SCANSOURCE, INC. 10-Q

Item 1. Financial Statements SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands, except share information) September 30, 2023 June 30, 2023 Assets Current assets: Cash and cash equivalents $ 42,647 $ 36,178 Accounts receivable, less allowance of $ 19,570 at September 30, 2023 and $ 15,480 at June 30, 2023 691,669 753,236 Inventories 656,170 757,574 Prepaid expenses and other current assets 116,949 110,087 Total current assets 1,507,435 1,657,075 Property and equipment, net 36,745 37,379 Goodwill 215,152 216,706 Identifiable intangible assets, net 63,675 68,495 Deferred income taxes 16,421 17,764 Other non-current assets 59,107 70,750 Total assets $ 1,898,535 $ 2,068,169 Liabilities and Shareholders’ Equity Current liabilities: Accounts payable $ 617,594 $ 691,119 Accrued expenses and other current liabilities 67,138 78,892 Income taxes payable 8,108 9,875 Current portion of long-term debt 8,209 6,915 Total current liabilities 701,049 786,801 Deferred income taxes 3,679 3,816 Long-term debt, net of current portion 141,774 144,006 Borrowings under revolving credit facility 98,125 178,980 Other long-term liabilities 38,655 49,268 Total liabilities 983,282 1,162,871 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, 24,960,231 and 24,844,203 shares issued and outstanding at September 30, 2023 and June 30, 2023, respectively 59,501 58,241 Retained earnings 952,110 936,678 Accumulated other comprehensive loss ( 96,358 ) ( 89,621 ) Total shareholders’ equity 915,253 905,298 Total liabilities and shareholders’ equity $ 1,898,535 $ 2,068,169 June 30, 2023 amounts are derived from audited consolidated financial statements. See accompanying notes to these condensed consolidated financial statements. 5 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED) (In thousands, except per share data) Quarter ended September 30, 2023 2022 Net sales $ 876,305 $ 943,813 Cost of goods sold 769,797 830,328 Gross profit 106,508 113,485 Selling, general and administrative expenses 75,436 71,593 Depreciation expense 2,795 2,763 Intangible amortization expense 4,193 4,241 Operating income 24,084 34,888 Interest expense 5,585 3,448 Interest income ( 1,325 ) ( 1,589 ) Other expense, net 677 746 Income before income taxes 19,147 32,283 Provision for income taxes 3,715 8,241 Net income $ 15,432 $ 24,042 Per share data: Net income per common share, basic $ 0.62 $ 0.95 Weighted-average shares outstanding, basic 24,886 25,201 Net income per common share, diluted $ 0.61 $ 0.94 Weighted-average shares outstanding, diluted 25,178 25,451 See accompanying notes to these condensed consolidated financial statements. 6 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (In thousands) Quarter ended September 30, 2023 2022 Net income $ 15,432 $ 24,042 Unrealized gain on hedged transaction, net of tax 153 1,879 Foreign currency translation adjustment ( 6,890 ) ( 7,217 ) Comprehensive income $ 8,695 $ 18,704 See accompanying notes to these condensed consolidated financial statements. 7 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) (In thousands, except share information) Common Stock (Shares) Common Stock (Amount) Retained Earnings Accumulated Other Comprehensive Loss Total Balance at June 30, 2023 24,844,203 $ 58,241 $ 936,678 $ ( 89,621 ) $ 905,298 Net income — — 15,432 — 15,432 Unrealized gain on hedged transaction, net of tax — — — 153 153 Foreign currency translation adjustment — — — ( 6,890 ) ( 6,890 ) Exercise of stock options and shares issued under share-based compensation plans, net of shares withheld for employee taxes 116,028 ( 1,510 ) — — ( 1,510 ) Share-based compensation — 2,770 — — 2,770 Balance at September 30, 2023 24,960,231 $ 59,501 $ 952,110 $ ( 96,358 ) $ 915,253 See accompanying notes to these condensed consolidated financial statements. 8 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) (In thousands, except share information) Common Stock (Shares) Common Stock (Amount) Retained Earnings Accumulated Other Comprehensive Loss Total Balance at June 30, 2022 25,187,351 $ 64,297 $ 846,869 $ ( 104,638 ) $ 806,528 Net income — — 24,042 — 24,042 Unrealized gain on hedged transaction, net of tax — — — 1,879 1,879 Foreign currency translation adjustment — — — ( 7,217 ) ( 7,217 ) Exercise of stock options and shares issued under share-based compensation plans, net of shares withheld for employee taxes 38,551 ( 586 ) — — ( 586 ) Share-based compensation — 2,358 — — 2,358 Balance at September 30, 2022 25,225,902 $ 66,069 $ 870,911 $ ( 109,976 ) $ 827,004 See accompanying notes to these condensed consolidated financial statements. 