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, 1999
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 76-0515249
(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
lastreport)
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, 1999,
4,232,211 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,
1999 1998
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................. $ 3,620 $ 2,538
Accounts receivable, net................... 32,280 34,893
Accounts receivable - affiliates .......... 495 373
Inventory.................................. 7,505 8,497
Deferred taxes ............................ 431 431
Income taxes receivable.................... 637 637
Other current assets ...................... 549 559
------- -------
Total current assets ............. 45,517 47,928
Property and equipment.......................... 2,876 2,902
Other assets .................................. 185 198
------- -------
Total ....................................... $ 48,578 $ 51,028
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable ............................. $ 15,166 $ 15,958
Accounts payable........................... 14,631 16,641
Accrued expenses........................... 5,744 5,273
Deferred service revenue................... 191 256
------- -------
Total current liabilities......... 35,732 38,128
Deferred credit - stock warrants........... 195 195
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,
4,503,411 and 4,503,411 shares issued and
outstanding on March 31, 1999 and December 31,
1998, respectively...... 45 45
Additional paid in capital.................... 10,196 10,196
Unearned equity compensation.................. (269) (269)
Treasury stock (271,200 shares, at cost)...... (834) (834)
Retained earnings............................. 3,513 3,567
------- -------
Total stockholders' equity........ 12,651 12,705
------- -------
Total........................................... $ 48,578 $ 51,028
======= =======
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,
1999 1998
---- ----
Total revenue------------------------------------ $ 47,868 $ 32,542
Cost of sales and services----------------------- 42,091 27,732
------- -------
Gross profit 5,777 4,810
Selling, general and administrative expenses----- 5,604 4,576
------- -------
Operating income--------------------------------- 173 234
Interest expense, net of other income------------ 242 28
------- -------
(Loss) income before (benefit) provision for
income taxes---------------------------------- (69) 206
(Benefit) provision for income taxes------------- (15) 82
-------- -------
Net(loss)income---------------------------------- $ (54) $ 124
======== =======
Net (loss) income per share:
Basic----------------------------------- $(0.01) $0.03
===== =====
Diluted--------------------------------- $(0.01) $0.03
===== =====
Weighted average shares outstanding:
Basic----------------------------------- 4,168,925 4,454,411
========= =========
Diluted--------------------------------- 4,168,925 4,457,106
========= =========
The potentially dilutive options were not used in the calculation of diluted
earnings per share for the quarter ended March 31, 1999 since the effect of
potentially dilutive securities in computing a loss per share is antidilutive.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Three Months
ended ended
March 31, March 31,
1999 1998
Net (loss) income-------------------------------- $ (54) $ 124
Adjustments to reconcile net (loss)
income to net cash provided by (used in)
operating activities:
Depreciation and amortization--------------- 265 167
Changes in assets and liabilities
that provided (used) cash:
Accounts receivable, net-------------------- 2,613 3,058
Accounts receivable - affiliates------------ (122) (93)
Inventory----------------------------------- 992 (1,342)
Other current assets------------------------ 10 (24)
Other assets-------------------------------- - (177)
Accounts payable---------------------------- (2,010) 2,515
Accrued expenses---------------------------- 471 37
Income taxes payable------------------------ (276)
Deferred service revenue-------------------- (65) (54)
-------- --------
Net cash provided by (used in) operating
activities------------------------- 2,100 (1,169)
Cash flows from investing activities:
Capital expenditures------------------------ (226) (153)
-------- --------
Net cash used in investing activities:--- (226) (153)
Cash flows from financing activities:
Net (decrease) increase in notes payable---- (792) 3,249
-------- --------
Net cash (used in) provided by financing
activities:------------------------ (792) 3,249
Net increase in cash and cash
equivalents--------------------------------- 1,082 1,927
Cash and cash equivalents at beginning of period- $ 2,538 $ 1,581
-------- --------
Cash and cash equivalents at end of period $ 3,620 $ 3,508
------- ======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest---------------------- $ 254 $ 46
======== ========
Cash paid for taxes $ 0 $ 348
======== ========
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. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Allstar Systems, Inc. and subsidiaries ("Allstar") are engaged in the sale
and service of computer and telecommunications hardware and software products.
