Note 5. Fair Value of Financial Instruments

FASB ASC 820, Fair Value Measurements, establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring assets and liabilities at fair values. This hierarchy establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are as follows:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the assessment date

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly

Level 3 – Unobservable inputs for the asset or liability

Our financial instruments consist of cash and cash equivalents, accounts and other receivables, a derivative liability, our outstanding notes and other debt, contingent consideration and accounts, interest and dividends payable.

The following table summarizes the fair value of our financial instruments at March 31, 2018 and December 31, 2017:

(Thousands)	Total		Quoted Prices in Active Markets (Level 1)		Prices with Other Observable Inputs (Level 2)		Prices with Unobservable Inputs (Level 3)
At March 31, 2018
Assets
Derivative asset	$	42,061	$	-	$	42,061	$	-
Total	$	42,061	$	-	$	42,061	$	-

Liabilities
Senior secured term loan B - variable rate, due October 24, 2022	$	2,008,760	$	-	$	2,008,760	$	-
Senior secured notes - 6.00%, due April 15, 2023		528,000		-		528,000		-
Senior unsecured notes - 8.25%, due October 15, 2023		1,051,725		-		1,051,725		-
Senior unsecured notes - 7.125%, due December 15, 2024		542,250		-		542,250		-
Senior secured revolving credit facility, variable rate, due April 24, 2020		299,970		-		299,970		-
Contingent consideration		89,236		-		-		89,236
Total		4,519,941		-		4,430,705		89,236

(Thousands)	Total		Quoted Prices in Active Markets (Level 1)		Prices with Other Observable Inputs (Level 2)		Prices with Unobservable Inputs (Level 3)
At December 31, 2017
Assets
Derivative asset	$	6,793	$	-	$	6,793	$	-
Total	$	6,793	$	-	$	6,793	$	-

Liabilities
Senior secured term loan B - variable rate, due October 24, 2022	$	2,011,237	$	-	$	2,011,237	$	-
Senior secured notes - 6.00%, due April 15, 2023		540,375		-		540,375		-
Senior unsecured notes - 8.25%, due October 15, 2023		1,073,925		-		1,073,925		-
Senior unsecured notes - 7.125%, due December 15, 2024		542,250		-		542,250		-
Senior secured revolving credit facility, variable rate, due April 24, 2020		279,972		-		279,972		-
Contingent consideration		105,762		-		-		105,762
Total	$	4,553,521	$	-	$	4,447,759	$	105,762

The carrying value of cash and cash equivalents, accounts and other receivables, and accounts, interest and dividends payable approximate fair values due to the short-term nature of these financial instruments.

The total principal balance of our outstanding notes and other debt was $4.6 billion at March 31, 2018, with a fair value of $4.4 billion. The estimated fair value of our outstanding notes and other debt was based on available external pricing data and current market rates for similar debt instruments, among other factors, which are classified as Level 2 inputs within the fair value hierarchy. Derivative assets are carried at fair value. See Note 7. The fair value of an interest rate swap is determined based on the present value of expected future cash flows using observable, quoted LIBOR swap rates for the full term of the swap and also incorporate credit valuation adjustments to appropriately reflect both Uniti’s own non-performance risk and non-performance risk of the respective counterparties. The Company has determined that the majority of the inputs used to value its derivative assets fall within Level 2 of the fair value hierarchy; however the associated credit valuation adjustments utilized Level 3 inputs, such as estimates of credit spreads, to evaluate the likelihood of default by the Company and its counterparties. As of March 31, 2018, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall value of the derivatives. As such, the Company classifies its derivative assets valuation in Level 2 of the fair value hierarchy.

As part of the acquisition of Hunt on July 3, 2017, we may be obligated to pay contingent consideration (the “Hunt Contingent Consideration”) upon the achievement of certain defined revenue milestones; therefore, we have recorded the estimated fair value of contingent consideration of approximately $10.5 million as of March 31, 2018. See Note 4. In accordance with the Hunt merger agreement, Uniti common shares will be used to satisfy the contingent consideration payment. The fair value of the Hunt Contingent Consideration at March 31, 2018 was determined using the closing price of our common shares in the active market and the probability of expected declared dividends, and is classified as Level 3.

As part of the acquisition of Tower Cloud on August 31, 2016, we may be obligated to pay contingent consideration upon achievement of certain defined operational and financial milestones. At the Company’s discretion, a combination of cash and Uniti common shares may be used to satisfy the contingent consideration payments, provided that at least 50% of the aggregate amount of payments is satisfied in cash. We recorded the estimated fair value of future contingent consideration of $78.7 million as of March 31, 2018. The fair value of the contingent consideration as of March 31, 2018, was determined using a discounted cash flow model and probability adjusted estimates of the future earnings and is classified as Level 3. During the three months ended March 31, 2018 and 2017, we paid $12.7 million and $18.8 million, respectively, for the achievement of certain milestones in accordance with the Tower Cloud merger agreement.

Changes in the fair value of contingent consideration arrangements are recorded in our Condensed Consolidated Statement of Income in the period in which the change occurs. For the three months ended March 31, 2018, there was a $3.9 million decrease in the fair value of the contingent consideration that was recorded in Other (income) expense on the Condensed Consolidated Statements of Income.

The following is a roll forward of our liabilities measured at fair value on a recurring basis using unobservable inputs (Level 3):

(Thousands)		December 31, 2017				Transfers into Level 3				(Gain)/Loss included in earnings				Settlements				March 31, 2018
Contingent consideration		$	105,762			$	-			$	(3,864	)		$	(12,662	)		$	89,236