Annual report pursuant to Section 13 and 15(d)

Fair Value of Financial Instruments

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Fair Value of Financial Instruments
 12 Months Ended
Dec. 31, 2019
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments
Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, we use a three-tier valuation hierarchy based upon observable and non-observable inputs:

Level 1 - Unadjusted quoted prices that are available in active markets for identical assets or liabilities at the measurement date.

Level 2 - Significant other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

•
Quoted prices for similar assets or liabilities in active markets;
•
Quoted prices for identical or similar assets or liabilities in non-active markets;
•
Inputs other than quoted prices that are observable for the asset or liability; and
•
Inputs that are derived principally from or corroborated by other observable market data.

Level 3 - Significant unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using model-based techniques, including option pricing models, discounted cash flow models, probability weighted models, and Monte Carlo simulations.
The Company's financial instruments include cash and cash equivalents, accounts receivable, derivative instruments, accounts payable, earn-out liabilities, revolving line of credit and equity investments.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The fair value hierarchy requires the use of observable market data when available. In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
Level 1: Equity securities
The fair value of equity securities held by the Company as of December 31, 2019 and December 31, 2018 was $4.3 million and $2.9 million, respectively, and is included in "Prepaid expenses and other current assets" on the accompanying Consolidated Balance Sheets.
Level 2: Derivative instruments
The Company had one interest rate swap contract, which is classified as a Level 2 financial instrument as it is not actively traded and is valued using pricing models that use observable inputs. The fair value of the interest swap contract entered into on August 21, 2012 was an asset of $6,088 and $0.1 million at December 31, 2019 and December 31, 2018, respectively. The interest rate swap was priced using discounted cash flow techniques. Changes in its fair value were recorded to other income (expense) with corresponding offsetting entries to current assets or liabilities, as appropriate. Significant inputs to the discounted cash flow model include projected future cash flows based on projected one-month LIBOR and the average margin for companies with similar credit ratings and similar maturities. See Note 14 for for further discussion of the interest rate swap.
Level 3: Contingent consideration (earn-out) liabilities
The fair value of contingent consideration liabilities ("earn-out") resulting from the 2017 MUSA-Stainless acquisition, 2018 MUSA-Galvanized acquisition, and 2019 American Stainless acquisition are classified as Level 3. The fair value of the MUSA-Stainless earn-out was estimated by applying the Monte Carlo Simulation approach using management's projection of pounds to be shipped and future price per unit. The fair value of the MUSA-Galvanized earn-out was estimated by applying the probability-weighted expected return method, using management's projection of pounds to be shipped and future price per unit. The fair value of the American Stainless earn-out was estimated by applying the probability-weighted expected return method using management's estimates of pounds to be shipped and future price per unit. Each quarter-end, the Company re-evaluates its assumptions for all earn-out liabilities and adjusts to reflect the updated fair values. Changes in the estimated fair value of the earn-out liabilities are reflected in the results of operations in the periods in which they are identified. Changes in the fair value of the earn-out liabilities may materially impact and cause volatility in the Company's operating results.
The following table presents a summary of changes in fair value of the Company's Level 3 earn-out liabilities measured on a recurring basis for 2019 and 2018:
(in thousands)
 
MUSA-Stainless
 
MUSA-Galvanized
 
American Stainless
 
Total
Balance at December 31, 2017
 
$
4,834

 
$
—

 
$
—

 
$
4,834

Fair value of the earn-out liability associated with the MUSA-Galvanized acquisition
 
—

 
3,800

 
—

 
$
3,800

Earn-out payments during the period
 
(2,164
)
 
(291
)
 
—

 
$
(2,455
)
Changes in fair value during the period
 
1,582

 
(151
)
 
—

 
$
1,431

Balance at December 31, 2018
 
$
4,252

 
$
3,358

 
$
—

 
$
7,610

Fair value of the earn-out liability associated with the American Stainless (ASTI) acquisition
 
—

 
—

 
6,366

 
$
6,366

Earn-out payments during period
 
(1,634
)
 
(712
)
 
(1,729
)
 
$
(4,075
)
Changes in fair value during the period
 
(215
)
 
(864
)
 
332

 
$
(747
)
Balance at December 31, 2019
 
$
2,403

 
$
1,782

 
$
4,969

 
$
9,154


Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The Company's only significant measurements of assets and liabilities at fair value on a non-recurring basis subsequent to their initial recognition were certain acquisition related assets and liabilities as of December 31, 2019 and December 31, 2018, respectively.
Customer List Intangible Asset
During the second quarter of 2019, management revised the initial estimate of the fair value of the customer list intangible asset acquired during the American Stainless acquisition, resulting in a decrease to the customer list intangible asset of $0.5 million (see Note 15 to the consolidated financial statements for additional information regarding this fair value measurement).
In the fourth quarter of 2018, management adjusted the fair value of the customer list intangible asset acquired during the MUSA-Galvanized acquisition by $0.3 million (see Note 15 to the consolidated financial statements for additional information regarding this fair value measurement).
Contingent consideration (earn-out) liabilities
During the second quarter of 2019, management revised the initial estimate of the fair value of the contingent consideration (earn-out) liability from the American Stainless acquisition, resulting in an increase to the earn-out liability of $0.2 million (see Note 15 to the consolidated financial statements for additional information regarding this fair value measurement).
Fair Value of Financial Instruments
For short-term instruments, other than those required to be reported at fair value on a recurring and non-recurring basis and for which disclosures are included above, management concluded the historical carrying value is a reasonable estimate of the fair value because of the short period of time between origination of such instruments and their expected realization. Therefore, as of December 31, 2019 and December 31, 2018, the carrying amount for cash and cash equivalents, accounts receivable, accounts payable, and the Company's revolving line of credit, which is based on a variable rate, approximates fair value.
There were no transfers of assets or liabilities between Level 1, Level 2 and Level 3 or changes in the fair value methodologies used by the Company in the years ended December 31, 2019 or December 31, 2018.