Fair Value Measurements

We invest our excess cash on deposit with major banks in money market, United States (“U.S.”) Treasury and government-sponsored entity, corporate, municipal government, asset-backed, and mortgage-backed residential debt securities. By policy, we invest primarily in high-grade marketable securities. We are exposed to credit risk in the event of default by the financial institutions or issuers of these investments to the extent of the amounts recorded in our Condensed Consolidated Balance Sheets.

We consider all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Typically, the cost of these investments approximates fair value. Marketable investments with a maturity greater than three months are classified as available-for-sale short-term investments. Available-for-sale securities are stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. The credit portion of any other-than-temporary impairment is included in net income. Realized gains and losses on sales of financial instruments are recognized upon sale of the investments using the specific identification method.

Our available-for-sale short-term investments are summarized as follows (in thousands):



	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
June 30, 2018
U.S. Government and sponsored entities	$	59,822	$	—	$	(773	)	$	59,049
Corporate debt securities	66,529		—		(662		)	65,867
Municipal securities	382		—		(3		)	379
Asset-backed securities	8,545		35		(77		)	8,503
Mortgage-backed securities – residential	210		—		(2		)	208
Total short-term investments	$	135,488	$	35	$	(1,517	)	$	134,006
December 31, 2017
U.S. Government and sponsored entities	$	59,824	$	—	$	(660	)	$	59,164
Corporate debt securities	79,356		—		(450		)	78,906
Municipal securities	382		—		(2		)	380
Asset-backed securities	9,808		44		(47		)	9,805
Mortgage-backed securities – residential	445		—		(3		)	442
Total short-term investments	$	149,815	$	44	$	(1,162	)	$	148,697

The fair value and duration that investments, including cash equivalents, have been in a gross unrealized loss position below are as follows (in thousands):



	Less than 12 Months					More than 12 Months					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2018
U.S. Government and sponsored entities	$	22,889	$	(346	)	$	36,008	$	(427	)	$	58,897	$	(773	)
Corporate debt securities	32,229		(349		)	33,293		(313		)	65,522		(662		)
Municipal securities	377		(3		)	—		—			377		(3		)
Asset-backed securities	4,302		(56		)	4,134		(21		)	8,436		(77		)
Mortgage-backed securities – residential	11		—			160		(2		)	171		(2		)
Total	$	59,808	$	(754	)	$	73,595	$	(763	)	$	133,403	$	(1,517	)
December 31, 2017
U.S. Government and sponsored entities	$	23,023	$	(206	)	$	35,989	$	(454	)	$	59,012	$	(660	)
Corporate debt securities	45,857		(207		)	32,634		(243		)	78,491		(450		)
Municipal securities	378		(2		)	—		—			378		(2		)
Asset-backed securities	6,779		(31		)	2,947		(16		)	9,726		(47		)
Mortgage-backed securities – residential	162		(2		)	142		(1		)	304		(3		)
Total	$	76,199	$	(448	)	$	71,712	$	(714	)	$	147,911	$	(1,162	)

For fixed income securities that have unrealized losses as of June 30, 2018, we do not have the intent to sell any of these investments and it is not more likely than not that we will be required to sell any of these investments before recovery of the entire amortized cost basis. We have evaluated these fixed income securities and determined that no credit losses exist. Accordingly, management has determined that the unrealized losses on our fixed income securities as of June 30, 2018 were temporary in nature.

Amortized cost and estimated fair value of investments as of June 30, 2018, are summarized as follows (in thousands):



	Amortized cost		Fair value
Mature in less than one year	$	78,377	$	77,843
Mature in one to three years	57,111		56,163
Total short-term investments	$	135,488	$	134,006

Net realized gains from sales of investments are recognized in interest income and other income (expense), net, and were immaterial during the three and six months ended June 30, 2018, and June 30, 2017, respectively. Net unrealized losses of $1.5 and $1.1 million were included in AOCI in the accompanying Condensed Consolidated Balance Sheets as of June 30, 2018, and December 31, 2017, respectively.

