Fair Value Measurements

The Company applies a fair value framework in order to measure and disclose its financial assets and liabilities. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:


Level 1	Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 assets consist of money market investments.

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Fair values are determined by utilizing quoted prices for similar assets and liabilities in active markets or other market observable inputs such as interest rates and yield curves. The Company’s Level 2 assets consist of U.S. government debt, corporate debt securities and asset back securities.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Company’s Level 3 assets and liabilities consist of the contingent purchase prices associated with the Company’s business combinations, respectively. The fair value of certain development or regulatory milestone based contingent purchase prices was determined in a discounted cash flow framework by probability weighting the future contractual payment with management's assessment of the likelihood of achieving these milestones and present valuing them using a risk-adjusted discount rate. Certain sales milestone based payments were determined in a discounted cash flow framework where risk-adjusted revenue scenarios were estimated using Monte Carlo simulation models to compute contractual payments which were present valued using a risk-adjusted discount rate.

Financial assets and liabilities measured at fair value on a recurring basis

Financial assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

Except for the Company’s Level 2 liabilities which are discussed in Note 10, “Convertible Senior Notes,” the following table sets forth the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016, by level, within the fair value hierarchy:



	As of September 30, 2017								As of December 31, 2016
Assets and Liabilities	Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of September 30, 2017		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2016
	(in thousands)
Assets:
Cash equivalents	$	14,686			$	—	$	14,686	$	56,097	$	—	$	—	$	56,097
Available for sale securities	—		42,168		—		42,168		$	—	$	—	$	—	—
Total assets at fair value	$	14,686	$	42,168	$	—	$	56,854	$	56,097	$	—	$	—	$	56,097
Liabilities:
Contingent purchase price	$	—	$	—	$	62,884	$	62,884	$	—	$	—	$	137,289	$	137,289
Total liabilities at fair value	$	—	$	—	$	62,884	$	62,884	$	—	$	—	$	137,289	$	137,289

Level 3 disclosures

The Company measures contingent purchase price at fair value based on significant inputs not observable in the market, which causes it to be classified as a Level 3 measurement within the fair value hierarchy. The valuation of contingent purchase price uses assumptions and estimates the Company believes would be made by a market participant in making the same valuation. The Company assesses these assumptions and estimates on an on-going basis as additional data impacting the assumptions and estimates are obtained. Changes in the fair value of contingent purchase price related to updated assumptions and estimates are recognized within selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.

The contingent purchase price may change significantly as additional data is obtained, impacting the Company’s assumptions regarding probabilities of successful achievement of related milestones used to estimate the fair value of the liability. In evaluating this information, considerable judgment is required to interpret the market data used to develop the assumptions and estimates. The estimates of fair value may not be indicative of the amounts that could be realized in a current market exchange. Accordingly, the use of different market assumptions and/or different valuation techniques may have a material effect on the estimated fair value amounts, and such changes could materially impact the Company’s results of operations in future periods.

The following table provides quantitative information associated with the fair value measurements of the Company’s Level 3 liabilities:



	Fair Value as of September 30, 2017		Valuation Technique	Unobservable Input	Range (Weighted Average)
	(in thousands)
Targanta:
Contingent purchase price	$	1,584	Probability-adjusted discounted cash flow	Probability of success	5%
				Period in which milestone is expected to be achieved	2021
				Discount rate	11%
Rempex:
Contingent purchase price: Event-based milestones	$	47,200	Probability-adjusted discounted cash flow	Probabilities of successes	18% - 90% (71%)
				Period in which milestones are expected to be achieved	2018 - 2024
				Discount rate	4.4% - 7.3%
Contingent purchase price: Sales-based milestones	$	14,100	Risk-adjusted revenue simulation	Probabilities of successes	15% - 85% (72%)
				Period in which milestones are expected to be achieved	2020 - 2022
				Discount rate	5.5% - 6.7%



