UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

~~Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for~~For the Quarterly Period Ended ~~September 30,~~December 31, 2002

ORor

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

~~Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for~~For the transition period from ~~___________________~~ to ~~____________________~~

Commission File Number: 000-26926

SCANSOURCE, INC.

(Exact name of registrant as specified in its charter)

South Carolina

~~SOUTH CAROLINA~~57-0965380

(State or other jurisdiction

of
incorporation or organization)

~~57-0965380~~
(I.R.S. Employer

Identification No.)

	6 Logue Court, Greenville, South Carolina		29615
(Address of principal executive offices)		~~29615~~ (Zip Code)

(864) 288-2432

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o¨

As of ~~October 18, 2002, 5,885,718~~February 1, 2003, 12,170,970 shares of the ~~registrant's~~registrant’s common stock, no par value, were outstanding.

SCANSOURCE, INC.

INDEX TO FORM 10-Q

~~September 30,~~December 31, 2002

					Page No.

PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements (Unaudited):


~~PART I.~~	~~FINANCIAL INFORMATION~~

	~~Item 1.~~	~~Financial Statements (Unaudited):~~
		Condensed Consolidated Balance Sheets as of June 30, 2002 and ~~September 30,~~December 31, 2002		3

		Condensed Consolidated Income Statements for the Quarters and Six Months Ended ~~September 30,~~December 31, 2001 and 2002		5

		Condensed Consolidated Statements of Cash Flows for the ~~Quarters~~Six Months Ended ~~September 30,~~December 31, 2001 and 2002	6	7

		Notes to Condensed Consolidated Financial Statements	7	8

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15	17

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20	24

	Item 4.	Disclosure Controls and Procedures	21	25

PART II.	OTHER INFORMATION

	Item 1.
~~PART II.~~Legal Proceedings	~~OTHER INFORMATION~~ 26

	Item 2.
	~~Item 1.~~	~~Legal Proceedings~~	22
	~~Item 2.~~	Changes in Securities and Use of Proceeds	22	26

	Item 3.	Defaults Upon Senior Securities	22	26

	Item 4.	Submission of Matters to a Vote of Security Holders	22	26

	Item 5.	Other Information	22	27

	Item 6.	Exhibits and Reports on Form 8-K	22

Cautionary Statements

Certain of the statements contained in this Form 10-Q, as well as in the Company’s other filings with the Securities and Exchange Commission, that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The Company cautions readers of this report that a number of important factors could cause the Company’s activities and/or actual results in fiscal 2003 and beyond to differ materially from those expressed in any such forward-looking statements. These factors include, without limitation, the Company’s dependence on vendors, product supply, senior management, centralized functions, and third-party shippers, the Company’s ability to compete successfully in a highly competitive market and manage significant additions in personnel and increases in working capital, the Company’s entry into new product markets in which it has no prior experience, the Company’s susceptibility to quarterly fluctuations in net sales and results of operations, the Company’s ability to manage successfully pricing or stock rotation opportunities associated with inventory value decreases, and other factors described herein and in other reports and documents filed by the Company with the Securities and Exchange Commission, including Exhibit 99.1 to the Company’s Form 10-K for the year ended June 30, 2002.

2PART 1. FINANCIAL INFORMATION

~~PART 1.~~

~~FINANCIAL INFORMATION~~

~~Item 1.~~

Item 1. Financial Statements

SCANSOURCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands)

June 30,
2002* September 30,
2002

Assets
Current Assets:
   Cash $ 1,296 $ 3,994
   Receivables:
     Trade, less allowance for doubtful accounts of $9,580 at June 30, 2002 and
         $9,361at September 30, 2002 119,158 140,464
     Other 7,860 6,367
   Inventories 182,636 152,941
   Prepaid expenses and other assets 1,258 1,732
   Deferred income taxes 10,225 10,225

     Total current assets 322,433 315,723

Property and equipment, net 25,995 26,870
Goodwill 9,575 9,841
Other assets, including identifiable intangible assets 1,029 955

     Total assets $ 359,032 $ 353,389

	June 30, 2002*		December 31, 2002
Assets
Current Assets:
Cash	$	1,296	$	3,463
Receivables:
Trade, less allowance for doubtful accounts of $9,580 at June 30, 2002 and $9,710 at December 31, 2002		119,158		135,510
Other		7,860		6,106
Inventories		182,636		152,499
Prepaid expenses and other assets		1,258		1,140
Prepaid taxes		—		5,015
Deferred income taxes		10,225		10,423

Total current assets		322,433		314,156

Property and equipment, net		25,995		26,940
Goodwill		9,575		9,841
Other assets, including identifiable intangible assets		1,029		1,328

Total assets	$	359,032	$	352,265

Derived from audited financial statements at June 30, 2002

See notes to condensed consolidated financial statements (unaudited).

SCANSOURCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands)

(Continued)

June 30,
2002* September 30,
2002

Liabilities and Shareholders’ Equity
Current Liabilities:
   Current portion of long-term debt $ 769 $ 773
   Subsidiary lines of credit 1,559 2,014
   Trade accounts payable 175,406 152,852
   Accrued expenses and other liabilities 8,261 13,202
   Income taxes payable 935 586

     Total current liabilities 186,930 169,427

Deferred income taxes 517 492
Borrowings under revolving credit facility 43,780 49,369
Long-term debt 8,319 8,123

     Total liabilities 239,546 227,411

Minority interest 1,437 1,393
Commitments and contingencies

Shareholders' equity:
   Preferred stock, no par value; 3,000 shares authorized, none issued — —
   Common stock, no par value; 10,000 shares authorized, 5,831 and 5,865 shares
       issued and outstanding at June 30, 2002 and September 30, 2002, respectively 48,223 48,763
   Retained earnings 68,732 74,723
   Accumulated other comprehensive income - cumulative currency translation
       adjustment 1,094 1,099

     Total shareholders' equity 118,049 124,585

     Total liabilities and shareholders' equity $ 359,032 $ 353,389

	June 30, 2002*		December 31, 2002
Liabilities and Shareholders’ Equity
Current Liabilities:
Current portion of long-term debt	$	769	$	779
Subsidiary lines of credit		1,559		703
Trade accounts payable		175,406		152,163
Accrued expenses and other liabilities		8,261		8,960
Income taxes payable		935		406

Total current liabilities		186,930		163,011
Deferred income taxes		517		1,295
Borrowings under revolving credit facility		43,780		40,151
Long-term debt		8,319		7,925

Total liabilities		239,546		212,382

Minority interest		1,437		1,470
Commitments and contingencies
Shareholders’ equity:
Preferred stock, no par value; 3,000 shares authorized, none issued		—		—
Common stock, no par value; 25,000 shares authorized, 11,661 and 12,160 shares issued and outstanding at June 30, 2002 and December 31, 2002, respectively		48,223		56,055
Retained earnings		68,732		80,545
Accumulated other comprehensive income—cumulative currency translation adjustment		1,094		1,813

Total shareholders’ equity		118,049		138,413

Total liabilities and shareholders’ equity	$	359,032	$	352,265

Derived from audited financial statements at June 30, 2002

See notes to condensed consolidated financial statements (unaudited).

SCANSOURCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)

(In ~~thousands, except per share data)~~thousands)

Quarter ended
September 30,
2001 2002
Net sales $ 188,843 $ 260,603
Cost of goods sold 167,931 230,408

     Gross profit 20,912 30,195

Selling, general and administrative expenses 13,004 19,677

     Operating income 7,908 10,518

Other expense (income):
   Interest expense 894 693
   Interest income (340 ) (304 )
   Other expense 54 205
     Other expense, net 608 594

     Income before income taxes 7,300 9,924

Provision for income taxes 2,774 3,933

     Net income $ 4,526 $ 5,991

Per share data:
   Basic earnings per share:
     Net income $ 0.79 $ 1.02

     Weighted-average shares outstanding 5,716 5,849

   Diluted earnings per share:
     Net income $ 0.73 $ 0.95

     Weighted-average shares outstanding 6,167 6,204

	Quarter ended December 31,							Six months ended December 31,
	2001				2002			2001			2002
Net sales	$	207,856			$	250,117		$	396,699		$	510,720
Cost of goods sold		185,898				223,207			353,829			453,615

Gross profit		21,958				26,910			42,870			57,105


Operating expenses:
Selling, general and admin. expenses		14,204				16,467			27,208			36,144
Impairment of capitalized software		840				—			840			—

		15,044				16,467			28,048			36,144

Operating income		6,914				10,443			14,822			20,961


Other expense (income):				��
Interest expense		690				556			1,584			1,249
Interest income		(308	)			(282	)		(648	)		(586	)
Other (income) expense		(16	)			126			38			331

Other expense, net		366				400			974			994

Income before income taxes and extraordinary gain		6,548				10,043			13,848			19,967
Provision for income taxes		2,490				4,221			5,264			8,154

Income before extraordinary gain		4,058				5,822			8,584			11,813

Extraordinary gain on excess of fair value of net assets acquired over cost, net of income taxes of $508		829				—			829			—

Net income	$	4,887			$	5,822		$	9,413		$	11,813

See notes to condensed consolidated financial statements (unaudited).

SCANSOURCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS ~~OF CASH FLOWS~~ (UNAUDITED)

(In ~~thousands)~~thousands, except per share data)

Quarter Ended
September 30,
2001 2002
Cash flows used in operating activities:
   Net income $ 4,526 $ 5,991
   Adjustments to reconcile net income to net cash used in operating activities:
     Depreciation and amortization 1,269 1,192
     Provision for doubtful accounts 326 1,480
     Deferred income tax benefit 20 1
     Tax benefit of stock option exercise — 73
     Minority interest in net income of subsidiaries 15 147
     Changes in operating assets and liabilities, net of acquisitions:
       Trade receivables (2,715 ) (22,781 )
       Other receivables 1,133 1,194
       Inventories 13,957 29,713
       Prepaid expenses and other assets 71 (175 )
       Other noncurrent assets 36 22
       Trade accounts payable (26,449 ) (22,559 )
       Accrued expenses and other liabilities (252 ) 4,940
       Income taxes payable — (349 )

     Net cash used in operating activities (8,063 ) (1,111 )

Cash flows used in investing activities:
   Capital expenditures (3,018 ) (2,040 )
   Cash paid for business acquisitions (15,556 ) (457 )

     Net cash used in investing activities (18,574 ) (2,497 )

Cash flows from financing activities:
   Advances on revolving credit, net 26,359 6,044
   Repayments of long-term debt borrowings (100 ) (192 )
   Exercise of stock options 91 467

     Net cash provided by financing activities 26,350 6,319

Effect of exchange rate changes upon cash — (13 )

Increase (decrease) in cash (287 ) 2,698

Cash at beginning of period 594 1,296

Cash at end of period $ 307 $ 3,994

(Continued)

	Quarter ended December 31,				Six months ended December 31,
	2001		2002		2001		2002
Per share data:
Basic earnings per share:
Income before extraordinary gain *	$	0.35	$	0.49	$	0.75	$	1.00
Extraordinary gain on excess of fair value of net assets acquired over cost, net of income taxes *		0.07		—		0.07		—

Net income *	$	0.42	$	0.49	$	0.82	$	1.00

Weighted-average shares outstanding *		11,466		11,947		11,447		11,822

Diluted earnings per share:
Income before extraordinary gain *	$	0.33	$	0.46	$	0.70	$	0.94
Extraordinary gain on excess of fair value of net assets acquired over cost, net of income taxes *		0.06		—		0.06		—

Net income *	$	0.39	$	0.46	$	0.76	$	0.94

Weighted-average shares outstanding *		12,408		12,646		12,371		12,527

Share and per share amounts for the quarter and six months have been restated to reflect a two-for-onestock split effected in the form of a 100% common stock dividend on January 28, 2003.

See notes to condensed consolidated financial statements (unaudited).

SCANSOURCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

	Six Months Ended December 31,
	2001			2002
Cash flows from operating activities:
Net income	$	9,413		$	11,813
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Extraordinary gain, net of income taxes		(829	)		—
Depreciation and amortization		2,340			2,429
Provision for doubtful accounts		2,630			1,902
Impairment of capitalized software		840			—
Deferred income tax benefit		(562	)		421
Tax benefit of stock option exercises		—			3,420
Minority interest in net income of subsidiaries		2			224
Changes in operating assets and liabilities, net of acquisitions:
Trade receivables		(13,751	)		(17,919	)
Other receivables		(1,421	)		1,757
Inventories		9,335			30,442
Prepaid expenses and other assets		20			118
Other noncurrent assets		1			(335	)
Trade accounts payable		(912	)		(23,319	)
Accrued expenses and other liabilities		(1,379	)		867
Income taxes payable		—			(5,545	)

Net cash provided by operating activities		5,727			6,275

Cash flows used in investing activities:
Capital expenditures		(4,871	)		(3,331	)
Cash paid for business acquisitions		(17,689	)		(457	)

Net cash used in investing activities		(22,560	)		(3,788	)

Cash flows from financing activities:
Advances (payments) on revolving credit, net		16,874			(4,485	)
Repayments of long-term debt borrowings		(304	)		(384	)
Exercise of stock options		706			4,412

Net cash provided by (used in) financing activities		17,276			(457	)

Effect of exchange rate changes upon cash		—			137

Increase in cash		443			2,167
Cash at beginning of period		594			1,296

Cash at end of period	$	1,037		$	3,463

See notes to condensed consolidated financial statements (unaudited).

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO ~~UNADUITED~~UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(1) Basis of Presentation

The interim financial information included herein is unaudited. Certain information and footnote disclosures normally included in the consolidated financial statements have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC), although the Company believes that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s June 30, 2002 annual report on Form 10-K. Other than as indicated herein, there have been no significant changes from the financial data published in that report. In the opinion of management, such unaudited information reflects all adjustments, consisting only of normal recurring accruals and other adjustments as disclosed herein, necessary for a fair presentation of the unaudited information.

Results for interim periods are not necessarily indicative of results expected for the full year, or for any subsequent period.

(2) Business Description and Certain Accounting Policies

ScanSource, Inc. (“Company”) is a leading distributor of specialty technology products, providing both value-added distribution sales to technology resellers and e-logistics services to specialty technology markets. The Company has two geographic distribution segments: one serving North America from the Memphis distribution center, and an international segment currently serving Latin America and Europe. The North American distribution segment markets automatic identification and data capture ~~(AIDC)~~(“AIDC”) and point-of-sale ~~(POS)~~(“POS”) products through its ScanSource sales unit; voice, data and converged communications equipment through its Catalyst Telecom sales unit; and converged communications products through its Paracon sales unit. The international distribution segment markets AIDC and POS products. A third segment, ChannelMax, provides e-logistics services.

Stock Split –Effective January 28, 2003, the Board of Directors approved a two-for-one stock split of the common stock effected in the form of a 100% common stock dividend. The effect of the stock split has been recognized retroactively in all share and per share data in the accompanying consolidated financial statements and the related notes to the consolidated financial statements.

Consolidation Policy –The consolidated financial statements include the accounts of the Company and all wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Minority Interest –Minority interest represents that portion of the net equity of majority-owned subsidiaries of the Company that is held by minority shareholders. The minority shareholders’ share of the subsidiaries’ income or loss is included in other expense in the consolidated income statements. ~~As discussed in Note 8, effective~~Effective July 1, 2002, the Company acquired an additional 8% of the stock of Netpoint International, Inc. (“Netpoint”) and an additional 12% of Outsourcing Unlimited, Inc. (“OUI”). The Company now owns 60% of Netpoint and 64% of OUI.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO ~~UNADUITED~~UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

Use of estimates –The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 and inventory reserves to reduce inventories to the lower of cost or market. 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 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.

Revenue Recognition–Revenues are recognized for the sale of products upon shipment. The Company provides a reserve for estimated product returns and allowances. The Company also has arrangements in which it earns a service fee determined as a percentage of the value of products shipped on behalf of the manufacturer, ~~who~~which retains the risk of ownership and credit loss. Such service fees earned by the Company are included in net sales and were less than 1% of net sales for the quarters and six months ended ~~September 30,~~December 31, 2001 and 2002.

Inventories –Inventories (consisting of AIDC, POS, business phone and computer telephony equipment) are stated at the lower of cost (first-in, first-out method) or market.

Foreign Currencies –The currency effects of translating the financial statements of the Company’s foreign entities that operate in local currency environments other than the U.S. dollar are included in the cumulative currency translation adjustment component of accumulated other comprehensive income. The assets and liabilities of these foreign entities are translated into U.S. dollars using the exchange rate at the end of the respective period. Sales, costs and expenses are translated at average exchange rates effective during the respective period.

Foreign currency transaction gains and losses are included in selling, general and administrative costs in the consolidated income statement and were less than 1% of operating income for the quarters and six months ended ~~September 30,~~December 31, 2001 and 2002.

Comprehensive Income –For the quarter and six months ended December 31, 2002, comprehensive income, comprised of net income and foreign currency translation gains or losses, approximated $6.5 million and $12.5 million, respectively. For the quarter and six months ended December 31, 2001, comprehensive income, comprised only of net income, approximated $4.9 million and $9.4 million, respectively.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Accounting Standards Recently Adopted –In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.144,Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 and the accounting and reporting provisions of APB 30 related to the disposal of a segment of a business and was adopted by the Company on July 1, 2002. The adoption of SFAS No. 144 had no effect on the Company’s financial position and results of operations.

In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This statement requires that the Company recognize costs associated with exit or

~~SCANSOURCE, INC. AND SUBSIDIARIES~~
~~NOTES TO UNADUITED CONDENSED CONSOLIDATED~~
~~FINANCIAL STATEMENTS~~

disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. The Company adopted SFAS No. 146 on July 1, 2002. The adoption of SFAS No. 146 had no effect on the Company’s financial position and results of operations.

Accounting Standards Not Yet Adopted – In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure. This statement amends the transition requirements of SFAS No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The disclosure provision is required for all companies with stock-based employee compensation, regardless of whether the company utilizes the fair value method of accounting described in SFAS No. 123 or the intrinsic value method described in APB Opinion No. 25,Accounting for Stock Issued to Employees. The amendments to the transition and annual disclosure provisions of SFAS No. 123 are effective for the Company’s fiscal year ended June 30, 2003. The disclosure requirements related to interim financial statements are effective for the Company’s quarter beginning January 1, 2003. The Company continues to account for stock-based employee compensation under the intrinsic value method described by APB Opinion No. 25. The Company anticipates that the adoption of SFAS No. 148 will not have an impact on the Company’s financial position and results of operations.

