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SCANSOURCE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
[August 28, 2014]

SCANSOURCE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.


(Edgar Glimpses Via Acquire Media NewsEdge) 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 dependence upon information systems and the ability to transition to a new ERP system without business disruption and in a timely and cost efficient manner; our ability to integrate acquisitions, and effectively manage and implement our growth strategies; our ability to manage the potential adverse effects of operating in foreign jurisdictions, including, adverse changes in economic, political and market conditions in Europe, Latin America, and in Brazil, Venezuela, and Argentina in particular; our ability to hedge or mitigate the effects of fluctuations in foreign exchange rates; our dependence on vendors, product supply, and availability; our ability to decrease our cost structure in response to competitive price pressures and changes in demand for our products; our ability to compete in new and existing markets that are highly competitive; our ability to anticipate adverse changes in tax laws, accounting rules, and other laws and regulations; our ability to effectively manage and implement our growth strategies; our ability to manage our business when general economic conditions are poor; 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 retain key employees, particularly senior management; our ability to centralize certain functions to provide efficient support to our business; our ability to manage and negotiate successful pricing and stock rotation opportunities associated with inventory value decreases; our ability to remain profitable in the face of narrow margins; our ability to manage loss, disclosure or misappropriation of, or access to, information or other breaches of our information security; our dependence on third-party freight carriers; our ability to manage the distribution channels; our ability to increase our business in Brazil; our exposure to the volatility of earnings due to changes in fair value of assets and liabilities, including changes in the fair value of our earn-out obligation to the sellers of CDC, changes in accounting principles, and our ability to make estimates and the assumptions underlying the estimates, which could have an effect on earnings; our ability to avoid goodwill and long-lived asset impairments resulting in material non-cash charges to earnings; our ability to manage disruptions or loss of certain assets from terrorist or military operations; our ability to obtain required capital at acceptable terms to fund our working capital and growth strategies; and our ability to resolve or settle potentially adverse litigation matters. 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.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 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. We caution readers not to place undue reliance on forward-looking statements. We undertake no obligation to update publicly or otherwise revise any forward-looking statements, whether as a result of new information, future events or other factors that affect the subject of these statements, except where we are expressly required to do so by law.



Overview ScanSource, Inc. is a leading international wholesale distributor of specialty technology products. ScanSource, Inc. and its subsidiaries (the "Company") provide value-added distribution services for approximately 290 technology manufacturers and sells to approximately 28,000 resellers in the following specialty technology markets: POS and Barcode, Security and Communications.

The Company operates in the United States, Canada, Latin America, and Europe and uses centralized distribution centers for major geographic regions. The Company distributes to the United States and Canada from its Southaven, Mississippi distribution center; to Latin America principally from distribution centers located in Florida, Mexico and Brazil; and to Europe from its distribution center in Belgium.


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 barcode technologies include Bematech, Cisco, Datalogic, Datamax-O'Neil, Elo, Epson, Honeywell, Intermec by Honeywell, Motorola, NCR, Toshiba Global Commerce Solutions and Zebra Technologies. The Company's key vendors for security technologies include Arecont, Axis, Bosch, Cisco, Datacard, Exacq Technologies, Fargo, HID, March Networks, Panasonic, Ruckus Wireless, Samsung, Sony and Zebra Card. The Company's key vendors in communications technologies include Aruba, Avaya, AudioCodes, Cisco, Dialogic, Extreme Networks, Meru Networks, Plantronics, Polycom, Shoretel and Sonus.

22-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements During fiscal year 2014, the Barcode & Security distribution segment added 3D printing solutions to their product offerings that are targeted at the manufacturing, healthcare, aerospace, and automotive markets.

In April 2014, it was announced that Zebra Technologies intends to purchase Motorola Solutions' enterprise business. Zebra Technologies and Motorola Solutions represent key vendors in our barcode technologies business.

In the fourth quarter of fiscal 2013, we announced a new management structure to enhance our worldwide technology markets focus and growth strategy. This worldwide management structure creates new leadership roles and reporting segments to globally leverage the Company's leadership in specific technology markets. As a part of this new structure, ScanSource has created two technology segments, each with its own president. The two segments are Worldwide Barcode & Security, which includes ScanSource POS and Barcode and ScanSource Security business units, and Worldwide Communications & Services, which encompasses ScanSource Catalyst, ScanSource Communications and ScanSource Services Group business units. The reporting segments of Worldwide Barcode & Security and Worldwide Communications & Services replaced the geographic segments of North America and International and gave the Company the ability to leverage its size and experience to deliver more value to our vendor and reseller partners in its existing markets.

We restructured our European Communications sales unit in the third quarter of fiscal year 2013 in order to support a strategy for profitable growth. The new organizational structure provided focused business unit leadership, as well as dedicated merchandising, sales and technical support teams, at the appropriate scale. In addition, the Company moved certain European support functions to centralized global teams in the United States to gain efficiencies. The annualized cost savings in connection with the restructuring, principally associated with the elimination of positions, was estimated at approximately $3.1 million. The Company incurred approximately $1.2 million in associated costs, including related severance expenses. These restructuring costs, which were accrued in the third quarter of fiscal year 2013, are included in selling, general and administration costs in the accompanying Consolidated Income Statements. For further discussion on our restructuring, refer to Note 14 -Restructuring Costs.

In the fourth quarter of fiscal year 2013, the Company decided not to proceed with the development of the Enterprise Resource Planning ("ERP") project using the Microsoft Dynamics AX software and we wrote off substantially all of the total capitalized expenses related to the original project. The non-cash charge recorded of $28.2 million before the effect of income taxes ($18.0 million net of the tax impact), included software development costs, hardware, software interfaces and other related costs. The remaining $0.6 million of the total $28.8 million capitalized balance was placed into service in July 2013. The software that was placed into service is not the ERP system itself, but an auxiliary database system designed to assist in the management of the product offerings. Prior to the write off, the capitalized software was included in property and equipment at cost on the Consolidated Balance Sheets.

In January 2013, through the Company's wholly-owned subsidiary Partner Services, Inc. ("PSI"), the Company filed a lawsuit in the U.S. District Court in Atlanta, Georgia against our former ERP software systems integration partner, Avanade, Inc. ("Avanade"). In June 2014, the parties reached a Settlement Agreement where both parties agreed to mutually dismiss all claims and counterclaims against the other in exchange for Avanade's payment to the Company of $15.0 million. The Company also reversed $2.0 million in accrued liabilities for unpaid invoices received from Avanade and paid a contingency fee of $1.5 million to the law firm who represented the Company in the lawsuit. The settlement, net of attorney fees and reversal of accrued liabilities is included in the impairment charges (legal recovery) line item on the Consolidated Income Statements.

In December 2013, the Company retained Systems Applications Products ("SAP") for software platform and implementation consulting services for a new Enterprise Resource Planning ("ERP") system. Development of our new ERP system began in January of 2014.

