-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MSvW0N2GWxfTVaEzfagfVbi549dyCVbZv4PNCXooxie2iZG9RVU1AQn3SZ/E7VU4 re9gVe389MEXEkPChuOUow== 0001020017-00-000004.txt : 20000329 0001020017-00-000004.hdr.sgml : 20000329 ACCESSION NUMBER: 0001020017-00-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLSTAR SYSTEMS INC CENTRAL INDEX KEY: 0001020017 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-COMPUTER & PERIPHERAL EQUIPMENT & SOFTWARE [5045] IRS NUMBER: 760515249 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21479 FILM NUMBER: 581192 BUSINESS ADDRESS: STREET 1: 6401 SOUTHWEST FREEWAY CITY: HOUSTON STATE: TX ZIP: 77074 BUSINESS PHONE: 7137952000 MAIL ADDRESS: STREET 1: 6401 SOUTHWEST FREEWAY CITY: HOUSTON STATE: TX ZIP: 77074 10-K 1 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 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: 0-21479 ALLSTAR SYSTEMS, INC. (Exact name of Registrant as specified in its charter) Delaware 76-0515249 (State of Incorporation) (I.R.S. Employer Identification No.) 6401 Southwest Freeway Houston, TX 77074 (Address of principal executive offices) (Zip code) Registrant's telephone number including area code: (713) 795-2000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to section 12(g) of the Act: COMMON STOCK, $.01 Par Value (Title of Class) 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 ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of the Common Stock on March 17, 2000, as reported on NASDAQ Small Cap Market, was approximately $7,805,300. The number of shares of Common Stock, $.01 Par Value, outstanding as of March 17, 2000 was 4,060,525. DOCUMENTS INCORPORATED BY REFERENCE PART I Item 1. Business SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS THIS ANNUAL REPORT ON FORM 10-K 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. - "BUSINESS" ITEM 2. - "PROPERTIES," ITEM 3. - "LEGAL PROCEEDINGS" AND ITEM 7. - "MANAGEMENTS 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 THIS ANNUAL REPORT ON FORM 10-K, 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. GENERAL Allstar Systems, Inc. is engaged in the business of providing its customers with single-source solutions to their information and communications technology needs. We market our products and services primarily in Texas from five locations in the Houston, Dallas-Fort Worth, El Paso, Austin and San Antonio metropolitan areas. Our customer base of approximately 2,800 accounts has been comprised primarily of mid-sized customers and regional offices of larger customers in commercial, educational and governmental sectors. In 1999, our revenue was derived through four primary areas of business: (1) IT Services has provided a variety of services related to the use of information technology, including primarily: Consulting and project management services related to networking. Supplemental IT technical staffing. Computer equipment repair services and desktop computer and application support. (2) CTI Software, through a wholly owned subsidiary, Stratasoft, Inc., has engaged in marketing its own software products for computer-telephony integration, including products for call center and other high volume calling applications. (3) Computer Products has engaged in the business of selling a wide variety of computer hardware and software products from over 600 manufacturers and suppliers. (4) Telecom Systems has engaged in the business of selling business telephone systems, including large "PBX" systems and smaller "key" systems. As discussed below in further detail in Item 1. "Recent Developments," we recently sold certain key assets of, and the ongoing business operations of, our Telecom Systems business and entered into an agreement to sell certain key assets of, and the ongoing business operations of, our Computer Products business. INDUSTRY CHANGES The market for information and communications technology products and services has experienced tremendous growth over the past decade and the industry has changed significantly as the market has grown and evolved. Reselling of popular computing hardware and software products, and the support and maintenance of such products, which was formerly an early stage high growth industry sector, has now matured. Other information technology industry sectors, such as consulting and project management related to Internet and Intranet network infrastructure are still somewhat early stage industry sectors. Yet other information technology industry sectors, such as consulting and project management related to Web-enabled Supply Chain Management and Customer Resource Management systems are in their infancy. As the information technology market has evolved, both challenges and opportunities have been created for industry participants. Our Computer Products business, which has evolved from a business model created in the early 1980's, has been struggling with numerous challenges related to the evolution of the computer reselling industry. Major product manufacturers have been changing their business models and their relationship with the computer reseller community. Web-based product reselling and direct selling by the major manufacturers is creating rapid change that has resulted in lower gross margins throughout the industry. The proliferation of new products has created an increasingly complex environment in which we and other computer resellers are forced to operate. Changes related to B2B e-commerce are changing the purchasing habits of corporations related to computer products purchasing. Many companies engaged in computer reselling have had difficulty adjusting to these changes and many of these companies have experienced financial difficulty. At the same time, we believe the market for information technology services has grown increasingly larger, and increasingly more complex and varied. Only a few short years ago, it was normal for a mid-sized corporation to have a single-source provider for all of its information technology services, but that has changed. The increasing number of software and hardware providers, combined with the increasing diversity of, and complexity of, computing technology used by corporate America today demands that information technology service providers specialize. Focus and specialization create improved quality, productivity and operational effectiveness. Corporate America today realizes this and increasingly looks to specialized service providers for their needs. The proliferation of network computing, using standardized operating systems and application software, combined with the continuing evolution of the Internet, continue to create new industry sectors. The implementation of Web-enabled extended enterprise applications such as supply chain management systems, customer relationship management systems, and systems used for e-Business and e-Commerce, are changing the shape of the information technology services industry. In addition, business opportunities are currently being created by the manner in which the Internet is destined to change commerce and communications. Web commerce, both business-to-consumer (B2C) and business-to-business (B2B), is expected to create very extensive change in the buying patterns and habits of both consumer and business buyers. This is creating unprecedented change and opportunity for businesses that offer products and services that can be marketed via the Internet. The Internet is also expected to radically change the method by which we communicate. Internet voice communications is expected to significantly change the market for long-distance communications over the next three-to-five years. Mindful of the manner in which the Internet is expected to change commerce and communications, and realizing that focused specialization by an operating company was key to operational and marketing effectiveness, we evaluated our situation and decided that change was prudent. We decided that we should exit our Telecom Systems business primarily because we had been ineffective at achieving profitably since we began Telecom Systems in 1994 and secondarily because the business of selling and installing telephone systems is a mature industry that offers less opportunity for growth than other emerging areas. We decided to sell our Computer Products division because, in spite of the fact that Computer Products is profitable, we could deploy the proceeds from a sale of Computer Products in other ways that we believe will ultimately create greater stockholder value. RECENT DEVELOPMENTS On March 16, 2000 we entered into separate agreements whereby we sold certain key assets of, and the ongoing business operations of, our Telecom Systems business and we propose to sell certain key assets of, and the ongoing business operations of, our Computer Products business. Proposed Disposition of Computer Products Business On March 16, 2000 Allstar entered into an agreement to sell certain assets of and the ongoing operations of our Computer Products division, along with certain assets and operations of our IT Services division related to our El Paso branch office. Under this agreement, said assets and operations are to be sold to Amherst Computer Products Southwest, L.P., an affiliate of Amherst Technologies, L.L.C. The sale transaction is expected to close on or before May 31, 2000 after shareholder and other required consents are obtained. The terms of the agreement include cash consideration of $14.25 million, plus a cash payment related to the purchase of certain inventory and equipment, the amount of which is to be determined, plus the possibility of receiving a future payment of up to $500,000 from an escrow account. The terms of the agreement also include possible future cash payments contingent upon future performance of the operations being sold. Allstar Systems expects to realize a gain of approximately $5.6 million, net of taxes, on the sale. Upon the closing of the proposed transaction and after realization of the retained current assets related to the Computer Products division, we expect to have no debt and cash on hand of approximately $18 to $20 million. Additional information regarding this proposed transaction can be found in the recently filed Proxy related to the transaction. Sale of Telecom Systems Business Through Telecom Systems, until March 16, 2000, we marketed, installed and serviced business telephone systems, including large PBX systems and small "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. Because we have been unable to profitably operate the Telecom Systems business, we determined to exit this business on November 2, 1999. On March 16, 2000, we sold Telecom Systems to Communications World International, Inc. ("CommWorld"), a publicly traded company (OTC Bulletin Board: CWII). Under the terms of the sale, for the inventory and operations of Telecom Systems, we received $250,000 cash, and the ability to obtain up to approximately 100,000 shares of restricted common stock of CommWorld depending upon the performance of the acquired operations during a period ending six months after the closing date. Additionally, the purchaser assumed all of our telephone equipment warranty obligations up to a maximum of $30,000. Any excess warranty costs incurred by the purchaser will be billed to us at an agreed upon rate. A disposal loss, including an estimate of the operating results from the measurement date, November 2, 1999 to the closing date of the sale of $580,000, and estimates for impairment of assets caused by the disposal decision of $558,000, totaling $1,138,000 (net of an income tax saving of $586,000) was recognized. The loss from discontinued operations (net of income tax savings of $167,000, $159,000 and $505,000) was $323,000, $310,000 and $981,000 in 1999, 1998 and 1997, respectively. We will retain accounts receivable of $1.4 million, net of reserves, fixed assets of $30,000 and liabilities related to the Telecom division. Fixed assets are being redeployed in the continuing operations. The accounts receivable will be collected in the ordinary course of business and these amounts will be used to repay all remaining liabilities of the Telecom division. Any excess cash will be used to repay our line of credit and fund general corporate purposes. BUSINESS STRATEGY We believe the proposed sale of our Computer Products division provides sufficient cash to initiate a fundamental change in our business strategy that will allow us to deploy our increased capital in endeavors that we believe will ultimately result in improved stockholder value. We believe we can produce more rapid growth, and better financial performance, by segregating the various IT Services operations into focused, specialized companies. We intend to organize our existing IT Services operations into wholly owned subsidiary companies, each branded to pursue a specialized mission and each led by a separate management team with personal financial incentives tied to their company's financial performance. We plan to continue to expand our CTI Software business through our wholly owned subsidiary, Stratasoft, Inc. Stratasoft is an example of our successfully entering a new market with a start-up operation and rapidly creating a valuable vertical market software company producing high levels of revenue and profitability growth in a short time. Stratasoft is working to enable its call center systems to utilize voice-over-IP technology and as voice-over-IP becomes a viable voice communications methodology, we expect the Stratasoft call center product to be ready for the significant change that will be created in call center communications. After the completion of the sale of Computer Products, we also intend to pursue starting, acquiring or investing in, including taking significant stakes in other companies that we expect to benefit from the manner in which the Internet is changing commerce and communications. Targeted businesses are expected to include B2B e-commerce product or services sales companies, companies providing IT services related to network and Web development and companies involved in the enabling of e-Commerce and e-Business. PRODUCTS AND SERVICES IT Services: To date, we have marketed a variety of service offerings related to the service and support of information technology systems. We have priced our services on a time and materials basis, under fixed price project pricing or under fixed fee service contracts, depending on customer preference and the level of service commitment required. To support and maintain the quality of these services and to maintain vendor accreditation necessary to service their significant product lines, our technical staff participates in various certification and authorization programs sponsored by hardware manufacturers and software suppliers. In markets where we do not maintain branch offices, we often subcontract for necessary technical personnel, particularly where required for larger scope or prolonged duration contracts. IT services include the following: o Consulting and project management services related to networking. o Supplemental IT technical staffing. o Computer equipment repair services and desktop computer and application support. As mentioned above in Item 1. "Business Strategy," we intend to organize our various IT Services offerings into separate wholly owned companies with a specialized focus in order to maximize management and operational effectiveness and because we believe that doing so will result in overall higher revenue growth and improved financial results. CTI Software: Through our wholly owned subsidiary, Stratasoft, Inc., we develop and market Stratasoft's proprietary CTI Software, which integrates business telephone systems and networked computer systems, under the trade name "Stratasoft." Stratasoft's products are designed to improve the efficiency of a call center or other type of high volume calling application, for both inbound and outbound calls. The software products offered are typically customized to suit a customer's particular needs and are often bundled with computer hardware supplied by us or by one of Stratasoft's value added resellers at the customer's request. Stratasoft currently has two primary computer-telephony software products, which it markets under the trade names StrataDial and StrataVoice. These products are further described below: o StrataDial. StrataDial is a predictive dialer software product for outbound call center applications such as sales and promotion, collections, surveys, lead generation and announcements that require personal contact. StrataDial features inbound/outbound call blending without requiring an automated call distribution feature of the telephone system. StrataDial collects campaign specific data during the telephone call and provides comprehensive on line reporting and statistical analysis of the campaign data. StrataDial also features open architecture that allows easy interaction with the customer's other database applications. Dialing parameters and campaign characteristics can be changed without shutting down the dialer, as is required with many competing products. o StrataVoice. StrataVoice is an outbound dialing product designed for high volume applications that do not require human interaction. StrataVoice applications include appointment confirmation and setting, court appearance notification, surveys, community notification such as school closings and emergency evacuation, employee updates, absenteeism notification, telemarketing and market research. A telephone system utilizing StrataVoice dials a computerized list of numbers and can ask the contacted person a number of questions, including branching to other questions and statements based on responses. StrataVoice also allows the contacted person to leave messages. Scripting tools are included that allow the user to develop campaigns. The system builds a database of respondent data and has comprehensive response reporting capabilities. Computer Products: Our Computer Products business has offered our customers a wide variety of computer hardware and software products available from approximately 600 manufacturers and suppliers. Our 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. We are an authorized reseller of products from a number of leading manufacturers of computer hardware, software and networking equipment. The Computer Products division had operating income in 1999 of $2,702,000 as compared to $560,000 in 1998. Downward pressures on product pricing margins have been a trend in the industry, although growth of revenues of 27.4% in 1999 as compared to 1998 were achieved in spite of continuing downward pressure on prices. As computer prices decrease, more significant increases in the number of units sold must occur in order to produce revenue growth. As discussed above in Item 1. "Recent Developments," the proposed sale of the Computer Products division is expected to close on or before May 31, 2000. FINANCIAL INFORMATION BY BUSINESS SEGMENT See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" for financial information on revenue and operating income of each business segment. SALES AND MARKETING To date, we have primarily marketed our products and services through direct sales representatives. Direct sales representatives have been teamed with in-house customer service representatives and assigned to specific customer accounts. We believe that direct sales lead to better account penetration and management, better communications and long-term relationships with its customers. Our sales personnel, including account managers and customer service representatives, are partially compensated, and in some cases are solely compensated, on the profitability of accounts that they participate in developing. Our three remaining business segments have utilized slightly different methods of sales and marketing: (1) IT Services. The IT Services business segment operates from all of our offices, and promotes its products and services through general and trade advertising, participation in trade shows and telemarketing campaigns. We believe that a significant portion of IT Services' new customers have originated through word-of-mouth referrals from existing customers and industry partners such as manufacturers' representatives, and through customer and lead sharing with our other two business units. (2) CTI Software. Stratasoft, Inc., our CTI Software business segment, operates from our Houston office and utilizes telemarketing, participation in trade shows and general trade advertising to market its products. Leads are followed up on and managed by account managers. In addition, Stratasoft markets its products through a network of value added resellers, who typically integrate their products with Stratasoft's software products to provide a complete solution. (3) Computer Products. Our Computer Products business segment operates from all of our offices, and promotes its products and services through general and trade advertising, participation in trade shows and telemarketing campaigns. As previously discussed, we entered into an agreement on March 16, 2000 to sell certain assets of, and the ongoing operations of this business. CUSTOMERS The focus of our marketing efforts has been on mid-sized customers and regional offices of larger customers located within the regions in which we maintain offices. We have occasionally provided products and/or services in markets where we do not have an office, typically to branch operations of customers with which we have an established relationship. Our customer base has not been concentrated in any industry group. Our top ten customers (which have varied from year to year) accounted for 21.2%, 31.7% and 28.4% of our revenue during 1997, 1998 and 1999, respectively. Approximately 2,800 customers purchased products or services from us during 1999. In 1999, the largest single customer constituted 8.3% of total revenues; however, in prior years, our largest customer has constituted as high as 11.2% of revenues. We have only a small amount of backlog relative to total revenues because we have no long-term commitments by customers to purchase products or services from us. Although we have service contracts with many of our large customers, such service contracts are project-based and/or terminable upon relatively short notice. SUPPLY AND DISTRIBUTION We have relied on wholesale distributors to supply a majority of the products that we have sold through our Computer Products and CTI Software business segments. We have purchased the majority of our products from three primary suppliers to obtain competitive pricing, better product availability and improved quality control. MANAGEMENT INFORMATION SYSTEMS We utilize a highly customized management information systems ("MIS") to manage most aspects of our business. Our MIS has provided our sales staff, customer service representatives and certain customers with product pricing and availability from its principal suppliers' warehouses throughout the United States. The purchasing systems are real time, allowing buyers to act within minutes on a newly received and credit-approved sales order. Our MIS contains productivity tools for sales lead generation, including integration between telemarketing and prospect database management. Sales management features include a variety of reports available for any combination of customer, salesperson, sales team and office criteria. We use our MIS to manage sales orders, purchasing, service contracts, service calls and work orders, engineer and technician scheduling and time tracking, service parts acquisition and manufacturer warranties. Reporting can also be generated for project profitability, contract and customer analysis, parts tracking and employee time tracking. EMPLOYEES As of December 31, 1999 we employed approximately 417 individuals. Of these, approximately 98 were employed in sales, marketing and customer service, 171 were employed in engineering and technical positions and 148 were employed in administration, finance and MIS. We believe that our ability to recruit and retain highly skilled and experienced technical, sales and management