In December 2002, the FASB’s Emerging Issues Task Force (“EITF”) issued EITF Issue No. 02-16,Accounting by a Customer (including a Reseller) for Cash Consideration Received from a Vendor. This issue addresses the appropriate accounting, by a distributor, for cash consideration received from a vendor and will become effective for the Company on January 1, 2003. The Company is evaluating the impact of this issue and has not yet determined the effect, if any, that the adoption of the issue will have on the Company’s financial position and results of operations.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(3) Revolving Credit Facility and Subsidiary Lines of Credit

The Company has a revolving credit facility with its bank group maturing on September 30, ~~2003,~~2004, with a borrowing limit of the lesser of (i) $80 million or (ii) the sum of 85% of eligible accounts receivable plus the lesser of (a) 50% of eligible inventory or (b) $40 million. The facility bears interest at the 30-day LIBOR rate of interest plus a rate varying from 1.00% to 2.50% tied to the Company’s funded debt to EBITDA ratio ranging from 2.50:1 to 4.25:1. The revolving credit facility is collateralized by accounts receivable and eligible inventory. The credit agreement contains certain financial covenants, including minimum net worth requirements, capital expenditure limits, a maximum funded debt to EBITDA ratio and a minimum fixed charge coverage ratio. The Company was in compliance with the various covenants at December 31, 2002. The effective interest rate at ~~September 30,~~December 31, 2002 was ~~4.07%~~3.44% and the outstanding balance was ~~$49.4~~$40.2 million on a calculated borrowing base that exceeded $80 million, leaving ~~$30.6~~$39.8 million available for additional borrowings. Effective October 31, 2002, the Company amended its credit facility, extending its maturity date to September 30, 2004 and increasing the limit on the operating lease payment covenant. The Company was in compliance with the remaining covenants.

One of the Company’s subsidiaries, ScanSource Latin America (Netpoint), has an asset-based line of credit agreement with a bank that is due on demand. The borrowing limit on the line is the lesser of $600,000 or the sum of 75% of domestic receivables and 50% of foreign receivables, plus 10% of eligible inventory (up to $250,000). The facility bears interest at the bank’s prime rate of interest plus one percent ~~(5.75%~~(5.25% at ~~September~~December 30, 2002). All of the subsidiary’s assets collateralize the line of credit. The Company has guaranteed 60% of the balance on the line, while the subsidiary’s minority shareholder guarantees the remaining 40% of the balance. The line of credit contains certain financial covenants including certain thresholds for the leverage ratio (liabilities to equity) and current ratio. The subsidiary was in compliance with the various covenants at ~~June 30,~~December 31, 2002. At ~~September 30,~~December 31, 2002, there were no outstanding borrowings on the line of credit ~~however,~~and outstanding standby letters of credit totaled $40,000 leaving $560,000 available for additional borrowings.

Another of the Company’s subsidiaries, ScanSource UK, has an asset-based line of credit agreement extending to ~~January~~February 23, 2003 with a borrowing limit of the lesser of £1.8 million (approximately ~~$2.8~~$2.9 million) or 75% of eligible accounts receivable. The facility bears interest at the Bank of England’s prime rate plus 2.25%. The effective rate was 6.25% at ~~September 30,~~December 31, 2002. All of the subsidiary’s assets collateralize the line of credit. At ~~September 30,~~December 31, 2002, the outstanding balance on the line of credit was approximately ~~$1.9 million~~$380,000 on a borrowing base of approximately ~~$2.8~~$2.9 million, leaving approximately ~~$900,000~~$2.5 million available for additional borrowings. The Company does not currently plan to renew the line of credit when it expires on February 23, 2003.

~~One of the Company’s subsidiaries,~~

ScanSource UK also has an overdraft loan facility that is due on demand under which it can draw up to £225,000 (approximately ~~$350,000)~~$362,000). The facility bears interest at the Bank of England’s prime rate plus 2.5% or 3.5% depending on the level of borrowings (6.5% at ~~September 30,~~December 31, 2002). All of the subsidiary’s assets collateralize this facility. At ~~September 30,~~December 31, 2002, the outstanding balance on this facility was approximately ~~$75,000~~$323,000 and approximately ~~$275,000~~$39,000 was available for additional borrowings.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO ~~UNADUITED~~UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(4) Long-term Debt

Long-term debt consists of the following at June 30, 2002 and ~~September 30,~~December 31, 2002:

June 30,
2002 September 30,
2002
Note payable to a bank, secured by distribution center land and building; monthly
    payments of principal and interest of $65,000; 3.72% variable interest rate;
    maturing in fiscal 2006 with a balloon payment of approximately $4.9 million $ 6,712,000 $ 6,581,000

Note payable to a bank, secured by office building and land; monthly payments of
    principal and interest of $15,000; 9.19% fixed interest rate; maturing in fiscal
    2007 with a balloon payment of approximately $1.5 million 1,618,000 1,608,000

Note payable to a bank, secured by motor coach; monthly payments of principal
    and interest of $7,000; 3.72% variable interest rate; maturing in fiscal 2006 with
    a balloon payment of approximately $153,000 429,000 411,000

Capital leases for equipment with monthly principal payments ranging from $33
    to $1,391 and effective interest rates ranging from 7.6% to 11.75% 329,000 296,000

9,088,000 8,896,000

Less current portion 769,000 773,000

Long-term portion $ 8,319,000 $ 8,123,000

	June 30, 2002		December 31, 2002
	June 30, 2002		December 31, 2002
Note payable to a bank, secured by distribution center land and building; monthly payments of principal and interest of $65,000; 3.09% variable interest rate; maturing in fiscal 2006 with a balloon payment of approximately $4.9 million	$	6,712,000	$	6,447,000

Note payable to a bank, secured by office building and land; monthly payments of principal and interest of $15,000; 9.19% fixed interest rate; maturing in fiscal 2007 with a balloon payment of approximately $1.5 million		1,618,000		1,600,000

Note payable to a bank, secured by motor coach; monthly payments of principal and interest of $7,000; 3.09% variable interest rate; maturing in fiscal 2006 with a balloon payment of approximately $153,000		429,000		393,000

Capital leases for equipment with monthly principal payments ranging from $33 to $1,391 and effective interest rates ranging from 7.6% to 11.75%		329,000		264,000

		9,088,000		8,704,000
Less current portion		769,000		779,000

Long-term portion	$	8,319,000	$	7,925,000

The ~~note payables~~notes payable secured by the distribution center and the motor coach contain certain financial covenants, including minimum net worth, capital expenditure limits, and a maximum debt to tangible net worth ratio, and prohibit the payment of dividends. The Company was in compliance with the various covenants at ~~September 30,~~December 31, 2002.

~~The~~

In addition to the foregoing, the Company owns an equity interest in a limited liability company for which it has guaranteed debt up to approximately $496,000. As of ~~September 30,~~December 31, 2002, the limited liability company had assets with a fair market value in excess of $2.3 million and liabilities of approximately $2.0 million.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO ~~UNADUITED~~UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(5) Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share are computed by dividing net income by the weighted-average number of common and potential common shares outstanding.

Income Shares Per Share
Amount
Quarter ended September 30, 2001:
   Basic earnings per share $ 4,526,000 5,716,000 $ 0.79
   Effect of dilutive stock options — 451,000

   Diluted earnings per share $ 4,526,000 6,167,000 $ 0.73

Quarter ended September 30, 2002:
   Basic earnings per share $ 5,991,000 5,849,000 $ 1.02
   Dilutive effect on earnings of ChannelMax options (73,000 ) —
   Effect of dilutive stock options — 355,000

   Diluted earnings per share $ 5,918,000 6,204,000 $ 0.95

Per Share
Amount

Income

Shares

Quarter ended December 31, 2001:

Basic earnings per share

$
4,887,000


11,466,000

$
0.42

Effect of dilutive stock options


—


942,000




Diluted earnings per share

$
4,887,000


12,408,000

$
0.39



Quarter ended December 31, 2002:

Basic earnings per share

$
5,822,000


11,947,000

$
0.49

Dilutive effect on earnings of ChannelMax options


(20,000
)

—

Effect of dilutive stock options


—


699,000




Diluted earnings per share

$
5,802,000


12,646,000

$
0.46



Six months ended December 31, 2001:

Basic earnings per share

$
9,413,000


11,447,000

$
0.82

Effect of dilutive stock options


—


924,000




Diluted earnings per share

$
9,413,000


12,371,000

$
0.76



Six months ended December 31, 2002:

Basic earnings per share

$
11,813,000


11,822,000

$
1.00

Dilutive effect on earnings of ChannelMax options


(93,000
)

—

Effect of dilutive stock options


—


705,000




Diluted earnings per share

$
11,720,000


12,527,000

$
0.94

(6) Goodwill and Other Intangible Assets

Effective July 1, 2001, the Company adopted SFAS No. 142, ~~“Goodwill~~Goodwill and Other Intangible ~~Assets”.~~ Assets.SFAS No. 142 revised the standards of accounting for goodwill by replacing the regular amortization of goodwill with the requirement that goodwill be reviewed for impairment annually or when events or circumstances occur between annual tests indicating that goodwill for a reporting unit (as defined) might be impaired. In accordance with SFAS No. 142, no goodwill amortization was recorded for the quarters and six months ended ~~September 30,~~December 31, 2001 and 2002.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Changes in the carrying amount of goodwill for the ~~quarter~~six months ended ~~September 30,~~December 31, 2002, by operating segment, are as follows:

North
American
Distribution
Segment ChannelMax
Segment International
Distribution
Segment Total

Balance as of June 30, 2002 $ 5,571,000 $ 172,000 $ 3,832,000 $ 9,575,000

Goodwill acquired during the quarter ended September
30, 2002 6,000 — 260,000 266,000

Balance as of September 30, 2002 $ 5,577,000 $ 172,000 $ 4,092,000 $ 9,841,000

11

	North American Distribution Segment		ChannelMax Segment		International Distribution Segment		Total
Balance as of June 30, 2002	$	5,571,000	$	172,000	$	3,832,000	$	9,575,000
Goodwill acquired during the six months ended December 31, 2002		6,000		—		260,000		266,000

Balance as of December 31, 2002	$	5,577,000	$	172,000	$	4,092,000	$	9,841,000

~~SCANSOURCE, INC. AND SUBSIDIARIES~~
~~NOTES TO UNADUITED CONDENSED CONSOLIDATED~~
~~FINANCIAL STATEMENTS~~

Identifiable intangible assets, included in other assets, consist of $337,000 in intangible assets acquired in fiscal 2002. These intangible assets are ~~being~~ amortized using the straight-line method over a period of 5 years. Amortization expense during the quarter and six months ended ~~September 30,~~December 31, 2002 was $17,000 and ~~accumulated~~$34,000, respectively. Accumulated amortization at ~~September 30,~~December 31, 2002 was ~~$43,000.~~$60,000. Amortization expense for fiscal years 2003 through 2006 is estimated to be approximately $67,000 and $42,000 for fiscal 2007.

