| 15. | Fair Value Measurements |
Authoritative accounting guidance establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair values as follows:
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Level 1 — observable inputs such as quoted prices for identical assets in active markets; |
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Level 2 — inputs other than quoted prices for identical assets in active markets that are observable either directly or indirectly; and |
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Level 3 — unobservable inputs in which there is little or no market data which requires the use of valuation techniques and the development of assumptions. |
Recurring Fair Value Measurements
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012 are as follows (in millions):
| Fair Value | ||||||||
| 2013 | 2012 | |||||||
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Assets |
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Derivative financial instruments (Level 2) |
$ | 5.8 | $ | 6.0 | ||||
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Liabilities |
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Derivative financial instruments (Level 2) |
$ | 8.5 | $ | 3.0 | ||||
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Acquisition-related contingent consideration (Note 2) (Level 3) |
4.6 | 17.8 | ||||||
Derivative financial instruments
The fair value of derivative financial instruments is based on standard valuation techniques that use, where possible, current market-based or independently sourced pricing units, such as interest rates, currency rates, or implied volatilities.
Acquisition-related contingent consideration
The estimated fair value of acquisition-related contingent consideration, which excludes earned amounts payable at December 31, 2013 and 2012, is considered a Level 3 measurement because the probability-weighted discounted cash flow methodology used to estimate fair value includes the use of significant unobservable inputs, principally the contractual contingent consideration sales targets and our current estimate of achieving those targets over the remaining contractual earn out period. We recorded an adjustment (decrease) of approximately $12 million to the estimated fair value of the obligation during 2013, which is reflected as a reduction to “Selling, general, and administrative expense” in the accompanying consolidated statement of income. The decrease in fair value during 2013 was the result of actual sales results for the business and a change in estimated sales volumes and growth rates beyond 2013 through the remaining contractual period. The fair value of the estimated obligation at December 31, 2013 is $4.6 million and the maximum remaining amount we could be required to pay under the terms of the contract is $19 million. An average increase or decrease of approximately 10% in the sales volume thresholds assumed in the probability-weighted discounted cash flow calculation would increase or decrease the estimated fair value of the contingent consideration by approximately $1 million. Other than the lower projected sales volumes noted above, there was not a significant change in the fair value inputs during 2013 or 2012.
The following is a reconciliation of the opening and closing balances related to our liability for acquisition-related contingent consideration (in millions):
| 2013 | 2012 | |||||||
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Acquisition-related contingent consideration obligation at beginning of year |
$ | 17.8 | $ | 25.8 | ||||
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Settlements (a) |
(1.0 | ) | (8.0 | ) | ||||
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Gain (fair value adjustment) (b) |
(12.2 | ) | — | |||||
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Acquisition-related contingent consideration obligation at end of year |
$ | 4.6 | $ | 17.8 | ||||
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| (a) | Reflects amounts earned in current year that are payable in the first quarter of the following year. |
| (b) | Included in “Selling, general, and administrative expenses” in the consolidated statement of income. |
Cash and cash equivalents
Cash and cash equivalents, which consist of bank deposits, are carried at cost. Due to the short-term nature of these cash balances, cost approximates fair value. The carrying value and estimated fair value of our cash and cash equivalents (considered a Level 2 fair value measurement) at December 31, 2013 and 2012 was $277.2 million and $365.7 million, respectively.
Long-term debt
The fair value of our long-term debt (including current portion) was determined from quoted market prices, where available, or from estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements. The fair value of our long-term debt (considered a Level 2 fair value measurement) was approximately $2,098.8 million and $2,706.5 million at December 31, 2013 and 2012, respectively.
Nonrecurring Fair Value Measurements
During 2013 and 2012, we recorded the DYC (2013) and Larios (2012) trade names at fair value in connection with our annual indefinite-lived intangible asset testing in the fourth quarter of those years. Refer to Note 12, Goodwill and Other Intangible Assets, for more information. We estimated fair value using a discounted cash flow analysis. These fair values are considered to be Level 3 fair value measures due to the use of significant unobservable inputs, including future expected revenue and profit margins to be generated by the brands. Other key assumptions in the fair value measure include discount rates and estimates of fair market royalty rates. Any increases (decreases) in expected revenue, profit margin, discount rate, or royalty rate in isolation would change the fair value estimate of the DYC trade name at December 31, 2013; a 10% decrease in the fair value of the DYC trade name would have resulted in an additional impairment of approximately $4.4 million at December 31, 2013.