Financial Instruments

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including available-for-sale fixed income, equity securities, co-promote termination payments receivable and the related liability, derivatives, and contingent liabilities.

Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The Company establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels are described in the below with Level 1 having the highest priority and Level 3 having the lowest:

Level 1 - Observable inputs such as quoted prices in active markets

Level 2 - Inputs other than the quoted prices in active markets that are observable either directly or indirectly

Level 3 - Unobservable inputs in which there is little or no market data, which require us to develop our own assumptions

Equity Investments and related liability to former license holders

The fair value of the Company’s long-term investments and related liability to former license holders are determined using quoted market prices in active markets and are discounted based on trading restrictions on the resale of the shares. The fair value of the liability to former license holders is based on 15% of the equity investment. This liability is classified as a derivative in accordance with ASC 815, Derivatives and Hedging ("ASC 815"), and is included in accrued liabilities. The discount rate used to value the available-for-sale securities as of September 30, 2013 and December 31, 2012 was 10% and 28%, respectively.

Contingent Liabilities

The Company issued contingent value rights and also assumed certain contingent liabilities associated with the acquisitions of Metabasis, Neurogen and CyDex. The liability for CVRs for Metabasis are determined using quoted market prices in active markets. The fair value of the liabilities for the Neurogen and CyDex contingent liabilities are determined based on the income approach. The discount rate used to value the CyDex contingent liabilities for the period ended September 30, 2013 was in the range of 1% to 5%. There are no remaining contingent value right obligations under the agreement with the former Neurogen shareholders. Under the CVR agreement with the former CyDex shareholders, the Company may be required to make payments upon achievement of certain clinical and regulatory milestones. In addition, the Company will pay CyDex shareholders, for each year through 2016, 20% of all CyDex-related revenue, but only to the extent that and beginning only when CyDex-related revenue for such year exceeds $15.0 million; plus an additional 10% of all CyDex-related revenue recognized during such year, but only to the extent that and beginning only when aggregate CyDex-related revenue for such year exceeds $35.0 million. Additionally, the Company assumed certain contractual obligations for milestone and royalty payments potentially due in connection with Captisol-enabled intravenous formulation of Clopidogrel and Captisol-enabled intravenous formulation of Topiramate.

Avinza Co-Promotion

The co-promote termination payments receivable represents a non-interest bearing receivable for future payments to be made by Pfizer and is recorded at its fair value. The receivable and liability will remain equal and adjusted each quarter for changes in the fair value of the obligation including any changes in the estimate of future net Avinza product sales.

The following table provides a summary of the assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2013 (in thousands):



Fair Value Measurements at Reporting Date Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Current portion of co-promote termination payments receivable	$	4,507	$	—	$	—	$	4,507
Available-for-sale securities	3,627		—		—		3,627
Long-term portion of co-promote termination payments receivable	8,387		—		—		8,387
Total assets	$	16,521	$	—	$	—	$	16,521
Liabilities:
Current portion of contingent liabilities - CyDex	$	1,879	$	—	$	—	$	1,879
Current portion of co-promote termination liability	4,507		—		—		4,507
Long-term portion of contingent liabilities-Metabasis	1,736		1,736		—		—
Long-term portion of contingent liabilities - CyDex	6,816		—		—		6,816
Liability for restricted investments owed to former licensees	544		—		—		544
Long-term portion of co-promote termination liability	8,387		—		—		8,387
Total liabilities	$	23,869	$	1,736	$	—	$	22,133

The following table provides a summary of the assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2012 (in thousands):



Fair Value Measurements at Reporting Date Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Current portion of co-promote termination payments receivable	$	4,327	$	—	$	—	$	4,327
Available-for-sale securities	1,426		—		—		1,426
Long-term portion of co-promote termination payments receivable	8,207		—		—		8,207
Total assets	$	13,960	$	—	$	—	$	13,960
Liabilities:
Current portion of contingent liabilities - CyDex	$	356	$	—	$	—	$	356
Current portion of co-promote termination liability	4,327		—		—		4,327
Long-term portion of contingent liabilities - CyDex	10,543		—		—		10,543
Liability for restricted investments owed to former licensees	214		—		—		214
Long-term portion of co-promote termination liability	8,207		—		—		8,207
Total liabilities	$	23,647	$	—	$	—	$	23,647

A reconciliation of the level 3 financial instruments as of September 30, 2013 is as follows (in thousands):



Assets:
Fair value of level 3 financial instrument assets as of December 31, 2012	$	13,960
Assumed payments made by Pfizer or assignee	(2,450		)
Fair value adjustments recorded as unrealized gain on available-for-sale securities	2,201
Fair value adjustments to co-promote termination liability	2,810
Fair value of level 3 financial instrument assets as of September 30, 2013	$	16,521

Liabilities
Fair value of level 3 financial instrument liabilities as of December 31, 2012	$	23,647
Assumed payments made by Pfizer or assignee	(2,450		)
Fair value adjustments for amounts owed related to restricted investments and recorded as other expense	330
Payments to CVR and other former license holders	(100		)
Fair value adjustments to contingent liabilities	(2,104		)
Fair value adjustments to co-promote termination liability	2,810
Fair value of level 3 financial instrument liabilities as of September 30, 2013	$	22,133