After we performed our annual goodwill impairment test in 2013 we determined that a goodwill impairment charge was necessary for our Brazilian POS & Barcode and European Communications reporting units. Prior to the test, no interim impairment indicators were identified. The Company's impairment testing included the determination of the reporting unit's fair value using market multiples and discounted cash flows modeling. The impairment charges were a result of reduced earnings and cash flow forecasts primarily due to the general macroeconomic environment and lower expectations of future results. Furthermore, earnout payments made to CDC shareholders have been lower than those forecasted and assumed in the calculation of goodwill, at the time of acquisition. During the fourth quarter of fiscal 2013, the Company recorded a non-cash charge for goodwill impairment of $5.4 million and $15.1 million in Europe and Brazil, respectively.

23-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements During fiscal year 2014, the Company completed its annual impairment test as of April 30 and determined that no goodwill impairment charge was necessary.

As compared to prior year, our Latin America subsidiary has been experiencing a significant drop in revenue in Venezuela due to increased country-specific risks. The Company's transactions in Venezuela are denominated in U.S. dollars, however, our Venezuelan resellers are having difficulties getting U.S. dollars to pay us as the government controls the available U.S. dollars within the country. Hence, we have heightened risk of collectability in this country. At June 30, 2014, the Company held $2.3 million in accounts receivable with 87% reserves specific to accounts receivable in Venezuela.

Our objective is to continue to grow profitable sales in the technologies we distribute and to focus on growth in security and communication technologies. We continue to evaluate strategic acquisitions to enhance our technological and geographic portfolios. In doing so, we face 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 and product availability.

As this competition could affect both our market share and pricing of our products, we may change our strategy in order to effectively compete in the marketplace.

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 scalable information systems, 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 continued to invest in new technologies, specifically, security, communication and 3D technology; increased marketing efforts to recruit resellers; and enhanced employee benefit plans to retain employees.

Evaluating Financial Condition and Operating Performance In addition to disclosing results that are determined in accordance with United States Generally Accepted Accounting Principles ("GAAP"), we also disclose certain non-GAAP financial measures, including adjusted net income and adjusted EPS, return on invested capital ("ROIC"), and "constant currency" a measure that excludes the translation exchange impact from changes in foreign currency exchange rates between reporting periods. We use non-GAAP financial measures to better understand and evaluate performance, including comparisons from period to period.

These non-GAAP financial measures have limitations as analytical tools, and the non-GAAP financial measures that we report may not be comparable to similarly titled amounts reported by other companies. Analysis of results and outlook on a non-GAAP basis should be considered in addition to, and not in substitution for or as superior to, measurements of financial performance prepared in accordance with GAAP.

Adjusted Net Income and Adjusted EPS To evaluate current period performance on a clearer and more consistent basis with prior periods, we disclose adjusted net income and adjusted diluted EPS.

Results for the current year ended June 30, 2014 excluded a legal recovery, net of attorney fees. Results for the year ended June 30, 2013 excluded charges associated with the impairment of our old ERP project using Microsoft Dynamics AX software and goodwill in two of our reporting units, and costs associated with tax compliance and personnel replacement in the Company's Belgian office.

Please see notes 1, 5 and 14 of the Notes to Consolidated Financial Statements for additional information on these items. We believe that these historical items are outside of our normal operating expenses. Adjusted net income and adjusted diluted EPS are useful in better assessing and understanding our operating performance, especially when comparing results with previous periods or forecasting results for future periods.

Below, we are providing a non-GAAP reconciliation of net income and earnings per share adjusted for the costs and charges mentioned above: 24-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Year ended June 30, 2014 Year ended June 30, 2013 Net Income Net Income Pre-Tax Income (Loss) Diluted EPS Pre-Tax Income (Loss) Diluted EPS GAAP Measures $ 123,107 $ 81,789 $ 2.86 $ 53,026 $ 34,662 $ 1.24 Adjustments: Legal recovery, net of attorney fees (15,490 ) (9,756 ) (0.34 ) - - - Costs associated with Belgian tax compliance and personnel replacement costs, including related professional fees - - - 2,121 1,400 0.05 Impairment charges - ERP - - - 28,210 18,015 0.64 Impairment charges - Goodwill - - - 20,562 15,201 0.54 Non-GAAP measures $ 107,617 $ 72,033 $ 2.52 $ 103,919 $ 69,278 $ 2.47 Return on Invested Capital Management uses ROIC as a performance measurement to assess efficiency at allocating capital under the Company's control to generate returns. Management believes this metric balances the Company's operating results with asset and liability management, is not impacted by capitalization decisions and is considered to have a strong correlation with shareholder value creation. In addition, it is easily computed, communicated and understood. ROIC also provides management a measure of the Company's profitability on a basis more comparable to historical or future periods.

ROIC assists us in comparing our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that do not reflect our core operating performance. We believe the calculation of ROIC provides useful information to investors and is an additional relevant comparison of our performance during the year. In addition, the Company's Board of Directors uses ROIC in evaluating business and management performance. Certain management incentive compensation targets are set and measured relative to ROIC.

We calculate ROIC as earnings before interest expense, income taxes, depreciation and amortization ("EBITDA") divided by invested capital. Invested capital is defined as average equity plus average daily funded interest-bearing debt for the period. The following table summarizes annualized return on invested capital ratio for the fiscal years ended June 30, 2014, 2013, and 2012, respectively.

Management adjusted the calculation of ROIC to exclude the impact of legal recoveries, net of attorney fees for the current year ended June 30, 2014.

Management also adjusted the calculation of ROIC to exclude the impact of ERP and goodwill impairment charges and costs associated with Belgian tax compliance for the year ended June 30, 2013. Management believes these adjustments provide a measure of the Company's profitability on a basis more comparable to historical or future periods. Had management not adjusted for the above mentioned items, the ROIC would have been 17.4% and 9% for the fiscal year ended June 30, 2014 and 2013, respectively. We believe the calculation of ROIC including adjusted EBITDA and adjusted average equity provides useful information to investors and is an additional relevant comparison of our performance during the year.

2014 2013 2012 Return on invested capital ratio 15.4 % 16.0 % 17.2 % 25-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements The components of our ROIC calculation and reconciliation to the Company's financial statements are shown, as follows: Reconciliation of EBITDA to Net Income Fiscal Year Ended June 30, 2014 2013 2012 (in thousands) Net income (GAAP) $ 81,789 $ 34,662 $ 74,288 Plus: income taxes 41,318 18,364 36,923 Plus: interest expense 731 775 1,639 Plus: depreciation & amortization 7,375 8,457 9,580 EBITDA 131,213 62,258 122,430 Adjustments(a) (15,490 ) 50,893 - Adjusted EBITDA (numerator for ROIC) (non-GAAP) $ 115,723 $ 113,151 $ 122,430 Invested capital calculations Fiscal Year Ended June 30, 2014 2013 2012 (in thousands) Equity - beginning of the year $ 695,956 $ 652,311 $ 587,394 Equity - end of the year 802,643 695,956 652,311 Adjustments, net of tax(a) (9,756 ) 34,616 - Average equity, adjusted 744,422 691,442 619,853 Average funded debt(b) 5,429 15,405 92,125 Invested capital (denominator) $ 749,851 $ 706,847 $ 711,978 Return on invested capital 15.4 % 16.0 % 17.2 % (a) Includes a legal recovery, net of attorney fees for the year ended June 30, 2014 and includes non-cash impairment charges, and expenses associated with Belgian tax compliance and personnel replacement costs, including related professional fees for year ended June 30, 2013.