	Fair Value as of December 31, 2016		Valuation Technique	Unobservable Input	Range (Weighted Average)
	(in thousands)
Targanta:
Contingent purchase price	$	5,857	Probability-adjusted discounted cash flow	Probability of success	20%
				Period in which milestone is expected to be achieved	2021
				Discount rate	11%
Incline:
Contingent purchase price	$	1,269	Probability-adjusted discounted cash flow	Probabilities of successes	5%
				Period in which milestones are expected to be achieved	2019
				Discount rate	18%
Rempex:
Contingent purchase price: Event-based milestones	$	95,800	Probability-adjusted discounted cash flow	Probabilities of successes	18% - 95% (78%)
				Period in which milestones are expected to be achieved	2017 - 2024
				Discount rate	5.2% - 8.5%
Contingent purchase price: Sales-based milestones	$	20,300	Risk-adjusted revenue simulation	Probabilities of successes	16% - 65% (56%)
				Period in which milestones are expected to be achieved	2018 - 2022
				Discount rate	6.6% - 8.2%
Annovation:
Contingent purchase price	$	14,063	Probability-adjusted discounted cash flow	Probabilities of successes	9% - 50% (34%)
				Period in which milestones are expected to be achieved	2018 - 2031
				Discount rate	6.0% - 10.0%

The fair value of the contingent purchase price represents the fair value of the Company’s liability for all potential payments under the Company’s acquisition agreements for Targanta, Incline Therapeutics, Inc. (Incline), Rempex Pharmaceuticals, Inc. (Rempex) and Annovation BioPharma, Inc. (Annovation). During the first quarter of 2017, the Company made a $20.0 million payment to the former equity holders of Rempex upon acceptance of the NDA for Vabomere. During the third quarter of 2017, the Company made a $40.0 million payment to the former equity holders of Rempex upon approval of Vabomere in the United States. There were no other changes to the potential future payments under the Company’s acquisition agreements. As of September 30, 2017, the remaining potential future payments to the former equity holders of Rempex and Targanta were $224.7 million and $49.4 million, respectively. The remaining potential future payments under the Company’s acquisition agreements do not include payments of $175.8 million (which includes $86.3 million to the former equity holders of Incline and Annovation and $89.5 million to other third parties) related to the Ionsys product, which was discontinued and withdrawn in the United States in June 2017 and which has also been discontinued in Europe, and the MDCO-700 development program, which the Company discontinued in August 2017.

The significant unobservable inputs used in the fair value measurement of the Company’s contingent purchase prices are the probabilities of successful achievement of development, regulatory, and sales milestones that would trigger payments under the Targanta, Incline, Rempex and Annovation agreements, probabilities as to the periods in which the milestones are expected to be achieved and discount rates. Significant changes in any of the probabilities of success or periods in which milestones will be achieved would result in a significantly higher or lower fair value measurement.

The changes in fair value of the Company’s Level 3 contingent purchase price during the three and nine months ended September 30, 2017 and 2016 were as follows:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
	(in thousands)
Balance at beginning of period	$	111,171		$	118,571		$	137,289		$	123,757
Payments	(40,616		)	(1,564		)	(62,618		)	(8,811		)
Fair value adjustments to contingent purchase prices included in net loss	(7,672		)	12,403			(11,788		)	14,464
Balance at end of period	$	62,883		$	129,410		$	62,883		$	129,410

For the three and nine months ended September 30, 2017 and 2016, changes in the carrying value of the contingent purchase price obligations resulted from changes in the fair value of the contingent consideration due to either the passage of time, changes in discount rates, changes in probabilities of success, or milestone payments. This includes a decrease of $14.7 million in the carrying value of the contingent purchase price to an estimated fair value of zero as a result of the Company’s decision to discontinue the clinical development program for MDCO-700 in August 2017. See Note 1, “Nature of Business,” for further details.

No other changes in valuation techniques or inputs occurred during the three and nine months ended September 30, 2017 and 2016.