Fair value of financial instruments and marketable securities

The Company follows the fair value measurement rules, which provide guidance on the use of fair value in accounting and disclosure for assets and liabilities when such accounting and disclosure is called for by other accounting literature. These rules establish a fair value hierarchy for inputs to be used to measure fair value of financial assets and liabilities. This hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three levels: Level 1 (highest priority), Level 2, and Level 3 (lowest priority).


·	Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the balance sheet date.

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).


·	Level 3—Inputs are unobservable and reflect the Company’s assumptions as to what market participants would use in pricing the asset or liability. The Company develops these inputs based on the best information available.

Cash equivalents and investments are reflected in the accompanying financial statements at fair value. The carrying amount of receivables, accounts payable and accrued expenses, and debt approximates fair value due to the short-term nature of those instruments.

Fair value of certain marketable securities is based upon market prices using quoted prices in active markets for identical assets quoted on the last day of the period. In establishing the estimated fair value of the remaining investments, the Company used the fair value as determined by its investment advisors using observable inputs other than quoted prices.

The Company reviews its investments on a periodic basis for other-than-temporary impairments. This review is subjective, as it requires management to evaluate whether an event or change in circumstances has occurred in that period that may have a significant adverse effect on the fair value of the investment.

The following represents the fair value using the hierarchy described above for the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018:



	March 31, 2019
	Total		Quoted prices in active markets for identical assets (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)
Marketable securities	$	206,018	$	—	$	206,018	$	—
Stock appreciation rights liability	$	1,034	$	—	$	—	$	1,034
Deferred consideration payable	$	38,200	$	—	$	38,200	$	—
Contingent consideration payable- development and regulatory milestones	$	270,800	$	—	$	—	$	270,800
Contingent consideration payable- net sales milestones and royalties	$	60,100	$	—	$	—	$	60,100



	December 31, 2018
	Total		Quoted prices in active markets for identical assets (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)
Marketable securities	$	58,088	$	—	$	58,088	$	—
Stock appreciation rights liability	$	3,814	$	—	$	—	$	3,814
Deferred consideration payable	$	37,700	$	—	$	37,700	$	—
Contingent consideration payable- development and regulatory milestones	$	257,040	$	—	$	—	$	257,040
Contingent consideration payable- net sales milestones and royalties	$	53,200	$	—	$	—	$	53,200

No transfers of assets between Level 1, Level 2, or Level 3 of the fair value measurement hierarchy occurred during the periods ended March 31, 2019 and December 31, 2018.

The following is a summary of marketable securities accounted for as available-for-sale securities at March 31, 2019 and December 31, 2018:



	March 31, 2019
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
Commercial paper	$	78,032	$	46	$	—		$	78,078
Corporate debt securities	114,811		68		(46		)	114,833
Asset-backed securities	13,104		4		(1		)	13,107
Total	$	205,947	$	118	$	(47	)	$	206,018



	December 31, 2018
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
Commercial paper	$	31,657	$	43	$	(1	)	$	31,699
Corporate debt securities	26,399		—		(10		)	26,389
Total	$	58,056	$	43	$	(11	)	$	58,088

At March 31, 2019 and December 31, 2018, the Company held securities with an unrealized loss position that were not considered to be other-than-temporarily impaired as the Company has the ability to hold such investments until recovery of their fair value. Unrealized gains and losses are reported as a component of accumulated other comprehensive (loss) income in stockholders’ equity. As of March 31, 2019 and December 31, 2018, the Company did not have any realized gains/losses from the sale of marketable securities.

The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of March 31, 2019 are as follows:



	March 31, 2019
	Securities in an unrealized loss position less than 12 months					Securities in an unrealized loss position greater than 12 months				Total
	Unrealized losses			Fair Value		Unrealized losses		Fair Value		Unrealized losses			Fair Value
Commercial paper	$	—		$	—	$	—	$	—	$	—		$	—
Corporate debt securities	(46		)	61,716		—		—		(46		)	61,716
Asset-backed securities	(1		)	6,077		—		—		(1		)	6,077
Total	$	(47	)	$	67,793	$	—	$	—	$	(47	)	$	67,793

The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of December 31, 2018 are as follows:



	December 31, 2018
	Securities in an unrealized loss position less than 12 months					Securities in an unrealized loss position greater than 12 months					Total
	Unrealized losses			Fair Value		Unrealized losses			Fair Value		Unrealized losses			Fair Value
Commercial paper	$	(1	)	$	1,993	$	—		$	—	$	(1	)	$	1,993
Corporate debt securities	(7		)	14,230		(3		)	10,087		(10		)	24,317
Total	$	(8	)	$	16,223	$	(3	)	$	10,087	$	(11	)	$	26,310

Marketable securities on the balance sheet at March 31, 2019 and December 31, 2018 mature as follows:



	March 31, 2019
	Less Than 12 Months		More Than 12 Months
Commercial paper	$	78,078	$	—
Corporate debt securities	55,621		59,212
Asset-backed securities	11,176		1,931
Total Marketable securities	$	144,875	$	61,143



	December 31, 2018
	Less Than 12 Months		More Than 12 Months
Commercial paper	$	31,699	$	—
Corporate debt securities	26,389		—
Total Marketable securities	$	58,088	$	—

The Company classifies all of its securities as current as they are all available for sale and are available for current operations.

