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 September 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 76-0515249
(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 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 September 30, 1998,
4,522,911 shares outstanding
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
September 30, December 31,
1998 1997
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash $ $ 280
Cash 1,431 1,301
Total cash and cash equivalents 1,431 1,581
Accounts receivable trade, net 28,671 23,759
Accounts receivable affiliates 655 434
Inventory 10,141 4,700
Deferred taxes 212 212
Other current asset 398 404
Total current assets 41,509 31,090
Property and equipment 2,281 2,013
Other assets 240 81
Total $ 44,030 $ 33,184
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 7,642 $ 1,572
Accounts payable 16,605 12,805
Accrued expenses 5,032 3,565
Income taxes payable (13) 82
Deferred service revenue 233 242
Total current liabilities 29,494 18,266
Deferred Credit - Stock warrants 195 195
Total liabilities 29,694 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 4,522,911 shares issued and outstanding
on December 31, 1997 and September 30, 1998, respectively 45 45
Additional paid in capital 10,250 10,013
Unearned restricted stock (270)
Treasury stock(271,200 shares, at cost) (834)
Retained earnings 5,145 4,665
Total stockholders' equity 14,336 14,723
Total $44,030 $33,184
====== ======
See notes to consolidated financial statements
<PAGE>
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Ended September 30,
1998 1997
---- ----
Total Revenue $ 44,775 $ 31,914
Cost of sales and services 38,211 27,777
------- -------
Gross Profit 6,564 4,137
Selling, general and administrative expenses 6,325 3,439
Operating income 239 698
Interest expense and other income (net) 95 82
Income before provision for income taxes 144 616
Provision for income taxes 57 236
Net income $ 87 $ 380
======== =========
Net income per share:
Basic $0.02 $0.09
==== ====
Diluted $0.02 $0.09
==== ====
Weighted average shares outstanding:
Basic 4,340,364 4,268,664
========= =========
Diluted 4,340,364 4,195,991
========= =========
Nine Months Ended September 30,
1998 1997
---- ----
Total Revenue $117,157 $ 90,745
Cost of sales and services 99,833 77,850
Gross Profit 17,324 12,895
Selling, general and administrative expenses 16,364 10,412
Operating income 960 2,483
Interest expense and other income (net) 175 680
Income before provision for income taxes 785 1,803
Provision for income taxes 305 701
Net income 480 $ 1,102
========= ===========
Net income per share:
Basic $0.11 $0.34
==== ====
Diluted $0.11 $0.34
==== ====
Weighted average shares outstanding:
Basic 4,405,517 3,212,059
========= =========
Diluted 4,395,310 3,187,569
========= =========
See notes to consolidated financial statements
<PAGE>
<TABLE>
<CAPTION>
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share amounts)
(Unaudited)
<S> <C> <C>
Nine Months Nine Months
ended ended
September 30, September 30,
1998 1997
Net income $ 480 $ 1,102
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Gain of disposal of assets
Depreciation and amortization 573 384
Deferred taxes 190
Deferred offering costs 412
Changes in assets and liabilities that provided (used) cash:
Accounts receivable trade, net (4,911) (2,482)
Accounts receivable affiliates (221) (87)
Inventory (5,441) (143)
Other current assets 6 (176)
Other assets (159)
Accounts payable 3,800 809
Accrued expenses 1,466 325
Income taxes payable (95) (552)
Deferred service revenue (9) (112)
Net cash provided by (used in) operating
activities (4,511) (330)
Cash flows from investing activities:
Capital Expenditures (842) (467)
Net cash used in investing activities: (842) (467)
Cash flows from financing activities:
Net proceeds from issurance of common stock 33 8,706
Purchase of treasury stock (900)
Net increase (decrease) in notes payable 6,070 (7,021)
Net cash provided by (used in) financing activities: 5,203 1,685
Net increase (decrease) in cash and cash
equivalents (150) 888
Cash and cash equivalents at beginning of period 1,581 229
Cash and cash equivalents at end of period $ 1,431 $ 1,117
======== =======
Supplemental disclosures of cash flow information:
Cash paid for interest $ 254 $ 794
========= ========
Cash paid for taxes $ 401 $ 976
========= ========
<FN>
See notes to consolidated financial statements
</FN>
</TABLE>
<PAGE>
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, San Antonio,
and El Paso, Texas and in Albuquerque and Las Cruces, New Mexico. In addition,
Allstar conducts sales of computer products through representatives located in
Florida, Missouri and Oklahoma.
