5. Investments and Fair Value Measurements

We invest our excess cash on deposit with major banks in money market, U.S. Treasury and government-sponsored entity, corporate debt, municipal, asset-backed, and mortgage-backed residential securities. By policy, we invest primarily in high-grade marketable securities. We are exposed to credit risk in the event of default by the financial institutions or issuers of these investments to the extent of amounts recorded in the condensed consolidated balance sheets.

We consider all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Typically, the cost of these investments has approximated fair value. Marketable investments with a maturity greater than three months are classified as available-for-sale short-term investments. Available-for-sale securities are stated at fair market value with unrealized gains and losses reported as a separate component of OCI, adjusted for deferred income taxes. The credit portion of any other-than-temporary impairment is included in net income. Realized gains and losses on sales of financial instruments are recognized upon sale of the investments using the specific identification method.

Our available-for-sale short-term investments as of June 30, 2013 and December 31, 2012 are as follows (in thousands):


	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
June 30, 2013
U.S. Government and sponsored entities	$	5,033	$	2	$	(1	)	$	5,034
Corporate debt securities		38,302		114		(87	)		38,329
Municipal securities		1,709		1		(4	)		1,706
Asset-backed securities		11,702		61		(21	)		11,742
Mortgage-backed securities – residential		6,751		22		(34	)		6,739

Total short-term investments	$	63,497	$	200	$	(147	)	$	63,550


December 31, 2012
U.S. Government and sponsored entities	$	17,371	$	7	$	—		$	17,378
Corporate debt securities		40,218		194		(17	)		40,395
Municipal securities		1,710		3		—			1,713
Asset-backed securities		12,128		66		(2	)		12,192
Mortgage-backed securities – residential		9,237		63		(12	)		9,288

Total short-term investments	$	80,664	$	333	$	(31	)	$	80,966

The fair value and duration that investments, including cash equivalents, have been in a gross unrealized loss position as of June 30, 2013 and December 31, 2012 are as follows (in thousands):


	Less than 12 Months					More than 12 Months						TOTAL
	Fair Value		Unrealized Losses			Fair Value			Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2013
U.S. Government and sponsored entities	$	1,439	$	(1	)	$	—		$	—		$	1,439	$	(1	)
Corporate debt securities		18,228		(87	)		—			—			18,228		(87	)
Municipal securities		831		(4	)		—			—			831		(4	)
Asset-backed securities		6,935		(21	)		—			—			6,935		(21	)
Mortgage-backed securities – residential		3,782		(28	)		(233	)		(6	)		3,549		(34	)

Total	$	31,215	$	(141	)	$	(233	)	$	(6	)	$	30,982	$	(147	)


December 31, 2012
U.S. Government and sponsored entities	$	15,791	$	(1	)	$	—		$	—		$	15,791	$	(1	)
Corporate debt securities		11,288		(17	)		—			—			11,288		(17	)
Asset-backed securities		1,959		(2	)		—			—			1,959		(2	)
Mortgage-backed securities – residential		1,263		(7	)		(300	)		(4	)		963		(11	)

Total	$	30,301	$	(27	)	$	(300	)	$	(4	)	$	30,001	$	(31	)

For fixed income securities that have unrealized losses as of June 30, 2013, we have determined that we do not have the intent to sell any of these investments and it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis. We have evaluated these fixed income securities and determined that no credit losses exist. Accordingly, management has determined that the unrealized losses on our fixed income securities as of June 30, 2013 were temporary in nature.

Amortized cost and estimated fair value of investments at June 30, 2013 is summarized by maturity date as follows (in thousands):


	Amortized cost		Fair value
Mature in less than one year	$	11,829	$	11,855
Mature in one to three years		51,668		51,695

Total short-term investments	$	63,497	$	63,550

For the three months ended June 30, 2013 and 2012, net realized losses of less than $0.1 and $0.1 million, respectively, from sales of investments were recognized in interest and other expense, net. For the six months ended June 30, 2013 and 2012, net realized losses of $0.1 million from sales of investments were recognized in interest and other expense, net. As of June 30, 2013 and December 31, 2012, net unrealized gains of $0.1 and $0.3 million were included in OCI in the accompanying condensed consolidated balance sheets.

Fair Value Measurements

ASC 820 identifies fair value as the exchange price, or exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a three-tier fair value hierarchy as follows:

Level 1: Inputs that are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;

Level 2: Inputs that are other than quoted prices included within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date for the duration of the instrument’s anticipated life or by comparison to similar instruments; and

Level 3: Inputs that are unobservable or that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. These include management’s own judgments about market participant assumptions developed based on the best information available in the circumstances.

