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EX-32.2 - EXHIBIT 32.2 - SCANSOURCE, INC.scansourceex32212312017.htm
EX-32.1 - EXHIBIT 32.1 - SCANSOURCE, INC.scansourceex32112312017.htm
EX-31.2 - EXHIBIT 31.2 - SCANSOURCE, INC.scansourceex31212312017.htm
EX-31.1 - EXHIBIT 31.1 - SCANSOURCE, INC.scansourceex31112312017.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 December 31, 2017

Commission File Number: 000-26926
 
 
 
scansourcelogo4a20.jpg
ScanSource, Inc.

South Carolina
(State of Incorporation)

57-0965380
(I.R.S. Employer Identification No.)

6 Logue Court
Greenville, South Carolina 29615
(864) 288-2432
 
 
 
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 such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
 
Smaller reporting company
¨

Accelerated filer
¨

 
 
Emerging growth company
¨

Non-accelerated filer
¨

(Do not check if a smaller reporting company)
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨   

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 February 2, 2018
Common Stock, no par value per share
 
25,571,355



SCANSOURCE, INC.
INDEX TO FORM 10-Q
December 31, 2017
 
 
 
Page #
 
 
 
Item 1.
 
Condensed Consolidated Balance Sheets as of December 31, 2017 and June 30, 2017
 
Condensed Consolidated Income Statements for the Quarter and Six Months Ended December 31, 2017 and 2016
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Quarter and Six Months Ended December 31, 2017 and 2016
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2017 and 2016
 
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

We include forward-looking statements in the "Management’s Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and "Risk Factors" sections and elsewhere herein. These statements generally can be identified by 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. 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 suggested by these forward-looking statements as a result of a number of factors including, but not limited to, changes in interest and exchange rates and regulatory regimes impacting our overseas operations, the impact of tax reform laws, the failure of acquisitions to meet our expectations, the failure to manage and implement our organic growth strategy, credit risks involving our larger customers and vendors, termination of our relationship with key vendors or a significant modification of the terms under which we operate with a key vendor, the decline in demand for the products and services that we provide, reduced prices for the products and services that we provide due both to competitor and customer actions, and the other factors set forth in "Risk Factors" contained in our Annual Report on Form 10-K for the year ended June 30, 2017.

3


PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share information)
 
December 31, 2017
 
June 30, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
35,435

 
$
56,094

Accounts receivable, less allowance of $47,264 at December 31, 2017 and $44,434 at June 30, 2017
717,336

 
637,293

Inventories
581,802

 
531,314

Prepaid expenses and other current assets
76,667

 
56,322

Total current assets
1,411,240

 
1,281,023

Property and equipment, net
76,626

 
56,566

Goodwill
302,912

 
200,881

Identifiable intangible assets, net
148,443

 
101,513

Deferred income taxes
11,794

 
29,491

Other non-current assets
54,267

 
48,829

Total assets
$
2,005,282

 
$
1,718,303

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
104

 
$

Accounts payable
515,302

 
513,155

Accrued expenses and other current liabilities
97,597

 
104,715

Current portion of contingent consideration
38,629

 
30,675

Income taxes payable
5,086

 
7,730

Total current liabilities
656,718

 
656,275

Deferred income taxes
11,110

 
2,008

Long-term debt
5,325

 
5,429

Borrowings under revolving credit facility
355,503

 
91,871

Long-term portion of contingent consideration
58,402

 
83,361

Other long-term liabilities
57,437

 
42,214

Total liabilities
1,144,495

 
881,158

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, 25,571,355 and 25,431,845 shares issued and outstanding at December 31, 2017 and June 30, 2017, respectively
64,896

 
61,169

Retained earnings
861,296

 
849,180

Accumulated other comprehensive income (loss)
(65,405
)
 
(73,204
)
Total shareholders’ equity
860,787

 
837,145

Total liabilities and shareholders’ equity
$
2,005,282

 
$
1,718,303

 
 
 
 
June 30, 2017 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
 
Six months ended
 
December 31,
 
December 31,
 
2017
 
2016
 
2017
 
2016
Net sales
$
1,032,212

 
$
904,792

 
$
1,956,771

 
$
1,837,357

Cost of goods sold
919,241

 
806,258

 
1,737,883

 
1,647,289

Gross profit
112,971

 
98,534

 
218,888

 
190,068

Selling, general and administrative expenses
74,763

 
66,880

 
147,950

 
130,145

Depreciation expense
3,467

 
2,423

 
6,707

 
4,492

Intangible amortization expense
5,487

 
4,165

 
10,498

 
7,320

Change in fair value of contingent consideration
6,913

 
1,791

 
23,794

 
1,961

Operating income
22,341

 
23,275

 
29,939

 
46,150

Interest expense
2,285

 
912

 
3,870

 
1,501

Interest income
(580
)
 
(892
)
 
(1,462
)
 
(1,908
)
Other (income) expense, net
326

 
(12,526
)
 
441

 
(11,948
)
Income before income taxes
20,310

 
35,781

 
27,090

 
58,505

Provision for income taxes
12,341

 
12,745

 
14,974

 
20,653

Net income
$
7,969

 
$
23,036

 
$
12,116

 
$
37,852

Per share data:
 
 
 
 
 
 
 
Net income per common share, basic
$
0.31

 
$
0.92

 
$
0.48

 
$
1.49

Weighted-average shares outstanding, basic
25,506

 
25,146

 
25,470

 
25,334

 
 
 
 
 
 
 
 
Net income per common share, diluted
$
0.31

 
$
0.91

 
$
0.47

 
$
1.48

Weighted-average shares outstanding, diluted
25,648

 
25,285

 
25,612

 
25,490

See accompanying notes to these condensed consolidated financial statements.


5


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

 
Quarter ended
 
Six months ended
 
December 31,
 
December 31,
 
2017
 
2016
 
2017
 
2016
Net income
$
7,969

 
$
23,036

 
$
12,116

 
$
37,852

Unrealized gain on hedged transaction, net of tax
320

 

 
349

 

Foreign currency translation adjustment
(2,435
)
 
(8,625
)
 
7,450

 
(9,563
)
Comprehensive income
$
5,854

 
$
14,411

 
$
19,915

 
$
28,289

See accompanying notes to these condensed consolidated financial statements.


