FAIR VALUE MEASUREMENTS

We apply the provisions of ASC Topic 820, Fair Value Measurements (“ASC 820”) for our financial assets and liabilities that are re-measured and reported at fair value each reporting period and our nonfinancial assets and liabilities that are re-measured and reported at fair value on a non-recurring basis. Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which it would transact and consider assumptions that market participants would use when pricing the asset or liability. ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. Financial assets and liabilities are categorized within the valuation hierarchy based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:


•	Level 1- Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.


•	Level 2 - Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.


•	Level 3 - Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.

The following tables represent the fair value hierarchy as of December 31, 2018 and 2017, for those assets and liabilities that we measure at fair value on a recurring basis (in thousands):



	Fair Value Measurements at December 31, 2018 Using:
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents	$	71,568	$	71,568	$	—	$	—
Corporate debt securities	113,097		—		113,097		—
U.S. treasury and government agency securities	10,323		—		10,323		—
Commercial paper	3,995		—		3,995		—
Certificates of deposit	13,500		—		13,500		—
Total Assets	$	212,483	$	71,568	$	140,915	$	—
Liabilities:
Contingent consideration - Lumara Health	$	—	$	—	$	—	$	—
Contingent consideration - MuGard	359		—		—		359
Total Liabilities	$	359	$	—	$	—	$	359



	Fair Value Measurements at December 31, 2017 Using:
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents	$	4,591	$	4,591	$	—	$	—
Corporate debt securities	116,152		—		116,152		—
U.S. treasury and government agency securities	9,291		—		9,291		—
Commercial paper	1,999		—		1,999		—
Certificates of deposit	9,151		—		9,151		—
Total Assets	$	141,184	$	4,591	$	136,593	$	—
Liabilities:
Contingent consideration - Lumara Health	$	49,187	$	—	$	—	$	49,187
Contingent consideration - MuGard	898		—		—		898
Total Liabilities	$	50,085	$	—	$	—	$	50,085

Marketable securities

Our cash equivalents are classified as Level 1 assets under the fair value hierarchy as these assets have been valued using quoted market prices in active markets and do not have any restrictions on redemption. Our marketable securities are classified as Level 2 assets under the fair value hierarchy as these assets were primarily determined from independent pricing services, which normally derive security prices from recently reported trades for identical or similar securities, making adjustments based upon other significant observable market transactions. At the end of each reporting period, we perform quantitative and qualitative analysis of prices received from third parties to determine whether prices are reasonable estimates of fair value. After completing our analysis, we did not adjust or override any fair value measurements provided by our pricing services as of December 31, 2018 or 2017. In addition, there were no transfers or reclassifications of any securities between Level 1 and Level 2 during 2018 or 2017.

Contingent consideration

In accordance with GAAP, for asset acquisitions, we record contingent consideration for obligations we consider to be probable and estimable and these liabilities are not adjusted to fair value. As of December 31, 2018, no contingent consideration was recorded in accrued expenses. As of December 31, 2017, $10.0 million of contingent consideration was recorded in accrued expenses and was paid to Endoceutics in April 2018 on the first anniversary of the closing of the license agreement between us and Endoceutics.

We recorded contingent consideration related to the November 2014 acquisition of Lumara Health Inc. (“Lumara Health”) for our Makena product and related to our June 2013 license agreement for MuGard^® Mucoadhesive Oral Wound Rinse (the “MuGard License Agreement”) with Abeona Therapeutics, Inc. (“Abeona”), under which we acquired the U.S. commercial rights for the management of oral mucositis and stomatitis (the “MuGard Rights”).

The fair value measurements of contingent consideration obligations and the related intangible assets arising from business combinations are classified as Level 3 assets under the fair value hierarchy as these assets have been valued using unobservable inputs. These inputs include: (a) the estimated amount and timing of projected cash flows; (b) the probability of the achievement of the factors on which the contingency is based; and (c) the risk-adjusted discount rate used to present value the probability-weighted cash flows. Significant increases or decreases in any of those inputs in isolation could result in a significantly lower or higher fair value measurement.

The following table presents a reconciliation of contingent consideration obligations related to the acquisition of Lumara Health and the MuGard Rights (in thousands):



Balance as of January 1, 2017	$	147,995
Payments made	(50,224		)
Adjustments to fair value of contingent consideration	(47,686		)
Balance as of December 31, 2017	$	50,085
Payments made	(119		)
Adjustments to fair value of contingent consideration	(49,607		)
Balance as of December 31, 2018	$	359

During 2018, we reduced the fair value of our contingent consideration liability by approximately $49.6 million, primarily based on actual Makena net sales to date and our expectations for future performance, which indicated that achievement of future milestones is not probable. This adjustment was based on our estimates, which are reliant on a number of external factors as well as the exercise of judgment.

The $47.7 million adjustment to the fair value of the contingent consideration liability in 2017 was primarily due to a decrease to the Makena contingent consideration based on a revision of our long-term forecast of total projected net Makena sales, which impacted both the amount and timing of future milestone payments. In addition, during 2017, we paid a $50.0 million sales milestone to the former stockholders of Lumara Health and a $0.2 million royalty payment for MuGard.

The fair value of the contingent milestone payments payable by us to the former stockholders of Lumara Health was determined based on our probability-adjusted discounted cash flows estimated to be realized from the net sales of Makena from December 1, 2014 through December 31, 2019.

The fair value of the contingent royalty payments payable by us to Abeona under the MuGard License Agreement was determined based on various market factors, including an analysis of estimated sales using a discount rate of approximately 14% as of December 31, 2018. In addition, as of December 31, 2018, we estimated that the undiscounted royalty amounts we could pay under the MuGard License Agreement, based on current projections, may range from $0.3 million to $0.6 million over the remainder of the ten year period, which commenced on June 6, 2013, the acquisition date, which is our best estimate of the period over which we expect the majority of the asset’s cash flows to be derived.

We believe the estimated fair values of the contingent payments associated with Lumara Health and the MuGard Rights are based on reasonable assumptions, however, our actual results may vary significantly from the estimated results.

Debt

We estimate the fair value of our debt obligations by using quoted market prices obtained from third-party pricing services, which is classified as a Level 2 input. As of December 31, 2018, the estimated fair value of the 2022 Convertible Notes and the 2019 Convertible Notes was $294.8 million and $20.9 million, respectively, which differed from their carrying values. As of December 31, 2017, the estimated fair value of our 2023 Senior Notes (as defined below), the 2022 Convertible Notes and the 2019 Convertible Notes was $463.7 million, $282.9 million and $21.6 million, respectively, which differed from their carrying values. See Note R, “Debt,” for additional information on our debt obligations.