personnel has been, and will continue to be, critical to our ability to execute our business plans. None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We believe that our relations with our employees are good. HISTORY AND REINCORPORATION Our company was incorporated under Texas law in 1983 under the name Technicomp Corp. On June 30, 1993, we changed our name to Allstar-Valcom, Inc., and then again, on December 28, 1993, we changed our name to Allstar Systems, Inc. On December 27, 1993, we engaged in a merger in which we were the surviving corporation. In the merger, Allstar Services, Inc. and R. Cano, Inc., both of which were affiliated with us, were merged with and into Allstar Systems, Inc. in order to streamline the business. In 1995 we formed a wholly owned subsidiary, Stratasoft, Inc., to purchase and develop our CTI Software business segment. In 1997, we formed another wholly-owned subsidiary, IT Staffing, Inc., for the purpose of conducting business in the placement of temporary and permanent technical personnel. In 1998 we formed another wholly owned subsidiary, Allstar Systems Rio Grande, Inc., to develop and manage business opportunities in the Rio Grande region congruent with the business of the parent. In October 1996, we effected a reincorporation and merger in the State of Delaware through which the 328,125 shares of our predecessor, Allstar Systems, Inc., a Texas corporation, which were outstanding prior to the merger, were converted into approximately 2,675,000 shares of the newly incorporated Delaware corporation (the "Reincorporation"). The effect of the Reincorporation on the number of shares outstanding prior to the Reincorporation was similar in effect to an approximately 8.15-for-1 stock split. RISKS OF OUR NEW BUSINESS STRATEGY We plan to sell our Computer Products Division, retain our IT Services and Stratasoft businesses, and embark on new lines of business that we have not yet identified. Our new business strategy is based on our ability to redeploy the proceeds from the sale of our Computer Products to both improve the performance of businesses we will retain and to enter new lines of business. This strategy involves many risks including the following: Closing of Computer Products Division Sale We believe that having cash on hand from the sale of the Computer Products Division will improve our ability to negotiate and consummate acquisitions, pursue investment opportunities and better enable us to start-up new lines of business, once we have identified the specific businesses we wish to pursue. We also will seek to grow our retained businesses using proceeds from the sale. Closing of the Computer Products Division sale is, however, subject to many contingencies which could cause the transaction not to close. Some of these conditions include: o the absence of any material adverse change in our business prior to closing; o the truth of the representations and warranties made by us and the buyer in the Asset Purchase Agreement; o consent of a number of our principal suppliers and customers to the assignment to the buyer of our contracts with them; o other conditions included in the Asset Purchase Agreement relating to the Computer Products Division sale, a copy of which is an exhibit to this report. If for any reason the proposed sale of the Computer Products Division does not close, we will not have sufficient cash to pursue our new business strategy. Risks of Potential Future Acquisitions and Investments Our business will depend in the future on the successful acquisition, integration, financing and performance of businesses we have not yet identified. Following the sale of our Computer Products Division, we plan to pursue starting-up, acquiring or taking significant stakes in businesses involved in internet commerce and communications. We have not yet identified any specific businesses to start, purchase or invest in, and thus many of the risks of our strategy are unascertainable. Our strategy involves the substantial risk that we will not find suitable businesses to acquire on terms we believe are reasonable and that the new businesses we choose to enter will not provide the benefits we expect. Our future business prospects should therefore be considered in light of the risks, expenses, problems and delays inherent in starting or acquiring a new business. We cannot be certain that we will identify and assess these risks. Some of the acquisition and operating risks that could adversely affect us include the following: o We may be unsuccessful in identifying new business opportunities, completing and financing acquisitions and start-ups on favorable terms and in subsequently operating the businesses profitably. o Competition for the acquisition of companies in the internet commerce and communication sector will likely be intense. Our competitors for suitable new businesses may have greater financial, personnel and technical resources than us which may put us at a disadvantage in finding and concluding acquisitions. These competitive limitations may compel us to select less attractive acquisitions than if we had greater resources at our disposal. o Businesses in the internet commerce and communication sector are the general focus of our new business expansion strategy. Businesses in this sector often have an undeveloped or unproven product, technology or marketing strategy which may prove unsuccessful. o We may choose to acquire or invest a business that is financially unstable or that is in the early stages of development, including one without earnings or positive cash flow, which may require substantial additional capital infusions to support. o Because we plan to seek new businesses with growth potential, there is a substantial likelihood that the new business will be in competition with much larger, more established and better capitalized competitors, thus putting it at a competitive disadvantage. o Our success in a new business will also depend on our ability to integrate a new business and its personnel with our existing business and personnel with a minimum of disruption to both existing and new enterprises, including management information systems. We also may be unable to attract and retain new, qualified personnel to operate and grow our new businesses. o If we choose to make a strategic investment by acquiring a minority interest in a business, we may lack sufficient control to influence the operations and strategy of the business and thus will depend on that entity's management for our success; additionally, if we choose to make an investment in a publicly traded company such investment would also be subject to market risks. Possible Need for Additional Financing We may be required to obtain cash to supplement our then available proceeds from the Computer Products Division Sale to acquire or begin a new business and for working capital to run existing businesses and any businesses we acquire. We have no commitments to provide any such additional capital and we may be unable to find suitable capital on terms we consider acceptable. If we obtain additional debt financing for our existing businesses or to acquire new businesses, we will be subject to the risks inherent in debt financing. Some of these include: o interest rate fluctuations; o inability to obtain additional debt financing; o insufficiency of cash flow to pay interest and principal; and o restrictive debt covenants imposed by lenders that may limit or prohibit business activities we consider desirable. We may seek to raise equity capital to meet our future cash needs. We may also issue additional shares of our common stock or other equity securities to acquire new businesses. If we do issue additional equity securities, some of the possible adverse possible effects include: o the percentage of our common stock owned by existing stockholders could be substantially reduced; o possible increases in the number of shares of our common stock that are considered restricted stock for federal and state securities laws purposes, the actual or potential future sale of which could adversely effect the price of our common stock; and o we may be required to issue preferred stock which could have rights, privileges and preferences superior to those of our then existing stockholders. Increased Dependence on IT Services and Stratasoft Our IT Services and Stratasoft software business will be our only two business segments immediately after the sale of our Computer Products Division. Because of that, the success of these business segments will take on a much greater significance to us. We plan to concentrate our efforts on growing these businesses and we expect to have additional financial resources to do so from the proceeds of the Computer Products Division sale. The risk exists that we may be unable to accomplish this improvement, and the operations of these remaining businesses may not enable us to operate profitably. Risks of Our Existing Businesses As noted above, if our Computer Products Division is sold and our new business strategy is implemented, the nature and magnitude of risks relating to our business will change significantly. If, however, we do not close the Computer Products sale as expected, our business will continue to be subject to the risks and uncertainties we have identified in the past, including those set forth below: Adverse Changes in Our Industry As described above under the caption "Changes in Industry Conditions," our industry is undergoing rapid changes that may adversely affect us. If we do not successfully adapt our business strategy to these new conditions, there is a growing risk that we may be unable to compete and be profitable in the future. Risk of Low Margin Business Significant levels of competition that characterize the computer reseller market, In order to attract and retain many of our larger customers, we have frequently agreed to volume discounts and maximum allowable markups that serve to limit the profitability of sales to such customers. Any increase in inventory devaluation risks that cannot be passed onto our customers would result in write-offs or markdowns of the value of such inventory with the result being a charge to gross profit. All of these factors have contributed to our decision to make the Computer Products Division available for sale. Dependence on Availability of Credit Our business activities have been capital intensive in that we are required to finance accounts receivable and inventory. In order to obtain necessary working capital, we have relied primarily on lines of credit under which the available credit is dependent on the amount and quality of our accounts receivable and inventory. As a result, the amount of credit available to us was adversely affected by factors such as delays in collection or deterioration in the quality of our accounts receivable, inventory obsolescence, economic trends in the computer industry, interest rate fluctuations and the lending policies of our lenders. Many of these factors were beyond our control. Any decrease or material limitation on the amount of capital available to us under our credit lines and other financing arrangements could limit our ability to fill existing sales orders, purchase inventory or expand our sales levels and, therefore, would have a material adverse effect on our financial condition and results of operations. (See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations"). Interest Rates Any significant increases in interest rates will increase our cost of capital and would have an adverse effect on our financial condition and results of operations. Our inability to have continuous access to capital at reasonable costs would materially and adversely impact our financial condition and results of operations. (See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations"). Highly Competitive Business We have been engaged in business activities that are intensely competitive and rapidly changing. Price competition could have a material adverse effect on our financial condition and results of operations. Our competitors included major computer products and telephone equipment manufacturers and distributors, including certain manufacturers and distributors that supplied products to us. Other competitors include established national, regional and local resellers, systems integrators, telephone systems dealers, computer-telephony value-added resellers and other computer-telephony software suppliers. Management of Growth We have experienced rapid growth that has, and may continue into 2000 to, put strains on our management and operational resources. Our ability to manage growth effectively required it to continue to implement and improve its operational, financial and sales systems, to develop the skills of our managers and supervisors and to hire, train, motivate and manage its employees. With the proceeds of the proposed sale of our Computer Products division, our management and operational resources will be facing new and different challenges, but the need to develop the skills of our managers and supervisors remains unchanged. Regional Concentration For the foreseeable future, we expect that we will continue to derive most of our revenue from customers located within the regions in which we maintain offices. Accordingly, an economic downturn in any of those metropolitan areas within the region in general, would likely have a material adverse effect on our financial condition and results of operations. Dependence on Key Personnel Our success for the foreseeable future will depend largely on the continued services of key members of management, leading salespersons and technical personnel. We do not maintain key personnel life insurance on any of our executive officers or salespersons other than our Chairman and Chief Executive Officer. Our success also depends in part on our ability to attract, hire, train and retain qualified managerial, technical and sales and marketing personnel at a reasonable cost, particularly those involved in providing systems integration, support services and training. Competition for such personnel is intense. Our financial condition and results of operations could be materially adversely affected if we are unable to attract, hire, train and retain qualified personnel. Dependence on Continued Authorization to Resell and Provide Manufacturer-Authorized Services Our future success in both product sales and services depends largely on our continued status as an authorized reseller of products and its continued authorization as a service provider. We maintain sales and service authorizations with many industry-leading product manufacturers. Without such sales and service authorizations, we would be unable to provide the range of products and services currently offered. In addition, some of these agreements are based upon our continued supply relationship with our major distributors. Furthermore, loss of manufacturer authorizations for products that have been financed under our credit facilities constitutes an event of default under such credit facilities. In general, the agreements between us and our product manufacturers either provide for fixed terms or for termination on 30 days prior written notice. Failure to maintain such authorizations could have a material adverse effect on our financial condition and our results of operations. Dependence on Suppliers Our business depends upon our ability to obtain an adequate supply of products and parts at competitive prices and on reasonable terms. Our suppliers are not obligated to have product on hand for timely delivery to us nor can they guarantee product availability in sufficient quantities to meet our demands. Any material disruption in our supply of products would have a material adverse effect on our financial condition and results of operations. Inventory Obsolescence The business in which we compete is characterized by rapid technological change and frequent introduction of new products and product enhancements. Our success depends in large part on our ability to identify and obtain products that meet the changing requirements of the marketplace. There can be no assurance that we will be able to identify and offer products necessary to remain competitive or avoid losses related to obsolete inventory and drastic price reductions. We attempt to maintain a level of inventory required to meet our near term delivery requirements by relying on the ready availability of products from our principal suppliers. Accordingly, the failure of our suppliers to maintain adequate inventory levels of products demanded by our existing and potential customers and to react effectively to new product introductions could have a material adverse effect on our financial condition and results of operations. Reliance on Key Customers Our top ten customers, which have varied from year to year, accounted for 21.2%, 31.7% and 28.4% of our revenue during 1997, 1998 and 1999, respectively. During 1999, our largest customer accounted for 8.3% of total revenues, but in past years the single largest customer has accounted for as much as 11.2% of total revenues. Based upon historical results and our existing relationships with customers, we believe that a substantial portion of our total revenue and gross profit will continue to be derived from sales to existing customers. However, while our revenues will be greatly reduced by the new direction the company is taking, the higher margins generated by the existing divisions along with reductions in overhead association with the proposed sale, should move us toward profitability in 2000. There are no long-term commitments by such customers to purchase products or services from the company. A significant reduction in business with any of our largest customers could have a material adverse effect on our financial condition and results of operations. Reliance on MIS Our success is largely dependent on the accuracy, quality and utilization of the information generated by our customized MIS, which affects our ability to manage our sales, accounting, inventory and distribution. We anticipate that we will continually need to refine and enhance our management information systems as we grow and the needs of our business evolve. We have not yet experienced any serious problems arising from the Year 2000 issue, and therefore do not anticipate any future interruption or errors in our information and telecommunications systems which would have an adverse effect on our financial condition and results of operations. (See Item 1 - "Management Information Systems" and Item 7 - "Year 2000 Issue"). Acquisition Risk We intend to pursue potential acquisitions of complementary businesses. The success of this strategy depends not only upon our ability to acquire complementary businesses on a cost-effective basis, but also upon our ability to integrate acquired operations into our organization effectively, to retain and motivate key personnel and to retain customers of acquired firms. Control by Existing Stockholders James H. Long, founder, Chairman of the Board, President and Chief Executive Officer, owns 50.1% of the outstanding Common Stock and Mr. Long will have the ability to control the election of a majority of the members of our board of directors, prevent the approval of certain matters requiring the approval of at least two-thirds of all stockholders and exert significant influence over our affairs. Anti-Takeover Considerations Our Certificate of Incorporation and Bylaws contain certain provisions that may delay, deter or prevent a change in our control. Among other things, these provisions authorize our board of directors to issue shares of preferred stock on such terms and with such rights, preferences and designations as the board of directors may determine without further stockholder action and limit the ability of stockholders to call special meetings or amend our Certificate of Incorporation or Bylaws. Each of these provisions, as well as the Delaware business combination statute could, among other things, restrict the ability of certain stockholders to effect a merger or business combination or obtain control of the company. Uncertain Revenue Sources In order to maintain a profit, we will have to grow the revenues of the retained business at a much greater rate than we have historically been able to grow those revenues. The relatively high level of operating expenses remaining after the divestiture of Computer Products will contribute to operating losses unless new revenues can be generated to offset the loss of revenues from the businesses that are sold. (See Item 1. "Recent Developments") Absence of Dividends We expect to retain cash generated from operations to support our cash needs and do not anticipate the payment of any dividends on the Common Stock for the foreseeable future. In addition, our credit facilities prohibit the declaration or payment of dividends, unless consent is obtained from each lender. Item 2. Properties FACILITIES We do not own any real property and currently lease all of our existing facilities. We lease our Houston office that is housed in a freestanding building of approximately 48,000 square feet. On November 30, 1999 the building was acquired by a related Corporation and a new lease was signed which expires on December 1, 2004. Our Dallas office has been housed in a freestanding building of approximately 20,000 square feet. The Dallas facility lease expired on June 30, 1998 and was renewed for an additional three years under similar terms and conditions. During 1997, the company added additional offices in Austin and El Paso, Texas and during 1998 we opened an additional office in San Antonio. In 1998 we expanded our distribution capabilities by entering into a three year lease on a 30,000 square foot warehouse in Dallas. The Dallas office and distribution center leases will transfer to the purchaser under the terms of the proposed sale of the Computer Products division we will acquire space nearby to house our IT Service technicians working in the Dallas market. The Austin, San Antonio and El Paso office leases will likewise be assumed by the purchaser. We will find suitable facilities in Austin and San Antonio as needed. Under the terms of the proposed sale the purchaser will also be acquiring the El Paso portion of our IT Service Division. Item 3. Legal Proceedings We are party to litigation and claims which management believes are normal in the course of our operations; while the results of such litigation and claims cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on our results of operations or financial position. On February 1, 2000, a competitor brought a suit against our wholly owned subsidiary Stratasoft, Inc. in the United States District Court for the Northern District of Georgia. The plaintiff alleges infringement of certain patents owned by the competitor and is seeking unspecified monetary damages. The suit is in its early stages of discovery, and therefore we are unable to determine the ultimate costs of this matter. We believe that this suit is without merit and intend to vigorously defend such action. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's shares are traded on the Nasdaq Small Cap Market under the symbol "ALLS". High Low Fiscal 1998 First quarter 5.50 3.875 Second quarter 5.125 3.625 Third quarter 4.125 1.875 Fourth quarter 3.25 1.25 Fiscal 1999 First quarter 2.1875 1.00 Second quarter 2.875 1.0625 Third quarter 1.75 1.0625 Fourth quarter 1.875 1.00 As of March 17, 2000, there were 45 shareholders of record. Management estimates that there are approximately 890 beneficial holders of our common stock. We have never declared or paid any cash dividends on our Common Stock. On March 17, 2000, the closing sales price of our Common Stock as reported by Nasdaq was $ 4.00 per share. We currently anticipate that we will retain all earnings for use in our business operations. The payment of dividends is prohibited under our credit agreements, unless approved by the lenders. Item 6. Selected Financial Data The following sets forth the selected data of the company for the five years ended December 31, 1999.
