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 June 30, 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 _X_ No
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
June 30, 1998, 4,517,911 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)
June 30, December 31,
1998 1997
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash $ - $ 280
Cash 1,724 1,301
-------- --------
Total cash and cash equivalents 1,724 1,581
Accounts receivable - trade, net 24,186 23,759
Accounts receivable - affiliates 587 434
Inventory 8,555 4,700
Deferred taxes 212 212
Other current asset 377 404
-------- --------
Total current assets 35,641 31,090
Property and equipment 1,885 2,013
Other assets 246 81
-------- --------
Total $ 37,772 $ 33,184
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 5,166 $ 1,572
Accounts payable 12,958 12,805
Accrued expenses 4,110 3,565
Income taxes payable (63) 82
Deferred service revenue 331 242
-------- --------
Total current liabilities 22,502 18,266
Deferred Credit - Stock warrants 195 195
-------- --------
Total liabilities 22,697 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 4,517,911 shares issued and outstanding
on December 31, 1997 and June 30, 1998, respectively 45 45
Additional paid in capital................ 10,013 10,013
Treasury stock............................ (40) --
Retained earnings......................... 5,057 4,665
-------- --------
Total stockholders' equity.......... 15,075 14,723
-------- --------
Total........................................ $37,772 $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 June 30,
1998 1997
Total Revenue $ 39,840 $ 32,239
Cost of sales and services 33,890 27,312
-------- --------
Gross Profit 5,950 4,927
Selling, general and administrative expenses 5,464 3,839
-------- --------
Operating income 486 1,088
Interest expense and other income (net) 51 309
-------- --------
Income before provision for income taxes 435 779
Provision for income taxes 165 310
-------- --------
Net income $ 270 $ 469
Net income per share:
Basic $0.06 $0.17
======== ========
Diluted $0.06 $0.17
Weighted average shares outstanding:
Basic 4,436,609 2,675,000
========= =========
Diluted 4,444,336 2,675,000
========= =========
Six Months Ended June 30,
1998 1997
Total Revenue $ 72,382 $ 58,831
Cost of sales and services 61,622 50,073
-------- --------
Gross Profit 10,760 8,758
Selling, general and administrative expenses 10,039 6,974
-------- --------
Operating income 721 1,784
Interest expense and other income (net) 79 597
-------- --------
Income before provision for income taxes 642 1,187
Provision for income taxes 249 465
-------- --------
Net income $ 393 $ 722
Net income per share:
Basic $0.09 $0.27
======== ========
Diluted $0.09 $0.27
======== ========
Weighted average shares outstanding:
Basic 4,438,357 2,675,000
========= =========
Diluted 4,442,242 2,675,000
========= =========
See notes to consolidated financial statements
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share amounts)
(Unaudited)
Six Months Six Months
ended ended
June 30, June 30,
1998 1997
Net income $ 393 $ 722
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Gain of disposal of assets --- ---
Depreciation and amortization 358 252
Deferred taxes --- 190
Changes in assets and liabilities that provided (used) cash:
Accounts receivable - trade, net (427) (3,464)
Accounts receivable - affiliates (153) (121)
Inventory (3,855) 480
Other current assets 27 10
Other assets.............................. (165) --
Deferred offering costs................... -- (100)
Accounts payable 153 2,109
Accrued expenses 544 314
Income taxes payable (145) 215
Deferred service revenue 89 (91)
-------- --------
Net cash provided by (used in) operating
activities (3,181) 516
Cash flows from investing activities:
Capital Expenditures (230) (125)
Proceeds from sale of fixed assets --- ---
-------- --------
Net cash used in investing activities: (230) (125)
Cash flows from financing activities:
Purchase of treasury stock................ (40) --
Net increase (decrease) in notes payable 3,594 1776
-------- --------
Net cash provided by (used in) financing
activities: 3,554 1,776
Net increase (decrease) in cash and cash
equivalents 143 2,167
Cash and cash equivalents at beginning of period 1,581 229
-------- --------
Cash and cash equivalents at end of period $ 1,724 $ 2,396
======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 117 $ 298
======== ========
Cash paid for taxes $ 364 $ 115
======== ========
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 June
30, 1998 and for the three and six months ended June 30, 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, 1998 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 and six months ended June 30, 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 ('AICPA') 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 1997 Allstar adopted the 1997 Incentive Stock Plan (the
"Incentive Plan") and the 1997 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 June 30,
1998, 28,000 stock option grants have been issued to directors under the
Director Plan. The exercise price of 20,000 of the directors' options is $4.625
per share and 8,000 options have an exercise price of $3.69 per share. As of
June 30, 1998 incentive stock options totaling 267,700 shares have been issued
to employees. The exercise price of 80,000 of the stock option grants is $6.00
per share, 100,300 of the stock option grants have an exercise price of $4.625
per share and 87,400 options have an exercise price of $3.75 per share. The
stock option grants will vest ratably over the five year period from the date of
issuance. In addition, incentive awards in the form of restricted stock were
granted for 14,286 shares which will vest ratably over the two year period
ending July 7, 1999 and 63,500 shares which will vest ratably over the five-year
period ending May 20, 2003.