Convertible 3.0% senior notes

In August 2015, the Company issued $150.0 million of 3.0% convertible senior notes due August 15, 2022 (the “Convertible Notes”). Interest is payable semi-annually on February 15 and August 15 of each year, beginning on February 15, 2016. The Company separately accounted for the liability and equity components of the Convertible Notes by allocating the proceeds between the liability component and equity component, as further discussed in Note 10. The fair value of the Convertible Notes, which differs from their carrying values, is influenced by interest rates, the Company’s stock price and stock price volatility and is determined by prices for the Convertible Notes observed in market trading which are Level 2 inputs. The estimated fair value of the Convertible Notes at March 31, 2019 and December 31, 2018 was $154.3 million and $146.6 million, respectively.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and borrowings under the credit and security agreement with MidCap Financial Trust and other financial institutions (as further discussed in Note 10) approximate fair value because of the immediate or short-term maturity of these financial instruments. The carrying amounts for the credit and security agreement approximate fair value based on market activity for other debt instruments with similar characteristics and comparable risk.

Deferred consideration payable

Pursuant to the Merger Agreement, Agilis equityholders may become entitled to receive contingent consideration payments from the Company based on the achievement of certain development milestones up to an aggregate maximum amount of $60.0 million and the achievement of certain regulatory approval milestones together with a milestone payment following the receipt of a priority review voucher up to an aggregate maximum amount of $535.0 million. The Company is required to pay $40.0 million of development milestone payments no later than the second anniversary of the closing of the Merger, regardless of whether the applicable milestones have been achieved. The fair value of the deferred consideration payable at March 31, 2019 was estimated to be $38.2 million by applying a discounted cash flow approach. The discount rates are estimated utilizing Corporate B rated bonds maturing in the years of expected payments based on the Company’s estimated development timelines for the acquired product candidates. As of March 31, 2019, $19.3 million of the deferred consideration payable was classified as current on the balance sheet.

Level 3 valuation

The stock appreciation rights ("SARs") liability is classified in Other liabilities on the Company’s consolidated balance sheets. The SARs liability is marked-to-market each reporting period with the change in fair value recorded as compensation expense on the Company’s consolidated statements of operations until the SARS vest. The fair value of the SARs liability is determined at each reporting period by utilizing the Black-Scholes option pricing model.

The contingent consideration payable is fair valued each reporting period with the change in fair value recorded as a gain or loss in the consolidated statements of operations. The fair value of the development and regulatory milestones is estimated utilizing a probability adjusted, discounted cash flow approach. The discount rates are estimated utilizing Corporate B rated bonds maturing in the years of expected payments based on the Company’s estimated development timelines for the acquired product candidate. The fair value of the net sales milestones and royalties is determined utilizing an option pricing model with Monte Carlo simulation to simulate a range of possible payment scenarios, and the average of the payments in these scenarios is then discounted to calculate present fair value.

The table presented below is a summary of changes in the fair value of the Company’s Level 3 valuations for the SARs liability, and the contingent consideration payable for the period ended March 31, 2019. The changes in the fair value of the Company's Level 3 valuations for the period ended March 31, 2018 were immaterial.



	Level 3 liabilities
	SARs			Contingent consideration payable- development and regulatory milestones		Contingent consideration payable- net sales milestones and royalties
Beginning balance as of December 31, 2018	$	3,814		$	257,040	$	53,200
Additions	—			—		—
Change in fair value	1,035			13,760		6,900
Payments	(3,815		)	$	—	$	—
Ending balance as of March 31, 2019	$	1,034		$	270,800	$	60,100

The following significant unobservable inputs were used in the valuation of the SARs liability, and the contingent consideration payable for the periods ended March 31, 2019 and December 31, 2018:



	March 31, 2019
	Fair Value	Valuation Technique	Unobservable Input	Range
SARs	$1,034	Option-pricing model	Volatility	57.34%
			Risk free interest rate	2.42%
			Strike price	$6.76 - $30.86
			Fair value of common stock	$37.64
			Expected life	0.76 years
Contingent consideration payable- development and regulatory milestones	$270,800	Probability-adjusted discounted cash flow	Potential development and regulatory milestones	$0 - $555 million
			Probabilities of success	25% - 94%
			Discount rates	4.3% - 6.4%
			Projected years of payments	2020 - 2026
Contingent considerable payable- net sales milestones and royalties	$60,100	Option-pricing model with Monte Carlo simulation	Potential net sales milestones	$0 - $150 million
			Probabilities of success	25% - 89%
			Potential percentage of net sales for royalties	2% - 6%
			Discount rate	13.5%
			Projected years of payments	2021 - 2038



	December 31, 2018
	Fair Value	Valuation Technique	Unobservable Input	Range
SARs	$3,814	Option-pricing model	Volatility	46.53% - 59.59%
			Risk free interest rate	2.44% - 2.63%
			Strike price	$6.76 - $30.86
			Fair value of common stock	$34.32
			Expected life	0.01 - 1.01 years
Contingent consideration payable- development and regulatory milestones	$257,040	Probability-adjusted discounted cash flow	Potential development and regulatory milestones	$0 - $555 million
			Probabilities of success	25% - 94%
			Discount rates	5.8% - 8.0%
			Projected years of payments	2020 - 2026
Contingent considerable payable- net sales milestones and royalties	$53,200	Option-pricing model with Monte Carlo simulation	Potential net sales milestones	$0 - $150 million
			Probabilities of success	25% - 89%
			Potential percentage of net sales for royalties	2% - 6%
			Discount rate	14.0%
			Projected years of payments	2021 - 2038

The contingent consideration is classified as a Level 3 liability as its valuation requires substantial judgment and estimation of factors that are not currently observable in the market. If different assumptions were used for the various inputs to the valuation approach, including but not limited to, assumptions involving probability adjusted sales estimates for the Agilis platform and estimated discount rates, the estimated fair value could be significantly higher or lower than the fair value determined.