Fair value of financial instruments

9 Months Ended

Sep. 30, 2020

Fair value of financial instruments

Fair value of financial instruments

4. Fair value of financial instruments

The Company determines the fair value of its financial instruments based upon the fair value hierarchy, which prioritizes valuation inputs based on the observable nature of those inputs. The fair value hierarchy applies only to the valuation inputs used in determining the reported fair value of the investments and is not a measure of the investment credit quality. The hierarchy defines three levels of valuation inputs:

Level 1 inputs	Quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date.
Level 2 inputs	Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3 inputs	Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability.

Items Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s financial instruments that are measured at fair value on a recurring basis (in thousands):

	September 30, 2020
Description	Total		Level 1		Level 2		Level 3
Financial assets
Cash equivalents	$	131,693	$	131,693	$	—	$	—
Total financial assets	$	131,693	$	131,693	$	—	$	—

	December 31, 2019
Description	Total		Level 1		Level 2		Level 3
Financial assets
Cash equivalents	$	77,176	$	75,678	$	1,498	$	—
Short-term investments		31,992		—		31,992		—
Total financial assets	$	109,168	$	75,678	$	33,490	$	—
Derivative liability	$	450		—		—	$	450

The Company’s cash equivalents and short-term investments consist of U.S. Government money market funds, corporate bonds, agency bonds and commercial paper of publicly traded companies. The investments and cash equivalents have been initially valued at the transaction price and subsequently valued, at the end of each reporting period, utilizing third party pricing services or other market observable data. The pricing services utilize industry standard valuation models, including both income and market-based approaches and observable market inputs to determine value. These observable market inputs include reportable trades, benchmark yields, credit spreads, broker/dealer quotes, bids, offers, current spot rates and other industry and economic events. The Company validates the prices provided by third party pricing services by reviewing their pricing methods and matrices, obtaining market values from other pricing sources, analyzing pricing data in certain instances and confirming that the relevant markets are active. After completing its validation procedures, the Company did not adjust or override any fair value measurements provided by the pricing services as of September 30, 2020 and December 31, 2019.

During 2019, a derivative liability was recorded as a result of the issuance of the 2019 Notes (see Note 12. Convertible Senior Notes). The fair value measurement of the derivative liability is classified as Level 3 under the fair value hierarchy and it has been valued using unobservable inputs. These inputs include: (1) a simulated share price at the time of conversion of the 2019 Notes, (2) assumed timing of conversion of the 2019 Notes, (3) risk-adjusted discount rate to present value the probability-weighted cash flows, and (4) entity specific cost of equity. Significant increases or decreases in any of those inputs in isolation could result in a significantly lower or higher fair value measurement.

The fair value of the derivative liability was determined using a Monte-Carlo simulation by calculating fair value of the 2019 Interest Make-Whole Payment to 2019 Note holders based on assumed timing of conversion of the 2019 Notes. At December 31, 2019, the risk-adjusted discount rate was determined to be 13.08% and entity specific cost of equity was determined to be 16.54%.

The following table represents a reconciliation of the derivative liability recorded in connection with the issuance of the 2019 Notes (in thousands):

January 1, 2020	$	450
Fair value adjustment		1,313
Derivative liability extinguished upon conversion		(1,763)
September 30, 2020	$	—

During the nine months ended September 30, 2020 the derivative liability has been settled upon conversion of all 2019 Notes into shares of common stock (see Note 12. Convertible Senior Notes).

Fair Value of Financial Instruments

The fair value of the Company’s long-term debt is determined using a discounted cash flow analysis with current applicable rates for similar instruments as of the condensed consolidated balance sheet dates. The carrying value of the Company’s long-term debt, including the current portion, at September 30, 2020 and December 31, 2019 was approximately $35.7 million and $35.1 million, respectively. The Company estimates that the fair value of its long-term debt, including the current portion, was approximately $37.0 million at both September 30, 2020 and December 31, 2019. The fair value of the Company’s long-term debt was determined using Level 3 inputs.

The fair value of the Company’s 5.00% Convertible Senior Notes due 2048 (the 2018 Notes) as of September 30, 2020 was approximately $10.0 million, which differs from the carrying value of the 2018 Notes of $20.8 million. The fair value of the 2018 Notes was determined using Level 2 inputs.