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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC. 20549
FORM 10-Q
Mark One Quarterly Report Pursuant to Section 13 or 15(d) of the
[X] Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2001
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____ to _____.
Commission file number 0-19349
SOFTWARE SPECTRUM, INC.
(Exact name of registrant as specified in its charter)
Texas 75-1878002
--------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2140 MERRITT DRIVE
GARLAND, TEXAS
75041
(Address of principal executive offices)
(Zip Code)
972-840-6600
(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 (l) 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 _____
----
At September 7, 2001, the Registrant had outstanding 3,134,513 shares
of its Common Stock, par value $.01 per share.
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INDEX
<Table>
<Caption>
PAGE
PART I. FINANCIAL INFORMATION NUMBER
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at July 31, 2001
and April 30, 2001 1
Consolidated Statements of Income for the
Three Months Ended July 31, 2001 and 2000 2
Consolidated Statements of Cash Flows for the
Three Months Ended July 31, 2001 and 2000 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 11
</Table>
3
SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
<Table>
<Caption>
July 31, April 30,
2001 2001
------------ ------------
(Unaudited)
Current assets
Cash and cash equivalents $ 8,725 $ 13,937
Marketable equity security 1,328 2,450
Trade accounts receivable, net of allowance for doubtful
accounts of $3,818 at July 31 and $3,649 at April 30 139,458 151,734
Prepaid expenses 1,205 1,010
Other current assets 1,328 3,156
------------ ------------
Total current assets 152,044 172,287
Furniture, equipment and leasehold improvements, at cost 45,254 43,495
Less accumulated depreciation and amortization 27,005 25,369
------------ ------------
18,249 18,126
Other assets, consisting primarily of goodwill, net of accumulated
amortization of $12,698 at July 31 and $12,095 at April 30 37,879 37,376
------------ ------------
$ 208,172 $ 227,789
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt $ 19,650 $ 3,800
Trade accounts payable 114,900 152,735
Other current liabilities 13,126 11,531
------------ ------------
Total current liabilities 147,676 168,066
Shareholders' equity
Preferred stock, par value $.01; authorized, 1,000,000 shares;
issued and outstanding, none -- --
Common stock, par value $.01; authorized, 20,000,000 shares;
issued, 4,619,889 shares at July 31 and 4,615,025 shares at April 30 46 46
Additional paid-in capital 42,648 42,601
Retained earnings 42,590 42,269
Currency translation adjustments (4,430) (4,835)
------------ ------------
80,854 80,081
Less treasury stock at cost - 1,409,801 shares 20,358 20,358
------------ ------------
Total shareholders' equity 60,496 59,723
------------ ------------
$ 208,172 $ 227,789
============ ============
</Table>
See notes to consolidated financial statements.
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SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share amounts)
<Table>
<Caption>
Three Months Ended
July 31,
----------------------------
2001 2000
------------ ------------
Net sales
Software services $ 275,633 $ 248,470
Contact services 12,680 15,429
------------ ------------
288,313 263,899
------------ ------------
Cost of sales
Software services 255,165 229,070
Contact services 9,352 12,029
------------ ------------
264,517 241,099
------------ ------------
Gross margin 23,796 22,800
Selling, general and administrative expenses 19,104 19,516
Depreciation and amortization 2,254 2,570
------------ ------------
Operating income 2,438 714
Non-operating expense (income)
Interest expense 194 359
Interest income (266) (283)
Unrealized loss on marketable equity security 1,956 --
------------ ------------
1,884 76
------------ ------------
Income before income taxes 554 638
Income tax expense 233 262
------------ ------------
Net income $ 321 $ 376
============ ============
Earnings per share - basic and diluted $ 0.10 $ 0.10
============ ============
Weighted average shares outstanding
Basic 3,208 3,721
============ ============
Diluted 3,211 3,740
============ ============
</Table>
See notes to consolidated financial statements.
