Note 4. 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 September 30, 2017 and March 31, 2017 are invested in the following:

	Amortized		Gross Unrealized		Gross Unrealized			Fair Market
	Cost		Gains		Losses			Value
	(in $000's)
September 30, 2017:
Short-term U.S. Treasury mutual fund securities	$	36,178	$	—	$	(9	)	$	36,169
Short-term government-backed securities		124,654		—		(87	)		124,567
Short-term corporate debt securities		57,955		2		(32	)		57,925
Long-term government-backed securities		48,186		—		(61	)		48,125
Long-term corporate debt securities		7,835		—		(6	)		7,829
	$	274,808	$	2	$	(195	)	$	274,615

	Amortized		Gross Unrealized		Gross Unrealized			Fair Market
	Cost		Gains		Losses			Value
	(in $000's)
March 31, 2017
Short-term U.S. Treasury mutual fund securities	$	45,199	$	—	$	(13	)	$	45,186
Short-term government-backed securities		90,199		1		(87	)		90,113
Short-term corporate debt securities		55,465		—		(31	)		55,434
Long-term U.S. Treasury mutual fund securities		1,998		—		(3	)		1,995
Long-term government-backed securities		43,484		5		(18	)		43,471
Long-term corporate debt securities		1,853		—		(1	)		1,852
	$	238,198	$	6	$	(153	)	$	238,051

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
September 30, 2017:	(in $000's)
Assets
Short-term U.S. Treasury mutual fund securities	$	—	$	36,169	$	—	$	36,169
Short-term government-backed securities		—		124,567		—		124,567
Short-term corporate debt securities		—		57,925		—		57,925
Long-term government-backed securities		—		48,125		—		48,125
Long-term corporate debt securities		—		7,829		—		7,829
Liabilities
Contingent consideration		—		—		9,835		9,835

	Level 1		Level 2		Level 3		Total
March 31, 2017:	(in $000's)
Assets
Short-term U.S. Treasury mutual fund securities	$	—	$	45,186	$	—	$	45,186
Short-term government-backed securities		—		90,113		—		90,113
Short-term corporate debt securities		—		55,434		—		55,434
Long-term U.S. Treasury mutual fund securities		—		1,995		—		1,995
Long-term government-backed securities		—		43,471		—		43,471
Long-term corporate debt securities		—		1,852		—		1,852
Liabilities
Contingent consideration		—		—		9,153		9,153

The Company has determined that the estimated fair value of its investments in U.S. Treasury mutual fund securities, government-backed securities, and corporate debt 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. The Company uses 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.

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

Weighted Average

September 30, 2017

Significant

(range, if

(in $000's)

Valuation Methodology

Unobservable Input

applicable)

Clinical and regulatory milestone

5,660

Probability

weighted income approach

Projected fiscal year of milestone payments

2019 to 2022

Discount rate

2.6% to 3.1%

Probability of occurrence

Probability adjusted level of 40% for the base case scenario and 0% to 28% for various upside and downside scenarios

Revenue-based milestone

4,175

Monte Carlo simulation model

Projected fiscal year of milestone payments

2023 to 2035

Discount rate

18%

Expected volatility for forecasted revenues

50%

9,835

The following table summarizes the change in fair value, as determined by Level 3 inputs, of the contingent consideration for the three and six months ended September 30, 2017 and 2016:

	For the Three Months Ended September 30,				For the Six Months Ended September 30,
		2017		2016		2017		2016
	(in $000's)				(in $000's)
Level 3 liabilities, beginning balance	$	9,418	$	7,739	$	9,153	$	7,563
Additions		—		—		—		—
Payments		—		—		—		—
Change in fair value		417		10		682		186
Level 3 liabilities, ending balance	$	9,835	$	7,749	$	9,835	$	7,749

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, heart pump and other medical device technologies. The aggregate carrying amount of the Company’s other investments was $12.6 million and $7.2 million at September 30, 2017 and March 31, 2017, respectively, and is classified within other assets in the unaudited condensed consolidated balance sheets. In July 2017, the Company made an additional $6.0 million investment in a private medical device company and recorded this transaction during the three months ended September 30, 2017. These investments are accounted for using the cost method and are evaluated for impairment and 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.