FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1998
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: 333-09789
ALLSTAR SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0062751
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6401 SOUTHWEST FREEWAY
HOUSTON, TEXAS 77074
(Address of principal executive offices) (Zip code)
(713) 795-2000
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ____ No X
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common Stock $.01 par value per share As of March 31, 1998, 4,454,411 shares
outstanding
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
March 31, December 31,
1998 1997
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash $ - $ 280
Cash 3,508 1,301
--------- --------
Total cash and cash equivalents 3,508 1,581
Accounts receivable - trade, net 20,701 23,759
Accounts receivable - affiliates 527 434
Inventory 6,042 4,700
Deferred taxes 212 212
Other current asset 428 404
--------- ---------
Total current assets 31,418 31,090
Property and equipment 2,004 2,013
Other assets 253 81
--------- ----------
Total $ 33,675 $ 33,184
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 4,821 $ 1,572
Accounts payable 10,290 12,805
Accrued expenses 3,528 3,565
Income taxes payable (194) 82
Deferred service revenue 188 242
--------- ----------
Total current liabilities 18,633 18,266
Deferred Credit - Stock warrants 195 195
--------- ----------
Total liabilities $ 18,828 $ 18,461
======= =======
Commitments and contingencies Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000
shares authorized, no shares issued
Common stock:
$.01 par value, 50,000,000 shares authorized,
4,454,411 and 4,454,411 shares
issued and outstanding on December
31, 1997 and March 31, 1998, respectively 45 45
Additional paid in capital 10,013 10,013
Retained earnings 4,789 4,665
--------- ----------
Total stockholders' equity 14,847 14,723
--------- ----------
Total $33,675 $33,184
====== ======
See notes to consolidated financial statements
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Ended March 31,
1998 1997
---- ----
Total Revenue $ 32,542 $ 26,593
Cost of sales and services 27,732 22,762
Gross Profit 4,810 3,831
Selling, general and administrative expenses 4,576 3,135
-------- --------
Operating income 234 696
---------------------------------
Interest expense and other income (net) 28 289
---------- ---------
Income before provision for income taxes 206 407
Provision for income taxes 82 154
---------- ---------
Net income $ 124 $ 253
========= =========
Net income per share:
Basic $0.03 $0.09
==== ====
Diluted $0.03 $0.09
==== ====
Weighted average shares outstanding:
Basic 4,454,411 2,675,000
========= =========
Diluted 4,457,106 2,675,000
========= =========
See notes to consolidated financial statements
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Three Months
ended ended
March 31, March 31,
1998 1997
Net income $ 124 $ 253
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Gain of disposal of assets --- ---
Depreciation and amortization 167 125
Deferred taxes --- ---
Changes in assets and liabilities that provided (used) cash:
Accounts receivable - trade, net 3,058 (676)
Accounts receivable - affiliates (93) (119)
Inventory (1,342) (272)
Other current assets (24) ---
Other assets (177) (40)
Accounts payable (2,515) 1,896
Accrued expenses (37) (71)
Income taxes payable (276) 136
Deferred service revenue (54) (69)
---------- ---------
Net cash provided by (used in)
operating activities (1,169) (1,163)
Cash flows from investing activities:
Capital Expenditures (153) (109)
Proceeds from sale of fixed assets --- ---
---------- ---------
Net cash used in investing activities: (153) (109)
Cash flows from financing activities:
Net increase (decrease) in notes payable 3,249 436
---------- ---------
Net cash provided by (used in) financing
activities: 3,249 436
Net increase (decrease) in cash and cash
equivalents 1,927 1,490
Cash and cash equivalents at beginning of period 1,581 229
-------- --------
Cash and cash equivalents at end of period $ 3,508 $ 1,719
======== =======
Supplemental disclosures of cash flow information:
Cash paid for interest $ 46 $ 403
========== ========
Cash paid for taxes $ 348 $ 1,032
========= =======
See notes to consolidated financial statements
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share amounts)
1. BASIS OF PRESENTATION
Allstar Systems, Inc. and subsidiaries ("Allstar"') is engaged in the sale
and service of computer and telecommunications hardware and software products.