During 1995 Allstar formed and incorporated Stratasoft, Inc., a wholly-owned
subsidiary, to create and market software related to the integration of computer
and telephone technologies. In January 1997, Allstar formed IT Staffing Inc., a
wholly-owned subsidiary, 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 engage in the sale and service of
computer products in western Texas and New Mexico.
A substantial portion of Allstar's sales and services are authorized under
arrangements with product manufacturers. 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
that underlie the credit arrangements that are used for working capital.
The condensed consolidated financial statements presented herein at March
31, 1999 and for the three months ended March 31, 1999 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.
Use of Estimates - The preparation of the financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
Accounting Pronouncements - In June 1998, SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, was issued by the FASB. SFAS No.
133 is effective for fiscal years beginning after January 1, 2000. Management is
evaluating what impact, if any, and additional disclosures may be required when
this statement is implemented.
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 and the Incentive 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, 1999, 28,000 stock option grants have been issued to
directors under the Director Plan. The exercise price of the 28,000 of the
directors' options is $1.50 per share. As of March 31, 1999 incentive stock
options totaling 268,350 shares have been issued to employees. The exercise
price of 8,000 of the stock option grants is $6.00 per share, 260,350 of the
stock option grants have an exercise price of $1.50 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 that will vest ratably over the two-year period ending July 7,
1999 and 49,000 shares, which will vest ratably over the five-year period ending
May 20, 2003.
3. LITIGATION
During 1998 Allstar filed suit against a former employee and said former
employee has filed a counter-claim against Allstar. Allstar intends to
vigorously defend such counter claim. Allstar is unable to estimate the range of
possible recovery by the former employee because the suit is still in the early
stages of discovery.
Allstar is party to 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.
4. SEGMENT INFORMATION
Allstar has three reportable segments: (1) Information Technology, (2)
Telecom Systems and (3) CTI Software. Information Technology includes products
and services relating to computer products and management information systems.
Telecom Systems includes products, installation and services relating to
telephone systems. CTI Software includes software products that facilitate
telephony and computer integration primarily for telemarketing and call center
applications. Allstar evaluates performance of each segment based on operating
income. Management only views accounts receivable, and not total assets, by
segment in their decision making.
For the quarter ended March 31, 1999 (unaudited):
Information Telecom CTI
Technology Systems Software Consolidated
Total revenue....................... $ 45,802 $ 1,296 $ 770 $ 47,868
Cost of sales and services.......... 40,950 810 331 42,091
------- -------- --------- --------
Gross profit........................ 4,852 486 439 5,777
Selling, general and
administrative expenses........... 4,595 512 497 5,604
-------- -------- --------- --------
Operating income (loss)............. $ 257 $ (26) $ (58) $ 173
========= ======== ========= ========
Less: Interest expense, net
of other income..................... 242
--------
Loss before benefit for income taxes $ (69)
========
Accounts receivable, net............ $ 28,151 $ 3,511 $ 618 $ 32,280
======= ======== ======== ========
For the quarter ended March 31, 1998 (unaudited):
Information Telecom CTI
Technology Systems Software Consolidated
Total revenue....................... $ 30,644 $ 1,072 $ 826 $ 32,542
Cost of sales and services.......... 26,317 900 515 27,732
------- -------- -------- --------
Gross profit........................ 4,327 172 311 4,810
Selling, general and
administrative expenses............. 3,634 568 374 4,576
------- -------- -------- --------
Operating income (loss)............. $ 693 $ (396) $ (63) $ 234
======= ======== ========
Less: Interest expense, net of
other income........................ 28
--------
Income before provision
for income taxes.................... $ 206
========
Accounts receivable, net............ $ 16,508 $ 3,378 $ 815 $ 20,701
======= ======== ======== ========
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
Allstar Systems, Inc. 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 services to
purchasers of computer products and other customers. The company operates from
offices in Houston, Austin, El Paso, San Antonio and Dallas, Texas and in
Albuquerque and Las Cruces, New Mexico. While all offices offer computer related
products and services, most 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 and related services. During the quarter
ended March 31, 1999, Information Technology totaled 95.7% of revenues while
Telecom Systems and CTI Software totaled 2.7% and 1.6% of revenues,
respectively.
