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PROTEON THERAPEUTICS INC filed this Form S-1/A on 10/07/2014
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Proteon Therapeutics, Inc.

Notes to Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

not a measure of the investment credit quality. Fair value measurements are classified and disclosed in one of the following three categories:

    Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
    Level 2—Valuations based on quoted prices for similar assets or liabilities in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
    Level 3—Valuations that require inputs that reflect the Company's own assumptions that are both significant to the fair value measurement and unobservable.

        To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

        Financial instruments measured at fair value on a recurring basis include cash equivalents, short-term investments (Note 3) and the derivative liability associated with the Convertible Notes (Note 5). The fair value of the derivative liability was determined based on Level 3 inputs as described in Note 5. An entity may elect to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in net loss. The Company did not elect to measure any additional financial instruments or other items at fair value. The Company is also required to disclose the fair value of financial instruments not carried at fair value. The carrying value of the Company's Convertible Notes approximates fair value considering their short-term maturity dates and considering that the stated interest rate is near current market rates for instruments with similar conversion and settlement features.

        There have been no changes to the valuation methods utilized by the Company during the years ended December 31, 2012 and 2013, the six months ended June 30, 2013 and 2014 (unaudited). The Company evaluates transfers between levels at the end of each reporting period. There were no transfers of financial instruments between levels during the years ended December 31, 2012 and 2013, the six months ended June 30, 2013 and 2014 (unaudited).

Derivative Instruments

        The Company occasionally issues financial instruments in which a derivative instrument is "embedded". Upon issuing the financial instrument, the Company 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. 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 any changes in fair value recorded in current period earnings.

        In connection with the issuance of the Convertible Notes in September 2013 and the Series D Preferred Stock in May 2014, the Company identified certain embedded features which require separation