(8) Senior Convertible Notes

Senior Convertible Notes consist of the following:


	June 30, 2014		December 31, 2013
	(In thousands)
March 2013 Investor Notes	$	—	$	24,482
March 2013 Arcapita Notes	$	—		3,653


Total Senior Convertible Notes	$	—	$	28,135

Effective March 28, 2013, the Company entered into a Note and Warrant Purchase Agreement (March 2013 NPA) authorizing the issuance of $22.5 million of Senior Subordinated Convertible Notes (the March 2013 Investor Notes) and Senior Subordinated Arcapita Notes (the March 2013 Arcapita Notes) (collectively, the Senior Convertible Notes). At each closing under the March 2013 NPA, the Company issued warrants to purchase shares of a newly created Series C Preferred Stock (the Series C) based on the principal balance of Senior Convertible Notes issued to each purchaser. The Company determined that the Series C warrants, which were subject to net share settlement, were equity classified. Collectively, the warrants issued pursuant to the March 2013 NPA were exercisable for Series C shares equal to 85.7% of the then outstanding capital stock of the Company on a fully diluted basis. The warrants had an exercise price of $0.0001 per share, were immediately exercisable and were scheduled to expire by their terms on March 28, 2023.

Pursuant to side letter agreements, in March and May 2013, holders of $7.5 million of Convertible Notes (see note 9) issued in November 2012 and January 2013 (the Initial Notes) exchanged their original principal balance for an equivalent principal amount of Senior Convertible Notes (the Exchanged Notes) and a pro-rata share of Series C warrants issued under the March 2013 NPA. The Company accounted for the warrants as a debt issuance cost and recorded an immediate charge for the fair value of the Series C warrants totaling $5.4 million in other income (expense). Pursuant to the exchange, the holders of the Exchanged Notes received notes senior in preference to the Initial Notes and with an extended maturity date of March 28, 2016.

Given that the terms of the Exchanged Notes were substantially different than the terms of the Initial Notes, the exchange was accounted for as an extinguishment of debt. Upon the exchange, the Company recognized a loss totaling $5.7 million for the six month period ended June 30, 2013. This loss represents the difference between (i) the fair value of the Exchanged Notes at reissuance and the fair value of Series C preferred stock warrants, and (ii) the carrying value of the Initial Notes. The Company elected to account for all of the issuances of its Senior Convertible Notes and various embedded derivatives in accordance with ASC Topic 825-10, Fair Value Option for Financial Liabilities, whereby the Company initially and subsequently measured this financial instrument in its entirety at fair value, with the changes in fair value recorded each reporting period in interest expense (income).

In March and May 2013, the Company issued an additional $5.0 million and $10.0 million of Senior Convertible Notes, respectively. The noteholders received a pro-rata share of Series C warrants for their participation in these financings. The Company accounted for the warrant issuances as a debt issuance cost and recorded an immediate charge for the fair value of the Series C warrants. For the three and six months ended June 30, 2013, the Company recorded $7.1 million and $10.7 million, respectively, as a charge to interest expense related to the warrants (see note 11).

In conjunction with the March 2013 NPA, the Company incurred $0.9 million of debt issuance costs during the six months ended June 30, 2013. These debt issuance costs were allocated between the debt and equity instruments related to the transaction. Of the total debt issuance costs, $0.6 million was allocated to the Senior Convertible Notes and recorded through interest expense, while the remaining $0.3 million was allocated to the Series C warrants with an offset for additional paid-in capital.

Net proceeds from the issuance of the Senior Convertible Notes were used (i) for investment in working capital to support revenue growth, (ii) for capital expenditures to improve the efficiency and throughput of existing manufacturing assets, and (iii) for settlement of all cash obligations under the Company’s cross license agreement with Cabot Corporation.

Upon the closing of the Company’s initial public offering discussed in note 2, the outstanding principal and accrued interest on the Senior Convertible Notes were marked to an aggregate fair value of $39.5 million and automatically converted into 3,591,604 shares of common stock equal to the unpaid principal amount of the Senior Convertible Notes and accrued interest as of June 18, 2014 divided by the Conversion Percentage, which was 62.5% of the initial public offering price of $11.00 per share. In addition, all outstanding Series C warrants were automatically net exercised, which together with the then outstanding shares of Series C preferred stock converted into 104,734 shares of common stock upon the closing of the Company’s IPO.

Fair Value Option

The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of the Senior Convertible Notes recorded at fair value at December 31, 2013:


	Aggregate fair value December 31, 2013		Aggregate unpaid principal balance December 31, 2013		Fair value over unpaid principal balance
	(In thousands)
March 2013 Investor Notes	$	24,482	$	19,567	$	4,915
March 2013 Arcapita Notes		3,653		2,980		673


Total Senior Convertible Notes	$	28,135	$	22,547	$	5,588

Fair Value Measurements

The change in the fair values of the Senior Convertible Notes during the six months ended June 30, 2013 and 2014 was determined by utilizing probability weighted discounted cash flow analyses, which took into consideration market and general economic events, as well as the Company’s financial results and other data available as of June 30, 2013 and 2014. These analyses determined the amount to be paid on the Senior Convertible Notes in either cash or shares at the occurrence of certain events in which the Senior Convertible Notes would be converted into shares of the Company’s common stock or would be repaid in cash. The probability weighted discounted cash flow analyses utilized assumptions related to the probability of the occurrence of each of the various events and appropriate discount rates for each of the scenarios as follows:


	December 31, 2013					June 30, 2013
Potential exit scenario event	Estimated exit date of future event		Estimated probability of future event			Estimated exit date of future event		Estimated probability of future event
IPO scenario 1		06/30/14		45	%		06/30/14		15	%
IPO scenario 2		03/31/15		5	%		03/31/15		25	%
Sale scenario 1		06/30/14		15	%		06/30/14		25	%
Sale scenario 2		03/31/15		15	%		03/31/15		20	%
Dissolution		09/30/14		5	%		03/31/14		10	%
Private company		At maturity		15	%		At maturity		5	%

The above scenarios incorporated a weighted average implied discount rate of 41.7% at both December 31, 2013 and June 30, 2013.

The fair value of the Senior Convertible Notes upon the closing of the Company’s IPO was determined to be $39.5 million.

The following table presents a roll-forward of the fair value of Level 3 (significant unobservable inputs) Senior Convertible Notes for the six months ended June 30, 2014 and 2013:


	March 2013 Investor Notes			March 2013 Arcapita Notes			Total Senior Convertible Notes
	(In thousands)
Beginning balance as of December 31, 2013	$	24,482		$	3,653		$	28,135
Change in fair value included in interest expense		9,803			1,570			11,373
Conversion of the Senior Convertible Notes		(34,285	)		(5,223	)		(39,508	)


Balance at June 30, 2014	$	—		$	—		$	—


	March 2013 Investor Notes		March 2013 Arcapita Notes		Total Senior Convertible Notes
	(In thousands)
Beginning balance as of December 31, 2012	$	—	$	—	$	—
Issuances of Senior Convertible Notes		13,434		1,536		14,970
Fair value of notes exchanged		6,132		1,444		7,576
Change in fair value included in interest expense		1,270		186		1,456


Balance at June 30, 2013	$	20,836	$	3,166	$	24,002

Changes in fair value of the Company’s Senior Convertible Notes for the six months ended June 30, 2014 and 2013 was $11.4 million and $1.5 million, respectively. Included in interest income (expense) for the six months ended June 30, 2013 was the charge for the fair value of the Series C warrants of $10.7 million (see note 11).