Fair Value Measurements

9 Months Ended

Sep. 30, 2013

Fair Value Disclosures [Abstract]

Fair Value Measurements

3. Fair Value Measurements

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012 (in thousands):

	SEPTEMBER 30, 2013
	TOTAL		LEVEL 1		LEVEL 2		LEVEL 3
Assets
Money market funds	$	28,660	$	28,660	$	—	$	—

	DECEMBER 31, 2012
	TOTAL		LEVEL 1		LEVEL 2		LEVEL 3
Assets
Money market funds	$	7,668	$	7,668	$	—	$	—
Liabilities
Common stock warrant liability	$	301	$	—	$	—	$	301
Preferred stock warrant liability		1,884		—		—		1,884
Convertible notes payable		41,860		—		—		41,860
Total liabilities at fair value	$	44,045	$	—	$	—	$	44,045

The money market funds held as of September 30, 2013, and December 31, 2012, were in active markets and, therefore, are measured based on the Level 1 valuation hierarchy.

The Company estimated the fair value of the common and preferred stock warrant liabilities as of December 31, 2012 using the Probability Weighted Expected Return Method (PWERM), which analyzes the returns afforded to common equity holders under multiple future scenarios. Under the PWERM, share value is based upon the probability-weighted present value of expected future net cash flows (distributions to shareholders), considering each of the possible future events and giving consideration to the rights and preferences of each share class. This method is most appropriate when the long-term outlook for an enterprise is largely known and multiple future scenarios can be reasonably estimated.

The common and preferred stock warrant liabilities were valued by a PWERM valuation using six scenarios, which included three initial public offering scenarios, two merger scenarios and a sale of the Company’s intellectual property. An annual discount rate of 35% was applied to the PWERM valuations as of December 31, 2012. The common stock warrant liability valuation also included an 18% discount for lack of marketability as of December 31, 2012. As the PWERM estimates the fair value of the common and preferred stock warrant liabilities using unobservable inputs, it is considered to be a Level 3 fair value measurement.

Effective on the date of the IPO, under ASC 815-40-15, Contracts in Entity’s Own Equity, the common and preferred stock warrant liabilities were considered to be indexed to the Company’s stock, and accordingly, the total warrants liability of $2,669,000 was reclassified and included in stockholders’ equity as of September 30, 2013. The Company revalued the warrants immediately prior to the IPO. The fair value of the warrants which would have expired on the date of the IPO unless exercised was determined using the intrinsic method based on the IPO price of $12.00 per share, which is deemed a “Level 2” valuation method. The fair value of the warrants that would not have expired on the date of the IPO regardless of whether or not they were exercised was determined using the Black-Scholes-Merton option-pricing model, which is deemed a “Level 3” valuation method.

As a result of the change in estimated fair value between December 31, 2012 and the closing of the IPO, the Company recognized a net gain from the total change in estimated fair value of the common and preferred stock warrant liabilities as shown in the tables below.

The following table provides a reconciliation of the beginning and ending balances for the common and preferred stock warrant liabilities measured at fair value using significant unobservable inputs (Level 3). The amounts included in the “Transfers out of Level 3” represent the beginning balance in the interim quarter during which it was transferred (in thousands):

	COMMON STOCK WARRANT LIABILITY
Fair value at December 31, 2012	$	301
Warrants issued		900
Change in fair value recorded in change in fair value of financial instruments		377
Transfers out of Level 3		(434	)
Reclassified to stockholders’ equity (deficit)		(1,144	)
Fair value at September 30, 2013	$	—

	PREFERRED STOCK WARRANT LIABILITY
Fair value at December 31, 2012	$	1,884
Change in fair value recorded in change in fair value of financial instruments		(823	)
Transfers out of Level 3		(140	)
Reclassified to stockholders’ equity (deficit)		(921	)
Fair value at September 30, 2013	$	—

Effective on the date of the IPO, all of the Company’s convertible notes were converted into shares of common stock. Prior to the IPO, convertible notes were valued by a PWERM valuation utilizing inputs similar to those used for estimating fair values of the common and preferred stock warrant liabilities described above. A discount rate of 25% was used for valuing the March and October 2012 Convertible Notes, defined in Note 11, as of December 31, 2012. A discount rate of 18% was used for valuing the October 2012 Subordinated Convertible Notes and the December 2012 Convertible Note, both defined in Note 11, as of December 31, 2012. These annual discount rates were applied in the PWERM valuation as of December 31, 2012. The Company revalued the warrants immediately prior to the IPO. As a result of the IPO, the number of shares to be issued became known and the Company estimated the fair value of the convertible notes using the intrinsic method based on the IPO price of $12 per share, which is deemed a “Level 2” valuation method. Due to the change in estimated fair values between December 31, 2012 or the issuance dates of the convertible notes issued during the nine months ended September 30, 2013 and the closing of the IPO, the Company recognized a gain from the change in estimated fair value of the convertible notes as shown in the table below.

The following table provides a reconciliation of the beginning and ending balances for the convertible notes measured at fair value using significant unobservable inputs (Level 3). The amounts included in the “Transfers out of Level 3” represent the beginning balance in the interim quarter during which it was transferred (in thousands):

Fair value at December 31, 2012	$	41,860
Convertible notes issued		9,069
Convertible notes cancelled		(1,360	)
Accrued interest		1,299
Change in fair valued recorded in change in fair value of financial instruments		(2,634	)
Transfers out of Level 3		(48,234	)
Fair value at September 30, 2013	$	—

During the three months ended September 30, 2013, as noted above, there were $574,000 of preferred and common stock warrants and $48,234,000 of convertible notes transferred from the Level 3 to Level 2 category.