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EX-32.1 - EXHIBIT 32.1 - SCANSOURCE, INC.scansourceex3210331201610q.htm
EX-32.2 - EXHIBIT 32.2 - SCANSOURCE, INC.scansourceex3220331201610q.htm
EX-31.1 - EXHIBIT 31.1 - SCANSOURCE, INC.scansourceex3110331201610q.htm
EX-31.2 - EXHIBIT 31.2 - SCANSOURCE, INC.scansourceex3120331201610q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
 Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the
Quarterly period ended March 31, 2016

Commission File Number: 000-26926
 
 
 
ScanSource, Inc.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA
 
57-0965380
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
6 Logue Court
Greenville, South Carolina, 29615
(Address of principal executive offices)
(864) 288-2432
(Registrant’s telephone number, including area code)
 
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post to such files.    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at May 6, 2016
Common Stock, no par value per share
 
25,663,707



SCANSOURCE, INC.
INDEX TO FORM 10-Q
March 31, 2016
 
 
 
Page #
 
 
 
Item 1.
 
Condensed Consolidated Balance Sheets as of March 31, 2016 and June 30, 2015
 
Condensed Consolidated Income Statements for the Quarter and Nine Months Ended March 31, 2016 and 2015
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Quarter and Nine Months Ended March 31, 2016 and 2015
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2016 and 2015
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 1
Legal Proceedings
Item 1A.
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
 
 
 
 
 


2


FORWARD-LOOKING STATEMENTS

The forward-looking statements included in the "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk" and "Risk Factors" sections and elsewhere herein, which reflect our best judgment based on factors currently known, involve risks and uncertainties. Words such as "expects," "anticipates," "believes," "intends," "plans," "hopes," "forecasts," "seeks," "estimates," "goals," "projects," "strategy," "future," "likely," "may," "should," and variations of such words and similar expressions are intended to identify such forward-looking statements. Any forward-looking statement made by us in this Form 10-Q is based only on information currently available to us and speaks only as of the date on which it is made. Except as may be required by law, we expressly disclaim any obligation to update these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events. Actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors including, but not limited to, the factors discussed in such sections and, in particular, those set forth in the cautionary statements included in "Risk Factors" contained in our Annual Report on Form 10-K for the year ended June 30, 2015. The forward-looking information we have provided in this Quarterly Report on Form 10-Q pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995, should be evaluated in the context of these factors.

3


PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share information)
 
 
March 31,
2016
 
June 30,
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
40,849

 
$
121,646

Accounts receivable, less allowance of $33,188 at March 31, 2016 and $32,589 at June 30, 2015
522,693

 
522,532

Inventories
568,247

 
553,063

Prepaid expenses and other current assets
54,249

 
46,917

Deferred income taxes
17,811

 
20,556

Total current assets
1,203,849

 
1,264,714

Property and equipment, net
50,076

 
46,574

Goodwill
90,912

 
66,509

Net identifiable intangible assets
53,064

 
46,272

Other non-current assets
41,560

 
52,872

Total assets
$
1,439,461

 
$
1,476,941

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current debt
$
774

 
$
2,860

Accounts payable
431,913

 
501,329

Accrued expenses and other current liabilities
98,429

 
81,000

Current portion of contingent consideration
12,915

 
9,391

Income taxes payable
3,218

 
4,180

Total current liabilities
547,249

 
598,760

Deferred income taxes
3,403

 
3,773

Long-term debt
5,429

 
5,966

Borrowings under revolving credit facility
73,641

 

Long-term portion of contingent consideration
14,226

 
24,569

Other long-term liabilities
38,139

 
34,888

Total liabilities
682,087

 
667,956

Commitments and contingencies


 


Shareholders’ equity:
 
 
 
Preferred stock, no par value; 3,000,000 shares authorized, none issued

 

Common stock, no par value; 45,000,000 shares authorized, 25,659,867 and 28,214,153 shares issued and outstanding at March 31, 2016 and June 30, 2015, respectively
67,534

 
157,172

Retained earnings
767,009

 
716,315

Accumulated other comprehensive income (loss)
(77,169
)
 
(64,502
)
Total shareholders’ equity
757,374

 
808,985

Total liabilities and shareholders’ equity
$
1,439,461

 
$
1,476,941

June 30, 2015 amounts are derived from audited consolidated financial statements.
 
See accompanying notes to these condensed consolidated financial statements.

4


SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
(In thousands, except per share data)
 
 
Quarter ended
 
Nine months ended
 
March 31,
 
March 31,
 
2016
 
2015
 
2016
 
2015
Net sales
$
798,404

 
$
763,203

 
$
2,662,754

 
$
2,361,941

Cost of goods sold
713,928

 
683,187

 
2,390,093

 
2,126,168

Gross profit
84,476

 
80,016

 
272,661

 
235,773

Selling, general and administrative expenses
61,690

 
58,235

 
190,202

 
158,047

Change in fair value of contingent consideration
1,139

 
285

 
4,520

 
1,262

Operating income
21,647

 
21,496

 
77,939

 
76,464

Interest expense
694

 
891

 
1,684

 
1,288

Interest income
(800
)
 
(731
)
 
(2,509
)
 
(2,057
)
Other (income) expense, net
400

 
1,515

 
1,357

 
2,238

Income before income taxes
21,353

 
19,821

 
77,407

 
74,995

Provision for income taxes
7,311

 
6,878

 
26,713

 
26,023

Net income
$
14,042

 
$
12,943

 
$
50,694

 
$
48,972

Per share data:
 
 
 
 
 
 
 
Net income per common share, basic
$
0.54

 
$
0.45

 
$
1.90

 
$
1.71

Weighted-average shares outstanding, basic
25,863

 
28,646

 
26,741

 
28,590

 
 
 
 
 
 
 
 
Net income per common share, diluted
$
0.54

 
$
0.45

 
$
1.88

 
$
1.70

Weighted-average shares outstanding, diluted
25,967

 
28,855

 
26,908

 
28,825

See accompanying notes to these condensed consolidated financial statements.


5


SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(In thousands)

 
Quarter ended
 
Nine months ended
 
March 31,
 
March 31,
 
2016
 
2015
 
2016
 
2015
Net income
$
14,042

 
$
12,943

 
$
50,694

 
$
48,972

Foreign currency translation adjustment
10,288

 
(31,899
)
 
(12,667
)
 
(55,201
)
Comprehensive income (loss)
$
24,330

 
$
(18,956
)
 
$
38,027

 
$
(6,229
)
See accompanying notes to these condensed consolidated financial statements.


6


SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 
Nine months ended
 
March 31,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
50,694

 
$
48,972

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
12,570

 
8,050

Amortization of debt issuance costs
223

 
223

Provision for (recovery of) doubtful accounts
2,803

 
(2,120
)
Share-based compensation
5,194

 
4,740

Deferred income taxes
7,248

 
4,910

Excess tax benefits from share-based payment arrangements
(101
)
 
(260
)
Change in fair value of contingent consideration
4,520

 
1,262

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
52,327

 
23,044

Inventories
(7,736
)
 
23,759

Prepaid expenses and other assets
(312
)
 
(140
)
Other non-current assets
(1,571
)
 
384

Accounts payable
(108,896
)
 
(78,497
)
Accrued expenses and other liabilities
8,005

 
(1,359
)
Income taxes payable
(656
)
 
(5,831
)
Net cash provided by (used in) operating activities
24,312

 
27,137

Cash flows from investing activities:
 
 
 
Capital expenditures
(9,120
)
 
(19,854
)
Cash paid for business acquisitions, net of cash acquired
(61,475
)
 
(59,740
)
Net cash provided by (used in) investing activities
(70,595
)
 
(79,594
)
Cash flows from financing activities:
 
 
 
Borrowings (repayments) on short-term borrowings, net

 
(27,952
)
Borrowings on revolving credit
1,058,720

 
93,579

Repayments on revolving credit
(985,079
)
 
(93,579
)
Repayments on long-term debt
(2,019
)
 
(318
)
Repayments on capital lease obligation
(162
)
 
(201
)
Contingent consideration payments
(7,286
)
 
(5,640
)
Exercise of stock options
3,816

 
379

Repurchase of common stock
(98,414
)
 
(2,694
)
Excess tax benefits from share-based payment arrangements
101

 
260

Net cash provided by (used in) financing activities
(30,323
)
 
(36,166
)
Effect of exchange rate changes on cash and cash equivalents
(4,191
)
 
(12,650
)
Increase (decrease) in cash and cash equivalents
(80,797
)
 
(101,273
)
Cash and cash equivalents at beginning of period
121,646

 
194,851

Cash and cash equivalents at end of period
$
40,849

 
$
93,578

 
 
 
 
See accompanying notes to these condensed consolidated financial statements.

