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, municipal, asset-backed, and mortgage-backed residential debt 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 our 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 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 September 30, 2015 and December 31, 2014 are as follows (in thousands):


	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
September 30, 2015
U.S. government and sponsored entities	$	108,267	$	151	$	(4	)	$	108,414
Corporate debt securities		171,241		87		(196	)		171,132
Asset-backed securities		30,565		213		(39	)		30,739
Mortgage-backed securities – residential		1,940		6		(5	)		1,941

Total short-term investments	$	312,013	$	457	$	(244	)	$	312,226


December 31, 2014
U.S. government and sponsored entities	$	75,993	$	34	$	(112	)	$	75,915
Corporate debt securities		218,493		74		(433	)		218,134
Municipal securities		2,375		1		—			2,376
Asset-backed securities		19,061		270		(65	)		19,266
Mortgage-backed securities – residential		2,898		13		(3	)		2,908

Total short-term investments	$	318,820	$	392	$	(613	)	$	318,599

The fair value and duration that investments, including cash equivalents, have been in a gross unrealized loss position as of September 30, 2015 and December 31, 2014 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
September 30, 2015
U.S. government and sponsored entities	$	17,404	$	(4	)	$	—	$	—		$	17,404	$	(4	)
Corporate debt securities		97,745		(196	)		—		—			97,745		(196	)
Asset-backed securities		25,112		(36	)		2,088		(3	)		27,200		(39	)
Mortgage-backed securities – residential		446		(5	)		—		—			446		(5	)

Total	$	140,707	$	(241	)	$	2,088	$	(3	)	$	142,795	$	(244	)


December 31, 2014
U.S. government and sponsored entities	$	120,433	$	(112	)	$	—	$	—		$	120,433	$	(112	)
Corporate debt securities		147,141		(433	)		—		—			147,141		(433	)
Asset-backed securities		14,261		(65	)		120		(1	)		14,381		(66	)
Mortgage-backed securities – residential		640		(2	)		—		—			640		(2	)

Total	$	282,475	$	(612	)	$	120	$	(1	)	$	282,595	$	(613	)

For fixed income securities that have unrealized losses as of September 30, 2015, 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 we 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 September 30, 2015 were temporary in nature.

Amortized cost and estimated fair value of investments as of September 30, 2015 is summarized by maturity date as follows (in thousands):


	Amortized cost		Fair value
Mature in less than one year	$	183,451	$	183,666
Mature in one to three years		128,562		128,560

Total short-term investments	$	312,013	$	312,226

Net realized gains of less than $0.1 million from sales of investments were recognized in interest income and other expense, net, for the three and nine months ended September 30, 2015 and 2014. Net unrealized gains of $0.2 million and net unrealized losses of $0.2 million, respectively, were included in OCI in the accompanying Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014, respectively.

Fair Value Measurements

ASC 820, Fair Value Measurement, 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. 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 conclusions of management and not 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 September 30, 2015 and December 31, 2014 in order of liquidity as follows (in thousands):


	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
September 30, 2015
Assets:
Money market funds	$	63,927	$	63,927	$	—	$	—
U.S. government and sponsored entities		108,414		41,663		66,751		—
Corporate debt securities		171,132		—		171,132		—
Asset-backed securities		30,739		—		30,540		199
Mortgage-backed securities – residential		1,941		—		1,941		—

	$	376,153	$	105,590	$	270,364	$	199

Liabilities:
Contingent consideration, current and noncurrent	$	49,732	$	—	$	—	$	49,732
Self-insurance		1,305		—		—		1,305

	$	51,037	$	—	$	—	$	51,037


	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
December 31, 2014
Assets:
Money market funds	$	25,841	$	25,841	$	—	$	—
U.S. government and sponsored entities		139,206		63,291		75,915		—
Corporate debt securities		233,758		—		233,758		—
Municipal securities		2,376		—		2,376		—
Asset-backed securities		19,266		—		19,012		254
Mortgage-backed securities – residential		2,908		—		2,908		—

	$	423,355	$	89,132	$	333,969	$	254

Liabilities:
Contingent consideration, current and noncurrent	$	12,277	$	—	$	—	$	12,277
Self-insurance		1,369		—		—		1,369

	$	13,646	$	—	$	—	$	13,646

Money market funds consist of $63.9 and $25.8 million, which have been classified as cash equivalents as of September 30, 2015 and December 31, 2014, respectively. U.S. government and sponsored entities securities include $63.3 million, which have been classified as cash equivalents as of December 31, 2014. Corporate debt securities include $15.6 million, which have been classified as cash equivalents as of December 31, 2014.

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 are actively traded at $1.00 Net Asset Value. There have been no transfers between Level 1 and 2 during the three and nine months ended September 30, 2015 and 2014.

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. Asset-backed securities in the portfolio are predominantly collateralized by credit cards and auto loans. We also hold two asset-backed securities collateralized by mortgage loans, which have been fully reserved.