(7) Segment Information

The Company operates in two ~~industry segments~~industries as a wholesale distributor of specialty technology products and a provider of e-logistics services to specialty technology markets. Based on geographic location, the Company has two distribution segments for distribution of specialty technology products. Thus, for reporting purposes, the Company has three reportable segments.

The measure of segment profit is income from operations, and the accounting policies of the segments are the same as those described in Note 1 of the Company’s June 30, 2002 annual report on Form 10-K.

The first reportable segment, North American distribution, offers approximately 23,000 products for sale in three primary categories: i) AIDC and POS equipment sold by the ScanSource sales team, ii) voice, data and converged communications equipment sold by the Catalyst Telecom sales team and iii) converged communications products sold by the Paracon sales team. These products are sold to more than 12,000 resellers and integrators of technology products, ~~who~~which are geographically disbursed over North America in a pattern that mirrors population concentration. Of its customers at ~~September 30,~~December 31, 2002, no single account represented more than 10% of the Company’s consolidated net sales.

The second reportable segment, international distribution, sells to two geographic markets, South America and Europe, and offers AIDC and POS equipment to more than 1,000 resellers and integrators of technology products. Of its customers at ~~September 30,~~December 31, 2002, no single account represented more than 10% of the Company’s consolidated net sales.

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The third reportable segment, ChannelMax, provides e-logistics services within North America for manufacturers and others in the AIDC and communication products markets. This unit serves less than 10 customers, none of whom accounted for more than 10% of the Company’s consolidated net sales. Certain ChannelMax sales are recognized on a net ~~revenue recognition~~fee basis (see Note 2). with the remainder recognized on a gross revenue basis.

The Company evaluates segment performance based on operating income. Intersegment sales consist primarily of fees charged by the ChannelMax segment to the North American distribution segment and sales by the North American distribution segment to the international distribution segment. All intersegment revenues and profits have been eliminated in the accompanying consolidated financial statements.

Accounts receivable, inventories, distribution center property and equipment and certain software can be identified by segment. However, cash, other current assets, other property and equipment, and other non-current assets are generally not distinguishable between the North American distribution and ChannelMax business segments and are listed as Corporate assets in the following table. Debt is also generally not distinguishable between segments.

~~SCANSOURCE, INC. AND SUBSIDIARIES~~
~~NOTES TO UNADUITED CONDENSED CONSOLIDATED~~
~~FINANCIAL STATEMENTS~~

Operating results for each business unit are summarized below:

Quarter ended
September 30,
2001 2002

Sales:
   North American distribution $ 164,092,000 $ 245,584,000
   ChannelMax 27,378,000 7,420,000
   International distribution — 13,300,000
   Less intersegment sales (2,627,000 ) (5,701,000 )
$ 188,843,000 $ 260,603,000

Operating income:
   North American distribution $ 7,116,000 $ 9,139,000
   ChannelMax 792,000 1,564,000
   International distribution — (185,000 )
$ 7,908,000 $ 10,518,000

Depreciation and amortization:
   ChannelMax $ 249,000 $ 456,000
   International distribution — 71,000
   Corporate 1,020,000 665,000
$ 1,269,000 $ 1,192,000

June 30,
2002 September 30,
2002
Assets:
   North American distribution $ 243,129,000 $ 238,063,000
   ChannelMax 51,938,000 47,484,000
   International distribution 23,788,000 26,559,000
   Corporate 40,177,000 41,283,000
$ 359,032,000 $ 353,389,000

~~(8) Acquisitions~~

	Quarter ended December 31,						Six months ended December 31,
	2001			2002			2001			2002
Sales:
North American distribution	$	186,057		$	233,257		$	350,149		$	478,841
ChannelMax		22,124			5,898			49,502			13,318
International distribution		2,766			16,647			2,766			29,947
Less intersegment sales		(3,091	)		(5,685	)		(5,718	)		(11,386	)

	$	207,856		$	250,117		$	396,699		$	510,720

Operating income:
North American distribution	$	7,162		$	10,327		$	14,278		$	19,466
ChannelMax		(347	)		364			445			1,928
International distribution		99			(248	)		99			(433	)

	$	6,914		$	10,443		$	14,822		$	20,961

Depreciation and amortization:
ChannelMax	$	293		$	492		$	542		$	948
International distribution		10			80			10			151
Corporate		768			665			1,788			1,330

	$	1,071		$	1,237		$	2,340		$	2,429

On November 9, 2001, the Company’s international distribution segment purchased 52% of the stock of Netpoint and committed to purchase the remaining 48% of the stock over the next six years at a predetermined multiple of pre-tax earnings. Effective July 1, 2002, the Company purchased an additional 8% of the stock of Netpoint. The acquisition was accounted for by the purchase method of accounting, and the operating results have been included in the Company’s consolidated results of operations from the date of acquisition. The Company paid approximately $452,000 in cash and assumed certain liabilities. The Company’s purchase price exceeded the fair value of the net assets acquired. The purchase price was

SCANSOURCE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

allocated to the fair value of net assets acquired, principally accounts receivable and inventories, and approximately $260,000 of goodwill resulted from the acquisition. The Company has a remaining commitment to purchase the remaining 40% of the stock over the next five years.

On September 28, 2001, the Company purchased 52% of the stock of OUI and committed to purchase the remaining 48% of the stock at a pre-determined multiple of pre-tax earnings over the next four years. Effective July 1, 2002, the Company purchased an addition 12% of the stock of OUI. The acquisition was accounted

Assets for by the purchase method of accounting, and the operating results have been included in the Company’s consolidated results of operations from the date of acquisition. The Company paid approximately $5,000 in cash and assumed certain liabilities. The Company’s purchase price for the existingeach business exceeded the fair value of the net assets acquired. The purchase price was allocated to the fair value of the net assets acquired, and approximately $6,000 of goodwill resulted from the acquisition. The Company has a remaining commitment to purchase the remaining 36% of the stock over the next three years.unit are summarized below:

Pro forma financial information is not provided for the additional acquisitions of ownership interests in Netpoint and OUI, because both are included in the Company’s consolidated financial statements, and the effect on net income from the additional acquisitions is expected to be less than 1% of the Company’s consolidated net income.

	June 30, 2002		December 31, 2002
Assets:
North American distribution	$	243,129	$	240,243
ChannelMax		51,938		41,967
International distribution		23,788		28,756
Corporate		40,177		41,299

	$	359,032	$	352,265

~~Item 2.~~

~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

Results of Operations

Net ~~Sales.~~Sales.The following tables summarize the Company’s sales ~~results, net of intersegment sales:~~results:

Quarter ended
September 30,
2001 2002 Difference Percentage
Change
(In thousands)

North American distribution $ 164,092 $ 243,897 $ 79,805 48.6 %
ChannelMax 24,751 3,406 (21,345 ) -86.2 %
International distribution — 13,300 13,300 —
Net Sales $ 188,843 $ 260,603 $ 71,760 38.0 %


Quarter ended
December 31,

Percentage


2001

2002

Difference

Change


(In thousands)

North American distribution

$
185,954

$
231,401

$
45,447


24.4
%
ChannelMax


19,136


2,069


(17,067
)

-89.2
%
International distribution


2,766


16,647


13,881


501.8
%




Net Sales

$
207,856

$
250,117

$
42,261


20.3
%





Six months ended
December 31,

Percentage


2001

2002

Difference

Change


(In thousands)

North American distribution

$
350,046

$
475,298

$
125,252


35.8
%
ChannelMax


43,887


5,475


(38,412
)

-87.5
%
International distribution


2,766


29,947


27,181


982.7
%




Net Sales

$
396,699

$
510,720

$
114,021


28.7
%




North American distribution sales include sales to the United States, Canada (less than 4%3% of total sales) and Mexico (less than 1% of total sales) from the Company’s Memphis, Tennessee distribution center. The increase in North American distribution sales for the quarter was driven by strong sales in the AIDC and POS product categories. The increase in North American distribution sales for the six months was driven by strong sales in the AIDC, POS and communication product categories. Growth of net sales resulted from increased sales to existing customers through competitive product pricing and marketing efforts to reach specialty technology resellers. During the current quarter, net sales growth was also driven by several large POS orders.