We utilize the market approach to measure the fair value of our fixed income securities. The market approach is a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of our fixed income securities is obtained using readily-available market prices from a variety of industry standard data providers, large financial institutions, and other third-party sources for the identical underlying securities. The fair value of our investments in certain money market funds is expected to maintain a Net Asset Value of $1 per share and, as such, is priced at the expected market price.

We obtain the fair value of our Level 2 financial instruments from several third party asset managers, custodian banks, and the accounting service providers. Independently, these service providers use professional pricing services to gather pricing data, which may include quoted market prices for identical or comparable instruments or inputs other than quoted prices that are observable either directly or indirectly. The service providers then analyze their gathered pricing inputs and apply proprietary valuation techniques, including consensus pricing, weighted average pricing, distribution curve-based algorithms, or pricing models such as discounted cash flow techniques to provide a fair value for each security.

As part of this process, we engaged a pricing service to assist management in its pricing analysis and assessment of other-than-temporary impairment. All estimates, key assumptions, and forecasts were either provided by or reviewed by us. While we chose to utilize a third party pricing service, the impairment analysis and related valuations represent the conclusions of management and not the conclusions or statements of any third party.

Our investments and liabilities measured at fair value have been presented in accordance with the fair value hierarchy specified in ASC 820 as of June 30, 2013 and December 31, 2012 in order of liquidity as follows (in thousands):


			Fair Value Measurements at Reporting Date using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
June 30, 2013
Assets:
Money market funds	$	123,502	$	123,502	$	—	$	—
U.S. Government and sponsored entities		5,034		—		5,034		—
Corporate debt securities		41,691		—		41,691		—
Municipal securities		1,706		—		1,706		—
Asset-backed securities		11,742		—		11,672		70
Mortgage-backed securities – residential		6,739		—		6,739		—

	$	190,414	$	123,502	$	66,842	$	70

Liabilities:
Contingent consideration, current and noncurrent	$	29,627	$	—	$	—	$	29,627
Self-insurance		1,558		—		—		1,558

	$	31,185	$	—	$	—	$	31,185


December 31, 2012
Assets:
Money market funds	$	112,714	$	112,714	$	—	$	—
U.S. Government and sponsored entities		20,177		15,214		4,963		—
Corporate debt securities		42,069		—		42,069		—
Municipal securities		1,713		—		1,713		—
Asset-backed securities		12,192		—		12,139		53
Mortgage-backed securities – residential		9,288		—		9,288		—

	$	198,153	$	127,928	$	70,172	$	53

Liabilities:
Contingent consideration, current and noncurrent	$	38,050	$	—	$	—	$	38,050
Self-insurance		1,375		—		—		1,375

	$	39,425	$	—	$	—	$	39,425

Money market funds consisted of $123.5 and $112.7 million, which have been classified as cash equivalents at June 30, 2013 and December 31, 2012, respectively. U.S. government and sponsored entities securities include $2.8 million, which have been classified as cash equivalents at December 31, 2012. Corporate debt securities include $3.4 and $1.7 million, which have been classified as cash equivalents at June 30, 2013 and December 31, 2012, respectively.

Investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices or alternative pricing sources with reasonable levels of price transparency. Investments in U.S. Treasury obligations and overnight money market mutual funds have been classified as Level 1 because these securities are valued based on quoted prices in active markets or they are actively traded at $1.00 Net Asset Value. There have been no transfers between Level 1 and 2 during the six months ended June 30, 2013 and 2012.

Government agency investments and corporate debt instruments, including investments in asset-backed and mortgage-backed securities, have generally been classified as Level 2 because markets for these securities are less active or valuations for such securities utilize significant inputs, which are directly or indirectly observable. We hold asset-backed securities with income payments derived from and collateralized by a specified pool of underlying assets. Predominanty, asset-backed securities in the portfolio are collateralized by credit cards and auto loans. We also hold two asset-backed securities collateralized by mortgage loans.

At June 30, 2013 and December 31, 2012, one corporate debt instrument has been classified as Level 3 due to its significantly low level of trading activity. The rollforward of Level 3 investments is not provided due to immateriality. Changes in unobservable inputs to the fair value measurement of Level 3 investments on a recurring basis will not result in a significantly higher or lower fair value measurement.