6


SCANSOURCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 
Six months ended
 
December 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
12,116

 
$
37,852

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
18,766

 
11,812

Amortization of debt issuance costs
158

 
148

Provision for doubtful accounts
5,331

 
4,007

Share-based compensation
3,233

 
3,147

Deferred income taxes
(1,540
)
 
(57
)
Excess tax benefits from share-based payment arrangements

 
(88
)
Change in fair value of contingent consideration
23,794

 
1,961

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
(72,975
)
 
(49,791
)
Inventories
(37,749
)
 
40,792

Prepaid expenses and other assets
(10,081
)
 
(20,805
)
Other non-current assets
(4,775
)
 
(1,205
)
Accounts payable
(11,524
)
 
(12,863
)
Accrued expenses and other liabilities
(5,654
)
 
13,892

Income taxes payable
(3,283
)
 
6,929

Net cash (used in) provided by operating activities
(84,183
)
 
35,731

Cash flows from investing activities:
 
 
 
Capital expenditures
(3,296
)
 
(3,261
)
Cash paid for business acquisitions, net of cash acquired
(143,768
)
 
(83,804
)
Net cash (used in) investing activities
(147,064
)
 
(87,065
)
Cash flows from financing activities:
 
 
 
Borrowings on revolving credit
1,279,193

 
829,141

Repayments on revolving credit
(1,015,672
)
 
(764,332
)
Debt issuance costs
(296
)
 

Repayments on capital lease obligation
(281
)
 
(123
)
Contingent consideration payments
(54,025
)
 
(10,241
)
Exercise and issuance of equity awards
2,126

 
4,217

Taxes paid on settlement of equity awards
(1,616
)
 
(1,736
)
Repurchase of common stock

 
(20,882
)
Excess tax benefits from share-based payment arrangements

 
88

Net cash provided by financing activities
209,429

 
36,132

Effect of exchange rate changes on cash and cash equivalents
1,159

 
(1,127
)
Decrease in cash and cash equivalents
(20,659
)
 
(16,329
)
Cash and cash equivalents at beginning of period
56,094

 
61,400

Cash and cash equivalents at end of period
$
35,435

 
$
45,071

 
 
 
 
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 from technology suppliers and sell to customers in specialty technology markets through its Worldwide Barcode, Networking & Security segment and Worldwide Communications & Services segment.

The Company operates in the United States, Canada, Latin America and Europe. The Company sells products into the United States and Canada principally from a facility located in Mississippi; into Latin America principally from facilities located in Florida, Mexico, Brazil and Colombia; and into Europe from facilities located in Belgium, France, Germany and the United Kingdom.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared by the Company’s management in accordance with United States generally accepted accounting principles ("U.S. GAAP") for interim financial information and applicable rules and regulations of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. The unaudited condensed consolidated financial statements included herein contain all adjustments (consisting of normal recurring and non-recurring adjustments) that are, in the opinion of management, necessary to present fairly the financial position as of December 31, 2017 and June 30, 2017, the results of operations for the quarters and six months ended December 31, 2017 and 2016, the statements of comprehensive income for the quarters and six months ended December 31, 2017 and 2016, and the statements of cash flows for the six months ended December 31, 2017 and 2016. The results of operations for the quarters and six months ended December 31, 2017 and 2016 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, 2017.

Summary of Significant Accounting Policies

Except as described below, there have been no material changes to the Company’s significant accounting policies for the six months ended December 31, 2017 from the policies described 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, 2017. 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, 2017.

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 zero-balance disbursement accounts at various financial institutions at which the Company does not maintain significant depository relationships. Due to the terms of the agreements governing these accounts, the Company generally does not have the right to offset 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. As a result, checks released but not yet cleared from these accounts in the amounts of $7.5 million and $8.3 million are included in accounts payable as of December 31, 2017 and June 30, 2017, respectively.












8


Long-lived Assets

The Company presents depreciation expense and intangible amortization expense individually on the Condensed Consolidated Income Statements. The Company's depreciation expense related to selling, general and administrative costs totaled $3.5 million and $6.7 million for the quarter and six months ended December 31, 2017 and $2.4 million and $4.5 million for the quarter and six months ended December 31, 2016, respectively. Depreciation expense reported as part of cost of goods sold on the Condensed Consolidated Income Statements totaled $0.9 million and $1.6 million for the quarter and six months ended December 31, 2017. There was no depreciation expense reported as part of cost of goods sold prior to the acquisition of POS Portal on July 31, 2017. The Company's amortization expense reported on the Condensed Consolidated Income Statements relate to selling, general and administrative costs, not the cost of selling goods. Intangible amortization expense totaled $5.5 million and $10.5 million for the quarter and six months ended December 31, 2017 and $4.2 million and $7.3 million for the quarter and six months ended December 31, 2016, respectively.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued a comprehensive new revenue recognition standard for contracts with customers that will supersede most current revenue recognition guidance, including industry-specific guidance under Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606). In March, April, May and December 2016 the FASB issued additional ASUs to provide supplemental adoption guidance and clarification to ASU 2014-09. 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 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, 2017. 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, 2018. The Company is currently in the process of evaluating the impact of this guidance on our consolidated financial results to determine the appropriate transition method for the Company. The Company has engaged a third-party consultant to assist with developing a multi-phase plan to assess the impact of adoption and is currently in the process of finalizing its conclusions on several aspects of the standard including principal versus agent considerations, identification of performance obligations, and the determination of when control of goods and services transfers to the Company’s customers. Additionally, the Company is in the process of evaluating the impact of the expanded disclosure requirements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) requiring lessees to reflect most leases on their balance sheets and recognize expenses on their income statements. 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) effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. This guidance was adopted by the Company prospectively on July 1, 2017. The new standard simplifies 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. See the Condensed Consolidated Statements of

9


Cash Flows for the six months ended December 31, 2017 for the prospective presentation of classifying excess tax benefits as an operating activity, not a financing activity as in prior years. 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. The Company elected to maintain its accounting policy to estimate to the total number of forfeitures for stock awards granted. 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.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) intended to reduce diversity in practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The update addresses eight specific cash flow issues, with the treatment of contingent consideration payments made after a business combination being the most directly applicable to the Company. The update requires that cash payments made approximately three months or less after an acquisition's consummation date should be classified as cash outflows for investing activities. Payment made thereafter up to the amount of the original contingent consideration liability should be classified as cash outflows from financing activities. Payments made in excess of the amount of the original contingent consideration liability should be classified as cash outflows from operating activities. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The standard will be applicable to the Company for the fiscal year beginning July 1, 2018. Early adoption is permitted, provided all eight amendments are adopted in the same period. The guidance requires adoption using a retrospective transition method. The Company is currently evaluating the impact on its consolidated financial statements upon the adoption of this new guidance.

The Company has reviewed other newly issued accounting pronouncements and concluded that they are either not applicable to its business or that no material effect is expected on its consolidated financial statements as a result of future adoption.

(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.
 