7


SCANSOURCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1) Business and Summary of Significant Accounting Policies

Business Description

ScanSource, Inc. is a leading global provider of technology products and solutions. ScanSource, Inc. and its subsidiaries ("the Company") provide value-added solutions for technology manufacturers and sell to resellers in specialty technology markets through its Worldwide Barcode & Security segment and Worldwide Communications & Services segment.

The Company operates in the United States, Canada, Latin America and Europe. The Company distributes to the United States and Canada from its distribution centers located in Mississippi and Virginia; to Latin America principally from distribution centers located in Florida, Mexico, Brazil and Colombia; and to Europe from distribution centers located in Belgium, France, Germany and the United Kingdom.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of ScanSource, Inc. have been prepared by the Company’s management in accordance with United States generally accepted accounting principles ("US GAAP") for interim financial information and applicable rules and regulations of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by US GAAP for annual financial statements. The unaudited condensed consolidated financial statements included herein contain all adjustments (consisting of normal recurring and non-recurring adjustments) which are, in the opinion of management, necessary to present fairly the financial position as of March 31, 2016 and June 30, 2015, the results of operations for the quarters and nine months ended March 31, 2016 and 2015, the statements of comprehensive income for the quarters and nine months ended March 31, 2016 and 2015 and the statements of cash flows for the nine months ended March 31, 2016 and 2015. The results of operations for the quarters and nine months ended March 31, 2016 and 2015 are not necessarily indicative of the results to be expected for a full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2015.

Summary of Significant Accounting Policies

Except as described below, there have been no material changes to the Company’s significant accounting policies for the nine months ended March 31, 2016 from the information included in the notes to the Company’s consolidated financial statements included in the Annual Report on Form 10-K for the fiscal year ended June 30, 2015. For a discussion of the Company’s significant accounting policies, please see the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2015.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less, when purchased, to be cash equivalents. The Company maintains some zero-balance, disbursement accounts at various financial institutions in which the Company does not maintain significant depository relationships. Due to the nature of the Company’s banking relationships with these institutions, the Company does not have the right to offset most if not all outstanding checks written from these accounts against cash on hand, and the respective institutions are not legally obligated to honor the checks until sufficient funds are transferred to fund the checks. Checks released but not yet cleared from these accounts in the amounts of $61.8 million and $62.9 million are included in accounts payable as of March 31, 2016 and June 30, 2015, respectively.

Recent Accounting Pronouncements

In May 2014, the FASB issued a comprehensive new revenue recognition standard for contracts with customers that will supersede most current revenue recognition guidance, including industry-specific guidance. The core principle of this standard is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle, the standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. This guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows

8


arising from an entity’s contracts with customers. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early application is prohibited. The standard permits the use of either the retrospective or cumulative effect transition method. This guidance will be applicable to the Company for the fiscal year beginning July 1, 2017. The Company is currently evaluating the impact on its consolidated financial statements upon the adoption of this new standard.

In December 2015, the FASB issued final guidance requiring companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet rather than separating deferred taxes into current and noncurrent amounts. In addition, companies will also be required to classify valuation allowances on deferred taxes as noncurrent. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early application is permitted. The guidance may be adopted on either a prospective or retrospective basis. This guidance will be applicable to the Company for the fiscal year beginning July 1, 2017. The Company is currently evaluating the impact on its consolidated financial statements upon the adoption of this new guidance.

In February 2016, the FASB issued Accounting Standard Update ("ASU") 2016-02,"Leases (Topic 842)" requiring lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to current guidance. Under the new guidance, lessees will be required to recognize a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The asset will be measured at the lease liability amount, adjusted for lease prepayments, lease incentives received, and the lessee's initial direct costs. For leases with a lease term of 12 months or less, as long as the lease does not include options to purchase the underlying assets, lessees can elect not to recognize a lease liability and right-of-use asset. Under the new guidance, lessor accounting is largely unchanged and the accounting for sale and leaseback transactions is simplified. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. This guidance will be applicable to the Company for the fiscal year beginning July 1, 2019. The guidance must be adopted using a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Company is currently evaluating the impact on its consolidated financial statements upon the adoption of this new guidance.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718)" simplifying several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory withholding requirements, as well as classification in the statement of cash flows. Under the new guidance, an entity will recognize all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. This change eliminates the current practice of recognizing excess tax benefits in additional paid-in-capital ("APIC") and tax deficiencies in APIC to the extent that there is a sufficient APIC pool related to previously recognized excess tax benefits. In addition, excess tax benefits and tax deficiencies are considered discrete items in the reporting period they occur and are not included in the estimate of an entity’s annual effective tax rate. As for classification on the statement of cash flows, excess tax benefits will no longer represent a financing activity since they are recognized in the income statement, and will appropriately be classified as an operating activity. The ASU allows an entity to elect as an accounting policy either to continue to estimate the total number of awards for which the requisite service period will not be rendered (as currently required) or to account for forfeitures when they occur. In regards to statutory withholding requirements, the new guidance stipulates that the net settlement of an award would not result, by itself, in liability classification of the award provided that the amount withheld for taxes does not exceed the maximum statutory tax rate in the employees’ relevant tax jurisdictions. The standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. If early adoption is elected, all amendments in the ASU that apply must be adopted in the same period. This guidance will be applicable to the Company for the fiscal year beginning July 1, 2017. The Company is currently evaluating the impact on its consolidated financial statements upon the adoption of this new guidance.
 

(2) Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share are computed by dividing net income by the weighted-average number of common and potential common shares outstanding.

9


 
Quarter ended
 
Nine months ended
 
March 31,
 
March 31,
 
2016
 
2015
 
2016
 
2015
 
(in thousands, except per share data)
Numerator:
 
 
 
 
 
 
 
Net Income
$
14,042

 
$
12,943

 
$
50,694

 
$
48,972

Denominator:
 
 
 
 
 
 
 
Weighted-average shares, basic
25,863

 
28,646

 
26,741

 
28,590

Dilutive effect of share-based payments
104

 
209

 
167

 
235

Weighted-average shares, diluted
25,967

 
28,855

 
26,908

 
28,825

 
 
 
 
 
 
 
 
Net income per common share, basic
$
0.54

 
$
0.45

 
$
1.90

 
$
1.71

Net income per common share, diluted
$
0.54

 
$
0.45

 
$
1.88

 
$
1.70


For the quarter and nine months ended March 31, 2016, weighted-average shares outstanding excluded from the computation of diluted earnings per share because their effect would be anti-dilutive were 868,211 and 835,055, respectively. For the quarter and nine months ended March 31, 2015, there were 426,045 and 339,510 weighted-average shares outstanding excluded from the computation of diluted earnings per share because their effect would be anti-dilutive.

(3) Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consists of the following: 
 
March 31,
2016
 
June 30,
2015
 
(in thousands)
Foreign currency translation adjustment
$
(77,169
)
 
$
(64,502
)
Accumulated other comprehensive income (loss)
$
(77,169
)
 
$
(64,502
)
 
 
 
 

The tax effect of amounts in comprehensive income (loss) reflect a tax expense or benefit as follows:
 
Quarter ended March 31,
 
Nine Months ended March 31,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Tax expense (benefit)
$
(1,264
)
 
$
1,090

 
$
1,723

 
$
2,376

 
 
 
 
 
 
 
 

(4) Acquisitions
Imago

On September 19, 2014, the Company acquired 100% of the shares of Imago Group plc, a European value-added provider of video and voice communications equipment and services, through a newly-formed special purchase entity. Subsequent to the acquisition, the Company changed Imago's name to ScanSource Video Communications Ltd. (dba Imago ScanSource). Imago ScanSource joined the Company’s Worldwide Communications and Services operating segment. This acquisition supports the Company’s strategy to be the leading value-added provider of video, voice, and networking solutions for resellers in Europe.

Under the share purchase agreement, the Company structured the purchase transaction with an initial cash payment of $37.4 million, plus two additional annual cash installments for the twelve month periods ending September 30, 2015 and 2016, based on the financial performance of Imago ScanSource. The Company acquired $1.9 million of cash during the acquisition, resulting in net $35.5 million cash paid for Imago ScanSource. Please see Note 8, Fair Value of Financial Instruments for further information regarding the fair value accounting for this contingent consideration.

Pro forma results of operations and a complete purchase price allocation have not been presented for this acquisition because the results of this acquisition are not material to our consolidated results individually or in aggregate with other acquisitions during the relative fiscal year. The purchase price of this acquisition was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the transaction date, resulting in goodwill and identifiable intangible assets. The purchase price allocated to goodwill and identifiable intangible assets as of the acquisition date is as follows:

 
Goodwill
 
Identifiable Intangible Assets
 
(in thousands)
Imago ScanSource
$
18,266

 
$
19,606


Intangible assets acquired include trade names, customer relationships, and non-compete agreements.