The company's Information Technology 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.
Services are provided by the Information Technology division both in
conjunction with and separately from its computer product sales. The company
typically prices its 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 services
provided 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 certifications 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 services business. The
most significant portion of the costs associated with the delivery of services
is 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 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 and declining
values. 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.
Special notice regarding forward-looking statements
This quarterly annual report on Form 10-Q contains forward-looking statements
within the meaning of the private securities litigation reform act of 1995
relating to future events or the future financial performance of the company
including, but not limited to, statements contained in item 1 "financial
statements" and item 2. - "management's discussion and analysis of financial
condition and results of operations." Readers are cautioned that any statement
that is not a statement of historical fact, including but not limited to,
statements which may be identified by words including, but not limited to,
"anticipate," "appear," "believe," "could," "estimate," "expect" "hope,"
"indicate," "intend," "likely," "may," "might," "plan," "potential," "seek,"
"should," "will," "would," and other variations or negative expressions thereof,
are predictions or estimations and are subject to known and unknown risks and
uncertainties. Numerous factors, including factors which the company has little
or no control over, may affect the company's actual results and may cause actual
results to differ materially from those expressed in the forward-looking
statements contained herein. In evaluating such statements, readers should
consider the various factors identified in the company's annual report on Form
10-K, as filed with the Securities and Exchange Commission including matters set
forth in item 1. "factors which may affect the future results of operations,"
which could cause actual events, performance or results to differ materially
from those indicated by such statements.
Three Months Ended March 31, 1999 Compared To Three Months Ended March 31, 1998
(Dollars in thousands)
TOTAL REVENUE. Total revenue increased by $15,326 (47.1%) from $32,542 in
1998 compared to $47,868 in 1999. Revenue from Information Technology increased
by $15,158 (49.5%) from $30,644 in 1998 to $45,802 in 1999. Revenue from
Information Technology as a percentage of total revenue increased 1.5% from
94.2% in 1998 to 95.7% in 1999. This was primarily attributable to revenues
derived from offices opened in late 1997 and during 1998, together with
significant revenue growth realized by adding new customers in the company's
Dallas office. Approximately $5,030 (33%) of the increase in Information
Technology revenues from the prior period was realized in new offices while
$10,296 (67%) was realized in offices existing prior to 1997.
Revenue from Telecom Systems increased by $224 (20.9%) from $1,072 in 1998 to
$1,296 in 1999. 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 3.3% in 1998 to 2.7% in 1999 because Information Technology
revenues increased at a much greater rate. CTI Software revenue decreased by $56
(6.8%) from $826 in 1998 to $770 in 1999. The decrease in CTI Software revenues
was due to the installation of a lesser number of systems in 1999 than were
installed in 1998. Revenue from CTI Software, as a percentage of total revenue,
decreased from 2.5% in 1998 to 1.6% in 1999 because the growth rates of the
company's other divisions were higher than the 6.8% decrease realized by CTI
Software.
GROSS PROFIT. Gross profit increased by $967 (20.1%) from $4,810 in 1998 to
$5,777 in 1999 and gross margin decreased from 14.8% in 1998 to 12.1% in 1999.
The gross margin for Information Technology decreased from 14.1% in 1998 to
10.6% in 1999, which was primarily the result of lower prices relative to unit
costs and the company's participation in large volume sales transactions with
lower margins. In addition, the company experienced lower utilization of its
Information Technology technical staff during the 1999 period as the company was
unable to immediately reassign staff from completed projects to new projects
because of customer needs or their locations. While the company's sales force
has been able to increase revenues compared to the 1998 period it was not able
to maintain gross margin at the prior year level because of intense competition
on the computer products markets and because the company has undertaken larger
transactions at lower margins to obtain or retain customers. Overall, the
revenue gain was greater than anticipated while the gross margin was
considerably below the anticipated level.
