Fair Value Measurements and Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are defined as buyers or sellers in the principal or most advantageous market for the asset or liability that are independent of the reporting entity, knowledgeable, and able and willing to transact for the asset or liability.

Valuation Hierarchy--A valuation hierarchy is used for presentation of the inputs to measure fair value. This hierarchy prioritizes the inputs into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

Our assets and liabilities measured at fair value on a recurring basis at October 1, 2011, were as follows:



			Fair Value Measurements at October 1, 2011 Using:
Assets and Liabilities Recorded at Fair Value on a Recurring Basis	Total Carrying Value at October 1, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Assets invested for self-insurance, classified as other assets, noncurrent	$	15,417	$	15,417	$	—	$	—

Liabilities:
Interest rate swaps, classified as accrued expenses	$	354	$	—	$	354	$	—
Fuel derivatives, classified as accrued expenses	251		—		251		—
Fuel derivatives, classified as other noncurrent liabilities	536				536
Deferred compensation	679		—		679		—

There were no transfers of assets or liabilities between Level 1 and Level 2 during the third quarter ended October 1, 2011.


L.	Fair Value Measurements and Financial Instruments (continued)

Our assets and liabilities measured at fair value on a recurring basis at December 31, 2010 were as follows:



			Fair Value Measurements at December 31, 2010 Using:
Assets and Liabilities Recorded at Fair Value on a Recurring Basis	Total Carrying Value at December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Assets invested for self-insurance, classified as other assets, noncurrent	$	11,475	$	11,475	$	—	$	—

Liabilities:
Interest rate swaps, classified as accrued expenses	$	1,040	$	—	$	1,040	$	—
Deferred compensation	690		—		690		—

The estimated fair value of the deferred compensation--classified as Level 2--is based on the value of the Company’s common shares, determined by independent valuation.

Fair Value of Financial Instruments--The fair values of our current assets and current liabilities, including cash, accounts receivable, accounts payable, and accrued expenses among others, approximate their reported carrying values because of their short-term nature. The assets invested for self-insurance are money market funds--classified as Level 1--based on quoted market prices of the identical underlying securities in active markets. The estimated fair value of our derivative instruments are calculated based on market rates to settle the instruments, as discussed below, representing the amount we would receive upon sale or pay upon transfer. Financial instruments classified as noncurrent liabilities and their carrying values and fair values were as follows:



	October 1, 2011				December 31, 2010
Financial Instruments Recorded at Historical Carrying Value	Carrying Value		Fair Value		Carrying Value		Fair Value
Revolving credit facility, noncurrent	$	43,900	$	43,900	$	30,000	$	30,000
Senior unsecured notes	30,000		29,099		30,000		30,007
Term loans, noncurrent	1,127		1,126		1,591		1,593
Total	$	75,027	$	74,125	$	61,591	$	61,600

The carrying value of our revolving credit facility approximates fair value as the interest rates on the amounts outstanding are variable. The fair value of our senior unsecured notes and our term loans is determined based on expected future weighted-average interest rates with the same remaining maturities.

Market Risk and Derivative Financial Instruments

In the normal course of business, we are exposed to market risk related to changes in foreign currency exchange rates, changes in interest rates and changes in fuel prices. We do not hold or issue derivative financial instruments for trading or speculative purposes. We use derivative financial instruments to manage risks, in part, associated with changes in interest rates and changes in fuel prices.


L.	Fair Value Measurements and Financial Instruments (continued)

Foreign Currency Rate Risk--We are exposed to market risk related to foreign currency exchange rate risk resulting from our operations in Canada, where we provide a comprehensive range of horticultural services. Our financial results could be affected by factors such as changes in the foreign currency exchange rate or differing economic conditions in the Canadian markets as compared with the markets for our services in the United States. Our earnings are affected by translation exposures from currency fluctuations in the value of the U.S. dollar as compared to the Canadian dollar. Similarly, the Canadian dollar-denominated assets and liabilities may result in financial exposure as to the timing of transactions and the net asset / liability position of our Canadian operations. Presently, we do not engage in hedging activities related to our foreign currency rate risk.

Interest Rate Risk--We are exposed to market risk related to changes in interest rates on long-term debt obligations. The interest rates on substantially all of our long-term debt outstanding are variable. We have entered into interest rate swap contracts--derivative financial instruments--with the objective of altering interest rate exposures related to a portion of variable debt.

Interest Rate Swaps--We hold interest rate swaps—cash-flow hedges—to effectively convert a portion of our variable-rate revolving credit borrowings to a fixed rate, thus reducing the impact of interest-rate changes on future interest expense. Under the contracts, we agree with the counterparty to exchange, at specified intervals, the difference between variable rate and fixed rate amounts calculated on a notional principal amount. These interest rate swaps have reset dates and fixed-rate indices that match those of our underlying variable-rate long-term debt and have been designated as cash-flow hedges for a portion of that debt. As all of the critical terms of our interest rate swap contracts match the debt to which they pertain, there was no ineffectiveness related to these interest rate swaps in 2011 or 2010 and all related unrealized gains and losses were deferred in accumulated other comprehensive income (loss). The estimated fair values of our interest rate swaps are calculated based on market rates to settle the instruments--classified as Level 2 of the valuation hierarchy--and represent the estimated amounts we would pay upon transfer, taking into consideration current market rates and creditworthiness.

Fuel Derivatives--Beginning in the second quarter 2011, we entered into fuel derivatives as “economic hedges” related to fuel consumed by Davey Tree service vehicles. The objectives of the economic hedges are to fix the price of a portion of our fuel needs and mitigate the earnings and cash flow volatility attributable to the risk of changing prices.

Our fuel derivative contracts are not traded on public exchanges. The fair value of each fuel derivative contract is the sum of expected future settlements between contract counterparties. The expected future settlements are determined by comparing the contract fuel price to the expected forward fuel price as of each settlement date and applying the differences between the contract prices to the notional gallons in the fuel derivative contract. The expected forward fuel price is based on observable inputs of commodity exchange prices in an active market. The fuel derivatives are classified in Level 2 of the valuation hierarchy.


L.	Fair Value Measurements and Financial Instruments (continued)

The following tables sets forth quantitative information related to our derivatives instruments and where these amounts are recorded in our consolidated financial statements.



	As of
	October 1, 2011		December 31, 2010
Cash Flow Hedges - Derivatives Designated as Hedging Instruments
Interest Rate Swaps:
Liability fair value of interest rate swaps, classified as accrued expenses	$	354	$	1,040

Notional amount of long-term debt hedged	$	30,000	$	30,000

Economic Hedges - Derivatives Not Designated as Hedging Instruments
Fuel Derivatives:
Liability fair value of fuel derivatives, classified as accrued expenses	$	251	$	—

Liability fair value of fuel derivatives, classified as other noncurrent liabilities	$	536	$	—

Longest remaining term, in months	27		—

Notional hedged volume, in thousands of gallons	2,800		—



	Three Months Ended				Nine Months Ended
	October 1, 2011		October 2, 2010		October 1, 2011		October 2, 2010
Cash Flow Hedges - Derivatives Designated as Hedging Instruments
Interest Rate Swaps:
Hedge gains, recognized in other comprehensive income	$	244	$	84	$	685	$	81

Economic Hedges - Derivatives Not Designated as Hedging Instruments
Fuel Derivatives:
Change in fair value, recognized in results of operations, as an increase in costs and expenses, operating	$	809	$	—	$	787	$	—