Note 5 — Fair Value of Financial Instruments

The valuation techniques required to determine fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. The two types of inputs create the following fair value hierarchy:

Level 1 - Quoted prices for identical instruments in active markets.

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 - Significant inputs to the valuation model are unobservable.

The fair value of certain of our cash equivalents are based upon quoted prices for identical instruments in active markets. The fair value of our other cash equivalents and our available for sale marketable securities is based upon a discounted cash flow model and approximate cost. The marketable securities in the rabbi trust are carried at fair value, which is based upon quoted market prices for identical securities. Derivative financial instruments are measured at fair value, the material portions of which are based on active or inactive markets for identical or similar instruments or model-derived valuations whose inputs are observable. Where model-derived valuations are appropriate, we use the applicable credit spread as the discount rate. Credit risk related to derivative financial instruments is considered minimal and is managed by requiring high credit standards for counterparties and through periodic settlements of positions.

The fair value of our contingent consideration liability to the sellers of businesses that we have acquired are revalued to their fair value each period and any increase or decrease is recorded into selling, general and administrative expense. Any changes in the assumed timing and amount of the probability of payment scenarios could impact the fair value.

The fair value of the portion of the TeraLogics contingent consideration that is based on customer execution of contract extensions was estimated using a probability weighted approach. Subject to the terms and conditions of the TeraLogics Purchase Agreement, contingent consideration will be paid over a period commencing on the closing date and ending on December 21, 2018. The fair value of the contingent consideration was determined by applying probabilities of achieving the periodic payment to each period’s potential payment, and summing the present value of any future payments.

The fair value of the portion of the TeraLogics contingent consideration that is based upon revenue targets was estimated using a real options approach. Each annual payment was modeled using a long digital options written on the underlying revenue metric. The strike price for each option is the respective revenue threshold as specified in the agreement, and the spot price is calibrated to the revenue forecast by calculating the present value of the corresponding projected revenues using a risk-adjusted discount rate. The volatility for the underlying revenue metrics was estimated to be 18% based on analysis of comparable guideline public companies. The risk-free rate was selected based on the quoted yields for U.S. Treasury securities with terms matching the earn-out payment period.

The fair value of the H4 Global contingent consideration was estimated using a probability weighted approach. Subject to the terms and conditions of the H4 Global Purchase Agreement, contingent consideration will be paid over a five year term that commenced on October 1, 2015 and ends on September 30, 2020. The payments will be calculated based on the award of certain contracts during the specified period. The fair value of the contingent consideration was determined by applying probabilities to different scenarios, and summing the present value of any future payments.

The fair value of the DTECH contingent consideration was estimated using a real options approach. Each annual payment was modeled using a portfolio of long and short digital options written on the underlying earnings metric (revenue or gross profit). The strike price for each option is the respective earnings threshold as specified in the agreement, and the spot price is calibrated to the revenue and gross profit forecast by calculating the present value of the corresponding projected earnings metric using a risk-adjusted discount rate. The volatility for the underlying earnings metrics was estimated to be 20% based on analysis of comparable guideline public companies. The risk-free rate was selected based on the quoted yields for U.S. Treasury securities with terms matching the earn-out payment period.

The inputs to each of the contingent consideration fair value models include significant unobservable inputs and therefore represent Level 3 measurements within the fair value hierarchy. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition dates and each subsequent period. Accordingly, changes in the assumptions described above can materially impact the amount of contingent consideration expense we record in any period.

As of December 31, 2015, the following table summarizes the change in fair value of our Level 3 DTECH contingent consideration liability (in thousands):

Balance as of September 30, 2015	$	7,507
Cash paid to seller	(5,000		)
Total remeasurement recognized in earnings	809

Balance as of December 31, 2015	$	3,316

There were no changes in the fair value of any of the other contingent consideration liabilities between the date of the respective business acquisitions and December 31, 2015.

The following table presents assets and liabilities measured and recorded at fair value on our balance sheets on a recurring basis (in thousands):

	December 31, 2015
	Level 1		Level 2		Level 3		Total
Assets
Cash equivalents	$	65,035	$	—	$	—	$	65,035
Marketable securities	—		23,612		—		23,612
Current derivative assets	—		18,966		—		18,966
Noncurrent derivative assets	—		3,324		—		3,324
Marketable securities in rabbi trust	803		—		—		803

Total assets measured at fair value	$	65,838	$	45,902	$	—	$	111,740

Liabilities
Current derivative liabilities	$	—	$	18,432	$	—	$	18,432
Noncurrent derivative liabilities	—		3,355		—		3,355
Noncurrent contingent consideration to seller of Teralogics - contract extensions	—		—		1,800		1,800
Noncurrent contingent consideration to seller of Teralogics - revenue targets	—		—		3,100		3,100
Noncurrent contingent consideration to seller of H4 Global	—		—		1,568		1,568
Current contingent consideration to seller of DTECH	—		—		2,371		2,371
Noncurrent contingent consideration to seller of DTECH	—		—		945		945

Total liabilities measured at fair value	$	—	$	21,787	$	9,784	$	31,571

	September 30, 2015
	Level 1		Level 2		Level 3		Total
Assets
Cash equivalents	$	68,194	$	—	$	—	$	68,194
Marketable securities	—		30,533		—		30,533
Current derivative assets	—		11,543		—		11,543
Noncurrent derivative assets	—		13,909		—		13,909
Marketable securities in rabbi trust	992		—		—		992

Total assets measured at fair value	$	69,186	$	55,985	$	—	$	125,171

Liabilities
Current derivative liabilities	$	—	$	9,370	$	—	$	9,370
Noncurrent derivative liabilities	—		13,909		—		13,909
Current contingent consideration to seller of DTECH	—		—		5,000		5,000
Noncurrent contingent consideration to seller of DTECH	—		—		2,507		2,507

Total liabilities measured at fair value	$	—	$	23,279	$	7,507	$	30,786

We carry certain financial instruments, including accounts receivable, short-term borrowings, accounts payable and accrued liabilities at cost, which we believe approximates fair value because of the short-term maturity of these instruments.

The fair value of long-term debt is calculated by discounting the value of the note based on market interest rates for similar debt instruments, which is a Level 2 technique. The following table presents the estimated fair value and carrying value of our long-term debt (in millions):

	December 31,		September 30,
	2015		2015
Fair value	$	122.4	$	125.8
Carrying value	$	126.5	$	126.7