VSE Corporation Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

Fair Value Measurements

3 Months Ended

Mar. 31, 2014

(8) Fair Value Measurements

The accounting standard for fair value measurements defines fair value, and establishes a market-based framework or hierarchy for measuring fair value. The standard is applicable whenever assets and liabilities are measured at fair value.

The fair value hierarchy established in the standard prioritizes the inputs used in valuation techniques into three levels as follows:

Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities;

Level 2 – Observable inputs other than the quoted prices in active markets for identical assets and liabilities – includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and

Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions.

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013 and the level they fall within the fair value hierarchy (in thousands):

Amounts Recorded at Fair Value	Financial Statement Classification	Fair Value Hierarchy	Fair Value March 31, 2014		Fair Value December 31, 2013
Non-COLI assets held in DSC Plan	Other assets	Level 1	$	211	$	198
Interest rate swaps	Accrued expenses	Level 2	$	156	$	326
Earn-out obligation – current	Current portion of earn-out obligations	Level 3	$	588		-
Earn-out obligation – long-term	Earn-out obligations	Level 3	$	8,648	$	9,062

Changes in the fair value of the Non-COLI assets held in the deferred supplemental compensation plan, as well as changes in the related deferred compensation obligation, are recorded as selling, general and administrative expenses.

We account for our interest rate swap agreements under the provisions of ASC 815, and have determined that our swap agreements qualify as highly effective hedges. Accordingly, the fair value of the swap agreements, which is a liability of approximately $156 thousand and $326 thousand at March 31, 2014 and December 31, 2013, respectively, has been reported in accrued expenses. The offset, net of an income tax effect of approximately $60 thousand and $125 thousand, is included in accumulated other comprehensive loss in the accompanying balance sheets as of March 31, 2014 and December 31, 2013, respectively. The amounts paid and received on the swap agreements will be recorded in interest expense as yield adjustments in the period during which the related floating-rate interest is incurred. We determine the fair value of the swap agreements based on a valuation model using market data inputs.

Our acquisition of WBI in 2011 may require us to make additional payments to the sellers of up to a total of $40 million over a four-year post closing period ending June 30, 2015 if WBI achieves certain financial performance. WBI earned approximately $219 thousand and $7.1 million based on its financial performance for the earn-out periods ended June 30, 2013 and 2012, respectively. Included in earn-out obligations on the March 31, 2014 balance sheet is an earn-out obligation of approximately $8.6 million, net of the current portion of $588 thousand classified in current portion of earn-out obligations, which represents our best estimate of the present value of the earn-out obligation. Changes in the fair value of the earn-out obligations are recorded as contract costs in the period of change through settlement.

The following table provides a reconciliation of the beginning and ending balance of the earn-out obligations measured at fair value on a recurring basis that used significant unobservable inputs (Level 3).

	Current portion		Long-term portion			Total
Balance as of December 31, 2013	$	-	$	9,062		$	9,062
Fair value adjustment included in earnings		-		174			174
Reclassification from long-term to short-term		588		(588	)		-
Balance as of March 31, 2014	$	588	$	8,648		$	9,236

We utilize the Monte Carlo valuation model for our earn-out obligation. Significant unobservable inputs used to value the contingent consideration include projected EBITDA and the discount rate. The model used a discount rate of 11.5% as of March 31, 2014. If a significant increase or decrease in the discount rate occurred in isolation, the result could be a significantly higher or lower fair value measurement.