11. Convertible Debt

0% Convertible Senior Secured Notes due 2020 – 2016 Notes

In March 2016, the Company closed an offering, or the Offering, of $165.0 million aggregate principal amount of 0% Convertible Senior Secured Notes due 2020, or the 2016 Notes, related warrants to purchase up to 21,999,999 shares of the Company’s common stock, or the Warrants, and 219,994 shares of Series Z Non-Convertible Non-Voting Preferred Stock, or the Series Z Preferred Stock, to qualified institutional buyers and accredited investors, or the Purchasers, pursuant to a securities purchase agreement, dated March 15, 2016, or the Securities Purchase Agreement, by and among the Company and the Purchasers. The Offering was led by funds managed by The Baupost Group, L.L.C., collectively, Baupost, which, prior to the Offering, was the holder of approximately 18.1% of the Company’s outstanding common stock.

The 2016 Notes will mature on July 1, 2020, unless earlier repurchased, redeemed or converted in accordance with the indenture entered into in connection with the issuance of the 2016 Notes, or the 2016 Indenture. The 2016 Notes shall only be convertible into shares of common stock of the Company at the conversion rate. In the event of a change of control transaction at any time, the 2016 Notes will be convertible for a period beginning on the closing of such change of control transaction and ending 35 trading days after the closing of such transaction. The conversion rate is 133.333 shares of common stock for each $1,000 principal amount of 2016 Notes, which represents a conversion price of $7.50 per share of common stock. The conversion rate and the corresponding conversion price will be subject to adjustment for certain events, but will not be adjusted for accrued and unpaid interest.

If one or more events of default occurs, then unless the principal of all of the 2016 Notes shall have already become due and payable, either the trustee or the holders of at least 25% in aggregate principal amount of the 2016 Notes then outstanding, by notice in writing to the Company (and to the trustee if given by holders), may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the 2016 Notes to be due and payable immediately, and upon any such declaration the same will become and will automatically be immediately due and payable. If an event of default resulting from a voluntary or involuntary liquidation, reorganization, or other relief occurs and is continuing, 100% of the principal of, and accrued and unpaid interest, if any, on, all 2016 Notes shall become and shall automatically be immediately due and payable.

Upon the occurrence of certain fundamental changes or adverse events related to the regulatory approval for and commercialization of Contrave, and net sales of the Company, as described in the indenture for the 2016 Notes, holders of the 2016 Notes will, at their option, have the right to require the Company to repurchase for cash all or a portion of their 2016 Notes at a repurchase price equal to 100% of the aggregate principal amount of 2016 Notes. In particular, under the indenture an adverse event is deemed to occur if consolidated net product sales (a non-GAAP measure defined in the 2016 Indenture as the Company’s net sales plus aggregate net sales by the Company’s distributors outside the United States) are less than $100 million for fiscal year 2017, provided that the effective date of such adverse event would not be deemed to occur until June 30, 2018. The 2016 Notes were not redeemable by the Company, in whole or in part, prior to the receipt of the required stockholder approvals, or the Stockholder Approval, which the Company obtained at its 2016 annual meeting of stockholders in July 2016. From and after the receipt of the Stockholder Approval, the 2016 Notes are not redeemable, in whole or in part, without the consent of the holders of not less than 70% in aggregate principal amount of the 2016 Notes at the time outstanding.

In March 2016, the Company entered into a Security Agreement by and among the Company, the guarantors party thereto from time to time and U.S. Bank National Association, as the collateral agent, pursuant to which the Company granted a first-priority security interest in substantially all of the Company’s current and future assets, subject to customary exclusions, to secure the Company’s obligations under the indenture. The security interests shall be released once less than 25% of the original principal amount of 2016 Notes issued on the date of the indenture remains outstanding.

The Purchasers received Warrants exercisable for a number of shares of common stock equal to the aggregate principal amount of the 2016 Notes acquired by the Purchasers, multiplied by the conversion rate. The exercise price of the Warrants is $15.00 per share and the Warrants expire on September 21, 2026. From and after the Stockholder Approval, the Warrants became only exercisable for a number of shares of common stock of the Company at the exercise price. In the event of a change of control transaction at any time, the Warrants will be exercisable for a period beginning on closing of such change of control transaction and ending 35 days after such transaction.