For tax purposes, due to the nondeductible nature of the amortization of identifiable intangible assets acquired, the Company recorded a deferred tax liability in the amount of $4.1 million. The deferred tax liability represents the difference between the book and tax bases in the assets and will decrease over time as the assets are amortized for book purposes.

Network1


10


On January 13, 2015, the Company acquired 100% of the shares of Intersmart Comércio Importação Exportação de Equipamentos Eletrônicos, S.A., a corporation organized under the laws of the Federative Republic of Brazil, and its related entities (collectively “Network1”) from the Network1 shareholders. Network1 is a Brazilian value-added provider of communications equipment and services and joined the Company’s Worldwide Communications and Services operating segment. ScanSource is committed to becoming the leading value-added provider of communications solutions for resellers in Latin America, and this acquisition represents an important step in this strategy.

Under the share purchase and sale agreement, the Company structured the purchase transaction with an initial cash payment of approximately $29.1 million, plus four additional annual cash installments based on a form of adjusted earnings before interest expense, taxes, depreciation and amortization ("adjusted EBITDA") for the periods ending June 30, 2015 through June 30, 2018. The Company acquired $4.8 million of cash during the acquisition, resulting in $24.3 million net cash paid for Network1. The Company assumed net debt of $35.2 million as part of the initial purchase consideration.

Pro forma results of operations and a complete purchase price allocation have not been presented for this acquisition because the results of this acquisition are not material to our consolidated results individually or in aggregate with other acquisitions during the relative fiscal year. The purchase price of this acquisition was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the transaction date. Please see Note 8, Fair Value of Financial Instruments for further information regarding the fair value accounting for this contingent consideration and Note 10, Commitments and Contingencies for further information regarding pre-acquisition contingencies and related indemnification receivables related to this acquisition.

During the second quarter of fiscal year 2016, the Company finalized the purchase accounting for the Network1 acquisition. The company elected to record all purchase accounting adjustments in fiscal year 2016 as opposed to the retrospective application guidance set forth in Accounting Standard Codification ("ASC") 805. Management has determined that retrospective application would be immaterial to the users of the consolidated financial statements. Further, during the third quarter of the fiscal year 2016, the Company identified an adjustment related to deferred taxes in association with the Network1 acquisition. The adjustment resulted in a reclassification of approximately $7.9 million from other non current assets to goodwill as of the opening balance sheet date. There was no impact to previously reported retained earnings, income from continuing operations, net income or earnings per share.

 
Goodwill
 
Identifiable Intangible Assets
 
(in thousands)
Network1
$
31,032

 
$
23,182


Intangible assets acquired include trade names, customer relationships, and non-compete agreements.

KBZ

On September 4, 2015, the Company acquired substantially all the assets of KBZ Communications, Inc. ("KBZ"), a Cisco Authorized Provider specializing in video conferencing, services, and cloud. KBZ joined the Company's Worldwide Barcode and Security operating segment. This acquisition supports the Company's strategy to be the leading value-added provider of specialty technology products and solutions. The results of operations of KBZ have been included in the consolidated results from the date of acquisition.

Under the asset purchase agreement, the Company acquired the assets of KBZ for a cash payment of $64.6 million. The Company acquired $3.1 million of cash during the acquisition, resulting in $61.5 million net cash paid for KBZ.

The purchase price of this acquisition was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the transaction date. As of the date of this report, the finalization of purchase accounting for the business combination is incomplete, therefore, the estimates provided are subject to change. Pro forma results of operations have not been presented for this acquisition because the results of this acquisition are not material to our consolidated results. An estimate of the purchase price allocation is as follows:


11


 
September 4, 2015
 
(in thousands)
Cash
$
3,122

Receivables, net
62,842

Inventory
11,130

Other Current Assets
10,303

Property and equipment, net
677

Goodwill
21,649

Identifiable intangible assets
18,400

Other non-current assets
1,399

 
$
129,522

Accounts payable
$
47,895

Accrued expenses and other current liabilities
14,863

Other long-term liabilities
2,167

Consideration transferred
64,597

 
$
129,522


Intangible assets acquired include trade names, customer relationships, and non-compete agreements.
(5) Goodwill and Other Identifiable Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended March 31, 2016, by reporting segment, are as follows:
 
Barcode & Security Segment
 
Communications & Services Segment
 
Total
 
(in thousands)
Balance as of June 30, 2015
$
15,535

 
$
50,974

 
$
66,509

Additions
21,649

 
8,496

1 
30,145

     Foreign currency translation adjustment
(682
)
 
(5,060
)
 
(5,742
)
Balance as of March 31, 2016
$
36,502

 
$
54,410

 
$
90,912

1 The Company finalized the purchase accounting for the Network1 acquisition during the quarter ended December 31, 2015 and subsequently identified an additional correction in the quarter ended March 31, 2016, which resulted in an increased value assumed for goodwill as compared to June 30, 2015.

The following table shows changes in the amount recognized for net identifiable intangible assets for the nine months ended March 31, 2016.
 
Net Identifiable Intangible Assets
 
(in thousands)
Balance as of June 30, 2015
$
46,272

Additions
18,400

Reductions2
(76
)
Amortization expense
(7,237
)
Foreign currency translation adjustment
(4,295
)
Balance as of March 31, 2016
$
53,064

2 The Company finalized the purchase accounting for the Network1 acquisition during the quarter ended December 31, 2015 and made reductions in the values assumed for net identifiable intangible assets.

Intangible asset balances include trade names, customer relationships, non-compete agreements, and distributor agreements.


12


(6) Short-Term Borrowings and Long-Term Debt

Short-Term Borrowings

Imago ScanSource has a multi-currency invoice discounting credit facility secured by the subsidiary’s assets for its operations based in the United Kingdom. The invoice discounting facility allows for the issuance of funds up to 85% of the amount of each invoice processed, subject to limits by currency of £4.2 million, €0.5 million, and $0.2 million. Borrowings under the invoice discounting facilities bear interest at a base rate determined by currency, plus a spread of 1.85%. The base rate is the United Kingdom base rate published by the Bank of England for GBP-based borrowings, 30-day Euro Interbank Offered Rate ("EUROLIBOR") for Euro-based borrowings, and the Lloyds Bank daily USD published rate for the USD-based borrowings. Additionally, the Company is assessed an annual commitment fee of less than £0.1 million. There were no outstanding balances at March 31, 2016 and June 30, 2015.

Revolving Credit Facility

The Company has a $300 million multi-currency senior secured revolving credit facility with JPMorgan Chase Bank N.A., as administrative agent, and a syndicate of banks (the “Amended Credit Agreement”) that matures on November 6, 2018. The Amended Credit Agreement allows for the issuance of up to $50 million for letters of credit and has a $150 million accordion feature that allows the Company to increase the availability to $450 million, subject to obtaining additional credit commitments for the lenders participating in the increase.

At the Company's option, loans denominated in U.S. dollars under the Amended Credit Agreement, other than swingline loans, bear interest at a rate equal to a spread over the London Interbank Offered Rate ("LIBOR") or alternate base rate depending upon the Company's ratio of total debt (excluding accounts payable and accrued liabilities), measured as of the end of the most recent quarter, to adjusted earnings before interest expense, taxes, depreciation and amortization ("EBITDA") for the most recently completed four quarters (the "Leverage Ratio"). The Leverage Ratio calculation excludes the Company's subsidiaries in Brazil. This spread ranges from 1.00% to 2.25% for LIBOR-based loans and 0.00% to 1.25% for alternate base rate loans. The spread in effect for the period ended March 31, 2016 was 1.00% for LIBOR-based loans and 0.00% for alternate base rate loans. Additionally, the Company is assessed commitment fees ranging from 0.175% to 0.40%, depending upon the Leverage Ratio, on non-utilized borrowing availability, excluding swingline loans. The commitment fee rate in effect for the period ended March 31, 2016 was 0.175%. Borrowings are guaranteed by substantially all of the domestic assets of the Company and a pledge of up to 65% of capital stock or other equity interest in certain foreign subsidiaries determined to be either material or a subsidiary borrower as defined in the Amended Credit Agreement. The Company was in compliance with all covenants under the credit facility as of March 31, 2016. There was $73.6 million and $0.0 million outstanding on the revolving credit facility at March 31, 2016 and June 30, 2015, respectively.

The average daily balance during the nine month period ended March 31, 2016 and 2015 was $93.5 million and $2.2 million, respectively. There was $226.4 million and $300 million available for additional borrowings as of March 31, 2016 and June 30, 2015, respectively. Letters of credit issued under the multi-currency revolving credit facility totaled €0.4 million and €0.0 million as of March 31, 2016 and June 30, 2015.