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SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
<Table>
<Caption>
Three Months Ended
July 31,
--------------------------
2001 2000
----------- -----------
Operating activities
Net income $ 321 $ 376
Adjustments to reconcile net income to net cash
used in operating activities
Provision for bad debts 275 227
Depreciation and amortization 2,254 2,570
Unrealized loss on marketable equity security 1,956 --
Changes in operating assets and liabilities
Trade accounts receivable 11,654 7,076
Marketable equity security (834) --
Prepaid expenses and other assets 557 (735)
Trade accounts payable and other
current liabilities (36,615) (15,065)
----------- -----------
Net cash used in operating activities (20,432) (5,551)
----------- -----------
Investing activities
Purchase of furniture, equipment and
leasehold improvements (1,789) (2,677)
----------- -----------
Net cash used in investing activities (1,789) (2,677)
----------- -----------
Financing activities
Borrowings on long-term debt 38,600 38,765
Repayments of long-term debt (22,750) (32,828)
Proceeds from stock issuance 47 123
Purchase of treasury stock -- (1,165)
----------- -----------
Net cash provided by financing activities 15,897 4,895
----------- -----------
Effect of exchange rate changes on cash 1,119 592
----------- -----------
Net cash used in continuing operations (5,205) (2,741)
Net cash provided by (used in) discontinued operations (7) 1,755
----------- -----------
Decrease in cash and cash equivalents (5,212) (986)
Cash and cash equivalents at beginning of period 13,937 5,652
----------- -----------
Cash and cash equivalents at end of period $ 8,725 $ 4,666
=========== ===========
Supplemental disclosure of cash paid during the period
Income taxes $ 85 $ 62
Interest 280 315
</Table>
See notes to consolidated financial statements.
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SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A -- BASIS OF PRESENTATION AND ACCOUNTING POLICIES
The accompanying financial statements include the accounts of Software Spectrum,
Inc. (the "Company") and its wholly-owned subsidiaries. All intercompany
accounts and transactions have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform to the current period
presentation.
The consolidated financial statements contained herein have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, all adjustments necessary for a fair
presentation of the consolidated financial position as of July 31, 2001 and the
consolidated results of operations and consolidated cash flows for the three
months ended July 31, 2001 and 2000 have been made. In addition, in the opinion
of management, all such adjustments made are of a normal recurring nature. The
results of operations for the periods presented are not necessarily indicative
of the results to be expected for the full fiscal year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the interim reporting rules of the
Securities and Exchange Commission. The interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and related notes for the year ended April 30, 2001, included in the
Company's 2001 Annual Report on Form 10-K.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible
Assets, which revises the accounting for purchased goodwill and intangible
assets. Under SFAS 142, goodwill and intangible assets with indefinite lives
will no longer be amortized, but will be tested for impairment annually as well
as in the event of an impairment indicator. The Company will adopt SFAS 142
effective May 1, 2002. For the quarter ended July 31, 2001, goodwill
amortization reduced net income and earnings per share by approximately
$350,000 and $.11 per share, respectively.
NOTE B -- OTHER COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
<Table>
<Caption>
Three Months Ended
July 31,
--------------------------
2001 2000
---------- -----------
Net income $ 321 $ 376
Currency translation adjustments 405 750
---------- -----------
Comprehensive income $ 726 $ 1,126
========== ===========
</Table>
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NOTE C -- EARNINGS PER SHARE
The following table (in thousands, except per share amounts) sets forth the
computation of basic and diluted earnings per share. Outstanding options that
were not included in the computation of diluted earnings per share because the
exercise price of the options was greater than the average market price of the
common shares totaled approximately 621,000 and 171,000 shares for the three
months ended July 31, 2001 and 2000, respectively.
