FAIR VALUE MEASUREMENTS

9 Months Ended

Sep. 30, 2013

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

E.    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 September 30, 2013:

	September 30, 2013
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets
Cash and cash equivalents: (1)
Money market funds	$	146,595	$	—	$	—	$	146,595
U.S. Treasury securities	59,999		—		—		59,999
Corporate and municipal notes	—		170,217		—		170,217
Short-term and long-term investments: (2)
Bank deposits	—		20,000		—		20,000
U.S. Treasury securities	75,039		—		—		75,039
Corporate and municipal notes	—		352,130		—		352,130
Total assets	$	281,633	$	542,347	$	—	$	823,980
Liabilities
Contingent consideration	$	—	$	—	$	161,372	$	161,372
Total liabilities	$	—	$	—	$	161,372	$	161,372

(1)   Excludes $161.7 million of cash as of September 30, 2013.

(2)   Excludes certificates of deposit of $12.2 million recorded at cost as of September 30, 2013.

Marketable Securities

The Company classifies its money market funds and U.S. Treasury securities as a Level 1 input under the fair value hierarchy as these assets have been valued using quoted market prices in active markets without any valuation adjustment. The Company classifies its bank deposits and corporate and municipal notes as a Level 2 input 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

In connection with the acquisitions of Trius, Adolor Corporation, or Adolor, and Calixa, Cubist recorded contingent consideration pertaining to the amounts potentially payable to the former stockholders of each company. 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, affecting 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.

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

	Contingent Consideration
	Trius	Adolor	Calixa
Fair value as of September 30, 2013 (in thousands)	$4,879	$80,401	$76,092
Valuation technique	Probability-adjusted discounted cash flow	Probability-adjusted discounted cash flow	Probability-adjusted discounted cash flow
Unobservable input
Probabilities of success - range (weighted average)	4% - 7% (6%)	29% - 54% (43%)	29% - 63% (48%)
Periods in which milestones are expected to be achieved	2016	2016 - 2020	2014 - 2018
Discount rate	8.0%	5.3% / 16%	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 the milestones will be achieved would result in a significantly lower or higher fair value measurement, respectively.

Trius

The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Trius, upon the achievement of certain sales milestones of tedizolid phosphate and other specified products was estimated to be $4.9 million as of September 30, 2013. The undiscounted amount of contingent consideration that Cubist could pay to the former stockholders of Trius under the merger agreement ranges from zero to $108.4 million. Tedizolid phosphate is in development for the treatment of serious Gram-positive bacterial infections, including those caused by MRSA.

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 $80.4 million and $77.0 million as of September 30, 2013 and December 31, 2012, respectively. The change in the fair value of the contingent consideration liability during the three and nine months ended September 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 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 $76.1 million and $112.2 million as of September 30, 2013 and December 31, 2012, respectively. The change in fair value for the three and nine months ended September 30, 2013, is primarily due to the $40.0 million milestone payment made 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 and 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 $180.0 million. 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.

Changes in the fair value of contingent consideration based upon unobservable inputs that are Level 3 measurements, were as follows:

	Contingent Consideration
	(in thousands)
Beginning balance as of December 31, 2012	$	189,213
Contingent consideration liability recorded upon acquisition of Trius	4,879
Contingent consideration expense	7,280
Contingent consideration milestone payment	(40,000		)
Ending balance as of September 30, 2013	$	161,372

Other Fair Value Measurements

Debt

The Company estimates the fair value of its 2020 Notes, 2018 Notes and 2017 Notes, or collectively the 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 2020 Notes, 2018 Notes and 2017 Notes were $480.8 million, $379.3 million and $526.2 million, respectively, as of September 30, 2013. See Note J., “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 September 30, 2013, the carrying value of the remaining annual payments to Glaxo of $14.1 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.