VSE Corporation Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Fair Value Measurements

Fair Value Measurements

12 Months Ended

Dec. 31, 2020

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 December 31, 2020 and December 31, 2019 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 December 31, 2020		Fair Value December 31, 2019
Non-COLI assets held in Deferred Supplemental Compensation Plan	Other assets	Level 1	$	1,120	$	710
Interest rate swaps	Accrued expenses	Level 2	$	1,603	$	1,473
Earn-out obligation-current	Current portion of earn-out obligation	Level 3	$	—	$	31,700
Earn-out obligation-long-term	Earn-out obligation	Level 3	$	—	$	5,000

Non-COLI assets held in the deferred supplemental compensation plan consist of equity funds with fair value based on observable inputs such as quoted prices for identical assets in active markets and changes in its fair value are recorded as selling, general and administrative expenses.

We account for our interest rate swap agreements under the provisions of ASC 815, Derivatives and Hedging, and have determined that our swap agreements qualify as cash flow hedges. Accordingly, the fair value of the swap agreements, which is a liability recorded in accrued expenses and other current liabilities, of approximately $1.6 million and approximately $1.5 million at December 31, 2020 and 2019, respectively. The offset, net of an income tax effect of approximately $400 thousand and $367 thousand is included in accumulated other comprehensive income in the accompanying balance sheets as of December 31, 2020 and 2019, 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 expect the hedges to remain fully effective during the remaining terms of the swap agreements. We determine the fair value of the swap agreements based on a valuation model using market data inputs.

We utilized an income approach to determine the fair value of our 1st Choice Aerospace acquisition earn-out obligation. Significant unobservable inputs used to value the contingent consideration include projected revenue and cost of services and the discount rate. If a significant increase or decrease in the discount rate occurred in isolation, the result could be significantly higher or lower fair value measurement.

Changes in earn-out obligation measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2020 and 2019 are as follows (in thousands):


	Current portion		Long-term portion		Total
Balance as of December 31, 2018	$	—	$	—	$	—
Acquisition date fair value of contingent consideration	34,800		—		34,800
Fair value adjustment included in costs and operating expenses	1,900		—		1,900
Reclassification from long-term to current	(5,000)		5,000		—
Balance as of December 31, 2019	31,700		5,000		36,700
Earn-out payments	(31,700)		—		(31,700)
Reclassification from long-term to current	5,000		(5,000)		—
Fair value adjustment included in costs and operating expenses	(5,000)		—		(5,000)
Balance as of December 31, 2020	$	—	$	—	$	—

Measurements on a Non-recurring Basis

The following table presents changes in the Level 3 fair value of certain assets measured on a non-recurring basis for the year ended December 31, 2020 (in thousands):


	Goodwill
Assets subject to impairment charges:
Balance as of December 31, 2019	$	182,377
Goodwill allocated to divested business	(7,379)
Carrying value prior to impairment	174,998
Impairment charge	(30,945)
Carrying value after impairment	144,053

Carrying value of assets not subject to impairment charge	94,073
Balance as of December 31, 2020	$	238,126

Goodwill is tested annually or upon the occurrence of a triggering event indicating that an impairment loss may have been incurred. Goodwill is measured on a non-recurring basis using fair value measurements with unobservable inputs (Level 3). The goodwill fair value is determined using a weighting of fair values derived from the income and market approach. Fair value is measured as of the impairment date. Goodwill for the VSE Aviation reporting unit was determined to be impaired and was written down to its estimated fair value during the second quarter of 2020. The key assumptions used to determine the fair value of the VSE Aviation reporting unit were: (a) expected cash flows with a compounded revenue growth rate of approximately 6% for a period of seven years; (b) long-term growth rate of 3% in the terminal year; and (c) a discount rate of 13.5%. The discount rate was based on a weighted average cost of capital adjusted for relevant risks of the reporting unit's future cash flow assumptions, taking into consideration the risks due to the uncertainty surrounding the effects of the COVID-19 pandemic on our operations. A negative change in any of the key assumptions for this reporting unit could increase the likelihood of additional impairment in future periods. For further discussion of the impairment, refer to Note (7) "Goodwill and Intangible Assets."