10. Fair Value of Financial Instruments

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.

The carrying amounts reported in the accompanying consolidated financial statements for cash, accounts receivable, accounts payable, and accrued expenses and other current liabilities (excluding the milestone rights liability) approximate their fair value due to their relatively short maturities. The fair value of the cash equivalents, note payable to principal stockholder (also referred to as The Mann Group Loan Arrangement), senior convertible notes, the facility financing obligation, the milestone rights liability and the warrant liability are disclosed in Note 10 – Fair Value of Financial Instruments.

The fair value of the cash equivalents, note payable to principal stockholder, senior convertible notes, the Facility Financing Obligation (as defined below), the Milestone Rights (as defined below) and warrant liability are discussed below.

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 December 31, 2017 and 2016, the Company held $41.0 million and $20.5 million, respectively, of cash equivalents, comprised of money market funds. The fair value of these money market funds was determined by using quoted prices for identical investments in an active market (Level 1 in the fair value hierarchy).

Note Payable to Principal Stockholder — The fair value of the note payable to the Company’s principal stockholder cannot be reasonably estimated as the Company would not be able to obtain a similar credit arrangement in the current economic environment. Therefore, the fair value is based upon carrying value.

Financial Liabilities — The following tables set forth the fair value of the Company’s financial instruments (in millions):

	As of December 31, 2017
			Fair Value Measurements Using
	Carrying Amount		Quoted Price in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value
Financial liabilities:
Senior convertible notes (2021 notes)	$	24.4	$	—	$	—	$	19.8	$	19.8
Facility financing obligation		52.7		—		—		54.6		54.6
Milestone rights		8.9		—		—		19.1		19.1
Total financial liabilities	$	86.0	$	—	$	—	$	93.5	$	93.5

	As of December 31, 2016
			Fair Value Measurements Using
	Carrying Value		Quoted Price in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value
Financial liabilities:
Senior convertible notes (2018 notes)	$	27.6	$	—	$	—	$	22.9	$	22.9
Facility financing obligation		71.3		—		—		74.5		74.5
Milestone rights		8.9		—		—		18.4		18.4
Warrant liability (at recurring fair value)		7.4		—		—		7.4		7.4
Total financial liabilities	$	115.2	$	—	$	—	$	123.2	$	123.2

The following table provides a roll forward of the fair values of financial assets and liabilities that are carried at fair value (in millions):

	Warrants			Assets Held for Sale
Fair value, January 1, 2016	$	—		$	—
Additions		12.8			17.3
Changes in fair value		(5.4	)		(0.6	)
Payments		—			—
Fair value, December 31, 2016	$	7.4		$	16.7
Additions		—			—
Changes in fair value		(5.5	)		—
Settlement through exchange of common shares		(1.9	)
Payments		—			(16.7	)
Fair value, December 31, 2017	$	—		$	—

Senior Convertible Notes — The estimated fair value of the 2021 notes was calculated based on model-derived valuations whose inputs were observable, such as the Company’s stock price and yields on U.S. Treasury notes and actively traded bonds, and non-observable, such as the Company’s longer-term historical volatility, and estimated yields implied from any available market trades of the Company’s issued debt instruments. As there was no current active and observable market for the 2021 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 flows based on terms of the notes with market-based assumptions regarding risk-free rate, risk-adjusted yields (20%), stock price volatility (102%) and recent price quotes and trading information regarding Company issued debt instruments and shares of common stock into which the notes are convertible (Level 3 in the fair value hierarchy).

Facility Financing Obligation — As discussed in Note 7 — Borrowings, the Company issued 2019 notes and subsequently issued Tranche B notes (the “Facility Financing Obligation”) in connection with the Facility Agreement. As there is no current observable market for the Facility Financing Obligation, 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. On December 31, 2017, the market discount rate was 12-13% for the principal for the facility financing obligation. Under the terms of the Facility Agreement, the Company is restricted from distributing any of its assets or declaring and distributing a dividend to its stockholders.

Milestone Rights Liability — In addition to the Facility Financing Obligation, the Company also issued the Milestone Rights. These rights are not reflected in the Facility Financing Obligation. 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 (14%) was selected based on an estimation of required rate of returns for similar investment opportunities using available market data. As of December 31, 2017, the carrying value of the milestone rights liability was $8.9 million and the fair value was estimated at $19.1 million. The fair value measurement of the liability is sensitive to the discount rate and the timing and probability of making milestone payments. If the achievement of each of the milestones which require payments were to be six months later than in the current forecast, the fair value of the liability would decrease by 4%. If the probabilities of meeting the $50 to $200 million milestones were to decrease by 5% or 10%, the fair value of the liability would decrease by 14% and 28%, respectively. Over the long term, these inputs are interrelated because if the Company’s performance improves, the timing of meeting the milestones would likely be earlier, the probability of making payments on the milestones would likely be higher and the discount rate would likely decrease, all of which would increase the fair value of the liability. The inverse is also true.

Warrant Liability — Warrant liabilities were measured at fair value using a Monte Carlo pricing valuation model. The assumptions used in the valuation model for the common stock warrant liabilities were: (a) a risk-free interest rate based on the rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the remaining contractual term of the warrants; (b) an assumed dividend yield of zero percent based on the Company’s expectation that it will pay no dividends in the foreseeable future; (c) an expected term based on the remaining contractual term of the warrants; (d) an expected volatility based upon the Company’s historical volatility over the remaining contractual term of the warrants; and (e) probability of a dilutive financing that may trigger a price protection clause. The significant unobservable input used in measuring the fair value of the common stock warrant liabilities is the expected volatility. Significant increases in volatility would result in a higher fair value measurement (Level 3 in the fair value hierarchy).

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis – Our assessment of the real property includes Level 3 inputs, and was based on a combination of the income, market and cost approaches and the market approach was used for machinery and equipment which required Level 3 inputs.

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. 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, 2017 and 2016.