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

The decrease in our return on invested capital from the prior year is largely due to higher average equity from retained earnings.

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, 2014 2013 2012 Statement of income data: Net sales 100.0 % 100.0 % 100.0 % Cost of goods sold 89.7 89.8 90.0 Gross profit 10.3 10.2 10.0Selling, general and administrative expenses 6.6 6.6 6.2 Impairment charges (legal recovery) (0.5 ) 1.7 0.0 Change in fair value of contingent consideration 0.1 0.1 0.0 Operating income 4.2 1.8 3.8 Interest expense (income), net (0.1 ) 0.0 0.0 Other expense (income), net 0.0 0.0 0.1 Income before income taxes and minority interest 4.2 1.8 3.7 Provision for income taxes 1.4 0.6 1.2 Net income 2.8 % 1.2 % 2.5 % Comparison of Fiscal Years Ended June 30, 2014 and 2013 26-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Currency In this Management Discussion and Analysis, we make references to "constant currency," a non-GAAP performance measure, that excludes the foreign exchange rate impact from fluctuations in the weighted average foreign exchange rates between reporting periods. Certain financial results are adjusted by translating current period results from currencies other than the U.S. dollar using the comparable weighted average foreign exchange rates from the prior year period.

This information is provided to view financial results without the impact of fluctuations in foreign currency rates, thereby enhancing comparability between reporting periods.

Net Sales The Company has two reportable segments, which are based on product sales. The following table summarizes the Company's net sales results by product categories and by geographic location for the comparable fiscal years ending June 30th: Segments 2014 2013 $ Change % Change (in thousands) Worldwide Barcode & Security $ 1,873,177 $ 1,828,219 $ 44,958 2.5 % Worldwide Communications & Services 1,040,457 1,048,745 (8,288 ) (0.8 )% Total net sales $ 2,913,634 $ 2,876,964 $ 36,670 1.3 % Geographic Sales 2014 2013 $ Change % Change (in thousands) North American sales units $ 2,179,890 $ 2,139,723 $ 40,167 1.9 % International sales units $ 733,744 737,241 (3,497 ) (0.5 )% Total net sales $ 2,913,634 $ 2,876,964 $ 36,670 1.3 % Worldwide Barcode & Security The Barcode & Security distribution segment consists of sales to technology resellers in our ScanSource POS & Barcode business units in North America, Europe and Latin America and our ScanSource Security business unit in North America. During fiscal year 2014 net sales for this segment increased $45.0 million or 2.5% compared to the prior fiscal year. On a constant currency basis, net sales for fiscal 2014 increased $46.4 million or 2.5% compared to prior year. The increase is primarily due to growth in all business units within Worldwide Barcode & Security, with the exception of the Miami export business.

Worldwide Communications & Services The Communications & Services distribution segment consists of sales to technology resellers in our ScanSource Communications business units in North America and Europe, ScanSource Catalyst in North America, and ScanSource Services Group. During fiscal year 2014, net sales for this segment decreased $8.3 million or 0.8% compared to the prior fiscal year. On a constant currency basis, net sales for fiscal 2014 decreased $11.1 million or 1.1%. compared to prior year. Sales growth in the North America Communications business unit was offset by weaker sales results for the Catalyst and Europe Communications business units.

Gross Profit The following table summarizes the Company's gross profit for the fiscal years ended June 30: 27-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements % of Sales June 30, 2014 2013 $ Change %Change 2014 2013 (in thousands) Worldwide Barcode & Security $ 168,233 $ 168,123 $ 110 0.1 % 9.0 % 9.2 % Worldwide Communications & Services 132,866 124,751 8,115 6.5 % 12.8 % 11.9 % Total gross profit $ 301,099 $ 292,874 $ 8,225 2.8 % 10.3 % 10.2 % Worldwide Barcode & Security Gross profit dollars for the Barcode & Security distribution segment remained relatively flat for the fiscal year ended June 30, 2014 as compared to prior year. As a percentage of sales, gross profit margin decreased slightly to 9.0% for fiscal year 2014 as compared to 9.2% for fiscal year 2013. This reduction is largely the result sales mix, principally higher sales volume of lower margin products.

Worldwide Communications & Services Gross profit dollars and gross profit margin for the Communications & Services distribution segment increased for the fiscal year ended June 30, 2014. As a percentage of sales, gross profit margin increased to 12.8% for fiscal year 2014 compared to 11.9% for fiscal year 2013, primarily due to higher service fee income and improved vendor program attainment.

Operating Expenses The following table summarizes the Company's operating expenses for the periods ended June 30: % of Sales June 30, 2014 2013 $ Change % Change 2014 2013 (in thousands) Selling, general and administrative expenses $ 192,492 $ 191,216 $ 1,276 0.7 % 6.6 % 6.6 % Impairment charges (legal recovery) (15,490 ) 48,772 (64,262 ) (131.8 )% (0.5 )% 1.7 % Change in fair value of contingent consideration 2,311 1,843 468 25.4 % 0.1 % 0.1 % Operating expenses $ 179,313 $ 241,831 $ (62,518 ) (25.9 )% 6.2 % 8.4 % Selling, general and administrative expenses ("SG&A") increased $1.3 million for the fiscal year ending June 30, 2014. The increase in SG&A expenses is primarily due to increased personnel headcount and higher healthcare costs, partially offset by lower bad debt expense.

In the fourth quarter of 2014, we recorded a $15.5 million legal recovery, net of attorney fees, related to our previously disclosed ERP litigation. In the fourth quarter of fiscal 2013, we recorded impairment charges from our ERP project and goodwill in our ScanSource Communications Europe and ScanSource Brasil sales units as mentioned above. Discussion on these impairments can be found in the overview section of the MD&A as well as Note 3 - Property & Equipment and Note 5 - Goodwill and Other Identifiable Intangible Assets in the notes to the consolidated financial statements.

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 $2.3 million loss, driven by recurring amortization of the unrecognized fair value discount and a decline in the discount rate used, partially offset by a reduction in forecasted results.

