6. Fair Value Measurements

The fair values of the Company’s financial instruments are estimated and classified using a hierarchal disclosure framework based upon the level of subjectivity of the inputs used in measuring assets and liabilities. The following table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2017, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. The Company classifies money market funds as Level 1 assets. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company classifies commercial paper holdings, U.S. Treasury securities, U.S. government agency securities and asset-backed security holdings as Level 2 assets and its 2017 Exchange Notes (see Note 11) as a Level 3 liability. Level 3 inputs are unobservable inputs for the assets or liabilities, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. 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.

Assets and liabilities measured at fair value that have recurring measurements are shown below (in thousands):

			Fair Value Measurement at Reporting Date Using
Description	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)
Assets:
Money market funds	$	33,917	$	33,917	$	—	$	—
U.S. Treasury securities		24,990		—		24,990		—
Total assets measured at fair value	$	58,907	$	33,917	$	24,990	$	—
Liabilities:
Contingent consideration - long-term	$	8,400	$	—	$	—	$	8,400
Convertible debt - 2017 Exchange Notes		17,034		—		—		17,034
Convertible debt - 2016 Notes		129,200		—		—		129,200
Total liabilities measured at fair value	$	154,634	$	—	$	—	$	154,634

			Fair Value Measurement at Reporting Date Using
Description	Balance as of December 31, 2016		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial instruments owned:
Money market funds	$	65,081	$	65,081	$	—	$	—
U.S. Treasury securities		100,005		—		100,005		—
Corporate debt securities		1,499				1,499
Total assets measured at fair value	$	166,585	$	65,081	$	101,504	$	—

Liabilities:
Contingent consideration - current	$	15,000	$	—	$	—	$	15,000
Contingent consideration - long-term		6,800						6,800
Convertible debt		101,900		—		—		101,900
Total liabilities measured at fair value	$	123,700	$	—	$	—	$	123,700

Due to limited trading activity, the 2017 Exchange Notes were transferred from Level 2 to Level 3 during the three months ended June 30, 2017. There were no transfers between Levels 1, 2 or 3 during the year ended December 31, 2016.

The following table presents additional information about Level 3 liabilities measured at fair value. Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for liabilities within the Level 3 category may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The following table presents changes in Level 3 liabilities measured at fair value for the nine months ended September 30, 2017 (in thousands):

Contingent Consideration—December 31, 2016	$	21,800
Payment to Takeda	$	(15,000	)
Change in fair value of contingent consideration (recognized in Net loss)		1,600
Contingent Consideration at fair value – September 30, 2017	$	8,400

2017 Exchange Notes—December 31, 2016	$	—
Transfer from Level 2 to Level 3 - April 1, 2017		21,866
Exchange Notes conversions (recognized in equity)		(894	)
Change in fair value of 2017 Exchange Notes (recognized in Net loss)		(3,938	)
2017 Exchange Notes at fair value – September 30, 2017	$	17,034

Convertible debt - 2016 Notes—December 31, 2016	$	101,900
Change in fair value of convertible debt (recognized in Net loss)		27,300
Convertible debt - 2016 Notes at fair value – September 30, 2017	$	129,200

In March 2016, the Company issued $165.0 million in aggregate principal amount of 2016 Notes (see Note 11), which included the principal amount of the convertible note, a conversion feature, warrant coverage, and preferred shares.

To measure the fair value of the principal amount, the Company used an income approach, discounting the principal amount due under the convertible note by market interest rates by potential scenario. To measure the fair value of the conversion feature of the convertible note, a Black-Scholes option pricing model was utilized. The Black-Scholes option pricing model utilized the following assumptions: (i) expected term; (ii) common stock price; (iii) risk-free interest rate; and (iv) expected volatility. Assumptions used in the estimates represent what market participants would use in pricing the liability components, including market interest rates, credit standing, yield curves, volatilities, and risk-free rates, all of which are defined as Level 2 observable inputs. The estimated implied interest rates were applied to the principal amount of the convertible note by scenario and were weighted based on the probability of each scenario occurring. The estimated volatilities and the risk-free rates were incorporated into the Black-Scholes option pricing models for the conversion feature of the convertible note by scenario and were weighted based on the probability of each scenario occurring. Scenarios and probabilities were based on Company management estimates and were incorporated into the determination of the fair values of the principal amount and the conversion feature of the convertible note.

A Black-Scholes option pricing model is also utilized to measure the fair value of the warrant coverage component of the 2016 Notes offering. The Black-Scholes option-pricing model utilizes the following assumptions: (i) expected term; (ii) common stock price; (iii) risk-free interest rate; and (iv) expected volatility. Assumptions used in the estimates represent what market participants would use in pricing the component, including volatilities and risk-free rates, which are defined as Level 2 observable inputs. The estimated volatilities and the risk-free rates are incorporated into the Black-Scholes option pricing models for the warrants by scenario and are weighted based on the probability of each scenario occurring. Scenarios and probabilities are based on Company management estimates and are incorporated into the determination of the fair value of the warrant coverage.

The fair values of the principal amount of the 2016 Notes, the conversion feature of the convertible note and the warrant coverage are impacted by certain unobservable inputs, most significantly with regards to the discount rates, probabilities of certain scenarios occurring, expected volatility, share price performance, and expected scenario timing. Significant changes to these inputs in isolation could result in a significantly different fair value measurement.

The fair value of the Company’s 2017 Exchange Notes is estimated using certain market data by reference to prices observed for recent trading activity in the 2017 Exchange Notes, adjusted for changes in the yield curve index of similar credit-quality borrowers, between the date of the observed price and the measurement date.

As part of the Separation Agreement between the Company and Takeda, the Company recorded a current contingent consideration liability and a long-term contingent consideration liability that have been classified as Level 3 inputs in the fair value hierarchy. The contingent consideration represents the estimated fair value of future payments due to Takeda based on: (i) Orexigen achieving annual net sales targets in certain years and (ii) Takeda performing certain obligations, as outlined in the Separation Agreement. The initial fair value of the long-term portion of the contingent consideration based on net sales was estimated through the use of a Monte Carlo simulation model. The Monte Carlo simulation model utilized the following assumptions: (i) expected term; (ii) risk-adjusted net sales; (iii) risk-free interest rate; and (iv) expected volatility. The initial fair value of the current portion of the contingent consideration based on Takeda performing certain obligations was estimated using a probability weighted approach. The probability was applied to the contingent consideration based on Takeda performing certain obligations and discounted to present value. The fair value of the Company’s contingent consideration liability is revalued to fair value each period and any increase or decrease is recorded into earnings. The fair value of the contingent consideration was impacted by certain unobservable inputs, most significantly with regards to the discount rates, probability of scenario occurrence, expected volatility, historical and projected net sales performance, and expected scenario timing. Significant changes to these inputs in isolation could result in a significantly different fair value measurement. The potential contingent consideration payments required upon achievement of sales-based milestones related to the Company’s acquisition of Contrave range from zero if none of the milestones are achieved to a maximum of $110.0 million (undiscounted)(see Note 5).