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, 2021

We utilize fair value measurement guidance prescribed by GAAP to value our financial instruments. The accounting standard for fair value measurements establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1); inputs other than the quoted prices in active markets that are observable either directly or indirectly (Level 2); and unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions (Level 3).

The carrying amounts of cash and cash equivalents, receivables, accounts payable and amounts included in other current assets and accrued expenses and other current liabilities that meet the definition of a financial instrument approximate fair value due to their relatively short maturity. The carrying value of our outstanding debt obligations approximates its fair value. The fair value of long-term debt is calculated using Level 2 inputs based on interest rates available for debt with terms and maturities similar to our existing debt arrangements.

Non-financial assets acquired and liabilities assumed in business combinations were measured at fair value using income, market and cost valuation methodologies. See Note (2), "Acquisitions and Divestitures." The fair value measurements were estimated using significant inputs that are not observable in the market and thus represent a Level 3 measurement.

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 and December 31, 2020 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, 2021		Fair Value December 31, 2020
Non-COLI assets held in Deferred Supplemental Compensation Plan	Other assets	Level 1	$	598	$	1,120
Interest rate swaps	Accrued expenses	Level 2	$	234	$	1,603
Earn-out obligation-current	Accrued expenses	Level 3	$	1,000	$	—
Earn-out obligation-long-term	Other long-term liabilities	Level 3	$	250	$	—

COLI assets held in our 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 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 highly effective cash flow hedges. We evaluate our hedges to determine their effectiveness and as of December 31, 2021 and 2020, the swaps were determined to be fully effective. Accordingly, the fair value of the swap agreements, which is a liability recorded in accrued expenses and other current liabilities in our consolidated balance sheets, of $234 thousand and $1.6 million as of December 31, 2021 and 2020, respectively. The offset, net of an income tax effect of $58 thousand and $400 thousand was included in accumulated other comprehensive income in the accompanying balance sheets as of December 31, 2021 and 2020, 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 primarily observable market data inputs.

In connection with the acquisition of Global Parts in July 2021, we may be required to make earn-out obligation payments of up to $2.0 million should Global Parts meet certain financial targets during the twelve months following the acquisition and meet a certain milestone event on or before March 2023. The preliminary fair value of the earn-out obligation was determined using a probability-based scenario analysis approach. Any change in the fair value of contingent consideration from events after the acquisition date will be recognized in earnings of the period when the event occurs. The probability-based approach used to fair value earn-out obligation is based on significant inputs not observed in the market and thus represents a Level 3 measurement. The significant unobservable inputs include projected revenues and percentage probability of occurrence. Changes in the revenue assumptions could result in a material change to the amount of the fair value measurement. Under the agreement, we were required to make an advanced payment of the earn-out obligation. The payment was made in August 2021.

In 2020, in connection with the 2019 acquisition of 1st Choice Aerospace, we made a payment of approximately $31.7 million to satisfy the earn-out and the remaining fair value of the earn-out obligation of $5 million was reversed and recognized in earnings.

Changes in earn-out obligation measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2021 and 2020 are as follows (in thousands):


	Current portion		Long-term portion		Total
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	—		—		—
Acquisition date fair value of contingent consideration	1,750		250		2,000
Earn-out payments	(750)		—		(750)

Balance as of December 31, 2021	$	1,000	$	250	$	1,250