Certain statements within this Annual Report on Form 10-K, including this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), are not historical facts and contain "forward-looking statements" as described in the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks and uncertainties and actual results could differ materially from those projected. Factors that could cause actual results to differ materially include the following: our ability to retain key employees, particularly senior management; our ability to retain and expand our existing and new customer relationships; our dependence on vendors, product supply, and availability; our ability to centralize certain functions to provide efficient support to our business; our dependence upon information systems; our ability to manage the potential adverse effects of operating in foreign jurisdictions; our ability to manage and limit our credit exposure due to the deterioration in the financial condition of our customers; our ability to remain profitable in the face of narrow margins; our ability to compete in new and existing markets that are highly competitive; our ability to manage our business when general economic conditions are poor; our ability to effectively manage and implement our growth strategies; our ability to manage and negotiate successful pricing and stock rotation opportunities associated with inventory value decreases; our ability to anticipate adverse changes in tax laws, accounting rules, and other laws and regulations; our inability to eliminate potential volatility in our net sales and operating results on a quarterly basis as a result of changes in demand for our products; our dependence on third-party freight carriers; our inability to resolve or settle potentially adverse litigation matters; and our inability to obtain required capital at acceptable terms to fund our working capital and growth strategies. Additional discussion of these and other factors affecting our business and prospects is contained in our periodic filings with the SEC, copies of which can be obtained at our Investor Relations website at www.scansource.com. Please refer to the cautionary statements and important factors discussed in Item 1A. "Risk Factors" in this Annual Report on Form 10-K for the year ended June 30, 2009 for further information. This discussion and analysis should be read in conjunction with "Selected Financial Data" and the Consolidated Financial Statements and the Notes thereto included elsewhere in this Annual Report on Form 10-K.

Overview

ScanSource, Inc. is a leading wholesale distributor of specialty technology products, providing value-added distribution sales to resellers in the specialty technology markets. The Company distributes more than 61,700 products worldwide. The Company has two geographic distribution segments: one serving North America from the Southaven, Mississippi distribution center, and an international segment currently serving Latin America (including Mexico) and Europe from distribution centers located in Florida and Mexico, and in Belgium and the United Kingdom, respectively. The North American distribution segment markets automatic identification and data capture ("AIDC") and point-of-sale ("POS") products through the ScanSource POS and Barcoding sales unit; voice, data and converged communications equipment through its Catalyst Telecom sales unit; video conferencing, telephony and communications products through its ScanSource Communications sales unit; and electronic security products and wireless infrastructure products through its ScanSource Security sales unit. The international distribution segment markets AIDC, POS and Barcode products through its ScanSource Latin America and European sales units, while communication products are marketed through its ScanSource Communications sales unit in Europe.

The Company was incorporated in December 1992 and is headquartered in Greenville, South Carolina. The Company serves North America from a single, centrally located distribution center located near the FedEx hub in Southaven, Mississippi. The single warehouse and strong management information system form the cornerstone of the Company's cost-driven operational strategy. This strategy has been expanded to Latin America and Europe, with distribution centers located in Florida and Mexico, and in Belgium and the United Kingdom, respectively.

North American Distribution Segment

The Company's North American distribution segment sells products exclusively to resellers and integrators in large and growing technology markets. Key AIDC vendors include Cisco, Datalogic, Honeywell, Intermec, Motorola and Zebra, and leading POS lines include Elo, Epson America, IBM, and NCR. Key communications vendors include Avaya, Extreme Networks, Juniper Networks, Plantronics and Polycom, while Dialogic supplies key components for the converged communications market. Key electronic security vendors include Alvarion, Axis, Cisco Security, Datacard, Digiop, DSC, Fargo, GE Security, HID, Motorola Wireless, Panasonic, Sony, Tropos and Zebra Card. During fiscal 2008, the Company relocated its North American distribution center from Memphis, Tennessee to a 600,000 square foot facility located in Southaven, Mississippi to meet the current and near-term growth requirements of the North American business.

International Distribution Segment

The Company's international distribution segment sells AIDC and POS and communications products exclusively to resellers and integrators in the Latin American (including Mexican) and European markets principally from the same product manufacturers as those sold by the North American distribution segment. Marketing efforts to recruit new reseller customers, competitive product pricing, the addition of new vendors, and strategic acquisitions have driven growth in net sales.

Cost Control/Profitability

The Company's operating income growth is driven not only by gross profits but by a disciplined control of operating expenses. The Company's operations feature a scalable information system, streamlined management, and centralized distribution, enabling it to achieve the economies of scale necessary for cost-effective order fulfillment. From its inception, the Company has managed its general and administrative expenses by maintaining strong cost controls. However, in order to continue to grow its markets, the Company has invested in new initiatives including investments in new geographic markets of Europe and Latin America, increased marketing efforts to recruit resellers, enhancements of employee benefit plans to retain employees, and strategic acquisitions in both the North American and International distribution segments.

