Fair Value Measurements | 3 Months Ended |
Oct. 31, 2013 |
Fair Value Measurements | ' |
Fair Value Measurements | ' |
Note 6. Fair Value Measurements |
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Fair Value Hierarchy |
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We apply the provisions of Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” (“ASC 820”), for our financial assets and liabilities that are re-measured and reported at fair value each reporting period and our nonfinancial assets and liabilities that are re-measured and reported at fair value on a non-recurring basis. We define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three level fair value hierarchy to prioritize the inputs used in valuations, as defined below: |
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Level 1: Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets. |
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Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. |
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Level 3: Unobservable inputs for the asset or liability. |
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Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis |
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As of October 31, 2013 and 2012, our financial assets that are re-measured at fair value on a recurring basis include money market funds that are classified as cash and cash equivalents in the Condensed Consolidated Balance Sheets. As there are no withdrawal restrictions, they are classified within Level 1 of the fair value hierarchy and are valued using quoted market prices for identical assets. |
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In order to protect our interest rate exposure in future years, we entered into forward starting interest rate swap agreements in February 2012 in which we agree to exchange our variable interest cash flows with fixed interest cash flows provided by one of our existing senior lenders, as further described in Notes 5 and 9 to the Condensed Consolidated Financial Statements. Our interest rate swap agreements are classified within Level 2 and are valued using discounted cash flow analyses based on the terms of the contracts and the interest rate curves. Changes in fair value in these interest rate swap agreements during the three months ended October 31, 2013 were recorded in accumulated other comprehensive income in the Condensed Consolidated Statements of Comprehensive Income. Amounts are reclassified from accumulated other comprehensive income in the period the hedged transaction affects earnings. |
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On August 1, 2011 (the first day of our fiscal 2012), we recorded a $2,700,000 liability for the estimated fair value of contingent consideration and a $3,000,000 liability for the estimated fair value of a three year price floor relating to the August 1, 2011 acquisition of the endoscopy procedural product business of Byrne Medical, Inc. (the “Byrne Medical Business” or the “Byrne Acquisition”). These fair value measurements were based on significant inputs not observed in the market and thus represent Level 3 measurements. |
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The fair value of the contingent consideration liability was based on future gross profit projections of the Byrne Medical Business under various potential scenarios for the two year period ended July 31, 2013 and weighting the probability of these outcomes. As such, the determination of fair value of the contingent consideration is subjective in nature and highly dependent on future gross profit projections. At the date of the acquisition, these cash flow projections were discounted using a rate of 14%. The discount rate was based on the weighted average cost of capital of the acquired business plus a credit risk premium for non-performance risk. This contingent consideration liability was adjusted periodically by recording changes in the fair value through our Condensed Consolidated Statements of Income. Based on actual gross profit results for the two year period ended July 31, 2013, contingent consideration was not earned. |
