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 manage our business when general economic conditions are poor; our ability to manage the potential adverse effects of operating in foreign jurisdictions; our dependence upon information systems and the ability to transition to a new ERP system without business disruption; our dependence on vendors, product supply, and availability; our ability to retain key employees, particularly senior management; our ability to retain and expand our existing and new customer relationships; our ability to manage and limit our credit exposure due to the deterioration in the financial condition of our customers; our ability to centralize certain functions to provide efficient support to our business; our ability to remain profitable in the face of narrow margins; our ability to manage and negotiate successful pricing and stock rotation opportunities associated with inventory value decreases; our ability to compete in new and existing markets that are highly competitive; our ability to integrate acquisitions and effectively manage and implement our growth strategies; our inability to obtain required capital at acceptable terms to fund our working capital and growth strategies; our ability to manage disruptions or loss of certain assets from terrorist or military operations; our ability to anticipate adverse changes in tax laws, accounting rules, and other laws and regulations; our ability to manage volatility in earnings resulting from U.S. GAAP requirements to revalue our earnout obligation to the sellers of CDC; 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 ability to resolve or settle potentially adverse litigation matters; and our ability to hedge or mitigate the effects of fluctuations in foreign exchange rates. 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 under the "Investors Relations" tab on our website at www.scansourceinc.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 further information. This discussion and analysis should be read in conjunction with Item 6. "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 100,000 products worldwide. The Company has two geographic distribution segments: the North American distribution segment serving the United States and Canada from the Southaven, Mississippi distribution center and an international segment serving Latin America and Europe from distribution centers located in Florida, Mexico, Brazil and Belgium. Each segment is managed around its geographic customer and vendor bases and is supported by its centralized infrastructure, such as warehousing and back office operations as appropriate. The North American distribution segment markets automatic identification and data capture ("AIDC") and point-of-sale ("POS") products through its 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, communications, and security products through its ScanSource Latin America sales unit; POS and AIDC products through its ScanSource Europe sales unit; and communication products through its ScanSource Communications sales unit in Europe.
The Company was incorporated in South Carolina in December 1992 and is headquartered in Greenville, South Carolina. The Company serves North America from a single, centrally-located distribution center located in Southaven, Mississippi, near the FedEx hub. 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. The Company distributes products for many of its key vendors in all of its geographic markets; however certain vendors only allow distribution to specific geographies. The Company's key vendors in its worldwide POS and barcoding sales units include Bematech, Cisco, Datalogic, Datamax-O'Neil, Elo, Epson, Honeywell, IBM, Intermec, Motorola, NCR, Toshiba and Zebra Technologies. The Company's key vendors in its worldwide communications sales units, including Catalyst Telecom, sales unit include Aruba, Avaya, Audiocodes, Dialogic, Extreme Networks, Meru Networks, Plantronics, Polycom and Shoretel. The Company's key vendors in its security sales units include Alvarion, Arecont, Axis, Bosch, Cisco, Datacard, Exacq Technologies, Fargo, HID, March Networks, Panasonic, Pelco, Ruckus Wireless, Samsung, Sony and Zebra Card.