9 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) Quarter ended September 30, 2023 2022 Cash flows from operating activities: Net income $ 15,432 $ 24,042 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 7,217 7,228 Amortization of debt issue costs 96 289 Provision for doubtful accounts 4,157 125 Share-based compensation 2,769 2,316 Deferred income taxes 1,303 2,274 Finance lease interest 15 2 Changes in operating assets and liabilities: Accounts receivable 53,284 ( 18,799 ) Inventories 99,630 ( 62,192 ) Prepaid expenses and other assets ( 7,743 ) 14,690 Other non-current assets 11,227 ( 9,469 ) Accounts payable ( 70,292 ) ( 1,053 ) Accrued expenses and other liabilities ( 21,764 ) ( 13,168 ) Income taxes payable ( 1,798 ) 5,256 Net cash provided by (used in) operating activities 93,533 ( 48,459 ) Cash flows from investing activities: Capital expenditures ( 2,315 ) ( 684 ) Net cash used in investing activities ( 2,315 ) ( 684 ) Cash flows from financing activities: Borrowings on revolving credit, net of expenses 588,570 579,011 Repayments on revolving credit, net of expenses ( 669,424 ) ( 542,147 ) (Repayments) borrowings on long-term debt, net ( 938 ) 18,402 Repayments on finance lease obligation ( 191 ) ( 303 ) Debt issuance costs — ( 1,407 ) Exercise of stock options 72 10 Taxes paid on settlement of equity awards ( 1,582 ) ( 596 ) Net cash (used in) provided by financing activities ( 83,493 ) 52,970 Effect of exchange rate changes on cash and cash equivalents ( 1,256 ) ( 1,342 ) Increase in cash and cash equivalents 6,469 2,485 Cash and cash equivalents at beginning of period 36,178 37,987 Cash and cash equivalents at end of period $ 42,647 $ 40,472 See accompanying notes to these condensed consolidated financial statements. 10 Table of Contents SCANSOURCE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) Business and Summary of Significant Accounting Policies Business Description ScanSource, Inc. (together with its subsidiaries referred to as “the Company” or “ScanSource”) is a leading hybrid distributor connecting devices to the cloud and accelerating growth for partners across hardware, Software as a Service ("SaaS"), connectivity and cloud. The Company brings technology solutions and services from the world’s leading suppliers of mobility and barcode, point-of-sale ("POS"), payments, networking, physical security, unified communications and collaboration, telecom and cloud services to market. The Company operates in the United States, Canada, Brazil and the United Kingdom ("UK"). The Company's two operating segments, Specialty Technology Solutions and Modern Communications & Cloud, are based on technology type and are generally related to technology devices and communication, connectivity and cloud services, respectively. 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 at September 30, 2023 and June 30, 2023, the results of operations for the quarters ended September 30, 2023 and 2022, the condensed consolidated statements of comprehensive income for the quarters ended September 30, 2023 and 2022, the condensed consolidated statements of shareholders' equity for the quarters ended September 30, 2023 and 2022 and the condensed consolidated statements of cash flows for the quarters ended September 30, 2023 and 2022. The results of operations for the quarter ended September 30, 2023 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, 2023. Unless otherwise indicated, disclosures provided in the Notes pertain to continuing operations only. Summary of Significant Accounting Policies There have been no material changes to the Company’s significant accounting policies for the quarter ended September 30, 2023 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, 2023. 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, 2023. 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 $ 10.3 million and $ 8.0 million are included in accounts payable on the condensed consolidated balance sheets at September 30, 2023 and June 30, 2023, respectively. Long-lived Assets 11 Table of Contents The Company presents depreciation expense and intangible amortization expense on the condensed consolidated income statements. The Company's depreciation expense related to selling, general and administrative costs totaled $ 2.8 million for the quarters ended September 30, 2023 and 2022. Depreciation expense reported as part of cost of goods sold on the condensed consolidated income statements totaled $ 0.2 million for the quarters ended September 30, 2023 and 2022. The Company's intangible amortization expense reported on the condensed consolidated income statements relates to selling, general and administrative costs, not the cost of selling goods. Intangible amortization expense totaled $ 4.2 million for the quarters ended September 30, 2023 and 2022. Recent Accounting Pronouncements In July 2023, the Securities and Exchange Commission issued final rules that require new and enhanced disclosures on cybersecurity risk management, strategy, governance, and incident reporting. Under the final rules, companies must report material cybersecurity incidents within four business days of determining the incident is material on Form 8-K. As additional information about the material aspects of the previously reported incidents become available, a Form 8-K/A must be filed with the additional disclosures. These disclosure requirements on Form 8-K are effective beginning December 18, 2023. For fiscal years ending on or after December 15, 2023, companies must disclose their cybersecurity processes, management's role in cybersecurity governance, and cybersecurity oversight by the Board of Directors on Form 10-K. The Company has reviewed 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) Trade