We review investments in debt securities for other-than-temporary impairment whenever the fair value is less than the amortized cost and evidence indicates the investment’s carrying amount is not recoverable within a reasonable period of time. We assess the fair value of individual securities as part of our ongoing portfolio management. Our other-than-temporary assessment includes reviewing the length of time and extent to which fair value has been less than amortized cost, the seniority and durations of the securities, adverse conditions related to a security, industry, or sector, historical and projected issuer financial performance, credit ratings, issuer specific news, and other available relevant information. To determine whether an impairment is other-than-temporary, we consider whether we have the intent to sell the impaired security or if it will be more likely than not that we will be required to sell the impaired security before a market price recovery and whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary.

In determining whether a credit loss existed, we used our best estimate of the present value of cash flows expected to be collected from each debt security. For asset-backed and mortgage-backed securities, cash flow estimates, including prepayment assumptions, we rely on data from widely accepted third party data sources or internal estimates. In addition to prepayment assumptions, cash flow estimates vary based on assumptions regarding the underlying collateral including default rates, recoveries, and changes in value. Expected cash flows were discounted using the effective interest rate implicit in the securities.

Based on this analysis, there were no other-than-temporary impairments, including credit-related impairments, during the six months ended June 30, 2013 and 2012. Accumulated other-than-temporary credit-related impairments charged to retained earnings and interest and other expense, net, consists of the following (in thousands):


	Impairments Charged to Retained Earnings		Impairments Recognized in Other Income (Expense), Net		Total
Accumulated impairments, net, attributable to assets still held at June 30, 2013	$	58	$	824	$	882

Liabilities for Contingent Consideration

Acquisition-related liabilities for contingent consideration (i.e., earnouts) are related to the purchase business combinations of GamSys and PrintLeader in 2013; Technique, OPS, Metrics Sistemas de Informação, Serviços e Comércio Ltda. and Metrics Sistemas de Informação e Serviço Ltda. (collectively, “Metrics”), FXcolors (“FX Colors”), and Cretaprint in 2012; Alphagraph, Entrac Technologies, Inc. (“Entrac”); and Streamline Development, LLC (“Streamline”) in 2011; and Radius Solutions Incorporated (“Radius”) in 2010. The fair value of these earnouts is estimated to be $29.6 and $38.1 million at June 30, 2013 and December 31, 2012, respectively, by applying the income approach in accordance with ASC 805-30-25-5. Key assumptions include discount rates between 4.2% and 6.4%, executive retention relative to acquisition-related executive deferred compensation cost, and probability-adjusted revenue and gross profit levels. Probability-adjusted revenue and gross profit are significant inputs that are not observable in the market, which ASC 820-10-35 refers to as Level 3 inputs. Acquisition-related executive deferred compensation cost of $0.5 million, which is dependent on the continuing employment of a former shareholder of an acquired company, has been applied against the earnout as of June 30, 2013. These contingent liabilities have been reflected in the condensed consolidated balance sheet as of June 30, 2013, as a current and noncurrent liability of $21.2 and $8.4 million, respectively.

The probability of achieving the 2013 Entrac, Cretaprint, Streamline, and Alphagraph earnout performance targets has been reduced, partially offset by an increase in the probability of achieving the 2013 Metrics earnout performance target. The 2012 Entrac earnout performance target was not achieved due to the delayed launch of the M500 product, which is Entrac’s next generation device. The 2012 Alphagraph earnout performance target was partially achieved. Consequently, the fair value of contingent consideration decreased by $1.6 and $2.1 million as of June 30, 2013 and December 31, 2012, respectively, partially offset by $0.8 and $1.7 million of earnout interest accretion related to all acquisitions, respectively. In accordance with ASC 805-30-35-1, changes in the fair value of contingent consideration subsequent to the acquisition date have been recognized in general and administrative expense.

Earnout payments during the six months ended June 30, 2013 of $8.9, $0.7, and $1.0 million, respectively, related to previously accrued Cretaprint, Alphagraph, and Radius contingent consideration liabilities. Earnout payments during the year ended December 31, 2012 of $0.6, $0.3, and $0.1 million, respectively, related to previously accrued Streamline, Radius, and FX Colors contingent consideration liabilities. The difference between the $2.1 million accrued Radius earnout liability and the amount paid represents a disputed indemnification.

