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Acquisitions
3 Months Ended
Sep. 30, 2011
Acquisitions 
Acquisitions

(5) Acquisitions

CDC Brasil, S.A.

On April 15, 2011, the Company, through its wholly-owned subsidiary, ScanSource do Brasil Participações LTDA, completed its acquisition of 100% of the shares of CDC, Brazil's leading distributor of AIDC and POS solutions. This acquisition gives the Company an established presence in South America's largest specialty technology market and will allow the Company to more easily scale its South American operations.

Under the Share Purchase and Sale Agreement, the Company structured the purchase transaction as an all cash share purchase with an initial payment of $36.2 million, net of cash acquired, and assumed working capital payables and debt at closing. The remaining purchase price will be paid in annual cash installments based upon the financial performance of CDC for the twelve month periods ended on June 30, from 2011 through 2015.

The following table summarizes preliminary fair value assessment of the assets acquired and liabilities assumed as of the acquisition date:

 

                 
     April 15, 2011  
     (in thousands)  

Consideration

         

Initial cash payment, net of cash acquired

    $ 36,228           

Fair value of earnout obligation

      23,952           
    

 

 

          

Total consideration

            $ 60,180   

Recognized amounts of identifiable assets acquired and liabilities assumed

                 

Accounts receivable, net of allowance

      21,378           

Inventories

      30,560           

Prepaid expenses and other assets

      3,575           

Deferred income taxes, net

      1,409           

Property and equipment, net

      1,741           

Intangible assets

      18,327           

Other assets

      16,013           

Short-term borrowings

      (1,277 )         

Accounts payable

      (34,006 )         

Accrued expenses and other liabilities

      (3,896 )         

Income taxes payable

      (2,097 )         

Other long-term liabilities

      (16,190 )         
    

 

 

          

Total identifiable net assets

              35,537   
            

 

 

  

Goodwill

            $ 24,643   
            

 

 

  

The Company's valuation of CDC's identified intangibles, contingent consideration, pre-acquisition contingencies and goodwill is incomplete as of the date of the Company's previous filing on the Company's Form 10-K for the year ended June 30, 2011 as well as of the date of this filing on Form 10-Q for the quarter ended September 30, 2011. ASC 805, Business Combinations, allows a measurement period in which companies may have up to one year to complete valuations of acquired companies. The values assigned to identifiable intangible assets, pre-acquisition contingencies, contingent consideration and goodwill may change due to revised and more appropriate assumptions and methodologies used in the third-party valuation of CDC's assets acquired and liabilities assumed. Additionally, the Company is still assessing the likelihood and valuation of the pre-acquisition contingencies identified in the due diligence process related to specific local tax contingencies. For events and circumstances existing on the acquisition date, significant changes to the purchase accounting will be retrospectively applied to the Company's comparative financial statements in accordance with ASC 805 within the applicable measurement period. Any changes to CDC opening balances outside of the appropriate measurement period will be reflected through current period earnings.

 

The Company used a combination of the market, cost and income approaches to estimate the fair values of CDC's assets acquired and liabilities assumed. The following table summarizes the amounts assigned to intangible assets from the purchase price:

 

         
     Amount  
     (in thousands)  

Indentified intangible assets

         

Trade names (2 year useful life)

    $ 2,746   

Customer relationships (6 year useful life)

      14,687   

Non-compete agreements (5 year useful life)

      894   
    

 

 

  

Total identified intangible assets

    $ 18,327   
    

 

 

  

The amounts recognized for the abovementioned intangible assets are preliminary and subject to change as the Company is still in process of finalizing its valuation of assets acquired and liabilities assumed. The weighted average amortization period is six years.

To estimate the fair value of the trade names, the Company used a form of the income approach using significant unobservable inputs (Level 3), in which the Company estimated the savings that would be realized from not having to pay a royalty for the use of the trade names. The Company identified reasonable market royalty rates that would be charged by a licensor to the licensee of the trade names and applied the market royalty rate to the revenue stream expected to be generated from using the trade names. The Company then tax-effected the royalty savings using the local corporate income tax rate and discounted the after-tax royalty savings over the estimated economic life of the asset.