Allstar's wholly owned subsidiary, Stratasoft, Inc. creates and markets software
related to the integration of computer and telephone technologies. In January,
1997 Allstar formed IT Staffing Inc. to provide temporary and permanent
placement services of technical personnel. In March, 1998 Allstar formed Allstar
Systems Rio Grande, Inc., a wholly-owned subsidiary, to conduct operations in
West Texas and New Mexico. All operations of the business are primarily
conducted from offices located in Houston, Dallas, Austin, McAllen and El Paso,
Texas and in Albuquerque and Las Cruces, New Mexico.
A substantial portion of Allstar's sales and services are authorized under
arrangements with product manufacturers and Allstar's operations are dependent
upon maintaining its approved status with such manufacturers. As a result of
these arrangements and arrangements with its customers, gross profit could be
limited by the availability of products or allowance for volume discounts.
Furthermore, net income before income taxes could be affected by changes in
interest rates which underlie the credit arrangements which are used for working
capital.
The condensed consolidated financial statements presented herein at March
31, 1998 and for the three-month period ended March 31, 1997 and 1998 are
unaudited; however, all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position, results of
operations and cash flows for the periods covered have been made and are of a
normal, recurring nature. Accounting measurements at interim dates inherently
involve greater reliance on estimates than at year end. The results of the
interim periods are not necessarily indicative of results for the full year. The
consolidated balance sheet at December 31, 1997 is derived from audited
consolidated financial statements but does not include all disclosures required
by generally accepted accounting principles. Although management believes the
disclosures are adequate, certain information and disclosures normally included
in the notes to the financial statements has been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission.
New Accounting Pronouncements. On January 1, 1998, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. Comprehensive income is a more inclusive financial
reporting methodology that includes disclosure of certain financial information
that historically has not been recognized in the presentation of net income.
SFAS No. 130 requires the, reporting of comprehensive income in addition to net
income from operations. For the three months ended March 31, 1998 and 1997, the
Company had no items of comprehensive income, and as a result the Company's
reported net income was the same as comprehensive income.
In March 1998, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants ('AICPN') reached a
consensus on Statement of position ("SOP") No. 98-1, Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use, which provides
guidance on accounting for the costs of computer software. SOP No. 98-1 is
effective for fiscal years beginning after December 15, 1998. Management is
evaluating what, if any, impact this SOP will have on the Company upon
implementation.
In April 1998, the ACSEC of the AICPA reached a consensus on SOP No. 98-5,
Reporting on the Costs of Start-up Activities, which provides that the costs of
such activities be expensed as incurred. SOP No. 98-5 is effective for fiscal
years beginning after December 15, 1998. Management is evaluating what, if any,
impact this SOP will have on the Company upon implementation.
In March 1998, the Emerging Issues task Force ("EITF") of the FASB reached
a consensus on Issue No. 97-11, Accounting for the Internal Costs Relating to
Real Estate Property Acquisitions, which requires that internal costs of
identifying and acquiring operating properties be expensed as incurred.
Management is currently evaluating the impact this EITF, which was effective for
transactions on or after March 20, 1998, will have on the Company.
2. INCENTIVE STOCK PLANS
In September 1996 Allstar adopted the 1996 Incentive Stock Plan (the
"Incentive Plan") and the 1996 Non-Employee Director Stock Option Plan (the
"Director Plan"). Under the Incentive Plan, Allstar's Compensation Committee may
grant up to 417,500 shares of common stock, which have been reserved for
issuance, to certain key employees of Allstar. The Incentive Plan provides for
the granting of incentive awards in the form of stock options, restricted stock,
phantom stock, stock bonuses and cash bonuses in accordance with the provisions
of the plan. Additionally, no shares may be granted after the tenth anniversary
of the Incentive Plan's adoption. Allstar has reserved for issuance, under the
Director Plan, 100,000 shares of common stock, subject to certain antidilution
adjustments. The Director Plan provides for a one-time option by newly elected
directors to purchase up to 5,000 common shares, after which each director is
entitled to receive an option to purchase up to 2,000 common shares upon each
date of re-election to Allstar's Board of Directors. Options granted under the
Director Plan have an exercise price equal to the fair market value on the date
of grant and generally expire ten years after the grant date. As of March 31,
1998, 20,000 stock option grants have been issued to directors under the
Director Plan. The exercise price of the directors' options is $4.625 per share.