Long-Term Debt

On August 1, 2007, the Company entered into an agreement with the State of Mississippi to provide financing for the acquisition and installation of certain equipment to be utilized at the Company’s Southaven, Mississippi distribution facility, through the issuance of an industrial development revenue bond. The bond matures on September 1, 2032 and accrues interest at the 30-day LIBOR rate plus a spread of 0.85%. The terms of the bond allow for payment of interest only for the first 10 years of the agreement, and then, starting on September 1, 2018 through 2032, principal and interest payments are due until the maturity date or the redemption of the bond. The agreement also provides the bondholder with a put option, exercisable only within 180 days of each fifth anniversary of the agreement, requiring the Company to pay back the bonds at 100% of the principal amount outstanding. As of March 31, 2016, the Company was in compliance with all covenants under this bond. The balance on the bond was $5.4 million as of March 31, 2016 and June 30, 2015 and is included in long-term debt. The interest rate at March 31, 2016 and June 30, 2015 was 1.29% and 1.03%, respectively.


13


Network1 has multiple term loan agreements, denominated in Brazilian reais, with Banco Bradesco, to provide funding for working capital needs. The agreements are collectively secured by accounts receivable of the subsidiary and a personal guarantee by a former shareholder. In general, in the absence of an event of default, the term loans mature on May 9, 2016. The terms of the loans provide for bi-annual payments of varying amounts and bear interest at 11.48% per annum. As of March 31, 2016, the subsidiary was in compliance with all covenants under this loan. The outstanding balance as of March 31, 2016 and June 30, 2015 was $0.8 million and $1.8 million, respectively, all of which is classified as current.

Network1 held a term loan agreement, denominated in U.S. dollars, with Banco Safra to provide funding for working capital needs. The loan was secured by accounts receivable of the subsidiary. The term loan matured on September 21, 2015 and was paid in full. The terms of this loan provided for quarterly payments and bore interest at 3.6% per annum. The loan possessed a cross-currency swap contrat, which bore interest at a base rate equal to the Average One-Day Interbank Deposit Rate ("CDI" rate), plus a spread of 2.75% per annum. The CDI interest rate at June 30, 2015 was approximately 13.6%. The outstanding balance as of March 31, 2016 and June 30, 2015 was $0.0 million and $0.7 million, respectively.

Network1 held a term loan agreement, denominated in the Brazilian real, with Banco do Brasil to provide funding for working capital needs. The loan was secured by accounts receivable of the subsidiary and a personal guarantee by a former shareholder. In general, in the absence of an event of default, the term loan was scheduled to mature on October 28, 2017. The terms of this loan provided for monthly payments and bore interest at 12.08% per annum. During the quarter ended December 31, 2015, the Company repaid the loan in full in advance of its maturity date. The outstanding balance as of March 31, 2016 was $0.0 million. The outstanding balance as of June 30, 2015 was $0.9 million, of which $0.4 million was classified as current.
 
Debt Issuance Costs

As of March 31, 2016, net debt issuance costs associated with the credit facility and bonds totaled $0.8 million and are being amortized on a straight-line basis through the maturity date of each respective debt instrument.

14


(7) Derivatives and Hedging Activities

The Company’s results of operations could be materially impacted by significant changes in foreign currency exchange rates and interest rates. These risks and the management of these risks are discussed in greater detail below. In an effort to manage the exposure to these risks, the Company periodically enters into various derivative instruments. The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments in accordance with US GAAP. The Company records all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedging instruments or the ineffective portions of cash flow hedges are adjusted to fair value through earnings in other income and expense.

Foreign Currency Derivatives – The Company conducts a portion of its business internationally in a variety of foreign currencies. The exposure to market risk for changes in foreign currency exchange rates arises from foreign currency-denominated assets and liabilities, and transactions arising from non-functional currency financing or trading activities. The Company’s objective is to preserve the economic value of non-functional currency-denominated cash flows. The Company attempts to hedge transaction exposures with natural offsets to the fullest extent possible and, once these opportunities have been exhausted, through forward contracts or other hedging instruments with third parties. These contracts hedge the exchange of various currencies, including the U.S. dollar, Brazilian real, euro, British pound, Canadian dollar, Mexican peso, Chilean peso, Colombian peso and Peruvian nuevo sol. While the Company utilizes foreign exchange contracts to hedge foreign currency exposure, the Company's foreign exchange policy prohibits the use of derivative financial instruments for speculative purposes.

The Company had contracts outstanding for purposes of managing cash flows with notional amounts of $90.5 million and $80.6 million for the exchange of foreign currencies as of March 31, 2016 and June 30, 2015, respectively. To date, the Company has chosen not to designate these derivatives as hedging instruments, and accordingly, these instruments are adjusted to fair value through earnings in other income and expense. Summarized financial information related to these derivative contracts and changes in the underlying value of the foreign currency exposures are as follows:
 
Quarter ended
 
Nine months ended
 
March 31,
 
March 31,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Net foreign exchange derivative contract (gains) losses
$
286

 
$
(3,255
)
 
$
(2,014
)
 
$
(6,741
)
Net foreign currency transactional and re-measurement (gains) losses
67

 
4,881

 
3,622

 
9,347

Net foreign currency (gains) losses
$
353

 
$
1,626

 
$
1,608

 
$
2,606


Net foreign exchange gains and losses consist of foreign currency transactional and functional currency re-measurements, offset by net foreign currency exchange contract gains and losses and are included in other income and expense. Foreign exchange gains and losses are generated as the result of fluctuations in the value of the the U.S. dollar versus the Brazilian real, the U.S. dollar versus the euro, British pound versus the euro, and other currencies versus the U.S. dollar.

Cross Currency Swaps – Through the acquisition of Network1, the Company has borrowings denominated in foreign currencies that have primarily been hedged into the functional currency of the respective borrowing entity using cross currency swaps in order to mitigate the impact of foreign currency exposures and interest rate exposures on these borrowings. These swaps involve the exchange of principal and fixed interest receipts of U.S. dollar-denominated debt held by one of our Brazilian subsidiaries (Network1) for principal and variable interest payments in Brazilian reais. The impact of the changes in foreign exchange rates of the cross currency debt instruments is recognized as an adjustment to other income and expense in the Condensed Consolidated Income Statements. Interest rate differentials paid or received under the swap agreements are recognized as adjustments to interest expense in the Condensed Consolidated Income Statements. The fair value of the swaps was a receivable $0.1 million as of June 30, 2015 and was included in prepaid expenses and other current assets in the Condensed Consolidated Balance Sheets. The outstanding swaps were settled and the related borrowings were paid in full during the quarter ended September 30, 2015.










15


The Company used the following derivative instruments, located on its Condensed Consolidated Balance Sheets, for the risk management purposes detailed above:
 
As of March 31, 2016
 
Fair Value  of
Derivatives
Designated as Hedge
Instruments
 
Fair Value  of
Derivatives
Not Designated as Hedge
Instruments
 
(in thousands)
Derivative assets:(a)
 
 
 
Forward foreign currency exchange contracts
$

 
$
297

Derivative liabilities:(b)
 
 
 
Forward foreign currency exchange contracts
$

 
$
618

(a)
All derivative assets are recorded as prepaid expenses and other current assets in the Condensed Consolidated Balance Sheets.
(b)
All derivative liabilities are recorded as accrued expenses and other current liabilities in the Condensed Consolidated Balance Sheets.


16


(8) Fair Value of Financial Instruments

Accounting guidance defines fair value as 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. Under this guidance, the Company is required to classify certain assets and liabilities based on the fair value hierarchy, which groups fair value measured assets and liabilities based upon the following levels of inputs:

Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 – Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

The assets and liabilities maintained by the Company that are required to be measured or disclosed at fair value on a recurring basis include the Company’s various debt instruments, deferred compensation plan investments, outstanding foreign exchange forward contracts, cross currency swap agreements and contingent consideration owed to the previous owners of Brasil Distribuidora de Tecnologias Especiais LTDA ("CDC" or "ScanSource Brasil"), Imago ScanSource and Network1. The carrying value of debt is considered to approximate fair value, as the Company’s debt instruments are either indexed to a variable rate using the market approach (Level 2 criteria) or the fixed rate applied approximates the variable rate published as of March 31, 2016.