<Table>
<Caption>
Three Months Ended
July 31,
--------------------------
2001 2000
---------- -----------
Net income $ 321 $ 376
========== ===========
Weighted average shares outstanding - basic 3,208 3,721
Effect of dilutive employee and director stock options 3 19
---------- -----------
Weighted average shares outstanding - diluted 3,211 3,740
---------- -----------
Earnings per share - basic and diluted $ 0.10 $ 0.10
========== ===========
</Table>
NOTE D -- BUSINESS SEGMENTS
Information for the Company's reportable segments for the three months ended
July 31, 2001 and 2000 is presented below (in thousands):
<Table>
<Caption>
Three Months Ended
July 31,
--------------------------
2001 2000
---------- -----------
Net sales
Software services $ 275,633 $ 248,470
Contact services 12,680 15,429
---------- -----------
$ 288,313 $ 263,899
========== ===========
Operating income (loss)
Software services $ 11,693 $ 10,723
Contact services 195 (165)
Unallocated corporate overhead (9,450) (9,844)
----------- -----------
$ 2,438 $ 714
========== ===========
</Table>
NOTE E -- MARKETABLE EQUITY SECURITY
The Company's marketable equity security consists of 137,600 shares of publicly
traded stock acquired in fiscal 2001 through the sale of a subsidiary. As of
September 7, 2001, the quoted market price of the stock was $5.40 per share.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a global business-to-business software services provider with
sales locations, operations and contact centers located in North America, Europe
and Asia/Pacific. The Company sells personal computer ("PC") software through
volume licensing and maintenance ("VLM") agreements, or right-to-copy
arrangements, and full-packaged PC software products. In addition, the Company
provides contact center solutions to software publishers, Internet service
providers, original equipment manufacturers and other organizations.
The following table sets forth certain items from the Company's Consolidated
Statements of Income expressed as a percentage of net sales.
<Table>
<Caption>
Three Months Ended
July 31,
--------------------------
2001 2000
---------- -----------
Net sales 100.0% 100.0%
Cost of sales 91.7 91.4
---------- -----------
Gross margin 8.3 8.6
Selling, general and administrative expenses 6.6 7.4
Depreciation and amortization 0.8 0.9
---------- -----------
Operating income 0.9 0.3
Non-operating expense, net 0.7 0.1
---------- -----------
Income before income taxes 0.2 0.2
Income tax expense 0.1 0.1
---------- -----------
Net income 0.1% 0.1%
========== ===========
</Table>
NET SALES
Software sales for the three months ended July 31, 2001 increased approximately
11% over those for the three months ended July 31, 2000, mainly due to the
addition of new customers. New customers were added primarily because of the
Company's strong competitive position with global enterprises and the expansion
of the sales force throughout fiscal 2001. Sales of software through VLM
agreements represented approximately 89% of software sales for the three months
ended July 31, 2001 compared to approximately 86% for the three months ended
July 31, 2000.
In May 2001, Microsoft announced changes to its licensing programs to be
effective October 1, 2001, including that new enterprise-wide licensing
arrangements will be priced, billed and collected directly by Microsoft. The
Company will continue to provide sales and support services related to these
transactions and will earn a service fee directly from Microsoft for these
activities. The Company will continue to realize software revenue from existing
enterprise-wide agreements, which generally have terms of three years, as well
as from sales of software under Microsoft's other licensing programs. This
change will result in significantly lower revenues for the Company on the
affected transactions. While it is not known what effect the changes in the new
Microsoft selling model will have on gross margin dollars, the Company does not
expect the changes to have a significant impact. For the quarter ended July
31, 2001, approximately 26% of the Company's product sales were under Microsoft
enterprise-wide licensing agreements.
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For the three months ended July 31, 2001, contact services revenues decreased
18% as compared to the three months ended July 31, 2000. The decrease was
primarily attributable to the decision by one of the Company's largest customers
in October 2000 to reduce and realign call volumes outsourced to third parties,
which resulted in lower call volumes in the Company's Dallas and Spokane call
centers. Contact services represented approximately 4% of the Company's overall
sales for the three months ended July 31, 2001 as compared to 6% for the three
months ended July 31, 2000 and generated approximately 14% and 15%,
respectively, of the Company's gross margin dollars.
Due to current economic conditions, the Company has seen indications of a
decline in information technology purchasing volumes over the past year. If
customers or potential customers decrease their spending for information
technology, the Company's revenues could be adversely affected.
The Company believes its future growth will depend upon its ability to maintain
and increase its customer base, to develop and expand its contact services and
to capitalize on continued growth in desktop technology markets around the
world.
INTERNATIONAL OPERATIONS
For the three months ended July 31, 2001, sales outside of North America
decreased 25% to $30 million, as compared to $40 million for the three months
ended July 31, 2000. Sales in Europe increased 9% to $18.5 million for the three
months ended July 31, 2001, while sales in Asia/Pacific decreased 49% to $11.6
million during the same period. The decline in Asia/Pacific is primarily due to
the delayed renewal of annual contracts by several key customers, as well as
weak economic conditions in the region.
