FAIR VALUE MEASUREMENTS

Recurring Fair Value Measurements

The following table sets forth our assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2014:



	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets
Cash and cash equivalents: ⁽¹⁾
Corporate and municipal notes	$	—	$	1,502	$	—	$	1,502
Short-term investments: ⁽²⁾
Bank deposits	—		60,200		—		60,200
U.S. Treasury securities	70,185		—		—		70,185
Corporate and municipal notes	—		307,897		—		307,897
Total assets	$	70,185	$	369,599	$	—	$	439,784
Liabilities
Contingent consideration - Optimer CVRs	$	6,094	$	—	$	—	$	6,094
Contingent consideration - other	—		—		161,360		161,360
Total liabilities	$	6,094	$	—	$	161,360	$	167,454

⁽¹⁾ Excludes $232.2 million of cash as of September 30, 2014.

⁽²⁾ Excludes certificates of deposit of $15.0 million recorded at cost as of September 30, 2014.

We did not transfer any assets or liabilities between levels during the three and nine months ended September 30, 2014.

Marketable Securities

We classify our U.S. Treasury securities as Level 1 assets under the fair value hierarchy as these assets have been valued using quoted market prices in active markets without any valuation adjustment. We classify our bank deposits and corporate and municipal notes as Level 2 assets under the fair value hierarchy, as these assets have been valued using information obtained through a third-party pricing service at each balance sheet date, using observable market inputs that may include trade information, broker or dealer quotes, bids, offers, or a combination of these data sources.

Contingent Consideration

Level 1

In connection with the acquisition of Optimer, we issued one transferable CVR for each outstanding share of Optimer's common stock. The fair value of the liability relating to the amount payable by us to the holders of the CVRs upon the achievement of certain sales milestones for DIFICID and other specified products was $6.1 million and $68.6 million as of September 30, 2014 and December 31, 2013, respectively. The fair value of the liability is based upon the market price of the security, which is traded in an active market. Changes in the fair value of the liability related to changes in the market price of the security are recognized within the condensed consolidated statements of comprehensive income. The undiscounted amount of contingent consideration that we could pay to the holders of the Optimer CVRs ranges from zero to $253.9 million.

Level 3

In connection with the acquisitions of Trius, Adolor Corporation (Adolor) and Calixa Therapeutics Inc. (Calixa), we recorded contingent consideration pertaining to the amounts potentially payable to the former stockholders of each company. Such contingent consideration is measured at fair value and based on significant inputs not observable in the market. The valuation of contingent consideration uses assumptions we believe would be made by a market participant. We assess these estimates on an ongoing basis as additional data impacting the assumptions is obtained. Changes in the fair value of contingent consideration related to updated assumptions and estimates are recognized within the condensed consolidated statements of comprehensive income.

Contingent consideration may change significantly as development progresses and additional data is obtained that will affect our assumptions regarding probabilities of successful achievement of related milestones used to estimate the fair value of the liability and the timing in which they are expected to be achieved. In evaluating the fair value information, considerable judgment is required to interpret the market data used to develop the estimates. The estimates of fair value may not be indicative of the amounts that could be realized in a current market exchange. Accordingly, the use of different market assumptions and/or different valuation techniques could result in materially different fair value estimates.

The following table provides quantitative information associated with the fair value measurement of our Level 3 contingent consideration:



	Fair Value as of September 30, 2014 (in thousands)			Unobservable Inputs
	Fair Value as of September 30, 2014 (in thousands)		Valuation technique	Probability of success - range (weighted average)	Periods in which milestones are expected to be achieved	Discount rate
Trius	$	5,310	Probability-adjusted discounted cash flow	4.0% - 6.5% (5.8%)	2016	8.0%
Adolor	46,128		Probability-adjusted discounted cash flow	25.0% - 30.0% (27.0%)	2018 - 2022	5.3% / 13.0%
Calixa	109,922		Probability-adjusted discounted cash flow	40.0% - 86.0% (65.0%)	2014 - 2018	5.3%
Total	$	161,360

The significant unobservable inputs used in the fair value measurement of our contingent consideration are the probabilities of successful achievement of development, regulatory and sales milestones, the period in which these milestones are expected to be achieved and a discount rate. Significant increases or decreases in any of the probabilities of success would result in a significantly higher or lower fair value measurement, respectively. Significant increases or decreases in the discount rate and/or the period in which the milestones will be achieved would result in a significantly lower or higher fair value measurement, respectively.