Year ended December 31, (In Thousands except share and per share amounts) 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- Operating Data: Revenue $ 89,627 $ 116,535 $ 23,764 $ 159,674 $ 201,817 Cost of sales and services 78,734 101,837 107,135 139,866 179,026 -------- -------- -------- -------- -------- Gross profit 10,893 14,698 16,629 19,808 22,791 Selling, general and Administrative expenses 8,496 11,121 12,527 20,659 20,183 -------- -------- -------- -------- -------- Operating income (loss) 2,397 3,577 4,102 (851) 2,608 Interest expense (net of other income) 1,212 1,145 642 319 648 -------- -------- -------- -------- -------- Income (loss) from continuing operations before provision (benefit) for income taxes 1,185 2,432 3,496 (1,170) 1,960 Provision (benefit) for income taxes 452 933 1,305 (382) 686 -------- -------- -------- -------- -------- Net income (loss) from continuing operations 733 1,499 2,191 (788) 1,274 Discontinued Operations: Net income (loss) from discontinued operations, net of taxes (214) 104 (323) (310) (981) Loss on disposal, net of taxes (1,138) Net income (loss) $ 519 $ 1,603 $ 1,844 $ (1,098) $ (845) ======== ======== ======== ========= ======== Net income (loss) per share: Basic Net income (loss) from continuing operations $ 0.17 $ 0.36 $ 0.62 $ (0.18) $ 0.31 Net income (loss) from discontinued operations (0.05) 0.02 (0.10) (0.07) (0.24) Loss on disposal (0.27) -------- -------- -------- -------- -------- Net income (loss) per share $ 0.12 $ 0.38 $ 0.52 $ (0.25) $ (0.20) ======== ======== ======== ======== ======== Diluted Net income (loss) from continuing operations $ 0.17 $ 0.36 $ 0.61 $ (0.18) $ 0.30 Net income (loss) from discontinued operations (0.05) 0.02 (0.09) (0.07) (0.23) Loss on disposal (0.27) -------- -------- -------- -------- -------- Net income (loss) per share $ 0.12 $ 0.38 $ 0.52 $ (0.25) $ (0.20) ======== ======== ======== ========= ========
As of December 31, (In Thousands) 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- Balance Sheet Data: Working Capital $ 1,732 $ 2,291 $ 12,738 $ 9,800 $ 9,567 Total Assets 24,266 24,720 34,855 51,028 53,916 Short-term borrowings (1) 9,912 9,975 1,572 15,958 15,869 Long-term debt -0- -0- -0- -0- -0- Stockholders' equity 2,724 4,327 14,637 12,705 11,830 (1) See Note 6 to our Consolidated Financial Statements. Short-term borrowings do not include amounts recorded as floor plan financing which are included in accounts payable.
The following discussion is qualified in its entirety by, and should be read in conjunction with, our Consolidated Financial Statements, including the Notes thereto, included elsewhere in this Annual Report on Form 10-K. Overview Our company was formed to engage in the business of reselling computer hardware and software products and providing related services. To date, most of our revenue has been derived from sales of computer products and related services. Operations are primarily conducted in Houston and Dallas, Texas. During 1997 we opened offices in Austin, McAllen and El Paso, Texas, and during 1998 opened additional offices in Albuquerque and Las Cruces, New Mexico, and San Antonio, Texas. During 1999 we reevaluated the structure of our operations of the new offices and merged their operations where a physical presence was not necessary, thereby retaining the El Paso, Austin and San Antonio offices, which we believe can effectively serve the targeted markets. Through Telecom Systems, we marketed, installed and serviced business telephone systems, including large PBX systems and small "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. On November 2, 1999, we approved a plan to sell or close our Telecom Systems division. Offers were entertained for the acquisition of a significant portion of the assets of Telecom Systems and to assume any ongoing operations of the division. The sale was finalized on March 16, 2000. Under the terms of the sale we received for the sale of the inventory and operations of Telecom Systems $250,000 cash, and the ability to obtain restricted stock in the purchaser contingent upon the performance of the acquired operations during a period ending six months after the closing date. Additionally, the purchaser assumed all of our telephone equipment warranty obligations up to a maximum of $30,000. Any excess warranty costs incurred by the purchaser will be billed to us at an agreed upon rate. A disposal loss, including an estimate of the operating results from the measurement date, November 2, 1999 to the closing date of the sale of $580,000, and estimates for impairment of assets caused by the disposal decision of $558,000, totaling $1,138,000 (net of an income tax saving of $586,000) was recognized. Our loss from discontinued operations (net of income tax savings of $167,000, $159,000 and $505,000) was $323,000, $310,000 and $981,000 in 1999, 1998 and 1997, respectively. We will retain accounts receivable of $1.4 million, net of reserves, fixed assets of $30,000 and liabilities related to the Telecom division. Fixed assets are being redeployed in the continuing operations. The accounts receivable will be collected in the ordinary course of business and these amounts will be used to repay all remaining liabilities of the Telecom division. Any excess cash will be used to repay our line of credit and fund general corporate purposes. Our continuing operations are reported as three segments and are IT Services, CTI Software and Computer Products. Telecom Systems was reported previously as a segment, accordingly, Telecom Systems has been presented as a discontinued operation for all information presented. The Computer Products and IT Services business units were previously combined and reported as the Information Technology segment during past reporting periods. On March 16, 2000 Allstar entered into an agreement to sell certain assets of and the ongoing operations of its Computer Products division. The sale is expected to close on or before May 31, 2000 after shareholder and other required consents are obtained. The gross margin varies substantially between each of these business segments. Over the past three years the gross margin in IT Services has ranged between 39.3% and 29.5%; the gross margin for CTI Software has ranged between 43.0% to 50.8% and the gross margin in Computer Products has ranged between 8.9% and 10.5%. IT Services, CTI Software and Computer Products accounted for 7.4%, 2.1% and 90.5% of total revenues, respectively, during 1999. In order to reduce freight costs and selling, general and administrative expenses associated with product handling, we drop ship orders directly from our suppliers to our customers where possible. Drop shipped orders (measured as the cost of goods drop shipped as a percentage of total cost of goods sold) were 31.9 % in 1998 and 44.4 % in 1999. While we have not believed that it is in our best interest to drop ship all orders, we have attempted to increase the volume of drop shipments with the expectation of reducing our freight, distribution and administrative costs related to these revenues. A significant portion of our selling, general and administrative expenses relate to personnel costs, some of which are variable and others of which are relatively fixed. Our variable personnel costs are substantially comprised of sales commissions, which are typically calculated based upon our gross profit on a particular sales transaction and thus generally fluctuate with our overall gross profit. The remainder of our 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. Manufacturers of many of the computer products resold by the company have consistently reduced unit prices near the end of a product's life cycle, most frequently following the introduction of newer, more advanced models. While some manufacturers of products sold by us offer to price-protect the inventory carried by us for a certain length of time following a price decrease by the manufacturer, recently many manufacturers have moved to more restrictive price protection policies or have largely eliminated price protection. Additionally, manufacturers have developed specialized marketing programs designed to improve or protect the manufacturer's market share. These programs often involve the granting of rebates to resellers to subsidize sales of computer products at reduced prices. While these programs generally enhance revenues they also generally result in lower margins being realized by the reseller. We have participated in an increasing number of these programs in recent years. Based upon recent trends, we believe that the number and amount of these programs will increase. Inacom Corp. ("Inacom") has historically been the largest supplier of products we sell, but purchases from Inacom have declined recently. Purchases from Inacom accounted for approximately 51.4%, 33.2%, and 17.7% of our total product purchases in 1997, 1998 and 1999, respectively. We have a long-term supply arrangement with Inacom under which we have agreed to purchase at least 80% of our products from Inacom, but only to the extent that such products were available through Inacom and made available within a reasonable period of time at reasonably competitive pricing. Inacom does not carry certain product lines that we sell and Inacom may be unable to offer reasonable product availability with reasonably competitive pricing on those product lines that it does carry. We expect prospectively that less than 80% of our total purchases, as in past years, will be made from Inacom. Results of Operations The following table sets forth, for the periods indicated, certain financial data derived from our consolidated statements of operations and indicates the percentage of total revenue for each item.
Year ended December 31, 1997 1998 1999 Amount % Amount % Amount % (Dollars in thousands) Revenue IT Services $ 10,240 8.3% $ 13,183 8.3% $ 14,857 7.4% CTI Software 2,145 1.7 3,095 1.9 4,318 2.1 Computer Products 111,379 90.0 143,396 89.8 182,642 90.5 ------- ----- ------- ----- ------- ----- Total 123,764 100.0 159,674 100.0 201,817 100.0 Gross profit IT Services 4,029 39.3 4,208 31.9 4,385 29.5 CTI Software 922 43.0 1,492 48.2 2,192 50.8 Computer Products 11,678 10.5 14,108 9.8 16,214 8.9 ------- ----- ------- ----- ------- ----- Total 16,629 13.4 19,808 12.4 22,791 11.3 Selling, general and administrative expenses IT Services 4,005 39.1 5,238 39.7 4,711 31.7 CTI Software 1,096 51.1 1,873 60.5 1,960 45.4 Computer Products 7,426 6.7 13,548 9.4 13,512 7.4 ------- ----- ------- ----- ------- ----- Total 12,527 10.1 20,659 12.9 20,183 10.0 Operating income (loss) IT Services 24 0.2 (1,030) (7.8) (326) (2.2) CTI Software (174) (8.1) (381)(12.3) 232 5.4 Computer Products 4,252 3.8 560 0.4 2,702 1.5 ------- ----- ------- ----- ------- ----- Total 4,102 3.3 (851) (0.5) 2,608 1.3 Interest expense (net of other income) 642 0.5 319 0.2 648 0.3 ------- ----- ------- ----- ------- ----- Income (loss from continuing operations before provision 3,460 2.8 (1,170) (0.7) 1,960 1.0 Provision (benefit) for income taxes 1,293 1.0 (382) (0.2) 686 (0.3) ------- ----- ------- ----- ------- ----- Net income (loss) from continuing operations 2,167 1.8 (788) 0.5 1,274 0.7 Discontinued operations: Income (loss) from discontinued operations, net of taxes (323 (0.3) (310) (0.2) (981) (0.5) Loss on disposal, net of taxes (1,138) (0.6) ------- ----- -------- ----- ------- ----- Net income $ 1,844 1.5% $ (1,098) (0.7)% $ (845) 0.4% ======= ===== ======= ===== ======= ===== (1) Percentages shown in the table above are percentages of total company revenue, except for each individual segment's gross profit, selling, general and administrative expenses, and operating income, which are percentages of the respective segment's revenue.