Quarter ended
 
Six months ended
 
December 31,
 
December 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share data)
Numerator:
 
 
 
 
 
 
 
Net Income
$
7,969

 
$
23,036

 
$
12,116

 
$
37,852

Denominator:
 
 
 
 
 
 
 
Weighted-average shares, basic
25,506

 
25,146

 
25,470

 
25,334

Dilutive effect of share-based payments
142

 
139

 
142

 
156

Weighted-average shares, diluted
25,648

 
25,285

 
25,612

 
25,490

 
 
 
 
 
 
 
 
Net income per common share, basic
$
0.31

 
$
0.92

 
$
0.48

 
$
1.49

Net income per common share, diluted
$
0.31

 
$
0.91

 
$
0.47

 
$
1.48


For the quarter and six months ended December 31, 2017, weighted-average shares outstanding excluded from the computation of diluted earnings per share because their effect would be anti-dilutive were 405,159 and 432,846, respectively. For the quarter and six months ended December 31, 2016, there were 568,955 and 517,845, respectively, 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: 

10


 
December 31, 2017
 
June 30, 2017
 
(in thousands)
Foreign currency translation adjustment
$
(65,767
)
 
$
(73,217
)
Unrealized gain (loss) on hedged transaction, net of tax
362

 
13

Accumulated other comprehensive income (loss)
$
(65,405
)
 
$
(73,204
)
 
 
 
 

The tax effect of amounts in comprehensive income (loss) reflect a tax expense or benefit as follows:
 
Quarter ended December 31,
 
Six months ended December 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Tax expense (benefit)
$
75

 
$
144

 
$
379

 
$
92

 
 
 
 
 
 
 
 
(4) Acquisitions
POS Portal

On July 31, 2017, the Company acquired all of the outstanding shares of POS Portal, Inc. ("POS Portal") a leading provider of payment devices and services primarily to the small and midsized ("SMB") market segment in the United States. POS Portal joined the Worldwide Barcode, Networking & Security segment.

Under the purchase agreement, the all-cash transaction included an initial purchase price of approximately $144.9 million paid in cash at closing. The Company paid an additional $3.4 million for customary closing adjustments during the six months ended December 31, 2017. The Company acquired $4.6 million in cash, net of debt payoff and other customary closing adjustments, resulting in $143.8 million net cash paid for POS Portal. The agreement also included a cash earn-out payment up to $13.2 million based on POS Portal's earnings before interest expense, taxes, depreciation and amortization (EBITDA) for the trailing twelve months (TTM) ending September 30, 2017, which was paid in full during the quarter ended December 31, 2017. A portion of the purchase price was placed into escrow to indemnify the Company for certain pre-acquisition damages. A portion of the escrow was released during the quarter ended December 31, 2017. As of December 31, 2017, the balance available in escrow was $13.1 million.

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. The goodwill balance is primarily attributed to expanding the Company's high-value capabilities and market reach across all payment channels. Goodwill, identifiable intangible assets and the related deferred tax liability are not deductible for tax purposes. Pro forma results of operations have not been presented for the acquisition of POS Portal because such results are not material to our consolidated results.

11


 
POS Portal
 
(in thousands)
Receivables
$
8,914

Inventory
8,352

Other current assets
917

Property and equipment
24,963

Goodwill
101,198

Identifiable intangible assets
57,000

Other non-current assets
100

 
$
201,444

 
 
Accounts payable
$
10,897

Accrued expenses and other current liabilities
5,130

Contingent consideration
13,098

Other long-term liabilities
102

Long-term deferred taxes payable
28,449

Consideration transferred, net of cash acquired
143,768

 
$
201,444


Intangible assets acquired include trade names, customer relationships, non-compete agreements and an encryption key library. The weighted-average amortization period for these identified intangible assets after purchase accounting adjustments, other than goodwill, was 10 years.

Intelisys

On August 29, 2016, the Company acquired substantially all the assets of Intelisys, a technology services company with voice, data, cable, wireless, and cloud services. Intelisys is part of the Company's Worldwide Communications and Services operating segment. With this acquisition, the Company broadens its capabilities in the telecom and cloud services market and generates the opportunity for high-growth recurring revenue.

Under the asset purchase agreement, the Company made an initial cash payment of approximately $84.6 million, which consisted of an initial purchase price of $83.6 million and $1.0 million for additional net assets acquired at closing, and agreed to make four additional annual cash installments based on a form of adjusted EBITDA for the periods ending June 30, 2017 through June 30, 2020. The Company acquired $0.8 million of cash as part of the acquisition, resulting in $83.8 million net cash paid for Intelisys initially. A portion of the purchase price was placed into escrow to indemnify the Company for certain pre-acquisition damages. As of December 31, 2017, the balance available in escrow was $8.5 million.

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. The goodwill balance is primarily attributed to entering the recurring revenue telecom and cloud services market and expanded market opportunities to grow recurring revenue streams. Goodwill and identifiable intangible assets are expected to be fully deductible for tax purposes.

12


 
Intelisys
 
(in thousands)
Receivables
$
21,655

Other current assets
1,547

Property and equipment
5,298

Goodwill
109,005

Identifiable intangible assets
63,110

Other non-current assets
1,839

 
$
202,454

 
 
Accounts payable
$
21,063

Accrued expenses and other current liabilities
2,587

Contingent consideration
95,000

Consideration transferred, net of cash acquired
83,804

 
$
202,454


Intangible assets acquired include trade names, customer relationships and non-compete agreements. The weighted-average amortization period for these identified intangible assets after purchase accounting adjustments, other than goodwill, was 10 years.
(5) Goodwill and Other Identifiable Intangible Assets

The changes in the carrying amount of goodwill for the six months ended December 31, 2017, by reporting segment, are as follows:
 
Barcode, Networking & Security Segment
 
Communications & Services Segment
 
Total
 
(in thousands)
Balance as of June 30, 2017
$
36,260

 
$
164,621

 
$
200,881

Additions
101,198

 

 
101,198

     Foreign currency translation adjustment
146

 
687

 
833

Balance as of December 31, 2017
$
137,604

 
$
165,308

 
$
302,912


The Company completed the acquisition of POS Portal, a leading provider of payment devices and services primarily to the SMB market segment in the United States. The addition of goodwill in the Worldwide Barcode, Networking & Security segment is the result of this acquisition.

The following table shows changes in the amount recognized for net identifiable intangible assets for the six months ended December 31, 2017.
 
Net Identifiable Intangible Assets
 
(in thousands)
Balance as of June 30, 2017
$
101,513

Additions
57,000

Amortization expense
(10,498
)
Foreign currency translation adjustment
428

Balance as of December 31, 2017
$
148,443


The intangible asset additions represent acquired assets for trade names, customer relationships, non-compete agreements and an encryption key library related to the POS Portal acquisition. These assets will be amortized over a period of four to twelve years.

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


13


The following table presents the Company’s debt as of December 31, 2017 and June 30, 2017.
 
