5. Fair value measurements

The fair value of the Company’s financial assets and liabilities measured on a recurring basis were as follows:

	June 30, 2018											December 31, 2017
(U.S. Dollars, in thousands)	Level 1		Level 2			Level 3			Total			Total
Assets
Collective trust funds	$	—	$	100		$	—		$	100		$	100
Treasury securities		558		—			—			558			556
Equity warrants		—		289			—			289			311
Equity securities		—		4,379			—			4,379			2,457
Debt security		—		—			18,010			18,010			16,050
Total	$	558	$	4,768		$	18,010		$	23,336		$	19,474
Liabilities
Contingent consideration	$	—	$	—		$	(26,600	)	$	(26,600	)	$	—
Deferred compensation plan		—		(1,369	)		—			(1,369	)		(1,379	)
Total	$	—	$	(1,369	)	$	(26,600	)	$	(27,969	)	$	(1,379	)

Equity Warrants and Securities

The Company holds investments in common stock and warrants to purchase shares of common stock of Bone Biologics, Inc. (“Bone Biologics”). The Company’s common stock investments are recorded within other long-term assets while the warrants are recorded within other current assets or other long-term assets, dependent upon the expiration date. Prior to 2018, these instruments were accounted for at cost as the fair value of these instruments was not readily determinable. Effective January 1, 2018, the Company is required to measure these equity investments at fair value and recognize any changes in fair value in net income as a result of adopting ASU 2016-01. However, for certain equity investments that do not have readily determinable fair values, the new guidance allows entities to choose to measure these investments using a new measurement alternative, which values the investments at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. The Company has elected to use the new measurement alternative for these equity investments in Bone Biologics, which resulted in an increase in the previously recorded value of the equity investments of $1.6 million, or $0.09 per share before taxes, during the three months ended March 31, 2018. These changes are classified as other income or expense. In addition, the Company made an additional investment in Bone Biologics during the first quarter of 2018, in which it purchased an additional 250,000 shares of common stock for $0.5 million.

Debt Security

The Company holds a debt security of eNeura, Inc., a privately held medical technology company that is developing devices for the treatment of migraines. The debt security matures on March 4, 2019. The fair value of the debt security, which is recorded within other current assets, is based upon significant unobservable inputs, including the use of a discounted cash flow model, requiring the Company to develop its own assumptions; therefore, the Company has categorized this asset as a Level 3 financial asset. As of June 30, 2018, the Company reassessed its estimate of fair value based on current financial information and other assumptions, resulting in a fair value of $18.0 million, an increase of $2.0 million when compared to the Company’s estimated fair value of the debt security as of December 31, 2017. This compares to an amortized cost basis in the debt security of $9.0 million.

The following table provides a reconciliation of the beginning and ending balances for debt securities measured at fair value using significant unobservable inputs (Level 3):

(U.S. Dollars, in thousands)	2018		2017
Debt security at January 1	$	16,050	$	12,220
Accrued interest income		—		—
Gains or losses recorded for the period
Recognized in net income		—		(5,585	)
Recognized in other comprehensive income		1,960		2,365
Debt security at June 30	$	18,010	$	9,000

Contingent Consideration

The contingent consideration consists of potential future milestone payments of up to $60.0 million in cash associated with the Spinal Kinetics acquisition. The milestone payments include (i) up to $15.0 million if the U.S. Food and Drug Administration grants approval of Spinal Kinetics’ M6-C artificial disc (“the FDA Milestone”) and (ii) revenue-based milestone payments of up to $45.0 million in connection with future sales of the M6-C artificial cervical disc and the M6-L artificial lumbar disc. Milestones must be achieved within five years of April 30, 2018 to trigger applicable payments. The fair value of the contingent consideration arrangement at the acquisition date was $25.5 million and was $26.6 million as of June 30, 2018; however, the actual amount ultimately paid could be higher or lower than the fair value of the contingent consideration. The increase in fair value of $1.1 million was recorded in other expense.

The Company estimated the fair value of the contingent consideration attributable to the FDA Milestone using a probability-weighted discounted cash flow model. This fair value is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The key assumptions in applying the probability-weighted discounted cash flow model include the Company’s estimation of the probability and timing of obtaining FDA approval for the M6-C artificial disc. Significant changes in these assumptions could result in a significantly higher or lower fair value.

The Company estimated the fair value of the potential future revenue-based milestone payments using a Monte Carlo simulation. This fair value measurement is based on significant inputs that are unobservable in the market, and thus represents a Level 3 measurement. The key assumptions in applying the Monte Carlo valuation model include the Company’s forecasted future revenues for Spinal Kinetics products, discount rate applied, and assumptions for potential volatility of the Company’s forecasted revenue. Significant changes in these assumptions could result in a significantly higher or lower fair value.

The following table provides a reconciliation of the beginning and ending balances for the contingent consideration measured at fair value using significant unobservable inputs (Level 3):

(U.S. Dollars, in thousands)	2018
Contingent consideration at January 1	$	—
Acquisition date fair value		25,491
Increase in fair value recognized in other income (expense)		1,109
Contingent consideration at June 30	$	26,600