As of March 31, 1998 incentive stock options totaling 180,300 shares have been
issued to employees. The exercise price of 80,000 of the stock option grants is
$6.00 per share and 100,300 of the stock option grants have an exercise price of
$4.625 per share. The stock option grants will vest ratably over the five year
period from the date of issuance. In addition, an incentive award in the form of
restricted stock was granted for 14,286 shares which will vest ratably over the
two year period ending July 7, 1999.
3. LITIGATION
On July 13, 1996, a former customer brought suit against the Company in the
152nd Judicial District Court of Harris County, Texas. The plaintiff alleges
that the Company failed to provide and complete promised installation and
configuration of certain computer equipment within the time promised by the
Company. Based on these allegations, the plaintiff is suing for breach of
contract and other statutory violations and is seeking actual monetary damages
of approximately $3 million and treble damages under the Texas Deceptive Trade
Practices Act. The Company is unable to estimate the range of possible recovery
by the plaintiff because the suit is still in the early stages of discovery.
However, the Company is vigorously defending the action.
Allstar is party to other litigation and claims which management believes
are normal in the course of its operations; while the results of such litigation
and claims cannot be predicted with certainty, Allstar believes the final
outcome of such matters will not have a materially adverse effect on its results
of operations or financial position.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
ALLSTAR SYSTEMS. INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is qualified in its entirety by, and should be
read in conjunction with, the Company's Consolidated Financial Statements,
including the Notes thereto.
OVERVIEW
The Company is engaged in the business of reselling computer hardware,
business telephone systems and software products and providing related services.
In addition, the Company derives revenue from providing IT Services to
purchasers of Computer Products and other customers. The Company operates from
offices in Houston, Austin, El Paso, Mcallen and Dallas, Texas and in
Albuquerque, New Mexico. While all offices offer computer related products and
services, certain offices do not offer telecommunications products and services.
The Company develops and markets CTI Software through its wholly-owned
subsidiary Stratasoft, Inc. To date, most of the Company's revenue has been
derived from Computer Products sales. During the quarter ended March 31, 1998,
Computer Products totaled 85.3% of revenues while IT Services, Telecom Systems
and CTI Software totaled 8.9%, 3.3% and 2.5% of revenues, respectively.
The Company's Computer Products division sells a wide variety of computer
hardware and software products available from over 600 manufacturers and
suppliers. The Company's products include desktop and laptop computers,
monitors, printers and other peripheral devices, operating system and
application software, network products and mid-range host and server systems.
The Company is an authorized reseller of products from a number of leading
manufacturers of computer hardware, software and networking equipment.
Generally, Computer Products sales are made on a purchase order basis, with
few on-going commitments to purchase from its customers. On certain occasions,
large "roll-out" orders are received with delivery scheduled over a longer term,
such as six to nine months, while normal orders are received and delivered to
the customers usually within approximately thirty days of the receipt of the
order. Because of this pattern of sales and delivery, the Company normally does
not have a significant backlog of computer product sales.
IT Services are provided by the Company both in conjunction with and
separately from its Computer Products sales. The Company typically prices its IT
Services on a time and materials basis or under fixed fee service contracts,
depending on customer preference and the level of service commitment required.
In markets where the Company does not maintain branch offices, it often
subcontracts for necessary technical personnel, particularly where required for
larger scope or prolonged duration contracts. The Company's IT Services include
information systems support, authorized warranty service, hardware repair and
maintenance services, complex network diagnostic services, end user support
services and software diagnostic services. The Company also offers complete
outsourcing of a customer's computer and network management and technical
support needs on a contract basis. In addition, the Company provides temporary
and permanent staffing services.
To support and maintain the quality of these services and to maintain
vendor accreditation necessary to resell and service its significant product
lines, the Company's technical staff participate in various certification and
authorization programs sponsored by hardware manufacturers and software
suppliers. The Company's ability to attract and retain qualified professional
and technical personnel is critical to the success of its IT Services business.
The most significant portion of the costs associated with the delivery of IT
Services are of personnel costs. Therefore, in order to be successful, the
Company's billable rates must be in excess of the personnel costs and its margin
is dependent upon maintaining high utilization of its service personnel. In
addition, the competition for high quality personnel has generally intensified
causing the Company's, along with other IT Service providers, personnel costs to
increase. The Company's costs of goods and services includes the personnel costs
of its billable technical staff.
While the Company has service contracts with its larger customers, many of
these contracts are project based or are terminable on relatively short notice.
