Fair Value Measurements

3 Months Ended

Mar. 31, 2014

We use a three-tier fair value hierarchy to prioritize the inputs used in our fair value measurements. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets, which includes our money market funds and treasury securities classified as available-for-sale securities and our investment in equity securities in publicly-held biotechnology companies; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable, which includes our fixed income securities and commercial paper classified as available-for-sale securities; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Our Level 3 investments include investments in the equity securities of publicly-held biotechnology companies for which we calculated a lack of marketability discount because there were restrictions on when we could trade the securities. The majority of our securities have been classified as Level 2. We obtain the fair value of our Level 2 investments from our custodian bank or from a professional pricing service. We validate the fair value of our Level 2 investments by understanding the pricing model used by the custodian banks or professional pricing service provider and comparing that fair value to the fair value based on observable market prices. During the three months ended March 31, 2014 and 2013 there were no transfers between our Level 1 and Level 2 investments. We use the end of reporting period method for determining transfers between levels.

We measure the following major security types at fair value on a recurring basis. We break down the inputs used to measure fair value for these assets at March 31, 2014 and December 31, 2013 as follows (in thousands):

	At March 31, 2014		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents (1)	$	149,945	$	141,013	$	8,932	$	—
Corporate debt securities (2)		344,930		—		344,930		—
Debt securities issued by U.S. government agencies (2)		67,598		—		67,598		—
Debt securities issued by the U.S. Treasury (2)		15,298		15,298		—		—
Debt securities issued by states of the United States and political subdivisions of the states (2)		41,689		—		41,689		—
Investment in Regulus Therapeutics Inc.		63,586		63,586		—		—
Equity securities (3)		2,903		985		—		1,918
Total	$	685,949	$	220,882	$	463,149	$	1,918

	At December 31, 2013		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents (1)	$	146,357	$	133,233	$	13,124	$	—
Corporate debt securities (2)		394,773		—		394,773		—
Debt securities issued by U.S. government agencies (2)		64,432		—		64,432		—
Debt securities issued by the U.S. Treasury (2)		15,328		15,328		—		—
Debt securities issued by states of the United States and political subdivisions of the states (2)		22,255		—		22,255		—
Investment in Regulus Therapeutics Inc.		52,096		52,096		—		—
Equity securities (3)		1,276		1,276		—		—
Total	$	696,517	$	201,933	$	494,584	$	—

(1)

Included in cash and cash equivalents on our condensed consolidated balance sheet.

(2)

Included in short-term investments on our condensed consolidated balance sheet.

(3)

Included in other current assets on our condensed consolidated balance sheet.

We classified as Level 3 the fair value of our investments in the equity securities of publicly-held biotechnology companies that are subject to trading restrictions for which we calculate a lack of marketability discount on the fair value of the investments. We consider the inputs we used to calculate the lack of marketability discount Level 3 inputs and, as a result, we categorized these investments as Level 3. We determined the lack of marketability discount by using a Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the stock until the restriction ended.

As of January 1, 2013, we classified the fair value measurements of our investments in the equity securities of Regulus and Sarepta Therapeutics, Inc. as Level 3. In the first quarter of 2013, we sold all of the common stock of Sarepta that we owned resulting in a realized gain of $1.1 million. As of March 31, 2013, our Level 3 investments consisted of our investment in Regulus, with a gross fair value of $54.6 million and a lack of marketability discount of $9.7 million. In the fourth quarter of 2013, we re-classified our investment in Regulus to a Level 1 investment because the contractual trading restrictions on the Regulus shares we own ended. We recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. In the first quarter of 2014, Achaogen completed an initial public offering. As a result, we stopped using the cost method of accounting for our equity investment in Achaogen and instead we began accounting for it at fair value, which includes a lack of marketability discount because there are restrictions on when we can trade the securities. As of March 31, 2014, we classified our investment in the equity securities of Achaogen as Level 3 with a gross fair value of $2.3 million and a lack of marketability discount of $365,000.

The following is a summary of our investments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2014 and 2013 (in thousands):

	Three Months Ended March 31,
	2014		2013

Beginning balance of Level 3 investments	$	—	$	34,350
Total gains and losses:
Included in gain on investments		—		(1,163	)
Included in accumulated other comprehensive income (loss)		1,918		11,716
Cost basis of shares sold		—		(40	)
Ending balance of Level 3 investments	$	1,918	$	44,863

Other Fair Value Disclosures

Our 2¾ percent convertible notes had a fair value of $505.2 million at March 31, 2014. We determine the fair value of our 2¾ percent convertible notes based on quoted market prices for these notes, which is a Level 2 measurement.

- 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.

+ References+ Details