The ~~decrease~~decreases in sales in the ChannelMax segment isfor the quarter and the six months are primarily due to ~~the continued shift by some customers out of the ChannelMax segment into the Catalyst Telecom sales unit of the North American distribution segment. Also affecting the comparability of quarters was~~ the December 2001 renegotiation of a customer’s contract that extended its term and lessened the amount of inventory and accounts receivable risk to the Company. As a result of those changes to the contract, revenue from the customer is now recognized on a net fee basis, rather than a gross revenue ~~basis.~~basis as it was in the prior periods. Had this customer’s contract been accounted for on a gross revenue basis for the quarter and six months ended ~~September 30,~~December 31, 2002, ChannelMax revenue would have been ~~$19.8~~$15.8 million ~~rather than~~and $35.9 million, respectively. ChannelMax’s revenues were also impacted during the ~~$3.4 million reported amount.~~quarter and six months by the slow economy. Over the past year, some telephone dealers have experienced lower sales and have therefore decreased their usage of ChannelMax’s services. Additionally, manufacturers served by ChannelMax have sufficient capacity due to the slower economy and have less need for ChannelMax’s outsourcing services.
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

The international distribution segment commenced in November 2001 with the acquisition of Netpoint International, a Miami-based distributor that exports primarily to Latin America. In January 2002, the Company opened a headquarters and distribution center in Liege, Belgium, serving all of Europe. In May 2002, the Company acquired ABC Technology Distribution, a United Kingdom-based distributor that serves the United Kingdom, Ireland and the remainder of Europe.
15

~~Item 2.~~ ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

Gross Profit.The following ~~table summarizes~~tables summarize the Company’s gross profit:
Quarter ended
September 30, Percentage of Net Sales
September 30,
2001 2002 2001 2002
(In thousands)

Gross Profit $ 20,912 $ 30,195 11.1 % 11.6 %

~~For the quarter ended September 30, 2002, consolidated gross margins~~

Quarter ended
December 31,

Percentage of Sales December 31,


2001

2002

2001

2002


(In thousands)

North American distribution

$
20,068

$
23,948

10.8
%

10.3
%
ChannelMax


1,535


674

8.0
%

32.6
%
International distribution


355


2,288

12.8
%

13.7
%



Gross Profit

$
21,958

$
26,910

10.6
%

10.8
%




Six months ended
December 31,

Percentage of Sales
December 31,


2001

2002

2001

2002


(In thousands)

North American distribution

$
39,438

$
51,108

11.3
%

10.8
%
ChannelMax


3,077


1,746

7.0
%

31.9
%
International distribution


355


4,251

12.8
%

14.2
%



Gross Profit

$
42,870

$
57,105

10.8
%

11.2
%



Gross profit as a percentage of net sales ~~improved as compared with~~for the ~~prior year~~North American distribution segment decreased during the quarter ~~principally~~and six months ended December 31, 2002 as a result of ~~higher international distribution gross margins~~several large low-margin POS sales orders during the quarter and a more competitive market environment for communications products due to a significant vendor’s decision to switch a portion of ~~14.8% and the effects of the renegotiation of~~its product line to open sourcing.
The increase in the ChannelMax ~~customer contract to qualify for net fee revenue recognition as discussed above. Also contributing to the improvement in~~ gross ~~margins~~profit margin as a percentage of net sales ~~were purchase discounts associated with opportunistic inventory purchases occurring in the June 2002 quarter that were earned as the product was sold~~ during the quarter and six months ended ~~September 30, 2002.~~December 31, 2002 is attributable to the renegotiation of a customer contract, as discussed above, that resulted in revenue being recognized on a net fee basis.

The increase in the international distribution gross profit margin as a percentage of net sales during the quarter and six months ended December 31, 2002 is primarily attributable to the commencing of operations in Europe during the past year.
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations
Operating Expenses.The following table summarizes the Company’s operating expenses:
Quarter ended
September 30, Percentage of Net Sales
September 30,
2001 2002 Difference Percentage
Change 2001 2002
(In thousands)

Operating expenses $ 13,004 $ 19,677 $ 6,673 51.3 % 6.9 % 7.6 %


December 31,

Percentage

Percentage of Sales December 31,


2001

2002

Difference

Change

2001

2002



(In thousands
)

Quarter

$
15,044

$
16,467


$
1,423

9.5
%

7.2
%

6.6
%
Six months

$
28,048

$
36,144


$
8,096

28.9
%

7.1
%

7.1
%
For the quarter ended ~~September 30,~~December 31, 2002, operating expenses benefited from approximately $800,000 in lower bad debts expense as compared to levels experienced in prior quarters. This decrease was partially offset, however, by approximately $500,000 of incremental direct expenses associated with the continued development of the European operations. For the quarter ended December 31, 2001, operating expenses included an $840,000 impairment of capitalized software, a discretionary $800,000 profit sharing contribution to the Company’s 401(k) plan, $400,000 in higher than expected bad debts expense, and the settlement of a claim with a former customer that resulted in a $924,000 recovery of operating expenses. Excluding these items, pro forma operating expenses as a percentage of net sales would have been 6.7% for both of the quarters ended December 31, 2001 and 2002.
Operating expenses for the six months ended December 31, 2002 included a $1.4 million discretionary profit sharing contribution to the 401(k) plan, ~~of $1.4 million, charitable contributions of~~ approximately ~~$700,000 and approximately $400,000~~$900,000 of incremental direct expenses associated with the continued development of the European ~~operations. Excluding~~operations, and charitable contributions of approximately $700,000. These increases to operating expenses during the six months were partially offset by approximately $800,000 in lower bad debts expense as compared to levels experienced in the comparable six month period. Operating expenses for the six months ended December 31, 2002 included the same items that affected the quarter ended December 31, 2002 noted above. Without the effects of these items, pro forma operating expenses for the ~~quarter~~six months ended ~~September 30,~~December 31, 2001 and 2002 would have been ~~$17.2 million~~6.8% and 6.6%, respectively of net sales.

Operating Income.The following table summarizes the Company’s operating income:
Quarter ended
September 30, Percentage of Net Sales
September 30,
2001 2002 Difference Percentage
Change 2001 2002
(In thousands)

Operating income $ 7,908 $ 10,518 $ 2,610 33.0 % 4.2 % 4.0 %


December 31,

Percentage

Percentage of Sales December 31,


2001

2002

Difference

Change

2001

2002



(In thousands
)

Quarter

$
6,914

$
10,443


$
3,529

51.0
%

3.3
%

4.2
%
Six months

$
14,822

$
20,961


$
6,139

41.4
%

3.7
%

4.1
%
Operating margins as a percentage of net sales for the quarter ended ~~September 30,~~December 31, 2002 were ~~lower~~higher than the prior year quarter due primarily to ~~increased~~decreased operating expenses as a percentage of net sales as noted above. The increase in operating margins as a percentage of net sales for the six months ended December 31, 2002 is attributable to the increase in gross margins during past six months as noted above.
16Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

Total Other Expense (Income).Other expense (income) consists principally of interest expense and interest income. Interest expense for the quarters ended December 31, 2001 and 2002 was $690,000 and $556,000, respectively, reflecting interest paid on borrowings on the Company’s lines of credit and long-term debt. Interest expense for the six months ended December 31, 2001 and 2002 was $1.6 million and $1.2 million, respectively. Interest expense for the quarter and six months ended December 31, 2002 was lower due to the decline in interest rates over the past year and lower average borrowings during the past 6 months.
Interest income for the quarters ended December 31, 2001 and 2002 was $308,000 and $282,000, respectively, representing interest collected principally from customers. Interest income for the six months ended December 31, 2001 and 2002 was $648,000 and $586,000, respectively.
Other expense for the quarter and six months ended December 31, 2002 was $16,000 and $48,000, respectively. Other expense for the quarter and six months ended December 31, 2001 was $17,000 and $71,000, respectively. Other expense is comprised primarily of the Company’s loss on an equity investment.
Minority interest, included in other expense, is comprised of the minority interest share of the subsidiaries’ net income. For the quarter and six months ended December 31, 2002 minority interest amounted to $110,000 and $283,000, respectively. Minority interest for the quarter and six months ended December 31, 2001 was $(33,000).
Provision For Income Taxes. Income tax expense was $2.5 million and $4.2 million for the quarters ended December 31, 2001 and 2002, respectively, reflecting an effective income tax rate of 38.0% and 42.0%, respectively. Income tax expense was $5.3 million and $8.2 million for the six months ended December 31, 2001 and 2002, respectively, reflecting an effective income tax rate of 38.0% and 40.8%, respectively. The increase in the tax rate during the past quarter and six months is attributable to the effect of not recognizing tax benefits for European operating losses during the quarter and six months ended December 31, 2002.
Extraordinary Item.During the quarter ended December 31, 2001, the Company finalized its accounting for the May 2001 acquisition of Pinacor, Inc., a business telephone distributor. The Company collected $1.3 million more of the purchased accounts receivable than it had previously estimated to be collectible. As a result, the fair value of the assets acquired in the acquisition exceeded the purchase price by $1.3 million. In accordance with SFAS 141, this amount was recognized as an extraordinary gain, net of $508,000 in taxes, during the quarter ended December 31, 2001.
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations
Net Income. The following table summarizes the Company’s net income:

December 31,

Percentage

Percentage of Sales
December 31,


2001

2002

Difference

Change

2001

2002



(In thousands
)

