3. FAIR VALUE

FASB ASC 820, “Fair Value Measurements and Disclosures” (ASC 820), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

Level 1—Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. The valuation under this approach does not entail a significant degree of judgment.

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The valuation technique for the Company’s Level 2 assets is based on quoted market prices for similar assets from observable pricing sources at the reporting date.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2017:



	Quoted Prices
	in Active		Significant		Significant
	Markets for		Other		Other
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets:
Money market funds	$	—	$	12,774	$	—	$	12,774
Commercial paper		—		7,472		—		7,472
U.S. government agencies and securities		2,999		—		—		2,999
Corporate bonds		—		2,920		—		2,920
Total assets	$	2,999	$	23,166	$	—	$	26,165
Liabilities:
Acquisition-related contingent consideration	$	—	$	—	$	37,098	$	37,098
Total liabilities	$	—	$	—	$	37,098	$	37,098

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2016:



	Quoted Prices
	in Active		Significant		Significant
	Markets for		Other		Other
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets:
Money market funds	$	—	$	17,085	$	—	$	17,085
Commercial paper		—		5,996		—		5,996
U.S. government agencies and securities		7,000		1,529		—		8,529
Corporate bonds		—		8,276		—		8,276
Total assets	$	7,000	$	32,886	$	—	$	39,886
Liabilities:
Acquisition-related contingent consideration	$	—	$	—	$	41,176	$	41,176
Total liabilities	$	—	$	—	$	41,176	$	41,176

There were no changes in the levels or methodology of measurement of financial assets and liabilities during the years ended December 31, 2017 and 2016.

Derivative Instruments. Vested non-employee options historically issued by the Company were accounted for as derivative liabilities and remeasured at fair value through earnings at each reporting period until exercised or forfeited. All vested non-employee options were exercised as of December 31, 2015.

The following table represents the Company’s Level 3 fair value measurements using significant other unobservable inputs for derivative instruments for each of the years ended December 31:



	2017		2016		2015
Beginning Balance	$	—	$	—	$	120
Total loss included in earnings		—		—		57
Exercises		—		—		(177)
Ending Balance	$	—	$	—	$	—

Acquisition-Related Contingent Consideration. Contingent consideration arrangements under the nContact merger agreement obligate the Company to pay former shareholders of nContact for the following milestones, if achieved:

Trial Enrollment Milestone – $7,500 upon completion of patient enrollment in the CONVERGE IDE clinical trial. Such payment is due within 30 days following enrollment of the final patient.

Regulatory Milestone – up to $42,500 upon the completion of the CONVERGE IDE clinical trial and receiving a PMA from FDA for the EPi-Sense AF Guided Coagulation System and/or any other nContact product with an indication for symptomatic persistent Afib or similar or related indication. The full contingent consideration amount of $42,500 is only earned if such regulatory approvals are received on or before January 1, 2020. The potential contingent consideration is reduced by 8.33% (or one-twelfth) each month following January 2020, and is reduced to zero if the regulatory milestone is achieved after December 31, 2020. Any payment of the regulatory milestone contingent consideration is due within 30 days following the receipt of the related PMA approval.

Commercial Milestone – for calendar years 2016 through 2019, nContact revenues in excess of specified target revenue amounts will result in contingent consideration equal to 1.5 times the revenues in excess of target. Payments of contingent consideration when the commercial milestone is achieved are due within 65 days of each calendar year end.

Subject to the terms and conditions of the merger agreement, all contingent consideration must be paid first in shares of AtriCure common stock. The merger agreement limits the total number of shares of AtriCure common stock issued in connection with the acquisition to 5,660, of which 3,757 shares were issued at closing of the nContact acquisition on October 13, 2015. Since the acquisition, no payments of contingent consideration have been required or made. As of December 31, 2017 and 2016, contingent consideration is recorded in other noncurrent liabilities in the Consolidated Balance Sheets.

The Company measures contingent consideration liabilities using unobservable inputs by applying an income approach, such as the discounted cash flow technique or the probability-weighted scenario method. Various key assumptions, such as the probability of achievement of the agreed milestones, projected revenues from acquisitions and the discount rate, are used in the determination of fair value of contingent consideration arrangements and are not observable in the market, thus representing a Level 3 measurement within the fair value hierarchy. Subsequent revisions to key assumptions, which impact the estimated fair value of contingent consideration liabilities, are reflected in the Consolidated Statements of Operations and Comprehensive Loss.

The fair value of the nContact contingent consideration was remeasured as of December 31, 2017, resulting in a decrease in fair value of $4,078. This decrease in fair value is due primarily to changes in estimates related to the timing of achievement of the regulatory milestone as a result of actual enrollment in the CONVERGE IDE clinical trial in 2017, offset partially by an increase in forecasted revenues for 2018 and 2019 under the commercial milestone payment. The fair value of contingent consideration increased $969 during the year ended December 31, 2016 due primarily to a reduction in the discount period. Adjustments to fair value are recorded in selling, general and administrative expenses in the accompanying Consolidated Statements of Operations and Comprehensive Loss.

The following table represents the company’s Level 3 fair value measurements using significant other unobservable inputs for acquisition-related contingent consideration for each of the years ended December 31:



	2017		2016		2015
Beginning Balance	$	41,176	$	40,207	$	—
Amounts acquired		—		—		40,207
Changes in fair value included in earnings		(4,078)		969		—
Ending Balance	$	37,098	$	41,176	$	40,207