For the three months ended July 31, 2001 and July 31, 2000, fluctuations in
foreign currencies reduced operating income by approximately $100,000 and
$290,000, respectively.
GROSS MARGIN
Overall gross margin as a percentage of net sales was 8.3% for the three months
ended July 31, 2001, as compared to 8.6% for the comparable period of the prior
year. The decrease in overall gross margin as a percentage of net sales is due
to lower gross margins on software sales. For the three months ended July 31,
2001, gross margin on software sales decreased to 7.4%, as compared to 7.8% for
the three months ended July 31, 2000, primarily due to price competition and an
increase in the percentage of revenue derived from enterprise-wide licensing
contracts, which typically have lower margins than traditional VLM arrangements.
The Company believes that gross margin percentages on sales of software may
continue to experience downward pressure if the current level of price
competition continues or if publishers respond to continued market pressures by
reducing financial incentives to resellers. While it is not known what effect
the changes in the new Microsoft selling model will have on gross margin
dollars, the Company believes that the new selling model for enterprise-wide
agreements and anticipated increases in gross margin dollars generated by
contact services may partially offset the potential impact on gross margin
percentages of price competition or reduced financial incentives.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses include the costs of the
Company's sales and marketing organization as well as purchasing, distribution
and administration costs. For the three months ended July 31, 2001, SG&A
expenses, as a percentage of net sales, decreased to 6.6%, as compared to 7.4%
for the three months ended July 31, 2000. The decrease is primarily due to the
sufficiency of the Company's infrastructure, which allowed the Company to
generate incremental sales volume without a corresponding increase in overhead
costs. The Company remains focused on controlling operating costs in both of its
business lines.
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DEPRECIATION AND AMORTIZATION
The decrease in depreciation and amortization for the three months ended July
31, 2001, as compared to the three months ended July 31, 2000, is primarily due
to a decline in goodwill.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible
Assets, which revises the accounting for purchased goodwill and intangible
assets. Under SFAS 142, goodwill and intangible assets with indefinite lives
will no longer be amortized, but will be tested for impairment annually as well
as in the event of an impairment indicator. The Company will adopt SFAS 142
effective May 1, 2002. For the quarter ended July 31, 2001, goodwill
amortization reduced net income and earnings per share by approximately $350,000
and $.11 per share, respectively.
OPERATING INCOME
Operating income for the three months ended July 31, 2001 was $2.4 million,
compared to $714,000 for the three months ended July 31, 2000. The increase in
operating income is primarily due to the increase in software sales and the
resulting increase in gross margin dollars, as well as the Company's ability to
control its operating costs.
UNREALIZED LOSS ON MARKETABLE EQUITY SECURITY
The Company's marketable equity security consists of 137,600 shares of publicly
traded stock acquired in December 2000 through the sale of a subsidiary. For the
quarter ended July 31, 2001, the Company incurred an unrealized loss of
approximately $2.0 million to adjust this security to its market value of $9.65
per share at July 31, 2001. The market price of the security was $5.40 per share
at September 7, 2001.
INCOME TAX EXPENSE
The Company's effective tax rate was approximately 42% for the three months
ended July 31, 2001 as compared to 41% for the three months ended July 31, 2000.
As disclosed in the Company's Annual Report on Form 10-K for the year ended
April 30, 2001, the Company has been engaged in settlement discussions with the
Internal Revenue Service ("IRS") concerning the deductibility of certain
payments made by the Company to its foreign subsidiaries. Recently, the Company
reached a tentative settlement with the IRS, which would resolve the
aforementioned issues for all applicable tax years. Under the terms of the
tentative settlement, the Company expects that its liability for additional
taxes, including interest expense, for all such tax years will approximate the
$1.5 million estimate previously accrued in the Company's April 30, 2001
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 2001, the Company had approximately $8.7 million in cash and cash
equivalents and had $19.7 million outstanding under its $100 million revolving
credit facility. The credit facility, which is secured by accounts receivable
and a pledge of the stock of certain of the Company's subsidiaries, permits the
Company to borrow up to $100 million, subject to availability under its
borrowing base. As of July 31, 2001, the Company had approximately $32 million
of additional borrowing availability under its credit facility. The facility
expires in March 2002. The Company intends to renew or replace the facility
prior to expiration.