Quarter

$
4,887

$
5,822


$
935

19.1
%

2.4
%

2.3
%
Six months

$
9,413

$
11,813


$
2,400

25.5
%

2.4
%

2.3
%
The increase in the amount of net income and decline in the net income margin are attributable to the changes in operating profits and provision for income taxes discussed above.
Liquidity and Capital Resources
The Company’s primary sources of liquidity are cash flows from operations, borrowings under the Company’s revolving credit facility, and, to a lesser extent, borrowings under the Company’s subsidiaries’ lines of credit and proceeds from the exercise of stock options.
The Company’s cash balance totaled $3.5 million at December 31, 2002 compared to $1.3 million at June 30, 2002. Domestic cash is generally swept on a nightly basis to pay down the Company’s line of credit. The Company’s working capital increased to $151.1 million at December 31, 2002 from $135.5 million at June 30, 2002. The increase in working capital resulted primarily from a $16.3 million increase in accounts receivable and a $23.2 million decrease in accounts payable. This was partially offset by a $30.1 million decrease in inventory.
The increase in the accounts receivable balance is attributable to an increase in sales during the past six months and an increase in days sales outstanding (DSO) in ending trade receivables from 45 days at June 30, 2002 to 50 days at December 31, 2002. The decrease in inventory was attributable to changes in inventory management. For the quarter ended December 31, 2002, inventory turnover improved to 5.8 times from 4.8 times at June 30, 2002. The decrease in accounts payable resulted primarily from the reduction in inventory purchases during the past six months.
Cash provided by operating activities was $6.3 million for the six months ended December 31, 2002 compared to $5.7 million provided by operations for the six months ended December 31, 2001. The increase in cash provided by operating activities was primarily attributable to the changes in current assets and liability accounts discussed in the above working capital analysis.
Cash used in investing activities for the six months ended December 31, 2002 was $3.8 million and included approximately $3.3 million for capital expenditures and $457,000 paid for the acquisition of additional ownership interests in two of the Company’s majority-owned subsidiaries (Netpoint and OUI). The Company’s capital expenditures resulted from the purchases of software and furniture and equipment. For the six months ended December 31, 2001, cash used in investing activities totaled $22.6 million, including $17.7 million paid for the Positive ID, Netpoint and OUI acquisitions and capital expenditures of approximately $4.9 million, primarily for furniture and equipment.
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations
Net borrowings under the Company’s credit facility with its bank group totaled $40.2 million at December 31, 2002 compared to $43.8 million at June 30, 2002, reflecting cash provided by operating activities.The credit facility has a borrowing limit of the lesser of (i) $80 million or (ii) the sum of 85% of eligible accounts receivable plus the lesser of (a) 50% of eligible inventory or (b) $40 million. At December 31, 2002, the borrowing base exceeded $80 million, leaving $39.8 million for additional borrowings. The credit facility matures on September 30, 2004 and bears interest at the 30-day LIBOR rate of interest plus a rate varying from 1.00% to 2.50% tied to the Company’s funded debt to EBITDA ratio ranging from 2.50:1 to 4.25:1. The effective interest rate at December 31, 2002 was 3.44%. The revolving credit facility is collateralized by domestic accounts receivable and eligible inventory. The credit agreement contains certain financial covenants, including minimum net worth requirements, capital expenditure limits, a maximum funded debt to EBITDA ratio and a minimum fixed charge coverage ratio. The Company was in compliance with the various covenants.
Cash used in financing activities for the six months ended December 31, 2002 totaled $457,000, including $4.9 million in payments on long-term debt and the Company’s credit facility and $4.4 million in proceeds from stock option exercises. Cash provided by financing activities for the six months ended December 31, 2001 totaled $17.3 million, primarily from borrowings under the Company’s credit facility.
The Company owns an equity interest in a limited liability company for which it has guaranteed debt up to approximately $496,000. As of December 31, 2002, the limited liability company had assets with a fair market value in excess of $2.3 million and liabilities of approximately $2.0 million.
The Company believes that it has sufficient liquidity to meet its forecasted cash requirements for at least the next year.
Recent Accounting Pronouncements
Accounting Standards Recently Adopted –In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.144,Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 and the accounting and reporting provisions of APB 30 related to the disposal of a segment of a business and was adopted by the Company on July 1, 2002. The adoption of SFAS No. 144 had no effect on the Company’s financial position and results of operations.
In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This statement requires that the Company recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. The Company adopted SFAS No. 146 on July 1, 2002. The adoption of SFAS No. 146 had no effect on the Company’s financial position and results of operations.
Accounting Standards Not Yet Adopted – In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure. This statement amends the transition requirements of SFAS No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations
stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The disclosure provision is required for all companies with stock-based employee compensation, regardless of whether the company utilizes the fair value method of accounting described in SFAS No. 123 or the intrinsic value method described in APB Opinion No. 25,Accounting for Stock Issued to Employees. The amendments to the transition and annual disclosure provisions of SFAS No. 123 are effective for the Company’s fiscal year ended June 30, 2003. The disclosure requirements related to interim financial statements are effective for the Company’s quarter beginning January 1, 2003. The Company continues to account for stock-based employee compensation under the intrinsic value method described by APB Opinion No. 25. The Company anticipates that the adoption of SFAS No. 148 will not have an impact on the Company’s financial position and results of operations.
In December 2002, the FASB’s Emerging Issues Task Force (“EITF”) issued EITF Issue No. 02-16,Accounting by a Customer (including a Reseller) for Cash Consideration Received from a Vendor. This issue addresses the appropriate accounting, by a distributor, for cash consideration received from a vendor and will become effective for the Company on January 1, 2003. The Company is evaluating the impact of this issue and has not yet determined the effect, if any, that the adoption of the issue will have on the Company’s financial position and results of operations.
~~Item 2.~~    ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~Total Other Expense (Income).~~ Other expense (income) consists principally of interest expense and interest income. Interest expense for the quarters ended September 30, 2001 and 2002 was $894,000 and $693,000, respectively, reflecting interest paid on borrowings on the Company’s line of credit and long-term debt. Interest expense for the quarter ended September 30, 2002 was lower due to the decline in interest rates compared to the prior year quarter.
         ~~Interest income for the quarters ended September 30, 2001 and 2002 was $340,000 and $304,000, respectively, principally representing interest collected from customers.~~
         Other expense for the quarters ended September 30, 2001 and 2002 was $54,000 and $205,000, respectively, representing the minority interest share of the Company’s majority-owned subsidiaries’ net income and the loss on an equity investment. Two of the majority-owned subsidiaries were acquired in the period after September 30, 2001.
~~Provision For Income Taxes.~~ Income tax expense was $2.8 million and $3.9 million for the quarters ended September 30, 2001 and 2002, respectively, reflecting an effective income tax rate of 38.0% and 39.6%, respectively. The increase in the tax rate is attributable to the effect of no tax benefits being recognized for the European operating losses during the quarter ended September 30, 2002.
~~Net Income.~~ ~~The following table summarizes the Company’s net income:~~
Quarter ended
September 30, Percentage of Net Sales
September 30,
2001 2002 Difference Percentage
Change 2001 2002
(In thousands)

Net income $ 4,526 $ 5,991 $ 1,465 32.4 % 2.4 % 2.3 %

         ~~The increase in the amount of net income and decline in the net income margin are primarily attributable to the changes in operating profits and the provision for income taxes as discussed above.~~
~~Liquidity and Capital Resources~~
         The Company’s primary sources of liquidity are cash flows from operations, borrowings under the Company’s revolving credit facility, and, to a lesser extent, borrowings under the Company’s subsidiaries’ lines of credit and proceeds from the exercise of stock options.
         The Company’s cash balance totaled $4.0 million at September 30, 2002 compared to $1.3 million at June 30, 2002. Cash is generally swept on a nightly basis to pay down the line of credit. The Company’s working capital increased to $146.3 million at September 30, 2002 from $135.5 million at June 30, 2002. The increase in working capital resulted primarily from a $22.8 million increase in accounts receivable and a $22.6 million decrease in accounts payable. This was partially offset by a $29.7 million decrease in inventory.
17

~~Item 2.~~    ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

         The increase in the accounts receivable balance is attributable to an increase in sales during the quarter. Days sales outstanding (DSO) in ending trade receivables remained comparable at September 30, 2002 and June 30, 2002 at 45 days. The decrease in inventory was attributable to better inventory management. For the quarter ended September 30, 2002, inventory turnover improved to 5.5 times from 4.8 times at June 30, 2002. The decrease in accounts payable resulted primarily from the reduction in inventory purchases during the quarter.
         Cash used in operating activities was $1.1 million for the quarter ended September 30, 2002 compared to $8.1 million used in operations for the quarter ended September 30, 2001. The decrease in cash used in operating activities was primarily attributable to the changes in current assets and liability accounts discussed in the above working capital analysis.
         Cash used in investing activities for the quarter ended September 30, 2002 was $2.5 million and included approximately $2.0 million for capital expenditures and $457,000 paid for the acquisition of additional ownership interests in two of the Company’s majority-owned subsidiaries (Netpoint and OUI). The Company’s capital expenditures resulted from the purchases of software and furniture and equipment. For the quarter ended September 30, 2001, cash used in investing activities totaled $18.6 million, including $15.6 million paid for the Positive ID acquisition and capital expenditures of approximately $3.0 million, primarily for furniture and equipment.
         Net borrowings under the Company’s credit facility with its bank group totaled $49.4 million at September 30, 2002 compared to $43.8 million at June 30, 2002, reflecting cash requirements for the Company’s increase in working capital and capital expenditures during the quarter ended September 30, 2002, as discussed above. The credit facility has a borrowing limit of the lesser of (i) $80 million or (ii) the sum of 85% of eligible accounts receivable plus the lesser of (a) 50% of eligible inventory or (b) $40 million. At September 30, 2002, the borrowing base exceeded $80 million, leaving $30.6 million for additional borrowings. The credit facility matures on September 30, 2003 and bears interest at the 30-day LIBOR rate of interest plus a rate varying from 1.00% to 2.50% tied to the Company’s funded debt to EBITDA ratio ranging from 2.50:1 to 4.25:1. The effective interest rate at September 30, 2002 was 4.07%. The revolving credit facility is collateralized by accounts receivable and eligible inventory. The credit agreement contains certain financial covenants, including minimum net worth requirements, capital expenditure limits, a maximum funded debt to EBITDA ratio and a minimum fixed charge coverage ratio. Effective October 31, 2002, the Company amended its credit facility, extending its maturity date to September 30, 2004 and increasing the limit on the operating lease payment covenant. The Company was in compliance with the remaining covenants.
         Cash provided by financing activities for the quarter ended September 30, 2002 totaled $6.3 million, including cash provided by borrowings under the Company’s credit facility. Cash provided by financing activities for the quarter ended September 30, 2001 totaled $26.4 million, primarily from borrowings under the Company’s credit facility.
         The Company owns an equity interest in a limited liability company for which it has guaranteed debt up to approximately $496,000. As of September 30, 2002, the limited liability company had assets with a fair market value in excess of $2.3 million and liabilities of approximately $2.0 million.
         ~~The Company believes that it has sufficient liquidity to meet its forecasted cash requirements for at least the next year.~~
18