Accounts and Notes Receivable, Net The Company maintains an allowance for doubtful accounts receivable for estimated future expected credit losses resulting from customers’ failure to make payments on accounts receivable due to the Company. The Company has notes receivable with certain customers, which are included in “Accounts receivable, less allowance” in the Condensed Consolidated Balance Sheets. Management determines the estimate of the allowance for doubtful accounts receivable by considering a number of factors, including: (i) historical experience, (ii) aging of the accounts receivable, (iii) specific information obtained by the Company on the financial condition and the current creditworthiness of its customers, (iv) the current economic and country-specific environment and (v) reasonable and supportable forecasts about collectability. Expected credit losses are estimated on a pool basis when similar risk characteristics exist using an age-based reserve model. Receivables that do not share risk characteristics are evaluated on an individual basis. Estimates of expected credit losses on trade receivables over the contractual life are recorded at inception and adjusted over the contractual life. The changes in the allowance for doubtful accounts for the three months ended September 30, 2023 are set forth in the table below. June 30, 2023 Amounts Charged to Expense Write-offs Other (1) September 30, 2023 (in thousands) Trade accounts and current notes receivable allowance $ 15,480 $ 4,157 $ ( 594 ) $ 527 $ 19,570 (1) "Other" amounts include recoveries and the effect of foreign currency fluctuations for the three months ended September 30, 2023. (3) Revenue Recognition The Company provides technology solutions and services from the world's leading suppliers of mobility, barcode, POS, payments, physical security, unified communications, collaboration, telecom and cloud services. This includes hardware, related accessories and device configuration as well as software licenses, professional services and hardware support programs. 12 Table of Contents In determining the appropriate amount of revenue to recognize, the Company applies the following five-step model: (i) identify contracts with customers; (ii) identify performance obligations in the contracts; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations per the contracts; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company recognizes revenue as control of products and services are transferred to customers, which is generally at the point of shipment. The Company delivers products to customers in several ways, including: (i) shipment from a Company warehouse, (ii) drop-shipment directly from the supplier, or (iii) electronic delivery for non-physical products. Principal versus Agent Considerations The Company is the principal for sales of all hardware and certain software and services. The Company considers itself the principal in those transactions where it has control of the product or service before it is transferred to the customer. The Company recognizes the principal-associated revenue and cost of goods sold on a gross basis. The Company is the agent for third-party service contracts, including product warranties and supplier-hosted software. These service contracts are sold separately from the products, and the Company often serves as the agent for the contract on behalf of the original equipment manufacturer. The Company's responsibility is to arrange for the provision of the specified service by the original equipment manufacturer, and the Company does not control the specified service before it is transferred to the customer. Because the Company acts as an agent, revenue is recognized net of cost at the time of sale. The Intelisys business operates under an agency model. Variable Considerations For certain transactions, products are sold with a right of return and may also provide other rebates or incentives, which are accounted for as variable consideration. The Company estimates a returns allowance based on historical experience and reduces revenue accordingly. The Company estimates the amount of variable consideration for rebates and incentives by using the expected value to be given to the customer and reduces the revenue by those estimated amounts. These estimates are reviewed and updated as necessary at the end of each reporting period. Contract Balances The Company records contract assets and liabilities for payments received from customers in advance of services performed. These assets and liabilities are the result of the sales of the Company's self-branded warranty programs and other transactions where control has not yet passed to the customer. These amounts are immaterial to the consolidated financial statements for the periods presented. Disaggregation of Revenue The following tables represent the Company's disaggregation of revenue: Quarter ended September 30, 2023 Specialty Technology Solutions Modern Communications & Cloud Total (in thousands) Revenue by product/service Hardware, software and cloud (excluding Intelisys) $ 509,570 $ 346,232 $ 855,802 Intelisys connectivity and cloud — 20,503 20,503 $ 509,570 $ 366,735 $ 