December 31, 2017
 
June 30, 2017
 
(in thousands)
Current portion of long-term debt
$
104

 
$

Revolving credit facility
355,503

 
91,871

Long-term debt
5,325

 
5,429

Total debt
$
360,932

 
$
97,300


Revolving Credit Facility

The Company has a 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 is scheduled to mature on April 3, 2022. On August 8, 2017, the Company amended the Amended Credit Agreement to increase the committed credit facility from $300 million to $400 million. The Amended Credit Agreement allows for the issuance of up to $50 million for letters of credit and has a $200 million accordion feature that allows the Company to increase the availability to $600 million, subject to obtaining additional credit commitments from the lenders participating in the increase. The Company incurred $0.3 million in debt issuance costs in connection with the August 8, 2017 amendment.

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, income taxes, depreciation and amortization ("EBITDA") for the most recently completed four quarters (the "Leverage Ratio"). This spread ranges from 1.00% to 2.125% for LIBOR-based loans and 0.00% to 1.125% for alternate base rate loans. Additionally, the Company is assessed commitment fees ranging from 0.175% to 0.35%, depending upon the Leverage Ratio, on non-utilized borrowing availability, excluding swingline loans. 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.

At December 31, 2017, the spread in effect was 1.625% for LIBOR-based loans and 0.625% for alternate base rate loans. The commitment fee rate in effect as of December 31, 2017 was 0.250%. The Company was in compliance with all covenants under the credit facility as of December 31, 2017.

The average daily outstanding balance during the six month periods ended December 31, 2017 and 2016 was $261.8 million and $129.7 million, respectively. There was $44.6 million and $208.1 million available for additional borrowings as of December 31, 2017 and June 30, 2017, respectively. There were no letters of credit issued under the multi-currency revolving credit facility as of December 31, 2017 and June 30, 2017.

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 warehouse, 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 December 31, 2017, the Company was in compliance with all covenants under this bond. The interest rate at December 31, 2017 and June 30, 2017 was 2.23% and 1.93%, respectively.
 
Debt Issuance Costs

As of December 31, 2017, net debt issuance costs associated with the credit facility and bond totaled $1.5 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

In an effort to manage the exposure to foreign currency exchange rates and interest rates, 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 U.S. GAAP. The Company records all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedging instruments and the ineffective portions of cash flow hedges designated as hedging instruments 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 $100.6 million and $67.1 million for the exchange of foreign currencies as of December 31, 2017 and June 30, 2017, 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
 
Six months ended
 
December 31,
 
December 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Net foreign exchange derivative contract (gains) losses
$
121

 
$
(199
)
 
$
942

 
$
(959
)
Net foreign currency transactional and re-measurement (gains) losses
473

 
507

 
(160
)
 
1,879

Net foreign currency (gains) losses
$
594

 
$
308

 
$
782

 
$
920


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 U.S. dollar versus the Brazilian real, the U.S. dollar versus the euro, the British pound versus the euro, and other currencies versus the U.S. dollar.

Interest Rates - The Company's earnings are affected by changes in interest rates due to the impact those changes have on interest expense from floating rate debt instruments. To manage the exposure, the Company has entered into an interest rate swap agreement with a notional amount of $50.0 million scheduled to mature on April 3, 2022. This swap agreement is designated as a cash flow hedge to hedge the variable rate interest payments on the revolving credit facility. Interest rate differentials paid or received under the swap agreement are recognized as adjustments to interest expense. To the extent the swap is effective in offsetting the variability of the hedged cash flows, changes in the fair value of the swap are not included in current earnings but are reported as other comprehensive income (loss). There was no ineffective portion to be recorded as an adjustment to earnings for the quarter and six months ended December 31, 2017.

The components of the cash flow hedge included in accumulated other comprehensive income (loss), net of income taxes, in the Condensed Consolidated Balance Sheets, are as follows:


15


 
 
Quarter ended
 
Six months ended
 
 
December 31,
 
December 31,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Net interest expense recognized as a result of interest rate swap
 
$
64

 
$

 
$
133

 
$

Unrealized gain (loss) in fair value of interest rate swap
 
447

 

 
424

 

Net increase (decrease) in accumulated other comprehensive income (loss)
 
$
511

 
$

 
$
557

 
$

Income tax effect
 
191

 

 
208

 

Net increase (decrease) in accumulated other comprehensive income (loss), net of tax
 
$
320

 
$

 
$
349

 
$


The Company used the following derivative instruments as of December 31, 2017 and June 30, 2017, reflected in its Condensed Consolidated Balance Sheets, for the risk management purposes detailed above:
 
 
 
December 31, 2017
 
June 30, 2017
 
Balance Sheet Location
 
Fair Value  of
Derivatives
Designated 
as Hedge Instruments
 
Fair Value  of
Derivatives
Not Designated as  Hedge Instruments
 
Fair Value  of
Derivatives
Designated
as Hedge Instruments
 
Fair Value  of
Derivatives
Not Designated as Hedge Instruments
 
 
 
(in thousands)
Derivative assets:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Prepaid expenses and other current assets
 
$

 
$
71

 
$

 
$
35

Interest rate swap agreement
Other non-current assets
 
$
578

 
$

 
$
21

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Accrued expenses and other current liabilities
 
$

 
$
169

 
$

 
$
131




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 classifies certain assets and liabilities based on the fair value hierarchy, which aggregates 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;
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 forward foreign currency exchange contracts, interest rate swap agreements and contingent consideration owed to the previous owners of Network1 and Intelisys. The carrying value of debt is considered to approximate fair value, as the Company’s debt instruments are indexed to a variable rate using the market approach (Level 2 criteria).

The following table summarizes the valuation of the Company’s remaining assets and liabilities measured at fair value on a recurring basis as of December 31, 2017:
 
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
$
23,893

 
$
23,893

 
$

 
$

Forward foreign currency exchange contracts
71

 

 
71

 

Interest rate swap agreement
578

 

 
578

 

Total assets at fair value
$
24,542

 
$
23,893

 
$
649

 
$

Liabilities:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
23,893

 
$
23,893

 
$

 
$

Forward foreign currency exchange contracts
169

 

 
169

 

Liability for contingent consideration, current and non-current portion
97,031

 

 

 
97,031

Total liabilities at fair value
$
121,093

 
$
23,893

 
$
169

 
$
97,031


















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, 2017:
 
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
$
21,439

 
$
21,439

 
$

 
$

Forward foreign currency exchange contracts
35

 

 
35

 

Interest rate swap agreement
21

 

 
21

 

Total assets at fair value
$
21,495

 
$
21,439

 
$
56

 
$

Liabilities:
 
 
 
 
 
 
 
Deferred compensation plan investments, current and non-current portion
$
21,074

 
$
21,074

 
$

 
$

Forward foreign currency exchange contracts
131

 

 
131

 

Liability for contingent consideration, current and non-current portion
114,036

 

 

 
114,036

Total liabilities at fair value
$
135,241

 
$
21,074

 
$
131

 
$
114,036


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 and active employees. These investments are recorded to prepaid expenses and other current assets or other non-current assets depending on their corresponding, anticipated distribution dates 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, 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. Fair values of interest rate swaps are measured using standard valuation models with inputs that can be derived from observable market transactions, including LIBOR spot and forward rates (Level 2). Foreign currency contracts and interest rate swap agreements are classified in the Condensed Consolidated Balance Sheets 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 Network1, Intelisys and POS Portal representing the amounts payable to former shareholders, as outlined under the terms of the purchase agreements, based upon the achievement of a projected earnings measure, net of specific pro forma adjustments. The contingent consideration due to the former shareholders of POS Portal was paid in full during the quarter ended December 31, 2017. 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).

