[LOGO] Softech
June 14, 2005
Craig Wilson
Senior Assistant Chief Accountant
United States
Securities and Exchange Commission
Room 4561
Washington, D.C. 20549
Re: SEC Letter Dated May 31, 2005 of Comments on SofTech, Inc. Filings between
May 31, 2004 and April 12, 2005
Dear Mr. Wilson:
Thank you for your comments that resulted from the review of SofTech's filings
with the Securities and Exchange Commission ("SEC") over the last year. Please
find our responses to your inquiries below. These responses are keyed in such a
manner to correspond to the Staff's questions.
Please note that our responses are in no way meant to be interpreted as
confrontational or intransigent but instead to provide the Staff with our
thinking on these matters. It is absolutely our intent to cooperate fully in
resolving these matters to the Staff's satisfaction in a timely manner.
CONSOLIDATED STATEMENTS OF OPERATIONS, PAGE 24
1. The capitalized software balance sheet account is composed almost
entirely of acquired technology from the acquisitions of the Advanced
Manufacturing Technology division ("AMT") in 1997, Adra Systems, Inc. ("Adra")
in 1998 and Workgroup Technology Corporation ("WTC") in 2002. Accordingly, such
amounts were recorded as a part of our purchase price allocation in accordance
with APB No 16 or SFAS No. 141, as applicable, rather than internal costs
capitalized pursuant to Statement of Financial Accounting Standards ("SFAS") No.
86. The net balance of the capitalized software balance sheet account at May 31,
2004 related to each of these product lines is as follows (000's):
Adra Systems $ 3,978
AMT 1,691
Workgroup Technology Corporation 751
--------
Total $ 6,420
As of our current fiscal year ended May 31, 2005, the total net balance related
to the above technologies was $4.452 million.
Given that the capitalized software costs summarized above arose from the
acquisitions, the Company has followed the impairment rules provided by SFAS No.
121 and SFAS No. 144, as applicable.
In classifying the amortization related to acquired technology and other
intangible assets, we note the following guidance from SFAS 142, paragraph 42:
"The amortization expense and impairment losses for intangible assets shall be
presented in income statement line items within continuing operations as deemed
appropriate for each entity".
In our judgment, the amortization of these intangible assets is properly
classified as part of operating expenses. Such classification is consistent with
our disclosure as to what is included in cost of products sold and cost of
services provided. The inclusion of all of these non-cash costs on one line in
the income statement also provides the reader with a clear understanding of the
components of our costs and our operating performance. Lastly, it is our
understanding that our classification of these costs is consistent with the
classification of similar costs by other public companies in our market space.
NOTE B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CAPITALIZED SOFTWARE COSTS AND RESEARCH AND DEVELOPMENT, PAGE 30
2. You properly note that upon purchasing AMT in 1997 and Adra in 1998 we
estimated the life of those technologies to be ten (10) years. Capitalized
software costs related to those purchases were amortized on a straight-line
basis over that estimated life. The straight-line method of amortization
resulted in a greater amortization amount than the method of calculating the
ratio of current gross revenues compared to current and anticipated future gross
revenues.
Each of the AMT and Adra technologies are mature technologies that continue to
be viable product offerings in their respective market niches. While it is quite
true that the product revenues have declined for each of these offerings over
the last eight years, the costs of marketing and supporting these technologies
have also declined. As a result the cash flow from these technologies remains
positive and relatively stable and supports the estimate of the assigned useful
lives.
At each balance sheet date, we compare the unamortized capitalized intangible
costs related to the product lines to the net realizable value in order to
determine if any capitalized costs need to be written off. At each of May 31,
2004, August 31, 2004, November 30, 2004 and February 28, 2005 the net
realizable value of these products exceeded the unamortized capitalized
intangible costs therefore no additional charges were warranted in accordance
with SFAS 144.
