J. DEBT

Convertible Senior Notes

Long-term debt, net is comprised of the Company’s Convertible Senior Notes, as follows:

	September 30, 2013			December 31, 2012
	(in thousands)
2020 Convertible Senior Notes
Principal amount outstanding	$	450,000		$	—
Unamortized discount	(114,323		)	—
Net carrying amount	335,677			—
2018 Convertible Senior Notes
Principal amount outstanding	350,000			—
Unamortized discount	(68,784		)	—
Net carrying amount	281,216			—
2017 Convertible Senior Notes
Principal amount outstanding	228,822			450,000
Unamortized discount	(36,176		)	(82,189		)
Net carrying amount	192,646			367,811
Total Convertible Senior Notes
Principal amount outstanding	1,028,822			450,000
Unamortized discount	(219,283		)	(82,189		)
Net carrying amount	$	809,539		$	367,811

In accordance with accounting guidance for debt with conversion and other options, Cubist accounted for the Convertible Senior Notes by allocating the proceeds between the liability component and the embedded conversion option, or equity component, due to Cubist’s ability to settle the Convertible Senior Notes in cash, common stock or a combination of cash and common stock, at Cubist’s option. The allocation was performed in a manner that reflected the non-convertible debt borrowing rate of Cubist for similar debt. The equity component of the Convertible Senior Notes was recognized as a debt discount and represents the difference between the proceeds from the issuance of the convertible notes and the fair value of the liability of the Convertible Senior Notes on their respective dates of issuance. The debt discount is amortized to interest expense using the effective interest method over the expected life of a similar liability without an equity component.

2018 Convertible Senior Notes and 2020 Convertible Senior Notes

In September 2013, Cubist issued $800.0 million aggregate principal amount of convertible senior unsecured notes in two series, with one series consisting of $350.0 million aggregate principal amount of the 2018 Notes, and the other series consisting of $450.0 million aggregate principal amount of the 2020 Notes, resulting in net proceeds to Cubist, after debt issuance costs, of $775.6 million. The 2018 Notes and 2020 Notes are convertible into common stock at an initial conversion rate of 12.1318 shares of common stock per $1,000 principal amount of convertible notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $82.43 per share of common stock. Holders of the 2018 Notes and 2020 Notes may convert their notes at any time prior to the close of business on the business day immediately before March 1, 2018 or March 1, 2020, respectively, only under the following circumstances: (i) during any calendar quarter (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (ii) during the five business day period after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of Cubist’s common stock and the conversion rate on each such trading day; or (iii) upon the occurrence of specified corporate events. Upon conversion, Cubist may deliver cash, common stock or a combination of cash and common stock, at Cubist’s option.

The 2018 Notes and 2020 Notes will mature on September 1, 2018 and 2020, respectively, unless repurchased or converted in accordance with their terms prior to such date. The 2018 Notes and 2020 Notes bear cash interest at an annual rate of 1.125% and 1.875%, respectively, which is payable on March 1st and September 1st of each year, beginning on March 1, 2014. As of September 30, 2013, the “if-converted value” did not exceed the principal amount of the 2018 Notes and 2020 Notes.

In connection with the issuance of the 2018 Notes and 2020 Notes, the Company incurred $24.4 million of issuance costs, which primarily consisted of underwriting, legal and other professional fees. The portions of these costs allocated to the equity components totaling $5.6 million were recorded as a reduction to additional paid-in capital. The portions of these costs allocated to the liability components totaling $18.8 million were recorded as assets on the balance sheet. The portions allocated to the liability components are amortized to interest expense using the effective interest method over the expected life of the respective 2018 Notes and 2020 Notes.

The Company determined the expected life of the debt discount for the 2018 Notes and 2020 Notes to be equal to the original five-year and seven-year terms of each of the 2018 Notes and 2020 Notes, respectively. The carrying value of the equity component related to the 2018 Notes and 2020 Notes as of September 30, 2013, net of issuance costs and taxes, was $42.6 million and $70.5 million, respectively. The effective interest rates on the liability components of the 2018 Notes and 2020 Notes for the period from the date of issuance through September 30, 2013 were 5.7% and 6.4%, respectively.

2017 Convertible Senior Notes

In October 2010, Cubist issued $450.0 million aggregate principal amount of the 2017 Notes, resulting in net proceeds to Cubist, after debt issuance costs, of $436.0 million. The 2017 Notes are convertible into common stock at an initial conversion rate of 34.2759 shares of common stock per $1,000 principal amount of convertible notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $29.18 per share of common stock. Holders of the 2017 Notes may convert the 2017 Notes at any time prior to the close of business on the business day immediately preceding May 1, 2017, only under the following circumstances: (i) during any calendar quarter (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (ii) during the five business day period after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of Cubist’s common stock and the conversion rate on each such trading day; or (iii) upon the occurrence of specified corporate events. Upon conversion, Cubist may deliver cash, common stock or a combination of cash and common stock, at Cubist’s option.