Through the Telecom Systems division, the Company markets, installs and
services business telephone systems, including large PBX systems and smaller
"key systems"', along with a variety of related products including hardware and
software products for data and voice integration, wide area connectivity and
telephone system networking, wireless communications and video conferencing.
The Company develops and markets proprietary CTI Software, which integrates
business telephone systems and networked computer systems, under the trade name
"Stratasoft."' Basic products offered by the Company are typically customized to
suit a customer's particular needs and are often bundled with computer hardware
supplied by the Company at the customer's request. Stratasoft products include
software for call center management, both in-bound and out-bound, as well as
interactive voice response software.
The Company believes that each of its four separate businesses are
complementary to each other and allow the Company to offer a broader range of
integrated products and services in order to satisfy its customers' information
and communication technology requirements than many of its competitors. The
Company's strategy is to maintain and expand its relationships with its
customers by satisfying a greater portion of these requirements.
A significant portion of Company's selling, general and administrative
expenses relate to personnel costs, some of which are variable and others of
which are relatively fixed. The Company's variable personnel costs are
substantially comprised of sales commissions, which are typically calculated
based upon the Company's gross profit on a particular sales transaction and thus
generally fluctuate with the Company's overall gross profit. The remainder of
the Company's selling, general and administrative expenses are relatively more
fixed and, while still somewhat variable, do not vary with increases in revenue
as directly as do sales commissions.
Inacom Corp. ("Inacom") is the largest supplier of products sold by the
Company. In August 1997, the Company renewed its long-term supply arrangement
with Inacom and agreed to purchase at least 80% of its Computer Products from
Inacom, but only to the extent that such products are made available within a
reasonable period of time at reasonably competitive pricing. Inacom does not
carry certain product lines sold by the Company and Inacom may be unable to
offer reasonable product availability and reasonably competitive pricing from
time to time on those product lines that it carries. The Company thus expects
that less than 80% of its total purchases will be made from Inacom, and that any
increase or decrease over historical levels in the percentage of products it
purchases from Inacom under the new Inacom agreement will not have any material
impact on the Company's results of operations.
The Company manages its inventory in order to minimize the amount of
inventory held for resale and the risk of inventory obsolescence and decreases
in market value. The Company attempts to maintain a level of inventory required
to reach only its near term delivery requirements by relying on the ready
availability of products from its principal suppliers. Manufacturers of the
Company's major products generally provide price protection, which reduces the
Company's exposure to decreases in prices. In addition, its suppliers generally
allow for returns of excess inventory, which, on a limited basis, are made
without material restocking fees.
This Form 10-Q contains forward looking statements that involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward looking statements. Such forward looking
statements include risks and uncertainties. Such risks and uncertainties, many
of which are not within the control of the Company, may cause the actual results
to differ materially from the results discussed in the forward looking
statements, including, but not limited to, the Company's ability to execute and
implement its plans and strategies and /or control the economic environment in
which the Company it operates.
The following table sets forth, for the periods indicated, certain
financial data derived from the Company's consolidated statements of operations
and indicates the percentage of total revenue for each item.
Three months ended March 31,
1998 1997
Amount % Amount %
Revenue(1)
Computer Products................... $27,752 85.3 $23,222 87.3
IT Services......................... 2,892 8.9 1,991 7.5
Telecom systems..................... 1,072 3.3 953 3.6
CTI Software........................ 826 2.5 427 1.6
----- ---- ----- ----
Total revenue..................... 32,542 100.0 26,593 100.0
Gross Profit
Computer Products................... 3,352 12.8 2,555 11.0
IT Services......................... 975 33.7 782 39.3
Telecom Systems..................... 172 16.0 303 31.9
CTI Software........................ 311 37.7 191 44.8
----- ---- ----- ----
Total Gross Profit................ 4,810 14.8 3,831 14.4
Selling, general and
administrative expense............ 4,576 14.1 3,135 11.8
----- ---- ----- ----
Operating income....................... 234 0.7 696 2.6
Interest expense (net of other income.. 28 0.1 289 1.1
----- ---- ----- ----
Income before provision for
income taxes 206 0.6 407 1.5
Provision (benefit) for
income taxes...................... 82 0.3 154 0.6
----- ---- ----- ----
Net Income............................. $ 124 0.4 $ 253 1.0
======== === ======== ===
Earnings per share..................... $0.03 $0.09
==== ====
Weighted average shares outstanding. 4,457,107 2,675,000
========= =========
(1) Percentages shown are percentages of total revenue, except gross profit
percentages which represent gross profit by each business unit as a percentage
for each such unit.