The following table summarizes the valuation of the Company’s remaining assets and liabilities measured at fair value on a recurring basis as of March 31, 2016:
 
Total
 
Quoted
prices in
active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
17,306

 
$
17,306

 
$

 
$

Forward foreign currency exchange contracts
297

 

 
297

 

Total assets at fair value
$
17,603

 
$
17,306

 
$
297

 
$

Liabilities:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
17,306

 
$
17,306

 
$

 
$

Forward foreign currency exchange contracts
618

 

 
618

 

Liability for contingent consideration, current and non-current portion
27,141

 

 

 
27,141

Total liabilities at fair value
$
45,065

 
$
17,306

 
$
618

 
$
27,141




















17


The following table summarizes the valuation of the Company’s remaining assets and liabilities measured at fair value on a recurring basis as of June 30, 2015:
 
Total
 
Quoted
prices in
active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
15,970

 
$
15,970

 
$

 
$

Forward foreign currency exchange contracts
125

 

 
125

 

Cross currency swap agreements
103

 

 
103

 

Total assets at fair value
$
16,198

 
$
15,970

 
$
228

 
$

Liabilities:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
15,970

 
$
15,970

 
$

 
$

Forward foreign currency exchange contracts
476

 

 
476

 

Liability for contingent consideration, current and non-current portion
33,960

 

 

 
33,960

Total liabilities at fair value
$
50,406

 
$
15,970

 
$
476

 
$
33,960


The investments in the deferred compensation plan are held in a rabbi trust and include mutual funds and cash equivalents for payment of non-qualified benefits for certain retired, terminated or active employees. These investments are recorded to prepaid expenses and other current assets or other non-current assets depending on their corresponding, anticipated distributions to recipients, which are reported in accrued expenses and other current liabilities or other long-term non-current liabilities, respectively.

Derivative instruments, such as foreign currency forward contracts and cross currency swap agreements are measured using the market approach on a recurring basis considering foreign currency spot rates and forward rates quoted by banks or foreign currency dealers and interest rates quoted by banks (Level 2). See Note 7 - Derivatives and Hedging Activities. Foreign currency contracts and cross currency swap agreements are classified in the consolidated balance sheet as prepaid expenses and other current assets or accrued expenses and other current liabilities, depending on the respective instruments' favorable or unfavorable positions.

The Company recorded contingent consideration liabilities at the acquisition date of CDC, Imago ScanSource and Network1 representing the amounts payable to former shareholders, as outlined under the terms of the share purchase agreements, based upon the achievement of a projected earnings measure, net of specific pro forma adjustments. The current and non-current portions of these obligations are reported separately on the Condensed Consolidated Balance Sheets. The fair value of the contingent considerations (Level 3) are determined using a form of a probability weighted discounted cash flow model. Subsequent changes in the fair value of the contingent consideration liabilities are recorded to the change in fair value of contingent consideration line item in the Condensed Consolidated Income Statements. Fluctuations due to foreign currency translation are captured in other comprehensive income through the changes in foreign currency translation adjustments line item as seen in Note 3 - Accumulated Other Comprehensive Income (Loss).

CDC is part of the Company's Worldwide Barcode and Security Segment, and Imago ScanSource and Network1 are part of the Company's Worldwide Communications and Services segment.
















18



The table below provides a summary of the changes in fair value of the Company’s contingent considerations (Level 3) for the CDC, Imago ScanSource and Network1 earnouts for the quarter and nine months ended March 31, 2016:
 
Contingent consideration for the quarter ended
 
Contingent consideration for the nine months ended
 
March 31, 2016
 
March 31, 2016
 
Barcode & Security Segment
 
Communications & Services Segment
 
Total
 
Barcode & Security Segment
 
Communications & Services Segment
 
Total
 
(in thousands)
Fair value at beginning of period
$
1,156

 
$
22,844

 
$
24,000

 
$
5,109

 
$
28,851

 
$
33,960

Payments

 

 

 
(3,133
)
 
(4,153
)
 
(7,286
)
Change in fair value of contingent consideration

 
1,139

 
1,139

 
126

 
4,394

 
4,520

Foreign currency translation adjustment
113

 
1,889

 
2,002

 
(833
)
 
(3,220
)
 
(4,053
)
Fair value at end of period
$
1,269

 
$
25,872

 
$
27,141

 
$
1,269

 
$
25,872

 
$
27,141


The table below provides a summary of the changes in fair value of the Company’s contingent considerations (Level 3) for the CDC and Imago ScanSource earnouts for the quarter and nine months ended March 31, 2015:
 
Contingent consideration for the quarter ended
 
Contingent consideration for the nine months ended
 
March 31, 2015
 
March 31, 2015
 
Barcode & Security Segment
 
Communications & Services Segment
 
Total
 
Barcode & Security Segment
 
Communications & Services Segment
 
Total
 
(in thousands)
Fair value at beginning of period
$
4,952

 
$
5,053

 
$
10,005

 
$
11,107

 
$

 
$
11,107

Issuance of contingent consideration

 
27,052

 
27,052

 

 
32,035

 
32,035

Payments
(111
)
 

 
(111
)
 
(5,640
)
 

 
(5,640
)
Change in fair value of contingent consideration
172

 
113

 
285

 
830

 
432

 
1,262

Foreign currency translation adjustment
(853
)
 
(5,020
)
 
(5,873
)
 
(2,137
)
 
(5,269
)
 
(7,406
)
Fair value at end of period
$
4,160

 
$
27,198

 
$
31,358

 
$
4,160

 
$
27,198

 
$
31,358


The fair values of amounts owed are recorded in current portion of contingent consideration and long-term portion of contingent consideration in the Company’s Condensed Consolidated Balance Sheets. The U.S. dollar amounts of actual disbursements made in connection with future earnout payments are subject to change as the liability is denominated in currencies other than the U.S. dollar and subject to foreign exchange fluctuation risk. The Company will revalue the contingent consideration liabilities at each reporting date through the last payment, with changes in the fair value of the contingent consideration reflected in the change in fair value of contingent consideration line item on the Company’s Condensed Consolidated Income Statements that is included in the calculation of operating income. The fair value of the contingent consideration liabilities associated with future earnout payments is based on several factors, including:

estimated future results, net of pro forma adjustments set forth in the share purchase agreements;
the probability of achieving these results; and
a discount rate reflective of the Company’s creditworthiness and market risk premium associated with the Brazilian and European markets.

A change in any of these unobservable inputs can significantly change the fair value of the contingent consideration.






19



Barcode and Security Segment

The fair value of the liability for the contingent consideration related to CDC recognized at March 31, 2016 was $1.3 million, all of which is classified as current. The remaining liability is based on financial results through June 30, 2015 and is undiscounted as of March 31, 2016, therefore, no change in the fair value of the contingent consideration is recognized in the Condensed Consolidated Income Statements for the quarter ended March 31, 2016. For the nine month period ended March 31, 2016, the change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statement contributed a loss of $0.1 million. Volatility in the foreign exchange between the Brazilian real and the U.S. dollar has driven moderate changes in the translation of this Brazilian real denominated liability. The liability for the contingent consideration recognized is based on the Company's best estimate of the final balance due to the previous owners of CDC per guidance in the Share Purchase and Sale Agreement. As of March 31, 2016, the Company has made a partial payment on the final balance due to the previous owners of CDC.

Communications and Services Segment

The fair value of the liability for the contingent consideration related to Imago ScanSource recognized at March 31, 2016 was $2.8 million, all of which is classified as current. The change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed a gain of less than $0.1 million and a expense of $0.6 million for the quarter and nine months ended March 31, 2016, respectively. The change for the quarter is primarily driven by actual results that were less than originally planned, partially offset by the recurring amortization of the unrecognized fair value discount. The change for the nine month period is primarily driven by the recurring amortization of the unrecognized fair value discount and better than expected results year to date. In addition, volatility in the foreign exchange between the British pound and the U.S. dollar has driven changes in the translation of this British pound denominated liability. Although there is no contractual limit, total future undiscounted contingent consideration payments are anticipated to range between $2.8 million and $3.0 million, based on the Company’s best estimate of the earnout calculated on a multiple of adjusted earnings, before interest expense, income taxes, depreciation and amortization.

The fair value of the liability for the contingent consideration related to Network1 recognized at March 31, 2016 was $23.0 million, of which $8.8 million is classified as current. The change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed expense of $1.2 million and $3.8 million for the quarter and nine months ended March 31, 2016. The change for the quarter is primarily driven by the recurring amortization of the unrecognized fair value discount and a reduction in the discount rate used. The change for the nine month period is largely driven by the recurring amortization of the unrecognized fair value discount and better than expected actual results. In addition, volatility in the foreign exchange between the Brazilian real and the U.S. dollar has driven changes in the translation of this Brazilian real denominated liability. Although there is no contractual limit, total future undiscounted contingent consideration payments are anticipated to range up to $28.6 million, based on the Company’s best estimate of the earnout calculated on a multiple of adjusted earnings, before interest expense, income taxes, depreciation and amortization, plus the effects of foreign exchange.




20



(9) Segment Information

The Company is a leading global provider of technology products and solutions to resellers in specialty technology markets. The Company has two reportable segments, based on product, customer and service type.

