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 December 31, 2015.

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, 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	$	17,556	$	17,556	$	—	$	—
Forward foreign currency exchange contracts	396		—		396		—
Total assets at fair value	$	17,952	$	17,556	$	396	$	—
Liabilities:
Deferred compensation plan investments, current and non-current portion	$	17,556	$	17,556	$	—	$	—
Forward foreign currency exchange contracts	973		—		973		—
Liability for contingent consideration, current and non-current portion	24,000		—		—		24,000
Total liabilities at fair value	$	42,529	$	17,556	$	973	$	24,000

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.

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 six months ended December 31, 2015:



	Contingent consideration for the quarter ended									Contingent consideration for the six months ended
	December 31, 2015									December 31, 2015
	Barcode & Security Segment			Communications & Services Segment			Total			Barcode & Security Segment			Communications & Services Segment			Total
	(in thousands)
Fair value at beginning of period	$	4,114		$	24,943		$	29,057		$	5,109		$	28,851		$	33,960
Payments	(3,133		)	(4,153		)	(7,286		)	(3,133		)	(4,153		)	(7,286		)
Change in fair value of contingent consideration	—			1,816			1,816			126			3,255			3,381
Foreign currency translation adjustment	175			238			413			(946		)	(5,109		)	(6,055		)
Fair value at end of period	$	1,156		$	22,844		$	24,000		$	1,156		$	22,844		$	24,000

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 six months ended December 31, 2014:



	Contingent consideration for the quarter ended									Contingent consideration for the six months ended
	December 31, 2014									December 31, 2014
	Barcode & Security Segment			Communications & Services Segment			Total			Barcode & Security Segment			Communications & Services Segment			Total
	(in thousands)
Fair value at beginning of period	$	5,194		$	4,968		$	10,162		$	11,107		$	—		$	11,107
Issuance of contingent consideration	—			—			—			—			4,983			4,983
Payments	—			—			—			(5,529		)	—			(5,529		)
Change in fair value of contingent consideration	160			303			463			658			318			976
Foreign currency translation adjustment	(402		)	(218		)	(620		)	(1,284		)	(248		)	(1,532		)
Fair value at end of period	$	4,952		$	5,053		$	10,005		$	4,952		$	5,053		$	10,005

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.

Barcode and Security Segment

The fair value of the liability for the contingent consideration related to CDC recognized at December 31, 2015 was $1.2 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 December 31, 2015, therefore, no change in the fair value of the contingent consideration is recognized in the Condensed Consolidated Income Statements for the quarter ended December 31, 2015. For the six month period ended December 31, 2015, 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.

Communications and Services Segment

The fair value of the liability for the contingent consideration related to Imago ScanSource recognized at December 31, 2015 was $2.9 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 expense of $0.3 million and $0.7 million for the quarter and six months ended December 31, 2015. The change for the quarter and six month period is primarily driven by the recurring amortization of the unrecognized fair value discount and better than expected results. 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 $3.3 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 December 31, 2015 was $19.9 million, of which $8.5 million is classified as current. The change in fair value of the contingent consideration recognized in the Condensed Consolidated Income Statements contributed expense of $1.5 million and $2.6 million for the quarter and six months ended December 31, 2015. The change for the quarter and six month period is largely driven by the recurring amortization of the unrecognized fair value discount and better than expected actual results, partially offset by an increased discount rate. 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 $26.3 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.