Echo Global Logistics, Inc. - 10-Q filing on 2016-10-27

Fair Value Measurement

9 Months Ended

Sep. 30, 2016

The Company applies ASC Topic 820, Fair Value Measurements and Disclosures, for its financial assets and financial liabilities. The guidance requires disclosures about assets and liabilities measured at fair value. The Company's financial liabilities primarily relate to contingent earn-out payments due to seller in connection with various acquisitions. The fair value of the due to seller liabilities at September 30, 2016 was $1.7 million. The potential earn-out payments and performance periods are defined in the individual purchase agreements for each acquisition. Earnings before interest, taxes, depreciation and amortization ("EBITDA") is the performance target defined and measured to determine the earnout payment due, if any, after each defined measurement period.

The Company's financial assets relate to contingent payments that may be due from the seller of Command if certain employee retention criteria are met. The fair value of the due from seller contingent asset at September 30, 2016 was $0.4 million. The fair value of the due from seller contingent asset is determined based on the likelihood of the employee retention criteria being met.

ASC Topic 820 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on observable or unobservable inputs to valuation techniques that are used to measure fair value. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity's pricing based upon its own market assumptions. The fair value hierarchy consists of the following three levels:


•	Level 1: Inputs are quoted prices in active markets for identical assets or liabilities.


•	Level 2: Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable and market-corroborated inputs, which are derived principally from or corroborated by observable market data.


•	Level 3: Inputs that are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

The significant inputs used to derive the fair value of the amounts due to seller include financial forecasts of future operating results, the probability of reaching the forecast and an appropriate discount rate for each contingent liability. Probabilities are estimated by reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to each acquisition as well as the Company’s historical experience with similar arrangements. If an acquisition reaches the required performance measure, the estimated probability would be increased to 100% and would still be classified as a contingent liability on the balance sheet. If the measure is not reached, the probability would be reduced to reflect the amount earned, if any, depending on the terms of the agreement. Discount rates used in determining the fair value of the contingent consideration due to seller ranged between 5% and 6%. Historical results of the respective acquisitions serve as the basis for the financial forecasts used in the valuation.

Quantitative factors are also considered in these forecasts, including acquisition synergies, growth and sales potential, and potential operational efficiencies gained. Changes to the significant inputs used in determining the fair value of the contingent consideration due to seller could result in a change in the fair value of the contingent consideration. However, the correlation and inverse relationship between higher projected financial results to the discount rate applied and probability of meeting the financial targets mitigates the effect of any changes to the unobservable inputs.

The following tables set forth the Company's financial assets and liabilities measured at fair value on a recurring basis and the basis of measurement at September 30, 2016 and December 31, 2015:



	Fair Value Measurements as of September 30, 2016
	Total			Level 1	Level 2	Level 3
Liabilities:
Contingent consideration due to seller	$	(1,710,000	)	—	—	$	(1,710,000	)
Assets:
Contingent consideration due from seller	$	395,392		—	—	$	395,392



	Fair Value Measurements as of December 31, 2015
	Total			Level 1	Level 2	Level 3
Liabilities:
Contingent consideration due to seller	$	(4,086,697	)	—	—	$	(4,086,697	)

The following table provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant unobservable inputs (Level 3):



	Due to Seller Liability
Balance at December 31, 2015	$	(4,086,697	)
Change in contingent consideration due to seller	102,954
Payments of contingent consideration due to seller	2,273,743
Balance at September 30, 2016	$	(1,710,000	)

The following table provides a reconciliation of the beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3):



	Due from Seller Asset
Balance at December 31, 2015	$	—
Command purchase price adjustment	1,176,417
Receipt of contingent consideration due from seller	(750,000		)
Change in contingent consideration due from seller	(31,025		)
Balance at September 30, 2016	$	395,392

For the nine months ended September 30, 2016 and 2015, the Company recognized a benefit of $71,929 and an expense of $145,938, respectively, in selling, general and administrative expense due to the change in fair value determined by a level three valuation technique. These changes in fair value resulted from using revised forecasts that took into account the most recent performance at each acquired business, the effect of the time value of money and the likelihood of the employee retention criteria being met.

During the nine months ended September 30, 2016 and 2015, the Company made contingent earn-out payments of $2,273,743 and $2,945,833, respectively, to the sellers of businesses acquired by the Company. During the nine months ended September 30, 2016, the Company received $750,000 of contingent payments from the seller of Command. The Company did not receive any contingent payments from the seller of Command in 2015.