In October 2015, we implemented changes to our reporting structure that moved a portion of our networking business from the Communications & Services segment to the Barcode & Security segment. We have reclassified prior period results for each of these business segments to provide comparable information.
Worldwide Barcode & Security Segment

The Barcode & Security segment focuses on automatic identification and data capture ("AIDC"), point-of-sale ("POS"), networking, electronic physical security, 3D printing technologies and other specialty technologies. We have business units within this segment for sales and merchandising functions in North America, Latin America, and Europe. We see adjacencies among these technologies in helping our resellers develop solutions, such as with networking products. AIDC and POS products interface with computer systems used to automate the collection, processing and communication of information for commercial and industrial applications, including retail sales, distribution, shipping, inventory control, materials handling, warehouse management and health care applications. Electronic physical security products include identification, access control, video surveillance, intrusion-related and wireless and networking infrastructure products. 3D printing solutions replace and complement traditional methods and reduce the time and cost of designing new products by printing real parts directly from digital input.

Worldwide Communications & Services Segment

The Communications & Services segment focuses on communications technologies and services. We have business units within this segment for sales and merchandising functions, and these business units offer voice, video conferencing, wireless, data networking and converged communications solutions in North America, Latin America, and Europe. As these solutions come together on IP networks, new opportunities are created for value-added resellers to move into adjacent solutions for all vertical markets, including education, healthcare, and government. Our teams deliver value-added support programs and services, including education and training, network assessments, custom configuration, implementation and marketing to help resellers develop a new technology practice, or to extend their capability and reach.









21


Selected financial information for each business segment is presented below:
 
Quarter ended
 
Nine months ended
 
March 31,
 
March 31,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Sales:
 
 
 
 
 
 
 
Worldwide Barcode & Security
$
532,534

 
$
482,780

 
$
1,795,733

 
$
1,578,723

Worldwide Communications & Services
265,870

 
280,423

 
867,021

 
783,218

 
$
798,404

 
$
763,203

 
$
2,662,754

 
$
2,361,941

Depreciation and amortization:
 
 
 
 
 
 
 
Worldwide Barcode & Security
$
1,459

 
$
1,172

 
$
4,005

 
$
3,248

Worldwide Communications & Services
1,963

 
2,538

 
6,265

 
4,802

Corporate
859

 

 
2,300

 

 
$
4,281

 
$
3,710

 
$
12,570

 
$
8,050

Operating income:
 
 
 
 
 
 
 
Worldwide Barcode & Security
$
11,375

 
$
10,081

 
$
44,188

 
$
36,888

Worldwide Communications & Services
10,301

 
11,707

 
34,062

 
42,692

Corporate
(29
)
 
(292
)
 
(311
)
 
(3,116
)
 
$
21,647

 
$
21,496

 
$
77,939

 
$
76,464

Capital expenditures:
 
 
 
 
 
 
 
Worldwide Barcode & Security
$
1,252

 
$
508

 
$
3,033

 
$
686

Worldwide Communications & Services
566

 
521

 
2,196

 
822

Corporate
3,836

 
5,042

 
3,891

 
18,346

 
$
5,654

 
$
6,071

 
$
9,120

 
$
19,854

Sales by Geography Category:
 
 
 
 
 
 
 
United States
$
599,375

 
$
545,764

 
$
1,996,270

 
$
1,751,435

International
206,748

 
228,461

 
693,526

 
644,341

Less intercompany sales
(7,719
)
 
(11,022
)
 
(27,042
)
 
(33,835
)
 
$
798,404

 
$
763,203

 
$
2,662,754

 
$
2,361,941

 
 
 
 
 
 
 
 

 
March 31, 2016
 
June 30, 2015
 
(in thousands)
Assets:
 
 
 
Worldwide Barcode & Security
$
797,871

 
$
740,020

Worldwide Communications & Services
577,303

 
599,358

Corporate
64,287

 
137,563

 
$
1,439,461

 
$
1,476,941

Property and equipment, net by Geography Category:
 
 
 
United States
$
45,191

 
$
41,159

International
4,885

 
5,415

 
$
50,076

 
$
46,574



22


(10) Commitments and Contingencies

The Company and its subsidiaries are, from time to time, parties to lawsuits arising out of operations. Although there can be no assurance, based upon information known to the Company, the Company believes that any liability resulting from an adverse determination of such lawsuits would not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

The Company is in the process of completing several capital projects for fiscal year 2016 that will result in significant cash commitments. Total capital expenditures for fiscal year 2016 are expected to range from $12 million to $15 million primarily for facilities expansions and IT investments.

During the Company's due diligence for the CDC and Network1 acquisitions, several pre-acquisition contingencies were identified regarding various Brazilian federal and state tax exposures. The Company is able to record indemnification receivables that are reported gross of the pre-acquisition contingency liabilities as they were escrowed or claimed against future earnout payments in the share purchase agreements. However, indemnity claims can be made up to the entire purchase price, which includes the initial payment and all future earnout payments. The table below summarizes the balances and line item presentation of these pre-acquisition contingencies and corresponding indemnification receivables in the Company's Condensed Consolidated Balance Sheets as of March 31, 2016:
 
March 31, 2016
 
CDC
 
Network1
 
(in thousands)
Assets
 
 
 
Prepaid expenses and other current assets
$
2,116

 
$
537

Other non-current assets
$

 
$
8,874

Liabilities
 
 
 
Accrued expenses and other current liabilities
$
2,116

 
$
537

Other long-term liabilities
$

 
$
8,874


The table below summarizes the balances and line item presentation of these pre-acquisition contingencies and corresponding indemnification receivables in the Company's Condensed Consolidated Balance Sheets as of June 30, 2015:

 
June 30, 2015
 
CDC
 
Network1
 
(in thousands)
Assets
 
 
 
Prepaid expenses and other current assets
$
3,156

 
$
520

Other non-current assets
$
69

 
$
10,769

Liabilities
 
 
 
Accrued expenses and other current liabilities
$
3,156

 
$
520

Other long-term liabilities
$
69

 
$
10,769


Changes in these contingent liabilities and receivables from June 30, 2015 are primarily driven by foreign currency translation.

(11) Income Taxes
The Company had approximately $1.7 million and $1.3 million of total gross unrecognized tax benefits as of March 31, 2016 and June 30, 2015, respectively. Of this total at March 31, 2016, approximately $1.2 million represents the amount of unrecognized tax benefits that are permanent in nature and, if recognized, would affect the annual effective tax rate. The Company does not believe that the total amount of unrecognized tax benefits will significantly increase or decrease within twelve months of the reporting date.
The Company conducts business globally and, as a result, one or more of its subsidiaries files income tax returns in the U.S. federal, various state, local and foreign jurisdictions. In the normal course of business, the Company is subject to examination by

23


taxing authorities in countries and states in which it operates. With certain exceptions, the Company is no longer subject to state and local, or non-U.S. income tax examinations by tax authorities for the years before June 30, 2011.

The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. As of March 31, 2016, the Company had approximately $1.2 million accrued for interest and penalties.

Income taxes for the interim period presented have been included in the accompanying condensed consolidated financial statements on the basis of an estimated annual effective tax rate. In addition to the amount of tax resulting from applying the estimated annual effective tax rate to pre-tax income, the Company includes certain items treated as discrete events to arrive at an estimated overall tax provision. During the current period, a discrete net tax benefit amount of $0.2 million was recorded, which is primarily attributable to the reversal of unrecognized tax benefits. During the quarter ended December 31, 2015, a discrete net tax benefit amount of $0.3 million was recorded, which is primarily attributable to a change in recognition of tax positions taken on prior year returns.

The Company’s effective tax rate of 34.5% for the nine months ended March 31, 2016 differs from the federal statutory rate of 35% primarily as a result of income derived from tax jurisdictions with varying income tax rates, nondeductible expenses, and state income taxes.

The Company has provided for U.S. income taxes for the current earnings of its Canadian subsidiary. Earnings from all other geographies will continue to be considered retained indefinitely for reinvestment. 
In prior years, financial results in Europe have generated pre-tax losses, primarily due to our European Communications business. Financial results in Belgium for the quarter and nine months ended March 31, 2016 produced pre-tax income of approximately $0.1 million and $1.2 million, respectively. In the judgment of management, it is more likely than not that the deferred tax asset will be realized.
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

ScanSource, Inc. is a leading global provider of technology products and solutions. ScanSource, Inc. and its subsidiaries (the "Company") provide value-added solutions for approximately 400 technology manufacturers and sell to approximately 33,000 resellers in the following specialty technology markets: POS and Barcode, Networking and Security, Communications and Emerging Technologies.

We operate our business under a management structure that enhances our worldwide technology market focus and growth strategy. As a part of this structure, ScanSource has two technology segments, each with its own president. The two segments are Worldwide Barcode & Security and Worldwide Communications & Services enabling the Company to leverage its size and experience to deliver more value to its vendor and reseller partners in its existing markets.