Year Ended December 31, 1999 Compared to the Year Ended December 31, 1998 (Dollars in thousands) Revenue. Total revenue increased $42,143 (26.4%) to $201,817 in 1999 from $159,674 in 1998. Total 1999 IT Services revenue which comprised 7.4% of total revenues compared to 8.3% in 1998, increased $1,674 (12.7%) to $14,857 in 1999 from $13,183 in 1998. The increase in revenue is attributable to growth in our newer offices and increased sales to existing customers and to new customers. Revenue from CTI Software, which comprised 2.1% of total revenue in 1999, compared to 1.9% in 1998, increased $1,223 (39.5%) to $4,318 in 1999 from $3,095 in 1998. The increased revenues from CTI Software were primarily the result of sales to new customers and the expansion of geographic market. Revenue from Computer Products, which comprised 90.5% of total revenue in 1999 compared to 89.8% in 1998, increased $39,246 (27.4%) to $182,642 in 1999 from $143,396 in 1998. The increase in Computer Products revenue was generally attributable to increased sales of products and services to new and existing customers and to sales generated in our newer branch offices. Of the $39,246 increase in Computer Products revenue, $25,396 (64.7%) resulted from increased sales in our more established offices in Houston and Dallas and $13,850 (35.3%) resulted from sales in our newer offices opened since mid-1997. The increase of $25,396 from the older, more established offices in Houston and Dallas represented an increase of 20.3% to $150,624 in 1999 from $125,228 in 1998. The increase of $13,850 from our newer branch offices represented an increase of 76.2% to $32,018 in 1999 from $18,168 in 1998. Gross Profit. Gross profit increased $2,983 (15.1%) to $22,791 in 1999 from $19,808 in 1998, while gross margin decreased to 11.3% in 1999 from 12.4% in 1998. IT Services gross profit increased by $177 (4.2%) to $4,385 in 1999 compared to $4,208 in 1998. Gross margin rates for IT Services were 29.5% in 1999 as compared to 31.9% in 1998. The increase in gross profit is commensurate with the increase in revenues as discussed above. The gross profit for CTI Software increased by $700 (46.9%) to $2,192 in 1999 from $1,492 in 1998. Gross margin rates for CTI Software were 50.8% in 1999 as compared to 48.2% in 1998. This increase was due primarily to higher revenues coupled with lower system installation costs, relative to revenue, reflecting improved productivity and efficiency due to improved software installation and customization tools introduced in 1998. Gross profit and gross margin in 1998 were affected by asset valuation markdowns of $2,040 in our Computer Products segment related to reducing the carrying value of that segment's inventory and certain vendor accounts receivables. In 1999 we sold at auction some of the inventory which had become aged. In addition, we continued to experience downward pressure on product selling prices from our customers. The gross margin for Computer Products decreased to 8.9% in 1999 from 9.8% in 1998, reflecting the effect of the aforementioned auctions, the downward pressures on pricing, excessive freight costs not passed on to customers and of write-offs of vendor accounts receivable. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $476 (2.3%) to $20,183 in 1999 from $20,659 in 1998. As a percentage of total revenue, selling, general and administrative expenses for continuing operations decreased to 10.0% in 1999 from 12.9% in 1998. The dollar decrease of approximately $476 was attributable to a decrease in Delaware franchise tax of $152 (26.4%) attributable to the restructuring of the authorized stock in 1998 and to reduced property taxes primarily resulting from both appealing the property taxes for the Houston office and to the closing of some of the branch offices opened in 1998. Additionally employee recruiting expenses were reduced by $112 and general office expenses decreased by $137, primarily due to the closing of unprofitable offices, downsizing of certain branch offices and the reduction of certain expense structures. Additionally, we realigned certain operations to eliminate redundancies and improve efficiency. Contract labor costs decreased by $429 (60.4%) due to the conversion to employee status and promotional and advertising expenses were decreased by $452 (221.5%), primarily due to increased vendor co-op funds received in 1999. These savings were offset by an increase in sales commissions of $294 (5.6%) attributable to the increased sales volume, and by and increase in bad debt expense of $326 (127.9%). IT Services' selling, general and administrative expenses decreased $527 (10.1%) to $4,711 in 1999 from $5,238 in 1998. For CTI Software, selling, general and administrative expenses increased $87 (4.6%) to $1,960 from $1,873 in 1998. Selling, general and administrative expenses in Computer Products decreased $36 (0.3%) to $13,512 in 1999 compared to $13,548 in 1998. Operating Income (loss). Operating income increased $3,459 (406.5%) to operating income of $2,608 in 1999 from a loss of $851 in 1998 due primarily to the increase in sales volume of $42,143. Operating income for IT Services increased $704 (68.3%) to an operating loss of $326 in 1999 compared to an operating loss of $1,030 in 1998. For CTI Software, the operating income increased $613 (160.9%) to income of $232 in 1999 from an operating loss of $381 in 1998. Computer Products' operating income increased $2,142 (382.5%) to operating income of $2,702 in 1999 from $560 in 1998. Interest Expense (Net of Other Income). Interest expense (net of other income) increased $329 (103.1%) to $648 in 1999 compared to $319 in 1998. Interest expense was lower in 1998 due to the reduction of outstanding debt resulting from the 1997 stock offering proceeds applied to the reduction of debt. Additionally, increased sales volume in 1999 resulting in higher inventory purchases and accounts receivable levels contributed to higher interest expense in 1999. Net Income (Loss) from continuing operations. Net income (loss) from continuing operations, after an income tax provision totaling $686 (reflecting an effective tax rate of 35.0% for 1999 compared to 32.6% for 1998), became income of $1,274 in 1999 compared to a loss of $788 in 1998. Discontinued operations. On November 2, 1999 we approved a plan to sell or close our Telecom Systems division. A sale of certain assets of the division and its ongoing operations closed on March 16, 2000. As a consequence of these events, the operations of Telecom Systems are reported as discontinued operations. The company experienced a net loss on the operations of the Telecom Division of $981 in 1999, net of a tax benefit of $505 and a loss on disposal of $1,138, net of a tax benefit of $586. The loss on discontinued operations in 1998 was $ 310, net of taxes of $159. Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997 (Dollars in thousands) Revenue. Total revenue increased $35,910 (29.0%) to $159,674 in 1998 from $123,764 in 1997. Total 1998 IT Services revenue consisted of $13,183 (8.3%) as compared to $10,240 (8.3%) , in 1997. Revenue from CTI Software, which comprised 1.9% of total revenue in 1998, compared to 1.7% in 1997, increased $950 (44.3%) to $3,095 in 1998 from $2,145 in 1997. The increased revenues from CTI Software were primarily the result of sales to new customers, the introduction of a new call center software product, the addition of several new resellers for their products and the integration of products with several third-party software products. Revenue from Computer Products, which comprised 89.8% of total revenue in 1998 compared to 90.0% in 1997, increased $32,017 (28.7%) to $143,396 in 1998 from $111,379 in 1997. The increase in Computer Products revenue was generally attributable to increased sales of products and services to new and existing customers and to sales generated in our newer branch offices. Of the $32,017 increase in Computer Product's revenue, $15,898 (49.7%) resulted from increased sales in our more established offices in Houston and Dallas and $16,119 (50.3%) resulted from sales in our newer offices opened since mid-1997. The increase of $15,898 from the older, more established offices in Houston and Dallas represented an increase of 14.6% to $124,851 in 1998 from $108,953 in 1997. The increase of $16,119 from our newer branch offices represented an increase of 785.9% to $18,170 in 1998 from $2,051 in 1997. Gross Profit. Gross profit increased $3,174 (19.1%) to $19,808 in 1998 from $16,629 in 1997, while gross margin decreased to 12.4% in 1998 from 13.4% in 1997. Gross profit and gross margin were affected by asset valuation markdowns of $2,040 in our Computer Products division related to reducing the carrying value of that segment's inventory and certain vendor accounts receivables. We decided that the mark-downs in inventory value were necessary based upon an analysis of the impact of supplier's changes in product return privileges and price protection policies made available by product manufacturers and suppliers. The markdowns related to reducing the carrying value of certain vendor accounts receivables were due to our inability to collect certain accounts related to special promotional funds owed to us from certain of our suppliers. Gross profit for IT Services increased $179 to $4,208 in 1998 from $4,029 in 1997 while gross margins decreased in 1998 to 31.9% from 39.3% in 1997 reflecting pricing pressures. The gross profit for CTI Software increased $570 to $1,492 in 1998 from $922 in 1997 while gross margins increased to 48.2% in 1998 from 43.0% in 1997. This increase was due primarily to lower system installation costs, relative to revenue, reflecting improved productivity and efficiency due to improved software installation and customization tools introduced in 1998. The gross profit for Computer Products decreased to 9.8% in 1998 from 10.5% in 1997, reflecting the effect of the aforementioned asset valuation markdowns Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $8,132 (64.9%) to $20,659 in 1998 from $12,527 in 1997. As a percentage of total revenue, selling, general and administrative expenses increased to 12.9% in 1998 from 10.1% in 1997. The dollar increase of approximately $3,200 was attributable to a 60.7% in sales personnel compensation due to our efforts to expand our sales force, particularly in the newer branch offices, and to increased commissions paid to sales staff resulting from increases in revenue; approximately $2,500 was attributable to a 59.5% increase in compensation to administrative personnel primarily related to the opening of additional offices; and $840 was attributable to a 79.3% increase in rent, utilities and telephone expenses primarily related to operating eight physical branch offices and a regional distribution facility at the end of the 1998 period compared to only three branch offices at the end of 1997. Other costs were generally higher in 1998 compared to 1997 due to opening and operating the additional branch offices and the distribution center and due to increased levels of business activity. Selling, general and administrative expenses in IT Services increased $1,233 (30.8%) to $5,238 in 1998 compared to $4,005 in 1997. For CTI Software, selling, general and administrative expenses increased $777 (70.9%) to $1,873 from $1,096 in 1997. For Computer products, selling, general and administrative expenses increased $6,122 (82.4%) to $13,548 from $7,426. Operating Income (loss). Operating income decreased $4,953 to a loss of $851 in 1998 from a profit of $4,102 in 1997 due primarily to the increase in selling, general and administrative expenses and the effect of the aforementioned asset valuation markdowns. Operating income in IT Services decreased $1,054 to a loss of $1,030 in 1998 from operating income of $24 in 1997. For CTI Software, the operating loss increased $207 (119.0%) to $381 in 1998 from $174 in 1997. For Computer Products, the operating income decreased $3,692 (86.8%) to $560 in 1998 from $4,252 in 1997. Interest Expense (Net of Other Income). Interest expense (net of other income) decreased $323 (50.3%) to $319 in 1998 compared to $642 in 1997. Interest expense decreased in 1998 due to the reduction of outstanding debt resulting from the 1997 stock offering proceeds applied to the reduction of debt. Net Income (Loss) From Continuing Operations. Net income (loss) from continuing operations, after an income tax benefit totaling $382 (reflecting an effective tax rate of 32.6% for 1998 compared to 37.4% for 1997), became a loss of $788 in 1998 compared to a profit of $2,167 in 1997. Discontinued Operations. The loss on discontinued operations was $310 in 1998, net of taxes of $159, as compared to $323 in 1997, net of taxes of $167. Quarterly Results of Operations The following table sets forth certain unaudited quarterly financial information for each of our last eight quarters and, in the opinion of management, includes all adjustments (consisting of only normal recurring adjustments) which the company considers necessary for a fair presentation of the information set forth therein. Our quarterly results may vary significantly depending on factors such as the timing of large customer orders, timing of new product introductions, adequacy of product supply, variations in our product costs, variations in our product mix, promotions, seasonal influences and competitive pricing pressures. Furthermore, we generally have experienced a higher volume of product orders in our computer products business segment in the fourth quarter, which we attribute to year-end capital spending by some of our customers. Any decrease in the number of year-end orders we experience may not be offset by increased revenues in our first three quarters. The results of any particular quarter may not be indicative of results for the full year or any future period.
1998 1999 ------------------------------------- -------------------------------------- First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Revenue IT Services $ 2,892 $ 3,062 $ 3,533 $ 3,696 $ 3,548 $ 3,691 $ 3,591 $ 4,027 CTI Software 826 513 723 1,033 770 825 1,329 1,394 Computer Products 27,752 34,447 38,217 42,980 42,254 44,611 45,961 49,816 ------- ------- ------- ------- ------- ------- ------- ------- Total 31,470 38,022 42,473 47,709 46,572 49,127 50,881 55,237 Cost of sales and services IT Services 1,917 2,025 2,406 2,627 2,531 2,479 2,415 3,047 CTI Software 515 278 319 491 331 413 623 759 Computer Products 24,400 30,556 33,733 40,599 38,419 41,001 41,793 45,215 ------- ------- ------- ------- ------- ------- ------- ------- Total 26,832 32,859 36,458 43,717 41,281 43,893 44,831 49,021 Gross Profit IT Services 975 1,037 1,127 1,069 1,017 1,212 1,176 980 CTI Software 311 235 404 542 439 412 706 635 Computer Products 3,352 3,891 4,484 2,381 3,835 3,610 4,168 4,601 ------- ------- ------- ------- ------- ------- ------- ------- Total 4,638 5,163 6,015 3,992 5,291 5,234 6,050 6,216 Selling, general and administrative expenses IT Services 972 1,212 1,452 1,602 1,136 1,227 1,201 1,147 CTI Software 374 450 395 654 497 448 524 491 Computer Products 2,662 3,219 3,615 4,052 3,459 3,345 3,237 3,471 ------- ------- ------- ------- ------- ------- ------- ------- Total 4,008 4,881 5,462 6,308 5,092 5,020 4,962 5,109 Operating income (loss) IT Services 3 (175) (325) (533) (119) (15) (25) (167) CTI Software (63) (215) 9 (112) (58) (36) 182 144 Computer Products 690 672 869 (1,671) 376 265 931 1,130 ------- ------- ------- ------- ------- ------- ------- ------- Total 630 282 553 (2,316) 199 214 1,088 1,107 Interest expense (net of other income) 21 44 88 166 222 183 169 74 ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes 609 238 465 (2,482) (23) 31 919 1,033 Provision (benefit) for income taxes 219 98 166 (865) 1 25 306 354 ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss) from continuing operations 390 140 299 (1,617) (24) 6 613 679 Discontinued operations: Net income (loss) from discontinued operations, net of tax (266) 130 (212) 38 (30) (376) (281) (294) Loss on disposal (1,138) ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss) $ 124 $ 270 $ 87 $ (1,579) $ (54) $ (370) $ 332 $ (753) ======= ======= ======= ======= ======= ======= ======= ======= Net Income (loss) per share: Basic: Continuing Operations $ 0.09 $ 0.03 $ 0.07 $ (0.38) $ (0.01) $ 0.01 $ 0.15 $ 0.16 Discontinued Operations (0.06) 0.03 (0.05) 0.01 (0.01) (0.09) (0.07) (0.07) Loss on Disposal (0.27) ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss) per share $ 0.03 $ 0.06 $ 0.02 $ (0.37) $ (0.02) $ (0.08) $ 0.08 $ (0.18) ======= ======= ======= ======= ======= ======= ======= ======= Diluted: Continuing Operations $ 0.09 $ 0.03 $ 0.07 $ (0.38) $ (0.01) $ 0.01 $ 0.14 $ 0.16 Discontinued Operations (0.06) 0.03 (0.05) 0.01 (0.01) (0.09) (0.06) (0.07) Loss on Disposal (0.27) ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss) per share $ 0.03 $ 0.06 $ 0.02 $ (0.37) $ (0.02) $ (0.08) $ 0.08 $ (0.18) ======= ======= ======= ======= ======= ======= ======= =======