3. LITIGATION
On July 13, 1997, 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 sued for breach of contract
and other statutory violations, seeking actual monetary damages of approximately
$3 million and treble damages under the Texas Deceptive Trade Practices Act. On
June 17, 1998, the Company settled suit with the Company paying $70,000 to the
plaintiff.
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, San Antonio and Dallas, Texas and
in Albuquerque and Las Cruces, 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 June 30,
1998, Computer Products totaled 86.5% of revenues while IT Services, Telecom
Systems and CTI Software totaled 7.7%, 4.5% and 1.3% of revenues, respectively.
The Company's Computer Products division sells a wide variety of computer
hardware and software products available from over 600 manufacturers. 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 participates 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 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 the 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 1996, 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 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 recent periods, the Company's
Computer Product suppliers generally allowed for returns of excess inventory,
which, on a limited basis, were made without material restocking fees. However,
the Company's significant suppliers recently revised their policies to restrict
the amount of returns allowed. It is expected that this change will increase the
Company's risks associated with inventory ownership. In particular, the Company
will have greater risk associated with inventory obsolescence. In addition,
certain manufacturers of computer products have generally become more
restrictive with respect to price protection. This will increase the Company's
risks, as they relate to the value of inventories. Each of these changes may
cause a reduction of gross margins realized on the sale of computer products.
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 operates.
The following table sets forth, for the periods indicated, certain
financial data derived from the Company's consolidated statements of operations
for the three months ended June 30, 1998 and 1997 and indicates the percentage
of total revenue for each item.
Three months ended June 30,
1998 1997
Amount % Amount %
Revenue(1)
Computer Products.................... $34,447 86.5 $27,567 85.5
IT Services.......................... 3,062 7.7 2,791 8.7
Telecom systems...................... 1,818 4.5 1,284 4.0
CTI Software......................... 513 1.3 597 1.8
------- ----- ------- -----
Total revenue....................... 39,840 100.0 32,239 100.0
Gross Profit
Computer Products.................... 3,891 11.3 3,001 10.9
IT Services.......................... 1,037 33.9 1,268 45.4
Telecom Systems...................... 787 43.3 333 26.0
CTI Software......................... 235 45.8 325 54.4
------- ----- ------- -----
Total Gross Profit.................. 5,950 14.9 4,927 15.3
Selling, general and administrative expense 5,464 13.7 3,839 11.9
------- ----- ------- -----
Operating income....................... 486 1.2 1,088 3.4
Interest expense (net of other income). 51 0.1 309 1.0
------- ----- ------- -----
Income before provision for income taxes 435 1.1 779 2.4
Provision (benefit) for income taxes... 165 0.4 310 1.0
------- ----- ------- -----
Net Income ........................... $ 270 0.7 $ 469 1.4
======= ===== ======= =====
Earnings per share..................... $0.06 $0.17
===== =====
Weighted average shares outstanding.. 4,436,609 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 June 30, 1998 Compared To Three Months Ended June 30, 1997
TOTAL REVENUE. Total revenue increased by $7.6 million (23.6%) from $32.2
million in 1997 compared to $39.8 million in 1998. Revenue from Computer
Products increased by $6.9 million (25.0%) from $27.6 million in 1997 to $34.4
million in 1998. Revenue from Computer Products as a percentage of total revenue
increased 1.0% from 85.5% in 1997 to 86.5% in 1998. Approximately $4.7 million
of the increase in Computer Products from the prior period was realized in new
offices while $2.2 million was realized in offices existing during the 1997
period. Revenue from IT Services increased $271,000 (9.7%) from $2.8 million in
1997 to $3.1 million in 1998 because of the continued expansion of its billable
technical staff, together with the addition of new customers. Revenue from IT
Services as a percentage of total revenue decreased from 8.7% in 1997 to 7.7% of
total revenues in 1998 due to the higher rate of growth realized in Computer
Products and Telecom Systems. Revenue from Telecom Systems increased by $534,000
(41.6%) from $1.3 million in 1997 to $1.8 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 increased from 4.0% in 1997 to
4.5% in 1998. CTI Software revenue decreased by $84,000 (14.1%) from $597,000 in
1997 to $513,000 in 1998. The decline in CTI Software revenues was due to
failure to complete the installation of all of the systems delivered during the
1998 period. Since revenue is recognized as the systems are installed the
failure to complete the installations caused revenue to fall below the prior
period. The systems, which were delivered during the 1998 period, are expected
to be completed in the subsequent period. Revenue from CTI Software, as a
percentage of total revenue, decreased from 1.8% in 1997 to 1.3% in 1998 for the
same reason.
