Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

v2.4.0.6
Fair Value Measurements
 9 Months Ended
Sep. 30, 2012
Fair Value Measurements [Abstract]  
Fair Value Measurements
 
4.
Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company applies ASC 820, which establishes a framework for measuring fair value and a fair value hierarchy that prioritizes the inputs used in valuation techniques. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
 
 
Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices in active markets for similar assets or liabilities.

Level 3 – Unobservable inputs.

The following tables set forth the Company's fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011.

Financial assets and liabilities carried at fair value as of September 30, 2012 and December 31, 2011 were classified as follows (in thousands):

   
Fair Value Measurements at September 30, 2012 Using
    
 
  
   
Quoted Prices in
Active Markets for
Identical Assets
    
Significant Other
Observable Inputs
    
Significant
Unobservable
Inputs
    
 
  
   
(Level 1)
    
(Level 2)
    
(Level 3)
    
Total
  
Assets:
  
 
    
 
    
 
    
 
  
Money market funds (1)
  $ 30,841     $ -     $ -     $ 30,841  
U.S. treasury securities
     16,999       -       -       16,999  
Foreign exchange options
     -       481       -       481  
Total
   $ 47,840     $ 481     $ -     $ 48,321  
                                 
Liabilities:
                                
Contingent warrant liabilities
   $ -     $ -     $ 32,179     $ 32,179  

   
Fair Value Measurements at December 31, 2011 Using
    
 
  
   
Quoted Prices in
Active Markets for
Identical Assets
    
Significant Other
Observable Inputs
    
Significant Unobservable Inputs
    
 
  
   
(Level 1)
    
(Level 2)
    
(Level 3)
    
Total
  
Assets:
  
 
    
 
    
 
    
 
  
Money market funds (1)
  $ 27,222     $ -     $ -     $ 27,222  
Foreign exchange options
     -       1,202       -       1,202  
Total
   $ 27,222     $ 1,202     $ -     $ 28,424  
                                 
Liabilities:
                                
Contingent warrant liabilities
   $ -     $ -     $ 379     $ 379  

(1)  Included in cash and cash equivalents
 
The fair value of the foreign exchange options at September 30, 2012 and December 31, 2011 was determined using readily observable market inputs from actively quoted markets obtained from various third-party data providers. These inputs, such as spot rate, forward rate and volatility have been derived from readily observable market data, meeting the criteria for Level 2 in the fair value hierarchy.

The fair value of the contingent warrant liabilities was determined at September 30, 2012 and December 31, 2011 using the Black-Scholes Model, which requires inputs such as the expected term of the warrants, volatility and risk-free interest rate. These inputs are subjective and generally require significant analysis and judgment to develop. At March 31, 2012, the Company changed its expected volatility assumption in the Black-Scholes Model from an estimate of volatility based on historical stock price volatility observed on XOMA's underlying stock to a volatility estimate based on the volatility implied from warrants issued by XOMA in recent private placement transactions. A market-based volatility rate was determined to be a more precise indicator for the fair value calculation of the Company's warrants.

The fair value of the contingent warrant liabilities was estimated using the following range of assumptions at September 30, 2012 and December 31, 2011:
 
 
   
September 30,
2012
    
December 31,
2011
  
Expected volatility
     40 %     102.1% - 103.2 %
Risk-free interest rate
     0.3% - 0.7 %     0.4 %
Expected term
  
2.2 - 4.4 years
    
2.9 - 3.1 years
  
 
The following table provides a summary of changes in the fair value of the Company's Level 3 financial liabilities for the nine months ended September 30, 2012 (in thousands):

Contingent warrant liabilities
  
September 30,
2012
  
Balance at December 31, 2011
   $ 379  
Initial fair value of warrants issued in March 2012
     6,390  
Reclassification of contingent warrant liability to equity upon exercise of warrants
     (336 )
Net increase in fair value of contingent warrant liabilities upon revaluation
     25,746  
Balance at September 30, 2012
   $ 32,179  

For the three and nine months ended September 30, 2012, the Company recognized net increases of $9.2 million and $25.7 million, respectively, in the estimated fair value of the contingent warrant liabilities resulting in recognized losses in the revaluation of contingent warrant liabilities line of the condensed consolidated statements of comprehensive loss.

For the three and nine months ended September 30, 2011, the Company recognized net decreases of $0.5 million and $3.3 million, respectively, in the estimated fair value of the contingent warrant liabilities resulting in recognized gains in the revaluation of contingent warrant liabilities line of the condensed consolidated statements of comprehensive loss.