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
September 30, 1998 and for the three and nine months ended September 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, 1997 is derived from audited
consolidated financial statements but does not include all disclosures required
by generally accepted accounting principles. Although management believes the
disclosures are adequate, certain information and disclosures normally included
in the notes to the financial statements has been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission.
New Accounting Pronouncements. On January 1, 1998, Allstar 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 nine months ended September 30, 1998
and 1997, Allstar had no items of comprehensive income, and as a result
Allstar'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 Allstar 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 Allstar 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 Allstar.
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 September
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
September 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
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.
<PAGE>
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
September 30, 1998, Computer Products totaled 85.4% of revenues while IT
Services, Telecom Systems and CTI Software totaled 7.9%, 5.1% and 1.6% 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 September 30, 1998 and 1997 and indicates the
percentage of total revenue for each item.
<TABLE>
<CAPTION>
Three Months ended September 30,
1998 1997
<S> <C> <C> <C> <C>
Amount % Amount %
Revenue(1)
Computer Products $38,217 85 4 $27,767 87 0
IT Services 3,533 7 9 2,696 8 5
Telecom systems 2,302 5 1 801 2 5
CTI Software 723 1 6 650 2 0
-------- --- -------- ---
Total revenue 44,775 100 0 31,914 100 0
Gross Profit
Computer Products 4,484 11 7 2,879 10 4
IT Services 1,127 31 9 843 31 3
Telecom Systems 549 23 9 183 22 8
CTI Software 404 55 9 232 35 7
-------- --- -------- ---
Total Gross Profit 6,564 14 7 4,137 13 0
Selling, general and administrative expense 6,325 14 1 3,439 10 8
-------- --- -------- ---
Operating income 239 0 5 698 2 2
Interest expense (net of other income) 95 0 2 82 0 3
-------- --- -------- ---
Income before provision for income taxes 144 0 3 616 1 9
Provision (benefit) for income taxes 57 0 1 237 0 7
-------- --- -------- ---
Net Income $ 87 0 2 $ 380 1 2
======= === ======== ===
Earnings per share $0 02 $0 09
==== ====
Weighted average shares outstanding 4,340,364 4,268,664
========= =========
<FN>
(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.
</FN>
</TABLE>
Three Months Ended September 30, 1998 Compared To Three Months Ended September
30, 1997
TOTAL REVENUE. Total revenue increased by $12.9 million (40.3%) from $31.9
million in 1997 compared to $44.8 million in 1998. Revenue from Computer
Products increased by $10.5 million (37.7%) from $27.8 million in 1997 to $38.2
million in 1998. Revenue from Computer Products as a percentage of total revenue
decreased 1.6% from 87.0% in 1997 to 85.4% in 1998. Approximately $2.5 million
of the increase in Computer Products from the prior period was realized in new
offices while $7.9 million was realized in offices existing during the 1997
period. Revenue from IT Services increased $837,000 (31.0%) from $2.7 million in
1997 to $3.5 million in 1998 because of the continued expansion of its billable
technical staff, together with the addition of new customers. Approximately
one-half of the increase in IT Services revenue was realized in new offices with
the other half being realized in offices existing in the 1997 period. Revenue
from IT Services as a percentage of total revenue decreased from 8.5% in 1997 to
7.9% of total revenues in 1998 due to the higher rates of growth realized in
Computer Products and Telecom Systems. Revenue from Telecom Systems increased by
$1.5 million (187.4%) from $801,000 in 1997 to $2.3 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
2.5% in 1997 to 5.1% in 1998. CTI Software revenue increased by $73,000 (11.2%)
from $650,000 in 1997 to $723,000 in 1998. The increase in CTI Software revenues
was due to the installation of a greater number of systems in 1998 than were
installed in 1997. Revenue from CTI Software, as a percentage of total revenue,
decreased from 2.0% in 1997 to 1.6% in 1998 because the growth rates of the
Company's other divisions were higher than the 11.2% increase achieved by CTI
Software.
GROSS PROFIT. Gross profit increased by $2.4 million (58.6%) from $4.1
million in 1997 to $6.6 million in 1998 and gross margin increased from 13.0% in
1997 to 14.7% in 1998. The gross margin for Computer Products increased from
10.4% in 1997 to 11.7% 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 and the ability of the
Company's sales force to obtain marginally higher prices in the 1998 period.