Fair Value Measurements

Our fair value hierarchy is defined as follows:

Level 1: Inputs that are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;

Level 2: Inputs that are other than quoted prices included within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date for the duration of the instrument’s anticipated life or by comparison to similar instruments; and

Level 3: Inputs that are unobservable or reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. These include management’s own judgments about market participant assumptions developed based on the best information available in the circumstances.

We utilize the market approach to measure the fair value of our fixed income securities. The market approach is a valuation technique that uses the prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of our fixed income securities is obtained using readily-available market prices from a variety of industry standard data providers, large financial institutions, and other third-party sources for the identical underlying securities. The fair value of our investments in certain money market funds is expected to maintain a net asset value of $1 per share and, as such, is priced at the expected market price.

We obtain the fair value of our Level 2 financial instruments from several third-party asset managers, custodian banks, and accounting service providers. Independently, these service providers use professional pricing services to gather pricing data, which may include quoted market prices for identical or comparable instruments or inputs other than quoted prices that are observable either directly or indirectly. As part of this process, we engaged a pricing service to assist management in its pricing analysis and assessment of other-than-temporary impairment. All estimates, key assumptions, and forecasts were either provided by or reviewed by us. While we utilize a third-party pricing service, the impairment analysis and related valuations represent conclusions of management and not conclusions or statements of any third party.

Our assets and liabilities measured at fair value by levels within the fair value hierarchy are summarized as follows (in thousands):



	June 30, 2018								December 31, 2017
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Money market funds	$	1,017	$	—	$	—	$	1,017	$	9,897	$	—	$	—	$	9,897
U.S. Government and sponsored entities	33,207		25,842		—		59,049		33,261		25,903		—		59,164
Corporate debt securities	—		65,867		—		65,867		—		78,906		—		78,906
Municipal securities	—		378		—		378		—		380		—		380
Asset-backed securities	—		8,462		43		8,505		—		9,754		51		9,805
Mortgage-backed securities – residential	—		208		—		208		—		442		—		442
	$	34,224	$	100,757	$	43	$	135,024	$	43,158	$	115,385	$	51	$	158,594
Liabilities:
Contingent consideration, current and noncurrent	$	—	$	—	$	22,129	$	22,129	$	—	$	—	$	35,702	$	35,702
Self-insurance	—		—		969		969		—		—		902		902
	$	—	$	—	$	23,098	$	23,098	$	—	$	—	$	36,604	$	36,604

Money market funds have been classified as cash equivalents as of June 30, 2018, and December 31, 2017, respectively.

Investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices or alternative pricing sources with reasonable levels of price transparency. Investments in U.S. Treasury obligations and overnight money market mutual funds have been classified as Level 1 because these securities are valued based on quoted prices in active markets or are actively traded at $1.00 net asset value. There have been no transfers between Level 1 and 2 during the six months ended June 30, 2018 and 2017.

Government agency investments and corporate debt instruments, including investments in asset-backed and mortgage-backed securities, have generally been classified as Level 2 because markets for these securities are less active or valuations for such securities utilize significant inputs, which are directly or indirectly observable. We hold asset-backed securities with income payments derived from and collateralized by a specified pool of underlying assets. Asset-backed securities in the portfolio are predominantly collateralized by credit cards and auto loans. We also hold two asset-backed securities collateralized by mortgage loans, which have been fully reserved.

Liabilities for Contingent Consideration

Acquisition-related liabilities for contingent consideration (i.e., earnouts) as of June 30, 2018 are related to the acquisitions of Escada Innovations Limited and Escada Systems, Inc. (collectively, “Escada”) and Generation Digital Solutions, Inc. (“Generation Digital”), in 2017; Optitex Ltd. (“Optitex”) and Rialco Limited (“Rialco”) in 2016; Shuttleworth Business Systems Limited and CDM Solutions Limited (collectively, “Shuttleworth”), and CTI in 2015; and PrintLeader Software (“PrintLeader”) in 2013.

