10-Q 1 d90674e10-q.txt FORM 10-Q FOR QUARTER ENDED JULY 31, 2001 1 ================================================================================ 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. ================================================================================ 2 INDEX

3 SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data) ASSETS

See notes to consolidated financial statements. 1 4 SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (in thousands, except per share amounts)

See notes to consolidated financial statements. 2 5 SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)

See notes to consolidated financial statements. 3 6 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):

4 7 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.

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):

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. 5 8 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.

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. 6 9 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. 7 10 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. 8 11 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. 9 12 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. 10 13 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. 11 14 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) 12 15 EXHIBIT INDEX

SOFTWARE SPECTRUM INC 10-Q