Fair Value Measurements

3 Months Ended

Oct. 31, 2011

Fair Value Measurements

Fair Value Measurements

Note 7. Fair Value Measurements

Fair Value Hierarchy

We apply the provisions of ASC 820, “Fair Value Measurements and Disclosures,” (“ASC 820”), for our financial assets and liabilities that are remeasured and reported at fair value each reporting period and our nonfinancial assets and liabilities that are remeasured 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:

Level 1: Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets.

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3: Unobservable inputs for the asset or liability.

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

As of October 31, 2011 and July 31, 2011, our financial assets that are remeasured 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.

In addition, we have a contingent consideration liability recorded within acquisitions payable relating to the ConFirm Acquisition, as further described in Note 3 to the Condensed Consolidated Financial Statements. The fair value of this liability was based on future sales projections of the ConFirm Monitoring Business under various potential scenarios for the one year period ending January 31, 2012 and weighting the probability of these outcomes.  At the date of the acquisition, these cash flow projections were discounted using a rate of 7%. 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 analysis resulted in an initial contingent consideration liability of $656,000, which was subsequently adjusted to $775,000 at July 31, 2011 by recording the change in the fair value through our results of operations during the fourth quarter of our fiscal 2011. At October 31, 2011, the fair value of this contingent consideration liability decreased to $689,000. The $86,000 change in fair value was recorded as a decrease to acquisitions payable and general and administrative expenses in the Condensed Consolidated Financial Statements at October 31, 2011. This recent decrease in estimated fair value was driven by changes in the assumptions pertaining to the achievement of the specified sales levels, partially offset by the accretion of the liability for the time value of money. This fair value measurement was based on significant inputs not observed in the market and thus represented a Level 3 measurement.

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 the three year price floor relating to the acquisition of the Byrne Medical Business, as further described in Note 3 to the Condensed Consolidated Financial Statements. These fair value measurements were based on significant inputs not observed in the market and thus represent Level 3 measurements. 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 ending July 31, 2013 and weighting the probability of these outcomes.  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. 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 are not limited to, the expected stock price volatility of our Common Stock over the expected life of the instrument and the expected dividend yield. These two liabilities will be adjusted periodically by recording changes in the fair value through our Condensed Consolidated Statements of Income driven by the time value of money and changes in the assumptions that were initially used in the valuations.  Accordingly, at October 31, 2011 we remeasured the fair value of the contingent consideration and the price floor to be $2,800,000 and $2,418,000, respectively. The $100,000 increase to the contingent consideration liability was due to the accretion of the liability for the time value of money and was recorded as an increase to acquisition payable and general and administrative expenses in the Condensed Consolidated Financial Statements at October 31, 2011. The $582,000 decrease to the fair value of the price floor (as determined by the Black-Scholes option valuation model) was recorded as a decrease to acquisitions payable and general and administrative expenses in the Condensed Consolidated Financial Statements at October 31, 2011 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.

The fair values of the Company’s financial instruments measured on a recurring basis were categorized as follows:

	October 31, 2011
	Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equilavents:
Bank deposits and certificates of deposit	$	15,730,000	$	—	$	—	$	15,730,000
Money markets	3,916,000		—		—		3,916,000
Total assets	$	19,646,000	$	—	$	—	$	19,646,000
Liabilities:
Acquisitions payable:
Contingent consideration	$	—	$	—	$	3,489,000	$	3,489,000
Price floor	—		—		2,418,000		2,418,000
Total liabilities (1)	$	—	$	—	$	5,907,000	$	5,907,000

	July 31, 2011
	Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equilavents:
Bank deposits and certificates of deposit	$	14,494,000	$	—	$	—	$	14,494,000
Money markets	3,916,000		—		—		3,916,000
Total assets	$	18,410,000	$	—	$	—	$	18,410,000
Liabilities:
Acquisitions payable:
Contingent consideration	$	—	$	—	$	775,000	$	775,000
Total liabilities (1)	$	—	$	—	$	775,000	$	775,000

(1) At October 31, 2011 and July 31, 2011, the fair values of the Company’s financial instruments measured on a recurring basis of $5,907,000 and $775,000, respectively, combined with the remaining payables for the acquisition of the Gambro Business of $1,033,000 and $1,550,000, respectively, equal the combined total of the current and long-term portions of acquisitions payable in the Condensed Consolidated Balance Sheets.

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 three months ended October 31, 2011 is as follows:

	Three Months Ended October 31, 2011
	ConFirm			Byrne		Byrne
	Contingent			Contingent		Price
	Consideration			Consideration		Floor			Total
Beginning balance	$	775,000		$	—	$	—		$	775,000
Total net unrealized (gains)/losses included in earnings	(86,000		)	100,000		(582,000		)	(568,000		)
Total net unrealized (gains)/losses included in other comprehensive income	—			—		—			—
Transfers into level 3 (gross)	—			—		—			—
Transfers out of level 3 (gross)	—			—		—			—
Net purchases, issuances, sales and settlements	—			2,700,000		3,000,000			5,700,000
Ending balance	$	689,000		$	2,800,000	$	2,418,000		$	5,907,000

There were no such recurring measurements using significant unobservable inputs for the three months ended October 31, 2010.

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

We re-measure the fair value of certain assets, such as intangible assets, goodwill and long-lived assets, including property and equipment and convertible notes receivable, 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 uses a two-step process that begins with an estimation of the fair value of the related operating segments by using average fair value results of the market multiple and discounted cash flow methodologies, as well as the comparable transaction methodology when applicable. 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 compares 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 is 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, our intangibles, goodwill and long-lived assets are classified within Level 3 of the fair value hierarchy on a non-recurring basis. On October 31, 2011, management concluded that no events or changes in circumstances have occurred during the three months ended October 31, 2011 that would indicate that the carrying amount of our intangible assets, goodwill and long-lived assets may not be recoverable.

Disclosure of Fair Value of Financial Instruments

As of October 31, 2011 and July 31, 2011, the carrying amounts for cash and cash equivalents, accounts receivable and accounts payable approximated fair value due to the short maturity of these instruments. We believe that as of October 31, 2011 and July 31, 2011, 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.