Three Months Ended March 31, 1998 Compared To Three Months Ended March 31, 1997
TOTAL REVENUE. All of the Company's business units increased revenues over
the prior year's comparable period. Total revenue increased by $5.9 million
(22.4%) from $26.6 million in 1997 compared to $32.5 million in 1998. Revenue
from Computer Products increased by $4.5 million (19.5%) from $23.2 million in
1997 to $27.8 million in 1998. Revenue from Computer Products as a percentage of
total revenue decreased 2.0% from 87.3% in 1997 to 85.3% in 1998. Approximately
$1.6 million of the increase in Computer Products from the prior period was
realized in new offices while $2.9 million was realized in offices existing in
1997. Revenue from IT Services increased $901,000 (45.3%) from $2.0 million in
1997 to $2.9 million in 1998 because of the continued expansion of its billable
technical staff, together with an emphasis on higher level services to the
Company's existing customers and the addition of new customers. Revenue from IT
Services as a percentage of total revenue increased from 7.5% in 1997 to 8.9% of
total revenues in 1998. Revenue from Telecom Systems increased by $119,000
(12.5%) from $953,000 million in 1997 to $1.1 million in 1998. The increase in
Telecom Systems revenue was primarily the result of the Company's ability to
obtain new orders for system installations from new customers. Revenue from
Telecom Systems as a percentage of total revenue decreased from 3.6% in 1997 to
3.3% in 1998 because other business units grew revenues at a greater rate than
Telecom Systems.. CTI Software revenue increased by $399,000 (93.5%) from
$427,000 in 1997 to $826,000 in 1998. The growth in CTI Software revenues was
primarily due to increased marketing efforts which resulted in the addition of
new customers and increased acceptance of the Company's software products in the
marketplace. Revenue from CTI Software, as a percentage of total revenue,
increased from 1.6% in 1997 to 2.5% in 1998.
GROSS PROFIT. Gross profit increased by $979,000 (25.5%) from $3.8 million
in 1997 to $4.8 million in 1998 and gross margin increased from 14.4% in 1997 to
14.8% in 1998. The gross margin for Computer Products increased from 11.0% in
1997 to 12.8% in 1998, which was primarily the result of lower unit costs on the
products purchased relative to their selling prices which reflects intensified
competition among the Company's suppliers. The gross profit from IT Services
increased 24.7% from $782,000 in 1997 to $975,000 in 1998. Gross margin
decreased from 39.3% in 1997 to 33.7% in 1998. This decrease in gross margin was
primarily attributable to a lower utilization rate of the Company's billable
technical staff leading to higher labor costs as a percent of revenue.
Additionally, the wage costs of the Company's billable staff are generally
higher in the 1998 period compared to the 1997 period, due to the relative
scarcity of qualified technical staff in the computing services industry. The
gross margin for Telecom Systems sales decreased from 31.9% in 1997 to 16.0% in
1998, reflecting higher installation costs than are normally incurred. The
Company treats its costs associated with its technical staff as part of the cost
of sales. Due to the relatively fixed nature of technical staff costs, when
lower than expected revenues are realized, cost of sales, expressed as a
percentage of revenues, increases proportionately. During the 1998 period the
Company was unable to complete the installation of several of its projects
resulting in the recognition of lower revenues and gross profits than were
expected The gross margin for CTI Software decreased from 44.8% in 1997 to 37.7%
in the 1998 due to higher installation costs on its products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES . Selling, general and
administrative expenses increased by $1.4 million (45.9%) from $3.1 million in
1997 to $4.6 million in 1998. As a percentage of total revenue, selling, general
and administrative expenses increased from 11.8% in 1997 to 14.1% in 1998. Those
components of selling, general and administrative expenses which increased
significantly, as a percentage of revenues, were commission expense, personnel
related costs and general expenses related to opening new offices. Commission
expense increased, as a percent of revenues, because gross margin, upon which
the Company bases its commission rates, increased in the 1998 period versus
1997. During the 1998 quarter, the Company employed a significant number of new
employees in its El Paso and New Mexico offices. Since these employees received
compensation prior to the realization of significant revenues the amount of
selling, general and administrative expenses increased both as to amount and as
expressed as a percent of revenues. The Company also increased the number of
administrative employees relative to the increases in revenues in order to
enhance its ability to meet the requirements of revenue growth and increases in
the number of offices operated by the Company. Most notably, the Company
commenced the upgrading of its computing systems to enhance the speed and
capacity of its systems. In addition, during the 1998 period the Company
incurred costs related to the opening of offices in McAllen and El Paso, Texas
and Albuquerque and Las Cruces, New Mexico without realizing revenues
commensurate with those expenses.