Due to the complexity and number of embedded features within the 2016 Notes and as permitted under accounting guidance, the Company elected to account for the 2016 Notes and all the embedded features (which we refer to collectively as, a “hybrid instrument”) under the fair value option. The Company recognizes the convertible debt at fair value rather than at historical cost with changes in fair value recorded in the consolidated statements of operations. Direct costs and fees incurred to issue the 2016 Notes were recognized in earnings as incurred and not deferred. On the initial measurement date of March 21, 2016, the fair value of the hybrid instrument was estimated at $120.0 million, which was $45.0 million lower than the principal amount of $165.0 million. Upfront costs and fees related to items for which the fair value option is elected was $5.3 million and was recorded as a component of selling, general and administrative expense for the year ended December 31, 2016. On September 30, 2017, the aggregate fair value of the 2016 Notes was estimated at approximately $129.2 million.

In connection with the Offering the Company issued 219,994 shares of Series Z Preferred Stock. The Series Z Preferred Stock is not convertible and does not pay or accrete dividends. The Series Z Preferred Stock is entitled to a liquidation preference upon a fundamental change, which includes a change of control. Upon a fundamental change, the Company must pay each holder an amount equal to the lesser of (i) the amount by which $975 exceeds the amount received by holders of each 100 shares of common stock and (ii) $225; provided however that, if $975 does not exceed the amount received by holders of each 100 shares of common stock, then the fundamental change amount will be $0.

The Series Z Preferred Stock expires on the earlier to occur of (a) December 31, 2020 or (b) upon receipt of the consent of the holders of at least seventy percent (70%) of the outstanding shares of Series Z Preferred Stock, voting as a separate class. Expiration requires no cash outlay by the Company. The Series Z Preferred Stock is classified outside of permanent equity, since all of the contingent events requiring payment are not solely within the Company’s control. The gross proceeds received on March 21, 2016, in the Offering, net of fees paid directly to the noteholders, were allocated to the initial fair value of the Warrants and 2016 Notes with the residual amount of approximately $3.3 million allocated to the Series Z Preferred Stock.

2.75% Convertible Senior Notes due 2020 – 2013 Notes

In December 2013, the Company issued $115.0 million in aggregate principal amount of 2.75% Convertible Senior Notes due 2020, or the 2013 Notes, in an offering to qualified institutional buyers conducted in accordance with Rule 144A under the Securities Act of 1933, as amended. Debt issuance costs of approximately $488,000 were primarily comprised of legal, accounting and other professional fees, the majority of which were recorded as a reduction to the 2013 Notes on the consolidated balance sheet and are being amortized to interest expense over the seven-year term of the 2013 Notes.

The Company has the option to settle the 2013 Notes through payment or delivery, as the case may be, of cash, shares of the Company’s common stock or a combination thereof, at the Company’s election. The conversion rate for the 2013 Notes is 12.21225 shares per $1,000 principal amount, which is equivalent to a conversion price of approximately $81.88 per share of common stock, and is subject to adjustment under the terms of the 2013 Notes.

The 2013 Notes will mature on December 1, 2020, unless earlier repurchased or converted in accordance with their terms prior to such date. Prior to the close of business on the business day immediately preceding September 1, 2020, holders may convert all or a portion of their 2013 Notes only under the following circumstances: (1) during any fiscal quarter commencing after March 31, 2014, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period immediately following any ten consecutive trading day period (the “measurement period”) in which, for each trading day of that measurement period, the trading price per $1,000 principal amount of notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock on such trading day and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. On and after September 1, 2020 until the close of business on the business day immediately preceding the maturity date, holders may convert all or a portion of their 2013 Notes at any time, regardless of the foregoing circumstances. Holders of the 2013 Notes will have the right to require the Company to repurchase all or some of their Notes at 100% of their principal amount, plus any accrued and unpaid interest, upon the occurrence of certain events.