Liquidity and Capital Resources Historically, we have satisfied our cash requirements principally through borrowings under our lines of credit and through operations. We maintain a cash position sufficient to pay only our immediately due obligations and expenses. When the amount of cash available falls below our immediate needs we request an advance under our credit facility. As our total revenue has grown, we have obtained increases in our available lines of credit to enable us to finance our growth. Our working capital was $12,738, $9,800 and $9,567 at December 31, 1997, 1998 and 1999, respectively. The decreases in working capital during 1999 and 1998 were primarily attributable to increases in our accounts payable as a result of product costs attributable to our revenue growth. At December 31, 1999 we had outstanding borrowings of $30,129. Our total collateral base was $30,462 at December 31, 1999, of which $1,952 is available to borrow from our secondary lenders and $1,620 is payable to the primary lender. Such amount was paid from existing cash balances in January 2000. At December 31, 1999, we had a $30,000 credit facility with our primary lender. As of December 31, 1999, we were fully borrowed against our available borrowing based due to the higher level of business during the fourth quarter. Cash Flows Operating activities provided net cash totaling $2,086 and $2,612 during 1997 and 1999, respectively, and used net cash totaling $10,831 during 1998. During 1997, net cash was provided from operations due primarily to net income, increased levels of trade accounts payable and accrued expenses which more than offset increases in accounts receivable. During 1998, net cash was used by operations due primarily to a net loss, a large increase in accounts receivable and an increase in inventory, which was offset somewhat by an increase in accounts payable and accrued expenses. During 1999 net cash provided by operations resulted from increases in accounts payable which offset our increase in accounts receivable. Accounts receivable increased $8,999, $9,377 and $3,138 during 1997, 1998 and 1999, respectively. Inventory decreased $162 and $516 in 1997 and 1999, respectively, and increased $3,797 in 1998. Investing activities used cash totaling $992, $1,764 and $276 during 1997, 1998 and 1999, respectively. Our investing activities that used cash during these periods were primarily related to capital expenditures related to new offices, an expanded work force and upgrading of computing equipment and our management information systems. During the next twelve months, we do not expect to incur material capital expenditures. Financing activities provided cash totaling $258, $13,552 and used cash totaling $227 during 1997,1998 and 1999, respectively. In July 1997, we received $8,661 net proceeds from the sale of Common Stock in a public offering. Those proceeds were used to reduce the outstanding balance under our line of credit. The primary source of cash from financing activities in other periods has been borrowings on our lines of credit. The lines of credit have been used principally to satisfy our cash requirements, including financing increases in accounts receivable and inventory. During 1998 and 1999 we used $834 and $138, respectively to repurchase shares that were held in treasury at the end of 1999. Asset Management Our cash flow from operations has been affected primarily by the timing of its collection of accounts receivable. We have typically sold our products and services on short-term credit terms and seek to minimize our credit risk by performing credit checks and conducting our own collection efforts. We had accounts receivable, net of allowance for doubtful accounts of $34,893 and $37,726 at December 31, 1998 and 1999, respectively. The number of days' sales outstanding in trade accounts receivable was 60 days, 67 days and 66 days for years 1997, 1998 and 1999, respectively. The increase in days' sales outstanding in 1998 was caused by a general slow down in payments by our customers. Bad debt expense as a percentage of total revenue for the same periods was 0.2%, 0.2% and 0.2% Our allowance for doubtful accounts, as a percentage of accounts receivable, was 1.0%, 1.0% and 1.0% at December 31, 1997, 1998 and 1999, respectively. We attempt to manage our inventory in order to minimize the amount of inventory held for resale and the risk of inventory obsolescence and decreases in market value. We attempt to maintain a level of inventory required to reach only our near term delivery requirements by relying on the ready availability of products from our principal suppliers. Manufacturers of our major products have in the past generally provided price protection, which reduces our exposure to decreases in prices, but during 1998 most major product manufacturers reduced or largely eliminated price protection. Our suppliers generally allow for some levels of returns of excess inventory, which, on a limited basis, are made without material restocking fees. During 1998, our suppliers generally became more restrictive in their policies regarding product return privileges. Inventory turnover for 1997, 1998 and 1999 was 21.5 times, 22.0 times, and 22.5 times, respectively. Credit Facilities On February 27, 1998 we executed agreements with Deutsche Financial Services ("DFS") for a revolving line of credit (the "DFS Facility") which is our principal source of liquidity. We have a credit facility with IBM Credit Corporation ("IBMCC") for the purchase of IBM branded computer products (the "IBMCC Facility"). The total credit available under the DFS Facility is $30,000, 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 $20,000. Available credit under the DFS Facility, net of Inventory Line advances, is $10,000, which we use 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 our inventory vendors directly, generally in exchange for negotiated financial incentives. Typically, the financial incentives received are such that DFS does not charge us interest until 40 days after the transaction is financed, at which time we are 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 DFS Facility is 7.0%. DFS may change the computation of the borrowing base and disqualify accounts receivable upon which advances have been made and require repayment of such advances to the extent such disqualifications cause our borrowings to exceed the reduced borrowing base. The DFS Facility is collateralized by a security interest in substantially all of our assets, including its accounts receivable, inventory and bank accounts. Collections of our 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 we are in compliance with our debt to tangible net worth covenant, we have discretion over the use and application of the funds collected in the lockbox. If we exceed that financial ratio, DFS may require that lockbox payments be applied to reduce our indebtedness to DFS. If in the future DFS requires that all lockbox payments be applied to reduce our indebtedness, we would be required to seek funding from DFS or other sources to meet substantially all of our cash needs. The DFS agreement contains restrictive covenants which, among other things, require specific ratios of current assets to current liabilities and debt to tangible net worth and require us to maintain a minimum tangible net worth. The terms of the agreement also prohibits the payment of dividends and other similar expenditures, including advances to related parties. The IBMCC Facility is a $2,000 credit 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 amount of the invoice for inventory financed through IBMCC is required to be paid. 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 and prohibits payment of dividends. At December 31, 1999, we had $30,080 and $48 outstanding on the DFS Facility and the IBMCC Facility, respectively. A payment was made in January 2000 to comply with the borrowing base limitations under the DFS Facility. Year 2000 Issue The Year 2000 issue is the result of computer programs using two digits to define the applicable year. These programs were designed without consideration for the effect of the change in century and if not corrected could have failed or created erroneous results at the turn of the century. Essentially all the company's MIS were potentially affected by the Year 2000 issue. In order to prepare for the Year 2000 issue we implemented the following remediation plan for our MIS: (1) Identification of all applications and hardware with potential Year 2000 issues. (2) For each item identified, perform an assessment to determine an appropriate action plan and timetable for remediation of each item. (3) Implementation of the specific action plan. (4) Test each application upon completion. (5) Place the new process into production and conduct system integration testing. We successfully implemented the above remediation plan for all affected MIS. Following the arrival of the Year 2000 we experienced no significant problems with any of our systems as a result of the Year 2000 issue. There was no interruption in our ability to transact business with suppliers and customers. We continue to monitor our systems, suppliers and customers for any unanticipated issues that may not have been manifested yet. The implementation of the remediation plan was entirely funded from operations. We estimate that we incurred approximately $300 in expenses during 1998 and 1999 related to the Year 2000 issue. Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Management is evaluating what impact, if any, and additional disclosures may be required when this statement is adopted. In March 1998, the Accounting Standards Committee ("AcSEC") issued Statement of Position ("SOP") No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This Statement provides guidance on accounting for costs of computer software developed or obtained for internal use. SOP No. 98-1 is effective for fiscal years beginning after December 15, 1998. In April 1998, SOP N0. 98-5, Reporting on the Costs of Start-Up Activities, was issued by AcSEC. This Statement provides guidance on determining what constitutes a start-up activity and requires that the costs of these start-up activities be expensed as incurred. We have implemented these two Statements in the year ending December 31, 1999. Item 7A. Quantitative and Qualitative Disclosures about Market Risk We incur certain market risks related to interest rate variations because we hold floating rate debt. Based upon the average amount of debt outstanding during 1999, a one-percent increase in interest rates paid by us on our debt would have resulted in an increase in interest expense of approximately $135 for the year. Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Financial Statements: Independent Auditors' Report 26 Consolidated Balance Sheets at December 31, 1998 and 1999 27 Consolidated Statements of Operations for the years ended December 31, 1997, 1998 and 1999 28 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999 29 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999 30 Notes to Consolidated Financial Statements for the years ended December 31, 1997, 1998 and 1999 31 INDEPENDENT AUDITORS' REPORT To the Stockholders of Allstar Systems, Inc.: We have audited the accompanying consolidated balance sheets of Allstar Systems, Inc. and subsidiaries ("Allstar") as of December 31, 1998 and 1999, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the index at Item 14(a)(2). These financial statements and financial statement schedule are the responsibility of Allstar's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Allstar at December 31, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP Houston, Texas March 17, 2000 ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1999 (In thousands, except share and par value amounts) ASSETS 1998 1999 Current Assets: Cash and cash equivalents $ 2,538 $ 4,647 Accounts receivable, net 34,893 37,726 Accounts receivable - affiliates 373 423 Inventory 8,497 7,442 Deferred taxes 431 836 Income taxes receivable 637 Other current assets 559 384 --------- --------- Total current assets 47,928 51,458 Property and equipment, net 2,902 2,280 Other assets 198 178 --------- --------- $ 51,028 $ 53,916 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable $ 15,958 $ 15,869 Accounts payable 16,641 21,687 Accrued expenses 5,273 3,896 Net liabilities related to discontinued operations 199 Deferred service revenue 256 240 --------- --------- Total current liabilities 38,128 41,891 Deferred credit - stock warrants 195 195 Commitments and Contingencies (See Note 11) Stockholders' Equity: Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued Common stock, $.01 par value, 15,000,000 shares authorized, 4,503,411 and 4,442,325 issued at December 31, 1998 and 1999, respectively 45 44 Additional paid in capital 10,196 10,037 Unearned equity compensation (269) (1) Treasury stock, at cost, 271,200 and 381,800 shares at (834) (972) December 31, 1998 and 1999, respectively Retained earnings 3,567 2,722 --------- --------- Total stockholders' equity 12,705 11,830 --------- --------- $ 51,028 $ 53,916 ========= ========= See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (In thousands, except share and per share amounts) Years ended December 31 ---------------------------------------------- 1997 1998 1999 Total revenue $ 123,764 $ 159,674 $ 201,817 Cost of goods and services 107,135 139,866 179,026 ------------ ------------ ------------ Gross profit 16,629 19,808 22,791 Selling, general and administrative expenses 12,527 20,659 20,183 ------------ ------------ ------------ Operating income (loss) 4,102 (851) 2,608 Interest expense (net of other income) 642 319 648 ------------ ------------ ------------ Income (loss) from continuing operations before provision (benefit) for income taxes 3,460 (1,170) 1,960 Provision (benefit) for income taxes 1,293 (382) 686 ------------ ------------ ------------ Net income (loss) from continuing operations 2,167 (788) 1,274 Discontinued operations: Net loss from discontinued operations, net of taxes (323) (310) (981) Loss on disposal, net of taxes (1,138) ------------ ------------ ------------ Net income (loss) $ 1,844 $ (1,098) $ (845) ============ ============ ============ Net income (loss) per share: Basic: Net income (loss) from continuing operations $ 0.62 $ (0.18) $ 0.31 Net loss from discontinued operations (0.10) (0.07) (0.24) Loss on disposal (0.27) ------------ ------------ ------------ Net loss per share $ (0.52) $ (0.25) $ (0.20) ============ ============ ============ Diluted: Net income (loss) from continuing operations $ 0.61 $ (0.18) $ 0.30 Discontinued operations (0.09) (0.07) (0.23) Loss on disposal (0.27) ------------ ------------ ------------ Net loss per share $ (0.52) $ (0.25) $ (0.20) ============ ============ ============ Weighted average number of shares outstanding: Basic 3,519,821 4,345,883 4,168,140 ============ ============ ============ Diluted 3,526,787 4,345,883 4,226,911 ============ ============ ============ See motes to consolidated financial statements
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (In thousands, except share and per share amounts) $.01 par value Additional Unearned Common Stock Paid-In Treasury Equity Retained Shares Amount Capital Stock Compensation Earnings Total Balance at January 1, 1997 2,675,000 $ 27 $ 1,479 $ 2,821 $ 4,327 Sale of common stock, net of initial public offering expenses of $2,040 on conversion 1,765,125 18 8,448 8,466 Issuance of restricted stock 14,286 86 $ (86) Net income 1,844 1,844 ---------- ------ --------- ------- -------- -------- ------- Balance at December 31, 1997 4,454,411 45 10,013 (86) 4,665 14,637 Issuance of restricted stock 63,500 237 (237) Cancellation of restricted stock (14,500) (54) 54 Purchase of treasury stock (271,200) $ (834) (834) Net loss (1,098) (1,098) ---------- ------ --------- -------- -------- -------- ------- Balance at December 31, 1998 4,232,211 45 10,196 (834) (269) 3,567 12,705 Cancellation of restricted stock (61,086) (1) (159) 268 108 Purchase of treasury stock (110,600) (138) (138) Net loss (845) (845) ---------- ------ --------- ------- -------- -------- ------- Balance at December 31, 1999 4,060,525 $ 44 $ 10,037 $ (972) $ (1) $ 2,722 $ 11,830 ========== ====== ========= ======= ======== ======== ======= See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (In thousands, except share and per share amounts) Years ended December 31 ---------------------------------------------- 1997 1998 1999 CASH FLOW FROM OPERATING ACTIVITIES: Net Income (loss) from continuing operations $ 2,167 $ (788) $ 1,274 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Gain on disposal of assets (7) Depreciation and amortization 623 882 840 Deferred tax provision 138 (219) Changes in assets and liabilities that provided (used) cash: Accounts receivable, net (8,999) (9,377) (3,138) Accounts receivable - affiliates (294) 61 (50) Inventory 162 (3,797) 516 Income taxes receivable (637) 637 Other current assets (144) (241) 175 Other assets 311 (117) (30) Accounts payable 7,817 2,079 5,046 Accrued expenses 806 1,708 (523) Income taxes payable (124) (82) Deferred service revenue (54) 14 (16) ------------ ------------ ------------ Net cash provided by (used in) operating activities 2,409 (10,521) 4,731 Net operating activities from discontinued operations (323) (310) (2,119) ------------ ------------ ------------ Net cash provided by (used in) operating activities 2,086 (10,831) 2,612 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (992) (1,774) (276) Proceeds from sale of fixed assets 10 ------------ ------------ ------------ Net cash used in investing activities (992) (1,764) (276) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Purchase of treasury stock (834) (138) Net proceeds on sale of common stock 8,661 Net increase (decrease) in notes payable (8,403) 14,386 (89) ------------ ------------ ------------ Net cash provided by (used in) financing activities 258 13,552 (227) ------------ ------------ ------------ NET INCREASE CASH AND CASH EQUIVALENTS 1,352 957 2,109 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 229 1,581 2,538 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,581 $ 2,538 $ 4,647 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 958 $ 403 $ 989 ============ ============ ============ Cash paid for income taxes $ 1,032 $ 397 $ ============ ============ ============ See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (In thousands, except share and per share amounts) 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Allstar Systems, Inc. and subsidiaries ("Allstar") is engaged in the sale and service of computer and telecommunications hardware and software products in the United States. 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 which underlie the credit arrangements which are used for working capital (see Note 6). Allstar's significant accounting policies are as follows: Principles of Consolidation - The accompanying consolidated financial statements include the accounts of Allstar Systems, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Inventory - Inventory consists primarily of personal computers and components and is valued at the lower of cost or market with cost determined on the first-in first-out method. Property and Equipment - Property and equipment are recorded at cost. Expenditures for repairs and maintenance are charged to expense when incurred, while expenditures for betterments are capitalized. Disposals are removed at cost less accumulated depreciation with the resulting gain or loss reflected in operations in the year of disposal. Property and equipment are depreciated over their estimated useful lives ranging from five to ten years using the straight-line method. Depreciation expense totaled $620, $833 and $790 for the years ended December 31, 1997, 1998 and 1999, respectively. Impairment of Long-Lived Assets - Allstar records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Income Taxes- Allstar accounts for income taxes under the liability method, which requires, among other things, recognition of deferred income tax liabilities and assets for the expected future tax consequences of events that have been recognized in Allstar's consolidated financial statements or tax returns. Under this method, deferred income tax liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities and the recognition of available tax carryforwards. Earnings per Share - In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," basic net income per share is computed on the basis of the weighted-average number of common shares outstanding during the periods. Diluted net income per share is computed based upon the weighted-average number of common shares plus the assumed issuance of common shares for all potentially dilutive securities using the treasury stock method (See Note 13). Revenue Recognition - Revenue from the sale of computer products is recognized when the product is shipped. Service income is recognized ratably over the service contract life. Revenues resulting from installations of equipment for which duration is in excess of three months are recognized using the percentage-of-completion method. The percentage of revenue recognized on each contract is based on the most recent cost estimate available. Revisions of estimates are reflected in the period in which the facts necessitating the revisions become known; when a contract indicates a loss, a provision is made for the total anticipated loss. At December 31, 1998, Allstar had $3,682 of such contracts in progress of which $1,567 of revenue had not been recognized along with $826 of cost related to those revenues. At December 31, 1999, Allstar had $1,524 of such contracts in progress of which $717 of revenue had not been recognized along with $400 of costs related to those revenues. Costs and estimated earnings in excess of billings on uncompleted contracts are included within the heading account receivable, net on the consolidated balance sheets. Research and Development Costs - Expenditures relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed as incurred. The amounts charged to expense were approximately $200 in the years ended December 31, 1997, 1998 and 1999, respectively. Employee Stock Based Compensation- Allstar recognizes compensation expense for stock options and other stock based employee compensation plans based on the intrinsic value of the equity instrument at the measurement date (See Note 12). Comprehensive Income- In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements and is effective for fiscal years beginning after December 15,1997. Allstar adopted SFAS No.130 in the year ended December 31, 1998. Allstar had no comprehensive income items to report for all periods presented. Segment Information- Allstar follows the provisions of SFAS No.131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 changes the way companies report selected segment information in annual financial statements and requires the companies to report selected segment information in interim financial reports to stockholders. See Note 14 for segment information. Recently Issued Accounting Standards- In June 1998, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivatives and Hedging Activities" which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Management is currently evaluating what, if any, additional adjustment or disclosure may be required when this statement is adopted. In March 1998, the Accounting Standards Committee ("AcSEC") issued Statement of Position ("SOP") No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This Statement provides guidance on accounting for costs of computer software developed or obtained for internal use. SOP No. 98-1 is effective for fiscal years beginning after December 15, 1998. In April 1998, SOP No. 98-5, Reporting on the Costs of Start-Up Activities, was issued by AcSEC. This Statement provides guidance on determining what constitutes a start-up activity and requires that the costs of these start-up activities be expensed as incurred. These two Statements were implemented by Allstar on January 1, 1999. The adoption of SOP P98-1 and SOP 98-5 did not have a material impact on the Company's financial position or results of operations. Fair Value of Financial Instruments - Allstar's financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable and notes payable for which the carrying values approximate fair values given the short-term maturity of the instruments. It is not practicable to estimate the fair values of related-party receivables due to the nature of the instruments. Cash and Cash Equivalents - Cash and cash equivalents include any highly liquid debt instruments with maturity of three months or less when purchased. 