GROSS PROFIT. Gross profit increased by $1.0 million (20.8%) from $4.9
million in 1997 to $5.9 million in 1998 and gross margin decreased from 15.3% in
1997 to 14.9% in 1998. The gross margin for Computer Products increased from
10.9% in 1997 to 11.3% 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 decreased 18.2% from $1.3 million in 1997 to $1.0 million in 1998.
Gross margin decreased from 45.4% in 1997 to 33.9% in 1998. This decrease in
gross margin was primarily attributable to a lower utilization rate, as well as,
higher compensation rates for the Company's billable technical staff, leading to
higher labor costs as a percent of revenue. 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. 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
increased from 26.0% in 1997 to 43.3% in 1998, reflecting improved pricing of
the Company's Telecom products The gross margin for CTI Software decreased from
54.4% in 1997 to 45.8% in the 1998 due to higher installation costs on its
products. 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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1.6 million (42.3%) from $3.8 million in
1997 to $5.4 million in 1998. As a percentage of total revenue, selling, general
and administrative expenses increased from 11.9% in 1997 to 13.7% in 1998. Those
components of selling, general and administrative expenses which increased
significantly, as a percentage of revenues, were personnel related costs,
general expenses related to opening new offices and expanding existing offices
and costs associated with the settlement of a law suit. During the 1998 quarter,
when compared to the 1997 period, the Company employed a significant number of
new employees in its Austin, El Paso and New Mexico offices, as well as
increases in its Dallas office staff. Since the employees in El Paso and New
Mexico received compensation prior to the realization of significant revenues
the amount of selling, general and administrative expenses increased both as to
amount and 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
upgraded its computing systems to enhance the speed and capacity of its systems.
During the upgrade significant overtime and other costs were incurred as the
system change was implemented. Some of these excess costs may continue into
subsequent periods. 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 $602,000 (55.3%) from $1.1
million in 1997 to $486,000 in 1998 due to higher selling, general and
administrative expenses. Operating income decreased as a percentage of total
revenue from 3.4% in 1997 to 1.2% in 1998. Contributing to the decrease in
operating income were operating losses incurred in newly opened offices. The
combined losses incurred in the operation of newly opened offices were
approximately $73,000.
INTEREST EXPENSE (NET OF OTHER INCOME). Interest expense (net of other
income) decreased $258,000 from $309,000 during 1997 period compared to $51,000
in the 1998 period. This reflects the reduced level of the Company's short-term
debt during the 1998 period when compared to 1998. The reduction was
accomplished by applying all of the net proceeds from the sale of common stock
in July, 1997 to the repayment of the Company's debt.
NET INCOME. Net income, after a provision for income taxes totaling
$165,000 (reflecting an effective tax rate of 39.8% in 1997 compared to 37.9% in
1998), decreased by $199,000 from $469,000 in 1997 to $270,000 in 1998.
The following table sets forth, for the periods indicated, certain
financial data derived from the Company's consolidated statements of operations
for the six months ended June 30, 1998 and 1997 and indicates the percentage of
total revenue for each item.