POS Portal is part of the Company's Worldwide Barcode, Networking and Security Segment. Network1 and Intelisys 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 Network1, Intelisys and POS Portal earnouts for the quarter and six months ended December 31, 2017. The contingent consideration due to the former shareholders of POS Portal was paid in full during the quarter ended December 31, 2017.
 
Contingent consideration for the quarter ended
 
Contingent consideration for the six months ended
 
December 31, 2017
 
December 31, 2017
 
Barcode, Networking & Security Segment
 
Communications & Services Segment
 
Total
 
Barcode, Networking & Security Segment
 
Communications & Services Segment
 
Total
 
(in thousands)
Fair value at beginning of period
$
13,167

 
$
90,326

 
$
103,493

 
$

 
$
114,036

 
$
114,036

Issuance of contingent consideration

 

 

 
13,098

 

 
13,098

Payments
(13,167
)
 

 
(13,167
)
 
(13,167
)
 
(40,858
)
 
(54,025
)
Change in fair value of contingent consideration

 
6,913

 
6,913

 
69

 
23,725

 
23,794

Foreign currency translation adjustment

 
(208
)
 
(208
)
 

 
128

 
128

Fair value at end of period
$

 
$
97,031

 
$
97,031

 
$

 
$
97,031

 
$
97,031


The table below provides a summary of the changes in fair value of the Company’s contingent considerations (Level 3) for the Imago, Network1 and Intelisys earnouts for the quarter and six months ended December 31, 2016. The contingent consideration due to the former shareholders of Imago was paid in full during the quarter ended December 31, 2016.

 
Contingent consideration for the quarter ended
 
Contingent consideration for the six months ended
 
December 31, 2016
 
December 31, 2016
 
Communications & Services Segment
 
Communications & Services Segment
 
(in thousands)
Fair value at beginning of period
$
110,835

 
$
24,652

Issuance of contingent consideration

 
95,000

Payments
(1,607
)
 
(10,241
)
Change in fair value of contingent consideration
1,791

 
1,961

Foreign currency translation adjustment
(139
)
 
(492
)
Fair value at end of period
$
110,880

 
$
110,880


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 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 United States and Brazilian markets.


19


A change in any of these unobservable inputs can significantly change the fair value of the contingent consideration. Valuation techniques and significant observable inputs used in recurring Level 3 fair value measurements for our contingent consideration liabilities as of December 31, 2017 and June 30, 2017 were as follows.

Reporting Period
 
Valuation Technique
 
Significant Unobservable Inputs
 
Weighted Average Rates
December 31, 2017
 
Discounted cash flow
 
Weighted average cost of capital
 
15.4
%
 
 
 
 
Adjusted EBITDA growth rate
 
17.9
%
 
 
 
 
 
 
 
June 30, 2017
 
Discounted cash flow
 
Weighted average cost of capital
 
14.2
%
 
 
 
 
Adjusted EBITDA growth rate
 
17.0
%

Worldwide Barcode, Networking & Security

POS Portal

The contingent consideration due to the former shareholders of POS Portal was paid in full during the quarter ended December 31, 2017. As such, no liability is recorded as of this reporting date and no change in fair value of the contingent consideration is recognized in the Condensed Consolidated Income Statements for the quarter ended December 31, 2017. For the six months ended December 31, 2017, the change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed a loss of less than $0.1 million.

Worldwide Communications & Services Segment

Intelisys

The discounted fair value of the liability for the contingent consideration due to the former shareholders of Intelisys recognized at December 31, 2017 was $90.7 million, of which $32.3 million is classified as current. The change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statement contributed a loss of $5.1 million and $9.2 million, respectively, for the quarter and six months ended December 31, 2017. The change in fair value for the quarter and six month period is primarily driven by the recurring amortization of the unrecognized fair value discount and an adjustment to the probability weights in the discounted cash flow model. Although there is no contractual limit, total future undiscounted contingent consideration payments are anticipated to range up to $115.2 million, based on the Company’s best estimate of the earnout calculated on a multiple of earnings, before interest expense, income taxes, depreciation and amortization.

The discounted fair value of the liability for the contingent consideration related to Intelisys recognized at December 31, 2016 was $98.2 million, of which $25.5 million is classified as current. The change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statement contributed a loss of $2.3 million and $3.2 million, respectively, for the quarter and six months ended December 31, 2016, primarily driven by the recurring amortization of the unrecognized fair value discount, partially offset by an increase in the discount rate used.

Network I

The discounted fair value of the liability for the contingent consideration due to the former shareholders of Network1 recognized at December 31, 2017 was $6.3 million, all of which is classified as current. For the quarter and six months ended December 31, 2017, the change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed a loss of $1.8 million and $14.5 million, respectively. The change in fair value for the quarter is primarily due to improved actual results. The change in fair value for the six month period is primarily driven by a change in estimate of the current year payment to the former shareholders of Network1, additional agreed upon adjustments to the projected final settlement and improved actual results for the second quarter. 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 $7.1 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


The discounted fair value of the liability for the contingent consideration related to Network1 recognized at December 31, 2016 was $12.7 million, of which $7.3 million is classified as current. For the quarter ended December 31, 2016, the change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed a loss of $0.2 million, primarily driven by the recurring amortization of the unrecognized fair value discount, partially offset by an increase in the discount rate used and less-than-expected results. For the six months ended December 31, 2016, the change in fair value of the contingent consideration contributed a gain of $0.1 million, primarily driven by less-than-expected actual results, partially offset by the recurring amortization of the unrecognized fair value discount. 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.

