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

9 Months Ended

Sep. 30, 2016

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 September 30, 2016 and December 31, 2015 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 September 30, 2016		Fair Value December 31, 2015
Non-COLI assets held in Deferred Supplemental Compensation Plan	Other assets	Level 1	$	292	$	264
Interest rate swaps	Accrued expenses	Level 2	$	503	$	123
Earn-out obligation-current	Current portion of earn-out obligation	Level 3	$	—	$	9,678
Earn-out obligation-long-term	Earn-out obligation	Level 3	—		$	10,166

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 cash flow hedges. Accordingly, the fair value of the swap agreements, which is a liability of approximately $503 thousand and $123 thousand at September 30, 2016 and December 31, 2015, respectively, has been classified in accrued expenses. The offset, net of an income tax effect of approximately $194 thousand and $48 thousand, is included in accumulated other comprehensive loss as of September 30, 2016 and December 31, 2015, respectively. The amounts paid and received on the swap agreements are recorded in interest expense 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 primarily observable market data inputs.

We utilized a probability-weighted discounted cash flow method to determine the fair value of our Aviation Acquisition post-closing earn-out obligation at December 31, 2015. Probabilities were applied to each potential pay-out scenario and the resulting values were discounted using a rate that considered our weighted average cost of capital, as well as a specific risk premium associated with the riskiness of the earn out itself, the related projections, and the overall business. Significant unobservable inputs used to value the contingent consideration included projected earnings before interest, taxes, depreciation and amortization and the discount rate. In July 2016, we reach an agreement with the sellers for an early termination and final payment of our post-closing earn-out obligation. The final earn-out payment of $10.5 million was made in July 2016 (see Note 2, Acquisitions, for a discussion of the termination of our Aviation Acquisition earn-out obligation).

During the nine months ended September 30, 2016, the fair value of the earn-out obligation related to the Aviation Acquisition decreased approximately $1.3 million, which was recorded within "Cost and operating expenses."

The following table provides a reconciliation of the beginning and ending balance of the earn-out obligation 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, 2015	$	9,678		$	10,166		$	19,844
Earn-out obligation payments	(18,515		)	—			(18,515		)
Fair value adjustment included in net income	(1,608		)	279			(1,329		)
Reclassification from long-term to current	10,445			(10,445		)	—
Balance as of September 30, 2016	$	—		$	—		$	—