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. Reclassifications - The accompanying consolidated financial statements for the years presented have been reclassified to give retroactive effect to certain changes in presentation. 3. DISCONTINUED OPERATIONS On November 2, 1999, Allstar approved a plan to sell or close its Telecom division. This is the measurement date. Allstar entertained offers to acquire a significant portion of the assets of the Telecom division and to assume any ongoing operations of the division. A sale was finalized on March 16, 2000. Under the terms of the sale Allstar received $250 cash, and the ability to obtain restrictive stock in the purchaser contingent upon the performance of the acquired operations during a period ending six months after the closing date. Additionally, the purchaser assumed all telephone equipment warranty obligations of Allstar up to a maximum of $30. Any excess warranty costs incurred by the purchaser will be billed to Allstar at an agreed upon rate. A disposal loss, including an estimate of the operating results from the measurement date, November 2, 1999 to the closing date of the sale of $580, and estimates for impairment of assets caused by the disposal decision of $558, totaling $1,138 (net of income tax savings of $586), was recognized. The disposal loss includes an operating loss of $284 (net of income tax savings of $146) from the measurement date to December 31, 1999. Pretax loss from discontinued operations (net of tax savings of $167, $159 and $505) was $323, $310, and $981 in 1997, 1998 and 1999 respectively. Allstar will retain accounts receivable of approximately $1,400, net of reserves, fixed assets of $30 and liabilities related to the Telecom division. Fixed assets are being redeployed in the continuing operations. The balance sheet caption "Net liabilities related to discontinued operations" includes $250 of net inventory not retained and $449 of estimated operating losses for the period from January 1, 2000 through the disposal date of March 16, 2000. Revenue for the Telecom division for the years ended December 31, 1997, 1998 and 999 was $5,403, $7,499 and $3,975, respectively. The Company allocates interest expense to its various divisions on a proportional basis based on accounts receivable. Interest expense allocated to the Telecom division for the years ended December 31, 1997 and 1998 and for the period from January 1, 1999 to November 2, 1999 was $55, $32, and $69, respectively. The Company has allocated interest expense from November 2, 1999 to the disposal date of March 16, 2000 of $20 both of which are included in the loss on disposal. 4. ACCOUNTS RECEIVABLE Accounts receivable consisted of the following at December 31, 1998 and 1999: 1998 1999 Accounts receivable $ 31,547 $ 35,929 Accounts receivable retained - Telecom 3,704 2,025 Allowances for doubtful accounts (358) (228) --------- -------- Total $ 34,893 $ 37,726 ========= ======== 5. PROPERTY AND EQUIPMENT Property and equipment consisted of the following at December 31, 1998 and 1999: 1998 1999 Equipment $ 502 $ 512 Computer equipment 4,218 4,067 Furniture and fixtures 442 507 Leasehold improvements 138 203 Vehicles 27 27 --------- -------- 5,327 5,316 Accumulated depreciation and amortization (2,425) (3,036) --------- -------- Total $ 2,902 $ 2,280 ========= ======== 6. CREDIT ARRANGEMENTS On February 27, 1998 Allstar entered into a credit agreement with a commercial finance company. The total credit available under the credit facility is $30,000, 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 facility for floor plan financing of inventory from approved manufacturers (the "Inventory Line") is $20,000. Available credit under the facility, net of Inventory Line advances, is $10,000, which is used by Allstar 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 interest accrues at prime rate, which for purposes of this agreement will not fall below 7.0%, plus 5.0% for outstanding balances over 40 days. At December 31, 1999, Allstar had $30,080 outstanding on the Inventory Line and Accounts Line, respectively, and was overdrawn on its available credit. A payment was made in January 2000 to comply with the borrowing base limitations. This agreement, which continues in full force and effect for 36 months or until terminated by 30 day written notice from the lender and may be terminated upon 90 days notice by Allstar, subject to a termination fee, is collateralized by substantially all of Allstar's assets. The agreement contains restrictive covenants which, among other things, require specific ratios of current assets to current liabilities and debt to tangible net worth and require Allstar to maintain a minimum tangible net worth. The terms of the agreement also prohibit the payment of dividends and limit the purchase of Allstar common stock, and other similar expenditures, including advances to related parties. Allstar also maintains a $2,000 revolving credit line with another commercial finance company to floor plan inventory. This line of credit accrues interest at prime (but not less than 6.5%) plus 6% for all outstanding balances over 30 days. At December 31, 1999 Allstar had $1,952 credit available under this line of credit. The combined borrowing base under all credit arrangements was $30,462 at December 31, 1999. The weighted-average interest rate for borrowings under all credit arrangements in effect during 1997, 1998 and 1999 was 10.50%, 7.53%, and 7.13% respectively. Interest expense was $761, $441 and $969 for the years ended December 31, 1997, 1998 and 1999 respectively. 7. INCOME TAXES The provision for income taxes for the years ended December 31, 1997, 1998 and 1999 consisted of the following:
1997 1998 1999 ---- ---- ---- Current provision (benefit): Federal $ 1,015 $ (166) $ 686 State 140 3 ------ ------ ------ Total current provision 1,155 (163) 686 Deferred provision (benefit) 138 (219) ------ ------ ------ Total provision (benefit) from continuing operations 1,293 (382) 686 Total benefit from discontinued operations (167) (159) (505) Total benefit from loss on disposal (586) ------ ------ ------ Total $ 1,126 $ (541) $ (405) ====== ====== ======
The total provision for income taxes during the years ended December 31, 1997, 1998 and 1999 varied from the U.S. federal statutory rate due to the following:
1997 1998 1999 ---- ---- ---- Federal income tax at statutory rate $ 1,176 $ (398) $ 665 Nondeductible expenses 24 26 21 State income taxes 140 3 Other (47) (13) ------ ------ ------ Total provision (benefit) from continuing operations $ 1,293 $ (382) $ 686 ====== ====== ======
Net deferred tax assets computed at the statutory rate related to temporary differences at December 31, 1998 and December 31, 1999 were as follows: 1998 1999 Net deferred tax assets: Accounts receivable $ 242 $ 172 Closing and severance costs 60 76 Deferred service revenue 62 (41) Inventory 67 43 Net operating loss carryforwards 586 --------- -------- Total current deferred tax assets $ 431 $ 836 ========= ======== At December 31, 1999, Allstar had approximately $1,724 of net operating loss carry forwards that expire in 2014. 8. ACCRUED EXPENSES Accrued liabilities consisted of the following as of December 31, 1998 and 1999: 1998 1999 ---- ---- Sales tax payable $ 2,253 $ 1,530 Accrued employee benefits, payroll and other related costs 1,736 1,506 Accrued interest 94 1 Other 1,190 859 ------ ------ Total $ 5,273 $ 3,896 ======== ======= 9. FRANCHISE FEES Allstar entered into an agreement in August 1996 in which Allstar is required to purchase at least 80% of its computer products from Inacom Corp. if such are available within a reasonable period of time at reasonably competitive prices. The agreement expires on December 31, 2001 and automatically renews for successive one-year periods. A cancellation fee of $571 will be payable by Allstar in the event of non-renewal or early termination of the agreement by either party; however, Allstar does not anticipate termination to occur by either party prior to the initial termination date. Allstar is accruing this cancellation fee over the initial agreement period by an approximate $9 monthly charge to earnings. For the years December 31, 1997, 1998 and 1999, Allstar charged to expense $105, respectively, related to this agreement. 10. SHAREHOLDERS' EQUITY In October 1996, Allstar completed a reincorporation in order to change its state of domicile to Delaware, to authorize 50,000,000 shares of $.01 par value common stock and to authorize 5,000,000 shares of $.01 par value preferred stock. During 1998 the shareholders of Allstar approved a reduction in the number of authorized shares of common stock from 50,000,000 to 15,000,000. Allstar's Board of Directors (the "Board") authorized the purchase of common stock of Allstar from time to time in the open market to be held in treasury for the purpose of, but not limited to, fulfilling any obligations arising under Allstar's stock option plans. At December 31, 1999, 381,800 shares were held in treasury under these authorizations. Allstar issued 14,286, 63,500 and 1,000 common shares of restricted stock in 1997, 1998 and 1999, respectively, and cancelled 14,500 and 62,086 common shares of restricted stock during 1998 and 1999, respectively. The restricted shares have par value of $0.01 per share. The remaining 2,200 shares, valued at $8, vest ratably at the end of each one year period over a five year period from the date of issuance. During 1997, Allstar issued warrants to purchase 176,750 common shares at $9.60 per share to underwriters in connection with a public offering of common stock. The warrants expire on July 7, 2002. During 1999, Allstar purchased 110,600 shares of treasury stock at a cost of $138,253. 11. COMMITMENTS AND CONTINGENCIES Operating Leases - Allstar subleases office space from Allstar Equities, Inc. ("Equities"), which is wholly owned by the principal stockholder of Allstar. In 1999, Allstar renewed its office sublease with monthly rental payments of $32 in 1997, $33 in 1998 and $38 in 1999 plus certain operating expenses through December 1, 2004. Rental expense under this agreement amounted to approximately $378, $390 and $395 during years ended December 31, 1997, 1998 and 1999, respectively. Additionally, minimum annual rentals on other operating leases amount to approximately, $927 in 2000, $708 in 2001, $691 in 2002, $643 in 2003, $571 in 2004 and $514 in years thereafter. Amounts paid during the years ended December 31, 1997, 1998 and 1999 under such agreements totaled approximately $142, $509 and $766 respectively. Benefit Plans - Allstar maintains a group medical and hospitalization insurance program under which Allstar pays employees' covered health care costs. Any claims exceeding $30 per employee or a cumulative maximum of approximately $577 per year are insured by an outside insurance company. Allstar's claim and premium expense for this self-insurance program totaled approximately, $684, $581, and $521 for the years ended December 31, 1997, 1998, and 1999, respectively. Allstar maintains a 401(k) savings plan wherein Allstar matches a portion of the employee contribution. In addition, Allstar has a discretionary matching fund based on the net profitability of Allstar. All full-time employees who have completed 90 days of service with Allstar are eligible to participate in the plan. Declaration of the discretionary portion of the matching fund is the decision of the Board. Allstar has made no additional contributions to the plan for the years ended December 31, 1997, 1998, or 1999. Under the standard Allstar matching program, Allstar's match was $24, $45 and $64 for the years ended December 31, 1997, 1998 and 1999, respectively. 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 material adverse effect on its results of operations or financial position. On February 1, 2000, a competitor brought a suit against Allstar Systems, Inc, and its wholly owned subsidiary Stratasoft, Inc. in the United States District Court for the Northern District of Georgia. The plaintiff alleges infringement of certain patents owned by the competitor and is seeking unspecified monetary damages. The suit is in its early stages of discovery, and therefore Allstar is unable to determine the ultimate costs of this matter. Management of Allstar believes that this suit is without merit and intends to vigorously defend such action. 12. STOCK OPTION PLANS Under the 1996 Incentive Stock Plan (the "Incentive Plan"') and the 1996 Non-Employee Director Stock Option Plan (the "Director Plan"). Allstar's Compensation Committee may grant up to 442,500 shares of common stock, which have been reserved for issuance to certain employees of Allstar. At December 31, 1999 21,268 shares were available for future grant under the Incentive Plan. 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 of which 63,000 were available for future grants at December 31, 1999. 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. During 1997, 1998 and 1999 Allstar granted options to purchase 20,000, 8,000 and 9,000 common shares to its directors, respectively, which vest immediately, and 180,300, 129,850 and 216,872 common shares to its employees, respectively, which vest over five years. Employees effected by the sale of the Telecom division (See Note 3) and the proposed sale of the Computer Products division (See Note16) will generally become vested in stock options held at the transaction close or two years from the date of grant. The plan's activity is summarized below:
1997 1998 1999 ---- ---- ---- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price Options outstanding at January 1 200,300 $ 5.17 200,300 $ 5.17 268,350 $ 1.63 Granted during the year 137,850 3.13 225,872 1.15 Exercised during the year Options canceled for repricing (260,350) 4.25 Option granted at new price 260,350 1.50 Canceled during the year (69,800) 4.50 (35,990) 1.45 -------- ------- -------- ------- Options outstanding at December 31 200,300 $ 5.17 268,350 $ 1.63 458,232 $ 1.41 ======= ====== ======= ====== ======= ======= Options exercisable at December 31 20,000 $ 5.17 56,940 $ 1.63 196,072 $ 1.41 ======= ====== ======= ====== ======= ======= Options outstanding price range $4.625 to $6.00. $1.5 to $6.00 $1.06 to $1.75 Weighted Average fair value of $1.61 $3.16 $1.07 options granted during the year Options weighted-average remaining life 9.7 Years 9.83 Years 9.87 Years
Allstar applies APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for options granted under the Plans. Accordingly, no compensation expense has been recognized. Had compensation expense been recognized based on the Black-Scholes option pricing model value at the grant date for awards consistent with SFAS No. 123, Allstar's net income (loss) and earnings per share would have been reduced to the pro forma amounts shown below. For purposes of estimating the fair value disclosures below, the fair value of each stock option has been estimated on the grant date or the grant repricing date with a Black-Scholes option pricing model using the following weighted-average assumptions; dividend yield of 0%; expected volatility of 179% to 126%; risk-free interest rate of 6.0% to 6.5%; and expected lives of eight years from the original date of the stock option grants. The effects of applying SFAS No. 123 for pro forma disclosures are not likely to be representative of the effects on reported net income (loss) for future years. 1997 1998 1999 ---- ---- ---- Net Income (loss): As reported $ 1,844 $ (1,098) $ (845) Pro forma $ 1,815 $ (1,180) $ (923) Earnings per share (Basic) As reported $ 0.52 $ (0.25) $ (0.20) Pro forma $ 0.52 $ (0.27) $ (0.22) Earnings per share (Diluted) As reported $ 0.52 $ (0.25) $ (0.20) Pro forma $ 0.51 $ (0.27) $ (0.22) 13. EARNINGS PER SHARE The computations of basic and diluted earnings per share for each year were as follows: 1997 1998 1999 (Amounts in thousands except share and per share data) Numerator: Net income (loss) fro continuing operations $ 2,167 $ (788) $ (1,274) Discontinued operations: Net loss from discontinued operations, net of taxes (323) (310) (981) Loss on disposal, net of taxes (1,138) -------- -------- -------- Net income (loss) $ 1,844 $ (1,098) $ (845) ======== ======= ======== Denominator: Denominator for basic earnings per share - weighted-average shares outstanding 3,519,821 4,345,883 4,168,140 Effect of dilutive securities: Shares issuable from assumed conversion of common stock options, warrants and restricted stock 6,966 57,786 -------- -------- -------- Denominator for diluted earnings per share 3,526,787 4,345,883 4,225,926 ========= ========= ========= Net income (loss) per share: Basic: Net income (loss) from continuing operations $ 0.62 $ (0.18) $ 0.31 Net loss from discontinued operations (0.10) (0.07) (0.24) Loss on disposal (0.27) -------- -------- -------- Net loss per share $ 0.52 $ (0.25) $ (0.20) ======== ======== ======== Diluted: Net income (loss) from continuing operations $ 0.62 $ (0.18) $ 0.30 Net loss from discontinued operations (0.10) (0.07) (0.23) Loss on disposal (0.27) -------- -------- -------- Net loss per share $ (0.52) $ (0.25) $ (0.20) ======== ======== ======== The potentially dilutive options were not used in the calculation of diluted earnings per share for the year ended December 31, 1998 since the effect of potentially dilutive securities in computing a loss per share is antidilutive. There were warrants to purchase, 176,750 shares of common stock for 1997, 1998 and 1999, respectively, which were not included in computing the effect of dilutive securities because the inclusion would have been antidilutive. There were 200,300, 8,000 and 37,600 options to purchase common stock for 1997, 1998 and 1999, respectively, which were not included in computing the effect of dilutive securities because the inclusion would have been antidilutive. 