While the Company's sales force has been able to increase the gross margin
realized on Computer Products revenues, in certain instances, the Company has
been providing a higher level of service to its customers. The increase in
services provided has enhanced the margin realized while increasing the
Company's selling, general and administrative costs. The gross profit from IT
Services increased 33.8% from $843,000 in 1997 to $1.1 million in 1998. Gross
margin increased slightly from 31.3% in 1997 to 31.9% in 1998. While the Company
incurred higher rates of compensation for its billable technical staff during
the 1998 period, the higher rates were offset by a greater utilization rate in
1998, resulting in a slight decrease in labor costs overall. The Company treats
its costs associated with its technical staff as part of the cost of sales. When
higher utilization rates are realized, cost of sales, expressed as a percentage
of revenues, decreases. The wage costs of the Company's billable staff continue
to be 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 profit for Telecom Systems sales increased $366,000 (200%) from 183,000 in
1997 to 549,000 in 1998. Gross margin improved nominally by 1.1% but continues
to reflect less that industry norms for gross profit realization. The gross
margin for CTI Software increased from 35.7% in 1997 to 55.9% in 1998 due to the
company's ability to realize higher prices for its CTI products relative to the
hardware and installation costs than in the 1997 period.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $2.9 million (83.9%) from $3.4 million in
1997 to $6.3 million in 1998. As a percentage of total revenue, selling, general
and administrative expenses increased from 10.8% in 1997 to 14.1% in 1998. Those
components of selling, general and administrative expenses which increased
significantly, as a percentage of revenues, were personnel related costs,
general expenses related to opening new offices and expanding existing offices.
In the 1998 period the Company operated offices in El Paso, San Antonio, McAllen
and New Mexico which did not exist in the 1997 period. In addition, the Company
has commenced selling through its direct sales representatives in Oklahoma,
Missouri and Florida. Throughout 1998 and especially during the 1998 quarter,
when compared to the 1997 period, the Company employed a significant number of
new employees in its new offices, as well as increases in its Austin and Dallas
office staffs. Since these employees generally receive 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 expected of revenue growth and increases in the number of
employees and of 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 1998 quarter the Company maintained a higher level of
sales and administrative personnel than in the 1997 period. The costs of the
personnel were greater, as a percentage of revenue, because the increase in
personnel exceeded the increase in revenues realized.
The Company has opened the new offices and employed additional sales and
administrative personnel with the expectation that revenues would be increased
commensurate with the increases in sales and administrative personnel. While
revenues increased in excess of 40% and gross profit increased by over 58% over
the prior year period, sales and administrative personnel costs increased by
approximately 85% over the prior period. The Company believes that revenues will
increase over time to restore the balance between the higher level of personnel
costs and revenues. However, such forward looking statements include risks and
uncertainties many of which are not within the control of the Company and which
may cause actual results to differ materially from the expectations expressed in
such statements. The risks and uncertainties, include but are not limited to,
the Company's ability to realize such expectations in the highly competitive and
rapidly changing businesses in which it is engaged, the Company's reliance upon
its suppliers and product availability, the Company's reliance on its key
customers and the establishment of new customer relationships to increase its
revenues. There can be no assurance that the Company will realize revenues
commensurate with its increases in selling and administrative expenses.
OPERATING INCOME. Operating income decreased by $459,000 (65.8%) from
$698,000 in 1997 to $239,000 in 1998 due, principally, to higher selling,
general and administrative expenses. Operating income decreased as a percentage
of total revenue from 2.2% in 1997 to 0.5% in 1998. Contributing to the decrease
in operating income were operating losses incurred in newly opened offices. The
combined pretax losses incurred in the operation of newly opened offices were
approximately $570,000 during the three months ended September 30, 1998, while
similar losses were $65,000 in the 1997 period..
INTEREST EXPENSE (NET OF OTHER INCOME). Interest expense (net of other
income) increased $13,000 from $82,000 during 1997 period compared to $95,000 in
the 1998 period. This reflects a higher level of the Company's short-term debt
during the 1998 period when compared to 1997 and lower interest rates during the
1998 period when compared to 1997.
NET INCOME. Net income, after a provision for income taxes totaling $57,000
(reflecting an effective tax rate of 38.5% in 1997 compared to 39.6% in 1998),
decreased by $293,000 from $380,000 in 1997 to $87,000 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 nine months ended September 30, 1998 and 1997 and indicates the
percentage of total revenue for each item.