Operating Income 28-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements The following table summarizes the Company's operating income for the fiscal years ended June 30: % of Sales June 30, 2014 2013 $ Change % Change 2014 2013 (in thousands) Worldwide Barcode & Security $ 51,523 $ 34,665 $ 16,858 48.6 % 2.8 % 1.9 % Worldwide Communications & Services 54,773 44,588 10,185 22.8 % 5.3 % 4.3 % Corporate 15,490 (28,210 ) 43,700 (154.9 )% - % nm* Total operating income $ 121,786 $ 51,043 $ 70,743 138.6 % 4.2 % 1.8 % *nm - percentages are not meaningful Worldwide Barcode & Security For the Barcode & Security distribution segment, operating income increased $16.9 million for the fiscal year ended June 30, 2014. The increase is largely the result of a $15.1 million impairment expense related to ScanSource Brasil, included in prior year results, as well as, a decrease in the provision for doubtful accounts.

Worldwide Communications & Services For the Communications & Services distribution segment, operating income increased $10.2 million for the fiscal year ended June 30, 2014. The increase is primarily attributable to increased gross profit margin and $5.4 million of goodwill impairment charges related to Europe Communications included in prior year results.

Corporate For the year ended June 30, 2014 Corporate received a legal recovery, net of attorney fees, of $15.5 million, related to our previously disclosed ERP litigation for the year ended June 30, 2014. We incurred a $28.2 million ERP impairment charge for the year ended June 30, 2013.

Total Other (Income) Expense The following table summarizes the Company's total other (income) expense for the fiscal years ended June 30: % of Sales June 30, 2014 2013 $ Change % Change 2014 2013 (in thousands) Interest expense $ 731 $ 775 $ (44 ) (5.7 )% - % - % Interest income (2,364 ) (2,238 ) (126 ) 5.6 % (0.1 )% (0.1 )% Net foreign exchange losses (gains) 616 (32 ) 648 nm* - % - % Other, net (304 ) (488 ) 184 (37.7 )% - % - % Total other (income) expense $ (1,321 ) $ (1,983 ) $ 662 (33.4 )% - % (0.1 )% *nm - percentages are not meaningful Interest expense reflects interest incurred on the Company's long-term debt, non-utilization fees from the Company's revolving credit facility and the amortization of debt issuance costs.

Interest income for the year ended June 30, 2014 was generated on interest-bearing customer receivables and interest earned on cash and cash equivalents.

29-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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, the Canadian dollar versus the U.S. dollar and other currencies versus U.S. dollar.

While we utilize foreign exchange contracts and debt in non-functional currencies to hedge foreign currency exposure, our foreign exchange policy prohibits the use of derivative financial instruments for speculative transactions.

Provision for Income Taxes Income tax expense was $41.3 million and $18.4 million for the fiscal years ended June 30, 2014 and 2013, respectively, reflecting an effective tax rate of 33.6% and 34.6%, respectively. The decrease in the effective tax rate is primarily due to the non-recurring impairment of goodwill in the United Kingdom for our European Communications reporting unit, which was not deductible for fiscal year 2013. The Company expects the fiscal year 2015 effective tax rate to range between 33% to 34%.

Comparison of Fiscal Years Ended June 30, 2013 and 2012 Net Sales The Company has two reportable segments, which are based on product sales. The following table summarizes the Company's net sales results by product categories and by geographic location for the comparable fiscal years ending June 30th: Segments 2013 2012 $ Change % Change (in thousands) Worldwide Barcode & Security $ 1,828,219 $ 1,837,307 $ (9,088 ) (0.5 )% Worldwide Communications & Services 1,048,745 1,177,989 (129,244 ) (11.0 )% Total net sales $ 2,876,964 $ 3,015,296 $ (138,332 ) (4.6 )% Geographic Sales 2013 2012 $ Change % Change (in thousands) North American distribution sales units $ 2,139,723 $ 2,236,459 $ (96,736 ) (4.3 )% International distribution sales units 737,241 778,837 (41,596 ) (5.3 )% Total net sales $ 2,876,964 $ 3,015,296 $ (138,332 ) (4.6 )% Worldwide Barcode & Security The Barcode/Security distribution segment consists of sales to technology resellers in our ScanSource POS & Barcode business units in North America, Europe and Latin America and our ScanSource Security business unit. During fiscal year 2013 net sales for this segment decreased, primarily due to unfavorable foreign currency exchange translation. On a constant currency basis, net sales for fiscal 2013 increased $25.4 million or 1.4%. The majority of the currency adjustment is from the change in the Brazilian Real. The Security and Brazil POS & Barcode sales units had year-over-year growth rates excluding the impact of foreign currency translation. The POS & Barcode sales units in North America and Europe experienced a slight decline in revenue. Our Latin America business unit had a slight increase in revenue.

Worldwide Communications & Services The Communications/Services distribution segment consists of sales to technology resellers in our ScanSource Communications business units in North America and Europe, ScanSource Catalyst in North America, and ScanSource Services Group.

During fiscal year 2013, net sales for this segment declined compared to the prior fiscal year, with little change attributable to foreign currency exchange translation. The decrease was largely attributable to the loss of Juniper Networks sales, which decreased approximately $109 million year-over-year. Our distribution agreement with Juniper Networks ended in September 2012.

30-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements ScanSource Communications in North America had strong year-over-year growth.

Sales for ScanSource Catalyst and ScanSource Communications in Europe declined primarily from the loss of Juniper sales as mentioned above.

Gross Profit The following table summarizes the Company's gross profit for the fiscal years ended June 30: % of Sales June 30, 2013 2012 $ Change % Change 2013 2012 (in thousands) Worldwide Barcode & Security $ 168,123 $ 169,080 $ (957 ) (0.6 )% 9.2 % 9.2 % Worldwide Communications & Services 124,751 132,944 (8,193 ) (6.2 )% 11.9 % 11.3 % Total gross profit $ 292,874 $ 302,024 $ (9,150 ) (3.0 )% 10.2 % 10.0 % Worldwide Barcode & Security Gross profit for the Barcode/Security distribution segment decreased for the fiscal year ended June 30, 2013. This reduction is the result of lower sales volumes. The gross profit expressed as a percentage of net sales was unchanged for the fiscal year 2013 compared to fiscal year 2012.

Worldwide Communications & Services Gross profit for the Communications/Services distribution segment decreased for the fiscal year ended June 30, 2013. This is the result of lower sales volume, primarily related to the loss of Juniper Networks revenues as described earlier.

The gross profit expressed as a percentage of net sales increased for fiscal year 2013 compared to fiscal year 2012 driven by improved product sales mix and vendor incentives.

Operating Expenses The following table summarizes the Company's operating expenses for the periods ended June 30: % of Sales June 30, 2013 2012 $ Change % Change 2013 2012 (in thousands) Selling, general and administrative expense $ 191,216 $ 188,388 $ 2,828 1.5 % 6.6 % 6.2 % Impairment charges 48,772 - 48,772 100.0 % 1.7 % - % Change in fair value of contingent consideration 1,843 120 1,723 1,435.8 % 0.1 % - % Operating expenses $ 241,831 $ 188,508 $ 53,323 28.3 % 8.4 % 6.2 % Selling, general and administrative expense increased for the fiscal year ending June 30, 2013 as a result of an increase in our provision for doubtful accounts for the year ended June 30, 2013. This increase was a result of increased expenses for the Barcode/Security segment in all geographies offset by recoveries and reserve reductions in North America. Included in the Barcode/Security expense is the increased country specific reserves for Venezuela that occurred during the current fiscal year. Fiscal year 2013 selling, general and administrative expense also includes $2.1 million in costs associated with Belgian tax compliance and personnel replacement costs, including professional fees and $1.2 million for restructuring costs associated with our Communications business unit in Europe.