The Company pays 2.75% interest per annum on the principal amount of the 2013 Notes semi-annually in arrears in cash on June 1 and December 1 of each year. If a designated event, as defined in the indenture for the 2013 Notes, including, but not limited to, a change in control, certain mergers or liquidation, occurs prior to the maturity date, subject to certain limitations, holders of the 2013 Notes may require the Company to repurchase all or a portion of their 2013 Notes for cash at a repurchase price equal to 100% of the principal amount of the 2013 Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the repurchase date.

The Company accounts separately for the liability and equity components of the 2013 Notes 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 the Company has no outstanding non-convertible public debt, the Company determined that senior, unsecured corporate bonds traded on the market represent a similar liability to the 2013 Notes without the conversion option. The Company estimated the implied interest rate of its 2013 Notes to be 8.69%, 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 rate was applied to the 2013 Notes, which resulted in a fair value of the liability component of $79.7 million upon issuance, calculated as the present value of implied future payments based on the $115.0 million in aggregate principal amount. The $31.3 million difference between the cash proceeds and the estimated fair value of the liability component was recorded in additional paid-in capital as the 2013 Notes were not considered redeemable. The estimated fair value of the 2013 Notes, considering Level 2 inputs, approximates their carrying value based upon the borrowing terms and conditions currently available to the Company.

In December 2016, the Company repurchased approximately $35.0 million in face value of the outstanding 2013 Notes for approximately $10 million in open-market transactions. As a result of the note repurchases, the Company recorded a gain on extinguishment of debt of approximately $18.3 million during the year ended December 31, 2016, determined as the difference between the purchase price and the net carrying value of the 2013 Notes that were purchased. No portion of the purchase price was ascribed to the equity component of the 2013 Notes as the purchase price was equal to the then fair value of the liability component of the 2013 Notes. In February 2017, the Company exchanged approximately $49.6 million in aggregate principal amount of the 2013 Notes for an equal principal amount of 2017 Exchange Notes.

A summary of the liability and equity components of the 2013 Notes is as follows at September 30, 2017 and December 31, 2016 (in thousands):

	September 30,			December 31,
	2017			2016
Principal amount of senior convertible notes outstanding	$	30,303		$	79,903
Unamortized discount of liability component		(4,890	)		(15,477	)
Unamortized debt issuance costs		(46	)		(147	)
Long term convertible debt	$	25,367		$	64,279
Carrying value of equity component, net of issuance costs	$	31,178		$	31,178
Remaining amortization period of discount on the liability component	3.3 years			4.0 years

2.75% Convertible Exchange Senior Notes due 2020 - 2017 Exchange Notes

In February 2017, the Company entered into an indenture, dated as of February 23, 2017, or the 2017 Indenture, between the Company and U.S. Bank National Association, as trustee, governing the Company’s new 2.75% Convertible Exchange Senior Notes due 2020, or the 2017 Exchange Notes. Approximately $49.6 million in aggregate principal amount of the 2013 Notes were exchanged for an equal principal amount of 2017 Exchange Notes.

The 2017 Exchange Notes are the Company’s senior, unsecured obligations and rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated in right of payment to the 2017 Exchange Notes; equal in right of payment to any of the Company’s unsecured indebtedness that is not so subordinated, including the 2013 Notes; effectively junior in right of payment to any of the Company’s secured indebtedness (including the Company’s existing 2016 Notes) to the extent of the value of the assets securing such indebtedness; and are structurally junior to all indebtedness and other liabilities (including trade payables) of the Company’s subsidiaries.

The 2017 Exchange Notes bear interest at a fixed rate of 2.75% per year, payable semi-annually in arrears on June 1 and December 1 of each year, beginning June 1, 2017. Interest on the 2017 Exchange Notes accrues from December 1, 2016. The 2017 Exchange Notes will mature on December 1, 2020, unless earlier repurchased, redeemed or converted.

