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Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2022

Note 6. Fair Value of Financial Instruments

In connection with the Sunosi acquisition, we pay a royalty on net sales of Sunosi. The discounted cash flow method used to value this contingent consideration includes inputs of not readily observable market data, which are Level 3 inputs. As of the May 9, 2022 acquisition date, the contingent consideration had a fair value of $36.1 million. The fair value of the contingent consideration was $35.3 million as of June 30, 2022 and is reflected as current accrued contingent consideration of $6.0 million and non-current contingent consideration liability of $29.3 million in the consolidated balance sheet.

The fair value of financial instruments measured on a recurring basis is as follows:


May 9, 2022	Level 1		Level 2		Level 3		Total
Liabilities:
Contingent consideration	$	—	$	—	$	36,140,407	$	36,140,407


June 30, 2022	Level 1		Level 2		Level 3		Total
Liabilities:
Contingent consideration	$	—	$	—	$	35,280,407	$	35,280,407
Total	$	—	$	—	$	35,280,407	$	35,280,407

The fair value of the contingent consideration was remeasured at June 30, 2022. The fair value of the financial instruments as of June 30, 2022 is as follows:




	Contingent Consideration
Balance at December 31, 2021	$	—
Initial estimate		36,140,407
Gain in fair value of contingent consideration		(860,000	)
Balance at June 30, 2022	$	35,280,407

The recurring Level 3 fair value measurements of contingent consideration for which a liability is recorded include the following significant unobservable inputs:


			As of June 30, 2022	As of May 9, 2022
	Valuation Methodology	Significant Unobservable Input	Weighted Average (range, if applicable)	Weighted Average (range, if applicable)
Contingent Consideration	Probability weighted income approach	Discount rate	13.2%	11.7%
		Revenue Discount rate	20.9%	20.8%

The fair value measurement of the contingent consideration is sensitive to the change in discount rate. As of June 30, 2022, if the discount rate increases or decreases by approximately 1%, the fair value of the contingent consideration would range

from $33.6 million to $37.0 million. As of June 30, 2022, if the revenue discount rate increases or decreases by approximately 1%, the fair value of the contingent consideration would range from $34.1 million to $36.6 million.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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