Fair Value of Financial Instruments

9 Months Ended

Jun. 30, 2019

Fair Value of Financial Instruments

Fair Value of Financial Instruments

Note 8 — 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 following table presents assets and liabilities measured and recorded at fair value on our balance sheets on a recurring basis (in thousands):

	June 30, 2019								September 30, 2018
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets
Cash equivalents	$	—	$	—	$	—	$	—	$	9,000	$	—	$	—	$	9,000
Current derivative assets		—		2,019		—		2,019		—		1,803		—		1,803
Noncurrent derivative assets		—		314		—		314		—		314		—		314
Noncurrent investment assets		—		—		3,076		3,076		—		—		—		—
Total assets measured at fair value	$	—	$	2,333	$	3,076	$	5,409	$	9,000	$	2,117	$	—	$	11,117
Liabilities
Current derivative liabilities		—		1,263		—		1,263		—		1,657		—		1,657
Noncurrent derivative liabilities		—		116		—		116		—		75		—		75
Contingent consideration to seller of Deltenna		—		—		2,580		2,580		—		—		1,081		1,081
Contingent consideration to seller of Shield		—		—		5,203		5,203		—		—		5,618		5,618
Contingent consideration to seller of TeraLogics - revenue targets		—		—		—		—		—		—		1,750		1,750
Contingent consideration to seller of H4 Global		—		—		679		679		—		—		665		665
Contingent consideration to seller of Nuvotronics		—		—		5,250		5,250		—		—		—		—
Total liabilities measured at fair value	$	—	$	1,379	$	13,712	$	15,091	$	—	$	1,732	$	9,114	$	10,846

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 is based upon a discounted cash flow model and approximate cost. 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 contingent consideration liabilities 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.

At June 30, 2019, we have the following remaining contingent consideration arrangements with the sellers of companies which we acquired:

● H4 Global: Payments of up to $3.0 million of contingent consideration based upon the value of contracts entered into over the five-year period ending September 30, 2020.

● Deltenna: Payments of up to $7.1 million of contingent consideration if Deltenna meets certain sales goals from the date of acquisition through the fiscal year ending September 30, 2022.

● Shield: Payments of up to $10.0 million of contingent consideration if Shield meets certain sales goals from the date of acquisition through July 31, 2025.

● Nuvotronics: Payments of up to $8.0 million of contingent consideration if Nuvotronics meets certain gross profit goals for the 12-month periods ended December 31, 2020 and December 31, 2021.

In addition, we have a contingent consideration arrangement with the Purchaser of our CGD Services business under which we are eligible to receive a cash payment of $3.0 million if the Purchaser is awarded certain government contracts in the future.

The fair value of Deltenna contingent consideration was valued using the real option approach. Under this approach, each payment was modeled using long digital options written on the underlying revenue metric. The strike price for each

option is the respective revenue as specified in the related 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 based upon analysis of comparable guideline public companies and was 37% as of June 30, 2019 and 53% as of September 30, 2018. The selected discount rate was 11% as of June 30, 2019 and 11.5% as of September 30, 2018.

The maximum remaining payout to the sellers of H4 Global is $3.0 million at June 30, 2019, and is based upon the value of contracts entered into over the five-year period ending September 30, 2020. 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 Shield contingent consideration was estimated based on Monte Carlo simulations. Under the purchase agreement, we will pay the sellers up to $10.0 million if Shield meets certain sales goals from the date of acquisition through July 31, 2025. The fair value of the contingent consideration was determined based upon a probability distribution of values based on 1,000,000 simulation trials. Key inputs for the simulation include projected revenues, assumed discount rates for projected revenues and cash flows, and volatility. The volatility and revenue risk adjustment factors were determined based on analysis of publicly traded comparable companies and as of June 30, 2019 were 26.0% and 17.4%, respectively, and as of September 30, 2018 were 20.0% and 14.5%, respectively. The discount rate used was based on our expected borrowing rate under our financing arrangements, which was determined to be 4.1% at June 30, 2019 and 3.9% at September 30, 2018.

The fair value of the Nuvotronics contingent consideration was estimated based on Monte Carlo simulations. Under the purchase agreement, we will pay the sellers up to $8.0 million if Nuvotronics meets certain gross profit goals for the 12- month periods ended December 31, 2020 and December 31, 2021. The fair value of the contingent consideration was determined based upon a probability distribution of values based on 1,000,000 simulation trials. Key inputs for the simulation include projected gross profits, assumed discount rates for projected gross profits, and gross profit volatility. The volatility factor used as of June 30, 2019 was 12.9% and was determined based on analysis of publicly traded comparable companies. The discount rate used as of June 30, 2019 was 7.3%, which was based on our risk-free rate of return adjusted for our gross profit required risk premium.

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 June 30, 2019, the following table summarizes the change in fair value of our Level 3 contingent consideration liabilities (in thousands):

	H4 Global		TeraLogics (Revenue Targets)		Deltenna		Shield		Nuvotronics		Total
Net balances at September 30, 2018	$	665	$	1,750	$	1,081	$	5,618	$	—	$	9,114
Initial measurement recognized at acquisition		—		—		—		—		4,900		4,900
Cash paid to seller		(385)		(1,750)		—		—		—		(2,135)
Total remeasurement loss recognized in earnings		399		—		1,499		(415)		350		1,833
Balance as of June 30, 2019	$	679	$	—	$	2,580	$	5,203	$	5,250	$	13,712

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.

As of June 30, 2019, we invested $3.1 million in a limited partnership investment fund that invests in mid-sized, privately owned companies in the military, commercial, or disruptive technology sectors. We have a maximum additional commitment to this fund of $6.9 million. As the fund holds investments in privately held companies with no

quoted market prices in active markets, significant unobservable inputs are used to value our investment and therefore represent Level 3 measurements within the fair value hierarchy.

As of June 30, 2019, the following table summarizes the change in fair value of our Level 3 investment assets (in thousands):

	Investment
Balance as of September 30, 2018	$	—
Cash paid for initial investment		3,076
Total remeasurement gain/(loss) recognized in earnings		—
Balance as of June 30, 2019	$	3,076

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):

	June 30,		September 30,
	2019		2018
Fair value	$	202.9	$	193.7
Carrying value	$	200.0	$	200.0

We did not have any significant non-financial assets or liabilities measured at fair value on a non-recurring basis in the third quarter and first nine months of fiscal 2019 or 2018 other than assets and liabilities acquired in business acquisitions described in Note 3 and the restricted stock units that were granted during fiscal 2019 that contain performance and market-based vesting criteria described in Note 11.