OPERATING INCOME. Operating income decreased by $462,000 (66.3%) from
$696,000 in 1997 to $234,000 in 1998 due to higher selling, general and
administrative expenses. Operating income decreased as a percentage of total
revenue from 2.6% in 1997 to 0.7% in 1998. Contributing to the decrease in
operating income were operating losses incurred in newly opened offices. The
combined operating losses incurred in the operation of newly opened offices was
approximately $109,000.
INTEREST EXPENSE (NET OF OTHER INCOME). Interest expense (net of other
income) decreased $261,000 from $289,000 during 1997 period compared to $28,000
in the 1998 period. This reflects the reduced level of the Company's short-term
debt during the 1998 period when compared to 1997. The reduction was
accomplished by applying all of the net proceeds from the sale of common stock
to the repayment of the Company's debt.
NET INCOME. Net income, after a provision for income taxes totaling $82,000
(reflecting an effective tax rate of 39.8% in 1998 compared to 37.8% in 1997),
decreased by $129,000 from $253,000 in 1997 to $124,000 in 1998.
Liquidity And Capital Resources
The Company's working capital was $12.8 million and $12.8 million at
December 31, 1997 and March 31, 1998, respectively. As of March 31, 1998, the
Company had borrowing capacity under the Company's credit facility of $12.6
million.
Cash Flow
Operating activities used net cash totaling $1.2 million during the three
months ended March 31, 1998. Operating activities used net cash during the three
months ended March 31, 1998 because of decreases in accounts payable and
increases in inventories. While trade accounts receivable decreased by $3.1
million this decrease was offset by increases in accounts payable and
inventories. Net income and depreciation provided cash of $291,000.
Investing activities used cash totaling $153,000 during the three months
ended March 31, 1998. The Company's investing activities that used cash during
this period was primarily related to capital expenditures. During the next
twelve months, the Company expects to incur an estimated $700,000 million for
capital expenditures, a majority of which is expected to be incurred for
leasehold improvements and other capital expenditures in connection with the
planned consolidation of its warehouse facilities into a single facility in the
Dallas-Fort Worth area, the refurbishment of its Dallas branch office and the
opening of branch offices in El Paso and San Antonio, Texas. The actual amount
and timing of such capital expenditures may vary substantially depending upon,
among other things, the actual facilities selected, the level of expenditures
required to render the facilities suitable for the Company's purposes and the
terms of lease arrangements pertaining to the facilities.
Financing activities provided cash totaling $3.2 million during the three
months ended March 31, 1998.
Asset Management
The Company had trade accounts receivable, net of allowance for doubtful
accounts, of $20.7 million at March 31, 1998. The number of days' sales
outstanding in trade accounts receivable was 53 days, which is equal to the days
outstanding of the prior quarter but reflecting slower than normal payment by
the Company's customers during the three months ended March 31, 1998. Bad debt
expense as a percentage of total revenue for the three months ended March 31,
1998 was 0.3%, which was higher than bad debt expense for the three months ended
March 31, 1997 because during the 1997 period the Company realized a recovery of
a previously charged off account. The Company's allowance for doubtful accounts,
as a percentage of trade accounts receivable, was 1.0% at December 31, 1997, and
1.5% at March 31, 1998. Inventory turnover for the three months ended March 31,
1998 and 1997 was 18.7 times, and 16.9 times, respectively.