The fair value of these earnouts is estimated to be $22.1 and $35.7 million as of June 30, 2018, and December 31, 2017, respectively, by applying the income approach in accordance with ASC 805-30-25-5. Key assumptions include risk-free discount rates between 0.6% and 4.98%, as well as probability-adjusted revenue, gross profit, and direct operating income using the Monte Carlo valuation method. Probability-adjusted revenue, gross profit, and direct operating income are significant inputs that are not observable in the market, and are therefore classified as Level 3 inputs. These contingent liabilities have been reflected in the Condensed Consolidated Balance Sheet as of June 30, 2018, as current and noncurrent liabilities of $8.0 and $14.1 million, respectively.

Changes in the fair value of contingent consideration are summarized as follows (in thousands):



Fair value of contingent consideration as of January 1, 2017	$	56,463
Fair value of Generation Digital contingent consideration at August 14, 2017	3,600
Fair value of Escada contingent consideration at October 1, 2017	2,049
Escrow adjustment for Reggiani acquisition	(4,711		)
Changes in valuation	4,761
Earnout accretion	1,711
Payments and settlements	(30,924		)
Foreign currency adjustment	2,753
Fair value of contingent consideration at December 31, 2017	$	35,702
Changes in valuation	(12,775		)
Earnout accretion	104
Payments	(751		)
Foreign currency adjustment	(151		)
Fair value of contingent consideration as of June 30, 2018	$	22,129

The Optitex and Shuttleworth earnout liability valuations decreased, on a combined basis, during the three and six months ended June 30, 2018 by $11.3 and $12.8 million, respectively, based on recent actual and updated forecasted financial performance data. The Optitex, CTI and Rialco earnout performance probabilities increased, while the Shuttleworth earnout performance probability decreased, during 2017. The earnout liability valuations increased during the three and six months ended June 30, 2017 by less than $0.1 and $0.9 million, respectively. Changes in the fair value of contingent consideration subsequent to the acquisition date are reported in general and administrative expenses.

Earnout payments and settlements during the three and six months ended June 30, 2018 of $0.1 and $0.8 million were primarily related to the Shuttleworth contingent consideration liability. Earnout payments and settlements during the year ended December 31, 2017 of $21.5, $6.8, $1.3, and $1.2 million were related to the previously accrued Reggiani, Optitex, Rialco, and Shuttleworth contingent consideration liabilities, respectively.

The primary inputs to the fair value measurement of contingent consideration liability are the discount rate and probability-adjusted revenue or earnings targets specified in the acquisition agreements. Accordingly, we reviewed the sensitivity of the fair value measurement to changes in these inputs. We assessed the probability of achieving the revenue and profitability performance targets for contingent consideration associated with each acquisition at percentage levels between 50% and 100% as of each respective acquisition date based on an assessment of the historical performance of each acquired entity, our current expectations of future performance, and other relevant factors. A change in probability-adjusted revenue of five percentage points from the level assumed in the current valuations would result in an increase in the fair value of contingent consideration of $2.0 million or a decrease of $1.7 million. A change in the discount rate of one percentage point would result in an increase in the fair value of contingent consideration of $0.2 million or a decrease of $0.2 million. The potential undiscounted amount of contingent consideration that we could be required to make related to our business acquisitions, beyond amounts currently accrued, was $11.3 million as of June 30, 2018.

Fair Value of Derivative Instruments

We utilize the income approach to measure the fair value of our derivative assets and liabilities. The income approach uses pricing models that rely on market observable inputs such as yield curves, currency exchange rates, and forward prices, and are therefore classified as Level 2 measurements. The notional amount of our derivative assets and liabilities was $250.7 and $239.4 million as of June 30, 2018 and December 31, 2017, respectively. We did not have any cash flow hedges as of June 30, 2018. The fair value of our derivative assets and liabilities that were designated for cash flow hedge accounting treatment having notional amounts of $3.9 million as of December 31, 2017 was not material.

Fair Value of Convertible Senior Notes

In September 2014, we issued $345 million aggregate principal amount of our Notes. The Notes are carried at their original issuance value, net of unamortized debt discount, and are not marked to market each period. The fair value of the Notes as of June 30, 2018 was approximately $342.8 million and was classified as a Level 2 fair value measurement. Fair value was estimated based upon actual quotations obtained at the end of the reporting period or the most recent date available. A substantial portion of the market value of our Notes in excess of the outstanding principal amount relates to the conversion premium.