7. Fair Value Measurements

ASC 820, “Fair Value Measurement,” establishes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the third is considered unobservable:

Level 1: Quoted prices for identical assets or liabilities in active markets which the Company can access.

Level 2: Observable inputs other than those described in Level 1.

Level 3: Unobservable inputs.

Cash Equivalents

The Company’s cash equivalents are highly liquid investments with original maturities of three months of less, which represent the only asset the Company measures at fair value on a recurring basis. The Company determines the fair value of our cash equivalents using a market approach based on quoted prices in active markets. The fair values of cash, accounts receivable, income taxes receivable, accounts payable, income taxes payable and accrued expenses and other current liabilities approximate their carrying values because of their short-term nature.

Foreign Currency Contracts

The Company addresses market risks from changes in foreign currency exchange rates through a risk management program that includes the use of derivative financial instruments to mitigate certain balance sheet foreign currency transaction exposures. The Company uses foreign currency forward contracts as a part of its strategy to manage exposures related to foreign currency denominated monetary assets and liabilities.

Contingent Consideration

On December 14, 2016, the Company acquired certain video signal processing and management technologies used in medical visualization solutions. Under the purchase and sale agreement, the owners are eligible to receive contingent consideration based on the achievement of certain revenue targets from 2018 to 2021. The undiscounted range of possible contingent consideration is zero to €5.5 million ($6.6 million). If such targets are achieved, the contingent consideration would be payable in cash in four installments from 2019 to 2022. As the acquired assets did not meet the definition of a business, the fair value of the contingent consideration is recognized when probable and estimable and is capitalized as part of the cost of the acquired assets. In December 2017, the Company recorded an estimated fair value of $1.3 million in contingent consideration, which is reported as a long-term liability in other liabilities on the consolidated balance sheet as of December 31, 2017.

On December 18, 2015, the Company acquired all assets and certain liabilities of Skyetek Inc. (“Skyetek”). Under the purchase and sale agreement for the Skyetek acquisition, the owners of Skyetek were eligible to receive contingent consideration based on the achievement of certain sales order commitment targets from October 2015 through June 2017. The undiscounted range of possible contingent consideration was zero to $0.3 million. If such targets were achieved, the contingent consideration would be payable in 2017. The Company recognized an estimated fair value of $0.2 million as part of the purchase price as of the acquisition date. Based on the actual sales order commitments through June 2017, the Company paid $0.1 million as the final Skyetek contingent consideration in the third quarter of 2017.

On November 11, 2015, the Company acquired Lincoln Laser Company (“Lincoln Laser”). Under the purchase and sale agreement for the Lincoln Laser acquisition, the shareholders of Lincoln Laser were eligible to receive contingent consideration based on the achievement of certain revenue targets for fiscal year 2016. The estimated fair value of the contingent consideration of $2.3 million was determined based on the Monte Carlo valuation method and was recorded as part of the purchase price as of the acquisition date. Based on Lincoln Laser’s fiscal year 2016 revenue results, the fair value of the contingent consideration was adjusted to $1.4 million as of December 31, 2016. The Company paid $1.4 million as final settlement of the contingent consideration in the first quarter of 2017.

On February 19, 2015, the Company acquired Applimotion Inc. (“Applimotion”). Under the purchase and sale agreement for the Applimotion acquisition, the shareholders of Applimotion are eligible to receive contingent consideration based on the achievement of certain revenue targets for fiscal years 2015 to 2017. The undiscounted range of contingent considerations is zero to $4.0 million. If such targets are achieved, the contingent consideration will be payable in cash in two installments in 2017 and 2018, respectively. The estimated fair value of the contingent consideration of $1.0 million was determined based on the Monte Carlo valuation method and was recorded as part of the purchase price as of the acquisition date. Subsequent changes in the estimated fair value of this contingent liability are recorded in the consolidated statement of operations in restructuring, acquisition and divestiture related costs until the liability is fully settled. Under the Monte Carlo valuation method, the fair value of the contingent consideration for Applimotion was $3.6 million as of December 31, 2016. Based on Applimotion’s revenue performance for 2015 and 2016, the Company paid $1.2 million in contingent consideration in the first quarter of 2017. Based on Applimotion’s revenue performance for 2016 and 2017, the fair value for the remaining contingent consideration for Applimotion was adjusted to $2.8 million, which is reported as a current liability in accrued expenses and other current liabilities on the consolidated balance sheet as of December 31, 2017. The Company paid $2.8 million as the final Applimotion contingent consideration payment in January 2018.

The following table summarizes the fair values of the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2017 (in thousands):

			Quoted Prices in				Significant Other
			Active Markets for		Significant Other		Unobservable
			Identical Assets		Observable Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash equivalents	$	2,665	$	2,665	$	—	$	—
Prepaid expenses and other current assets:
Foreign currency forward contracts		150		—		150		—
	$	2,815	$	2,665	$	150	$	—
Liabilities
Accrued expenses and other current liabilities:
Contingent consideration - Current	$	2,800	$	—	$	—	$	2,800
Foreign currency forward contracts (1)		—		—		—		—
Other liabilities:
Contingent consideration - Long-term		1,304		—		—		1,304
	$	4,104	$	—	$	—	$	4,104

(1)

The unrealized loss from foreign currency forward contracts was nominal as of December 31, 2017.

The following table summarizes the fair values of the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 (in thousands):

			Quoted Prices in				Significant Other
			Active Markets for		Significant Other		Unobservable
			Identical Assets		Observable Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Assets
Cash equivalents	$	9,569	$	9,569	$	—	$	—
Liabilities
Accrued expenses and other current liabilities:
Contingent consideration - Current	$	2,775	$	—	$	—	$	2,775
Other liabilities:
Contingent consideration - Long-term		2,381		—		—		2,381
	$	5,156	$	—	$	—	$	5,156

During the years ended December 31, 2017 and 2016, there were no transfers between fair value levels.

Changes in the fair value of our Level 3 contingent consideration for the year ended December 31, 2017 was as follows (in thousands):

	Contingent Consideration
Balance at December 31, 2016	$	5,156
Payments of contingent consideration		(2,781	)
Fair value adjustments		1,729
Balance at December 31, 2017	$	4,104

As of December 31, 2017, the significant unobservable inputs used in the fair value measurement of the Company’s contingent consideration were historical revenues, projected revenues and a discount rate. Increases or decreases in the unobservable inputs would result in a higher or lower fair value measurement.

Except for the assets and liabilities acquired from the WOM, Laser Quantum and ThingMagic acquisitions, as disclosed in Note 3, there were no assets and liabilities that were measured at fair value on a non-recurring basis during 2017. See Note 11 for discussion of the estimated fair value of the Company’s outstanding debt and Note 13 for discussion of the estimated fair value of the Company’s pension plan assets.