876,305 13 Table of Contents Quarter ended September 30, 2022 Specialty Technology Solutions Modern Communications & Cloud Total (in thousands) Revenue by product/service Hardware, software and cloud (excluding Intelisys) $ 576,329 $ 348,631 $ 924,960 Intelisys connectivity and cloud — 18,853 18,853 $ 576,329 $ 367,484 $ 943,813 (4) 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 September 30, 2023 2022 (in thousands, except per share data) Numerator: Net income $ 15,432 $ 24,042 Denominator: Weighted-average shares, basic 24,886 25,201 Dilutive effect of share-based payments 292 250 Weighted-average shares, diluted 25,178 25,451 Net income per common share, basic $ 0.62 $ 0.95 Net income per common share, diluted $ 0.61 $ 0.94 For the quarters ended September 30, 2023 and 2022, weighted-average shares outstanding excluded from the computation of diluted earnings per share because their effect would be anti-dilutive were 854,893 and 1,128,445 , respectively. (5) Accumulated Other Comprehensive Loss The components of accumulated other comprehensive loss, net of tax are as follows: September 30, 2023 June 30, 2023 (in thousands) Foreign currency translation adjustment $ ( 100,026 ) $ ( 93,136 ) Unrealized gain on hedged transaction, net of tax 3,668 3,515 Accumulated other comprehensive loss $ ( 96,358 ) $ ( 89,621 ) The tax effect of amounts in comprehensive loss reflect a tax (benefit) expense as follows: Quarter ended September 30, 2023 2022 (in thousands) Tax (benefit) expense $ ( 54 ) $ 414 14 Table of Contents (6) Goodwill and Other Identifiable Intangible Assets The changes in the carrying amount of goodwill for the quarter ended September 30, 2023, by reporting segment, are set forth in the table below. Specialty Technology Solutions Modern Communications & Cloud Total (in thousands) Balance at June 30, 2023 $ 16,370 $ 200,336 $ 216,706 Foreign currency translation adjustment — ( 1,554 ) ( 1,554 ) Balance at September 30, 2023 $ 16,370 $ 198,782 $ 215,152 The following table shows changes in the amount recognized for net identifiable intangible assets for the three months ended September 30, 2023. Net Identifiable Intangible Assets (in thousands) Balance at June 30, 2023 $ 68,495 Amortization expense ( 4,193 ) Foreign currency translation adjustment ( 627 ) Balance at September 30, 2023 $ 63,675 (7) Short-Term Borrowings and Long-Term Debt The following table presents the Company’s debt at September 30, 2023 and June 30, 2023. September 30, 2023 June 30, 2023 (in thousands) Current portion of long-term debt $ 8,209 $ 6,915 Mississippi revenue bond, net of current portion 3,024 3,381 Senior secured term loan facility, net of current portion 138,750 140,625 Borrowings under revolving credit facility 98,125 178,980 Total debt $ 248,108 $ 329,901 Credit Facility The Company has a multi-currency senior secured credit facility (as amended, the "Amended Credit Agreement") with JPMorgan Chase Bank N.A., as administrative agent, and a syndicate of banks (collectively the "Lenders"). On September 28, 2022, the Company amended and restated the Amended Credit Agreement, which includes (i) a five-year , $ 350 million multicurrency senior secured revolving credit facility and (ii) a five-year $ 150 million senior secured term loan facility. The Amended Credit Agreement extended the credit facility maturity date to September 28, 2027. In addition, pursuant to an “accordion feature,” the Company may increase its borrowings up to an additional $ 250 million, subject to obtaining additional credit commitments from the lenders participating in the increase. The Amended Credit Agreement allows for the issuance of up to $ 50 million for letters of credit. Borrowings under the Amended Credit Agreement are guaranteed by substantially all of the domestic assets of the Company and its domestic subsidiaries. Under the terms of the revolving credit facility, the payment of cash dividends is restricted. The Company incurred debt issuance costs of $ 1.4 million in connection with the amendment and restatement of the Amended Credit Agreement. These costs were capitalized to other non-current assets on the Condensed Consolidated Balance Sheets and added to the unamortized debt issuance costs from the previous credit facility. Loans denominated in U.S. dollars, other than swingline loans, bear interest at a rate per annum equal to, at the Company’s option, (i) the adjusted term Secured Overnight Financing Rate ("SOFR") or adjusted daily simple SOFR plus an additional margin ranging from 1.00 % to 1.75 % depending upon the Company’s ratio of (A) total consolidated debt less up to $ 30 million 15 Table of Contents of unrestricted domestic cash to (B) trailing four-quarter consolidated EBITDA measured as of the end of the most recent year or quarter, as applicable, for which financial statements have been delivered to the Lenders (the “leverage ratio”); or (ii) the alternate base rate plus an additional margin ranging from 0 % to 0.75 %, depending upon the Company’s leverage ratio, plus, if applicable, certain mandatory costs. All swingline loans denominated in U.S. dollars bear interest based upon the adjusted daily simple SOFR plus an