Note 9. Assets and Liabilities Measured at Fair Value

The Company’s financial assets and liabilities are measured at fair value and classified within the fair value hierarchy, which is defined as follows:

Level 1 — Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 — Inputs other than quoted prices in active markets that are observable for the asset or liability, either directly or indirectly.

Level 3 — Inputs that are unobservable for the asset or liability.

A summary of the fair value of the Company’s recurring assets and liabilities aggregated by the level in the fair value hierarchy within which those measurements fall as of March 31, 2017 are identified in the following table (in thousands):

	Level 2		Total
Assets:
Commercial paper	$	110,659	$	110,659
Corporate debt securities	124,028		124,028
Money market funds	2,197		2,197

	$	236,884	$	236,884

	Level 2		Level 3		Total
Liabilities:
Contingent consideration payable	$	—	$	274,300	$	274,300
Derivative liability	101		—		101
Deferred compensation plan liability	1,847		—		1,847

	$	1,948	$	274,300	$	276,248

A summary of the fair value of the Company’s recurring assets and liabilities aggregated by the level in the fair value hierarchy within which those measurements fall as of December 31, 2016 are identified in the following table (in thousands):

	Level 2		Total
Assets:
Commercial paper	$	68,390	$	68,390
Corporate debt securities	74,535		74,535
Money market funds	1,829		1,829

	$	144,754	$	144,754

	Level 2		Level 3		Total
Liabilities:
Contingent consideration payable	$	—	$	269,722	$	269,722
Derivative liability	265		—		265
Deferred compensation plan liability	1,479		—		1,479

	$	1,744	$	269,722	$	271,466

See “—Note 7. Debt Instruments” for the carrying amount and estimated fair value of the Company’s Convertible Notes due in 2023, that falls into Level 2 category within the fair value level hierarchy. The fair value was determined using broker quotes in a non-active market for valuation.

The Company did not have any Level 3 assets as of March 31, 2017 or as of December 31, 2016.

Cash, Money Market Funds and Marketable Securities

The Company classifies its cash and money market funds within the fair value hierarchy as Level 1 as these assets are valued using quoted prices in active market for identical assets at the measurement date. The Company considers its investments in marketable securities as available for sale and classifies these assets within the fair value hierarchy as Level 2 primarily utilizing broker quotes in a non-active market for valuation of these securities. No changes in valuation techniques or inputs occurred during the three months ended March 31, 2017. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the three months ended March 31, 2017.

Contingent Consideration Payable

The contingent consideration payable resulted from the acquisitions of Scioderm and Callidus. The most recent valuation was determined using a probability weighted discounted cash flow valuation approach. Using this approach, expected future cash flows are calculated over the expected life of the agreement, are discounted, and then exercise scenario probabilities are applied. The valuation is performed quarterly. Gains and losses are included in the statement of operations.

As discussed in “—Note 3. Acquisitions,” on July 5, 2016, the Company entered into the MiaMed Agreement with MiaMed. MiaMed is a pre-clinical biotechnology company focused on developing protein replacement for CDKL5 and related diseases. Under the terms of the MiaMed Agreement, the Company agreed to pay up to an additional $83.0 million in connection with the achievement of certain clinical, regulatory and commercial milestones, for a potential aggregate deal value of $89.5 million. The MiaMed Agreement was accounted for as an asset acquisition and as such the Company determined that a liability for future milestone payments is not required to be recorded until the actual contingencies are met and will be recorded to research and development expenses when the contingency is resolved.

The contingent consideration payable for Scioderm and Callidus has been classified as a Level 3 recurring 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 the estimated fair value could be significantly higher or lower than the fair value the Company determined. The Company may be required to record losses in future periods, including expenses related to CDKL5.

The following significant unobservable inputs were used in the valuation of the contingent consideration payable to former Scioderm stockholders:

Contingent Consideration
Liability

Fair value as of
March 31, 2017

Valuation Technique

Unobservable Input

Range

Clinical and regulatory milestones

237.8 million

Probability weighted discounted cash flow

Discount rate

Probability of achievement of milestones

Projected year of payments

0.8%-1.3%

66.5% -100.0%

2017-2019

Revenue-based milestones

26.2 million

Monte Carlo

Revenue volatility

Probability of achievement of milestones

Discount rate

Projected year of payments

51%

66.5%

1.4%-2.7%

2019-2035

The following significant unobservable inputs were used in the valuation of the contingent consideration payable of Callidus for the ATB200 Pompe program:

Contingent Consideration
Liability

Fair value as of
March 31, 2017

Valuation Technique

Unobservable Input

Range

Clinical and regulatory milestones

9.9 million

Probability weighted discounted cash flow

Discount rate

Probability of achievement of milestones

Projected year of payments

13.0%

32.0%-45.0%

2018-2022

Contingent consideration liabilities are remeasured to fair value each reporting period using projected revenues, discount rates, probabilities of payment and projected payment dates. Projected contingent payment amounts related to clinical and regulatory based milestones are discounted back to the current period using a discounted cash flow model. Revenue-based payments are valued using a monte-carlo valuation model, which simulates future revenues during the earn out-period using management’s best estimates. Projected revenues are based on the Company’s most recent internal operational budgets and long-range strategic plans. Increases in projected revenues and probabilities of payment may result in higher fair value measurements. Increases in discount rates and the time to payment may result in lower fair value measurements. Increases or decreases in any of those inputs together, or in isolation, may result in a significantly lower or higher fair value measurement. There is no assurance that any of the conditions for the milestone payments will be met.

The following table shows the change in the balance of contingent consideration payable for the three months ended March 31, 2017 and 2016, respectively (in thousands):

	Three Months Ended March 31,
	2017		2016

Balance, beginning of the period	$	269,722	$	274,077
Unrealized change in fair value change during the period, included in Statement of Operations	4,578		3,152


Balance, end of the period	$	274,300	$	277,229

Deferred Compensation Plan- Investment and Liability

The Deferral Plan provides certain key employees and members of the Board of Directors with an opportunity to defer the receipt of such participant’s base salary, bonus and director’s fees, as applicable. Deferral Plan assets are classified as trading securities and recorded at fair value with changes in the investments’ fair value recognized in the period they occur. The asset investments consist of market exchanged mutual funds. The Company considers its investments in marketable securities, as available-for-sale and classifies these assets and related liability within the fair value hierarchy as Level 2 primarily utilizing broker quotes in a non-active market for valuation of these securities.

Foreign Currency Exchange Rate Exposure

The Company transacts business in various foreign countries and therefore, is subject to risk of foreign currency exchange rate fluctuations. As such, in June 2016, the Company entered into a forward contract to economically hedge transactional exposure associated with commitments arising from trade accounts payable denominated in a currency other than the functional currency of the respective operating entity. The Company did not designate this forward contract as a hedging instrument under applicable accounting guidance and, therefore, the change in fair value resulted in a gain of $0.2 million that was recorded in the Consolidated Statements of Operations for the three months ended March 31, 2017 and the corresponding liability of $0.1 million was recorded as other current liability in the Consolidated Balance Sheets. The forward contract settles in monthly installments with the final installment settlement in June 2017.