The gross profit for Telecom Systems increased by $314 (183%) from 172 in
1998 to 486 in 1999. Gross margin improved significantly over the prior year
from 16.0% in 1998 to 37.5% in 1999. Under normal circumstances the company
expects to realize between 25% and 35% gross margins in Telecom Systems. As a
result, gross margin in the 1999 period was slightly higher than expected. The
significant improvement that was realized in the 1999 period was because the
1998 period was far below expectations. During the 1998 period the company
experienced very high installation costs while during the 1999 period these
costs were at normalized levels. Gross profit in CTI Software increased $128
(41.2%). The gross margin for CTI Software increased from 37.7% in 1998 to 57.0%
in 1999 due to the company's ability to realize higher prices for its CTI
products relative to the hardware component than in the 1998 period.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1,028 (22.5%) from $4,576 million in 1998
to $5,604 million in 1999. As a percentage of total revenue, selling, general
and administrative expenses decreased from 14.1% in 1998 to 11.7% in 1999. The
decrease in selling, general and administrative expenses as a percentage of
revenue was the direct result of the company's effort to reduce these costs
through office closing and downsizing when expected revenues were insufficient
to cover operating expenses. Additionally, the company realigned certain
operations to eliminate redundancies and improve efficiency. Selling, general,
and administrative expenses increased in absolute amount when compared to the
1998 period but declined, as a percentage of revenue, by 2.4%. In addition,
selling, general and administrative expenses declined both in absolute dollars
and as a percentage of revenue from the immediately preceding quarter. Selling,
general and administrative expenses decreased from $7,057 (14.1% of revenue)
during the fourth quarter of 1998 to $5,604 (11.7% of revenue) during the
current quarter, a decrease of $1,453. The fourth quarter of 1998 included a
charge for office closing and downsizing of approximately $260, therefore the
comparative decrease ongoing selling, general and administrative expense is
$1,193. During 1998 the company increased its spending relating to opening and
manning new offices and sales operations with the expectation of producing a
sufficient revenue base to cover those expenses and turn these new offices into
profitable operations. Late in 1998, management realized that certain offices
and operations would not be able to attain sufficient revenues to meet those
expectations. Consequently, the company began downsizing or closing those
operations that has resulted in reduced selling, general and administrative
expenses and lower losses in the new offices.
OPERATING INCOME. Operating income decreased by $61 (26.1%) from $234 in
1998 to $173 in 1999 due, principally, to lower gross margins realized in
Information Technology operations. Overall the company increased revenue, with
decreased selling, general and administrative expenses. However, operating
income did not increase due to the low gross margins realized in the sale of
computer products and the low margins resulting from the under utilization of
its technical staff.. Management attributes this to highly competitive market
conditions and the high volume of low margin business conducted during the 1999
period. Additionally, the company's failure to keep its technical staff fully
utilized caused the incurrence of costs without the realization of revenues to
cover those costs. Operating income decreased as a percentage of total revenue
from 0.7% in 1998 to 0.4% in 1999.
INTEREST EXPENSE, NET OF OTHER INCOME. Interest expense, net of other
income increased $214 from $28 during the 1998 period compared to $242 in the
1999 period. This reflects a higher level of the company's short-term debt
during the 1999 period when compared to 1998 and slightly lower interest rates
during the 1999 period when compared to 1998.
NET INCOME. Net income, after a benefit for income taxes totaling $15
(reflecting an effective tax rate of 40% in 1998 compared to 22% in 1999),
decreased by $178 from net income of $124 in 1998 to a net loss of $54 in 1999.
The following table sets forth, for the periods indicated, certain
financial data derived from the company's unaudited consolidated statements of
operations for the three months ended March 31, 1999 and 1998 and indicates the
percentage of total revenue for each item.