On October 1, 2015, we branded ScanSource Security as ScanSource Networking and Security to build on the growing demand for networking solutions.  With these changes and the acquisition of KBZ, we moved some business operations from our Communications & Services segment to our Barcode & Security segment.  We have reclassified prior period results to provide comparable information.

The Company operates in the United States, Canada, Latin America and Europe. The Company distributes to the United States and Canada from its distribution centers located in Mississippi and Virginia; to Latin America principally from distribution centers located in Florida, Mexico, Brazil and Colombia; and to Europe principally from distribution centers in Belgium, France, Germany and the United Kingdom.

The Company distributes products for many of its key vendors in all of its geographic markets; however, certain vendors only allow distribution to specific geographies. The Company's key vendors include Aruba/HPE, Axis, AudioCodes, Avaya, Barco, Bematech, Cisco, Datalogic, Dell, Dialogic, Elo, Epson, Honeywell, HID, Ingenico, Jabra, March Networks, Mitel, NCR, Oracle, Panasonic, Plantronics, Polycom, Ruckus Wireless, Samsung, ShoreTel, Sony, Spectralink, Toshiba Global Commerce Solutions, Ubiquiti, Unify, Verifone and Zebra Technologies.

On September 4, 2015, the Company acquired substantially all the assets of KBZ Communications, Inc., a Cisco Authorized Distributor specializing in video conferencing, services and cloud. KBZ joined the Company's Worldwide Barcode and Security

24


operating segment. This acquisition supports the Company's strategy to be the leading value-added provider of specialty technology products and solutions.

On January 13, 2015, the Company acquired 100% of the shares of Intersmart Comércio Importação Exportação de Equipamentos Eletrônicos, S.A., a corporation organized under the laws of the Federative Republic of Brazil, and its related entities (collectively “Network1"). Network1 is a Brazilian value-added provider of communications equipment and services and joined the Company’s Worldwide Communications and Services operating segment. ScanSource is committed to becoming the leading value-added provider of specialty technology products and solutions for resellers in Latin America, and this acquisition represents an important step in this strategy.

On September 19, 2014, the Company acquired 100% of the shares of Imago Group plc, a European value-added provider of video and voice communications equipment and services, through a newly-formed special purchase entity. Subsequent to the acquisition, the Company changed Imago's name to ScanSource Video Communications Ltd. (dba Imago ScanSource). Imago ScanSource is a part of the Company’s Worldwide Communications and Services operating segment. This acquisition supports the Company’s strategy to be the leading value-added provider of specialty technology products and solutions for resellers in Europe.

We implemented a new ERP system in our European operations (excluding Imago ScanSource) and North American operations in February 2015 and July 2015, respectively. We intend to implement the new ERP system in additional geographical operations.

Our objective is to continue to grow profitable sales in the technologies we distribute. We continue to evaluate strategic acquisitions to enhance our technological and geographic portfolios, as well as introduce new product lines to our line card. In doing so, we face numerous challenges that require attention and resources. Certain business units and geographies continue to experience increased competition. This competition may come in the form of pricing, credit terms, service levels and product availability. As this competition could affect both our market share and pricing of our products, we may change our strategy in order to effectively compete in the marketplace.

Evaluating Financial Condition and Operating Performance

In addition to disclosing results that are determined in accordance with United States generally accepted accounting principles ("US GAAP"), we also disclose certain non-GAAP financial measures. These measures include non-GAAP operating income, non-GAAP net income, non-GAAP EPS, return on invested capital ("ROIC") and "constant currency." Constant currency is a measure that excludes the translation exchange impact from changes in foreign currency exchange rates between reporting periods. We use non-GAAP financial measures to better understand and evaluate performance, including comparisons from period to period.

These non-GAAP financial measures have limitations as analytical tools, and the non-GAAP financial measures that we report may not be comparable to similarly titled amounts reported by other companies. Analysis of results and outlook on a non-GAAP basis should be considered in addition to, and not in substitution for or as superior to, measurements of financial performance prepared in accordance with US GAAP.

Non-GAAP Operating Income, Non-GAAP Net Income and Non-GAAP EPS

To evaluate current period performance on a clearer and more consistent basis with prior periods, the Company discloses non-GAAP operating income, non-GAAP net income and non-GAAP diluted earnings per share. Non-GAAP results exclude amortization of intangible assets related to acquisitions, change in fair value of contingent consideration, and acquisition costs. Non-GAAP operating income, non-GAAP pre-tax income, non-GAAP net income and non-GAAP diluted EPS are useful in better assessing and understanding the Company's operating performance, especially when comparing results with previous periods or forecasting performance for future periods.
Below we are providing a non-GAAP reconciliation of operating income, net income and earnings per share adjusted for the costs and charges mentioned above:

25


 
Quarter ended March 31, 2016
 
Quarter ended March 31, 2015
 
Operating Income
 
Pre-Tax Income
 
Net Income
 
Diluted EPS
 
Operating Income
 
Pre-Tax Income
 
Net Income
 
Diluted EPS
 
(in thousands)
GAAP Measures
$
21,647

 
$
21,353

 
$
14,042

 
$
0.54

 
$
21,496

 
$
19,821

 
$
12,943

 
$
0.45

Adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amortization of intangible assets
2,507

 
2,507

 
1,703

 
0.07

 
2,114

 
2,114

 
1,464

 
0.05

Change in fair value of contingent consideration
1,139

 
1,139

 
748

 
0.03

 
285

 
285

 
200

 
0.01

Acquisition costs
29

 
29

 
29

 

 
292

 
292

 
292

 
0.01

Non-GAAP measures
$
25,322

 
$
25,028

 
$
16,522

 
$
0.64

 
$
24,187

 
$
22,512

 
$
14,899

 
$
0.52

Return on Invested Capital

Management uses ROIC as a performance measurement to assess efficiency at allocating capital under the Company's control to generate returns. Management believes this metric balances the Company's operating results with asset and liability management, is not impacted by capitalization decisions and is considered to have a strong correlation with shareholder value creation. In addition, it is easily computed, communicated and understood. ROIC also provides management a measure of the Company's profitability on a basis more comparable to historical or future periods.

ROIC assists us in comparing our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that do not reflect our core operating performance. Adjusted EBITDA excludes changes in fair value of contingent consideration and acquisition costs. We believe the calculation of ROIC provides useful information to investors and is an additional relevant comparison of our performance during the year. In addition, the Company's Board of Directors uses ROIC in evaluating business and management performance. Certain management incentive compensation targets are set and measured relative to ROIC.
 
We calculate ROIC as earnings before interest expense, income taxes, depreciation and amortization, plus change in fair value of contingent consideration and other non-GAAP adjustments ("adjusted EBITDA") divided by invested capital. Invested capital is defined as average equity plus average daily funded interest-bearing debt for the period. The following table summarizes annualized return on invested capital ratio for the quarters ended March 31, 2016 and 2015, respectively:
  
Quarter ended March 31,
 
2016
 
2015
Return on invested capital ratio, annualized(a)
12.3
%
 
12.1
%
(a)
The annualized EBITDA amount is divided by days in the quarter times 365 days per year (366 during leap years). There were 91 days in the current quarter and 90 days in the prior year quarter.

The components of this calculation and reconciliation to our financial statements are shown on the following schedule:
 
Quarter ended March 31,
 
2016
 
2015
 
(in thousands)
Reconciliation of net income to EBITDA:
 
Net income (GAAP)
$
14,042

 
$
12,943

Plus: interest expense
694

 
891

Plus: income taxes
7,311

 
6,878

Plus: depreciation and amortization
4,281

 
3,710

EBITDA (non-GAAP)
26,328

 
24,422

Plus: Change in fair value of contingent consideration
1,139

 
285

Plus: Acquisition costs
29

 
292

Adjusted EBITDA (numerator for ROIC) (non-GAAP)
$
27,496

 
$
24,999


26


 
Quarter ended March 31,
 
2016
 
2015
 
(in thousands)
Invested capital calculations:
 
Equity – beginning of the quarter
$
754,794

 
$
818,748

Equity – end of the quarter
757,374

 
799,051

Add: Change in fair value of contingent consideration, net of tax
748

 
200

Add: Acquisition costs, net of tax (a)
29

 
292

Average equity
756,473

 
809,146

Average funded debt (b) 
146,213

 
32,046

Invested capital (denominator for ROIC) (non-GAAP)
$
902,686

 
$
841,192


(a)
Acquisition costs are nondeductible for tax purposes.
(b)
Average funded debt is calculated as the average daily amounts outstanding on our current and long-term interest-bearing debt.