In the fourth quarter of fiscal 2013, we recorded impairment charges from our ERP project, and goodwill in our ScanSource Communications Europe and ScanSource Brasil sales units as mentioned above. Discussion on these impairments can be found 31-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements in the overview section of the MD&A as well as Note 3 - Property & Equipment and Note 5 - Goodwill and Other Identifiable Intangible Assets in the notes to the consolidated financial statements.

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 loss, driven by recurring amortization of the unrecognized fair value discount partially offset by income from changes to forecasted and actual results.

Operating Income The following table summarizes the Company's operating income for the fiscal years ended June 30: % of Sales June 30, 2013 2012 $ Change % Change 2013 2012 (in thousands) Worldwide Barcode & Security $ 34,665 $ 56,669 $ (22,004 ) (38.8 )% 1.9 % 3.1 % Worldwide Communications & Services 44,588 56,847 (12,259 ) (21.6 )% 4.3 % 4.8 % Corporate (28,210 ) - (28,210 ) nm* nm* - % Total operating income $ 51,043 $ 113,516 $ (62,473 ) (55.0 )% 1.8 % 3.8 % *nm - percentages are not meaningful Worldwide Barcode & Security For the Barcode/Security distribution segment, operating income dollars and percentage decreased for the fiscal year ended June 30, 2013. The change is largely the result of higher selling, general and administrative expenses which include a $15.1 million impairment expense related to ScanSource Brasil, as mentioned in the overview above, as well as an increase in the provision for doubtful accounts.

Worldwide Communications & Services For the Communications/Services distribution segment, operating income in dollars and as a percentage of sales decreased. The change is attributable to lower gross margin dollars resulting from lower sales in fiscal year 2013, the effect of the ScanSource Communications Europe restructuring costs, lower provision for doubtful accounts and $5.4 million of goodwill impairment charges.

Corporate Corporate incurred a $28.2 million loss relating to the ERP impairment charge discussed previously.

Total Other (Income) Expense The following table summarizes the Company's total other (income) expense for the fiscal years ended June 30: 32-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements % of Sales June 30, 2013 2012 $ Change % Change 2013 2012 (in thousands) Interest expense $ 775 $ 1,639 $ (864 ) (52.7 )% - % 0.1 % Interest income (2,238 ) (2,886 ) 648 (22.5 )% (0.1 )% (0.1 )% Net foreign exchange (gains) losses (32 ) 3,766 (3,798 ) (100.8 )% - % 0.1 % Other, net (488 ) (214 ) (274 ) 128.0 % - % - % Total other (income) expense $ (1,983 ) $ 2,305 $ (4,288 ) (186.0 )% (0.1 )% 0.1 % Interest expense reflects interest incurred on borrowings on the Company's revolving credit facility and long-term debt, including commitment fees on non-utilized borrowing availability. The decrease in interest expense is the result of lower average debt balances in the current year versus the prior year.

The Company generates interest income on longer-term interest-bearing accounts receivable, cash invested in Brazil to fund a portion of future earnout payments and to supplement local working capital needs, and, to a lesser extent, interest earned on cash and cash equivalent balances in locations other than Brazil. The reduction in interest income year over year is the result of lower cash balances in Brazil in fiscal 2013 as compared to fiscal 2012.

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. 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 foreign exchange loss in fiscal 2012, the Brazilian business incurred significant losses on U.S. dollar denominated exposures in the first quarter of fiscal 2012 that were not hedged at the time. Subsequently, we have been including these exposures in our hedging activities.

Goodwill Impairment Charge We completed our annual impairment test as of June 30, 2013 and determined that the book value of the European Communications and the Brazilian POS & Barcode sales units were in excess of fair value and a goodwill impairment was required.

Prior to this test, no interim indicators of impairment were identified. Reduced earnings and cash flow forecast primarily due to the general macroeconomic environment and lower expectations of future results contributed to our determination. Furthermore, earnout payments made to CDC shareholders have been lower than those forecasted and assumed in the calculation of goodwill, at the time of acquisition. Accordingly, we recorded a non-cash pretax goodwill impairment charge of $20.6 million, or $15.2 million after tax at the local tax rate, relating to our reporting units. These goodwill charges are included in a separate operating expense line item, "Impairment charges including ERP & goodwill" in our Consolidated Income Statements. Income and market approaches were used to determine the fair value of each of our seven reporting units. The application of goodwill impairment tests requires management's judgment for many of the inputs. Key assumptions in the impairment test included our forecasted revenue growth rate, discount rate assumptions, and working capital requirements. Changes in these estimates could result in additional impairment of goodwill in a future period. The impairment charge reflects our view of anticipated risks based on our expectations of market and general economic conditions. Annual impairment testing did not result in an impairment of goodwill for the year ended June 30, 2012. For additional information regarding goodwill, see Note 5 - Goodwill and Other Identifiable Intangible Assets.

Provision for Income Taxes Income tax expense was $18.4 million and $36.9 million for the fiscal years ended June 30, 2013 and 2012, respectively, reflecting an effective tax rate of 34.6% and 33.2%, respectively. This increase in the effective tax rate is primarily the result of the nondeductible goodwill impairment in the United Kingdom for our European Communications reporting unit.

33-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Quarterly Results The following tables set forth certain unaudited quarterly financial data. The information has been derived from unaudited financial statements that, in the opinion of management, reflect all adjustments.

Three Months Ended Fiscal 2014 Fiscal 2013 Jun. 30 Mar. 31 Dec. 31 Sept. 30 Jun. 30 Mar. 31 Dec. 31 Sept. 30 2014 2014 2013 2013 2013 2013 2012 2012 (in thousands, except per share data) Net sales $ 758,113 $ 682,998 $ 740,618 $ 731,904 $ 712,678 $ 682,965 $ 747,716 $ 733,605 Cost of goods sold 684,120 609,647 663,362 655,405 637,027 614,133 673,365 659,565 Gross profit $ 73,993 $ 73,351 $ 77,256 $ 76,499 $ 75,651 $ 68,832 $ 74,351 $ 74,040 Net income $ 27,105 $ 16,949 $ 18,298 $ 19,437 $ (13,315 ) $ 13,978 $ 16,357 $ 17,642 Weighted-average shares outstanding, basic 28,525 28,502 28,293 28,034 27,922 27,847 27,713 27,618 Weighted-average shares outstanding, diluted 28,763 28,730 28,597 28,257 27,922 28,024 27,958 27,901 Net income (loss) per common share, basic $ 0.95 $ 0.59 $ 0.65 $ 0.69 $ (0.48 ) $ 0.50 $ 0.59 $ 0.64 Net income (loss) per common share, diluted $ 0.94 $ 0.59 $ 0.64 $ 0.69 $ (0.48 ) $ 0.50 $ 0.59 $ 0.63 34-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP" or "GAAP"). The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis management evaluates its estimates, including those related to the allowance for uncollectible accounts receivable, inventory reserves to reduce inventories to the lower of cost or market, and vendor incentives. Management bases its estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, the results of which form a basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ materially from these estimates under different assumptions or conditions, however, management believes that its estimates, including those for the above-described items, are reasonable and that the actual results will not vary significantly from the estimated amounts. For further discussion of our significant accounting policies, refer to Note 1 - Business and Summary of Significant Accounting Policies.