additional margin ranging from 1.00 % to 1.75 % depending upon the Company's leverage ratio, or such other rate as the Company and the applicable swingline lender may agree. The adjusted term SOFR and adjusted daily simple SOFR include a fixed credit adjustment of 0.10 % over the applicable SOFR reference rate. Loans denominated in foreign currencies bear interest at a rate per annum equal to the applicable benchmark rate set forth in the Amended Credit Agreement plus an additional margin ranging from 1.00 % to 1.75 %, depending upon the Company’s leverage ratio plus, if applicable, certain mandatory costs. During the quarter ended September 30, 2023, the Company's borrowings under the credit facility were U.S. dollar loans. The spread in effect as of September 30, 2023 was 1.50 %, plus a 0.10 % credit spread adjustment for SOFR-based loans and 0.50 % for alternate base rate loans. The commitment fee rate in effect at September 30, 2023 was 0.25 %. The Amended Credit Agreement includes customary representations, warranties and affirmative and negative covenants, including financial covenants. Specifically, the Company’s Leverage Ratio must be less than or equal to 3.50 to 1.00 at all times. In addition, the Company’s Interest Coverage Ratio (as such term is defined in the Amended Credit Agreement) must be at least 3.00 to 1.00 at the end of each fiscal quarter. In the event of a default, customary remedies are available to the lenders, including acceleration and increased interest rates. The Company was in compliance with all covenants under the credit facility at September 30, 2023. The average daily outstanding balance on the revolving credit facility, excluding the term loan facility, during the three month periods ended September 30, 2023 and 2022 was $ 200.9 million and $ 200.5 million, respectively. There was $ 251.9 million and $ 171.0 million available for additional borrowings as of September 30, 2023 and June 30, 2023, respectively. The effective interest rates for the revolving line of credit were 6.92 % and 6.74 % as of September 30, 2023 and June 30, 2023, respectively. There were no letters of credit issued under the multi-currency revolving credit facility at September 30, 2023 or June 30, 2023. Mississippi Revenue Bond 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. The bond accrues interest at the one-month term SOFR plus an adjustment of 0.10 % 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. 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. At September 30, 2023, the Company was in compliance with all covenants under this bond. The interest rates at September 30, 2023 and June 30, 2023 were 6.28 % and 6.11 %, respectively. Debt Issuance Costs At September 30, 2023, 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. (8) Derivatives and Hedging Activities The Company's results of operations could be materially impacted by significant changes in foreign currency exchange rates and interest rates. In an effort to manage the exposure to these risks, the Company periodically enters into various derivative instruments. The Company's accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments in accordance with U.S. GAAP. The Company records all derivatives on the Condensed Consolidated Balance Sheet at fair value. Derivatives that are not designated as hedging instruments or the ineffective portions of cash flow hedges are adjusted to fair value through earnings in other income and expense. Foreign Currency Derivatives – The Company conducts a portion of its business internationally in a variety of foreign currencies and is exposed to market risk for changes in foreign currency exchange rates. The Company attempts to hedge transaction exposures with natural offsets to the fullest extent possible and once these opportunities have been exhausted the Company uses currency options and forward contracts or other hedging instruments with third parties. These contracts will periodically hedge the exchange of various currencies, including the U.S. dollar, Brazilian real, euro, British pound and Canadian dollar. 16 Table of Contents The Company had contracts outstanding for purposes of managing cash flows with notional amounts of $ 34.4 million and $ 34.3 million for the exchange of foreign currencies at September 30, 2023 and June 30, 2023, 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 included in the Condensed Consolidated Income Statements for the quarter ended September 30, 2023 and 2022 are as follows: Quarter ended September 30, 2023 2022 (in thousands) Net foreign exchange derivative contract (gains) losses $ ( 368 ) $ 438 Net foreign currency transactional and re-measurement losses 1,064 484 Net foreign currency exchange losses $ 696 $ 922 Net foreign currency 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 the Canadian dollar versus the U.S. dollar. Interest Rates - The Company’s earnings are also affected by changes in interest rates due to the impact those changes have on interest expense from floating rate debt instruments. The Company manages its exposure to changes in interest rates by using interest rate swaps to hedge this exposure and to achieve a desired