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After giving effect for the Company’s three-for-two stock splits, the stock portion of the consideration paid for the Byrne Acquisition consisted of 902,528 shares of Cantel common stock and was based on the closing price of Cantel common stock on the NYSE on July 29, 2011 ($11.08). Subject to certain conditions and limitations, under a three year price floor, we agreed that if the aggregate value of the stock consideration is less than $10,000,000 on July 31, 2014, we will pay to the sellers in cash or stock (at our option) an amount equal to the difference between $10,000,000 and the then value of the shares (based on the closing price of Cantel common stock on the NYSE on July 31, 2014). This three-year price floor is a free standing financial instrument that we recorded as a liability at fair value on the date of acquisition. The 902,528 shares of Cantel common stock were (i) placed in escrow at the time of the acquisition as security for certain indemnification obligations of the sellers and (ii) subjected to a multi-year lock-up feature prohibiting the sellers from selling or otherwise transferring the shares. In November 2013, one-third of the shares were released from escrow and the lock-up feature. Likewise, the three year price floor is in the process of being modified to exclude the released shares and reduce the $10,000,000 value guaranty by one-third to $6,666,666. |
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The fair value of the three year price floor liability was determined using the Black-Scholes option valuation model, which is affected by our stock price and risk free interest rate as well as assumptions regarding a number of subjective variables, including, but not limited to, the expected stock price volatility of our common stock over the expected life of the instrument and the expected dividend yield. This liability is adjusted periodically by recording changes in the fair value through our Condensed Consolidated Statements of Income, as shown below in the reconciliation of our liabilities that are measured and recorded at fair value on a recurring basis, driven by the time value of money and changes in the assumptions that were initially used in the valuation. The decrease to the fair value of the price floor (as determined by the Black-Scholes option valuation model) was recorded as a decrease to accrued expenses or other long-term liabilities and general and administrative expenses in the Condensed Consolidated Financial Statements and was primarily due to the impact of our stock price being higher than at the time of the acquisition, the life of the price floor being less than three years and changes in the expected stock price volatility. Due to the significant increase in our stock price from $11.08 at August 1, 2011, the exclusion of the price floor on one third of the shares issued to the sellers and the short amount of time remaining until July 31, 2014, we do not expect the fair value of the price floor liability to increase during the remainder of fiscal 2014 beyond its October 31, 2013 nominal fair value. |
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The fair values of the Company’s financial instruments measured on a recurring basis were categorized as follows: |
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| | October 31, 2013 | |
| | Level 1 | | Level 2 | | Level 3 | | Total | |
Assets: | | | | | | | | | |
Cash and cash equivalents: | | | | | | | | | |
Money markets | | $ | 4,571,000 | | $ | — | | $ | — | | $ | 4,571,000 | |
Total assets | | $ | 4,571,000 | | $ | — | | $ | — | | $ | 4,571,000 | |
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Liabilities: | | | | | | | | | |
Accrued expenses: | | | | | | | | | |
Interest rate swap agreements | | $ | — | | $ | 112,000 | | $ | — | | $ | 112,000 | |
Price floor | | — | | — | | 1,000 | | 1,000 | |
Total accrued expenses | | — | | 112,000 | | 1,000 | | 113,000 | |
Other long-term liabilities: | | | | | | | | | |
Interest rate swap agreements | | — | | 35,000 | | — | | 35,000 | |
Total liabilities | | $ | — | | $ | 147,000 | | $ | 1,000 | | $ | 148,000 | |
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| | July 31, 2013 | |
| | Level 1 | | Level 2 | | Level 3 | | Total | |
Assets: | | | | | | | | | |
Cash and cash equivalents: | | | | | | | | | |
Money markets | | $ | 4,241,000 | | $ | — | | $ | — | | $ | 4,241,000 | |
Total assets | | $ | 4,241,000 | | $ | — | | $ | — | | $ | 4,241,000 | |
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Liabilities: | | | | | | | | | |
Accrued expenses: | | | | | | | | | |
Interest rate swap agreements | | $ | — | | $ | 133,000 | | $ | — | | $ | 133,000 | |
Total accrued expenses | | — | | 133,000 | | — | | 133,000 | |
Other long-term liabilities: | | | | | | | | | |
Price floor | | — | | — | | 45,000 | | 45,000 | |
Interest rate swap agreements | | — | | 29,000 | | — | | 29,000 | |
Total other long-term liabilities | | — | | 29,000 | | 45,000 | | 74,000 | |
Total liabilities | | $ | — | | $ | 162,000 | | $ | 45,000 | | $ | 207,000 | |
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A reconciliation of our liabilities that are measured and recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) for the last five quarters is as follows: |
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| | Byrne | | Byrne | | | | | | |
| | Contingent | | Price | | | | | | |
| | Consideration | | Floor | | Total | | | | |
Balance, July 31, 2012 | | $ | 1,500,000 | | $ | 1,037,000 | | $ | 2,537,000 | | | | |