<TABLE>
<CAPTION>
Nine months ended September 30,
<S> <C> <C>
1998 1997
Amount % Amount %
Revenue(1)
Computer Products $100,417 85.7 $78,620 86.6
IT Services 9,487 8.1 7,413 8.2
Telecom systems 5,192 4.4 3,038 3.4
CTI Software 2,061 1.8 1,674 1.8
Total revenue 117,157 100.0 90,745 100.0
Gross Profit
Computer Products 11,724 11.7 8,602 10.9
IT Services 3,142 33.1 2,725 36.8
Telecom Systems 1,508 29.0 820 27.0
CTI Software 950 46.1 748 44.7
Total Gross Profit 17,324 14.8 12,895 14.2
Selling, general and administrative expense 16,364 14.0 10,412 11.5
Operating income 960 0.8 2,483 2.7
Interest expense (net of other income 175 0.1 680 0.7
Income before provision for income taxes 785 0.7 1,803 2.0
Provision (benefit) for income taxes 305 0.3 701 0.8
Net Income $ 480 0.4 $ 1,102 1.2
Earnings per share $0.11 $0.34
Weighted average shares outstanding 4,405,517 3,212,059
<FN>
(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.
</FN>
</TABLE>
<PAGE>
Nine Months Ended September 30, 1998 Compared To Nine Months Ended September 30,
1997.
TOTAL REVENUE. Total revenue increased by $26.4 million (29.1%) from $90.7
million in 1997 compared to $117.2 million in 1998. Revenue from Computer
Products increased by $21.8 million (27.7%) from $78.6 million in 1997 to $100.4
million in 1998. Revenue from Computer Products as a percentage of total revenue
decreased 0.9% from 86.6% in 1997 to 85.7% in 1998. Approximately $5.0 million
of the increase in Computer Products from the prior period was realized in new
offices while $16.8 million was realized in offices existing during the 1997
period. Revenue from IT Services increased $2.1 million (28.0%) from $7.4
million in 1997 to $9.5 million in 1998 because of the continued expansion of
its billable technical staff, together with the addition of new customers and
the opening of new offices, approximately $800,000 of the increase between the
1997 period and the 1998 period was attributable to new offices. Revenue from IT
Services as a percentage of total revenue decreased from 8.2% in 1997 to 8.1% of
total revenues in 1998. Revenue from Telecom Systems increased by $2.2 million
(70.9%) from $3.0 million in 1997 to $5.2 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 and the addition
of sales personnel. Revenue from Telecom Systems as a percentage of total
revenue increased from 3.4% in 1997 to 4.4% in 1998. CTI Software revenue
increased by $387,000 (23.2%) from $1.6 million in 1997 to $2.1 million in 1998.
The increase in CTI Software revenues was the result of the addition of new
customers and expanded marketing. Revenue from CTI Software, as a percentage of
total revenue, remained at 1.8% in both periods.
GROSS PROFIT. Gross profit increased by $4.4 million (34.3%) from $12.9
million in 1997 to $17.3 million in 1998 and gross margin increased from 14.2%
in 1997 to 14.8% in 1998. The gross margin for Computer Products increased from
10.9% in 1997 to 11.7% 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 and the ability of the
Company's sales force to obtain marginally higher prices in the 1998 period. The
gross profit from IT Services increased 15.3% from $2.7 million in 1997 to $3.1
million in 1998. Gross margin for IT Services decreased from 36.8% in 1997 to
33.1% 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. Gross profit for Telecom Systems increased
$688,000 (83.9%) from $820,000 in the 1997 period to $1.5 million in 1998. The
gross margin for Telecom Systems sales increased from 27.0% in 1997 to 29.0% in
1998, reflecting modest reduction in the installation costs, expressed as a
percentage of revenues. The gross margin for CTI Software increased from 44.7%
in 1997 to 46.1% in the 1998 due to improvement in the pricing of CTI software
products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $6.0 million (57.2%) from $10.4 million in
1997 to $16.4 million in 1998. As a percentage of total revenue, selling,
general and administrative expenses increased from 11.5% in 1997 to 14.0% 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 and payments of "unearned commissions' in the form of minimum
commissions guaranteed to newly hired sales personnel during their start-up
period. During the 1998 period, when compared to the 1997 period, the Company
employed a significant number of new employees in its San Antonio, El Paso and
New Mexico offices, as well as increases in its Austin and Dallas office staffs.