proportion of fixed versus floating rate debt. On April 30, 2019, the Company entered into an interest rate swap agreement to lock into a fixed LIBOR interest rate, which was amended on September 28, 2022, to change the reference rate from LIBOR to SOFR. The swap agreement has a notional amount of $ 100.0 million, with a $ 50.0 million tranche scheduled to mature on April 30, 2024 and a $ 50.0 million tranche scheduled to mature April 30, 2026. On March 31, 2023, the Company entered into an interest rate swap agreement to lock into a fixed SOFR interest rate with a notional amount of $ 25 million and a maturity date of March 31, 2028. These interest rate swap agreements are designated as cash flow hedges to hedge the variable rate interest payments on the revolving credit facility. Interest rate differentials paid or received under the swap agreements are recognized as adjustments to interest expense. To the extent the swaps are effective in offsetting the variability of the hedged cash flows, changes in the fair value of the swaps 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 ended September 30, 2023 and 2022. The components of the cash flow hedge included in the Condensed Consolidated Statement of Comprehensive Income for the quarter ended September 30, 2023 and 2022, are as follows: Quarter ended September 30, 2023 2022 (in thousands) Net interest (income) expense recognized as a result of interest rate swap $ ( 759 ) $ 32 Unrealized gain in fair value of interest rate swap 974 2,500 Net increase in accumulated other comprehensive income 215 2,532 Income tax effect 62 653 Net increase in accumulated other comprehensive income, net of tax $ 153 $ 1,879 The Company used the following derivative instruments at September 30, 2023 and June 30, 2023, reflected in its Condensed Consolidated Balance Sheets, for the risk management purposes detailed above: 17 Table of Contents September 30, 2023 June 30, 2023 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 — $ 27 — $ 1 Foreign currency hedge Prepaid expenses and other current assets — — $ 100 — Interest rate swap agreement Other non-current assets $ 4,902 — $ 4,687 — Derivative liabilities: Foreign currency hedge Accrued expenses and other current liabilities $ 108 — — — 18 Table of Contents (9) 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; 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 at fair value on a recurring basis include deferred compensation plan investments, forward foreign currency exchange contracts, foreign currency hedge agreements and interest rate swap agreements. 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). The following table summarizes the valuation of the Company’s remaining assets and liabilities measured at fair value on a recurring basis at September 30, 2023: Total Quoted prices in active markets (Level 1) Significant other observable inputs (Level 2) (in thousands) Assets: Deferred compensation plan investments, current and non-current portion $ 28,773 $ 28,773 $ — Forward foreign currency exchange contracts 27 — 27 Interest rate swap agreement 4,902 — 4,902 Total assets at fair value $ 33,702 $ 28,773 $ 4,929 Liabilities: Deferred compensation plan investments, current and non-current portion $ 28,773 $ 28,773 $ — Foreign currency hedge 108 — 108 Total liabilities at fair value $ 28,881 $ 28,773 $ 108 The following table summarizes the valuation of the Company’s remaining assets and liabilities measured at fair value on a recurring basis at June 30, 2023: 19 Table of Contents Total Quoted prices in active markets (Level 1) Significant other observable inputs (Level 2) (in thousands) Assets: Deferred compensation plan investments, current and non-current portion $ 28,209 $ 28,209 $ — Forward foreign currency exchange contracts 1 — 1 Foreign currency hedge 100 — 100 Interest rate swap agreement 4,687 — 4,687 Total assets at fair value $ 32,997 $ 28,209 $ 4,788 Liabilities: Deferred compensation plan investments, current and non-current portion $ 28,229 $ 28,229 $ — Total liabilities at fair value $ 28,229 $ 28,229 $ — 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 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). Fair values of interest rate swaps are measured using standard valuation models with inputs that can be derived from observable market transactions, including SOFR 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 non-current assets or accrued expenses and other long-term liabilities, depending on the respective instruments' favorable or unfavorable positions. See Note 8 - Derivatives and Hedging Activities . (10) Segment Information The Company is a leading provider of technology solutions and services to customers in specialty technology markets. The Company has two reportable segments, based on technology type. Specialty Technology Solutions Segment The Specialty Technology Solutions segment includes the Company’s business in mobility and barcode, POS, payments, security and networking technologies. Mobility and barcode solutions include mobile computing, barcode scanners and imagers, radio frequency identification devices, barcode printing and related services. POS and payments