Trius Therapeutics, Inc.—The fair value of contingent consideration payable by us to the former stockholders of Trius upon the achievement of certain sales milestones of SIVEXTRO and other specified products was estimated to be $5.3 million and $5.0 million as of September 30, 2014 and December 31, 2013, respectively. The change in the fair value of the contingent consideration liability during the three and nine months ended September 30, 2014, is due to the time value of money. The undiscounted amount of contingent consideration that we could pay to the former stockholders of Trius under the merger agreement ranges from zero to $108.4 million. SIVEXTRO is a once daily intravenous and oral oxazolidinone antibiotic treatment for certain serious skin infections caused by susceptible Gram-positive bacteria, including methicillin-resistant Staphylococcus aureus (MRSA).

Adolor Corporation—The fair value of contingent consideration payable by us to the former stockholders of Adolor upon the achievement of certain regulatory milestones, sales milestones or a combination of both, with respect to bevenopran, was estimated to be $46.1 million and $44.2 million as of September 30, 2014 and December 31, 2013, respectively. The change in the fair value of the contingent consideration liability during the three and nine months ended September 30, 2014, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that we could pay to the former stockholders of Adolor under the merger agreement ranges from zero to $233.8 million. Bevenopran is in development as a potential treatment for opioid-induced constipation (OIC) in patients with chronic, non-cancer pain.

Calixa Therapeutics Inc.—The fair value of contingent consideration payable by us to the former stockholders of Calixa upon the achievement of certain regulatory and sales milestones with respect to ZERBAXA^TM (ceftolozane/tazobactam for injection) was estimated to be $109.9 million and $105.6 million as of September 30, 2014 and December 31, 2013, respectively. The change in the fair value of the contingent consideration liability during the three and nine months ended September 30, 2014, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that we could pay to the former stockholders of Calixa under the merger agreement ranges from zero to $180.0 million. ZERBAXA is in development as a potential treatment for complicated urinary tract infections (cUTI), complicated intra-abdominal infections (cIAI), hospital-acquired bacterial pneumonia (HABP) and ventilator-associated bacterial pneumonia (VABP).

Changes in the fair value of our Level 3 contingent consideration were as follows:



	Contingent Consideration
	(in thousands)
Beginning balance as of December 31, 2013	$	154,761
Contingent consideration expense	6,599
Ending balance as of September 30, 2014	$	161,360

Other Fair Value Measurements

Debt

We estimate the fair value of our 2020 Notes, 2018 Notes and 2017 Notes (Convertible Senior Notes) by using a quoted market rate in an inactive market, which is classified as a Level 2 input. The estimated fair values of the Convertible Senior Notes consisted of the following at:



	September 30, 2014		December 31, 2013
	(in thousands)
2020 Notes	$	499,235	$	516,843
2018 Notes	378,452		403,473
2017 Notes	526,833		550,317
Total estimated fair value of Convertible Senior Notes	$	1,404,520	$	1,470,633

See Note H., “Debt,” for additional information.

Payable to Glaxo

In connection with the acquisition of Adolor in December 2011, we assumed the obligation to pay Glaxo Group Limited (Glaxo) six annual payments aggregating to $22.5 million as a result of Adolor’s termination of its collaboration agreement with Glaxo in September 2011. The amount payable to Glaxo was recorded at its estimated fair value at the time of acquisition and is allocated between current and non-current liabilities within the condensed consolidated balance sheets based on the contractual payment dates. The fair value estimate utilizes a discount rate, which is classified as a Level 3 input. As of September 30, 2014, the $11.3 million carrying value of the remaining annual payments to Glaxo approximates its fair value. Imputed interest on the amount payable to Glaxo is recorded as interest expense within the condensed consolidated statements of comprehensive income.