Six months ended June 30,
1998 1997
Amount % Amount %
Revenue(1)
Computer Products........................... $62,199 86.5 $50,714 86.2
IT Services................................. 5,955 7.7 4,857 8.3
Telecom systems............................. 2,890 4.5 2,237 3.8
CTI Software 1,338 1.3 1,023 1.7
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Total revenue............................. 72,382 100.0 58,831 100.0
Gross Profit
Computer Products........................... 7,243 11.3 5,452 10.8
IT Services................................. 2,012 33.9 2,153 44.3
Telecom Systems............................. 959 43.3 637 28.5
CTI Software ............................ 546 45.8 516 50.4
------- ----- ------- -----
Total Gross Profit........................ 10,760 14.9 8,758 14.9
Selling, general and administrative expense.... 10,039 13.7 6,974 11.9
------- ----- ------- -----
Operating income............................... 721 1.2 1,784 3.0
Interest expense (net of other income.......... 79 0.1 597 1.0
------- ----- ------- -----
Income before provision for income taxes....... 642 1.1 1,187 2.0
Provision (benefit) for income taxes........... 249 0.4 465 0.8
------- ----- ------- -----
Net Income ............................ $ 393 0.7 $ 722 1.2
------- ----- ------- -----
Earnings per share............................. $0.09 $0.27
===== =====
Weighted average shares outstanding......... 4,438,357 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.
Six Months Ended June 30, 1998 Compared To Six Months Ended June 30, 1997
TOTAL REVENUE. Total revenue increased by $13.6 million (23.0%) from $58.8
million in 1997 compared to $72.4 million in 1998. Revenue from Computer
Products increased by $11.5 million (22.6%) from $50.7 million in 1997 to $62.2
million in 1998. Revenue from Computer Products as a percentage of total revenue
decreased 0.3% from 86.2% in 1997 to 85.9% in 1998. Approximately $5.9 million
of the increase in Computer Products from the prior period was realized in new
offices while $5.6 million was realized in offices existing during the 1997
period. Revenue from IT Services increased $1.1 million (22.6%) from $4.9
million in 1997 to $6.0 million in 1998 because of the continued expansion of
its billable technical staff, together with the addition of new customers.
Revenue from IT Services as a percentage of total revenue decreased from 8.3% in
1997 to 8.2% of total revenues in 1998 due to the higher rate of growth realized
in Telecom Systems and CTI Software. Revenue from Telecom Systems increased by
$654,000 (29.2%) from $2.2 million in 1997 to $2.9 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 increased from 3.8% in 1997 to
4.0% in 1998. CTI Software revenue increased by $315,000 (30.8%) from $1.0
million in 1997 to $1.3 million in 1998. The increase in CTI Software revenues
was the result of the addition of new customers and expanded marketing. The
increase was partially offset by the failure to complete the installation of all
of the systems delivered during the second quarter of 1998. Revenue from CTI
Software, as a percentage of total revenue, increased from 1.7% in 1997 to 1.9%
in 1998.
GROSS PROFIT. Gross profit increased by $2.0 million (22.9%) from $8.8
million in 1997 to $10.8 million in 1998 and gross margin remained constant at
14.9% in 1998 versus 14.9% in 1997. The gross margin for Computer Products
increased from 10.8% in 1997 to 11.6% 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 decreased 6.6% from $2.2 million in 1997 to $2.0 million
in 1998. Gross margin for IT Services decreased from 44.3% in 1997 to 33.8% in
1998. This decrease in gross margin was primarily attributable to a lower
utilization rate, as well as, higher compensation rates for the Company's
billable technical staff, leading to higher labor costs as a percent of revenue.
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. 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
increased from 28.5% in 1997 to 33.2% in 1998, reflecting improved pricing of
the Company's Telecom products. The gross margin for CTI Software decreased from
50.4% in 1997 to 40.8% in the 1998 due to higher installation costs on its
products. 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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $3.0 million (44.0%) from $7.0 million in
1997 to $10.0 million in 1998. As a percentage of total revenue, selling,
general and administrative expenses increased from 11.9% in 1997 to 13.9% in
1998. Those components of selling, general and administrative expenses which
increased significantly, as a percentage of revenues, were commissions in
Computer Products, personnel related costs, general expenses related to opening
new offices and expanding existing offices and costs associated with the
settlement of a law suit. The increase in commission expense in Computer
Products was due to an increase in gross margin during the 1998 period versus
the 1997 period. During the 1998 period, when compared to the 1997 period, the
Company employed a significant number of new employees in its Austin, El Paso
and New Mexico offices, as well as increases in its Dallas office staff. Since
the employees in El Paso and New Mexico received compensation prior to the
realization of significant revenues the amount of selling, general and
administrative expenses increased both as to amount and 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 upgraded its computing
systems to enhance the speed and capacity of its systems. During the upgrade
significant overtime and other costs were incurred as the system change was
implemented. Some of these excess costs may continue into subsequent periods. 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 $1.1 million (59.6%) from
$1.8 million in 1997 to $722,000 in 1998 due to higher selling, general and
administrative expenses. Operating income decreased as a percentage of total
revenue from 3.0% in 1997 to 1.0% in 1998. Contributing to the decrease in
operating income were operating losses incurred in newly opened offices. The
combined losses incurred in the operation of newly opened offices were
approximately $182,000.