Evaluating Financial Condition and Operating Performance

The Company's management places a significant emphasis on operating income and return on invested capital ("ROIC") in evaluating and monitoring the Company's financial condition and operating performance. ROIC is used by the Company to assess its efficiency at allocating the capital under its control to generate returns. ROIC is computed by the Company as net income plus income taxes, interest expense, depreciation and amortization divided by invested capital. Invested capital includes all monetary capital invested calculated as follows - average interest bearing debt and average shareholders' equity.

The following table summarizes the Company's return on invested capital ratio for the fiscal years ended June 30, 2009, 2008, and 2007, respectively:

2009 2008 2007 Return on invested capital ratio 17.7 % 22.7 % 19.7 %

The discussion that follows this overview explains the decrease in ROIC from the comparative periods shown above. The Company uses ROIC as a performance measurement because it believes that this metric best balances the Company's operating results with its asset and liability management, it excludes the results of capitalization decisions, is easily computed, communicated and understood and drives changes in shareholder value. The components of this calculation and a reconciliation to the Company's financial statements is shown, as follows:

    Reconciliation of EBITDA to Net Income

                                                   Fiscal Year Ended June 30,
                                               2009           2008           2007
                                                         (in thousands)
    Net income                               $  47,688      $  55,632      $  42,626
    Plus: income taxes                          27,966         34,586         25,987
    Plus: interest expense                       2,176          5,471          7,689
    Plus: depreciation & amortization            6,781          7,127          6,930

    EBITDA (numerator)                       $  84,611      $ 102,816      $  83,232


    Invested capital calculations

                                                   Fiscal Year Ended June 30,
                                               2009           2008           2007
                                                         (in thousands)
    Equity - beginning of the year           $ 395,753      $ 324,744      $ 273,409
    Equity - end of the year                   445,446        395,753        324,744

    Average equity                             420,600        360,249        299,077
    Average debt(1)                             57,605         92,456        122,483

    Invested capital (denominator)           $ 478,205      $ 452,705      $ 421,560

    Return on invested capital                    17.7 %         22.7 %         19.7 %

(1) Average debt is based upon average daily debt and is therefore not able to be represented in this format.

Results of Operations

The following table sets forth for the periods indicated certain income and expense items as a percentage of net sales:

                                                        Fiscal Year Ended June 30,
                                                 2009              2008              2007
Statement of income data:
Net sales                                         100.0 %           100.0 %           100.0 %
Cost of goods sold                                 88.7              89.5              89.4

Gross profit                                       11.3              10.5              10.6
Selling, general and administrative
expenses                                            7.3               6.2               6.8

Operating income                                    4.0               4.3               3.8
Interest expense (income), net                        -               0.2               0.3
Other (income) expense, net                        (0.1 )               -                 -

Total other (income) expense                       (0.1 )             0.2               0.3

Income before income taxes and minority
interest                                            4.1               4.1               3.5
Provision for income taxes                          1.5               1.5               1.3

Net income                                          2.6 %             2.6 %             2.2 %

Comparison of Fiscal Years Ended June 30, 2009 and 2008

Net Sales

The Company has two reporting segments, which are based on geographic location. The following table summarizes the Company's net sales results (net of inter-segment sales) for each of these reporting segments for the comparable fiscal years ending June 30th:

Product Category



                                            2009            2008          $ Change         % Change
                                                       (in thousands)
POS, barcoding and security products     $ 1,161,956     $ 1,379,573     $ (217,617 )         (15.8 %)
Communications products                      686,013         795,912       (109,899 )         (13.8 %)

Net Sales                                $ 1,847,969     $ 2,175,485     $ (327,516 )         (15.1 %)

Geographic Segments



                                           2009            2008          $ Change         % Change
                                                      (in thousands)
North American distribution segment     $ 1,500,144     $ 1,777,534     $ (277,390 )         (15.6 %)
International distribution segment          347,825         397,951        (50,126 )         (12.6 %)

Total net sales                         $ 1,847,969     $ 2,175,485     $ (327,516 )         (15.1 %)

Consolidated net sales for the fiscal year ended June 30, 2009 decreased 15.1% to $1.85 billion in comparison to prior fiscal year net sales of $2.18 billion.

North American Distribution

The North American distribution segment includes sales to technology resellers in the United States and Canada that originate from our centralized distribution facility located in Southaven, Mississippi. We note that sales to technology resellers in Canada accounted for less than 5% of total net sales for both fiscal years presented. For the fiscal year ended June 30, 2009, net sales for this segment decreased by approximately $277.4 million, or 15.6%, as compared to the prior fiscal period.