Our objective is to continue to grow profitable sales in the technologies we distribute. In doing so, our management team faces numerous challenges that require attention and resources. Certain business units and geographies are experiencing increased competition for the products we distribute. This competition may come in the form of pricing, credit terms, service levels, product availability and in some cases, changes from a closed distribution sales model, where resellers must purchase exclusively from one distributor, to an open distribution sales model, where resellers may choose to purchase from multiple distributors. As this competition could affect both our market share and pricing of our products, we may change our strategy in order to effectively compete.
We have continued investing in our international distribution segment, particularly in Europe, by temporarily accepting lower than normal returns in the business in an effort to protect existing market share and gain new customers. In the current year, our results in the international distribution segment were weaker than expected as the markets in Europe and Latin America seemed to contract and competitive pressures intensified. While certain international markets are volatile in the current macroeconomic environment, especially parts of Europe, we are continuing to invest in this business to position the Company favorably against our competitors for the long term. We are in the process of designing and developing a new Enterprise Resource Planning ("ERP") system that is intended to be used globally and provide operational efficiencies. We have recently received a project assessment from a third party service provider, which indicates that the project will take longer to implement and exceed our previously disclosed cost estimates. During the year, we have consolidated the warehousing function of our German communications business into our Belgian operations. This consolidation gives us logistical efficiencies and service level advantages such as greater flexibility and scalability.
We have committed funds to Brazil to provide for a portion of future contingent consideration payments owed to the former shareholders of CDC and are continuously working to add new vendors and grow existing vendors in our various geographies. This is our first full year of results with our most recent acquisition, CDC, Brazil's leading distributor of AIDC and POS solutions. Also, we continue to evaluate strategic acquisitions to enhance our technological and geographic portfolios.
Cost Control/Profitability
Our operating income growth is driven not only by gross profits but by a disciplined control of operating expenses. Our operations feature a scalable information system, streamlined management, and centralized distribution, enabling us to achieve the economies of scale necessary for cost-effective order fulfillment. From inception, we have managed our general and administrative expenses by maintaining strong cost controls. However, in order to continue to grow in our markets, we have invested in new initiatives, including investments in new geographic markets such as Europe and Latin America; increased marketing efforts to recruit resellers; and enhanced employee benefit plans to retain employees.
Evaluating Financial Condition and Operating Performance We place a significant emphasis on operating income and return on invested capital ("ROIC") in evaluating and monitoring financial condition and operating performance. We use ROIC, a non-GAAP measure, to assess efficiency at allocating capital under our control to generate returns. We compute ROIC as earnings before interest, taxes, depreciation and amortization ("EBITDA") divided by invested capital. Invested capital is defined as average equity plus daily average funded debt for the period.
The following table summarizes our return on invested capital ratio for the fiscal years ended June 30, 2012, 2011, and 2010, respectively:

Management uses ROIC as a performance measurement because we believe this metric best balances the Company's operating results with asset and liability management, excludes the results of capitalization decisions, is easily computed and understand, and drives changes in shareholder value. The components of this calculation and reconciliation to the Company's financial statements are shown, as follows:

Reconciliation of EBITDA to Net Income      Fiscal Year Ended June 30,
                                          2012          2011        2010
                                                  (in thousands)
Net income                             $   74,288    $  73,523    $ 48,812
Plus: income taxes                         36,923       38,363      26,929
Plus: interest expense                      1,639        1,723       1,472
Plus: depreciation & amortization           9,922        6,662       6,064
EBITDA (numerator)                     $  122,772    $ 120,271    $ 83,277


Invested capital calculations        Fiscal Year Ended June 30,
                                  2012          2011          2010
                                           (in thousands)
Equity - beginning of the year $ 587,394     $ 486,851     $ 445,446
Equity - end of the year         652,311       587,394       486,851
Average equity                   619,853       537,123       466,148
Average funded debt(1)            92,125        46,186        31,800
Invested capital (denominator) $ 711,978     $ 583,309     $ 497,948
Return on invested capital          17.2 %        20.6 %        16.7 %

(1) Average funded debt is calculated as the daily average amounts outstanding on our short-term and long-term interest-bearing debt.

Our return on invested capital was 17.2% for the year, down from 20.6% in the prior year, but up from 16.7% in fiscal 2010 . The decrease from the prior year is largely due to lower margins arising from mix and competitive pricing pressures and increased headcount and investment in our international segment to sustain market share and existing volumes throughout the current European economic downturn.

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,
                                                    2012         2011       2010
Statement of income data:
Net sales                                         100.0  %      100.0  %   100.0 %
Cost of goods sold                                 90.0          89.7       89.6
Gross profit                                       10.0          10.3       10.4
Selling, general and administrative expenses        6.2           6.0        6.8
Change in fair value of contingent consideration    0.0           0.0        0.0
Operating income                                    3.8           4.2        3.6
Interest expense (income), net                      0.0           0.0        0.0
Other expense (income), net                         0.1           0.0        0.0
Income before income taxes and minority interest    3.7           4.2        3.6
Provision for income taxes                          1.2           1.4        1.3
Net income                                          2.5  %        2.8  %     2.3 %

Comparison of Fiscal Years Ended June 30, 2012 and 2011
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 product categories and reporting segments
for the comparable fiscal years ending June 30th:
Product Category
                                         2012           2011        $ Change    % Change
                                                  (in thousands)
POS, barcoding and security products $ 1,837,307    $ 1,615,461    $ 221,846       13.7 %
Communications products                1,177,989      1,051,070      126,919       12.1 %
Total net sales                      $ 3,015,296    $ 2,666,531    $ 348,765       13.1 %


Geographic Segments
                                        2012           2011        $ Change    % Change
                                                 (in thousands)
North American distribution segment $ 2,236,459    $ 2,022,668    $ 213,791       10.6 %
International distribution segment      778,837        643,863      134,974       21.0 %
Total net sales                     $ 3,015,296    $ 2,666,531    $ 348,765       13.1 %

Consolidated net sales for the fiscal year ended June 30, 2012 increased 13.1% to $3.0 billion in comparison to prior fiscal year net sales of $2.7 billion. Fiscal year June 30, 2012 net sales include the addition of CDC in Brazil, which we acquired on April 15, 2011.

