10-Q 1 d92879e10-q.txt FORM 10-Q FOR QUARTER ENDED OCTOBER 31, 2001 ================================================================================ 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 OCTOBER 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 December 7, 2001, the Registrant had outstanding 3,076,413 shares of its Common Stock, par value $.01 per share. ================================================================================ INDEX

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

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

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

See notes to consolidated financial statements. 3 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 October 31, 2001, the consolidated results of operations for the three and six months ended October 31, 2001 and 2000, and the consolidated cash flows for the six months ended October 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 accounting principles generally accepted in the United States of America 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 three and six months ended October 31, 2001, goodwill amortization reduced net income by $341,000 and $688,000, and earnings per share by approximately $.11 and $.22 per share, respectively. NOTE B -- OTHER COMPREHENSIVE INCOME The components of comprehensive income are as follows (in thousands):

4 SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 their effect would be antidilutive totaled approximately 728,000 and 674,000 shares for the three and six months ended October 31, 2001 and 665,000 and 639,000 shares for the three and six months ended October 31, 2000, respectively.

NOTE D -- BUSINESS SEGMENTS Information for the Company's reportable segments for the three and six months ended October 31, 2001 and 2000 is presented below (in thousands):

Sales to one Product Services customer accounted for approximately 13% and 8% of total sales for the three and six months ended October 31, 2001. No customer accounted for more than 10% of sales for the three or six months ended October 31, 2000. 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 December 7, 2001, the quoted market price of the stock was $5.88 per share. 5 SOFTWARE SPECTRUM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE F -- SUBSEQUENT EVENT Effective November 30, 2001, the Company amended its existing revolving credit facility. The amended credit facility (the "Amended 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 $75 million, subject to availability under its borrowing base. The Amended Facility continues to require the Company to maintain certain financial covenants and ratios and continues to place limitations on dividends, capital expenditures and certain other borrowings. The Amended Facility bears interest at a variable rate and expires in November 2004. 6 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 Operations expressed as a percentage of net sales.