~~Item 2.~~    ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~Recent Accounting Pronouncements~~
~~In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.144,~~ ~~Accounting for the Impairment or Disposal of Long-Lived Assets~~, which addresses financial reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 and the accounting and reporting provisions of APB 30 related to the disposal of a segment of a business and was adopted by the Company on July 1, 2002. The adoption of SFAS No. 144 had no effect on the Company’s financial position and results of operations.
~~In June 2002, the FASB issued SFAS No. 146,~~ ~~Accounting for Costs Associated with Exit or Disposal Activities~~. This statement requires that the Company recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. The Company adopted SFAS No. 146 on July 1, 2002. The adoption of SFAS No. 146 had no effect on the Company’s financial position and results of operations.
19

Item 3. Quantitative and Qualitative Disclosures about Market Risk
~~Quantitative and Qualitative Disclosures about Market Risk~~

The Company’s principal exposure to changes in financial market conditions in the normal course of its business is a result of its selective use of bank debt and, to a much lesser extent, transacting business in foreign currencies in connection with its foreign operations.

The Company is exposed to changes in interest rates primarily as a result of its borrowing activities, which include a revolving credit facility with a bank group used to maintain liquidity and fund the Company’s business operations. The nature and amount of the Company’s debt may vary as a result of future business requirements, market conditions and other factors. The definitive extent of the Company’s interest rate risk is not quantifiable or predictable because of the variability of future interest rates and business financing requirements, but the Company does not believe such risk is material. A hypothetical 100 basis point increase or decrease in interest rates on borrowings on the Company’s revolving line of credit, variable rate long term debt and subsidiary lines of credit would have resulted in an approximate ~~$149,000~~$123,000 decrease or increase in pre-tax income for the quarter ended ~~September 30,~~December 31, 2002. The Company does not currently use derivative instruments or take other actions to adjust the Company’s interest rate risk profile.

The Company is exposed to foreign currency risks that arise from its foreign operations in Canada, Mexico, Latin America and Europe. These risks include the translation of local currency balances of foreign subsidiaries, intercompany loans with foreign subsidiaries and, to a lesser extent, transactions denominated in foreign currencies. The Company monitors its risk associated with the volatility of certain foreign currencies against its functional currency, the U.S. dollar. The impact of changes in the relationship of other currencies to the U.S. dollar have historically not been significant, and such changes in the future are not expected to have a material impact on the Company’s results of operations or cash flows. If, however, there were a sustained decline of these currencies versus the U.S. dollar, the consolidated financial statements could be adversely affected. The Company does not utilize forward exchange contracts, currency options or other traditional hedging vehicles to adjust the Company’s foreign exchange rate risk profile. The Company does not enter into foreign currency transactions for speculative purposes. Foreign currency gains and losses are not material and are included in selling, general and administrative expenses.

The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. On the basis of the fair value of the Company’s market sensitive instruments at ~~September 30,~~December 31, 2002, the Company does not consider the potential near-term losses in future earnings, fair values ~~and~~or cash flows from reasonably possible near-term changes in interest rates ~~and~~or exchange rates to be material.
20

Item 4. Disclosure Controls and Procedures
~~Disclosure Controls and Procedures~~

As of ~~November 7, 2002,~~February 5, 2003, under the supervision and with the participation of the Company’s Principal Executive Officer and the Principal Financial Officer, management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Principal Executive Officer and the Principal Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of ~~September 30,~~December 31, 2002. There were no significant changes in the Company’s internal controls or in the other factors that could significantly affect those controls subsequent to ~~September~~December 31, 2002.
PART II. OTHER INFORMATION
Item 1.Legal Proceedings. Not applicable
Item 2.Changes in Securities and Use of Proceeds.Not applicable
Item 3.Defaults Upon Senior Securities.Not applicable
Item 4.Submission of Matters to a Vote of Security Holders.
The Company’s annual meeting of shareholders was held on December 5, 2002. At the annual meeting, the shareholders (i) elected five directors who constitute all the directors continuing on the Board after the meeting, (ii) approved an amendment to the Company’s Amended and Restated Articles of Incorporation, (iii) approved the Company’s Long-Term Incentive Plan, and (iv) ratified the selection of auditors for fiscal 2003. Votes on each matter presented at the annual meeting (on a pre-split basis) were as follows:
(a) Election of directors:

Number of Shares
Nominees

For

Withheld
Michael L. Baur

3,835,253

1,330,081
Steven R. Fischer

4,924,780

240,554
James G. Foody

4,924,688

240,646
Steven H. Owings

3,822,496

1,342,838
John P. Reilly

4,960,048

205,286
(b) Proposal to amend the Company’s Amended and Restated Articles of Incorporation to increase the number of authorized shares of Common Stock of the Company from 10,000,000 to 25,000,000 shares:
Number of Shares
For
4,156,635
Against
1,004,290
Abstain
4,409
(c) Proposal to approve the Company’s Long-Term Incentive Plan:
Number of Shares
For
4,609,708
Against
551,051
Abstain
4,575
(d) Proposal to ratify the appointment of Ernst & Young LLP as the Company’s independent auditors for the fiscal year ending June 30, ~~2002.~~2003:
21

~~PART II.~~    ~~OTHER INFORMATION~~
Number of Shares
For
5,008,902
Against
153,232
Abstain
3,200

~~Item 1.~~    ~~Legal Proceedings.~~ ~~Not applicable~~

~~Item 2.~~    ~~Changes in Securities and Use of Proceeds.~~~~Not applicable~~

~~Item 3.~~    ~~Defaults Upon Senior Securities.~~~~Not applicable~~

~~Item 4.~~    ~~Submission of Matters to a Vote of Security Holders.~~~~Not applicable~~

~~Item 5.~~    ~~Other Information.~~~~Not applicable~~

Item 5.Other Information. Not applicable
Item 6.Exhibits and Reports on Form 8-K.
a) Exhibits
~~Item 6.~~
3.1
~~Exhibits and Reports on Form 8-K.~~

         ~~(a)      Exhibits~~

10.1*

The Company’s Amended and Restated Articles of Incorporation increasing the number of authorized shares of Common Stock ~~Option~~of the Company to 25,000,000 shares, as amended.
10.1
Second Amendment to the Credit Agreement dated ~~June 5, 1995 covering options granted to Robert S. McLain, Jr.~~as of October 31, 2002 by and among ScanSource, Inc., a South Carolina corporation, 4100 Quest, L.L.C., ChannelMax, Inc., Branch Banking and Trust Company of South Carolina, as agent and a bank, Fifth Third Bank, First Tennessee Bank National Association, and Hibernia National Bank.
10.2
*

10.2* ~~Stock Option~~
Employment Agreement dated ~~July 26, 1996 covering options granted to Robert S. McLain, Jr.~~
10.3* ~~Stock Option Agreement dated December 3, 1996 covering options granted to Robert S. McLain, Jr~~
10.4* ~~Stock Option Agreement dated March 19, 1997 covering options granted to Paige Rosamond.~~
10.5* ~~1997 Catalyst Stock Option Plan~~as of October 18, 2002 between the Registrant and ~~Form of Stock Option Agreement.~~Steven H. Owings.
10.3
*

Employment Agreement dated as of October 18, 2002 between the Registrant and Michael L. Baur.
10.4
~~99.1~~
*

Employment Agreement dated as of October 18, 2002 between the Registrant and Jeffery A. Bryson.
10.5
*
Employment Agreement dated as of November 12, 2002 between the Registrant and Richard P. Cleys.
10.6
*
2002 Long-Term Incentive Plan.
99.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2

~~99.2~~
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Management contract or compensatory plan or arrangement

(b) Reports on Form 8-K

          ~~None~~

22
~~SIGNATURES~~

  A report was filed on October 18, 2002 regarding a change in independent accountants.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SCANSOURCE, INC.