The table below summarizes the pertinent information used in this evaluation for
each of the periods noted for the AMT product line:
- ----------------------- --------------------- -------------------- --------------------- --------------------
FISCAL YEAR ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED
(000's) MAY 31, 2004 AUGUST 31, 2004 NOVEMBER 30, 2004 FEBRUARY 28, 2005
- ----------------------- --------------------- -------------------- --------------------- --------------------
Product revenue $ 334 $ 88 $ 86 $ 119
- ----------------------- --------------------- -------------------- --------------------- --------------------
Service revenue 1,069 245 232 234
----- --- --- ---
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total revenue 1,403 333 318 353
- ----------------------- --------------------- -------------------- --------------------- --------------------
- ----------------------- --------------------- -------------------- --------------------- --------------------
Cost of sales 196 33 32 30
--- -- -- --
- ----------------------- --------------------- -------------------- --------------------- --------------------
Gross margin 1,207 300 286 323
- ----------------------- --------------------- -------------------- --------------------- --------------------
- ----------------------- --------------------- -------------------- --------------------- --------------------
Operating expenses 1,135 252 252 272
----- --- --- ---
- ----------------------- --------------------- -------------------- --------------------- --------------------
- ----------------------- --------------------- -------------------- --------------------- --------------------
Operating income 72 48 34 51
- ----------------------- --------------------- -------------------- --------------------- --------------------
Non-cash expenses 424 111 111 111
--- --- --- ---
- ----------------------- --------------------- -------------------- --------------------- --------------------
Cash flow 496 159 145 162
- ----------------------- --------------------- -------------------- --------------------- --------------------
Unamortized
capitalized software
costs 1,691 1,585 1,479 1,373
- ----------------------- --------------------- -------------------- --------------------- --------------------
Net realizable value
over remaining
economic life * 2,721 2,602 2,483 2,364
- ----------------------- --------------------- -------------------- --------------------- --------------------
Note: * The net realizable value over the remaining economic life is equal to
the future cash flow expected from this product line over its useful
life
The Adra product line was expanded with an acquisition of a related product line
in December 2002 called ProductCenter. ProductCenter, acquired in the WTC
transaction, is a technology that allows for the control and sharing of
engineering data created in design technologies like that of Adra.
While the revenue can be identified separately, the costs associated with
selling and supporting the technologies are not as clearly distinguishable. For
example, R&D resources are shared between the two product lines, and sales and
marketing personnel and expenditures are aimed at the same audience for both
technologies.
The table below summarizes the pertinent information used in this evaluation for
each of the periods noted for the Adra and ProductCenter technologies:
- -------------------------- -------------------- -------------------- -------------------- -------------------
QUARTER ENDED QUARTER ENDED
FISCAL YEAR ENDED QUARTER ENDED NOVEMBER 30, 2004 FEBRUARY 28, 2005
(000's) MAY 31, 2004 AUGUST 31, 2004
- -------------------------- -------------------- -------------------- -------------------- -------------------
Product revenue
- - Adra $ 1,308 $ 208 $ 326 $ 402
- - ProductCenter 1,417 122 275 249
----- --- --- ---
Subtotal 2,725 330 601 651
- -------------------------- -------------------- -------------------- -------------------- -------------------
Service revenue
- - Adra 4,137 978 1,155 925
- - ProductCenter 4,065 1,136 1,147 1,081
----- ----- ----- -----
Subtotal 8,202 2,114 2,302 2,006
- -------------------------- -------------------- -------------------- -------------------- -------------------
Total revenue
- - Adra 5,445 1,186 1,481 1,327
- - ProductCenter 5,482 1,258 1,422 1,330
----- ----- ----- -----
Total revenue 10,927 2,444 2,903 2,657
- -------------------------- -------------------- -------------------- -------------------- -------------------
- -------------------------- -------------------- -------------------- -------------------- -------------------
Cost of sales 1,917 365 395 430
----- --- --- ---
- -------------------------- -------------------- -------------------- -------------------- -------------------
Gross margin 9,010 2,079 2,508 2,227
- -------------------------- -------------------- -------------------- -------------------- -------------------
- -------------------------- -------------------- -------------------- -------------------- -------------------
Operating expenses 9,322 2,188 2,268 2,308
----- ----- ----- -----
- -------------------------- -------------------- -------------------- -------------------- -------------------
- -------------------------- -------------------- -------------------- -------------------- -------------------
Operating income (312) (109) 240 (81)
- -------------------------- -------------------- -------------------- -------------------- -------------------
Non-cash expenses 2,146 521 519 514
----- --- --- ---
- -------------------------- -------------------- -------------------- -------------------- -------------------
Cash flow 1,834 412 759 433
- -------------------------- -------------------- -------------------- -------------------- -------------------
Unamortized capitalized
software costs 5,348 4,936 4,524 4,112
- -------------------------- -------------------- -------------------- -------------------- -------------------
Net realizable value
over remaining economic
life * 18,462 17,815 17,168 16,521
- -------------------------- -------------------- -------------------- -------------------- -------------------
Note:
* The net realizable value over the remaining economic life is equal to the
future cash flow expected from this product line over its useful life
It is clear from the above that the ten-year estimated economic life used for
amortizing the software costs for the AMT and Adra technology purchases was a
reasonable method based on the actual results over the seven-plus years we have
owned those technologies and our estimates of ongoing cash flows over the
remaining useful lives.
