Fair Value Measurements

9 Months Ended

Sep. 30, 2014

Fair Value Measurements

4. Fair Value Measurements

We have certain financial assets and liabilities recorded at fair value which have been classified as Level 1, 2 or 3 within the fair value hierarchy as described in the accounting standards for fair value measurements.

Accounting standards define fair value 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 as of the measurement date. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. The accounting standard provides an established hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors that market participants would use in valuing the asset or liability. The accounting standard prioritizes the inputs used in measuring the fair value into the following hierarchy:

• Level 1 includes financial instruments for which quoted market prices for identical instruments are available in active markets.

• Level 2 includes financial instruments for which there are inputs other than quoted prices included within Level 1 that are observable for the instrument such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets with insufficient volume or infrequent transactions (less active markets) or model-driven valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

• Level 3 includes financial instruments for which fair value is derived from valuation techniques in which one or more significant inputs are unobservable, including management’s own assumptions.

The following table presents our fair value hierarchy for assets and liabilities measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013 (in thousands):

	Fair value as of September 30, 2014
	Total		Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	8,760	$	8,760	$	—	$	—
Corporate debt securities		68,237		—		68,237		—
Certificates of deposit		13,870		—		13,870		—
Commercial paper		2,000		—		2,000		—
	$	92,867	$	8,760	$	84,107	$	—
Liabilities:
Convertible note payable	$	10,665	$	—	$	—	$	10,665
	Fair value as of December 31, 2013
	Total		Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	17,170	$	17,170	$	—	$	—
Corporate debt securities		71,416		—		71,416		—
Certificates of deposit		11,710		—		11,710		—
Debt securities of U.S. government-sponsored agencies		7,001		—		7,001		—
Commercial paper		6,071		—		6,071		—
	$	113,368	$	17,170	$	96,198	$	—
Liabilities:
Convertible note payable	$	11,279	$	—	$	—	$	11,279

Changes in the estimated fair value of convertible note payable from December 31, 2013 through September 30, 2014 are as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at December 31, 2013	$	11,279
Change in estimated fair value of convertible note payable		(614	)
Balance at September 30, 2014	$	10,665

We obtain pricing information from quoted market prices or quotes from brokers/dealers. We generally determine the fair value of our investment securities using standard observable inputs, including reported trades, broker/dealer quotes, bids and/or offers. Refer to Note 3 for information regarding our investments.

We used an income approach in the form of a convertible bond valuation model to value the convertible note payable. The convertible bond model considered the debt and option characteristics of the note. The key inputs to the model as of September 30, 2014 and December 31, 2013 were volatility (80% and 66%, respectively), risk-free rate (0.17% and 0.325%, respectively), and credit spread (7.92% and 7.4%, respectively). The volatility inputs were based on historical and implied volatility of peer companies. Peer companies were materially consistent with those used to determine volatility for stock-based compensation. Beginning in 2014, our historical volatility was included with the peer companies for purposes of estimating volatility. As of September 30, 2014, the volatility input included 40% weighting of our historical volatility and 60% weighting of historical and implied volatility of peer companies. The risk-free rate inputs were based on the yield of U.S. Treasury Strips as of each date. The credit spread inputs were based on an analysis of our creditworthiness and market rates for comparable straight debt instruments. We recorded a gain from the change in valuation of convertible note payable of $1.8 million and $0.6 million for the three and nine months ended September 30, 2014, respectively on our condensed statements of operations and comprehensive loss. We recorded a gain of $0.7 million and a loss of $3.8 million, respectively, for the same periods in 2013. A 10% increase or decrease in volatility would result in approximately a 2% increase or decrease in our estimated fair value of convertible note payable.