Current Debt Obligations
Historically, the Company has satisfied its cash requirements principally
through borrowings under its lines of credit and through operations. The Company
maintains a cash position sufficient to pay only its immediately due obligations
and expenses. When the amount of cash available falls below its immediate needs,
the Company requests advances under a credit facility provided by Deutsche
Financial Services ("DFS Facility")
The total credit available under the DFS Facility is $30.0 million, subject
to borrowing base limitations which are generally computed as a percentage of
various classes of eligible accounts receivable and qualifying inventory. Credit
available under the DFS Facility for floor plan financing of inventory from
approved manufacturers (the "Inventory Line") is $20.0 million. Available credit
under the DFS Facility, net of Inventory Line advances, is $10.0 million, which
is used by the Company primarily to carry accounts receivable and for other
working capital and general corporate purposes (the "Accounts Line"). Borrowings
under the Accounts Line bear interest at the fluctuating prime rate minus 1.0%
per annum. Under the Inventory Line, DFS pays the Company's inventory vendors
directly, generally in exchange for negotiated financial incentives. Typically,
the financial incentives received are such that DFS does not charge interest to
the Company until 40 days after the transaction is financed, at which time the
Company is required to either pay the full invoice amount of the inventory
purchased from corporate funds or to borrow under the Accounts Line for the
amount due to DFS. Inventory Line advances not paid within 40 days after the
financing date bear interest at the fluctuating prime rate plus 5.0%. For
purposes of calculating interest charges the minimum prime rate under the New
DFS Facility is 7.00%. DFS may change the computation of the borrowing base and
to disqualify accounts receivable upon which advances have been made and require
repayment of such advances to the extent such disqualifications cause the
Company's borrowings to exceed the reduced borrowing base.
The DFS Facility is collateralized by a security interest in substantially
all of the Company's assets, including its accounts receivable, inventory,
equipment and bank accounts. Collections of the Company's accounts receivable
are required to be applied through a lockbox arrangement to repay indebtedness
to DFS; however, DFS has amended the lockbox agreement to make such arrangements
contingent upon certain financial ratios. Provided the Company is in compliance
with its debt to tangible net worth covenant, the Company has discretion over
the use and application of the funds collected in the lockbox. If the Company
exceeds that financial ratio, DFS may require that lockbox payments be applied
to reduce the Company's indebtedness to DFS. If in the future DFS requires that
all lockbox payments be applied to reduce the Company's indebtedness, the
Company would be required to seek funding from DFS or other sources to meet
substantially all of its cash needs.
The Company has a $2.0 million credit facility with IBM Credit Corporation
(the " IBMCC Facility") for the purchase of IBM branded inventory from certain
suppliers. Advances under the IBMCC Facility are typically interest free for 30
days after the financing date for transactions in which adequate financial
incentives are received by IBMCC from the vendor. Within 30 days after the
financing date, the full invoice amount for inventory financed through IBMCC is
required to be paid by the Company. Amounts remaining outstanding thereafter
bear interest at the fluctuating prime rate (but not less than 6.5%) plus 6.0%.
IBMCC retains a security interest in the inventory financed. The IBMCC Facility
is immediately terminable by either party by written notice to the other.
Under the DFS Facility the Company is required to maintain (i) a tangible
net worth of $10.0 million, (ii) a ratio of debt minus subordinated debt to
tangible net worth of 4 to 1 and (iii) a ratio of current tangible assets to
current liabilities of not less than 1.4 to 1.
Both the IBMCC Facility and the DFS Facility prohibit the payment of
dividends unless consented to by the lender.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 13, 1996, a former customer brought suit against the Company in the
152nd Judicial District Court of Harris County, Texas. The plaintiff alleges
that the Company failed to provide and complete promised installation and
configuration of certain computer equipment within the time promised by the
Company. Based on these allegations, the plaintiff is suing for breach of
contract and other statutory violations and is seeking actual monetary damages
of approximately $3 million and treble damages under the Texas Deceptive Trade
Practices Act. The Company is unable to estimate the range of possible recovery
by the plaintiff because the suit is still in the early stages of discovery.
However, the Company is vigorously defending the action.
Allstar is party to other litigation and claims which management believes
are normal in the course of its operations; while the results of such litigation
and claims cannot be predicted with certainty, Allstar believes the final
outcome of such matters will not have a materially adverse effect on its results
of operations or financial position.
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.
Allstar Systems, Inc.
MAY 15, 1997 By: /s/ JAMES H. LONG
Date James H. Long, Chief Executive Officer
MAY 15, 1997 By:/s/ DONALD R. CHADWICK
Date Donald R. Chadwick, Chief Financial Officer