Fair Value Measurement

12 Months Ended

Dec. 31, 2016

3. Fair Value Measurement

Fair value is defined as 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. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

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Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

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Level 2: Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.

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Level 3: Unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

In determining fair value, we utilize 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 our assessment of fair value.

The carrying amounts of our financial assets and liabilities, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses as of December 31, 2016 and January 2, 2016, approximate fair value because of the short maturity of these instruments.

As of December 31, 2016 and January 2, 2016, financial assets and liabilities measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

	As of December 31, 2016								As of January 2, 2016
	Fair Value Measurements								Fair Value Measurements
(in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Money market funds	$	8,270		—		—	$	8,270	$	9,212		—		—	$	9,212
Liabilities:
Earn-out liability	$	—		—	$	694	$	694	$	—		—	$	1,005	$	1,005

Our Level 1 financial assets are money market funds whose fair values are based on quoted market prices. We do not have any Level 2 financial assets or liabilities. The fair value of the earn-out liability arising from the acquisitions of RetinaLabs and Ocunetics is classified within Level 3 of the fair value hierarchy since it is based on significant unobservable inputs. The significant unobservable inputs include projected royalties and discount rates to present value the payments. A significant increase (decrease) in the projected royalty payments in isolation could result in a significantly higher (lower) fair value measurement and a significant increase (decrease) in the discount rate in isolation could result in a significantly lower (higher) fair value measurement. The fair value of the earn-out liability is calculated on a quarterly basis based on a collaborative effort of our operations, finance and accounting groups based on additional information as it becomes available. Any change in the fair value adjustment is recorded in the consolidated statement of operations of that period. The decrease in re-measurement of the contingent earn-out was due to a decrease in expected future revenues to be generated from these acquisitions. Both of these deals were structured with an earn-out component. The earn-out liability is included in accrued expenses and other long-term liabilities in the consolidated balance sheets. In December 31, 2016, we reduced the fair value of the earn-out liability related to Ocunetics to zero as we do not expect to generate any revenues related to the acquired Ocunetics patent. The Ocunetics patent was written off in December 2016, see Note 7 – Intangible Assets.

Charges related to fair value adjustments were $95 thousand, $5 thousand and $1.3 million for the fiscal years 2016, 2015 and 2014, respectively

The following table presents quantitative information about the inputs and valuation methodologies used for our fair value measurements classified in Level 3 of the fair value hierarchy as of December 31, 2016 and January 2, 2016.

As of December 31, 2016	Fair Value (in thousands)		Valuation Technique	Significant Unobservable Input	Weighted Average (range)
Earn-out liability	$	694	Discounted cash flow	Projected royalties (in thousands)	$2,154
				Discount rate	11.22% (11.22% - 27.00%)

As of January 2, 2016	Fair Value (in thousands)		Valuation Technique	Significant Unobservable Input	Weighted Average (range)
Earn-out liability	$	1,005	Discounted cash flow	Projected royalties (in thousands)	$2,949 ($134 - $3,153)
				Discount rate	11.36% (10.23% - 27.00%)

The following table provides a reconciliation of the beginning and ending balances of the contingent consideration – cash (Level 3 liabilities) (in thousands):

Balance as of January 3, 2015	$	1,423
Payments against earn-out		(423	)
Change in fair value of earn-out liability		5
Balance as of January 2, 2016		1,005
Payments against earn-out		(406	)
Change in fair value of earn-out liability		95
Balance as of December 31, 2016	$	694

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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