To estimate the fair value of the customer relationships, the Company used a form of the income approach using significant unobservable inputs (Level 3), in which the Company estimated the value of the intangible asset by discounting future cash flows and applying charges for the Company's other contributory assets. The Company identified various revenue streams to different sets of customers and adjusted future revenues for reseller attrition based on historical attrition rates. The Company then applied an estimated industry operating margin factor to applicable, projected revenues to estimate the total operating income from the existing customer relationships. The Company used an industry margin-based rate, because it was determined that any margin in excess of this rate was due to other factors not separately identifiable. Projected, after-tax operating margin was then reduced by the Company's required rates of return for other contributory assets. The net cash flows attributable to customer relationships were then discounted to determine the amount allocated from the purchase price.

To estimate the fair value of the non-compete agreements, the Company used a form of the income approach using significant unobservable inputs (Level 3), in which the Company estimated the amount of revenue and operating income that would be lost if these key employees were not bound by the non-compete agreements and joined or started another a competing business. To do so, the Company estimated the market share that would be lost in future years, considering the favorable impact of the earnout that would reduce the likelihood of these key employees from leaving the Company through fiscal 2015. The Company then estimated the operating margin on the future, lost revenues and tax-effected that margin at the local corporate income tax rate. The after-tax projected operating margin was then discounted to determine the fair value of the non-compete agreements.

The discount rates used to calculate the present value of the cash flow streams of each of the identified intangible assets from the CDC acquisition was prepared on a debt-free basis, which excludes any provision for debt service and reflects the cash flows available for distribution to all suppliers of capital (both debt and equity). Accordingly, the discount rate applied to the free cash flows reflects the return required by all providers of capital weighted by their relative contribution to the total capital of the business (on a market value basis). This discount rate represents CDC's weighted average cost of capital.

The fair value of the liability for the contingent consideration recognized at September 30, 2011 was $21.3 million, of which an estimated $2.1 million is expected to be paid during the quarter ended December 31, 2011. 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 sheet as of September 30, 2011. The U.S. dollar amounts of actual disbursements made in conjunction with future earnout payments are subject to change as the liability is denominated in Brazilian reais and subject to foreign exchange fluctuation risk. The remaining balance of $19.1 million is recorded in the "long-term portion of contingent consideration" line item on the Company's condensed consolidated balance sheet as of September 30, 2011. Although there is no contractual limit, total future undiscounted contingent consideration payments can range from $2.1 million, which is the portion expected to be paid during the quarter ended December 31, 2011, up to $52.1 million, based on the Company's best estimate as the earnout is based on a multiple of adjusted earnings as defined in the Share Purchase and Sale Agreement.

 

Also in accordance with ASC 805, the Company will revalue the contingent consideration liability 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 statement that is included in the calculation of operating income. The fair value of the contingent consideration liability associated with future earnout payments is based on several factors, including:

 

  •  

estimated future results, net of pro forma adjustments;

 

  •  

the probability of achieving these results; and

 

  •  

a discount rate reflective of the Company's creditworthiness and market risk premium associated with the Brazilian market.

The change in fair value of the contingent consideration recognized in the condensed consolidated financial statements for the quarter ended September 30, 2011 increased operating expenses by $0.9 million.

The Company included an estimated $14.1 million in other long-term liabilities for pre-acquisition contingencies for provincial and local tax liabilities that were identified in the Company's due diligence process. The Company is able to record equal and offsetting indemnification assets as the contingencies were escrowed in the Share Purchase and Sale Agreement in other assets. As part of the initial payment, the sellers placed $27.4 million into a special and exclusive bank account to be released according to the specifications of the Share Purchase and Sale Agreement. However, indemnity claims can be made up to the entire purchase price. The estimated undiscounted range of indemnification assets and corresponding contingent liabilities is between $5.1 million and $22.9 million. As the Company is still in the process of gathering more information regarding the timing and amounts of these escrowed contingencies, the liabilities and corresponding receivables from sellers are subject to change until settlement. Any changes based on facts that existed as of the acquisition date within the ASC 805 measurement period will be adjusted through purchase accounting and potentially the goodwill associated with the purchase of CDC. Subsequent to the ASC 805 measurement period, adjustments will be made through the income statement.