FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2013

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

D. FAIR VALUE MEASUREMENTS

The following tables set forth the Company’s assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2013:

	June 30, 2013
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets
Cash and cash equivalents: (1)
Corporate and municipal notes	$	—	$	79,267	$	—	$	79,267
Short-term and long-term investments: (2)
Bank deposits	—		116,902		—		116,902
U.S. Treasury securities	93,038		—		—		93,038
Corporate and municipal notes	—		573,223		—		573,223
Total assets	$	93,038	$	769,392	$	—	$	862,430
Liabilities
Contingent consideration	$	—	$	—	$	193,852	$	193,852
Total liabilities	$	—	$	—	$	193,852	$	193,852

(1)   Excludes $126.2 million of cash as of June 30, 2013.

(2)   Excludes certificates of deposit of $12.0 million recorded at cost as of June 30, 2013.

Marketable Securities

The Company classifies its bank deposits and corporate and municipal notes as a Level 2 input under the fair value hierarchy. 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

In connection with the acquisitions of Adolor Corporation, or Adolor, and Calixa, Cubist recorded contingent consideration pertaining to the amounts potentially payable to Adolor’s former stockholders pursuant to Cubist’s agreement to acquire Adolor and to Calixa’s former stockholders pursuant to Cubist’s agreement to acquire Calixa. Contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which represents a Level 3 measurement within the fair value hierarchy. The valuation of contingent consideration uses assumptions the Company believes would be made by a market participant. The Company assesses 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, impacting the Company’s 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.

Level 3 Disclosures

The following table provides quantitative information associated with the fair value measurement of the Company’s Level 3 inputs:

	Fair Value as of June 30, 2013		Valuation Technique	Unobservable Input	Range (Weighted Average)
	(in thousands)
Adolor
Contingent Consideration	$	79,248	Probability-adjusted discounted cash flow	Probabilities of success	29% - 54% (43%)
				Periods in which milestones are expected to be achieved	2016 - 2020
				Discount rates	5.3% / 16%
Calixa
Contingent Consideration	$	114,604	Probability-adjusted discounted cash flow	Probabilities of success	29% - 100% (57%)
				Periods in which milestones are expected to be achieved	2013 - 2018
				Discount rate	5.3%

The significant unobservable inputs used in the fair value measurement of Cubist’s 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 milestones will be achieved would result in a significantly lower or higher fair value measurement, respectively.

The table below provides a roll-forward of fair value balances that used Level 3 inputs:

	Contingent Consideration
	(in thousands)
Beginning balance as of December 31, 2012	$	189,213
Contingent consideration expense	4,639
Ending balance as of June 30, 2013	$	193,852

Adolor

The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Adolor upon the achievement of certain regulatory milestones, sales milestones or a combination of both, with respect to bevenopran (formerly known as CB-5945), was estimated to be $79.2 million and $77.0 million as of June 30, 2013 and December 31, 2012, respectively. The change in the fair value of the contingent consideration liability during the three and six months ended June 30, 2013, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that Cubist could pay to the former stockholders of Adolor under the merger agreement ranges from zero to $233.8 million. Bevenopran is an oral, peripherally-acting mu opioid receptor antagonist in development for the potential treatment of opioid-induced constipation in patients with chronic, non-cancer pain.

Calixa

The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Calixa, upon the achievement of certain development, regulatory and sales milestones with respect to ceftolozane/tazobactam was estimated to be $114.6 million and $112.2 million as of June 30, 2013 and December 31, 2012, respectively. The change in fair value for the three and six months ended June 30, 2013, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that Cubist could pay to the former stockholders of Calixa under the merger agreement is $220.0 million, including a $40.0 million milestone payment which is due in August 2013 as a result of first patient enrollment in the Company’s ceftolozane/tazobactam open-label study in patients with ventilator-associated bacterial pneumonia, or VABP, in July 2013. Ceftolozane/tazobactam is being developed as a potential treatment for complicated urinary tract infections, or cUTI, complicated intra-abdominal infections, or cIAI, hospital-acquired bacterial pneumonia, or HABP, and VABP.

Other Fair Value Measurements

Debt

The Company estimates the fair value of its 2.50% Notes by using a quoted market rate in an inactive market, which is classified as a Level 2 input. The estimated fair value and carrying value of the $450.0 million aggregate principal amount of the outstanding 2.50% Notes was $812.8 million and $375.1 million, respectively, as of June 30, 2013. See Note G., “Debt,” for additional information.

Payable to Glaxo

In connection with the acquisition of Adolor in December 2011, Cubist assumed the obligation to pay Glaxo Group Limited, or 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 June 30, 2013, the carrying value of the remaining annual payments to Glaxo of $17.4 million 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.