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S-1
PROTEON THERAPEUTICS INC filed this Form S-1 on 09/16/2014
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Table of Contents

    Derivative Instruments

        We occasionally issue financial instruments in which a derivative instrument is "embedded." Upon issuing the financial instrument, we assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e., the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument as defined in ASC 815 Derivatives and Hedging. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and (2) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract and carried at fair value with changes in fair value recorded in current period earnings.

    Convertible Notes

        On September 4, 2013, we issued, at par value, convertible promissory notes with an aggregate principal amount of approximately $4.3 million. The notes were due March 31, 2014, upon written notice from holders of a majority of the then-outstanding aggregate principal amount, and accrued interest at an annual rate of 8%. We determined that the debt contained certain features requiring evaluation for separate accounting from the fixed interest rate host instrument including (i) holder's optional conversion upon maturity; (ii) mandatory conversion upon a reverse acquisition; (iii) automatic conversion upon a qualified financing; (iv) holder's optional conversion upon a non-qualified financing; (v) issuer's optional redemption; (vi) redemption upon a change in control; (vii) put upon a breach; and (viii) a put upon an event of default. In certain cases these features require us to either convert the notes or accelerate their repayment at a significant premium to the principal and accrued interest then outstanding.

        The embedded features requiring separate accounting were combined and valued upon issuance using a single income valuation approach. As of September 4, 2013 and December 31, 2013, we ascribed a probability to the automatic conversion upon a qualified financing of 85% and 100%, respectively. As of September 4, 2013 and December 31, 2013, we ascribed a probability to the redemption feature upon a change in control of 15% and 0%, respectively. From December 31, 2013 to the conversion of the convertible notes into Series D convertible preferred stock on May 13, 2014, as described below, the estimates of these probabilities did not change. For all other features included in the combined embedded derivative, we estimated a 0% probability of occurrence at all times.

        We recorded approximately $1.4 million as the fair value of the combined embedded derivative liability on September 4, 2013, with a corresponding amount recorded as debt discount. The debt discount has been amortized to interest expense over the life of the notes using the effective interest method. As of December 31, 2013 and June 30, 2014, the fair value of the combined embedded derivative liability was $1.4 million and $0, respectively. Changes in the estimated fair value of the embedded features were recorded in earnings in the period in which they occurred.

        In connection with the issuance of our Series D convertible preferred stock on May 13, 2014, the notes in the aggregate amount of approximately $4.6 million in principal plus accrued interest were converted into 10,344,201 shares of Series D convertible preferred stock. As the debt discount had been fully amortized prior to conversion, there was no gain or loss recognized upon conversion of the notes.

    Stock-Based Compensation

        From our inception in June 2001, until December 31, 2005, we applied the guidance in Accounting Principles Bulletin, or APB 25. Under APB 25, there is no stock-based compensation expense recognized for awards granted with an exercise price equal to the fair value of the underlying stock on the date of grant.

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