The 2017 Exchange Notes are convertible at any time prior to the close of business on the business day immediately preceding the maturity date, at the option of the holders, into (i) shares of the Company’s common stock, plus (ii) a cash payment equal to $150 for each $1,000 principal amount of 2017 Exchange Notes converted, or the Additional Conversion Payment, subject to certain adjustments. For conversions prior to September 1, 2018 and prior to the Company’s election to exercise its Mandatory Conversion Right (as defined in the 2017 Indenture), the Company will make an interest make-whole payment to a converting holder for each $1,000 principal amount of 2017 Exchange Notes being converted, or the Interest Make-Whole Payment. The Company may pay any Interest Make-Whole Payment either in cash or in shares of common stock, at the Company’s election. If the Company elects to pay any Interest Make-Whole Payment in cash it will pay cash in an amount equal to the Interest Make-Whole Payment. If Company elects, or is deemed to have elected, to pay any Interest Make-Whole Payment by delivering shares of common stock, the number of shares of common stock a converting holder of 2017 Exchange Notes will receive for each $1,000 principal amount of 2017 Exchange Notes will be the number of shares equal to the amount of the Interest Make-Whole Payment to be paid to such holder, divided by the product of (x) 98% and (y) the simple average of the daily volume-weighted average price of the common stock for the five trading days ending on and including the trading day immediately preceding the conversion date. Subject to compliance with certain conditions, the Company has the right, or the Mandatory Conversion Right, to, at its option, mandatorily convert all of the 2017 Exchange Notes if the daily volume-weighted average price of the common stock is equal to or greater than 60.0% of the applicable conversion price of the 2017 Exchange Notes for at least 20 Daily VWAP Trading Days (as defined in the 2017 Indenture) (whether or not consecutive) during any 30 consecutive Daily VWAP Trading Day period (including the last trading day of such period).

The conversion rate for the 2017 Exchange Note is initially approximately 66.6667 shares of common stock per $1,000 principal amount of 2017 Exchange Notes (equivalent to an initial conversion price of $15.00 per share of common stock), and will be subject to adjustment upon the occurrence of certain events.

The Company may redeem for cash all or any portion of the 2017 Exchange Notes, at its option, on or after December 1, 2019 at a redemption price equal to 100% of the principal amount of the 2017 Exchange Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. Upon a fundamental change (as defined in the indenture governing the 2017 Exchange Notes), subject to certain exceptions, the holders of the 2017 Exchange Notes may require that the Company repurchase some or all of their 2017 Exchange Notes for cash at a repurchase price equal to 100% of the principal amount of the 2017 Exchange Notes being repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. The 2017 Exchange Notes contain customary events of default, which may result in the acceleration of the maturity of the 2017 Exchange Notes.

The exchange of approximately $49.6 million in aggregate principal amount of the 2013 Notes for an equal principal amount of 2017 Exchange Notes, with an initial fair value of $26.4 million, was recognized as an extinguishment of the 2013 Notes. As a result of the exchange, the Company recorded a net gain on extinguishment of debt of approximately $12.3 million during the nine months ended September 30, 2017, determined as the difference between the initial fair value of the 2017 Exchange Notes given in exchange for 2013 Notes with a net carrying value of approximately $40.2 million, net of transaction costs. No portion of the exchange consideration was ascribed to the equity component of the 2013 Notes, as the exchange consideration was equal to the then fair value of the liability component of the 2013 Notes.

Due to the complexity and number of embedded features within the 2017 Exchange Notes and as permitted under accounting guidance, the Company elected to account for the 2017 Exchange Notes and all the embedded features (which we refer to collectively as, a “hybrid instrument”) under the fair value option. The Company recognizes the 2017 Exchange Notes at fair value with changes in fair value recognized in the consolidated statements of operations. Approximately $1.5 million in direct costs and fees incurred to issue the 2017 Exchange Notes were recognized in earnings as incurred and are presented net of the gain on extinguishment of debt. On the closing of the exchange transaction, February 23, 2017, the aggregate fair value of the 2017 Exchange Notes was estimated at approximately $26.4 million. On September 30, 2017, the aggregate fair value of the 2017 Exchange Notes was estimated at approximately $17.0 million.

During the nine months ended September 30, 2017, holders of the 2017 Exchange Notes converted notes with an aggregate principal balance of $9.2 million into 784,237 shares of the Company’s common stock, including 173,705 shares of common stock issued for the Interest Make-Whole Payment, and $1.4 million representing the aggregate Additional Conversion Payment made to the noteholders.