FAIR VALUE OF FINANCIAL INSTRUMENTS

On a recurring basis, the Company measures certain financial assets and financial liabilities at fair value based upon quoted market prices, where available. Where quoted market prices or other observable inputs are not available, the Company applies valuation techniques to estimate fair value. FASB ASC Topic 820, Fair Value Measurements and Disclosures, establishes a three-level valuation hierarchy for disclosure of fair value measurements. The categorization of financial assets and financial liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:


•	Level 1 - Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.


•	Level 2 - Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.


•	Level 3 - Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.

The Company's financial instruments include cash and cash equivalents, marketable securities, accounts receivable, accounts payable and contingent consideration. The carrying amount of cash and cash equivalents, accounts receivable, and accounts payable approximates fair value due to their immediate or short-term maturities. The recurring fair value measurements using significant unobservable inputs (Level 3) relate to marketable securities, which are comprised of auction rate securities, and contingent consideration liabilities.

The following tables provide information by level for assets and liabilities that are measured at fair value on a recurring basis:



	Fair Value Measurements using inputs considered as:
(in thousands)	Level 1		Level 2		Level 3		Fair Value at May 31, 2018
Financial Assets
Short-term investments*	$	2,100	$	—	$	—	$	2,100
Marketable securities	—		—		1,317		1,317
Total Financial Assets	$	2,100	$	—	$	1,317	$	3,417
Financial Liabilities
Contingent liability for acquisition earn outs	$	—	$	—	$	3,261	$	3,261
Total Financial Liabilities	$	—	$	—	$	3,261	$	3,261

*included in cash and cash equivalents.



	Fair Value Measurements using inputs considered as:
(in thousands)	Level 1		Level 2		Level 3		Fair Value at May 31, 2017
Financial Assets
Marketable securities	$	—	$	—	$	1,215	$	1,215
Total Financial Assets	$	—	$	—	$	1,215	$	1,215
Financial Liabilities
Contingent liability for acquisition earn outs	$	—	$	—	$	12,761	$	12,761
Total Financial Liabilities	$	—	$	—	$	12,761	$	12,761

There were no transfers in and out of Level 1, 2 and 3 measurements for the years ended May 31, 2018 and 2017.

The table below presents the changes in fair value components of Level 3 instruments in the year ended May 31, 2018 (in thousands of dollars):



	Financial Assets		Financial Liabilities
(in thousands)	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at May 31, 2017	$	1,215	$	12,761
Change in fair value of contingent consideration, net (1)	—		250
Fair market value adjustments	102		—
Contingent consideration payments	—		(9,750		)
Balance at May 31, 2018	$	1,317	$	3,261

The table below presents the changes in fair value components of Level 3 instruments in the year ended May 31, 2017 (in thousands of dollars):



	Financial Assets			Financial Liabilities
(in thousands)	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)			Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at May 31, 2016	$	1,653		$	38,275
Change in fair value of contingent consideration (1)	—			(15,261		)
Currency (gain) loss from remeasurement	—			(153		)
Fair market value adjustments	12			—
Sale of securities	(450		)	—
Contingent consideration payments	—			(10,100		)
Balance at May 31, 2017	$	1,215		$	12,761

(1) Change in the fair value of contingent consideration is included in earnings and comprised of changes in estimated earn out payments based on projections of Company performance and amortization of the present value discount.

The Company made the decision to discontinue its investment in the TiLo product that was acquired in August 2013 as part of the Clinical Devices acquisition. This decision resulted in the write-off of the acquired in-process research and development (IPR&D) of $3.6 million along with a $3.1 million gain from the reduction in the fair value of contingent consideration liability associated with future milestones that will no longer be met during the second quarter of fiscal year 2017. The write-off of the IPR&D is included in acquisition, restructuring and other, net on the consolidated statement of operations.

The Company revised the sales projections for the AngioVac product as a result of reviews performed by executive management across all products. The adjustments to the sales projections resulted in a $13.4 million gain in the second quarter of fiscal year 2017 from the reduction in the fair value of the contingent liability that is based on lower projected sales volume over the contractual earn out period.

Short-term Investments

Short-term investments consist of highly liquid investments in municipal bonds that reset on a weekly basis and can be called at any point in time.

Marketable Securities

Marketable securities consist solely of an auction rate security. Assumptions associated with the auction rate security include the interest rate benchmarks, the probability of full repayment of the principal considering the credit quality and guarantees in place, and the rate of return required by investors to own such securities given the current liquidity risk.

Contingent Liability for Acquisition Earn Outs

Some of our business combinations involve the potential for the payment of future contingent consideration upon the achievement of certain product development milestones or various other performance conditions. Payment of the additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels or product development targets. Contingent consideration is recorded at the estimated fair value of the contingent payments on the acquisition date. The fair value of the contingent consideration is remeasured at the estimated fair value at each reporting period with the change in fair value recognized as income or expense within change in fair value of contingent consideration in the consolidated statements of income.

We measure the initial liability and remeasure the liability on a recurring basis using Level 3 inputs as defined under authoritative guidance for fair value measurements and is determined using a discounted cash flow model applied to projected net sales, using probabilities of achieving projected net sales and projected payment dates. Projected net sales are based on our internal projections and extensive analysis of the target market and the sales potential. Increases or decreases in any valuation inputs in isolation may result in a significantly lower or higher fair value measurement in the future.

The recurring Level 3 fair value measurements of the contingent consideration liabilities include the following significant unobservable inputs as of May 31, 2018:



(in thousands)	Fair value at May 31, 2018		Valuation Technique	Unobservable Input	Range
Revenue based payments	$	3,261	Discounted cash flow	Discount rate Probability of payment Projected fiscal year of payment	4% 100% 2019 - 2020

At May 31, 2018, the estimated potential amount of undiscounted future contingent consideration that the Company expects to pay as a result of all completed acquisitions is approximately $3.3 million, which represents the remaining contractual minimum payments.