Three months ended March 31,
1999 1998
---- ----
Amount % Amount %
Revenue :
Information Technology................. $ 45,802 95.7 $ 30,644 94.2
Telecom Systems........................ 1,296 2.7 1,072 3.3
CTI Software........................... 770 1.6 826 2.5
------- ----- ------- -----
Total revenue................. 47,868 100.0 32,542 100.0
Gross profit:
Information Technology................. 4,852 10.6 4,327 14.1
Telecom Systems........................ 486 37.5 172 16.0
CTI Software........................... 439 57.0 311 37.7
------- ---- ------- ----
Total gross profit............ 5,777 12.1 4,810 14.8
Selling, general and administrative
expenses............................. 5,604 11.7 4,576 14.1
------- ---- ------- ----
Operating income....................... 173 0.4 234 0.7
Interest expense, net of other income.. 242 0.5 28 0.1
------- ---- ------- ----
(Loss) income before (benefit)
provision for income taxes............ (69) (0.1) 206 0.6
(Benefit) provision for income taxes... (15) 0.0 82 0.3
------- ---- ------- ----
Net (loss) income...................... $ (54) (0.1) $ 124 0.4
======= ==== ======= ====
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.
Liquidity and Capital Resources
The company's working capital was $9,785 and $9,800 at March 31, 1999 and
December 31, 1998, respectively. As of March 31, 1999, the company had borrowing
capacity under the company's credit facility of $26,546 of which $26,546 was
used under the company's floor plan and revolving credit facility. Unused
borrowing capacity at March 31, 1999 was $0.
Cash Flow
Operating activities provided net cash totaling $2,100 during the three
months ended March 31, 1999. Operating activities provided net cash during the
three months ended March 31, 1999 because of decreases in inventories and
accounts receivable of $922 and $2,613, respectively, which were partially
offset by decreases in accounts payable. Net income and depreciation provided
cash of $211 in the three months ended March 31, 1999 versus $291 in the 1998
period. The decrease in inventories was primarily the result of an effort to
reduce inventories that had accumulated to greater than required levels. The
decrease in accounts receivable was the result of improved collections from
customers.
Investing activities used cash totaling $226 during the three months ended
March 31, 1999. 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 capital expenditures for upgrades and
replacement of existing equipment facilities, as well as, upgrades of computing
equipment which may be required to address Y2K problems, if any. The actual
amount and timing of such capital expenditures may vary substantially depending
upon, among other things, the actual need for replacements and upgrades.
Financing activities used cash totaling $792 by reducing borrowings under
the company's credit facility during the three months ended March 31, 1999.
Asset Management
The company had accounts receivable, net of allowance for doubtful
accounts, of $32,280 at March 31, 1999. The number of days' sales outstanding in
accounts receivable was 64 days, which is slightly lower than the 67 days
outstanding at December 31, 1998 but higher than 53 days outstanding for the
prior year period. The number of days outstanding continues to reflect improved
but, still slower than normal payment by the company's customers during the
three months ended March 31, 1999. Bad debt expense as a percentage of total
revenue for the three months ended March 31, 1999 was 0.2%, which was less than
the 0.3% for the three months ended March 31, 1998. The company's allowance for
doubtful accounts, as a percentage of accounts receivable, was 1.5% at December
31, 1998 and 5.0% at March 31, 1999, a significant portion of the increase
reflects a change in the method of providing for returns and allowances. During
the first quarter of 1999 the company began providing for returns and allowance
based upon the revenue effect of such returns rather than the net cost effect of
such returns. The change has no effect on net income but increases the stated
amount of the allowance as compared to accounts receivable while reflecting
higher levels of inventory. Inventory turnover for the three months ended March
31, 1999 was 12.5 times versus 18.7 times in comparable period in 1998. The
decline in inventory turnover during the three months ended March 31, 1999 was
the result of having a high level of stocking to meet customer requirements and
having higher levels of inventories than are required.
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 7.0%. 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 1.25 to 1.
Both the IBMCC Facility and the DFS Facility prohibit the payment of
dividends unless consented to by the lender.
Year 2000 Issue
The Year 2000 problem generally results from the use in computer
hardware and software of two digits rather than four digits to define the
applicable year. When computers must process dates both before and after January
1, 2000, two-digit year "fields" may create processing ambiguities that can
cause errors and system failures. For example, a date represented by "00" may be
interpreted by the system as referring to the year 1900 rather than 2000. The
effects of the Year 2000 problem can be exacerbated by the interdependence of
computer and telecommunications systems in the United States and throughout the
world. This interdependence can affect the company and its suppliers, trading
partners, and customers ("outside entities"). The Year 2000 problem has been
more fully described in the company's previous periodic reports filed with the
Securities and Exchange Commission, including the company's most recent annual
report on form 10K. Some of the identified risks related to the Year 2000
problem include, but are not limited to, shortage of technical and managerial
resources required to deal with the problem; potential shortcomings in the
company's ability to identify and resolve all issues related to the problem; the
cascading effect of problems resulting from the company's vendors, suppliers,
customers and governmental agencies readiness.
