Note 3. Marketable Securities and Fair Value Measurements

Marketable Securities

The Company’s marketable securities are classified as available-for-sale securities and, accordingly, are recorded at fair value. The difference between amortized cost and fair value is included in stockholders’ equity.

The Company’s marketable securities at December 31, 2016 and March 31, 2016 are invested in the following:

	Amortized		Gross Unrealized		Gross Unrealized			Fair Market
	Cost		Gains		Losses			Value
	(in $000's)
December 31, 2016:
Short-term US Treasury mutual fund securities	$	44,181	$	1	$	(5	)	$	44,177
Short-term government-backed securities		86,070		5		(29	)		86,046
Short-term corporate debt securities		49,454		3		(40	)		49,417
Long-term government-backed securities		18,248		-		(8	)		18,240
	$	197,953	$	9	$	(82	)	$	197,880

	Amortized		Gross Unrealized		Gross Unrealized			Fair Market
	Cost		Gains		Losses			Value
	(in $000's)
March 31, 2016:
Short-term US Treasury mutual fund securities	$	45,635	$	21	$	—		$	45,656
Short-term government-backed securities		118,125		45		(4	)		118,166
Long-term government-backed securities		999		1		-			1,000
	$	164,759	$	67	$	(4	)	$	164,822

Fair Value Hierarchy

Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three categories:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

Level 1 primarily consists of financial instruments whose values are based on quoted market prices such as exchange-traded instruments and listed equities.

Level 2 includes financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 is comprised of unobservable inputs that are supported by little or no market activity. Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flows, or similar techniques, and at least one significant model assumption or input is unobservable.

The following table presents the Company’s financial instruments recorded at fair value in the condensed consolidated balance sheets, classified according to the three categories described above:

	Level 1		Level 2		Level 3		Total
December 31, 2016:	(in $000's)
Assets
Short-term U.S. Treasury mutual fund securities	$	—	$	44,177	$	—	$	44,177
Short-term government-backed securities		—		86,046		—		86,046
Short-term corporate debt securities		—		49,417		—		49,417
Long-term government-backed securities		—		18,240		—		18,240
Liabilities
Contingent consideration		—		—		8,175		8,175

	Level 1		Level 2		Level 3		Total
March 31, 2016:	(in $000's)
Assets
Short-term U.S. Treasury mutual fund securities	$	—	$	45,656	$	—	$	45,656
Short-term government-backed securities		—		118,166		—		118,166
Long-term government-backed securities		—		1,000		—		1,000
Liabilities
Contingent consideration		—		—		7,563		7,563

The Company’s investments in U.S. Treasury mutual fund securities, short-term government-backed securities, short-term corporate debt securities and long-term government-backed securities are reported as Level 2 financial assets as they are not exchange-traded instruments.

The Company’s financial liabilities consisted of contingent consideration potentially payable related to the acquisition of ECP Entwicklungsgesellschaft mbH (“ECP”) and AIS GmbH Aachen Innovative Solutions (“AIS”), in July 2014. The Company acquired ECP for $13.0 million in cash, with additional potential payouts totaling $15.0 million based on the achievement of certain clinical and regulatory and revenue-based milestones. These potential milestone payments may be made, at the Company’s option, by a combination of cash or Abiomed common stock. As of December 31, 2016, the Company used a combination of an income approach, based on various revenue and cost assumptions and applying a probability to each outcome and a Monte-Carlo valuation model. For the clinical and regulatory milestone, probabilities were applied to each potential scenario and the resulting values were discounted using a rate that considers weighted average cost of capital as well as a specific risk premium associated with the riskiness of the earn out itself, the related projections, and the overall business. The revenue-based milestone is valued using a Monte-Carlo valuation model, which simulates estimated future revenues during the earn out-period using management's best estimates. Projected revenues are based on our most recent internal operational budgets and long-range strategic plans. During the quarter ended December 31, 2016, the Company changed the valuation method used to value the revenue-based milestone from a probability-weighted income approach to a Monte-Carlo valuation method. The change did not have a material impact on the Company’s condensed consolidated financial statements for the three and nine months ended December 31, 2016.

This liability is reported as Level 3 as the estimated fair value of the contingent consideration related to the acquisition of the ECP requires significant management judgment or estimation and is calculated using the following valuation methods:

Fair Value at

Significant

Weighted Average

December 31, 2016

Valuation

Unobservable

(range, if

(in $000's)

Methodologies

Input

applicable)

Clinical and regulatory milestone

4,607

Probability

weighted income approach

Projected fiscal year of payments

2019 to 2022

Discount rate

Probability of occurrence

Probability adjusted level of 50% for the base case scenario and 5% to 20% for various upside and downside scenarios

Revenue-based milestone

3,568

Monte Carlo simulation model

Expected volatility for forecasted ECP revenues

50%

Discount rate

18%

Projected fiscal year of payments

2023 to 2035

8,175

The following table summarizes the change in fair value, as determined by Level 3 inputs, of the contingent consideration for the three and nine months ended December 31, 2016 and 2015:

	For the Three Months Ended December 31,				For the Nine Months Ended December 31,
		2016		2015		2016		2015
	(in $000's)				(in $000's)
Level 3 liabilities, beginning balance	$	7,749	$	6,817	$	7,563	$	6,510
Additions		—		—		—		—
Payments		—		—		—		—
Change in fair value		426		575		612		882
Level 3 liabilities, ending balance	$	8,175	$	7,392	$	8,175	$	7,392

The change in fair value of the contingent consideration was primarily due to the passage of time on the fair value measurement of milestones related to the ECP acquisition. Adjustments associated with the change in fair value of contingent consideration are included in research and development expenses in the Company’s condensed consolidated statements of operations. Significant increases or decreases in any of the probabilities of success or changes in expected timelines for achievement of any of these milestones could result in a significantly higher or lower fair value of the liability. The fair value of the contingent consideration at each reporting date is updated by reflecting the changes in fair value reflected in the Company’s statement of operations. There is no assurance that any of the conditions for the milestone payments will be met.

Other Investments

The Company periodically makes investments in private medical device companies that focus on heart failure and heart pump technologies. The aggregate carrying amount of the Company’s other investments was $4.5 million and $4.4 million at December 31, 2016 and March 31, 2016, respectively, and is classified within other assets in the unaudited condensed consolidated balance sheets. These investments are accounted for using the cost method and are measured at fair value only if there are identified events or changes in circumstances that may have a significant adverse effect on the fair value of these investments.