14. SEGMENT INFORMATION Allstar has three reportable segments: (1) IT Services, (2) CTI Software and (3) Computer Products. IT Services includes various services relating to computer products and management information systems. CTI Software includes software products that facilitate telephony and computer integration primarily for telemarketing and call center applications. Computer Products includes sales of a wide variety of computer hardware and software products. As discussed in Note 3, the Company's Telecom Systems business segment is reported as a discontinued operation. Accordingly, all years prior to the disposal date are not presented below. Subsequent to the disposal of Telecom Systems, the Company reevaluated its assessment of reporting segments. The components previously reported as the Information Technology segment have been reflected as the reportable segments captioned IT Services and Computer Products for the years ended December 31, 1997, 1998 and 1999. The accounting policies of the business segments are the same as those described in Note 1. 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. Intersegment sales and transfers are not significant. For the year ended December 31, 1999: IT CTI Computer Services Software Products Consolidated Revenue $ 14,857 $ 4,318 $182,642 $201,817 Cost of goods sold 10,472 2,126 166,428 179,026 ------- ------- ------- ------- Gross profit 4,385 2,192 16,214 22,791 Selling, general and administrative expense 4,711 1,960 13,512 20,183 ------- ------- ------- ------- Operating income (loss) $ (326) $ 232 $ 2,702 $ 2,608 ======= ======= ======= ======= Accounts receivable $ 2,593 $ 689 $ 34,444 $ 37,726 ======= ======= ======= ======= For the year ended December 31, 1998: IT CTI Computer Services Software Products Consolidated Revenue $ 13,183 $ 3,095 $143,396 $159,674 Cost of goods sold 8,975 1,603 129,288 139,866 ------- ------- ------- ------- Gross profit 4,208 1,492 14,108 19,808 Selling, general and administrative expense 5,238 1,873 13,548 20,659 ------- ------- ------- ------- Operating income (loss) $ (1,030) $ (381) $ 560 $ (851) ======= ======= ======= ======= For the year ended December 31, 1997: IT CTI Computer Services Software Products Consolidated Revenue $ 10,240 $ 2,145 $111,379 $123,764 Cost of goods sold 6,211 1,223 99,701 107,135 ------- ------- ------- ------- Gross profit 4,029 922 11,678 16,629 Selling, general and administrative expense 4,005 1,096 7,426 12,527 ------- ------- ------- ------- Operating income (loss) $ 24 $ (174) $ 4,252 $ 4,102 ======= ======= ======= ======= 15. RELATED-PARTY TRANSACTIONS Allstar has from time to time made payments on behalf of Equities and Allstar's principal stockholders for taxes, property and equipment. Allstar and its principal stockholder entered into a $173 promissory note to repay these advances. The note amortizes in equal annual installments of principal and interest through 2001. This note bears interest at 9% per year. Also Allstar and Equities entered into a promissory note whereby Equities would repay $387 of amounts advanced in monthly installments of $7, including interest, through November 1998 with a final payment of $275 due on December 1, 1998. This note bears interest at 9% per year. Effective December 1, 1998 this note was extended for a period of one year, with interest and principal becoming due on December 1, 1999. On December 1, 1999 a note payable from Equities was signed for $335,551 for 60 monthly payments of $6,965. The note bears interest at 9%. Equities made twelve payments in advance and at December 31, 1999 the Company's receivables from Equities amounted to approximately $227,663. The principal amounts as of December 31, 1997 and December 31, 1998 were classified as Accounts receivable - affiliates based on the expectation of repayment within one year. At December 31, 1997 and December 31, 1998, Allstar's receivables from these affiliates amounted to approximately $434 and $373, respectively. 16. SUBSEQUENT EVENTS On March 16, 2000 Allstar entered into an agreement to sell certain assets of and the ongoing operations of its Computer Products division. The sale transaction is expected to close on or before May 31, 2000 after shareholder and other required consents are obtained. The terms of this agreement include cash consideration of $14.25 million plus a cash payment related to the purchase of certain inventory and equipment, which is to be determined at closing. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure NONE PART III Items 10. Directors and Executive Officers Directors James H. Long - Director, April 1983 to present. James H. Long, age 41, is the founder of the Company and has served as Chairman of the Board, Chief Executive Officer and President since the Company's inception in 1983. Prior to founding the Company, Mr. Long served with the United States Navy in a technical position and was then employed by IBM in a technical position. Donald R. Chadwick - Director, September 12, 1996 to present. Donald R. Chadwick, age 56, has served as Secretary since February, 1992 and served as the Chief Financial Officer of the Company from February 1992 until December, 1999. As Chief Financial Officer, his duties included supervision of finance, accounting and controller functions within the Company. Richard D. Darrell - Director, July 29, 1997 to present. Richard D. Darrell, age 44, has been President of American Technology Acquisition Corporation, a company specializing in mergers, acquisitions, and divestitures of technology related companies since 1995. Prior to that, Mr. Darrell served as President and Chief Executive Officer of Direct Computer Corporation, a computer reseller and distribution company based in Dallas, Texas. Jack M. Johnson, Jr. - Director, July 29, 1997 to present. Jack M. Johnson, Jr., age 60, has been Managing General Partner of Winterman & Company, a general partnership that owns approximately 25,000 acres of real estate in Texas, which is used in farming, ranching, and oil and gas exploration activities, since 1996. Mr. Johnson is also President of Winco Agriproducts, an agricultural products company that primarily processes rice for seed and commercial sale. Mr. Johnson was previously the Chairman of the Board of the Lower Colorado River Authority, the sixth largest electrical utility in Texas, with approximately 1,700 employees and an annual budget of over $400 million. Mr. Johnson was previously Chairman of North Houston Bank, a commercial bank with assets of approximately $75 million. Mr. Johnson currently serves on the board of directors of Houston National Bank, a commercial bank located in Houston, Texas with assets of approximately $100 million; Security State Bank, a commercial bank in Anahuac, Texas with assets of approximately $60 million and Team, Inc. a publicly traded company which provides environmental services for industrial operations. Mark T. Hilz - Director, June 24, 1999 to present. Mark T. Hilz, age 40, has served as Chief Executive Officer of Nichecast, Inc., a privately held internet services company. From 1990 to 1998, Mr. Hilz was founder, President and Chief Executive Officer of PC Service Source, Inc., a publicly-held distributor of personal computer hardware for repair industry. Board and Committee Activity, Structure and Compensation During 1999 the board of directors held four meetings. Each director attended at least 75% of the meetings held during 1999 by the Board and all of the meetings of committees on which he served. The Board of Directors has two standing committees, an Audit Committee and a Compensation Committee. Audit Committee. The Audit Committee is currently composed of Messrs. Darrell and Johnson. During 1999, the Audit committee met twice. The functions of the Audit Committee include: 1. Reviewing the accounting principles and practices employed by the Company; 2. Meeting with Company's independent auditors to review their report on their examination of the Company's accounts, their comments on the integral controls of the Company and the actions taken by management in response to such comments; and 3. Recommending annually to the Board of Directors the appointment of the Company's auditors. Compensation Committee. The Compensation Committee is currently composed of Messrs. Hilz and Darrell. In November 1998, the Compensation Committee met on matters dealing 1999. The functions of the Compensation Committee include: 1. Reviewing and making recommendations regarding the compensation of the Company's officers; and 2. Administrating and making awards under the Company's compensation plans. Each director who is not an employee of the Company is paid $1,000 for each Board meeting attended and $500 for each committee meeting attended plus reasonable out-of-pocket expenses incurred to attend Board or committee meetings. In addition, each non-employee director is entitled to receive stock options pursuant to the Company's Non-Employee Director Stock Option Plan (the "Director Plan"). Upon his first election to the Board each such director receives options to purchase 5,000 shares and upon each time a director is reelected such director receives options to purchase 2,000 shares of common stock. All options granted vest immediately. All options granted under the Director Plan will have an exercise price equal to the fair market value of a share of Common Stock on the date of grant and will expire ten years after the date of grant (subject to earlier termination under the Director Plan. Options granted under the Director Plan are subject to early termination on the occurrence of certain events, including termination of service on the Board, other than by death. During 1999, options to acquire 9,000 shares of Common Stock were granted under the Director Plan. Executive Officers The executive officers of the Company serve until resignation or removal by the Board of Directors. Set forth below is certain information about the Company's Executive Officers, other than James H. Long and Donald R. Chadwick. Frank Cano - President, Computer Products Division, September 1997 to present. Frank Cano, age 35, became the President of Information Technology Division for the Company in September 1997 and was responsible for the management of the Computer Products Division. In January 1999, Mr. Cano became President of the Information Technology Division which includes the Computer Products and IT Services division. Prior to that Mr. Cano was Senior Vice President, Branch Operations from July 1996 to September 1997, and was responsible for the general management of the Company's branch offices. From June 1992 to June 1996, Mr. Cano was the Branch Manager of the Company's Dallas-Fort Worth office. Thomas N. McCulley - Vice President, Information Systems, September 1996 to present. Thomas N. McCulley, age 53, has been the Vice President, Information Systems for the Company since July 1996. From January 1992 to June 1996, Mr. McCulley served as the Information Services Director for the Company. He has responsibility for management and supervision of the Company's Management Information Systems. William R. Hennessy - President, Stratasoft, Inc., September 1996 to present. William R. Hennessy, age 40, has served as the President of Stratasoft, Inc., the Company's wholly owned subsidiary that was formed in 1995 to develop and market CTI Software, since joining the Company in January 1996. Mr. Hennessy's responsibilities include the general management of Stratasoft, Inc. From July 1991 to January 1996, Mr. Hennessy was employed by Inter-Tel, Incorporated, a telephone systems manufacturer and sales and service company, where he served as the Director of MIS and the Director of Voice and Data Integration for the central region. Family Relationships James H. Long and Frank Cano are brothers-in-law. There are no other family relationships among any of the directors and executive officers of the Company. Item 11. Executive Compensation Summary Compensation Table. The following table reflects compensation for services to the Company for the years ended December 31, 1999, 1998 and 1997 of (i) the Chief Executive Officer of the Company and (ii) the three most highly compensated executive officers of the Company who were serving as executive officers at the end of 1999 and whose total annual salary and bonus exceeded $100,000 in 1999 (the "Name Executive Officers").
Annual Compensation Long Term Compensation - ---------------------------------------------------------------------- -------------------------- Awards -------------------------- Name and Principal Year Salary Bonus Other Annual Restricted Number of Compensation Stock Securities (1) Awards Underlying Options (8)(10) Position James H. Long (2) 1999 $150,000 Chief Executive 1998 150,000 $80,200 2,400 Officer 1997 150,000 Donald R. Chadwick (3)(5)(9) 1999 110,000 63,572 Chief Financial 1998 108,853 $15,000 2,400 Officer 1997 98,458 1,500 85,716 13,000 Frank Cano (4)(5)(6) 1999 100,000 564 20,000 President, Information 1998 96,875 13,051 $10,000 15,000 5,600 Technology 1997 78,125 22,297 16,000 William R. Hennessy 1999 85,000 55,856 10,000 President Stratasoft, 1998 84,637 3,000 7,500 Inc. (7) 1997 81,400 73,880 8,000 (1) Amounts exclude the value of perquisites and personal benefits because the aggregate amount thereof did not exceed the lesser of $50,000 or 10% of the Named Executive Officer's total annual salary and bonus. (2) Company has made personal loans to Mr. Long from time to time. See Item 13. Certain Relationships and Related Transactions "Certain Transactions." (3) During the year ended December 31, 1999, Mr. Chadwick received 48,572 stock options in exchange for 24,286 shares of restricted stock. The options have an exercise price of $1.06. (4) During the year ended December 31, 1999, Mr. Cano received 20,000 stock options in exchange for 10,000 shares of restricted stock. The options have an exercise price of $1.06. (5) Includes $1,500 as consideration for execution of employment agreements. (6) Includes compensation based upon attainment of certain performance goals. (7) Includes compensation based upon gross profit realized. (8) Number of securities underlying options shown for 1998 includes options originally issued in 1997 and repriced during 1998 and options newly issued in 1998. (9) Retired as Chief Financial Officer effective December 31, 1999. Retains position as Secretary. (10) The number of securities underlying options shown for 1999 includes options received in exchange for restricted stock originally issued in 1997 and 1998.
Stock Options Under the Company's 1996 Incentive Stock Option Plan (the "Incentive Stock Option Plan") options to purchase shares of the Common Stock may be granted to executive officers and other employees. As of December 31, 1999, 438,232 shares were reserved for issuance upon exercise of outstanding options and 4,268 were reserved and remained available for future grants pursuant to the Incentive Stock Option Plan. During 1999, options to purchase 93,572 shares of Common Stock were granted to the Named Executive Officers under the Incentive Stock Option Plan including 78,572 options which were granted at an exercise price of $1.06 in exchange for 39,286 shares of restricted stock. Options Granted in Last Fiscal Year. The following table provides information concerning stock options granted to the Named Executive Officers during the year ended December 31, 1999.
Number of Percent of Exercise Expiration Potential Potential Shares of Total or Base Date Realizable Realizable Common Options Price Value at Value at Stock Granted to ($/share) Assumed Annual Assumed Underlying Employees Rate of Stock Annual Rate Options in Fiscal Price of Stock Granted Year Appreciations Price for Option Appreciations Term 5% (1) for Option Term 10% (1) Donald R. Chadwick 63,572 35.9% 1.06 4/01/09 $ 24,544 $54,236 Frank Cano 20,000 8.6% 1.06 4/01/09 $ 5,874 $12,979 William R. Hennessy 10,000 4.3% 1.06 4/01/09 $ 2,937 $ 6,490 (1) Actual gains, if any, on stock option exercises are dependent on future performance of the Common Stock. No appreciation in the price of the Common Stock will result in no gain.
Aggregated Option Exercises and Year-End Option Values Number of Securities Value of Unexercised Shares Value Underlying Unexercised In-the money Acquired Realized Options at Options at on Exercise December 31, 1999 December 31, 1999 Exercisable Unexercisable Exercisable Unexerciable James H. Long 0 0 2,400 480 $ 514 $ 2,056 Donald R. Chadwick 0 0 64,686 0 $69,266 0 Frank Cano 0 0 11,520 30,080 $12,336 $32,210 William R. Hennessy 0 0 5,200 12,800 $ 5,568 $13,706
The Named Executive Officers held 126,686 options that were exercisable at December 31, 1999, none were exercised during 1999 and there were 93,572 in-the-money unexercised options at December 31, 1999. Compensation Committee Report The compensation committee of the Board of Directors (the "Committee") has furnished the following report on executive compensation for the fiscal 1999: The Committee met on November 2, 1998. The compensation of executive officers during 1999 was continued under compensation arrangements existing prior to the formation of the Committee except that equity based compensation would be enhanced to further align the interests of the officers of the Company with those of the stockholders. Those compensation arrangements are described below: Base compensation for the executive officers of the company is intended to afford a reasonable payment for the services rendered to the Company and the responsibilities assumed by the executive officer relative to the expected performance of the areas managed by the officers. With the exception of the Chief Executive Officer and Chief Financial officer, bonuses, which are generally paid monthly, and stock- based awards are contingent upon attaining or exceeding predetermined financial performance goals established at the beginning of each fiscal year. The Chief Executive Officer and Chief Financial Officer may receive bonuses or stock rewards based on the overall performance of the Company's as well as the Committee's subjective evaluation of their performance. Mr. Long, the Company's Chief Executive Officer, received his base salary for the fiscal year ended December 31, 1999. The amount of such compensation was determined by the terms of his employment contract with the Company. A bonus in the amount of $80,200 was granted to Mr. Long in 1999 as compensation for the year ended December 31, 1998. The stock options issued to officers in 1999 were issued in exchange for shares of restricted Common Stock relative to the Company's 1998 performance. During the 1998 the Board, as a whole, determined that due to the significant decline in the price of the Common Stock the options issued in 1997 and 1998 no longer provided an incentive to management and other key employees of the Company due to the decrease in the value of the Company's Common Stock. It was further determined that the loss of key management and /or its technical personnel would not be conducive to regaining a higher value for its stockholders. The Committee will be reformed after the annual meeting of the stockholders with all non-employee directors as members of the Committee. The Committee intends to meet during 1999 and review established policies with respect to executive officer compensation. THE COMPENSATION COMMITTEE Richard D. Darrell Mark T. Hilz Jack M. Johnson, Jr. Employment Agreements Each of the Named Executive Officers of the Company has entered into an employment agreement (collectively, the "Executive Employment Agreements") with the Company. Under the terms of their respective agreements, Messrs. Long, Chadwick, Cano and Hennessy are entitled to an annual base salary of $150,000, $101,000, $100,000 and $85,000, respectively, plus other bonuses, the amounts and payment of which are within the discretion of the Compensation Committee. The Executive Employment Agreements may be terminated by the Company or by the executive officer at any time by giving proper notice. The Executive Employment Agreements generally provide that the executive officer will not, for the term of his employment and for the period ranging from twelve to eighteen months following the end of such Named Executive Officer's employment with