State of Readiness:
The company's board of directors has been briefed about the Year 2000
problem. The board of directors has adopted a Year 2000 project (the "Y2K Plan")
aimed at preventing the company's mission-critical functions from being impaired
due to the year 2000 problem. "Mission-critical" functions are those critical
functions whose loss would cause an immediate stoppage or significant impairment
to core business processes.
The company's Vice President of Information Systems is supervising the
implementation of the Y2K Plan. The company is actively implementing the Y2K
Plan, which will be modified as events warrant. Under the plan, the company has
inventoried all of the computer systems and the telephone system at its
corporate offices. The company is upgrading all computer and software systems
that cannot be verified as warranted by the system's manufacturer to be Year
2000 compliant. The company's corporate offices telephone system is warranted by
the manufacturer to be Year 2000 compliant. During the first quarter of 1999 the
company continued its evaluation of computer hardware and software systems,
continuing to upgrade hardware systems that do not pass standardized year 2000
compliance tests and systems which cannot be determined from the available
information made available by the product's manufacturer, to be year 2000
compliant. During the second quarter of 1999, the company plans to complete the
inventory of all computers, software and telephone systems used in its branch
offices and will have established the time table for upgrading or replacing any
systems that cannot be verified as warranted by the system's manufacturer to be
Year 2000 compliant. In addition, the company currently plans to perform a
total-system-shut-down test in June, 1999, the purpose of which is to roll the
computer dates forward to past January 1, 2000 in an attempt to evaluate the
system performance using test transactions.
The company's Y2K Plan recognizes that the computer, telecommunications
and other systems of outside entities have the potential for major,
mission-critical, adverse effects on the conduct of company business. The
company does not have control of these outside entities or outside systems;
however, the company's Y2K Plan includes attempting to verify the readiness of
those outside entities or outside systems which might possibly have a material
adverse effect on the company's business by contacting those outside entities to
determine their readiness and to coordinate with those outside entities to
mitigate the possibility of an interruption of any mission-critical process. In
addition, the company is researching and documenting the standard year 2000
readiness statements of all major suppliers, product manufacturers and
customers. The company will, throughout 1999, attempt to evaluate the readiness
of any outside systems that might possibly create a material adverse effect on
any mission-critical process.
It is important to recognize that the processes of inventorying,
assessing, analyzing, converting (where necessary), testing, and developing
contingency plans for mission-critical items in anticipation of the Year 2000
event may be iterative processes, requiring a repeat of some or all of these
processes as the company learns more about the Year 2000 problem and its effects
on the internal business information systems and on outside systems, and about
the effects of embedded microprocessors on systems and business operations. The
company anticipates that it will continue with these processes through January
1, 2000 and on into the year 2000 in order to assess and remediate problems that
reasonably can be identified only after the start of the new century.
Costs to Address Year 2000 Issues:
The company has not incurred substantial historical costs for Year 2000
awareness, inventory, assessment, analysis, conversion, testing, or contingency
planning and anticipates that any future costs for these purposes, including
those for implementing Year 2000 contingency plans, although not possible at
this time to accurately predict, are not likely to be substantial. The company
has incurred expenditures, as part of an overall upgrading of its computer and
telecommunications systems, during 1998 and through 1999 to date. The company
has also recognized higher expenditures in managing its information and
telecommunications systems as staff members have expended time and resources
evaluating the company's Year 2000 readiness and implemented required changes.