Since the new employees in all offices 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 San Antonio, 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 $1.5 million (61.3%) from
$2.5 million in 1997 to $960,000 in 1998 due to higher selling, general and
administrative expenses. Operating income decreased as a percentage of total
revenue from 2.7% in 1997 to 0.8% in 1998. Contributing to the decrease in
operating income were operating losses incurred in newly opened offices. The
combined pretax losses incurred in the operation of newly opened offices were
approximately $553,000 compared to $65,000 during the 1997 period..
INTEREST EXPENSE (NET OF OTHER INCOME). Interest expense (net of other
income) decreased $505,000 from $680,000 during 1997 period compared to $175,000
in the 1998 period. This reflects the reduced level of the Company's short-term
debt during the 1998 period when compared to 1997. The reduction was
accomplished by applying all of the net proceeds from the sale of common stock
in July, 1997 to the repayment of the Company's debt.
NET INCOME. Net income, after a provision for income taxes totaling
$305,000 (reflecting an effective tax rate of 38.9% in 1997 and 38.9% in 1998),
decreased by $622,000 from $1.1 million in 1997 to $480,000 in 1998.
Liquidity and Capital Resources
The Company's working capital was $12.8 million and $12.0 million at
December 31, 1997 and September 30, 1998, respectively. As of September 30,
1998, the Company had borrowing capacity under the Company's credit facility of
$26.1 million of which $22.3 million was used under the Company's floor plan and
revolving credit facility. Unused borrowing capacity at September 30, 1998 was
$3.8 million.
Cash Flow
Operating activities used net cash totaling $4,511,000 during the nine
months ended September 30, 1998. Operating activities used net cash during the
nine months ended September 30, 1998 because of increases in inventories and
accounts receivable which were partially offset by increases in accounts payable
and accrued expenses. Net income and depreciation provided cash of $953,000 in
the nine months ended September 30, 1998 versus $1.5 million in the 1997 period.
The increase in inventories was primarily the result of increases in inventories
staged for delivery to customers and inventories being stocked for certain
customers. Of the $5.4 million increase during the nine months ended September
30, 1998, $3.2 million related to an increase in inventories staged for delivery
to customers, $1.6 million of the increase relates to higher stocking
requirements imposed by customers and the balance was due to a higher level of
sales activities.
Investing activities used cash totaling $842,000 during the nine months
ended September 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 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 $6.1 million from borrowing
under the Company's credit facility during the nine months ended September 30,
1998. The Company expended $900,000 for the purchase of treasury stock to be
used for employee incentive stock plans. The Company issued restricted shares to
certain of its employees and charged expense and increased paid in capital for
$33,000 during the nine months ended September 30, 1998 relating to the issuance
of such shares.
<PAGE>
Asset Management
The Company had trade accounts receivable, net of allowance for doubtful
accounts, of $28.7 million at September 30, 1998. The number of days' sales
outstanding in trade accounts receivable was 53 days, which is slightly lower
than the days outstanding of the prior quarter. 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 September 30, 1998. Bad debt
expense as a percentage of total revenue for the three months ended September
30, 1998 was 0.2%, which was 0.1% less than bad debt expense for the three
months ended September 30, 1997. The Company's allowance for doubtful accounts,
as a percentage of trade accounts receivable, was 1.0% at December 31, 1997 and
1.7% at September 30, 1998. Inventory turnover for the three and nine months
ended September 30, 1998 was 12.6 times, and 16.4 times, respectively. The
decline in inventory turnover during the three months ended September 30, 1998
was the result of having a high level of staged inventory as of September 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
September 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.
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.
November 4, 1998 By: /s/ JAMES H. LONG
-----------------
Date James H. Long, Chief Executive Officer
November 4, 1998 By: /s/ DONALD R. CHADWICK
----------------------
Date Donald R. Chadwick, Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 2396
<SECURITIES> 0
<RECEIVABLES> 20582
<ALLOWANCES> 0
<INVENTORY> 4382
<CURRENT-ASSETS> 164
<PP&E> 2830
<DEPRECIATION> (1313)
<TOTAL-ASSETS> 29765
<CURRENT-LIABILITIES> 24716
<BONDS> 0
0
07
<COMMON> 27
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 29765
<SALES> 58831
<TOTAL-REVENUES> 58831
<CGS> 50073
<TOTAL-COSTS> 50073
<OTHER-EXPENSES> 6974
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 597
<INCOME-PRETAX> 1187
<INCOME-TAX> 465
<INCOME-CONTINUING> 722
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 722
<EPS-PRIMARY> .27
<EPS-DILUTED> .27
</TABLE>