27


Results of Operations
Currency

We make references to "constant currency," a non-GAAP performance measure that excludes the foreign exchange rate impact from fluctuations in the weighted-average foreign exchange rates between reporting periods. Constant currency is calculated by translating current period results from currencies other than the U.S. dollar using the comparable weighted-average foreign exchange rates from the prior year period. This information is provided to view financial results without the translation impact of fluctuations in foreign currency rates, thereby enhancing comparability between reporting periods.

Net Sales
The Company has two reportable segments. The following tables summarize the Company’s net sales results by technology segment and by geographic location for the quarters and nine months ended March 31, 2016 and 2015. Prior period results have been reclassified in the current year to account for the movement of certain business operations from the Worldwide Communications & Services segment to the Worldwide Barcode & Security segment.
 
Quarter ended March 31,
 
 
Net Sales by Segment:
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
 
 
Worldwide Barcode & Security
$
532,534

 
$
482,780

 
$
49,754

 
10.3
 %
Worldwide Communications & Services
265,870

 
280,423

 
(14,553
)
 
(5.2
)%
Total net sales
$
798,404

 
$
763,203

 
$
35,201

 
4.6
 %
 
 
 
 
 
 
 
 
 
Nine Months ended March 31,
 
 
 
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
 
 

Worldwide Barcode & Security
$
1,795,733

 
$
1,578,723

 
$
217,010

 
13.7
 %
Worldwide Communications & Services
867,021

 
783,218

 
83,803

 
10.7
 %
Total net sales
$
2,662,754

 
$
2,361,941

 
$
300,813

 
12.7
 %

On a constant currency basis and excluding acquisitions, consolidated net sales for the Company decreased $5.1 million, or 0.7%, compared with the prior year quarter and increased $54.5 million, or 2.3%, compared with the prior year nine month period.

Worldwide Barcode & Security

The Barcode & Security segment consists of sales to technology resellers in North America, Europe and Latin America. Sales for the Barcode & Security segment increased $49.8 million and $217.0 million compared to the prior year quarter and nine month period, respectively, primarily due to the inclusion of sales from acquisitions for the quarter and nine months ended March 31, 2016. Excluding the foreign exchange negative impact of $11.2 million and $77.7 million and sales from acquisitions of $63.6 million and $229.7 million for the current quarter and nine month period, adjusted net sales for the Barcode & Security segment decreased $2.7 million, or 0.6%, for the quarter and increased $65.0 million, or 4.1%, for the nine month period compared to prior year. For the quarter to date period, the decrease in adjusted net sales is primarily due to lower sales volume in our networking business in North America and POS and Barcode business in Europe, partially offset by greater sales volume in Brazil. The increase in adjusted net sales for the nine month period is primarily due to sales growth in our POS and Barcode business within all geographies except Europe.

Worldwide Communications & Services
The Communications & Services segment consists of sales to technology resellers in North America, Europe and Latin America. Sales for the Communications & Services segment decreased $14.6 million compared to the prior year quarter primarily due to the negative foreign exchange impact on our Brazilian operations. Sales increased $83.8 million compared to the prior year nine month period primarily due to the inclusion of sales from acquisitions. Excluding the foreign exchange negative impact of $12.2 million and $19.9 million for the current quarter and nine month period, respectively, and sales from acquisitions of $118.9 million for the nine month period, adjusted net sales for the Communications & Services segment decreased $2.4 million, or 0.8%, for the quarter and $10.5 million, or 1.3%, for the nine month period. The decrease in adjusted net sales for quarter and nine month period is largely due to lower sales volume in North America and Europe, partially offset by sales growth in Brazil.

28


 
Quarter ended March 31,
 
 
Net Sales by Geography:
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
 
 
United States
$
591,663

 
$
534,742

 
$
56,921

 
10.6
 %
International
$
206,741

 
$
228,461

 
(21,720
)
 
(9.5
)%
Total net sales
$
798,404

 
$
763,203

 
$
35,201

 
4.6
 %
 
 
 
 
 
 
 
 
 
Nine Months ended March 31,
 
 
 
2016
 
2015
 
$ Change
 
% Change
 
(in thousands)
 
 
United States
$
1,969,236

 
$
1,717,600

 
$
251,636

 
14.7
 %
International
693,518

 
644,341

 
49,177

 
7.6
 %
Total net sales
$
2,662,754

 
$
2,361,941

 
$
300,813

 
12.7
 %

Gross Profit
The following table summarizes the Company’s gross profit for the quarters and nine months ended March 31, 2016 and 2015:
 
Quarter ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
(in thousands)
 
 
 
 
 
 
Worldwide Barcode & Security
$
46,614

 
$
41,209

 
$
5,405

 
13.1
 %
 
8.8
%
 
8.5
%
Worldwide Communications & Services
37,862

 
38,807

 
(945
)
 
(2.4
)%
 
14.2
%
 
13.8
%
Gross profit
$
84,476

 
$
80,016

 
$
4,460

 
5.6
 %
 
10.6
%
 
10.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
(in thousands)
 
 
 
 
 
 
Worldwide Barcode & Security
$
152,348

 
$
130,570

 
$
21,778

 
16.7
%
 
8.5
%
 
8.3
%
Worldwide Communications & Services
120,313

 
105,203

 
15,110

 
14.4
%
 
13.9
%
 
13.4
%
Gross profit
$
272,661

 
$
235,773

 
$
36,888

 
15.6
%
 
10.2
%
 
10.0
%

Worldwide Barcode & Security

Gross profit dollars and gross profit margin increased for the Barcode & Security segment for the quarter and nine months ended March 31, 2016 compared to the prior year. The increase in gross profit dollars and margin is primarily due to the inclusion of KBZ results and a more favorable sales mix.

Worldwide Communications & Services

In the Communications & Services segment, gross profit dollars decreased for the quarter ended March 31, 2016 primarily due to lower sales volume, however gross profit margin increased compared to the prior year. For the nine months ended March 31, 2016, gross profit dollars and gross profit margin increased. The increase in gross profit margin is primarily due to a more favorable sales mix.

Operating Expenses

The following table summarizes our operating expenses for the quarters and nine months ended March 31, 2016 and 2015:

29


 
Quarter ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
(in thousands)
 
 
 
 
 
 
Selling, general and administrative expenses
$
61,690

 
$
58,235

 
$
3,455

 
5.9
%
 
7.7
%
 
7.6
%
Change in fair value of contingent consideration
1,139

 
285

 
854

 
299.6
%
 
0.1
%
 
0.0
%
Operating expenses
$
62,829

 
$
58,520

 
$
4,309

 
7.4
%
 
7.9
%
 
7.7
%

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
(in thousands)
 
 
 
 
 
 
Selling, general and administrative expenses
$
190,202

 
$
158,047

 
$
32,155

 
20.3
%
 
7.1
%
 
6.7
%
Change in fair value of contingent consideration
4,520

 
1,262

 
3,258

 
258.2
%
 
0.2
%
 
0.1
%
Operating expenses
$
194,722

 
$
159,309

 
$
35,413

 
22.2
%
 
7.3
%
 
6.7
%

Selling, general and administrative expenses ("SG&A") increased $3.5 million and $32.2 million for the quarter and nine months ended March 31, 2016, respectively. The increase in SG&A for the quarter compared to the prior year quarter is primarily due to increased employee-related expenses from recent acquisitions. The increase in SG&A for the nine month period as compared to prior year is largely due to increased employee-related expenses, bad debt expense and amortization expense on intangibles generated through acquisitions. The Company had a credit for bad debt expense for the prior year nine month period due to improved accounts receivable collections and reduction of specific reserves.

We present changes in fair value of the contingent consideration owed to the former shareholders of CDC, Imago ScanSource and Network1 as a separate line item in operating expenses. We have recorded fair value adjustment losses of $1.1 million and $4.5 million for the quarter and nine months ended March 31, 2016, respectively. These losses are primarily the result of the recurring amortization of the unrecognized fair value discount and improvements in actual results.

Operating Income

The following table summarizes our operating income for the quarters and nine months ended March 31, 2016 and 2015:
 
 
Quarter ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
(in thousands)
 
 
 
 
 
 
Worldwide Barcode & Security
$
11,375

 
$
10,081

 
$
1,294

 
12.8
 %
 
2.1
%
 
2.1
%
Worldwide Communications & Services
10,301

 
11,707

 
(1,406
)
 
(12.0
)%
 
3.9
%
 
4.2
%
Corporate
(29
)
 
(292
)
 
263

 
nm*

 
nm*

 
nm*

Operating income
$
21,647

 
$
21,496

 
$
151

 
0.7
 %
 
2.7
%
 
2.8
%
*nm - percentages are not meaningful
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months ended March 31,
 
 
 
 
 
% of Net Sales March 31,
 
2016