Imago

The contingent consideration due to the former shareholders of Imago was paid in full during the quarter ended December 31, 2016. The change in fair value of the contingent consideration recognized in the Consolidated Income Statements contributed a gain of $0.8 million and $1.1 million, respectively, for the quarter and six months ended December 31, 2016. The change in fair value is primarily driven by actual results that were less-than-expected, including special adjustments as determined by the stock purchase agreement. In addition, volatility in the foreign exchange rate between the British pound and the U.S. dollar drove changes in the translation of this British pound-denominated liability.

(9) Segment Information

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

Worldwide Barcode, Networking & Security Segment

The Worldwide Barcode, Networking & Security segment focuses on automatic identification and data capture ("AIDC"), point-of-sale ("POS"), payments, networking, electronic physical security and other specialty technologies. We have business units within this segment in North America, Latin America and Europe. We see adjacencies among these technologies in helping our customers 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.

Worldwide Communications & Services Segment

The Worldwide Communications & Services segment focuses on communications technologies and services. We have business units within this segment that offer voice, video conferencing, wireless, data networking, cable, collaboration, converged communications solutions, cloud and telecom services. We have business units within this segment in North America, Latin America and Europe. As these solutions come together on IP networks, new opportunities are created for customers to move into adjacent solutions for all vertical markets, such as 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 customers 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
 
Six months ended
 
December 31,
 
December 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Sales:
 
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
719,786

 
$
593,833

 
$
1,340,114

 
$
1,221,043

Worldwide Communications & Services
312,426

 
310,959

 
616,657

 
616,314

 
$
1,032,212

 
$
904,792

 
$
1,956,771

 
$
1,837,357

Depreciation and amortization:
 
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
4,843

 
$
1,718

 
$
8,584

 
$
3,355

Worldwide Communications & Services
4,173

 
4,051

 
8,431

 
6,820

Corporate
885

 
819

 
1,751

 
1,637

 
$
9,901

 
$
6,588

 
$
18,766

 
$
11,812

Change in fair value of contingent consideration:
 
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$

 
$

 
$
69

 
$

Worldwide Communications & Services
6,913

 
$
1,791

 
$
23,725

 
$
1,961

 
$
6,913

 
$
1,791

 
$
23,794

 
$
1,961

Operating income:
 
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
15,542

 
$
12,131

 
$
29,578

 
$
25,554

Worldwide Communications & Services
6,799

 
11,479

 
533

 
21,429

Corporate

 
(335
)
 
(172
)
 
(833
)
 
$
22,341

 
$
23,275

 
$
29,939

 
$
46,150

Capital expenditures:
 
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
919

 
$
523

 
$
1,740

 
$
1,378

Worldwide Communications & Services
367

 
476

 
708

 
1,091

Corporate
699

 
286

 
848

 
792

 
$
1,985

 
$
1,285

 
$
3,296

 
$
3,261

Sales by Geography Category:
 
 
 
 
 
 
 
United States and Canada
$
764,445

 
$
676,600

 
$
1,458,824

 
$
1,396,971

International(1)
276,918

 
236,977

 
514,827

 
459,742

Less intercompany sales
(9,151
)
 
(8,785
)
 
(16,880
)
 
(19,356
)
 
$
1,032,212

 
$
904,792

 
$
1,956,771

 
$
1,837,357

 
 
 
 
 
 
 
 
(1) For the quarters and six months ended December 31, 2017 and 2016, there were no sales in excess of 10% of consolidated net sales to any single international country.


22


 
December 31, 2017
 
June 30, 2017
 
(in thousands)
Assets:
 
 
 
Worldwide Barcode, Networking & Security
$
1,103,863

 
$
885,786

Worldwide Communications & Services
832,616

 
769,342

Corporate
68,803

 
63,175

 
$
2,005,282

 
$
1,718,303

Property and equipment, net by Geography Category:
 
 
 
United States and Canada
$
72,336

 
$
51,853

International
4,290

 
4,713

 
$
76,626

 
$
56,566



23


(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 expects total capital expenditures to range from $8 million to $11 million for fiscal year 2018, primarily for 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 sufficient funds to pay those obligations were escrowed or the Company is entitled to offset those obligations against future earnout payments under 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 December 31, 2017 and June 30, 2017:
 
CDC
 
Network1
 
(in thousands)
Assets
 
 
 
Prepaid expenses and other current assets
$
2,212

 
$
1,294

Other non-current assets
$

 
$
8,235

Liabilities
 
 
 
Accrued expenses and other current liabilities
$
2,212

 
$
1,294

Other long-term liabilities
$

 
$
8,235

 
 
 
 
There have been no changes in the classifications and amounts of pre-acquisition contingencies recognized from June 30, 2017.

(11) Income Taxes
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act reduces the corporate federal tax rate from 35% to 21% effective January 1, 2018 and implements a territorial tax system. Since the Company has a June 30th fiscal year-end, the lower tax rate will result in a blended U.S. statutory federal rate of approximately 28% for the fiscal year ending June 30, 2018, and 21% for subsequent fiscal years. As part of the Tax Act, U.S. companies are required to pay a one-time transition tax on the deemed repatriation of undistributed foreign earnings and remeasure deferred tax assets and liabilities.
Income taxes for the quarter and six months ended December 31, 2017 have been included in the accompanying condensed consolidated financial statements using an estimated annual effective tax rate. In addition to applying the estimated annual effective tax rate to pre-tax income, the Company also includes certain items treated as discrete events to arrive at an estimated overall tax provision. The table below summarizes the effect of discrete items on the income tax rate for the quarter and six months ended December 31, 2017.
 
Quarter ended
 
Six months ended
 
December 31, 2017
 
December 31, 2017
 
(in thousands)
Income before income taxes
$
20,310

 
$
27,090

Accrual income tax rate(1)
28.0
%
 
29.8
%
Accrued income tax expense, before discrete items
5,681

 
8,074

Discrete tax expense (benefit):
 
 
 
Transition tax on repatriation of foreign earnings
9,300

 
9,300

Remeasurement of deferred taxes (U.S.)
(3,510
)
 
(3,510
)
Remeasurement of deferred taxes (Belgium)
900

 
900

Other
(30
)
 
210

Total net discrete tax expense
6,660

 
6,900

Provision for income taxes
$
12,341

 
$
14,974

Effective income tax rate
60.8
%
 
55.3
%
Income tax rate effect of discrete items
32.8
%
 
25.5
%
 
 
 
 
(1) The estimated effect of the rate change for the quarter and six months ended December 31, 2017 is a benefit of approximately $1.6 million.