solutions include POS systems, integrated POS software platforms, self-service kiosks including self-checkout, payment terminals and mobile payment devices. Security solutions include video surveillance and analytics, video management software and access control. Networking solutions include switching, routing and wireless products and software. The Company has business operations within this segment in the United States, Canada and Brazil. Modern Communications & Cloud Segment The Modern Communications & Cloud segment includes the Company’s business in communications and collaboration, connectivity and cloud services. Communications and collaboration solutions, delivered in the cloud, on-premise or hybrid, include voice, video, integration of communication platforms and contact center solutions. The Intelisys connectivity and cloud marketplace offers telecom, cable, Unified Communications as a Service (“UCaaS”), Contact Center as a Service (“CCaaS”), Infrastructure as a Service, Software-Defined Wide-Area Network and other cloud services. This segment includes SaaS and subscription services, which the Company offers using digital tools and platforms. The Company has business operations within this segment in the United States, Canada, Brazil and the UK. Selected financial information for each business segment is presented below: 20 Table of Contents Quarter ended September 30, 2023 2022 (in thousands) Sales: Specialty Technology Solutions $ 509,570 $ 576,329 Modern Communications & Cloud 366,735 367,484 $ 876,305 $ 943,813 Depreciation and amortization: Specialty Technology Solutions $ 2,756 $ 2,702 Modern Communications & Cloud 3,741 3,649 Corporate 720 877 $ 7,217 $ 7,228 Operating income (loss): Specialty Technology Solutions $ 11,872 $ 21,852 Modern Communications & Cloud 12,413 13,036 Corporate ( 201 ) — $ 24,084 $ 34,888 Capital expenditures: Specialty Technology Solutions $ ( 1,261 ) $ ( 195 ) Modern Communications & Cloud ( 1,054 ) ( 489 ) $ ( 2,315 ) $ ( 684 ) Sales by Geography Category: United States and Canada $ 792,464 $ 861,602 International 85,305 84,275 Less intercompany sales ( 1,464 ) ( 2,064 ) $ 876,305 $ 943,813 September 30, 2023 June 30, 2023 (in thousands) Assets: Specialty Technology Solutions $ 1,016,749 $ 1,104,103 Modern Communications & Cloud 881,786 964,066 Corporate — — $ 1,898,535 $ 2,068,169 Property and equipment, net by Geography Category: United States and Canada $ 26,023 $ 27,323 International 10,722 10,056 $ 36,745 $ 37,379 (11) Leases In accordance with Accounting Standards Codification ("ASC") 842, at contract inception the Company determines if a contract contains a lease by assessing whether the contract contains an identified asset and whether the Company has the ability to control the asset. The Company also determines if the lease meets the classification criteria for an operating lease versus a finance lease under ASC 842. Substantially all of the Company's leases are operating leases for real estate, warehouse and office equipment ranging in duration from 1 year to 10 years. The Company has elected not to record short-term operating 21 Table of Contents leases with an initial term of 12 months or less on the Condensed Consolidated Balance Sheets. Operating leases are recorded as other non-current assets, accrued expenses and other current liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheets. The Company has finance leases for information technology equipment expiring through fiscal year 2027. Finance leases are recorded as property and equipment, net , accrued expenses and other current liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheets. The gross amount of the balances recorded related to finance leases is immaterial to the condensed consolidated financial statements at September 30, 2023 and the consolidated financial statements at June 30, 2023. Operating lease right-of-use assets and lease liabilities are recognized at the commencement date based on the net present value of future minimum lease payments over the lease term. The Company generally is not able to determine the rate implicit in its leases and has elected to apply an incremental borrowing rate as the discount rate for the present value determination, which is based on the Company's cost of borrowings for the relevant terms of each lease and geographical economic factors. Certain operating lease agreements contain options to extend or terminate the lease. The lease term used is adjusted for these options when the Company is reasonably certain it will exercise the option. Operating lease expense is recognized on a straight-line basis over the lease term. Variable lease payments not based on a rate or index, such as costs for common area maintenance, are expensed as incurred. Further, the Company has elected the practical expedient to recognize all lease and non-lease components as a single lease component, where applicable. The following table presents amounts recorded on the Condensed Consolidated Balance Sheets related to operating leases at September 30, 2023 and June 30, 2023: September 30, 2023 June 30, 2023 Operating leases Balance Sheet location (in thousands) Operating lease right-of-use