The Company's North American POS, barcoding, and security product categories saw revenues decrease by 16% in comparison to the prior fiscal year. During the fiscal year ended June 30, 2009, all of these units were challenged by weaker end-user demand caused by tighter credit markets and uncertain economic conditions in North America. Sales of substantially all of our major vendors and product lines were down in comparison to the prior fiscal year, as many of the larger deals and projects that we normally expect to see during the fiscal year were delayed or even cancelled.

The Company has two North American sales units that sell communications products to our customers - the Catalyst Telecom and ScanSource Communications sales units. The combined sales of these units were 15.1% lower for the fiscal year ended June 30, 2009 versus the prior fiscal year. Both of these sales units were also impacted by the prevailing macroeconomic conditions in North America discussed above, and a majority of the vendors in these units experienced lower sales on a comparative basis.

For the first six months of the fiscal year ended June 30, 2009, our key vendor in the Catalyst Telecom sales unit implemented various corrective program changes in response to an unsuccessful new program roll-out from the prior fiscal year. Due to the negative reaction surrounding the initial program roll-out, in addition to the uncertainty associated with the subsequent changes designed to correct the program, revenues for this sales unit

were adversely impacted as reseller purchases were delayed or lost to competitive products during the first half of the fiscal year. We believe that this vendor continues to make progress with its programs, products, and service offerings and we are encouraged that these changes have been well-received by our resellers. Accordingly, we attribute the overall lack of demand experienced over the last half of the fiscal year to be driven primarily by the uncertain economic climate and an absence of larger transactions that would normally occur in a more stable economic environment.

International Distribution

The international distribution segment includes sales to Latin America (including Mexico) and Europe from the ScanSource POS and Barcoding sales unit and in Europe through the ScanSource Communications sales unit. Sales for the overall international segment decreased by 12.6%, or $50.1 million, as compared to the prior fiscal year. However, on a constant exchange rate basis, the sales decrease was approximately 7.0%. The constant currency decline in sales for both geographies was also driven by weakness in end-user demand which was largely attributable to the economic downturn experienced in both Europe and Latin America.

Gross Profit

The following table summarizes the Company's gross profit for the fiscal years
ended June 30th:



                                                                                                   % of Sales
                                                                                                    June 30,
                                         2009         2008       $ Change        % Change        2009       2008
                                                 (in thousands)
North American distribution segment    $ 155,916    $ 176,692    $ (20,776 )        (11.8 %)     10.4 %      9.9 %
International distribution segment        52,932       50,926        2,006            3.9 %      15.2 %     12.8 %

Total gross profit                     $ 208,848    $ 227,618    $ (18,770 )         (8.2 %)     11.3 %     10.5 %

North American Distribution

Gross profit for the North American distribution segment decreased $20.8 million, or 11.8%, for the fiscal year ended June 30, 2009, as compared to the prior fiscal year. The decrease in gross profit is primarily the result of lower sales volume in all of our sales units, as previously discussed. While total gross profit for the North American distribution segment decreased, gross profit, expressed as a percentage of net sales, actually increased to 10.4% for the fiscal year ended June 30, 2009 as compared to 9.9% for the prior fiscal year. This improvement is largely the result of a more favorable product mix and less margin dilution due to an absence of larger deals and projects that traditionally carry lower margins.

International Distribution

Despite a decrease in sales for the international distribution segment, gross profit actually increased by $2.0 million, or 3.9% for the fiscal year ended June 30, 2009, as compared to the prior fiscal year. The increase in gross profit for the fiscal year ended June 30, 2009 was achieved primarily through the use of strategic inventory purchases in the anticipation of subsequent vendor price increases in our European operating segment. These opportunistic purchases resulted in the achievement of significantly higher gross margins during the second half of the fiscal year. As a result, gross profit, expressed as a percentage of net sales for this segment increased to 15.2% in the fiscal year ended June 30, 2009 versus 12.8% in the prior fiscal year. While gross profit of this segment, expressed as a percentage of net sales, is typically greater than the North American distribution segment, the significant increase in gross margin percentage experienced during the quarter is a direct result of this unique buying opportunity, and does not necessarily reflect a sustainable increase in profitability for this segment.

Operating Expenses

The following table summarizes the Company's operating expenses for the periods ended June 30th:

% of Sales June 30, 2009 2008 $ Change % Change 2009 2008

For the fiscal year ended June 30, 2009, operating expenses were $134.7 million, which was slightly higher than the prior fiscal year. Approximately $2.7 million of this increase is attributable to the incremental operating expenses associated with our acquisition of MTV Telecom in April 2008. Offsetting these incremental costs is the favorable year over year exchange rate impact on operating expenses in our international distribution segment.

Operating expenses as a percentage of sales increased to 7.3% for the fiscal year ended June 30, 2009, compared to 6.2% in the prior year comparative period. This increase is largely due to the significant decline in revenues between the two comparable periods. However, the increase also reflects the Company's continued investment in our ScanSource Security sales units in North America and ScanSource Communications sales unit in Europe.

