2018 notes were issued at the closing of the exchange on August 10, 2015. The Company analyzed this exchange and concluded that the exchange represents an extinguishment of the 2015 notes and a new issuance of 2018 notes and recorded such notes at fair value, which resulted in a premium of $0.7 million.

The 2018 notes are the Company’s general, unsecured, senior obligations, except that the 2018 notes were subordinated to the Sanofi Loan facility prior to the extinguishment of the facility on November 9, 2016. The 2018 notes rank equally in right of payment with the Company’s other unsecured senior debt. The 2018 notes bear interest at the rate of 5.75% per year on the principal amount, payable semiannually in arrears in cash on February 15 and August 15 of each year, beginning February 15, 2016, with interest accruing from August 15, 2015. The 2018 notes mature on August 15, 2018. Accrued interest related to these notes is recorded in accrued expenses and other current liabilities on the accompanying consolidated balance sheets.

The 2018 notes are convertible, at the option of the holder, at any time on or prior to the close of business on the business day immediately preceding the stated maturity date, into shares of the Company’s common stock at an initial conversion rate of 29 shares per $1,000 principal amount of the 2018 notes, which is equal to a conversion price of approximately $34.00 per share, the same conversion price as that of the 2015 notes on the date of exchange. The conversion rate is subject to adjustment under certain circumstances described in an indenture governing the 2018 notes dated August 10, 2015 with Wells Fargo, National Association, including in connection with a make-whole fundamental change.

If certain fundamental changes occur, the Company will be obligated to pay a fundamental change make-whole premium on any 2018 notes converted in connection with such fundamental change by increasing the conversion rate on such 2018 notes. In such instances, the amount of the fundamental change make-whole premium will be based on the Company’s common stock price and the effective date of the applicable fundamental change. If the Company undergoes certain fundamental changes, except in certain circumstances, each holder of 2018 notes will have the option to require the Company to repurchase all or any portion of that holder’s 2018 notes. The fundamental change repurchase price will be 100% of the principal amount of the 2018 notes to be repurchased plus accrued and unpaid interest, if any.

On or after the date that is one year following the original issue date of the 2018 notes, the Company will have the right to redeem for cash all or part of the 2018 notes if the last reported sale price of its common stock exceeds 130% of the conversion price then in effect for 20 or more trading days during the 30 consecutive trading day period ending on the trading day immediately prior to the date of the redemption notice. The redemption price will equal the sum of 100% of the principal amount of the 2018 notes to be redeemed, plus accrued and unpaid interest. Under the terms of the 2018 Note Indenture, the conversion option can be net-share settled and the maximum number of shares that could be required to be delivered under the indenture, including the make-whole shares, is fixed and less than the number of authorized and unissued shares less the maximum number of shares that could be required to be delivered during the term of the 2018 notes under existing commitments. Applying the Company’s sequencing policy, the Company performed an analysis at the time of the offering of the 2018 notes and each reporting date since and has concluded that the number of available authorized shares at the time of the offering and each subsequent reporting date was sufficient to deliver the number of shares that could be required to be delivered during the term of the 2018 notes under existing commitments.

The 2018 notes provide that upon an acceleration of certain indebtedness, including the 9.75% Senior Convertible Notes due in 2019 (the “2019 notes”) and the 8.75% Senior Convertible Notes due in 2019 (the “Tranche B notes”) issued to Deerfield pursuant to the Facility Agreement, the holders may elect to accelerate the Company’s repayment obligations under the notes if such acceleration is not cured, waived, rescinded or annulled. There can be no assurance that the holders would not choose to exercise these rights in the event such events were to occur.

The Company incurred approximately $0.8 million in issuance costs, which are recorded as an offset to the 2018 notes in the accompanying consolidated balance sheets. These costs are being accreted to interest expense using the effective interest method over the term of the 2018 notes.

Accretion of debt issuance expense in connection with the 2018 notes during the years ended December 31, 2016 and 2015 was $257,000 and $93,000, respectively. Amortization of the 2018 notes premium during the years ended December 31, 2016 and 2015 was $234,000 and $86,000, respectively.

Issuance of Common Stock in Exchange for the 2015 Notes — On July 28, 2015, the Company entered into separate, privately-negotiated exchange agreements (the “Stock-for-Note Exchange Agreements”) with certain holders of the 2015 notes pursuant to which the Company agreed to issue shares of its common stock to such holders in exchange for the delivery to the Company of up to $56.9 million aggregate principal amount of the 2015 notes.

Pursuant to the Stock-for-Note Exchange Agreements, the parties agreed to price the exchange transactions over a 10 trading day period spanning from July 29, 2015 to and including August 11, 2015. Between July 28, 2015 and August 10, 2015, the Company issued an aggregate of 380,000 shares of common stock to such holders in exchange for such holders’ delivery to the Company of $8.0 million aggregate principal amount of the 2015 notes, resulting in a weighted-average exchange price of $110.00 per share.

Issuance of New 5.75% Convertible Senior Subordinated Exchange Notes Due 2015 in Exchange for the 2015 Notes — On August 14, 2015, the Company exchanged $32.1 million aggregate principal amount of newly issued, 5.75% Convertible Senior Subordinated Exchange Notes due 2015 (the “Exchange Notes”) for the same principal amount of the Company’s previously outstanding 2015 notes. The Exchange Notes, payable at maturity on September 30, 2015, were convertible, at the option of each holder thereof, at any time on or prior to the close of business on the business day immediately preceding the stated maturity date. The holders of the Exchange Notes did not elect to convert any of the outstanding principal amount of the Exchange Notes into shares of the Company’s common stock. As a result, on September 30, 2015, the Company paid $32.1 million to settle the Exchange Notes.

Settlement of 2015 Notes and Exchange Notes — On August 17, 2015, the Company paid $32.2 million to settle the remaining 2015 notes. As of September 30, 2015, all 2015 notes, including the Exchange Notes, have been settled resulting in a total loss on extinguishment of debt equal to $1.0 million. The loss on extinguishment of debt resulted from the write-off of debt discount and debt issuance costs associated with the 2015 notes and Exchange Notes and the difference between the principal amounts being exchanged for shares of the Company’s common stock, pursuant to the various Stock-for-Note Exchange Agreements, and the fair market value of the Company’s common stock issued in exchange for such reduction in principal.

Accretion of debt issuance costs in connection with the 2015 notes during the years ended December 31, 2015 and 2014 was $0.6 million and $0.9 million, respectively.

Refer to Note 6 — Related-Party Arrangements for information regarding the Note payable to principal stockholder.