Total net unrealized gains included in general and administrative expense in earnings | | — | | (313,000 | ) | (313,000 | ) | | | |
Transfers into or out of level 3 | | — | | — | | — | | | | |
Net purchases, issuances, sales and settlements | | — | | — | | — | | | | |
Balance, October 31, 2012 | | 1,500,000 | | 724,000 | | 2,224,000 | | | | |
Total net unrealized gains included in general and administrative expense in earnings | | (1,500,000 | ) | (410,000 | ) | (1,910,000 | ) | | | |
Transfers into or out of level 3 | | — | | — | | — | | | | |
Net purchases, issuances, sales and settlements | | — | | — | | — | | | | |
Balance, January 31, 2013 | | — | | 314,000 | | 314,000 | | | | |
Total net unrealized gains included in general and administrative expense in earnings | | — | | (59,000 | ) | (59,000 | ) | | | |
Transfers into or out of level 3 | | — | | — | | — | | | | |
Net purchases, issuances, sales and settlements | | — | | — | | — | | | | |
Balance, April 30, 2013 | | — | | 255,000 | | 255,000 | | | | |
Total net unrealized gains included in general and administrative expense in earnings | | — | | (210,000 | ) | (210,000 | ) | | | |
Transfers into or out of level 3 | | — | | — | | — | | | | |
Net purchases, issuances, sales and settlements | | — | | — | | — | | | | |
Balance, July 31, 2013 | | — | | 45,000 | | 45,000 | | | | |
Total net unrealized gains included in general and administrative expense in earnings | | — | | (44,000 | ) | (44,000 | ) | | | |
Transfers into or out of level 3 | | — | | — | | — | | | | |
Net purchases, issuances, sales and settlements | | — | | — | | — | | | | |
Balance, October 31, 2013 | | $ | — | | $ | 1,000 | | $ | 1,000 | | | | |
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Assets Measured and Recorded at Fair Value on a Nonrecurring Basis |
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We re-measure the fair value of certain assets, such as intangible assets, goodwill and long-lived assets, including property, equipment and other assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually. In performing a review for goodwill impairment, management first assesses qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than the carrying amount before proceeding to step one of the two-step quantitative goodwill impairment test, if necessary. For our quantitative test, we use a two-step process that begins with an estimation of the fair value of the related operating segments by using fair value results of the discounted cash flow methodology, as well as the market multiple and comparable transaction methodologies. The first step is a review for potential impairment, and the second step measures the amount of impairment, if any. In performing our annual review for indefinite lived intangibles, management performs a qualitative assessment, and if a quantitative assessment is necessary, we compare the current fair value of such assets to their carrying values. With respect to amortizable intangible assets when impairment indicators are present, management determines whether expected future non-discounted cash flows are sufficient to recover the carrying value of the assets; if not, the carrying value of the assets is adjusted to their fair value. With respect to long-lived assets, an assessment is made to determine if the sum of the expected future non-discounted cash flows from the use of the assets and eventual disposition is less than the carrying value. If the sum of the expected non-discounted cash flows is less than the carrying value, an impairment loss is recognized based on fair value. As the inputs utilized for our periodic impairment assessments are not based on observable market data, but are based on management’s assumptions and estimates, our goodwill, intangibles and long-lived assets are classified within Level 3 of the fair value hierarchy on a non-recurring basis. On July 31, 2013, management concluded that none of our long-lived assets, including goodwill and intangibles with indefinite-lives, were impaired and no other events or changes in circumstances have occurred during the three months ended October 31, 2013 that would indicate that the carrying amount of our long-lived assets may not be recoverable. |
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Disclosure of Fair Value of Financial Instruments |
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As of October 31, 2013 and July 31, 2013, the carrying amounts for cash and cash equivalents (excluding money markets), accounts receivable and accounts payable approximated fair value due to the short maturity of these instruments. We believe that as of October 31, 2013 and July 31, 2013, the fair value of our outstanding borrowings under our credit facilities approximated the carrying value of those obligations since the borrowing rates were at prevailing market interest rates, principally under LIBOR contracts ranging from one to twelve months. |