Changes in the fair value of contingent consideration are summarized as follows:


Fair value of contingent consideration at January 1, 2012	$	8,704
Fair value of Cretaprint contingent consideration at January 10, 2012		16,445
Fair value of FX Colors contingent consideration at April 5, 2012		190
Fair value of Metrics contingent consideration at April 10, 2012		5,582
Fair value of OPS contingent consideration at October 1, 2012		2,600
Fair value of Technique contingent consideration at November 16, 2012		4,410
Deferred compensation expense dependent on future employment		907
Changes in valuation		(432	)
Payments		(968	)
Foreign currency adjustment		612


Fair value of contingent consideration at December 31, 2012	$	38,050
Fair value of PrintLeader contingent consideration at May 8, 2013		389
Fair value of GamSys contingent consideration at May 31, 2013		2,640
Deferred compensation expense dependent on future employment		465
Changes in valuation		(828	)
Payments		(10,616	)
Foreign currency adjustment		(473	)

Fair value of contingent consideration at June 30, 2013	$	29,627

ASU 2011-04 requires a narrative description of the sensitivity of recurring fair value measurements to changes in unobservable inputs if a change in those inputs might result in a significantly higher or lower fair value measurement. Since the primary inputs to the fair value measurement of the contingent consideration liability are the discount rate and probability-adjusted revenue, we reviewed the sensitivity of the fair value measurement to changes in these inputs. Probability-adjusted gross profit was not considered in the sensitivity analysis as its impact on the fair value measurement is conditional on achievement of the revenue performance targets and has significantly less impact on the overall potential earnout payment.

We assessed the probability of achieving the revenue performance targets for the contingent consideration associated with each acquisition at percentage levels between 70% and 100% as of each respective acquisition date based on an assessment of the historical performance of each acquired entity, our current expectations of future performance, and other relevant factors. A change in probability-adjusted revenue of 5% from the level assumed in the respective valuations would result in an increase (decrease) in the earnout liability of approximately $1.0 or $(1.4) million, respectively, resulting in a corresponding adjustment to general and administrative expense. Likewise, a change in the discount rate of one percentage point results in either an increase of or decrease of $0.3 million in the fair value of contingent consideration.

Liability for Self-Insurance

We are partially self-insured for certain losses related to employee medical and dental coverage, excluding employees covered by health maintenance organizations. We generally have an individual stop loss deductible of $125 thousand per enrollee unless specific exposures are separately insured. We have accrued a contingent liability of $1.6 and $1.4 million as of June 30, 2013 and December 31, 2012, respectively, which are not discounted, based upon examination of historical trends, our claims experience, industry claims experience, actuarial analysis, and estimates. The primary estimates used in the development of our accrual as of June 30, 2013 and December 31, 2012, include total enrollment (including employee contributions), population demographics, and historical claims costs incurred, which are significant inputs that are not observable in the market, which ASC 820-10-35 refers to as Level 3 inputs.

Changes in the contingent liability for self-insurance are summarized as follows:


Fair value of self-insurance liability at January 1, 2012	$	1,640
Additions to reserve		12,440
Employee contributions		2,340
Less: insurance claims, stop loss premium, and administrative fees paid		(15,045	)

Fair value of self-insurance liability at December 31, 2012	$	1,375
Additions to reserve		5,920
Employee contributions		1,154
Less: insurance claims, stop loss premium, and administrative fees paid		(6,891	)

Fair value of self-insurance liability at June 30, 2013	$	1,558

While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity of claims and medical cost inflation, differ from our estimates, our consolidated financial position, results of operations, or cash flows could be impacted. ASU 2011-04 requires a narrative description of the sensitivity of recurring fair value measurements to changes in unobservable inputs if a change in those inputs might result in a significantly higher or lower fair value measurement. Since the primary inputs to the fair value measurement of the self-insurance liability are the historical claims costs incurred, we reviewed the sensitivity of the fair value measurement to changes in medical cost assumptions and the severity of claims experienced by employees. A change in the severity of claims experienced or medical cost inflation of 10% results in either an increase or decrease in the fair value of the self-insurance liability of approximately $0.1 million.

Fair Value of Derivative Instruments

We utilize the income approach to measure the fair value of our derivative assets and liabilities under ASC 820. The income approach uses pricing models that rely on market observable inputs such as yield curves, currency exchange rates, and forward prices, and are therefore classified as Level 2 measurements. The notional amount of our derivative assets and liabilities was $20.9 and $3.2 million as of June 30, 2013 and December 31, 2012, respectively. The fair value of our derivative assets and liabilities that were designated for cash flow hedge accounting treatment having notional amounts of $2.7 million as of June 30, 2013 and December 31, 2012 was not material.