assets Other non-current assets $ 11,775 $ 12,539 Current operating lease liabilities Accrued expenses and other current liabilities $ 4,270 $ 4,355 Long-term operating lease liabilities Other long-term liabilities $ 8,569 $ 9,329 The following table presents amounts recorded in operating lease expense as part of selling general and administrative expenses on the Condensed Consolidated Income Statements during the quarter ended September 30, 2023 and 2022. Operating lease costs contain immaterial amounts of short-term lease costs for leases with an initial term of 12 months or less. Quarter ended September 30, 2023 2022 (in thousands) Operating lease cost $ 1,209 $ 1,286 Variable lease cost 383 344 $ 1,592 $ 1,630 Supplemental cash flow information related to the Company's operating leases for the three months ended September 30, 2023 and 2022 are presented in the table below: Quarter ended September 30, 2023 2022 (in thousands) Cash paid for amounts in the measurement of lease liabilities $ 1,412 $ 1,339 Right-of-use assets obtained in exchange for lease obligations 230 111 The weighted-average remaining lease term and discount rate at September 30, 2023 are presented in the table below: 22 Table of Contents September 30, 2023 Weighted-average remaining lease term 3.41 years Weighted-average discount rate 4.58 % The following table presents the maturities of the Company's operating lease liabilities at September 30, 2023: Operating leases (in thousands) 2024 $ 3,769 2025 3,677 2026 3,096 2027 2,678 2028 632 Thereafter — Total future payments 13,852 Less: amounts representing interest 1,013 Present value of lease payments $ 12,839 (12) Commitments and Contingencies The Company is, from time to time, party 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. During the Company's due diligence for the Network1 acquisition, several pre-acquisition contingencies were identified regarding various Brazilian federal and state tax exposures. The Company recorded indemnification receivables that are reported gross of the pre-acquisition contingency liabilities as the funds were escrowed as part of the acquisition. The amount available after the impact of foreign currency translation for future pre-acquisition contingency settlements or to be released to the sellers was $ 3.4 million at September 30, 2023 and June 30, 2023. The table below summarizes the balances and line item presentation of Network1's pre-acquisition contingencies and corresponding indemnification receivables in the Company's Condensed Consolidated Balance Sheets at September 30, 2023 and June 30, 2023: September 30, 2023 June 30, 2023 Network1 (in thousands) Assets Prepaid expenses and other current assets $ 16 $ 16 Other non-current assets $ 3,994 $ 4,150 Liabilities Accrued expenses and other current liabilities $ 16 $ 16 Other long-term liabilities $ 3,994 $ 4,150 (13) Income Taxes Income taxes for the quarters ended September 30, 2023 and 2022 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 includes certain items treated as discrete events to arrive at an estimated overall tax provision. During the quarter ended September 30, 2023, a discrete net tax benefit of $ 1.5 million was recorded for additional foreign tax credits permitted for the 2023 fiscal year as a result of the issuance of IRS Notice 2023-55. During the quarter ended September 30, 2022, a discrete net tax benefit of $ 0.5 million was recorded, which is primarily attributable to a notional interest deduction on the net equity of the Company's Brazilian subsidiary. 23 Table of Contents The Company’s effective tax rate of 19.4 % for the quarter ended September 30, 2023, differs from the current federal statutory rate of 21% primarily as a result of income derived from tax jurisdictions with varying income tax rates, nondeductible expenses, state income taxes, and discrete items. The Company's effective tax rate was 25.5 % for the quarter ended September 30, 2022. As of September 30, 2023, the Company is not permanently reinvested with respect to all earnings generated by foreign operations. The Company has determined that there is no material deferred tax liability for federal, state and withholding tax related to undistributed earnings. During the quarter ended September 30, 2023, foreign subsidiaries did not repatriate cash to the United States. There is no certainty to the timing of any future distributions of such earnings to the U.S. in whole or in part. The Company had approximately $ 1.2 million of total gross unrecognized tax benefits at September 30, 2023 and June 30, 2023. Of this total at September 30, 2023, approximately $ 1 million represents the amount of unrecognized tax benefits that are permanent in nature and, if recognized, would affect the annual effective tax rate. The Company does not believe that the total amount of unrecognized tax benefits will significantly increase or decrease within twelve months of the reporting date. The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. At September 30, 2023 and June 30, 2023, the Company had approximately $ 1.2 million accrued for interest and penalties. 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, 2018.