Annual report pursuant to Section 13 and 15(d)

FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

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FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS
12 Months Ended
Dec. 31, 2015
Fair Value Disclosures [Abstract]  
FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS
FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS
We measure our financial assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. Additionally, we are required to provide disclosure and categorize assets and liabilities measured at fair value into one of three different levels depending on the assumptions (i.e., inputs) used in the valuation. Level 1 provides the most reliable measure of fair value while Level 3 generally requires significant management judgment. Financial assets and liabilities are classified in their entirety based on the lowest level of input significant to the fair value measurement. The fair value hierarchy is defined as follows:
Level 1—Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Valuations are based on quoted prices for similar assets or liabilities in active markets, or quoted prices in markets that are not active for which significant inputs are observable, either directly or indirectly.
Level 3—Valuations are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Inputs reflect management’s best estimate of what market participants would use in valuing the asset or liability at the measurement date.
Our common stock purchase warrants issued in conjunction with debt and consulting services are detachable, or free standing, instruments. In addition, we have recorded a derivative liability associated with the conversion feature in our Senior Convertible Note. We estimate fair values of these warrants and derivative liabilities utilizing Level 3 inputs for all classes of warrants and derivative liabilities issued. Other than the Financing Warrant and Senior Convertible Note derivative liability, we use the Black-Scholes option valuation technique as it embodies all of the requisite assumptions (including trading volatility, remaining term to maturity, market price, strike price, and risk free rates) necessary to fair value these instruments. To determine the value of the Financing Warrant and Senior Convertible Note derivative liability, we used a Monte Carlo option-pricing model, which takes into consideration the market values of comparable public companies, considering among other factors, the use of multiples of earnings, and adjusted to reflect the restrictions on the ability of our shares to trade in an active market. We determined that as the Financing Warrant and debt conversion can only be exercised upon the probability of satisfying a performance condition such as a Qualifying IPO or Fundamental Transaction, as provided for in the applicable instrument, and thus a closed-form model such as the Black-Scholes option valuation model would not be appropriate. (See Note 6).
The following assumptions were used in the Black-Scholes option-pricing model to determine the fair value of the warrant liabilities:
 
IPO Date
Assumptions:
 
Risk-free interest rate
1.25% - 2.31%
Expected dividend yield
0%
Expected volatility
64.0% - 69.6%
Expected term (in years)
3.58 – 5.95

We used a fair value per share of our common stock of $6.00 as of the IPO Date to determine the fair value of derivative and warrant liabilities.
We estimated the fair value of our warrants and Senior Convertible Note derivative at the time of issuance and subsequently remeasured the fair value using the Black-Scholes option valuation model or Monte Carlo option-pricing model as discussed above, at each reporting date through the IPO Date, using the following inputs: the risk-free interest rates; the expected dividend rates; the remaining expected life of the warrants; and the expected volatility of the price of the underlying common stock. Under the Monte Carlo option-pricing model we estimated the fair value of the Senior Convertible Note derivative liability and Financing Warrant liability at the time of issuance and subsequent remeasurement dates considering the probability of achieving a milestone, the cost of capital, and the estimated time period the right would be outstanding. The estimates were based, in part, on subjective assumptions and could differ materially following the measurement date (see Note 6). Changes to these assumptions as well as our stock price on the reporting date could have had a significant impact on the fair value of the warrant liabilities until the IPO Date.
As a result of the expiration of the redemption and put option features included in the Bridge Warrants, Consulting Warrant and Financing Warrant as of the IPO Date, under accounting rules, these warrant liabilities are no longer classified as liabilities. There are no warrant liabilities or other liabilities to be measured at fair value on a recurring basis as of December 31, 2014.
The following table provides a reconciliation of all liabilities measured at fair value using Level 3 significant unobservable inputs:
 
Warrant
Liabilities(1)
 
Senior
Convertible
Note Derivative
Liability(2)
Balance at January 1, 2014
$
3,276,084

 
$
5,056,502

Issuance of warrant and derivative liabilities

 

Change in fair value
382,327

 
1,633,272

Write-off due to conversion and IPO
(3,658,411
)
 
(6,689,774
)
Balance at December 31, 2014
$

 
$

(1)
The change in the fair value of the warrants was recorded as a reduction to other income in the consolidated statement of operations of $382,000 for the year ended December 31, 2014. Due to the expiration of the redemption and put option features included in the Bridge Warrants, Consulting Warrant and Financing Warrant as of the IPO Date, these warrant liabilities were recorded as an increase of $3.7 million to additional paid-in capital in the consolidated balance sheet as of December 31, 2014.
(2)
The extinguishment of the senior convertible note derivative liability was recorded as an increase of $5.5 million to additional paid-in capital and a gain of $1.6 million to other income in the consolidated statement of operations for the year ended December 31, 2014.