NOTE J. RELATED PARTY TRANSACTIONS, PAGE 38
3. It is our firm belief that the borrowing arrangement between the Company
and Greenleaf Capital represents an arms length agreement between the parties
and that the interest rate charged on those borrowings has always represented
the market rate based on our credit profile.
The relationship with Greenleaf Capital extends back to 1996 when Mr. Johnston,
Greenleaf's President and sole owner, became a Director of SofTech. In 1998,
Greenleaf extended a $5.0 million debt facility that was subordinate to a $9
million loan from a third party bank. The interest rate on the $9.0 million loan
from the third party bank and the Greenleaf subordinated debt was prime plus
2.25%. These funds were used to acquire Adra Systems.
In 1999, the Company defaulted on its $9 million bank debt and Greenleaf
provided an additional debt facility that allowed the Company to avoid the
collection and possible foreclosure process that was threatened. The interest
rate established at the inception of this arrangement with Greenleaf was prime
plus 3% reflecting the increased credit risk.
When the strategy pursued by the former CEO and VP of Sales between the time
Greenleaf provided that additional debt facility and the end of fiscal 2001 was
deemed a failure and resulted in a cash loss for fiscal 2001 of about $(3.1)
million, Mr. Johnston and the Board of Directors took the necessary actions to
replace the management team and embark on a very different strategic course. The
reorganization that took place in June 2001 has resulted in four consecutive
years of positive cash flow. During this period of time, the interest rate under
the Greenleaf debt facilities has reflected our credit profile. At June 2001,
the interest rate was 11.3%. This interest rate has steadily declined (9.75% at
June 2002, 7.25% at June 2003 and 6.25% at June 2004) as the Company's financial
performance and business outlook have improved.
Through all the financial turmoil and significant restructuring, the Company has
never missed a debt payment to Greenleaf Capital. The debt agreement has been
amended from time to time for a number of reasons including to adjust the
interest rate to market rate as the Company's financial performance has
improved, extend the term, provide additional funds for growth, etc. While
Greenleaf has certainly increased its overall stake in the Company, a long and
well-established financial relationship has been built on mutual trust and
respect over a very long period of time.
The statement referred to by the Staff on page 38 of our Annual Report was not
intended to convey a literal belief that the Company is incapable of refinancing
this debt on these terms, rather the intent of this statement was to reinforce
the previous sentence in that paragraph that the Company is very dependent on
Greenleaf. The Company's relationship, and the underlying mutual fairness in the
financing arrangement, is such that the Company has not recently sought to
refinance this obligation, nor does it intend to do so. Likewise, we have no
reason to believe that Greenleaf has made any attempt to exit this relationship
for the purpose of earning a higher return elsewhere. It is this very solid
relationship built on many years of timely payment and open and honest
communication between the Company and Greenleaf Capital that would be extremely
difficult to replicate in the near term.
The interest rate of 6.25% established in June 2004 was a negotiated interest
rate at a premium to the prime rate of 4%. It is our belief that the 6.25%
interest rate approximates the market rate for a Company our size with our
history of performance especially over the last four years. The interest rate is
higher by 25 and 75 basis points when compared to the interest rate two
comparable companies in our market space are currently paying on their
borrowings to unrelated third parties. While we are not privy to all of the
information available to the lenders to these two companies, we believe that
they represent a reasonable proxy vis-a-vis our responsibility to evaluate the
rate we are being charged, as well as our accounting and disclosure obligations.
Based on all of the above, management concluded that the carrying value of the
debt approximated fair value, and that the guidance set forth in APB No. 21 is
not applicable.
FORM 8-K FILED AUGUST 31, 2004, OCTOBER 15, 2004, JANUARY 6, 2005 AND APRIL 12,
2005
As noted in the SEC's items numbered 4, 5 and 6 we use two non-GAAP measures of
performance to describe our periodic performance when we issue our quarterly and
annual press releases. It is our belief that these two non-GAAP measures are
important for measuring financial performance and providing investors with
information for measuring value.
4. The Company today generates almost all of its revenue from the
acquisitions of AMT in 1997, Adra in 1998 and WTC in 2002. The intangible assets
resulting from these acquisitions are by far the largest assets on the balance
sheet. As of May 31, 2004, these intangible assets were approximately 80% of our
total assets. Non-cash expenses accounted for about 18.3% of the Company's GAAP
expenses and 21% of the revenue for the year ended May 31, 2004. It is our
belief that few other public companies in the U.S. have balance sheets so
weighted by intangible assets or income statements so heavily influenced by
non-cash expenses. Certainly no public companies that we are aware of in our
market niche have a profile anything like SofTech's.