~~/s/ MICHAEL~~ L. B~~AUR~~
    /s/    Michael L. Baur
MICHAEL L. BAUR
Chief Executive Officer

~~/s/ JEFFERY~~ A. B~~RYSON~~
    /s/    Richard P. Cleys
~~JEFFERY A. BRYSON~~
RICHARD P. CLEYS
Chief Financial Officer

Date: ~~November 14, 2002~~February 11, 2003
23
CERTIFICATE OF PRINCIPAL EXECUTIVE OFFICER
I, Michael L. Baur, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ScanSource, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and we have:

a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is prepared;
b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 11, 2003

~~Date: November 14, 2002~~
/s/    M~~ICHAEL~~ L. B~~AUR~~
MICHAEL L. BAUR

Michael L. Baur
President and Chief Executive Officer

24
CERTIFICATE OF PRINCIPAL FINANCIAL OFFICER
I, ~~Jeffery A. Bryson,~~Richard P. Cleys, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ScanSource, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and we have:

a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is prepared;
b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 11, 2003

~~Date: November 14, 2002~~
/s/    J~~EFFERY~~ A. B~~RYSON~~
RICHARD P. CLEYS
~~Jeffery A. Bryson~~
    Richard P. Cleys
    Vice President and Chief Financial Officer ~~Vice President~~
~~of Administration and Investor Relations~~

25
30

	June 30, 2002*		September 30, 2002


Assets
Current Assets:
Cash	$	1,296	$	3,994
Receivables:
Trade, less allowance for doubtful accounts of $9,580 at June 30, 2002 and $9,361at September 30, 2002		119,158		140,464
Other		7,860		6,367
Inventories		182,636		152,941
Prepaid expenses and other assets		1,258		1,732
Deferred income taxes		10,225		10,225


Total current assets		322,433		315,723


Property and equipment, net		25,995		26,870
Goodwill		9,575		9,841
Other assets, including identifiable intangible assets		1,029		955


Total assets	$	359,032	$	353,389

	Quarter ended September 30,

	2001			2002

Net sales	$	188,843		$	260,603
Cost of goods sold		167,931			230,408


Gross profit		20,912			30,195


Selling, general and administrative expenses		13,004			19,677


Operating income		7,908			10,518


Other expense (income):
Interest expense		894			693
Interest income		(340	)		(304	)
Other expense		54			205

Other expense, net		608			594


Income before income taxes		7,300			9,924

Provision for income taxes		2,774			3,933


Net income	$	4,526		$	5,991


Per share data:
Basic earnings per share:
Net income	$	0.79		$	1.02


Weighted-average shares outstanding		5,716			5,849


Diluted earnings per share:
Net income	$	0.73		$	0.95


Weighted-average shares outstanding		6,167			6,204

	June 30, 2002		September 30, 2002

Note payable to a bank, secured by distribution center land and building; monthly payments of principal and interest of $65,000; 3.72% variable interest rate; maturing in fiscal 2006 with a balloon payment of approximately $4.9 million	$	6,712,000	$	6,581,000

Note payable to a bank, secured by office building and land; monthly payments of principal and interest of $15,000; 9.19% fixed interest rate; maturing in fiscal 2007 with a balloon payment of approximately $1.5 million		1,618,000		1,608,000

Note payable to a bank, secured by motor coach; monthly payments of principal and interest of $7,000; 3.72% variable interest rate; maturing in fiscal 2006 with a balloon payment of approximately $153,000		429,000		411,000

Capital leases for equipment with monthly principal payments ranging from $33 to $1,391 and effective interest rates ranging from 7.6% to 11.75%		329,000		296,000


		9,088,000		8,896,000

Less current portion		769,000		773,000


Long-term portion	$	8,319,000	$	8,123,000

	Income			Shares		Per Share Amount

Quarter ended September 30, 2001:
Basic earnings per share	$	4,526,000			5,716,000	$	0.79

Effect of dilutive stock options		—			451,000


Diluted earnings per share	$	4,526,000			6,167,000	$	0.73


Quarter ended September 30, 2002:
Basic earnings per share	$	5,991,000			5,849,000	$	1.02

Dilutive effect on earnings of ChannelMax options		(73,000	)		—
Effect of dilutive stock options		—			355,000


Diluted earnings per share	$	5,918,000			6,204,000	$	0.95

					Per Share Amount
	Income			Shares	Per Share Amount
Quarter ended December 31, 2001:
Basic earnings per share	$	4,887,000		11,466,000	$	0.42

Effect of dilutive stock options		—		942,000

Diluted earnings per share	$	4,887,000		12,408,000	$	0.39

Quarter ended December 31, 2002:
Basic earnings per share	$	5,822,000		11,947,000	$	0.49

Dilutive effect on earnings of ChannelMax options		(20,000	)	—
Effect of dilutive stock options		—		699,000

Diluted earnings per share	$	5,802,000		12,646,000	$	0.46

Six months ended December 31, 2001:
Basic earnings per share	$	9,413,000		11,447,000	$	0.82

Effect of dilutive stock options		—		924,000

Diluted earnings per share	$	9,413,000		12,371,000	$	0.76

Six months ended December 31, 2002:
Basic earnings per share	$	11,813,000		11,822,000	$	1.00

Dilutive effect on earnings of ChannelMax options		(93,000	)	—
Effect of dilutive stock options		—		705,000

Diluted earnings per share	$	11,720,000		12,527,000	$	0.94

	North American Distribution Segment		ChannelMax Segment		International Distribution Segment		Total


Balance as of June 30, 2002	$	5,571,000	$	172,000	$	3,832,000	$	9,575,000

Goodwill acquired during the quarter ended September 30, 2002		6,000		—		260,000		266,000


Balance as of September 30, 2002	$	5,577,000	$	172,000	$	4,092,000	$	9,841,000

	Quarter ended December 31,							Percentage
	2001		2002		Difference			Change
	(In thousands)
North American distribution	$	185,954	$	231,401	$	45,447		24.4	%
ChannelMax		19,136		2,069		(17,067	)	-89.2	%
International distribution		2,766		16,647		13,881		501.8	%

Net Sales	$	207,856	$	250,117	$	42,261		20.3	%

	Quarter ended September 30,				Percentage of Net Sales September 30,

	2001		2002		2001			2002

	(In thousands)

Gross Profit	$	20,912	$	30,195		11.1	%		11.6	%

	Quarter ended December 31,				Percentage of Sales December 31,
	2001		2002		2001		2002
	(In thousands)
North American distribution	$	20,068	$	23,948	10.8	%	10.3	%
ChannelMax		1,535		674	8.0	%	32.6	%
International distribution		355		2,288	12.8	%	13.7	%

Gross Profit	$	21,958	$	26,910	10.6	%	10.8	%

	Six months ended December 31,				Percentage of Sales December 31,
	2001		2002		2001		2002
	(In thousands)
North American distribution	$	39,438	$	51,108	11.3	%	10.8	%
ChannelMax		3,077		1,746	7.0	%	31.9	%
International distribution		355		4,251	12.8	%	14.2	%

Gross Profit	$	42,870	$	57,105	10.8	%	11.2	%

	December 31,							Percentage		Percentage of Sales December 31,
	2001		2002			Difference		Change		2001		2002
				(In thousands	)
Quarter	$	15,044	$	16,467		$	1,423	9.5	%	7.2	%	6.6	%
Six months	$	28,048	$	36,144		$	8,096	28.9	%	7.1	%	7.1	%

	Number of Shares
Nominees	For	Withheld
Michael L. Baur	3,835,253	1,330,081
Steven R. Fischer	4,924,780	240,554
James G. Foody	4,924,688	240,646
Steven H. Owings	3,822,496	1,342,838
John P. Reilly	4,960,048	205,286

~~PART II.~~	~~OTHER INFORMATION~~	Number of Shares
For		5,008,902
Against		153,232
Abstain		3,200

	10.1*	The Company’s Amended and Restated Articles of Incorporation increasing the number of authorized shares of Common Stock ~~Option~~of the Company to 25,000,000 shares, as amended.

10.1		Second Amendment to the Credit Agreement dated ~~June 5, 1995 covering options granted to Robert S. McLain, Jr.~~as of October 31, 2002 by and among ScanSource, Inc., a South Carolina corporation, 4100 Quest, L.L.C., ChannelMax, Inc., Branch Banking and Trust Company of South Carolina, as agent and a bank, Fifth Third Bank, First Tennessee Bank National Association, and Hibernia National Bank.

10.2	*
	10.2*	~~Stock Option~~ Employment Agreement dated ~~July 26, 1996 covering options granted to Robert S. McLain, Jr.~~

	10.3*	~~Stock Option Agreement dated December 3, 1996 covering options granted to Robert S. McLain, Jr~~

	10.4*	~~Stock Option Agreement dated March 19, 1997 covering options granted to Paige Rosamond.~~

	10.5*	~~1997 Catalyst Stock Option Plan~~as of October 18, 2002 between the Registrant and ~~Form of Stock Option Agreement.~~Steven H. Owings.

10.3	*	Employment Agreement dated as of October 18, 2002 between the Registrant and Michael L. Baur.

10.4	~~99.1~~ *	Employment Agreement dated as of October 18, 2002 between the Registrant and Jeffery A. Bryson.

10.5	*	Employment Agreement dated as of November 12, 2002 between the Registrant and Richard P. Cleys.

10.6	*	2002 Long-Term Incentive Plan.

99.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2
	~~99.2~~	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

			SCANSOURCE, INC.
			~~/s/ MICHAEL~~ L. B~~AUR~~

		/s/ Michael L. Baur
			MICHAEL L. BAUR Chief Executive Officer


			~~/s/ JEFFERY~~ A. B~~RYSON~~
			/s/ Richard P. Cleys
			~~JEFFERY A. BRYSON~~ RICHARD P. CLEYS Chief Financial Officer

1.		I have reviewed this quarterly report on Form 10-Q of ScanSource, Inc.;

2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	a.		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is prepared;

	b.		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	a.		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

~~SIGNATURES~~

SIGNATURES

CERTIFICATIONS