Operating Income

The following table summarizes the Company's operating income for the fiscal
years ended June 30th:



                                                                                               % of Sales
                                                                                                June 30,
                                  2009         2008       $ Change         % Change         2009        2008
                                          (in thousands)
North American distribution     $ 56,261     $ 76,233     $ (19,972 )         (26.2 %)       3.8 %       4.3 %
International distribution        17,857       17,732           125             0.7 %        5.1 %       4.5 %

                                $ 74,118     $ 93,965     $ (19,847 )         (21.1 %)       4.0 %       4.3 %

Operating income decreased 21.1% or $19.8 million for the fiscal year ended June 30, 2009 as compared to the prior fiscal year. This decrease was entirely the result of lower sales volumes experienced in our North America distribution segment due to the prevailing economic conditions. While our International distribution segment also experienced lower sales volumes, the sales generated in the current year yielded significantly more gross profit than the comparative sales in the prior fiscal year, as discussed previously.

Total Other (Income) Expense

The following table summarizes the Company's total other (income) expense for
the fiscal years ended June 30th:



                                                                                                   % of Sales
                                                                                                    June 30,
                                   2009            2008         $ Change        % Change        2009        2008
                                              (in thousands)
Interest expense                 $  2,176        $  5,471       $  (3,295 )        (60.2 %)      0.1 %       0.3 %
Interest income                    (1,405 )        (1,512 )           107           (7.1 %)     (0.1 %)     (0.1 %)
Net foreign exchange losses
(gains)                             1,587             194           1,393          718.0 %       0.1 %       0.0 %
Other, net                         (3,894 )          (406 )        (3,488 )        858.9 %      (0.2 %)      0.0 %

Total other (income) expense     $ (1,536 )      $  3,747       $  (5,283 )       (141.0 %)     (0.1 %)      0.2 %

Interest expense reflects interest paid on borrowings on the Company's revolving credit facility and long-term debt. Interest expense for the period ended June 30, 2009 was $2.2 million compared to $5.5 million for the comparative prior year period. The decrease in interest expense is primarily the result of lower average debt balances between the respective periods, and, to a much lesser extent, lower interest rates experienced between the comparative periods.

Interest income for the period ended June 30, 2009 was consistent with the comparative prior year periods. The Company generates interest income on longer-term interest bearing receivables, and, to a much lesser extent, interest earned on cash and cash-equivalent balances on hand.

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. Foreign exchange losses and gains are generated as the result of fluctuations in the value of the Euro versus the British Pound and the U.S. Dollar versus other currencies. During the fiscal year ended June 30, 2009, the Company generated a net foreign exchange loss due to the strengthening of the U.S. Dollar against the Euro, the British Pound, the Mexican Peso, and the Canadian Dollar. While the Company utilizes foreign exchange contracts and debt in non-functional currencies to hedge foreign currency exposure, our foreign exchange policy prohibits us from entering into speculative transactions.

During the quarter ended December 31, 2008, the Company settled a claim against a former legal service provider resulting in a $3.5 million recovery. The settlement was received by the Company on December 5, 2008 and was recorded as other income.

Provision for Income Taxes

Income tax expense was $28.0 million and $34.6 million for the fiscal years ended June 30, 2009 and 2008, respectively, reflecting an effective tax rate of 37.0% and 38.3%, respectively. The decrease in the effective tax rate for the fiscal year ended June 30, 2009 is largely attributable to the Company's receipt of a favorable tax ruling from a state taxing jurisdiction that was retroactive to fiscal 2008, which had the effect of decreasing our effective tax rate for the fiscal year ended June 30, 2009.

Net Income

The following table summarizes the Company's net income for the fiscal year ended June 30th:

% of Sales June 30, 2009 2008 $ Change % Change 2009 2008

Net income for the fiscal year ended June 30, 2009 was $47.7 million, a $7.9 million decrease over the prior fiscal year period. The decrease in net income is attributable to the changes in operating profits previously discussed.

Comparison of Fiscal Years Ended June 30, 2008 and 2007

Net Sales

The Company has two reporting segments, which are based on geographic location. The following table summarizes the Company's net sales results (net of inter-segment sales) for each of these reporting segments for the comparable fiscal years ending June 30th:

Product Category



                                           2008          2007       $ Change    % Change
                                                   (in thousands)
 POS, barcoding and security products   $ 1,379,573   $ 1,200,497   $ 179,076       14.9 %
 Communications products                    795,912       786,430       9,482        1.2 %

 Total net sales                        $ 2,175,485   $ 1,986,927   $ 188,558        9.5 %

Geographic Segments



                                          2008          2007       $ Change    % Change
                                                  (in thousands)
. . .