Note 3—Financial Instruments

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

•

Level 1—inputs are based upon unadjusted quoted prices for identical instruments traded in active markets;

•

Level 2—inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

•

Level 3—inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

Financial assets and liabilities measured at fair value on a recurring basis consisted of the following types of instruments as of June 30, 2013 and July 1, 2012:


	Fair Value as of June 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
			(In thousands)
*Assets:*
Money market funds	$	8,798	$	8,798	$	—	$	—

Short-term investments:
Corporate debt securities and certificates of deposits		35,034		—		35,034		—
Government sponsored enterprise debt securities		8,246		—		8,246		—
Mutual funds		2,851		2,851		—		—

Total short-term investments		46,131		2,851		43,280		—

Total financial assets	$	54,929	$	11,649	$	43,280	$	—

*Liabilities:*
Contingent consideration	$	650	$	—	$	—	$	650

Total financial liabilities	$	650	$	—	$	—	$	650


	Fair Value as of July 1, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
			(In thousands)
*Assets:*
Money market funds	$	8,650	$	8,650	$	—	$	—

Short-term investments:
Corporate debt securities		23,703		—		23,703		—
Government sponsored enterprise debt securities		12,515		—		12,515		—
Mutual funds		3,062		3,062		—		—

Total short-term investments		39,280		3,062		36,218		—

Total financial assets	$	47,930	$	11,712	$	36,218	$	—

*Liabilities:*
Contingent consideration	$	540	$	—	$	—	$	540

Total financial liabilities	$	540	$	—	$	—	$	540

The fair values of our money market funds and mutual funds were derived from quoted market prices as active markets for these instruments exist. The fair values of corporate debt securities, certificates of deposits and government sponsored enterprise debt securities were derived from non-binding market consensus prices that are corroborated by observable market data.

The investments in mutual funds are held in a Rabbi trust to support the terms of our deferred compensation plan discussed further in Note 10.

The following table summarizes available-for-sale and trading securities recorded as cash and cash equivalents or short-term investments:


	Amortized Cost Basis		Gross Unrealized Gains (Losses)			Fair Value
			(In thousands)
June 30, 2013
Money market funds	$	8,798	$	—		$	8,798
Corporate debt securities and certificates of deposits		35,171		(137	)		35,034
Government sponsored enterprise debt securities		8,263		(17	)		8,246
Mutual funds		2,851		—			2,851

Total financial assets	$	55,083	$	(154	)	$	54,929

July 1, 2012
Money market funds	$	8,650	$	—		$	8,650
Corporate debt securities		23,705		(2	)		23,703
Government sponsored enterprise debt securities		12,513		2			12,515
Mutual funds		3,062		—			3,062

Total financial assets	$	47,930	$	—		$	47,930

The following table summarizes the contractual maturities of fixed income securities (Corporate debt securities, certificates of deposits and Government sponsored enterprise debt securities) recorded as short-term investments:


	Amortized Cost		Fair Value
	(In thousands)
Less than 1 year	$	8,325	$	8,325
Due in 1 to 3 years		35,109		34,955

Total	$	43,434	$	43,280

Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.

Level 3 financial liability:

The following table reconciles the beginning and ending balances for Level 3 liabilities for fiscal 2013 (in thousands):


	Contingent consideration
Balance as of July 1, 2012	$	540
Add: Adjustment to present value of contingent consideration		110

Balance as of June 30, 2013	$	650

Contingent consideration on acquired business was measured at fair value on a recurring basis using Level 3 inputs as defined in the fair value hierarchy. The following table presents certain information about the significant unobservable inputs used in the fair value measurement for the contingent consideration measured at fair value on a recurring basis using significant unobservable inputs:


Description	Valuation Techniques	Significant Unobservable Inputs
Liabilities: Contingent consideration	Present value of a Probability Weighted earn-out model using an appropriate discount rate.	Estimate of future revenue associated with acquired technology. Revenue of $4.9 million over a range of 3.5 years to 4 years.

An increase in the revenue growth percentage could result in a significantly higher estimated fair value of the contingent consideration liability. Alternatively, a decrease in the revenue growth percentage could result in a significantly lower estimated fair value of contingent consideration liability.

The fair value of contingent consideration was derived from a probability weighted earn-out model of future contingent payments. The cash payments, if any, are expected to be made quarterly, and based upon revenue generated from the acquired product line, starting in the first quarter of fiscal 2014. No payments were made in fiscal 2013. The change in the time period of estimated revenue to be generated from the acquired product line resulted in accretion of contingent liability in fiscal 2013. The valuation of this liability is estimated based upon a collaborative effort of the Company’s marketing and finance departments. These future contingent payments are calculated based on estimates of future revenue attributable to the acquired technology (Note 12). To obtain a current valuation of these projected cash flows, an expected present value technique is applied using an appropriate discount rate. The cash flow projections and discount rates will be reviewed quarterly and updated as and when necessary. Potential valuation adjustments will be made as future revenue projections are updated which affect the calculation of the related contingent consideration payments. These adjustments will be recorded in the consolidated statement of operations.