NOTE 5. FINANCIAL INSTRUMENTS

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy, which is based on three levels of inputs, the first two of which are considered observable and the last unobservable, that may be used to measure fair value, is as follows:

The Company classifies its financial instruments within Level 1 or Level 2 of the fair value hierarchy on the basis of valuations using quoted market prices or alternate pricing sources and models utilizing market observable inputs, respectively. The Company’s money market funds are valued based on quoted prices for the specific securities in an active market and are therefore classified as Level 1. The Company’s government securities, commercial paper and corporate debt securities are valued on the basis of valuations provided by third-party pricing services, as derived from such services’ pricing models. As of June 30, 2018, the Company has not made any adjustments to the prices obtained from its third-party pricing providers.

Cash and Cash Equivalents and Marketable Securities

The Company’s money market funds and marketable securities are categorized as Level 1 and 2, respectively, within the fair value hierarchy. The following table shows the cost, gross unrealized losses and fair value, with a breakdown by significant investment category, of the Company’s cash and cash equivalents and marketable securities as of June 30, 2018:

As of June 30, 2018, the Company held securities with an aggregate fair value of $25.5 million that were in an unrealized loss position for less than 12 months. No securities have been in unrealized loss positions for greater than 12 months. Gross unrealized losses at June 30, 2018 represented temporary impairments on government securities, commercial paper and corporate debt securities related to multiple issuers and were primarily caused by fluctuations in U.S. interest rates. The Company may sell certain of its marketable securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. As of June 30, 2018, the Company considered the declines in market value of its marketable securities to be temporary in nature.

All of the Company’s marketable securities were due within 2 years of June 30, 2018.

As of December 31, 2017, the Company’s cash and cash equivalents and marketable securities balances were as follows:

Stock Warrants

All of the Company’s outstanding stock warrants are categorized as Level 3 within the fair value hierarchy. Stock warrants have been recorded at their fair value using either a probability weighted expected return model or the Black-Scholes option-pricing model. These models incorporate contractual terms, maturity, risk-free interest rates and volatility. The value of the Company’s stock warrants would increase if a higher risk-free interest rate was used, and would decrease if a lower risk-free interest rate was used. Similarly, a higher volatility assumption would increase the value of the stock warrants, and a lower volatility assumption would decrease the value of the stock warrants. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s management with the assistance of a third-party valuation specialist.

In 2016, in connection with the Investment Agreement between the Company and Acacia Research Corporation (“Acacia”) and the convertible secured promissory note issued by the Company to Acacia (the “Acacia Note”), the Company issued three four-year warrants (the “Acacia Note Warrants”) and a five-year warrant (the “Primary Warrant”). In March 2017, each of the Primary Warrant and the Acacia Note Warrants was amended to provide that the exercise prices thereof shall be equal to the lower of $13.6088 or the Company’s initial public offering (“IPO”) price per share.

In May 2017, upon exercise of the Primary Warrant, the Company issued to Acacia a five-year warrant to purchase 809,400 shares of the Company’s common stock (the “10% Warrant”) at an exercise price of $13.6088. At issuance date, the fair value of the 10% Warrant under Level 3 measurement was $5,790.

In April 2018, in connection with the advisory agreement between the Company and a financial advisory firm, the Company issued a five-year warrant to purchase up to 20,000 shares of the Company’s common stock (“April 2018 Warrant”). The April 2018 Warrant was fully vested and exercisable upon issuance and has an exercise price of $11.73 per share.

The following table summarizes quantitative information with respect to the significant unobservable inputs that were used to value the April 2018 Warrant:

The following table represents a roll-forward of the fair value of the April 2018 Warrant, which was recorded within other accrued liabilities in the accompanying condensed consolidated balance sheet during the six months ended June 30, 2018:

As of June 30, 2018, the total fair value of the April 2018 Warrant increased by $15 to $222. The expense relating to the April 2018 Warrant has been recorded to general and administrative expense in the Company’s consolidated statement of operations and comprehensive loss for the three and six months ended June 30, 2018.

The following table summarizes quantitative information with respect to the significant unobservable inputs that were used to value the Company’s 10% Warrant:

There were no transfers between Level 1, Level 2 or Level 3 financial instruments in the six months ended June 30, 2018.