North American Distribution
The North American distribution segment includes sales to technology resellers in the United States and Canada. Sales to technology resellers in Canada accounted for less than 4% of total net sales for both fiscal years presented. During fiscal 2012 net sales for this segment increased by approximately $214 million, or 10.6%, as compared to the prior fiscal year, with increases in all of our sales units. We had particularly strong year-over-year growth rates in our ScanSource Security and ScanSource Communications sales units.
Net sales for the Company's North American POS, barcoding, and security product categories increased by 7.4% in comparison to the prior fiscal year. We have experienced increased competition in the POS and AIDC channel in North America in response to market share gains in the previous period. ScanSource Security continues to deliver strong double-digit growth over the prior year, primarily from video surveillance and wireless networking products from vendors such as Axis Communications and Ruckus Wireless.
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 14.1% higher for the fiscal year ended June 30, 2012 versus the prior fiscal year. We have had strong performance with several of our key vendors, including Aruba, Polycom and ShoreTel. International Distribution
The international distribution segment markets POS, AIDC, communications and security products in Latin America and POS, AIDC and communications products in Europe. Sales for the international segment increased $135 million or 21.0% over the prior year, attributable primarily to the first full year of results in Brazil from the CDC acquisition completed in April 2011. Aside from incremental business in Brazil, revenues in our international segment remained flat over the prior year due to competitive pressures, coupled with the Eurozone economic downturn.
Additionally, our fiscal year sales growth was partially offset by weaker average euro to U.S. dollar and Brazilian real to U.S. dollar exchange rates over the prior year. Changes in foreign exchange had an unfavorable impact of $28.4 million to our international segment's net sales for the year ended June 30, 2012. Excluding the impact of foreign exchange rate fluctuation, the net sales increase was 25.4%.
Gross Profit
The following table summarizes the Company's gross profit for the fiscal years ended June 30th:

                                                                                    % of Sales
                                                                                     June 30,
                       2012           2011         $ Change       % Change       2012         2011
                                 (in thousands)
North American
distribution
segment            $  218,709     $  201,831     $    16,878          8.4 %        9.8 %       10.0 %
International
distribution
segment                83,315         72,476          10,839         15.0 %       10.7 %       11.3 %
Total gross profit $  302,024     $  274,307     $    27,717         10.1 %       10.0 %       10.3 %

North American Distribution
Gross profit for the North American distribution segment increased $16.9 million, or 8.4%, for the fiscal year ended June 30, 2012. The increase in gross profit was primarily the result of higher sales volume in all of our sales units. However, due to unfavorable vendor programs, partially offset by favorable product mix, we have incurred lower margins, effectively reducing gross profit percentage by 0.2% in North America.

International Distribution
Gross profit in our international distribution segment increased $10.8 million, or 15.0%, for the fiscal year ended June 30, 2012. The increase in gross profit is primarily the result of the impact of having a full year of CDC results, partially offset by the decrease in gross profit generated in Europe. Gross profit as a percentage of sales decreased 0.6% from the prior year. This is largely the result of increased inventory reserves in Europe, coupled with changes to certain vendor programs.
Operating Expenses
The following table summarizes the Company's operating expenses for the periods ended June 30th:

                                                                                      % of Sales
                                                                                       June 30,
                       2012           2011         $ Change       % Change        2012         2011
                                 (in thousands)
Selling, general
and administrative
expense            $  188,388     $  161,326     $    27,062         16.8  %        6.3 %        6.1  %
Change in fair
value of
contingent
consideration             120           (128 )           248       (193.8 )%          - %          -  %
Operating expense  $  188,508     $  161,198     $    27,310         16.9  %        6.3 %        6.0  %