The 2017 Notes will mature on November 1, 2017, unless repurchased or converted in accordance with their terms prior to such date. The 2017 Notes bear cash interest at an annual rate of 2.50%, which is payable on May 1st and November 1st of each year. As of September 30, 2013, the “if-converted value” exceeded the remaining principal amount of the 2017 Notes by $269.6 million.

The Company determined the expected life of the debt discount for the 2017 Notes to be equal to the original seven-year term of each of the 2017 Notes, resulting in an amortization period ending November 1, 2017. For the nine months ended September 30, 2013, the effective interest rate on the liability component of the 2017 Notes was 7.0%.

In September 2013, certain holders of $221.2 million of the aggregate principal amount of the 2017 Notes converted their notes at a conversion rate of 34.2759 shares of common stock per $1,000 of principal amount, or approximately $29.18 per share of common stock, into 7,580,923 shares of the Company’s common stock. To induce these holders to convert, the Company agreed to make individually-negotiated cash payments to the converting holders of the 2017 Notes in an aggregate amount of $22.0 million as consideration for their agreement to convert their 2017 Notes. No transaction or solicitation fees were incurred as a result of the conversion and privately-negotiated payments. The conversions were accounted for as an extinguishment of the liability and equity components of the 2017 Notes. In accordance with the accounting guidance for induced conversions of convertible debt with a cash conversion feature, the Company recognized an aggregate loss of $34.6 million during the three months ended September 30, 2013, comprised of: (i) $22.0 million equal to the amount of the cash inducement payments, which represents the fair value of the consideration transferred in excess of the fair value of consideration issuable in accordance with the original conversion terms and (ii) $12.6 million representing the difference between the net carrying value and the fair value of the liability component of the principal at the time of each conversion. The aggregate loss was recorded to other income (expense) within the condensed consolidated statement of comprehensive income. The remainder of the consideration transferred was allocated to the reacquisition of the equity component and recorded as a reduction to additional paid-in capital.

Convertible Bond Hedge and Warrant Transactions

To minimize the impact of potential dilution to the Company’s common stock upon conversion of the 2018 Notes and 2020 Notes, Cubist entered into convertible bond hedges covering 9,705,442 shares of the Company’s common stock. The convertible bond hedges have an exercise price of approximately $82.43 per share and are exercisable when and if the 2018 Notes and 2020 Notes are converted. If upon conversion of the 2018 Notes and 2020 Notes, the price of the Company’s common stock is above the exercise price of the convertible bond hedges, the counterparties will deliver shares of the Company’s common stock and/or cash with an aggregate value approximately equal to the difference between the price of the Company’s common stock at the conversion date and the exercise price, multiplied by the number of shares of the Company’s common stock related to the convertible bond hedge transaction being exercised. The convertible bond hedges are separate transactions entered into by the Company and are not part of the terms of the 2018 Notes, 2020 Notes or the warrants. Holders of the 2018 Notes, 2020 Notes and warrants will not have any rights with respect to the convertible bond hedges. The Company paid $179.4 million for these convertible bond hedges and recorded this amount as a reduction to additional paid-in capital, net of tax.

Concurrently with entering into the convertible bond hedge transactions, Cubist entered into warrant transactions whereby Cubist sold warrants to acquire, subject to customary adjustments, 9,705,442 shares of the Company’s common stock with an exercise price of approximately $96.43 per share, also subject to adjustment. The warrants are exercisable over the 80 trading day period beginning on November 30, 2018 or November 30, 2020, as applicable. The warrants will have a dilutive effect to the extent that the market price per share of the Company’s common stock, as measured under the terms of the warrant transactions, exceeds the applicable exercise price of the warrants during the measurement period at the maturity of the warrants. The Company received $121.7 million for these warrants and recorded this amount to additional paid-in capital.

Credit Facility

In November 2012, Cubist entered into a $150.0 million three-year senior secured, syndicated revolving credit facility, or the credit facility, with a group of lenders, including Royal Bank of Canada, as administrative agent. On September 3, 2013, the Company entered into an amendment to the credit facility. The credit facility was amended to: (i) permit the 2018 Notes, 2020 Notes and the convertible bond hedge and warrant transactions; (ii) adjust the definition of consolidated EBITDA to permit specific acquisitions; (iii) modify certain covenants related to investments, restricted payments and indebtedness; (iv) add additional financial covenants including a senior secured leverage ratio and minimum liquidity requirement; (v) increase the maximum permitted level of the Company’s total leverage ratio; and (vi) allow for the option to increase the credit facility by up to an additional $150.0 million, subject to pro forma compliance with financial covenants under the credit facility. In addition, the amendment added a new pricing tier based on the Company’s total leverage ratio. As a result, the applicable margin ranges from 2.25% to 3.00% for the Eurodollar rate and 1.25% to 2.00% for the base rate based on the Company’s total leverage ratio. The credit facility, which includes a sublimit for letters of credit, will be used for general corporate purposes. There were no outstanding borrowings under the credit facility as of September 30, 2013 or December 31, 2012.