Fair Value Measurements

The Company utilizes the methods of fair value measurement as described in FASB ASC 820, “Fair Value Measurements” to value its financial assets and liabilities, including the financial instruments issued in the transaction described in Note 3, Strategic Alliance and Investment by Elutions, Inc. and the contingent consideration liability described in Note 2, Acquisition. As defined in FASB ASC 820, fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, FASB ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

Recurring Fair Value Measurements

The fair value of the Company’s Note and the Holder Redemption Option were determined using a binomial lattice model. (See Note 3, Strategic Alliance and Investment by Elutions, Inc., for further discussion of the Note and Holder Redemption Option.) The Holder Redemption Option was determined to be an embedded derivative liability that was required to be bifurcated and recorded as a liability.

The Company has classified the Holder Redemption Option and Note as Level 3 liabilities. Changes in the fair value of the Holder Redemption Option are recognized in the Condensed Consolidated Statements of Operations and Comprehensive Loss. The Company reassesses the fair value of this liability on a quarterly basis. Based on that assessment, the Company recognized an increase of $122,000 and a decrease of $20,000 in the fair value of this liability during the thirteen weeks ended July 2, 2016 and July 4, 2015, respectively, and recognized an increase of $49,000 and an increase of $105,000 during the twenty-six weeks ended July 2, 2016 and July 4, 2015, respectively. To determine the fair value of the Holder Redemption Option, management evaluates assumptions that require significant judgment. Changes in certain inputs to the valuation model, including the Company’s period end stock price and stock volatility, can have a significant impact on the estimated fair value. The fair value recorded for the Holder Redemption Option may vary significantly from period to period. This variability may result in the actual liability for a period either above or below the estimates recorded in the Company’s consolidated financial statements, resulting in significant fluctuations in other income (expense) as a result of the corresponding non-cash gain or loss recorded. The model requires the following inputs: (i) price of the Company’s common stock; (ii) the expected life of the instrument or derivative; (iii) risk-free interest rate; (iv) estimated dividend yield, and (v) estimated stock volatility. Assumptions used in the calculation require significant management judgment.

The following table sets forth the Level 3 inputs to the binomial lattice model that were used to determine the fair value of the Note and the Holder Redemption Option:



	July 2, 2016			January 2, 2016
Common stock price	$	1.08		$	2.22
Dividend yield	—		%	—		%
Expected term	0.3 years			0.75 years
Risk-free interest rate	0.7		%	1.3		%
Estimated stock volatility	58.7		%	45.0		%

In addition, the Company determined that the provision of the Note that permits Cartesian Limited to prepay the Note after 18 months if the trading price of the Company’s common stock exceeds $5.50 per share for a specified period of time is an embedded derivative asset that requires bifurcation (the “Issuer Call Option”). As of July 2, 2016 and January 2, 2016, the fair value of the Issuer Call Option was determined to be immaterial.

Because the Company measures the Holder Redemption Option at fair value on a recurring basis, transfers, if any, between the levels of the fair value hierarchy are recognized at the end of the fiscal quarter in which the change in circumstances that caused the transfer occurred.

In connection with the acquisition of the Farncombe Entities, the Company recorded a liability related to the Earn-Out portion of the purchase consideration. See Note 2, Acquisition, for further discussion of the Earn-Out liability. The Company has classified the Earn-Out liability as a Level 3 liability and the fair value of the Earn-Out liability will be evaluated each reporting period and changes in its fair value will be included in the Company’s results of operations. The fair value of the Earn-Out liability was calculated using a Monte Carlo simulation using a risk-adjusted discount rate applied to management’s estimate of forecasted revenues that are eligible under the Earn-Out as described in the Purchase Agreement. To determine the fair value of the Earn-Out liability, management evaluates assumptions that require significant judgment. Changes in certain inputs to the valuation model, including the Company’s estimate of future revenues, can have a significant impact on the estimated fair value. The fair value recorded for the Earn-Out liability may vary significantly from period to period. This variability may result in the actual liability for a period either above or below the estimates recorded in the Company’s Consolidated Financial Statements, resulting in significant fluctuations in results of operations as a result of the corresponding non-cash gain or loss recorded.

Because the Company measures the Earn-Out liability at fair value on a recurring basis transfers, if any, between the levels of the fair value hierarchy are recognized at the end of the fiscal quarter in which the change in circumstances that caused the transfer occurred.

There were no transfers between Level 1, 2 or 3 liabilities during the twenty-six weeks ended July 2, 2016 or during the fiscal year ended January 2, 2016.

As of July 2, 2016 and January 2, 2016, liabilities recorded at fair value on a recurring basis consist of the following (in thousands):



	Total		Quoted prices in active markets Level 1		Significant other observable inputs Level 2		Significant other unobservable inputs Level 3
July 2, 2016:
Holder Redemption Option	$	1,001	$	—	$	—	$	1,001
Earn-Out Liability	$	1,875	$	—	$	—	$	1,875
January 2, 2016:
Holder Redemption Option	$	952	$	—	$	—	$	952
Earn-Out Liability	$	2,176	$	—	$	—	$	2,176

The following table summarizes the year-to-date changes to the fair value of the Holder Redemption Option and Earn-Out liability, which are Level 3 liabilities (in thousands):



	Holder Redemption Option		Earn-Out Liability
Fair value at January 2, 2016	$	952	$	2,176
Increase (decrease) in fair value	49		(301		)
Fair value at July 2, 2016	$	1,001	$	1,875

Other Fair Value Disclosures

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair values because of the relatively short-term maturities of these financial instruments.