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, to determine 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 three and nine months ended September 30, 2015 and 2014.

Liabilities for Contingent Consideration

Acquisition-related liabilities for contingent consideration (i.e., earnouts) are related to the purchase business combinations of Reggiani in 2015; DiMS! organizing print BV (“DIMS”), DirectSmile GmbH (“DirectSmile”), and SmartLinc, Inc. (“SmartLinc”) in 2014; Outback Software Pty. Ltd. doing business as Metrix Software (“Metrix”), GamSys Software SPRL (“GamSys”), and PrintLeader Software (“PrintLeader”) in 2013; and Technique, Inc. and Technique Business Systems Limited (collectively, “Technique”), Online Print Marketing Ltd. and DataCreation Pty. Ltd. together doing business as Online Print Solutions (“OPS”), Metrics Sistemas de Informação, Serviços e Comércio Ltda. and Metrics Sistemas de Informação e Serviço Ltda. (collectively, “Metrics”), FXcolors (“FX Colors”), and Creta Print S.L. (“Cretaprint”) in 2012.

The fair value of these earnouts is estimated to be $49.7 and $12.3 million as of September 30, 2015 and December 31, 2014, respectively, by applying the income approach in accordance with ASC 805-30-25-5, Business Combinations. Key assumptions include discount rates between 4.2% and 6.4% and probability-adjusted revenue and EBIT levels. Probability-adjusted revenue and EBIT are significant inputs that are not observable in the market, which ASC 820-10-35 refers to as Level 3 inputs. These contingent liabilities have been reflected in the Condensed Consolidated Balance Sheet as of September 30, 2015 as current and noncurrent liabilities of $2.6 and $47.1 million, respectively.

The DIMS, DirectSmile, GamSys, and SmartLinc earnout performance probability percentages were reduced in 2015. The OPS, Technique, and DIMS earnout performance probability percentages were reduced or not achieved in 2014, partially offset by increased performance achievement with respect to the Metrics earnout performance target in 2014. Consequently, the decrease in the fair value of contingent consideration was $3.3 and $4.5 million, partially offset by $0.9 and $0.7 million of earnout interest accretion related to all acquisitions, during the nine months and year ended September 30, 2015 and December 31, 2014, 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 nine months ended September 30, 2015 of $2.0, $0.6, and $0.3 million are primarily related to the previously accrued Technique, Metrix, and SmartLinc contingent consideration liabilities, respectively. Earnout payments during the year ended December 31, 2014 of $6.2, $4.5, $2.0, and $1.2 million are primarily related to the previously accrued Cretaprint, Metrics, Technique, and GamSys contingent consideration liabilities, respectively.

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


Fair value of contingent consideration at January 1, 2014	$	21,052

Fair value of SmartLinc contingent consideration at January 16, 2014		1,546
Fair value of DirectSmile contingent consideration at July 18, 2014		4,162
Fair value of DIMS contingent consideration at September 15, 2014		4,456
Changes in valuation		(3,813	)
Payments		(14,047	)
Foreign currency adjustment		(1,079	)

Fair value of contingent consideration at December 31, 2014	$	12,277

Fair value of Reggiani contingent consideration at July 1, 2015	$	43,170
Changes in valuation		(2,430	)
Payments		(3,041	)
Foreign currency adjustment		(244	)

Fair value of contingent consideration at September 30, 2015	$	49,732

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. We assessed the probability of achieving the revenue performance targets for the contingent consideration associated with each acquisition at percentage levels between 60% 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 five percentage points from the level assumed in the current valuations would result in a change in the fair value of contingent consideration of $1.3 million resulting in a corresponding adjustment to general and administrative expense. A change in the discount rate of one percentage point results in a change in the fair value of contingent consideration of $0.7 million. The potential undiscounted amount of future contingent consideration cash payments that we could be required to make related to our business acquisitions, beyond amounts currently accrued, is $10.8 million as of September 30, 2015.

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 $82.5 and $89.5 million as of September 30, 2015 and December 31, 2014, respectively. The fair value of our derivative assets and liabilities that were designated for cash flow hedge accounting treatment having notional amounts of $3.0 and $2.9 million as of September 30, 2015 and December 31, 2014 was not material.

Fair Value of Convertible Senior Notes

In September 2014, we issued $345 million aggregate principal amount of 0.75% Convertible Senior Notes due 2019 (“Notes”). The Notes are carried at their original issuance value, net of unamortized debt discount, and are not marked to market each period. The approximate fair value of the Notes as of September 30, 2015 was approximately $350 million and was considered a Level 2 fair value measurement. Fair value was estimated based upon actual quotations obtained at the end of the reporting period or the most recent date available. A substantial portion of the market value of our Notes in excess of the outstanding principal amount relates to the conversion premium.