NET SALES Software sales for the three and six months ended October 31, 2001 increased approximately 47% and 29% over those for the three and six months ended October 31, 2000. The increase is partially due to sales to new customers. The Company's strong competitive position with global enterprises, licensing expertise, electronic innovation, and the expansion of the sales force throughout fiscal 2001 contributed to the addition of these new customers. A portion of the revenue growth is also attributable to announced changes in Microsoft licensing programs effective October 1, 2001 which, in a number of cases, resulted in customers purchasing software earlier than anticipated. In addition, revenues for the October 31, 2001 quarter increased due to the timing of a significant transaction with one large customer. This customer accounted for approximately 14% of total product sales for the three months ended October 31, 2001, but was less than 10% of total product sales for the six months ended October 31, 2001 and the three and six months ended October 31, 2000. Sales of software through VLM agreements represented approximately 92% and 90% of software sales for the three and six months ended October 31, 2001 compared to approximately 84% and 85% for the three and six months ended October 31, 2000, respectively. 7 As previously discussed, effective October 1, 2001, certain new Microsoft enterprise-wide licensing arrangements ("Enterprise Agreements") are 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. In addition, the Company will continue to realize software revenue from existing Enterprise 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 the precise impact of these changes on gross margin dollars is not known, the Company does not expect the effect to be significant. For the six months ended October 31, 2001, approximately 24% of the Company's product sales were under Enterprise Agreements, none of which were under the new selling model. For the three and six months ended October 31, 2001, Contact Services revenues decreased 1% and 10% as compared to the three and six months ended October 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 both the three and six months ended October 31, 2001 as compared to 6% for both the three and six months ended October 31, 2000. Such revenue accounted for approximately 17% and 16%, respectively, of the Company's gross margin dollars for the three and six months ended October 31, 2001, and 12% and 14%, respectively, of the Company's gross margin dollars for the comparable periods in the prior year. The Company believes that customers may reduce their information technology purchasing volumes due to current economic conditions. If customers or potential customers decrease their spending for information technology, the Company's revenues could be adversely affected. In recent discussions with the Company's principal Contact Services customers concerning their long-term outsourcing strategies, the Company has been made aware of plans by these customers to move current call volumes handled by the Company to offshore locations during calendar year 2002. The impact of these plans on the Company's Contact Services business cannot be determined at the present time; however, if the Company is not able to replace volumes lost as a result of the implementation of such strategies on terms comparable to those existing today, the Company's Contact Services business would be adversely impacted. 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 and six months ended October 31, 2001, sales outside of North America increased 66% and 13% to $48 million and $78 million, respectively, as compared to $29 million and $69 million for the three and six months ended October 31, 2000. Sales in Europe increased 22% and 16% to $22 million and $40 million for the three and six months ended October 31, 2001, while sales in Asia/Pacific increased 137% and 11% to $26 million and $38 million during the same period. During fiscal 2002, certain large customers in Asia Pacific delayed the renewal of their licensing contracts, resulting in a significant shift of revenue from the July to the October fiscal quarter. For the three and six months ended October 31, 2001, fluctuations in foreign currencies reduced operating income by approximately $359,000 and $459,000, respectively. Fluctuations in foreign currencies increased operating income by approximately $301,000 and $12,000 for the three and six months ended October 31, 2000. 8 GROSS MARGIN Overall gross margin as a percentage of net sales was 7.3% and 7.7%, respectively, for the three and six months ended October 31, 2001, as compared to 8.7% for the comparable periods 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 and six months ended October 31, 2001, gross margin on software sales decreased to 6.3% and 6.8%, as compared to 8.1% and 8.0% for the three and six months ended October 31, 2000, primarily due to price competition and an increase in the percentage of revenue derived from licensing 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 continue to respond to market pressures by reducing financial incentives to resellers. While the precise effect that the new Microsoft selling model will have on gross margin dollars is not currently known, the Company believes that the impact of the new model may partially offset the potential pressure on gross margin percentages of price competition and 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 and six months ended October 31, 2001, SG&A expenses, as a percentage of net sales, decreased to 5.7% and 6.1%, as compared to 8.3% and 7.8% for the three and six months ended October 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. In addition, SG&A expenses for the three and six months ended October 31, 2000 included a nonrecurring charge of $730,000 relating to excess capacity created by the decline in the Contact Services business. The Company remains focused on controlling operating costs in both of its business lines. DEPRECIATION AND AMORTIZATION The decrease in depreciation and amortization for the three and six months ended October 31, 2001, as compared to the three and six months ended October 31, 2000, is primarily attributable to a decline in the level of fixed assets used in the Company's Contact Services business. 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 three and six months ended October 31, 2001, goodwill amortization reduced net income by approximately $341,000 and $688,000 and earnings per share by approximately $.11 and $.22 per share, respectively. OPERATING INCOME Operating income for the three and six months ended October 31, 2001 was $3.5 million and $5.9 million, compared to operating losses of $1.4 million and $702,000 for the three and six months ended October 31, 2000. The increase in operating income is due to the increase in software sales and the resulting increase in gross margin dollars, improved operations in the Contact Services 9 business, the Company's ability to control its operating costs, and $1.3 million of nonrecurring charges related to the Contact Services business that were incurred in the October 31, 2000 quarter. 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 October 31, 2001, the Company incurred an unrealized loss of approximately $900,000 to adjust this security to its market value of $3.02 per share at October 31, 2001. The market price of the security was $5.88 per share at December 7, 2001. INCOME TAX EXPENSE The Company's effective tax rate was approximately 42% for the three and six months ended October 31, 2001 as compared to 44% and 47% for the three and six months ended October 31, 2000. The decrease in the Company's effective tax rate is primarily due to the impact of its international operations. During the quarter ended October 31, 2001, the Company resolved, for all applicable tax years, the tax issues previously disclosed in the Company's Annual Report on Form 10-K for the year ended April 30, 2001. The Company's total liability for additional taxes, including interest expense, for all such tax years approximated the $1.5 million estimate previously accrued in the Company's April 30, 2001 financial statements. LIQUIDITY AND CAPITAL RESOURCES At October 31, 2001, the Company had approximately $35 million in cash and cash equivalents and had $3.8 million of debt outstanding. The Company amended its revolving credit facility effective November 30, 2001. Based on its expected borrowing requirements, the Company reduced the facility to $75 million, subject to availability under the borrowing base. The amended credit facility (the "Amended Facility"), which is secured by accounts receivable and a pledge of the stock of certain of the Company's subsidiaries, bears interest at a variable rate and expires in November 2004. The Amended Facility continues to require the Company to maintain certain financial covenants and ratios and continues to place limitations on dividends, capital expenditures and certain other borrowings. As of November 30, 2001, the Company had approximately $67 million of borrowing availability under the terms of the Amended Facility. The increase in trade accounts receivable and trade accounts payable from April 30, 2001 to October 31, 2001 is due to the increased sales in the October 31, 2001 quarter and the timing of collections of accounts receivable and payments to the Company's vendors. At October 31, 2001 and April 30, 2001, accounts receivable represented approximately 48 and 56 days of historical sales, respectively. For the six months ended October 31, 2001, the Company's operating activities provided $25 million of cash compared to $12 million of cash used in operations during the six months ended October 31, 2000. The increase in cash provided by operations is primarily due to the required timing of payments to the Company's largest vendors, as well as the increase in operating income. The increase in furniture, equipment and leasehold improvements from April 30, 2001 to October 31, 2001 reflects approximately $2.8 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 December 7, 2001 the Company had repurchased 1,493,400 shares of Common Stock, for a 10 total of $21.1 million, under the stock repurchase program and has been authorized by its Board of Directors to repurchase up to an additional $706,000 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 the Amended Facility. 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. 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 and six months ended October 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. 11 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS On September 20, 2001, the Company held its Annual Meeting of Shareholders (the "Meeting"). At the Meeting, Mellon C. Baird and Keith R. Coogan were elected as directors to serve three-year terms expiring at the Company's Annual Meeting of Shareholders to be held in the Year 2004. In addition, Amendment No. 2 to the Company's 1998 Long-Term Incentive Plan, which increased the number of shares of Common Stock reserved for issuance under the plan by 150,000 shares, was approved. The following table sets forth the number of shares of Common Stock that were voted for or against or abstained from each matter.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 10.13 - Management Continuity Agreement ("Continuity Agreement") between the Company and James W. Brown, dated March 1, 1998 together with schedule identifying additional executive officers that are parties to Continuity Agreements. Exhibit 10.18(e) - Fifth Amendment to Amended and Restated Credit Agreement and Modification to Other Loan Documents, dated November 30, 2001 among the Company, JPMorgan Chase Bank, as a Bank, as Administrative Agent and as Collateral Agent, and other participating financial institutions. (b) Reports on Form 8-K No reports on Form 8-K were filed during the three month period ended October 31, 2001. 12 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: December 17, 2001 By: /s/ James W. Brown -------------------------------------- James W. Brown Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 13 EXHIBIT INDEX

SOFTWARE SPECTRUM INC 10-Q