Revenue Recognition Revenue is recognized once four criteria are met: (1) the Company must have persuasive evidence that an arrangement exists; (2) delivery must occur (this includes the transfer of both title and risk of loss, provided that no significant obligations remain); (3) the price must be fixed and determinable; and (4) collectability must be reasonably assured. The Company allows its customers to return product for exchange or credit subject to certain limitations.

Service revenue associated with configuration and marketing services is recognized when the work is complete and the four criteria discussed above have been substantially met. Service revenue associated with configuration, marketing, service contracts and other services approximated 2% or less of consolidated net sales for fiscal years 2014, 2013 and 2012.

We also distribute third-party service contracts, typically for product maintenance and support. These service contracts are sold separately from the products, and often the Company serves as the agent for the contract on behalf of the original equipment manufacturer. Since we act as an agent on behalf of most of these service contracts sold, revenue is recognized net of cost at the time of sale. We also distribute some self-branded warranty programs and engage a third party (generally the original equipment manufacturer) to cover the fulfillment of any obligations arising from these contracts. These revenues and associated third party costs are amortized over the life of contract and presented in net sales and cost of goods sold, respectively.

During the fiscal years ended June 30, 2014, 2013 and 2012, the Company has not engaged in any sales transactions involving multiple element arrangements. Had any arrangements with multiple deliverables occurred, we would follow the guidance set forth in the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") 605 - Revenue Recognition.

Allowances for Trade and Notes Receivable The Company maintains an allowance for uncollectible accounts receivable for estimated losses resulting from customers' failure to make payments on accounts receivable due to the Company. Management determines the estimate of the allowance for uncollectible accounts receivable by considering a number of factors, including: (1) historical experience, (2) aging of the accounts receivable, and (3) specific information obtained by the Company on the financial condition and the current creditworthiness of its customers. If the financial condition of the Company's customers were to deteriorate and reduce the ability of the Company's customers to make payments on their accounts, the Company may be required to increase its allowance by recording additional bad debt expense. Likewise, should the financial condition of the Company's customers improve and result in payments or settlements of previously reserved amounts, the Company may be required to record a reduction in bad debt expense to reverse the recorded allowance.

Inventory Reserves Management determines the inventory reserves required to reduce inventories to the lower of cost or market based principally on the effects of technological changes, quantities of goods and length of time on hand, and other factors. An estimate is made of the market value, less cost to dispose, of products whose value is determined to be impaired. If these products are ultimately sold at less than estimated amounts, additional reserves may be required. The estimates used to calculate these reserves are applied consistently. The adjustments are recorded in the period in which the loss of utility of the inventory occurs, which establishes a new cost basis for the inventory. This new cost basis is maintained until such time that the reserved inventory is disposed of, 35-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements returned to the vendor or sold. To the extent that specifically reserved inventory is sold, cost of goods sold is expensed for the new cost basis of the inventory sold.

Vendor Programs The Company receives incentives from vendors related to volume rebates, cooperative advertising allowances and other incentive agreements. These incentives are generally under quarterly, semi-annual or annual agreements with the vendors. Some of these incentives are negotiated on an ad hoc basis to support specific programs mutually developed between the Company and the vendor.

Vendors generally require that we use their cooperative advertising allowances exclusively for advertising or other marketing programs. Incentives received from vendors for specifically identified incremental cooperative advertising programs are recorded as adjustments to selling, general and administrative expenses. FASB's ASC 605 - Revenue Recognition, addresses accounting by a customer (including a reseller) for certain consideration received from a vendor. This guidance requires that the portion of these vendor funds in excess of our costs be reflected as a reduction of inventory. Such funds are recognized as a reduction of the cost of products sold when the related inventory is sold.

The Company records unrestricted volume rebates received as a reduction of inventory and as a reduction of the cost of goods sold when the related inventory is sold. Amounts received or receivables from vendors that are not yet earned are deferred in the consolidated balance sheets. In addition, the Company may receive early payment discounts from certain vendors. The Company records early payment discounts received as a reduction of inventory and recognizes the discount as a reduction of cost of goods sold when the related inventory is sold. ASC 605 requires management to make certain estimates of the amounts of vendor incentives that will be received. Actual recognition of the vendor consideration may vary from management estimates based on actual results.

Share-Based Payments The Company accounts for share-based compensation using the provisions of ASC 718, Accounting for Stock Compensation, which requires the recognition of the fair value of share-based compensation. Share-based compensation is estimated at the grant date based on the fair value of the awards, in accordance with the provisions of ASC 718. Since this compensation cost is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company has elected to expense grants of awards with graded vesting on a straight-line basis over the requisite service period for each separately vesting portion of the award.

Income Taxes Income taxes are accounted for under the asset and liability method. Deferred income taxes reflect tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts.

Valuation allowances are provided against deferred tax assets in accordance with ASC 740, Accounting for Income Taxes. During fiscal 2013, the Company reviewed and modified its policy toward permanently reinvested foreign earnings. The Company has provided for U.S. income taxes for the current earnings of its Canadian subsidiary. Earnings from all other geographies will continue to be considered retained indefinitely for reinvestment. The tax effect of this accounting policy change is immaterial to the financial statements. See Note 11 - Income Taxes, for further discussion.

Additionally, the Company maintains reserves for uncertain tax provisions in accordance with ASC 740. See Note 11 - Income Taxes, in the Notes to Consolidated Financial Statements for more information.

Business Combinations The Company accounts for business combinations in accordance with ASC Topic 805, Business Combinations. ASC 805 establishes principles and requirements for recognizing the total consideration transferred to and the assets acquired, liabilities assumed and any non-controlling interest in the acquired target in a business combination. ASC 805 also provides guidance for recognizing and measuring goodwill acquired in a business combination and requires the acquirer to disclose information that users may need to evaluate and understand the financial impact of the business combination. See Note 4 - Acquisitions, in the Notes to Consolidated Financial Statements for further discussion.

