Fair Value Measurements

6 Months Ended

Jun. 30, 2019

Fair Value Disclosures [Abstract]

Fair Value Measurements

4. Fair Value Measurements

Our financial assets consist of cash equivalents, short-term and long-term investments, accounts receivable, net, and leasehold receivables. Cash equivalents, short-term investments and long-term investments, which consist of money market funds, corporate debt securities and U.S. government and government agency debt securities, are reported at fair value. Accounts receivable, net and leasehold receivables are stated at the net realizable amount, which approximates fair value.

Our financial liabilities consist of accounts payable and accrued liabilities, which are stated at the invoiced or estimated payout amount, respectively, and approximate fair value, contingent consideration obligations as a result of business acquisitions, which are reported at fair value, lease liabilities, which approximate fair value and our debt; see Note 10 – “Debt” for further discussion on the fair value of our debt.

As of June 30, 2019, our contingent consideration obligations represent the estimated fair value of the additional consideration payable in connection with our acquisitions of Gram Games in the second quarter of 2018 and Small Giant in the first quarter of 2019.

Under the terms of the Gram Games acquisition, contingent consideration may be payable based on the achievement of certain future profitability performance targets during each annual period following the acquisition date for a total of three years, with no maximum limit as to the contingent consideration achievable. We estimated the acquisition date and subsequent reporting period fair values of the contingent consideration obligation using a Monte Carlo simulation. The significant unobservable inputs used in the fair value measurement of the contingent consideration obligation were Gram Games’ projected performance, a risk-adjusted discount rate and performance volatility similar to industry peers. Changes to projected performance of the acquired business could result in a higher or lower contingent consideration obligation in the future. As of December 31, 2018, the estimated fair value of the Gram Games contingent consideration obligation was $49.0 million and as of June 30, 2019, the estimated fair value of the contingent consideration obligation increased to $72.8 million, primarily due to stronger than expected performance and the increased probability of achievement. For six months ended June 30, 2019, we recognized $23.8 million of expense within research and development expenses in our consolidated statement of operations. For the three months ended June 30, 2019, we recognized a $2.7 million benefit within research and development expenses in our consolidated statement of operations, driven by continued refinement of forecasted financial results.  

Under the terms of the Small Giant acquisition, contingent consideration may be payable based on the achievement of certain future profitability performance targets during each annual period following the acquisition date for a total of three years, with no maximum limit as to the contingent consideration achievable. We estimated the acquisition date and subsequent reporting period fair values of the contingent consideration obligation using a Monte Carlo simulation. The significant unobservable inputs used in the fair value measurement of the contingent consideration obligation were Small Giant’s projected performance, a risk-adjusted discount rate and performance volatility similar to industry peers. Changes to projected performance of the acquired business could result in a higher or lower contingent consideration obligation in the future. At acquisition, the estimated fair value of the contingent consideration obligation was $98.0 million. As of June 30, 2019, the estimated fair value of the contingent consideration obligation increased to $183.6 million, primarily due to stronger than expected performance and the increased probability of achievement. Accordingly, for the three and six months ended June 30, 2019, we recognized $26.6 million and $85.6 million, respectively, of expense within research and development expenses in our consolidated statement of operations.

We estimate fair value as the exit price, which represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between knowledgeable and willing market participants.

The valuation techniques used to measure the fair value of the Company’s financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model-driven valuations using significant inputs derived from or corroborated by observable market data. We use a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Includes inputs, other than Level 1 inputs, that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs that are supported by little or no market activity.

The composition of our financial assets and liabilities as of June 30, 2019 and December 31, 2018 among the three levels of the fair value hierarchy are as follows (in thousands):

	June 30, 2019
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	190,094	$	—	$	—	$	190,094
Corporate debt securities		—		228,388		—		228,388
Short-term investments:
Corporate debt securities		—		134,262		—		134,262
U.S. government and government agency debt    securities		—		3,003		—		3,003
Long-term investments:
Corporate debt securities		—		2,004		—		2,004
Total financial assets	$	190,094	$	367,657	$	—	$	557,751
Liabilities:
Contingent consideration	$	—	$	—	$	256,400	$	256,400

	December 31, 2018
	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents:
Money market funds	$	565	$	—	$	—	$	565
Corporate debt securities		—		4,987		—		4,987
Short-term investments:
Corporate debt securities		—		36,232		—		36,232
Total financial assets	$	565	$	41,219	$	—	$	41,784
Liabilities:
Contingent consideration	$	—	$	—	$	49,000	$	49,000

The following table presents the activity for the six months ended June 30, 2019 related to our Level 3 liabilities (in thousands):

Level 3 Liabilities:	Total
Contingent consideration obligation –  December 31, 2018	$	49,000
Additions		98,000
Fair value adjustments		109,400
Contingent consideration obligation –  June 30, 2019	$	256,400

We had no transfers between valuation levels from December 31, 2018 to June 30, 2019.