This unique financial profile makes it more difficult for investors, customers,
suppliers, employees, lenders and others to compare our periodic performance to
other companies in our market space. This is especially true given our financial
struggles between fiscal years 1999 and 2001 and the fact that we are a small
cap company. An interested party is more likely to simply stop taking notice
after reading that the Company incurred a GAAP loss while, in fact, the GAAP
loss hides the greatly improved performance. This is exactly what happened in Q2
fiscal 2005 when we incurred a GAAP loss of about $(90,000). Our free cash flow
of $536,000 was better than some historical quarterly periods when we recorded
GAAP income but generated less free cash flow (see Q3 FY 1998 for example).
While we recognize the importance of reporting our results in accordance with
GAAP, we believe that many of our financial statement users are more keenly
focused on free cash flow and pro forma earnings as a measure of our
performance. For the reasons stated above regarding the nature of the pro forma
adjustments, we do not believe that there are material limitations associated
with the use of this information.
Question 8 of the Frequently Asked Questions regarding the Use of Non-GAAP
Financial Measures states that there is "no PER SE prohibition against removing
a recurring item" when evaluating performance but puts the burden of
demonstrating the usefulness of the measure on the company. Given the detailed
tables and the easy reconciliation of these non-GAAP measures to comparable GAAP
measures of performance, management believed the information highlighted in
Question 8 was self evident in its press releases of financial results.
5. As detailed in the explanation above, we believe "free cash flow" as
defined in our press release is a meaningful measure of performance. Question 13
of Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures
specifically states that using such a term "would not ordinarily violate the
prohibitions of Regulation S-K". Caution is advised given the fact that the term
"free cash flow" does not have a uniform definition. We have attempted, within
our press release, to clearly define this term so that there could be no
confusion. Further, our reconciliation of a comparable GAAP defined term to Free
Cash Flow is very clearly displayed. We do not believe there to be any material
limitations with the use of this term "Free Cash Flow" and therefore none are
identified. The specific limitation identified in Question 13 regarding debt
service or other non-discretionary expenditures is not a material limitation in
our circumstances in that we have always had borrowing capacity through our
revolving line of credit that was far in excess of the annual debt service
payments.
6. Footnote 12 to the Final Rule: Conditions for the Use of Non-GAAP
Financial Measures effective March 28, 2003 reads as follows:
"Section 401(b) of the Sarbanes-Oxley Act directs the Commission to adopt rules
concerning the public disclosure or release of "pro forma financial information"
by a company filing reports under Section 13(a) [15 U.S.C. ss. 78m(a)] or 15(d)
[15 U.S.C. ss. 780(d)]. Because the Commission's rules and regulations address
the use of "pro forma financial information" in other contexts, particularly in
Regulation S-X, and use that term differently from its use in the Sarbanes-Oxley
Act, we are adopting the term "non-GAAP financial measures" to identify the
types of information targeted by Section 401(b) of the Sarbanes-Oxley Act."
The reference within the body of the Final Rule states that Regulation G applies
whenever a company publicly discloses or releases material information that
includes a non-GAAP financial measure.
It is our understanding from our reading of Regulation G that the requirements
and the prohibitions of the Regulation (see Final Rule: Conditions for the Use
of Non-GAAP Financial Measures effective March 28, 2003, Section II.A.3a. and b.
and Section II. B.) require specific disclosures when non-GAAP measures are
utilized including a reconciliation to a comparable GAAP measure. In addition,
certain specific prohibitions are included in the Regulation.
We have again reviewed these prohibitions and do not see that the terms "free
cash flows" and/or "pro forma net income" that we use in our press releases are
either directly or indirectly prohibited.
I can be reached at (781)890-8373 or by e-mail at JMULLANEY@SOFTECH.COM if you
require any additional information or would like to discuss further.
We acknowledge that the Company is responsible for the adequacy and accuracy of
the disclosure in the filing. We understand that Staff comments or changes to
disclosure in response to Staff comments do not foreclose the Commission from
taking any action with respect to the filing. The Company may not assert Staff
comments as a defense in any proceeding initiated by the Commission or any
person under the federal securities laws of the United States.
Sincerely,
/s/Joseph P. Mullaney
Joseph P. Mullaney
President