Goodwill The carrying value of goodwill is reviewed at a reporting unit level at least annually for impairment, or more frequently if impairment indicators exist. Our goodwill reporting units are those components that are one level below our Worldwide Barcode & Security and Worldwide Communications & Services operating segments for a total of seven reporting units. The goodwill testing utilizes a two-step impairment analysis, whereby the Company compares the carrying value of each identified reporting unit to its fair value. The fair values of the reporting units are estimated using the net present value of discounted cash flows generated by each 36-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements reporting unit. Considerable judgment is necessary in estimating future cash flows, discount rates and other factors affecting the estimated fair value of the reporting units, including the operating and macroeconomic factors.

Historical financial information, internal plans and projections, and industry information are used in making such estimates.

In the two-step impairment analysis, goodwill is first tested for impairment by comparing the fair value of the reporting unit with the reporting unit's carrying amount to identify any potential impairment. If fair value is determined to be less than carrying value, a second step is used whereby the implied fair value of the reporting unit's goodwill, determined through a hypothetical purchase price allocation, is compared with the carrying amount of the reporting units' goodwill. If the implied fair value of the reporting unit's goodwill is less than its carrying amount, an impairment charge is recorded in current earnings for the difference. We also assess the recoverability of goodwill if facts and circumstances indicate goodwill may be impaired. In our most recent annual test, we estimated the fair value of our reporting units primarily based on the discounted cash flow method. We also utilized fair value estimates derived from the market approach utilizing the public company market multiple method to validate the results of the discounted cash flow method, which required us to make assumptions about the applicability of those multiples to our reporting units. The discounted cash flow method required us to estimate future cash flows and discount those amounts to a present value.

The assumptions utilized in determining fair value included: • Industry weighted-average cost of capital ("WACC"): We utilized a WACC relative to each reporting unit's respective geography and industry as the discount rate for estimated future cash flows. The WACC is intended to represent a rate of return that would be expected by a market place participant in each respective geography.

• Operating income: We utilized historical and expected revenue growth rates, gross margins and operating expense percentages, which varied based on the projections of each reporting unit being evaluated.

• Cash flows from working capital changes: We utilized aprojected cash flow impact pertaining to expected changes in working capital as each of our goodwill reporting units grow.

While we believe our assumptions are appropriate, they are subject to uncertainty and by nature include judgments and estimates regarding future events, including projected growth rates, margin percentages and operating efficiencies. During fiscal year 2014, the Company completed its annual impairment test as of April 30 and determined that no goodwill impairment charge was necessary. However, as of the most recent annual impairment test the estimated fair value of the Company's Latin American goodwill reporting unit exceeded its carrying value by smaller margins than the Company's other goodwill reporting units. The estimated fair value of the Latin America goodwill reporting unit exceeded the carrying value by 10.2%. The increase in sensitivity to this goodwill reporting unit is driven largely by the general macroeconomic environment and lower expectations for future results in the units. Key assumptions used in determining fair value include projected growth and operating margin, working capital requirements and discount rates. While we do not believe that this goodwill reporting unit is impaired at this time, if we are not able to achieve projected operating margins within the expected working capital requirements and/or there are unfavorable changes to the discount rate, a future impairment of goodwill is at least reasonably possible.

During fiscal 2013, the Company recorded a non-cash impairment charge of $5.4 million and $15.1 million for our European Communications and ScanSource Brasil reporting units. The carrying value of the European POS & Barcode and ScanSource Latin America goodwill as of June 30, 2013 was $4.5 million and $4.0 million, respectively. The increase in sensitivity to these goodwill reporting units are driven largely by the general macroeconomic environment and lower expectations for future results in the units. Key assumptions used in determining fair value include projected growth and operating margin, working capital requirements and discount rates.

See Note 5 - Goodwill and Other Identifiable Intangible Assets in the Notes to Consolidated Financial Statements for further discussion on our goodwill impairment testing and results.

Liability for Contingent Consideration In addition to the initial cash consideration paid to former CDC shareholders, the Company is obligated to make additional earnout payments based on future results through fiscal year 2015 based on a multiple of the subsidiary's pro forma net income as defined in the Share Purchase and Sale Agreement. Future payments are to be paid in Brazilian currency, the real. There are two remaining earnout payments payable in annual installments on August 31, 2014 and October 31, 2015. In accordance with ASC Topic 805, the Company determines the fair value of this liability for contingent consideration at each reporting date throughout the term of the earnout using a discounted cash flow model following the income approach. Each period the Company will reflect the contingent consideration liability at fair value with changes recorded in the change in fair value of contingent consideration line item on the Consolidated Income Statement. Current and noncurrent portions of the liability are presented in the current portion of contingent consideration and long-term portion of contingent consideration line items on the Consolidated Balance Sheets.

37-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Accounting Standards Recently Issued See Note 1 in the Notes to Consolidated Financial Statements for the discussion on recent accounting pronouncements.

Liquidity and Capital Resources Our primary sources of liquidity are cash flows from operations and borrowings under the $300 million revolving credit facility, $5.4 million industrial revenue bond and €6 million line of credit for our European subsidiary. As a distribution company, our business requires significant investment in working capital, particularly accounts receivable and inventory, partially financed through our accounts payable to vendors, cash on hand and revolving lines of credit. In general, as our sales volumes increase, our net investment in working capital typically increases, which typically results in decreased cash flow from operating activities. Conversely, when sales volumes decrease, our net investment in working capital typically decreases, which typically results in increased cash flow from operating activities.

Cash and cash equivalents totaled $194.9 million at June 30, 2014, compared to $148.2 million at June 30, 2013, of which $39.7 million and $23.8 million was held outside of the United States as of June 30, 2014 and 2013, respectively.

Checks released but not yet cleared from these accounts in the amounts of $84.1 million and $65.9 million are classified as accounts payable as of June 30, 2014 and June 30, 2013, respectively.

We conduct business in many locations throughout the world where we generate and use cash. The Company provides for U.S. income taxes for the earnings of its Canadian subsidiary. Earnings from all other geographies will continue to be considered retained indefinitely for reinvestment. If these funds were needed in the operations of the United States, we would be required to record and pay significant income taxes upon repatriation of these funds. See Note 11 - Income Taxes in the Notes to the Consolidated Financial Statements for further discussion.

Our net investment in working capital increased $101.5 million to $715.9 million at June 30, 2014 from $614.4 million at June 30, 2013, principally from higher cash, accounts receivable and inventory balances, partially offset by higher accounts payable. Our net investment in working capital is affected by several factors such as fluctuations in sales volume, net income, timing of collections from customers, increases and decreases to inventory levels, payments to vendors, as well as cash generated or used by other financing and investing activities.

Net cash provided by operating activities was $47.7 million for year ended June 30, 2014, compared to $129.4 million provided by operating activity in the prior year. The decrease in operating cash flows is largely the result of higher inventory and accounts receivable balances, partially offset by higher accounts payable and net income.

