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Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2020

6. Fair Value of Financial Instruments

The Company applies the following hierarchy to determine the fair value of financial instruments, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement. The levels in the hierarchy are defined as follows:

●Level 1: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

●Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

●Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The valuation techniques that may be used by the Company to determine the fair value of Level 2 and Level 3 financial instruments are the market approach, the income approach and the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value based on current market expectations about those future amounts, including present value techniques, option-pricing models and the excess earnings method. The cost approach is based on the amount that would be required to replace the service capacity of an asset (replacement cost).

The following tables set forth the Company's financial instruments measured at fair value on a recurring basis and presents them within the fair value hierarchy using the lowest level of input that is significant to the fair value measurement at March 31, 2020 and December 31, 2019 (dollars in millions):


			Quoted Prices		Significant
			in Active		Other		Significant
			Markets		Observable		Unobservable
			Available		Inputs		Inputs
March 31, 2020	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Interest rate and cross currency swap agreements	$	21.1	$	—	$	21.1	$	—
Foreign exchange contracts		0.8		—		0.8		—
Embedded derivatives in purchase and delivery contracts		0.1		—		0.1		—
Total assets recorded at fair value	$	22.0	$	—	$	22.0	$	—

Liabilities:
Contingent consideration	$	11.9	$	—	$	—	$	11.9
Hybrid instrument liability		10.9		—		—		10.9
Interest rate and cross currency swap agreements		17.0		—		17.0		—
Foreign exchange contracts		0.8		—		0.8		—
Fixed price commodity contracts		0.8		—		0.8		—
Total liabilities recorded at fair value	$	41.4	$	—	$	18.6	$	22.8


			Quoted Prices		Significant
			in Active		Other		Significant
			Markets		Observable		Unobservable
			Available		Inputs		Inputs
December 31, 2019	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Interest rate and cross currency swap agreements	$	10.1	$	—	$	10.1	$	—
Foreign exchange contracts		0.9		—		0.9		—
Embedded derivatives in purchase and delivery contracts		0.1		—		0.1		—
Fixed price commodity contracts		0.3		—		0.3		—
Total assets recorded at fair value	$	11.4	$	—	$	11.4	$	—

Liabilities:
Contingent consideration	$	15.8	$	—	$	—	$	15.8
Hybrid instrument liability		10.6		—		—		10.6
Interest rate and cross currency swap agreements		16.9		—		16.9		—
Foreign exchange contracts		0.4		—		0.4		—
Embedded derivatives in purchase and delivery contracts		0.6		—		0.6		—
Total liabilities recorded at fair value	$	44.3	$	—	$	17.9	$	26.4

The Company's financial instruments consist primarily of cash equivalents, short-term investments, restricted cash, derivative instruments consisting of forward foreign exchange contracts, cross-currency interest rate swap agreements, commodity contracts, derivatives embedded in certain purchase and sale contracts, derivatives embedded within noncontrolling interests, accounts receivable, accounts payable, contingent consideration and long-term debt. The carrying amounts of the Company's cash equivalents, short-term investments and restricted cash, accounts receivable, borrowings under a revolving credit agreement and accounts payable approximate fair value because of their short-term nature. Derivative assets and liabilities are measured at fair value on a recurring basis. The Company's long-term debt consists principally of a note purchase agreement entered into in 2012 and a revolving credit agreement, long term loan agreement and note purchase agreement entered into in 2019.

The Company has evaluated the estimated fair value of financial instruments using available market information and management’s estimates. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts.

Derivative financial instruments are classified within Level 2 because there is not an active market for each derivative contract. However, the inputs used to calculate the value of the instruments are obtained from active markets.

The fair value of the long-term fixed interest rate debt, which has been classified as Level 2, was $453.1 million and $517.4 million at March 31, 2020 and December 31, 2019, respectively, based on market and observable sources with similar maturity dates.

The Company measures certain assets and liabilities at fair value with changes in fair value recognized in earnings. Fair value treatment may be elected either upon initial recognition of an eligible asset or liability or, for an existing asset or liability, if an event triggers a new basis of accounting. The Company did not elect to remeasure any of its existing financial assets or liabilities and did not elect the fair value option for any financial assets or liabilities which originated during the three months ended March 31, 2020 or 2019.

Excluded from the table above are restricted cash, cash equivalents and short-term investments related to time and call deposits. The Company has a program to enter into money markets and time deposits with varying maturity dates ranging from one to twelve months, as well as call deposits for which the Company has the ability to redeem the invested amounts generally over a period of 95 days. The Company has classified these investments within cash and cash equivalents or short-term investments within the consolidated balance sheets based on call and maturity dates and these are not subject to fair value measurement. The following tables set forth the balances of restricted cash, cash equivalents and short-term investments as of March 31, 2020 and December 31, 2019 (dollars in millions):


	March 31,		December 31,
	2020		2019
Restricted cash	$	3.4	$	3.6
Cash equivalents		303.6		9.0
Short-term investments		56.2		6.6

On a quarterly basis, the Company reviews its short-term investments to determine if there have been any events that could create an impairment. None were noted for the three month periods ended March 31, 2020 or 2019.

As part of certain acquisitions, the Company recorded contingent consideration liabilities that have been classified as Level 3 in the fair value hierarchy. The contingent consideration represents the estimated fair value of future payments to the former shareholders of certain acquired companies based on the applicable acquired company achieving annual revenue and gross margin targets in certain years as specified in the relevant purchase and sale agreement. The Company initially values the contingent consideration by using a Monte Carlo simulation or an income approach method. The Monte Carlo method models future revenue and costs of goods sold projections and discounts the average results to present value. The income approach method involves calculating the earnout payment based on the forecasted cash flows, adjusting the future earnout payment for the risk of reaching the projected financials, and then discounting the future payments to present value by the counterparty risk. The counterparty risk considers the risk of the buyer having the cash to make the earnout payments and is commensurate with a cost of debt over an appropriate term.

The following table sets forth the changes in contingent consideration liabilities for the three months ended March 31, 2020 (dollars in millions):


Balance at December 31, 2019	$	15.8
Current period adjustments		(2.3)
Current period settlements		(1.5)
Foreign currency effect		(0.1)
Balance at March 31, 2020	$	11.9

As part of the Mestrelab acquisition, the Company entered into an agreement with the noncontrolling interest holders that provides the Company with the right to purchase, and the noncontrolling interest holders with the right to sell, the remaining 49% of Mestrelab for cash at a contractually defined redemption value. These rights (an embedded derivative) are exercisable beginning in 2022 and can be accelerated, at a discounted redemption value, upon certain events related to post combination services. As the option is tied to continued employment, the Company classified the hybrid instrument (noncontrolling interest with an embedded derivative) as a long-term liability on the consolidated balance sheet. Subsequent to the acquisition, the carrying value of the hybrid instrument is remeasured to fair value with changes recorded to stock-based compensation expense in proportion to the requisite service period vested. The hybrid instrument is classified as Level 3 in the fair value hierarchy.

The following table sets forth the changes in hybrid instrument liability for the three months ended March 31, 2020 (dollars in millions):


Balance at December 31, 2019	$	10.6
Current period adjustments		0.3
Balance at March 31, 2020	$	10.9

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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