INTEREST EXPENSE (NET OF OTHER INCOME). Interest expense (net of other
income) decreased $518,000 from $597,000 during 1997 period compared to $79,000
in the 1998 period. This reflects the reduced level of the Company's short-term
debt during the 1998 period when compared to 1998. The reduction was
accomplished by applying all of the net proceeds from the sale of common stock
in July, 1997 to the repayment of the Company's debt.
NET INCOME. Net income, after a provision for income taxes totaling
$249,000 (reflecting an effective tax rate of 39.2% in 1997 compared to 38.8% in
1998), decreased by $331,000 from $722,000 in 1997 to $393,000 in 1998.
Liquidity and Capital Resources
The Company's working capital was $12.8 million and $13.1 million at
December 31, 1998 and June 30, 1998, respectively. As of June 30, 1998, the
Company had borrowing capacity under the Company's credit facility of $4.9
million.
Cash Flow
Operating activities used net cash totaling $3,181,000 during the six
months ended June 30, 1998. Operating activities used net cash during the six
months ended June 30, 1998 because of increases in inventories. Net income and
depreciation provided cash of $751,000. The increase in inventories was
primarily the result of increases in inventories staged for delivery to
customers. Of the $3.8 million increase during the six months ended June 30,
1998, $2.3 million related to an increase in inventories staged for delivery to
customers and the balance of the increase relates to higher stocking
requirements imposed by customers and a higher level of sales activities.
Investing activities used cash totaling $230,000 during the six months
ended June 30, 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 $500,000 million for
capital expenditures, a majority of which is expected to be incurred for
leasehold improvements and other capital expenditures in connection with the
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. 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 $3.6 million during the six
months ended June 30, 1998.
Asset Management
The Company had trade accounts receivable, net of allowance for doubtful
accounts, of $24.2 million at June 30, 1998. The number of days' sales
outstanding in trade accounts receivable was 54 days, which is slightly higher
than the days outstanding of the prior quarter. The number of days outstanding
continues to reflect slower than normal payment by the Company's customers
during the three months ended June 30, 1998. Bad debt expense as a percentage of
total revenue for the three months ended June 30, 1998 was 0.3%, which was equal
to bad debt expense for the three months ended June 30, 1997. The Company's
allowance for doubtful accounts, as a percentage of trade accounts receivable,
was 1.0% at December 31, 1998 and 2.4% at June 30, 1998. Inventory turnover for
the three and six months ended June 30, 1998 was 13.9 times, and 17.0 times,
respectively. The decline in inventory turnover during the three months ended
June 30, 1998 was the result of having an unusually high level of staged
inventory as of June 30, 1998.
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, 1997, 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 sued for breach of contract
and other statutory violations, seeking actual monetary damages of approximately
$3 million and treble damages under the Texas Deceptive Trade Practices Act. On
June 17, 1998, the Company settled suit with the Company paying $70,000 to the
plaintiff.
The Company 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, The Company believes
the final outcome of such matters will not have a materially adverse effect on
its results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 16, 1998 the Company held its annual meeting of stockholders for
the following purposes:
1. To elect six directors;
2. To amend Article Fourth of the Certificate of
Incorporation of the Company to reduce the number of
authorized shares of common stock, $0.01 par value, from
50,000,000 to 15,000,000
The voting on the above matters by the stockholders was as follows:
Matter For Withheld
Election of Directors:
James H. Long 3,800,739 12,450
Donald R. Chadwick 3,800,739 12,450
G. Chris Andersen 3,800,739 12,450
Richard D. Darrell 3,800,739 12,450
Jack M. Johnson, Jr. 3,800,739 12,450
Donald D. Sykora 3,800,739 12,450
Amend Article Fourth of the Certificate of Incorporation
of the Company to reduce the number of authorized shares
of common stock, $0.01 par value, from 50,000,000 to
15,000,000 3,804,359 8,900
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.
August 4, 1998 By: /s/ JAMES H. LONG
Date James H. Long, Chief Executive Officer
August 4 1998 By: /s/ DONALD R. CHADWICK
Date Donald R. Chadwick, Chief Financial Officer