The number of days sales outstanding ("DSO") was 55 at June 30, 2014 and June 30, 2013, which is within our typically expected range. Accounts receivable increased due to higher sales.

Inventory turnover decreased to 5.6 times during the fourth quarter of the current fiscal year, compared to 6.2 times in the prior year quarter. Throughout fiscal year 2014 inventory turnover ranged from 5.1 to 6.3 times. The decrease in inventory turns in relation to the prior year comparative quarter is primarily due to higher inventory levels in anticipation of the upcoming quarter demand.

Cash used in investing activities for the year ended June 30, 2014 was $11.2 million, compared to $4.8 million used in the prior year. Current year capital expenditures were attributable to the Company's new Enterprise Resource Planning ("ERP") system, while prior year investing cash flows were primarily attributable to investments that were subsequently impaired, as well as, building improvements in the United States and Europe.

In December 2013, we retained SAP for the software platform and implementation consulting services for a new ERP system. The Company is currently working on the development and implementation of the new ERP platform. Management expects capital spending for fiscal 2015 to range from $17 million to $22 million, primarily related to the ERP system.

In fiscal 2014, cash provided by financing activities totaled to $9.3 million, compared to $5.0 million cash used in financing activities in the prior year.

The change in cash flow is primarily attributable to increased exercises of stock options and no activity related to our short-term borrowings.

The Company has a $300 million multi-currency senior secured revolving credit facility that was scheduled to mature on October 11, 2016. On November 6, 2013, the Company entered into an amendment of this credit facility ("Amended Credit Agreement") with JP Morgan Chase Bank, N.A, as administrative agent, and a syndicate of banks to extend its maturity to November 6, 2018. The Amended Credit Agreement allows for the issuance of up to $50 million for letters of credit and has a $150 million accordion 38-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements feature that allows the Company to increase the availability to $450 million, subject to obtaining additional credit commitments for the lenders participating in the increase.

At our option, loans denominated in U.S. dollars under the Amended Credit Agreement, other than swingline loans, bear interest at a rate equal to a spread over the London Interbank Offered Rate ("LIBOR") or alternate base rate depending upon the Company's ratio of total debt (excluding accounts payable and accrued liabilities) to 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"). The Leverage Ratio calculation excludes the Company's subsidiary in Brazil. This spread ranges from 1.00% to 2.25% for LIBOR-based loans and 0.00% to 1.25% for alternate base rate loans.

Additionally, the Company is assessed commitment fees ranging from 0.175% to 0.40% depending on the Leverage Ratio, on non-utilized borrowings availability, excluding swingline loans. Borrowings under the Amended Credit Agreement are guaranteed by substantially all of the domestic assets of the Company and a pledge of up to 65% of capital stock or other equity interest in certain foreign subsidiaries determined to be either material or a subsidiary borrower as defined in the Amended Credit Agreement. We were in compliance with all covenants under the credit facility as of June 30, 2014.

There were no outstanding borrowings on the Company's $300 million revolving credit facility as of June 30, 2014 and 2013.

On a gross basis, we made zero borrowings and repayments on the $300.0 million revolving credit facility in fiscal 2014. In the prior year, we borrowed $515.3 million and repaid $515.9 million. The average daily balance on the revolving credit facility was $0.0 million and $9.4 million for the years ended June 30, 2014 and 2013, respectively. There were no standby letters of credits issued and outstanding as of June 30, 2014, leaving $300 million available for borrowings under the revolving credit facility.

In addition to our multi-currency $300 million revolving credit facility, we have a €6.0 million subsidiary line of credit utilized by our European operations which bears interest at the 30-day Euro Interbank Offered Rate ("EURIBOR") plus a spread ranging from 1.25% to 2.00% per annum. There were no outstanding borrowings as of June 30, 2014 and 2013. This facility is secured by the assets of our European operations and is guaranteed by ScanSource, Inc.

On April 15, 2011, the Company, through its wholly-owned subsidiary, ScanSource do Brasil Participações LTDA completed its acquisition of all of the shares of CDC, pursuant to a Share Purchase and Sale Agreement dated April 7, 2011. The purchase price was paid with an initial payment of $36.2 million, net of cash acquired, assumption of working capital payables and debt, and variable annual payments through October 2015 based on CDC's annual financial results. The Company has made its first three payments to the former shareholders totaling $10.4 million. As of June 30, 2014, we have $11.1 million recorded for the earnout obligation, of which $5.9 million is classified as current and due August 31, 2014. Future earnout payments will be funded by cash on hand and our existing revolving credit facility.

On August 1, 2007, the Company entered into an agreement with the State of Mississippi in order to provide financing for the acquisition and installation of certain equipment to be utilized at the Company's Southaven, Mississippi distribution facility, through the issuance of an industrial development revenue bond. The bond matures on September 1, 2032 and accrues interest at the 30-day LIBOR rate 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, and then, 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. The outstanding balance on this facility was $5.4 million as of June 30, 2014 and 2013, and the effective interest rate was 1.00% and 1.04%, respectively. The Company was in compliance with all covenants associated with this agreement as of June 30, 2014.

The Company believes that its existing sources of liquidity, including cash resources and cash provided by operating activities, supplemented as necessary with funds under the Company's credit agreements, will provide sufficient resources to meet the Company's present and future working capital and cash requirements for at least the next twelve months.

Commitments At June 30, 2014, the Company had contractual obligations in the form of non-cancelable operating leases, a capital lease (including interest payments), debt (including interest payments) and the contingent consideration for the earnout pertaining to the CDC acquisition. See Notes 6, 8 and 12 of the Notes to the Consolidated Financial Statements. The following table summarizes our future contractual obligations: 39-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Payments Due by Period Greater than Total Year 1 Years 2-3 Years 4-5 5 Years (in thousands) Contractual Obligations Non-cancelable operating leases(1) $ 15,871 $ 4,734 $ 7,510 $ 2,417 $ 1,210 Capital lease 743 250 493 - - Principal debt payments 5,429 - - 231 5,198 Contingent consideration(2) 11,107 5,851 5,256 - - Other(3) - - - - - Total obligations $ 33,150 $ 10,835 $ 13,259 $ 2,648 $ 6,408 (1) Amounts to be paid in future periods for real estate taxes, insurance, and other operating expenses applicable to the properties pursuant to the respective operating leases have been excluded from the table above as the amounts payable in future periods are generally not specified in the lease agreements and are dependent upon amounts which are not known at this time.

Such amounts were not material in the current fiscal year.

(2) Amounts disclosed regarding future CDC earnout payments are presented at their discounted fair value. Estimated future, undiscounted earnout payments total $12.0 million as of June 30, 2014.

(3) Amounts totaling $14.0 million of deferred compensation which are included in accrued expenses and other current liabilities and other long-term liabilities in our Consolidated Balance Sheets as of June 30, 2014 have been excluded from the table above due to the uncertainty of the timing of the payment of these obligations, which are generally at the discretion of the individual employees or upon death of the former employee, respectively.

40 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements

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