The Company’s effective tax rate of 55.3% for the six months ended December 31, 2017 differs from the current federal statutory rate of 21% primarily as a result of items recorded discretely, income derived from tax jurisdictions with varying income tax rates and the application of a blended U.S. federal rate for the current fiscal year as a result of tax reform legislation.
As part of transitioning to the territorial tax system the Tax Act includes a mandatory deemed repatriation of all undistributed foreign earnings that are subject to a U.S. income tax. For the quarter ended December 31, 2017, the Company recognized a provisional discrete income tax expense of $9.3 million for a one-time transition tax liability on total post-1986 foreign subsidiaries’ earnings and profits (“E&P”) that were previously deferred from U.S. income taxes. The Company has not yet completed the calculation of total post-1986 foreign E&P for foreign subsidiaries and the tax expense currently recognized may change as the value of cash and other specified assets changes, which is part of the basis of the transition tax. No additional income tax expense has been provided for any remaining undistributed foreign earnings not subject to the transition tax and any additional outside basis difference inherent for these entities as such amounts continue to be indefinitely reinvested in foreign operations. Further, the amount of related unrecognized deferred tax liability is under review but not practicable to estimate at this time.
As part of accounting for the Tax Act, the Company remeasured certain deferred tax assets and liabilities based on the rates at which such deferred taxes are expected to reverse in the future, which is generally 21%. For the quarter ended December 31, 2017, the Company recognized a provisional discrete income tax benefit of $3.5 million for the remeasurement of the Company’s net deferred tax liability balance. However, the Company is still analyzing certain aspects of the Tax Act and refining calculations, which are dependent on final results for fiscal year 2018, which could potentially affect the measurement of these deferred taxes or give rise to new deferred tax amounts.
At December 31, 2017, the Company has not completed accounting for the tax effects of the enactment of the Tax Act. The Securities and Exchange Commission has issued rules that would allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impact. The Company currently anticipates finalizing and recording any resulting adjustments by the end of the current fiscal year 2018. The Company made a reasonable estimate of the one-time transition tax and remeasurement of existing deferred tax balances. The transitional impacts resulted in a provisional income tax expense of $5.8 million as a discrete event for the quarter ended December 31, 2017. The Company has not been able to make a reasonable estimate for any additional outside basis difference inherent for foreign subsidiaries as these amounts continue to be reinvested in foreign operations. The Company continues to account for those items based on existing accounting under ASC 740, Income Taxes. The Company will continue to provide for U.S. income taxes for the current earnings of its Canadian subsidiary. The provisional estimates provided may be impacted by a number of additional considerations, including, but not limited to, the issuance of final regulations, the Company's ongoing analysis of the new tax law and the Company's actual earnings for the fiscal year ending June 30, 2018.
The Company had approximately $2.1 million and $2.2 million of total gross unrecognized tax benefits as of December 31, 2017 and June 30, 2017, respectively. Of this total at December 31, 2017, approximately $1.4 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.

24


The Company conducts business globally and 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 taxing authorities in countries and states in which it operates. With certain exceptions, the Company is no longer subject to federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before June 30, 2012.

The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. As of December 31, 2017 and June 30, 2017, the Company had approximately $1.2 million and $1.1 million accrued for interest and penalties, respectively.
Financial results in Belgium for the quarter and six months ended December 31, 2017 produced a pre-tax loss of approximately $1.7 million and $0.8 million, respectively. In the judgment of management, the conditions that gave rise to the recent losses are temporary and that it is more likely than not that the deferred tax asset will be realized. If Belgium business does not return to profitability as expected, this could affect the valuation of certain deferred tax assets. Belgium enacted a corporate tax reform law on December 25, 2017 which reduces the corporate tax rate from 33% to 25% over a three-year period. The Company remeasured certain deferred tax assets and liabilities based on the rates at which such deferred taxes are expected to reverse in the future. As a result, the Company recognized income tax expense of $0.9 million as a discrete event during the current quarter.


25



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 from over 500 technology suppliers and sell to over 35,000 customers in the following specialty technology markets: point-of-sale (POS), payments, barcode, physical security, unified communications and collaboration, cloud and telecom services.

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: Worldwide Barcode, Networking & Security and Worldwide Communications & Services. We operate in the United States, Canada, Latin America and Europe.

Our key vendors include Aruba/HPE, Avaya, Axis, Bematech, CenturyLink, Cisco, Comcast Business, Datalogic, Elo, Epson, Extreme, Honeywell, HP, Ingencio, Jabra, Mitel, NCR, Plantronics, Polycom, Ruckus Wireless, Toshiba Global Commerce Solutions, Verifone, Verizon, Windstream and Zebra Technologies.

Recent Developments

The Tax Cuts and Jobs Act (the "Tax Act") was enacted in the United States on December 22, 2017. The Tax Act reduces the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018, implements a territorial tax system, and requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, as well as creates new taxes on certain foreign-sourced earnings. See Note 11 - Income Taxes in the Notes to the Consolidated Financial Statements for further discussion.

On July 31, 2017 we acquired substantially all of the outstanding shares of POS Portal, a leading provider of payment devices and services primarily to the SMB market segment in the United States. POS Portal joined our Worldwide Barcode, Networking & Security operating segment. With the addition of POS Portal, we believe we have created the industry's leading payments channel, ensuring customers have access to the solutions, services and support that can help them be successful.

Our Strategy

Our objective is to continue to grow profitable sales in the technologies we sell and to focus on growth in higher margin businesses. We continue to evaluate strategic acquisitions to enhance our technological offerings and service capabilities. In doing so, we face numerous challenges that require attention and resources. Certain business units and geographies are experiencing increased competition for the products and services we sell. 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.





26


Results of Operations

Net Sales
The following tables summarize the Company’s net sales results by technology segment and by geographic location for the quarters and six months ended December 31, 2017 and 2016.
 
Quarter ended December 31,
 
 
 
% Change, Constant Currency, Excluding Acquisitions (a)
Net Sales by Segment:
2017
 
2016
 
$ Change
 
% Change
 
 
(in thousands)
 
 
 
 
Worldwide Barcode, Networking & Security
$
719,786

 
$
593,833

 
$
125,953

 
21.2
%
 
16.3
 %
Worldwide Communications & Services
312,426

 
310,959

 
1,467

 
0.5
%
 
(0.9
)%
Total net sales
$
1,032,212

 
$
904,792

 
$
127,420

 
14.1
%
 
10.4
 %
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31,
 
 
 
% Change, Constant Currency, Excluding Acquisitions (a)
 
2017
 
2016
 
$ Change
 
% Change
 
 
(in thousands)
 
 

 
 
Worldwide Barcode, Networking & Security
$
1,340,114

 
$
1,221,043

 
$
119,071

 
9.8
%
 
5.7
 %
Worldwide Communications & Services
616,657

 
616,314

 
343

 
0.1
%
 
(2.1
)%
Total net sales
$
1,956,771

 
$
1,837,357

 
$
119,414

 
6.5
%
 
3.1
 %
(a) A reconciliation of non-GAAP net sales in constant currency, excluding acquisitions is presented at the end of Results of Operations in the non-GAAP section.