For the fiscal year ended June 30, 2012, selling, general and administrative expenses were $188.4 million, a 16.8% increase from the prior year. Operating expenses as a percentage of sales increased to 6.3% for the fiscal year ended June 30, 2012, compared to 6.0% in the prior year. This increase was mainly attributable to a full year of operating results from the acquisition of CDC, higher compensation expense and incremental expenses related to our ERP project that are required to be expensed as incurred.
We have elected to present changes in fair value of the contingent consideration owed to former shareholders of CDC separately from other selling, general and administrative expenses. In the current year, we have recorded a $0.1 million loss, driven by changes to forecasted and actual results, offset by recurring amortization of the unrecognized fair value discount. During fiscal year 2012, quarterly changes in fair value of the contingent consideration ranged from a $1.1 million loss to a $1.1 million gain. Operating Income
The following table summarizes the Company's operating income for the fiscal years ended June 30th:

                                                                                     % of Sales
                                                                                      June 30,
                       2012           2011         $ Change       % Change        2012         2011
                                 (in thousands)
North American
distribution
segment            $  104,044     $   94,932     $     9,112          9.6  %        4.7 %        4.7 %
International
distribution
segment                 9,472         18,177          (8,705 )      (47.9 )%        1.2 %        2.8 %
Total operating
income             $  113,516     $  113,109     $       407          0.4  %        3.8 %        4.2 %

North American Distribution
For the North American distribution segment, operating income increased 9.6% or $9.1 million from the prior year. The change is largely the result of higher volume in the current year. Operating income percentage has remained consistent from the prior year.

International Distribution
For the international distribution segment, operating income decreased 47.9% or $8.7 million from the prior year. The decrease is attributable to weaker operating results in fiscal year 2012. Operating margin percentage decreased 1.6% from the prior year. In the current year, gross margins are down in Europe because of increased inventory reserves and changes to vendor programs, as mentioned above. Additionally, operating expenses are higher as we continue to invest in international markets. Results from CDC have partially offset the decreased operating income generated in Europe. 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,
                               2012        2011       $ Change    % Change     2012      2011
                                       (in thousands)
Interest expense             $ 1,639     $ 1,723     $    (84 )     (4.9 )%    0.1  %    0.1  %
Interest income               (2,886 )    (1,212 )     (1,674 )    138.1  %   (0.1 )%   (0.1 )%
Net foreign exchange losses    3,766         965        2,801      290.3  %    0.1  %      -  %
Other, net                      (214 )      (253 )         39      (15.4 )%      -  %      -  %
Total other (income) expense $ 2,305     $ 1,223     $  1,082       88.5  %    0.1  %      -  %

Interest expense reflects interest paid on borrowings on the Company's revolving credit facility and long-term debt. Interest expense for the fiscal year ended June 30, 2012 was $1.6 million compared to $1.7 million for the comparative prior year period.
Interest income for the period ended June 30, 2012 increased $1.7 million from the comparative prior year . The Company generates interest income on cash invested in Brazil to fund a portion of future earnout payments and to supplement local working capital needs, in addition to longer-term interest bearing receivables and, to a lesser extent, interest earned on cash and cash equivalent balances.
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 gains and losses are generated as the result of fluctuations in the value of the British pound versus the euro, the U.S. dollar versus the euro, the U.S. dollar versus the Brazilian real and other currencies versus U.S. dollar. For fiscal 2012, the majority of losses were associated with exposures between the U.S. dollar and Brazilian real. In September 2011, we incurred a $2.5 million non-recurring loss in conjunction with an unfavorable forward exchange contract to purchase Brazilian reais. In August 2011, the Company decided to pre-fund a portion of the estimated earnout payments associated with the CDC acquisition. This contract was designed to preserve the currency exchange for the few weeks required to transfer the cash to Brazil. From the time that we entered into the contract through settlement, the real devalued from the contractual rate by 11.8%, ultimately resulting in a $2.5 million loss. Further contributing to the fiscal year foreign exchange loss, the Brazilian business incurred significant losses on U.S. dollar denominated exposures in the first quarter that were not hedged at the time. Subsequently, we have been including these exposures in our hedging activities. Provision for Income Taxes
Income tax expense was $36.9 million and $38.4 million for the fiscal years ended June 30, 2012 and 2011, respectively, reflecting an effective tax rate of 33.2% and 34.3%, respectively. This decrease reflects the benefit of changes in geographic mix to tax jurisdictions with lower corporate income tax rates, the recognition of various tax credits in multiple jurisdictions and the reversal of certain tax reserves. The Company expects the fiscal year 2013 effective tax rate to be more consistent with fiscal year 2011.

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