The decrease in trade accounts receivable and trade accounts payable from April
30, 2001 to July 31, 2001 is due to the timing of collections of accounts
receivable and payments to the Company's vendors. At July 31, 2001 and April 30,
2001, accounts receivable represented approximately 45 and 56 days of historical
sales, respectively.
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For the three months ended July 31, 2001, the Company's operating activities
used $20 million of cash compared to $5.6 million of cash used in operations
during the three months ended July 31, 2000. The increase in cash used in
operations is primarily due to the timing of payments to the Company's largest
vendors.
The increase in furniture, equipment and leasehold improvements from April 30,
2001 to July 31, 2001 reflects approximately $1.8 million of capital
expenditures related primarily to the ongoing investment in the Company's
computer systems.
In 1997, the Company implemented a stock repurchase program which allows for the
purchase of the Company's Common Stock from time to time in the open market or
through privately negotiated transactions. The Company funds such purchases with
cash or borrowings under the Company's credit facility. As of September 7, 2001
the Company had repurchased 1,435,300 shares of Common Stock, for a total of
$20.3 million, under the stock repurchase program and has been authorized by its
Board of Directors to repurchase up to an additional $1.4 million of its common
stock.
The Company expects that its cash requirements for fiscal 2002 will be satisfied
from cash flow from operations and borrowings under its credit facility, which
the Company intends to renew or replace prior to expiration.
EURO CURRENCY ISSUES
On January 1, 1999, eleven of the fifteen member countries of the European Union
introduced a common legal currency called the Euro, which is intended to replace
the currently existing currencies of the participating countries by January
2002. The Company does not believe that use of the Euro has or will materially
impact its financial condition, operating results or use of derivative
instruments.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Other than statements of historical fact, this Management's Discussion and
Analysis of Financial Condition and Results of Operations includes certain
statements of the Company that may constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. The
Company uses words like "expects", "anticipates" or "believes" to identify
forward-looking statements. These statements include future market trends,
expectations concerning the Company's growth and profitability, expectations
regarding the economy and the software industry in general, key performance
indicators that impact the Company, statements regarding market risk and
statements included in the Euro Currency discussion above. In developing any
forward-looking statements, the Company makes a number of assumptions, including
expectations for continued market growth, supplier relationships, anticipated
revenue and gross margin levels, legal and regulatory proceedings and cost
savings and efficiencies. Although the Company believes these assumptions are
reasonable, no assurance can be given that they will prove correct. The
Company's ability to continue to grow its product and contact services
businesses and improve operational efficiencies will be key to its success in
the future. If the industry's or the Company's performance differs materially
from these assumptions or estimates, Software Spectrum's actual results could
vary significantly from the estimated performance reflected in any
forward-looking statements. Accordingly, forward-looking statements should not
be relied upon as a prediction of actual results. Further, the Company
undertakes no obligation to update forward-looking statements after the date
they are made to conform the statements to actual results or changes in the
Company's expectations. The Company's report on Form 10-K for the fiscal year
ended April 30, 2001 contains certain cautionary statements under
"Forward-Looking Information" that identify factors that could cause the
Company's actual results to differ materially from those in the forward-looking
statements in this discussion. All forward-looking statements in this discussion
are expressly qualified in their entirety by the cautionary statements in this
paragraph and under "Forward-Looking Information" in the Company's Form 10-K.
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INFLATION
The Company believes that inflation has not had a material impact on its
operations or liquidity to date.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information about market risks for the three months ended July 31, 2001 does not
differ materially from that discussed in Item 7 of the Company's Annual Report
on Form 10-K for its fiscal year ended April 30, 2001.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.2(b) - Amendment No. 2, dated July 1, 2001, to
Microsoft Large Account Reseller Agreement, dated January 1,
2000 between MSLI, GP and the Company.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three month
period ended July 31, 2001.
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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.
SOFTWARE SPECTRUM, INC.
Date: September 14, 2001 By: /s/ James W. Brown
------------------------------------------------
James W. Brown
Vice President and Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
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EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.2(b) - Amendment No. 2, dated July 1, 2001, to Microsoft Large
Account Reseller Agreement, dated January 1, 2000 between
MSLI, GP and the Company.
</Table>
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