Worldwide Barcode, Networking & Security

The Barcode, Networking & Security segment consists of sales to customers in North America, Europe and Latin America. For the quarter and six months ended December 31, 2017, net sales for the Barcode, Networking & Security segment increased $126.0 million and $119.1 million compared to the prior-year quarter and six month period, respectively. Excluding the foreign exchange positive impact and net sales from the POS Portal acquisition, adjusted net sales increased $96.6 million, or 16.3%, for the quarter ended December 31, 2017 and $69.5 million, or 5.7%, for the six months ended December 31, 2017. The increase in net sales and adjusted net sales for the quarter and six month period is primarily due to sales growth in North America and Europe.

Worldwide Communications & Services
The Communications & Services segment consists of sales to customers in North America, Europe and Latin America. For the quarter and six months ended December 31, 2017, net sales for the Communications & Services segment increased $1.5 million, and $0.3 million, compared to the prior-year quarter and six month period, respectively. Excluding the foreign exchange impact, adjusted net sales decreased $2.7 million, or 0.9%, for the quarter ended December 31, 2017 as a result of lower sales volume in our North American business, excluding Intelisys, partially offset by sales growth in Brazil. Intelisys sales increased quarter-over-quarter. Excluding the foreign exchange impact and net sales from the Intelisys acquisition for the three months ended September 30, 2017, adjusted net sales decreased $13.1 million, or 2.1%, for the six months ended December 31, 2017, primarily due to lower sales volume in our North American business, partially offset by sales growth in Brazil.

27


 
Quarter ended December 31,
 
 
 
% Change, Constant Currency, Excluding Acquisitions (a)
Net Sales by Geography:
2017
 
2016
 
$ Change
 
% Change
 
 
(in thousands)
 
 
 
 
United States and Canada
$
755,312

 
$
667,818

 
$
87,494

 
13.1
%
 
10.2
%
International
$
276,900

 
$
236,974

 
39,926

 
16.8
%
 
11.0
%
Total net sales
$
1,032,212

 
$
904,792

 
$
127,420

 
14.1
%
 
10.4
%
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31,
 
 
 
% Change, Constant Currency, Excluding Acquisitions (a)
 
2017
 
2016
 
$ Change
 
% Change
 
 
(in thousands)
 
 
 
 
United States and Canada
$
1,441,982

 
$
1,377,627

 
$
64,355

 
4.7
%
 
1.7
%
International
514,789

 
459,730

 
55,059

 
12.0
%
 
7.2
%
Total net sales
$
1,956,771

 
$
1,837,357

 
$
119,414

 
6.5
%
 
3.1
%
(a) A reconciliation of non-GAAP net sales in constant currency, excluding acquisitions is presented at the end of Results of Operations in the non-GAAP section.

Gross Profit
The following table summarizes the Company’s gross profit for the quarters and six months ended December 31, 2017 and 2016:
 
Quarter ended December 31,
 
 
 
 
 
% of Net Sales December 31,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
(in thousands)
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
61,983

 
$
48,956

 
$
13,027

 
26.6
%
 
8.6
%
 
8.2
%
Worldwide Communications & Services
50,988

 
49,578

 
1,410

 
2.8
%
 
16.3
%
 
15.9
%
Gross profit
$
112,971

 
$
98,534

 
$
14,437

 
14.7
%
 
10.9
%
 
10.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31,
 
 
 
 
 
% of Net Sales December 31,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
(in thousands)
 
 
 
 
 
 
Worldwide Barcode, Networking & Security
$
119,446

 
$
98,207

 
$
21,239

 
21.6
%
 
8.9
%
 
8.0
%
Worldwide Communications & Services
99,442

 
91,861

 
7,581

 
8.3
%
 
16.1
%
 
14.9
%
Gross profit
$
218,888

 
$
190,068

 
$
28,820

 
15.2
%
 
11.2
%
 
10.3
%
 
 
 
 
 
 
 
 
 
 
 
 

Worldwide Barcode, Networking & Security

Gross profit dollars and gross profit margin for the Barcode, Networking & Security segment increased for the quarter and six months ended December 31, 2017, compared to the prior-year quarter and six month period. For the quarter, gross profit dollars and margin increased primarily as a result of increased sales volumes, including results contributed by POS Portal. Gross profit dollars and margin increased for the six month period largely due to improved vendor program recognition and the addition of POS Portal.

Worldwide Communications & Services

In the Communications & Services segment, gross profit dollars and gross profit margin increased for the quarter and six months ended December 31, 2017 compared to the prior-year quarter and six month period. Results for the quarter increased due to higher sales contributed by Intelisys. Gross profit dollars and gross profit margin increased for the six months ended December 31, 2017 largely due to improved sales mix.

28



Operating Expenses

The following table summarizes our operating expenses for the quarters and six months ended December 31, 2017 and 2016:
 
Quarter ended December 31,
 
 
 
 
 
% of Net Sales December 31,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
(in thousands)
 
 
 
 
 
 
Selling, general and administrative expenses
$
74,763

 
$
66,880

 
$
7,883

 
11.8
%
 
7.2
%
 
7.4
%
Depreciation expense
3,467

 
2,423

 
1,044

 
43.1
%
 
0.3
%
 
0.3
%
Intangible amortization expense
5,487

 
4,165

 
1,322

 
31.7
%
 
0.5
%
 
0.5
%
Change in fair value of contingent consideration
6,913

 
1,791

 
5,122

 
286.0
%
 
0.7
%
 
0.2
%
Operating expenses
$
90,630

 
$
75,259

 
$
15,371

 
20.4
%
 
8.8
%
 
8.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31,
 
 
 
 
 
% of Net Sales December 31,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
(in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative expenses
$
147,950

 
$
130,145

 
$
17,805

 
13.7
%
 
7.6
%
 
7.1
%
Depreciation expense
6,707

 
4,492

 
2,215

 
49.3
%
 
0.3
%
 
0.2
%
Intangible amortization expense
10,498

 
7,320

 
3,178

 
43.4
%
 
0.5
%
 
0.4
%
Change in fair value of contingent consideration
23,794

 
1,961

 
21,833

 
1,113.4
%
 
1.2
%
 
0.1
%
Operating expenses
$
188,949

 
$
143,918

 
$
45,031

 
31.3
%
 
9.7
%
 
7.8
%

Selling, general and administrative expenses ("SG&A") increased $7.9 million and $17.8 million for the quarter and six months ended December 31, 2017, respectively, as compared to the prior year. The increase in SG&A for the quarter and six months is primarily due to increased employee-related expenses, largely due to recent acquisitions.

The increase in depreciation expense for the quarter and