Fair value measurements

Financial assets and liabilities

The estimated fair values of financial instruments are determined based on relevant market information. These estimates involve uncertainty and cannot be determined with precision. The Company’s financial instruments consist primarily of cash, cash equivalents, and interest rate swaps. In addition, contingent earn-out liabilities resulting from business combinations are recorded at fair value. The following methods and assumptions are used to estimate the fair value of each class of financial assets or liabilities that is valued on a recurring basis.

Cash and cash equivalents. This includes all cash and liquid investments with an original maturity of three months or less from the date acquired. The carrying amount approximates fair value because of the short maturity of these instruments. Cash equivalents also consist of money market funds with fair values based on quoted market prices. The Company’s cash and cash equivalents are held at major commercial banks.

Contingent earn-out liabilities. This class of financial liabilities represents the Company’s estimated fair value of the contingent earn-out liabilities related to acquisitions based on probability assessments of certain performance achievements during the earn-out periods. The performance targets are specific to the operation of the acquired company subsequent to the acquisition. These inputs are considered key estimates made by the Company that are unobservable because there are no active markets to support them. Contingent earn-out liabilities are included in accounts payable and accrued liabilities and other long-term liabilities on the consolidated balance sheets.

Interest rate swaps. The Company uses interest rate swaps to manage interest rate risk. The fair values of interest rate swaps are determined using the market standard methodology of discounting the future variable cash payments, or receipts, over the life of the agreements. The variable interest rates used in the calculation of projected cash payments, or receipts, are based on observable market interest rate curves.

Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The valuation can be determined using widely accepted valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). As a basis for applying a market-based approach in fair value measurements, GAAP establishes a fair value hierarchy that prioritizes into three broad levels the inputs to valuation techniques used to measure fair value. The following is a brief description of those three levels:


•	Level 1—Quoted prices in active markets for identical assets or liabilities.


•	Level 2—Observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.


•	Level 3—Unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies.

Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. There were no significant transfers between Level 1, Level 2, or Level 3 during the three months ended March 31, 2016 or 2015.

The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis and the related classifications are as follows (in thousands):



	Fair value as of March 31,		Fair value measurement as of March 31, 2016 using fair value hierarchy
	2016		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents (1)	$	52,437	$	52,437	$	—	$	—
Financial liabilities
Interest rate swaps (2)	3,613		—		3,613		—
Contingent earn-out liabilities (3)	1,505		—		—		1,505

	Fair value as of December 31,		Fair value measurement as of December 31, 2015 using fair value hierarchy
	2015		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents (1)	$	71,825	$	71,825	$	—	$	—
Interest rate swaps (2)	419		—		419		—
Financial liabilities
Contingent earn-out liabilities (3)	7,250		—		—		7,250


(1)	Fair value is based on quoted market prices.


(2)	Fair value is determined using market standard models with observable inputs.


(3)	This fair value measurement is based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value using the income approach. In developing these estimates, the Company considered certain performance projections, historical results, and general macroeconomic environment and industry trends.

Contingent earn-out liabilities

The Company entered into an earn-out agreement in connection with its acquisition of Southwind Health Partners, L.L.C. and Southwind Navigator, LLC (together, “Southwind”) in December 2009. The Company’s fair value estimate of the Southwind earn-out liability was $5.6 million as of the date of acquisition. The fair value of the Southwind earn-out liability was affected by changes in the Company's stock price and by changes in estimates regarding expected operating results through the end of the evaluation period, which was December 31, 2014. As of March 31, 2016, $21.4 million had been earned and paid in cash and shares to the former owners of the Southwind business, which includes the final payment of $1.0 million that was paid during the three months ended March 31, 2016. There is no remaining contingent obligation related to this earn-out agreement.

The Company's fair value estimate of the earn-out liability related to the Company’s acquisition of Clinovations, LLC (“Clinovations”) in November 2014 was $4.5 million as of the date of acquisition. The fair value of the Clinovations earn-out liability is affected by changes in estimates regarding expected operating results through the evaluation periods, which will end on December 31, 2017 with payments extending through April 2018. A portion of the earn-out liability will be paid in the form of the Company’s common stock. The maximum payout of the earn-out liability is $9.5 million, while the minimum is zero. Based on the results of Clinovations’ operating results, the fair value of the contingent obligation for Clinovations as of March 31, 2016 was estimated at $1.2 million. The fair value of the Clinovations earn-out liability is affected by changes in estimates regarding expected operating results, discount rates for each evaluation period, which vary from approximately 6.9% to 7.5%, and the volatility of the Company's common stock, which was 30.0% as of March 31, 2016.

The Company's fair value estimate of the earn-out liability related to the Company’s acquisition of ThoughtWright, LLC d/b/a GradesFirst (“GradesFirst”) in December 2014 was $3.6 million as of the date of acquisition. The fair value of the GradesFirst earn-out liability was affected by changes in estimates regarding expected operating results through the evaluation period, which ended on December 31, 2015. The maximum earn-out potential of $4.0 million was earned during the evaluation period and paid during the three months ended March 31, 2016. There is no remaining contingent obligation related to this earn-out agreement.

Changes in the fair value of the contingent earn-out liabilities subsequent to the acquisition date, including changes arising from events that occurred after the acquisition date, such as changes in the Company’s estimate of performance achievements, discount rates, and stock price, are recognized in earnings in the periods during which the estimated fair value changes.

The following table represents a reconciliation of the change in the contingent earn-out liabilities for the three months ended March 31, 2016 and 2015 (in thousands):



	Three Months Ended March 31,
	2016			2015
Beginning balance	$	7,250		$	12,946
Addition due to acquisition	357			—
Fair value change in Southwind contingent earn-out liability (1)	—			209
Fair value change in Clinovations contingent earn-out liability (1)	(1,070		)	135
Southwind earn-out payments	(1,032		)	—
GradesFirst earn-out payments	(4,000		)	—
360Fresh earn-out payments	—			(1,500		)
Ending balance	$	1,505		$	11,790


(1)	Amounts were recognized in cost of services on the consolidated statements of operations.

Financial instruments not recorded at fair value on a recurring basis

Equity method investments. The Company's equity method investments represent the Company's ownership interest in Evolent Health, Inc. and its subsidiary, Evolent Health LLC. The fair value of the Company's ownership interest in Evolent Health, Inc. and its subsidiary was $122.4 million as of March 31, 2016 based on the quoted closing stock price as reported on the New York Stock Exchange prior to any discount. For further information, see Note 7, "Investments in unconsolidated entities." The fair value of the Company's equity method investments is measured quarterly for disclosure purposes. The Company's equity method investments are recorded at fair value only if an impairment charge is recognized.

Senior secured term loan. The Company estimates that the fair value of its senior secured term loan was $444.0 million as of March 31, 2016. The fair value was determined based on discounting the future expected variable cash payments over the life of the loan. The variable interest rates used in the calculation are based on observable market interest rates. The senior secured term loan would be classified as Level 2 within the fair value hierarchy if it were measured at fair value.

Non-financial assets and liabilities

Certain assets and liabilities are not measured at fair value on an ongoing basis but instead are measured at fair value on a non-recurring basis, so that such assets and liabilities are subject to fair value adjustments in certain circumstances (such as when there is evidence of impairment). During the three months ended March 31, 2016 and 2015, no fair value adjustments or material fair value measurements were required for non-financial assets or liabilities.