It is difficult to assess the additional expenditures over and above what would
have been expended under normal circumstances, but the company estimates that it
has incurred expenditures in the form of additional expenses of approximately
$325 over and above that which would have been incurred were it not for the Year
2000 issue. In addition, the company estimates that it has made capital
expenditures in the amount of approximately $200 to $300 over an above the
amount of capital expenditures that would have been required if it were not for
the Year 2000 issue. Although impossible to accurately predict, the company
currently believes that the additional expenditures specifically related to
preparing for the Year 2000 issue will not be significant. Although the company
believes that its estimates are reasonable, there can be no assurance that the
costs of implementing the Y2K Plan will not differ materially from the estimated
costs or that the company will not be materially adversely affected by year 2000
issues.
Worst Case Scenario:
The Securities and Exchange Commission requires that public companies
must forecast the most reasonably likely worst case Year 2000 scenario, assuming
that the company's Year 2000 plan is not effective. Analysis of the most
reasonably likely worst case Year 2000 scenarios the company may face leads to
contemplation of the following possibilities which, though considered highly
unlikely, must be included in any consideration of worst cases: widespread
failure of electrical, natural gas, and similar supplies by utilities serving
the company; widespread disruption of the services of communications common
carriers; similar disruption to means and modes of transportation for the
company and its employees, contractors, suppliers, and customers; significant
disruption to the company's ability to gain access to, and continue working in,
office buildings and other facilities; the failure of substantial numbers of
mission-critical hardware and software computer systems, including both internal
business systems and other systems (such as those with embedded
microprocessors); and the failure of outside systems, the effects of which would
have a cumulative material adverse impact on the company's mission-critical
systems. Among other things, the company could face substantial claims by
customers for loss of revenues due to service level interruptions, inability to
fulfill contractual obligations, inability to account for certain revenues or
obligations or to bill customers or pay vendors accurately and on a timely
basis, and increased expenses associated with litigation, stabilization of
operations following mission-critical failures, and the execution of contingency
plans. The company could also experience an inability by customers, and others
to pay, on a timely basis or at all, obligations owed to the company. The
company's suppliers may not be able to deliver goods and services required by
the company. Under these circumstances, the adverse effect on the company, and
the diminution of company revenues, could be material, although not quantifiable
at this time. Further in this scenario, the cumulative effect of these failures
could have a substantial adverse effect on the economy, domestically and
internationally. The adverse effect on the company, and the diminution of
company revenues, from a domestic or global recession or depression also could
be material, although not quantifiable at this time. The company will continue
to monitor business conditions with the aim of assessing and quantifying
material adverse effects, if any, that result or may result from the Year 2000
problem.
Contingency Plans:
As part of its Y2K Plan, the company is developing contingency plans
that deal with, among others, two primary aspects of the year 2000 problem: (i)
that the company, despite its good-faith, reasonable efforts, may not have
satisfactorily remediated all internal, mission-critical systems; and (ii) that
systems of outside entities may not be Year 2000 ready, despite the company's
good-faith, reasonable efforts to work with outside entities. These contingency
plans are being designed to mitigate the disruptions or other adverse effects
resulting from Year 2000 incompatibilities regarding these mission-critical
functions or systems, and to facilitate the early identification and remediation
of mission-critical Year 2000 problems that first manifest themselves after
January 1, 2000.
These contingency plans will contemplate an assessment of all
mission-critical internal information and communications technology systems and
internal operational systems that use computer-based controls and any
recognizable potential outside entities or systems which might possibly have a
material adverse affect on any mission-critical processes. This process will be
pursued continuously into the Year 2000 as circumstances require.
These contingency plans will include the creation, as deemed reasonably
appropriate, of teams that will be standing by on the eve of the new millennium,
prepared to respond rapidly and otherwise as necessary to mitigate any problems
with mission-critical processes as soon as they become known.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During 1998 Allstar filed suit against a former employee and said former
employee has filed a counter-claim against Allstar. Allstar intends to
vigorously defend such counter claim. Allstar is unable to estimate the range of
possible recovery by the former employee because the suit is still in the early
stages of discovery.
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.
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 17, 1999 By: /s/ JAMES H. LONG
-----------------
Date James H. Long, Chief Executive Officer
May 17, 1999 By: /s/ DONALD R. CHADWICK
----------------------
Date Donald R. Chadwick, Chief Financial Officer