the Company, solicit any of the Company's employees or customers or otherwise interfere with the business of the Company. Item 12. Security Ownership Security Ownership of Management The following table sets forth, as of March 22, 1999 the number of shares of Common Stock owned by each Director, nominee as a Director, each Named Executive Officer, as defined in "Executive Compensation," and all Directors and Executive Officers as a group. Title of Class Name of Amount and Nature of Percent Beneficial Owner Beneficial Owner (1) of Class Common Stock James H. Long 2,051,000 50.5% Common Stock Donald R. Chadwick 105,503 (2) 2.6% Common Stock Frank Cano 11,820 (3) * Common Stock William R. Hennessey 5,200 (4) * Common Stock All officers and directors 2,179,503 53.5% (1) Beneficial owner of a security includes any person who shares voting or investment power with respect to or has the right to acquire beneficial ownership of such security within 60 days. (2) Includes 64,686 shares which may be acquired upon exercise of currently exercisable options and 517 shares owned by his spouse for which Mr. Chadwick disclaims beneficial ownership and 300 shares owned by his minor children for which Mr. Chadwick disclaims beneficial ownership. (3) Includes 11,520 shares which may be acquired upon exercise of currently exercisable options and 300 shares owned by Mr. Cano's spouse for which Mr. Cano disclaims beneficial ownership. (4) Includes 5,200 shares which may be acquired upon exercise of currently exercisable options. Security Ownership of Certain Beneficial Owners Title of Class Name and Address of Amount and Nature of Percent Beneficial Owner Beneficial Owner Of Class Common Stock Jack B. Corey 267,500 6.6% 37102 FM 149, P.O. Box 525 Pinehurst, TX 77362 Item 13. Certain Relationships and Related Transactions Certain Transactions The Company has from time to time made payments on behalf of Allstar Equities, Inc. a Texas corporation ("Equities"), which is wholly-owned by James H. Long, the Company's President and Chief Executive Officer, and on behalf of Mr. Long, personally for taxes, property and equipment. Effective on December 1, 1999 a note payable by Equities was signed for $335,551 for 60 monthly installments of $6965. The note bears interest at 9% per year. At December 31, 1999, the Company's receivables from Equities amounted to approximately $277,663. The Company leases office space from Equities. In 1998, the Company extended and existing office sublease through December 13,1998. Thereafter, and until December 1, 1999, the Company occupied the space on a month-to-month basis. On December 1, 1999 Equities purchased the building and executed a direct lease with the Company with an expiration date of December 31, 2004. The new lease has rental rates of $37,692 per month and Equities has prepaid interest of $27,941. In August 1996, the Company retained an independent real estate consulting firm to conduct a survey of rental rates for facilities in Houston, Texas that are compatible to its Houston headquarters facility. Based upon this survey, and additional consultations with representatives of the real estate consulting firm, the Company believes that the rental rate and other terms of the Company's sublease from Allstar equities are at least as favorable as those that could be obtained in an arms-length transaction with an unaffiliated third party. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) List of documents filed as part of this report (1) Consolidated Financial Statements - See Index to Consolidated Financial Statements on Page 25 (2) Exhibits
Exhibits Filed Herewith Exhibit or Incorporated by Number Description Reference to: 2.1 Plan and Agreement of Merger by and Between Exhibit 2.1 to Form Allstar Systems, Inc, a Texas corporation and S-1 filed Aug. 8, 1996 Allstar Systems, Inc. a Deleware corporation 3.1 Bylaws of the Company Exhibit 3.1 to Form S-1 filed Aug. 8, 1996 3.2 Certificate of Incorporation of the Company Exhibit 3.2 to Form S-1 filed Aug. 8, 1996 4.1 Specimen Common Stock Certificate Exhibit 4.1 to Form S-1 filed Aug. 8, 1996 4.2 See Exhibits 3.1 and 3.2 for provisions of the Certificate of Exhibit 4.2 to Form Incorporation and Bylaws of the Company defining the rights of the S-1 filed Aug. 8, 1996 holders of Common Stock. 10.1 Revolving Loan and Security Agreement by and between Exhibit 10.1 to Form IBM Credit Corporation and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.2 Agreement for Wholesale Financing dated September 20, 1993, by Exhibit 10.2 to Form and between ITT Commercial Finance Corp. and Allstar-Valcom, Inc. S-1 filed Aug. 8, 1996 10.3 Amendment to Agreement for Wholesale Financing dated Exhibit 10.3 to Form October 25, 1994, by and between ITT Commercial Finance Corp. S-1 filed Aug. 8, 1996 and Allstar Systems, Inc. 10.4 Sublease Agreement by and between Allstar Equities and Allstar Exhibit 10.4 to Form Systems, Inc. S-1 filed Aug. 8, 1996 10.5 Form of Employment Agreement by and between the Company and Exhibit 10.5 to Form certain members of Management. S-1 filed Aug. 8, 1996 10.6 Employment Agreement dated September 7, 1995, by and between Exhibit 10.6 to Form Stratasoft, Inc. and William R. Hennessy. S-1 filed Aug. 8, 1996 10.7 Assignment of Certain Software dated September 7, 1995, by Exhibit 10.7 to Form International Lan and Communications, Inc. and Aspen System S-1 filed Aug. 8, 1996 Technologies, Inc. to Stratasoft, Inc. 10.8 Microsoft Solution Provider Agreement by and between Microsoft Exhibit 10.8 to Form Corporation and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.9 Novell Platinum Reseller Agreement by and between Novell, Inc. Exhibit 10.9 to Form and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.10 Allstar Systems, Inc. 401(k) Plan. Exhibit 10.10 to Form S-1 filed Aug. 8, 1996 10.11 Allstar Systems, Inc. 1996 Incentive Stock Plan. Exhibit 10.11 to Form S-1 filed Aug. 8, 1996 10.12 Allstar Systems, Inc. 1996 Non-Employee Director Stock Option Plan. Exhibit 10.12 to Form S-1 filed Aug. 8, 1996 10.13 Primary Vendor Volume Purchase Agreement dated August 1, 1996 by Exhibit 10.13 to Form and between Inacom Corp. and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.14 Resale Agreement dated December 14, 1995, by and between Ingram Exhibit 10.14 to Form Micro Inc. and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.15 Volume Purchase Agreement dated October 31, 1995, by and between Exhibit 10.15 to Form Tech Data Corporation and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.16 Intelligent Electronics Reseller Agreement by and between Intelligent Exhibit 10.16 to Form Electronics, Inc. and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.17 MicroAge Purchasing Agreement by and between MicroAge Computer Exhibit 10.17 to Form Centers, Inc. and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.18 IBM Business Partner Agreement by and between IBM Exhibit 10.18 to Form and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.19 Confirmation of Allstar Systems, Inc.'s status as a Compaq authorized Exhibit 10.19 to Form reseller dated August 6, 1996. S-1 filed Aug. 8, 1996 10.20 Hewlett-Packard U.S. Agreement for Authorized Second Tier Resellers Exhibit 10.20 to Form by and between Hewlett-Packard Company and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.21 Associate Agreement by and between NEC America, Inc. and Exhibit 10.21 to Form Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.22 Mitel Elite Dealer Agreement and Extension Addendum by and between Exhibit 10.22 to Form Mitel, Inc. and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.23 Dealer Agreement dated March 1, 1995, by and between Applied Voice Exhibit 10.23 to Form Technology and Allstar Systems, Inc. S-1 filed Aug. 8, 1996 10.24 Industrial Lease Agreement dated March 9, 1996, by and between Exhibit 10.24 to Form H-5 J.E.T. Ltd. as lessor and Allstar Systems, Inc. as lessee. S-1 filed Aug. 8, 1996 10.25 Lease Agreement dated June 24, 1992, by and between James J. Exhibit 10.25 to Form Laney, et al. As lessors, and Technicomp Corporation and S-1 filed Aug. 8, 1996 Allstar Services as lessees. 10.26 Agreement for Wholesale Financing, Business Financing Agreement Form 10-K filed Mar. and related agreements and correspondence by and between DFS Financia 31, 1998 Services and Allstar Systems, Inc., dated February 27, 1998 10.27 Sublease Agreement by and between X.O. Spec Corporation and Form 10-K filed Mar. Allstar Systems, Inc. dated May 12, 1997 31, 1998 10.28 Lease Agreement dated May 14, 1998 by and between University Hill Plaza Form 10-K filed April and Allstar Systems Rio Grande, Inc. 12, 1999 10.29 Lease Agreement dated March 4, 1998 by and between The Rugby Form 10-K filed April Group, Inc., and Allstar Systems, Inc. 12, 1999 10.30 Sublease Extention Agreement dated December 31, 1998 by and between Form 10-K filed April Allstar Equities, Inc. and Allstar Systems, Inc. 12, 1999 10.31 Amendment to Lease Agreement dated June 24, 1992, by and between Form 10-K filed April James J. Laney, et al. As lessors, and Technicomp Corporation and 12, 1999 Allstar Services as lessees. 10.32 Lease Agreement by and between Allstar Equities, Inc. and Allstar Form 10-K filed March Systems, Inc. 28, 2000 10.33 Asset Purchase Agreement Between Amherst Computer Products Exhibit 2.1 to Form Southwest, L.P., Amherst Technologies, L.L.C. and Allstar 8-K filed March 22, Systems, Inc. dated March 16, 2000 2000 10.34 Voting and Support Agreement between Amherst Computer Products Exhibit 99.1 to Form Southwest, L.P. and Allstar Systems, Inc., dated March 16, 2000 8-K filed March 22, 2000 10.35 Promissory Note between James H. Long and Allstar Systems, Inc. Form 10-K filed March dated December 1, 1999 28, 2000 21.1 List of Subsidiaries of the Company. Form 10-K filed Mar. 28, 2000 23.1 Independent Auditors' Consent of Deloitte & Touche LLP,. Form 10-K filed Mar. 28, 2000 27.1 Financial Data Schedule. Form 10-K filed Mar. 28, 2000 99.1 Schedule II Valuation and Qualifying Accounts Form 10-K filed Mar. 28, 2000 b No Form 8-K has been filed in the last quarter of the fiscal year covered by this report
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, March 22, 1999. Allstar Systems, Inc. (Registrant) By: /s/ James H. Long James H Long, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Capacity /s/ James H. Long Chief Executive Officer, President and Chairman of the Board, (Principal Financial and Accounting Officer) /s/ Donald R. Chadwick Secretary and Director /s/ Mark T. Hilz Director /s/ Richard D. Darrell Director /s/ Jack M. Johnson Director EX-10.32 2 HOUSTON OFFICE LEASE OFFICE BUILDING LEASE by and between ALLSTAR EQUITIES, INC., a Texas Corporation, as Landlord and ALLSTAR SYSTEMS, INC., a Delaware Corporation, as Tenant Dated: November 30, 1999 BASIC LEASE PROVISIONS Item 1. Date of Lease. The Office Building Lease (the "Lease") attached hereto is made and entered into effective as of the 30th day of November, 1999. Item 2. Tenant. "Tenant" means Allstar Systems, Inc., a Delaware corporation, whose address is: 6401 Southwest Freeway, Houston, Texas 77074. Contact: Donald R. Chadwick. Item 3. Landlord. "Landlord" means Allstar Equities, Inc., a Texas corporation, whose address is 6401 Southwest Freeway, Houston, Texas 77074. Contact: James H. Long. Item 4. Building. "Building" means the office building commonly referred to as 6401 Southwest Freeway, Houston, Texas 77074 together with all parking and related amenities which has been constructed on the land (the "Land") located on 2.251 acres of land, being Lots 1 and 3 of Block 5 of the replat of Block 5, Sharpstown Industrial Park, Section 2, Harris County, Texas, according to the map or plat recorded thereof in Volume 70, Page 48, of the Map Records of Harris County, Texas. Item 5. Lease Term. The "Lease Term" is the period commencing on November 30, 1999, (the "Commencement Date") and, continuing for sixty (60) calendar months thereafter. In the event the Commencement Date is other than the first day of a calendar month, the Lease Term shall be calculated as if the Commencement Date were the first day of the next full calendar month and rent shall be prorated for the first partial month of the Lease. Item 6. Base Rent. The "Base Rent" for the Lease Term shall be $37,692.00 per month. Item 7. Security Deposit. Tenant shall pay, contemporaneously with the execution hereof, a Security Deposit of $37,692.00. Item 8. Permitted Use. Tenant shall use and occupy the Building for business offices and no other use or purpose without the prior written consent of Landlord. These Basic Lease Provisions are incorporated into and made a part of the Lease attached hereto. Each reference in the Lease to any of the information or definitions set forth in these Basic Lease Provisions shall mean and refer to the information and definitions hereinabove set forth and shall be used in conjunction with the provisions of the Lease. In the event of any direct conflict between these Basic Lease Provisions and the Lease, these Basic Lease Provisions shall control; provided, however, that those provisions of the Lease (including its Exhibits and Riders) which expressly require an adjustment or modification to any of the matters set forth in these Basic Lease Provisions shall supersede the provisions of these Basic Lease Provisions. LANDLORD: TENANT: ALLSTAR EQUITIES, INC. ALLSTAR SYSTEMS, INC. By: __________________________ By: __________________________ James H. Long Donald L. Chadwick President Chief Financial Officer OFFICE BUILDING LEASE This Office Building Lease (the "Lease") is made and entered into effective as of the 30th day of November, 1999, by and between Allstar Equities, Inc., a Texas corporation (hereinafter called "Landlord"), and Allstar Systems, Inc., a Delaware corporation (hereinafter called "Tenant"). WITNESSETH: Landlord, in consideration of the rent to be paid and the covenants and agreements to be performed by Tenant, as hereinafter set forth, does hereby Lease, Demise and Let unto Tenant and Tenant accepts the Building for the Lease Term specified in Item 5 of the Basic Lease Provisions, all upon and subject to the following terms, provisions, covenants, agreements and conditions: 1. Base Rent. Tenant covenants and agrees to pay Landlord in legal currency of the United States of America on or in advance of the first day of each month during the Lease Term, without demand, set-off or deduction whatsoever, the Base Rent as provided for in Item 6 of the Basic Lease Provisions. 2. Additional Rent. In addition to the Base Rent, Tenant also covenants and agrees to pay all other cost and expenses set forth in this Lease. 3. Payments and Performance. Tenant agrees to pay all rents and sums provided to be paid by Tenant hereunder at the times and in the manner herein provided, without any set-off, deduction or counterclaim whatsoever. The obligation of Tenant to pay such rent is an independent covenant and no act or circumstance whatsoever, whether such act or circumstance constitutes a breach of covenant by Landlord or not, shall release Tenant from the obligation to pay rent. Any amount which becomes owing by Tenant to Landlord hereunder shall bear interest from the date due until paid at an annual rate (the "Past Due Rate") equal to the maximum nonusurious rate which Landlord is legally entitled to contract for, charge or collect under applicable state or federal law. In addition, Tenant shall pay a late charge in the amount of five percent (5%) of any installment of rent hereunder which is not paid within ten (10) days of the date on which it is due for the purpose of defraying Landlord's administrative expenses incident to the handling of such overdue payments. 4. Security Deposit. Tenant has deposited with Landlord on the date of the execution of this Lease the sum set forth in Item 7 of the Basic Lease Provisions as security for the full and faithful performance by Tenant of Tenant's covenants and obligations hereunder. Such security deposit shall not bear interest and shall not be considered an advance payment of rent or a measure or limitation of Landlord's damages in case of default by Tenant. In the event Tenant defaults in the performance of any of the covenants or obligations to be performed by it hereunder, including but not limited to the payment of any rent to be paid hereunder, Landlord may, from time to time, without prejudice to any other remedy, use such security deposit to the extent necessary to make good any arrearages in rent or in any sum as to which Tenant is in default or otherwise obligated to pay hereunder and to pay for any other damage, injury, expense or liability caused to Landlord by such default, whether such damage or deficiency may accrue before or after termination of this Lease. Following any such application of the security deposit, Tenant shall pay and be obligated to pay to Landlord on demand the amount so applied in order to restore the security deposit to its original amount. If Tenant is not in default hereunder on the date on which this Lease is terminated (the "Expiration Date"), any remaining balance of the security deposit shall be returned by Landlord to Tenant within thirty (30) days of the Expiration Date and after delivery by Tenant of possession of the Building to Landlord in accordance with the terms and conditions of this Lease. 5. Installation of Improvements. Landlord has made no representations or warranties as to the condition of the Building or the Land, nor has Landlord made any commitment to remodel, repair or redecorate. Tenant has been in possession of the Building and accepts the same in its current "AS IS" condition. 6. Assignment and Subletting. (a) In the event Tenant should desire to assign this Lease or sublet the Building or any part thereof, Tenant shall give Landlord written notice of such desire at least sixty (60) days in advance of the date on which Tenant desires to make such assignment or sublease, which notice shall contain the name and the nature and character of the business of the proposed assignee or subtenant and the term, use, rental rate and other particulars of the proposed subletting or assignment, including without limitation, evidence satisfactory to Landlord that the proposed subtenant or assignee is financially responsible and will immediately occupy and thereafter use the Building (or any sublet portion thereof) for the remainder of the Lease Term (or for the entire term of the sublease, if shorter). Landlord shall then have a period of thirty (30) days following receipt of such notice within which to notify Tenant in writing that Landlord elects (1) to terminate this Lease as to the space so affected as of the date so specified by Tenant for such assignment or subletting, (2) to permit Tenant to assign this Lease or sublet such space, or (3) to refuse to consent to Tenant's assignment or subleasing of such space and to continue this Lease in full force and effect as to the entire Building. If Landlord shall fail to notify Tenant in writing of such election within said thirty (30) day period, Landlord shall be deemed to have elected option (3) above. Landlord may condition any consent to an assignment or subletting upon Tenant's payment to Landlord of any reasonable costs incurred by Landlord in reviewing and approving such requested assignment or subletting, including, without limitation, Landlord's attorneys' fees. No assignment or subletting by Tenant shall relieve Tenant of any obligations under this Lease. Consent of Landlord to a particular assignment or sublease or other transaction shall not be deemed a consent to any other or subsequent transaction. (b) If Landlord consents to any subletting or assignment by Tenant as hereinabove provided and subsequently any rents received by Tenant under any such sublease are in excess of the rent payable by Tenant to Landlord or Tenant receives any additional consideration from the assignee under any such assignment, then Landlord may, at its option, either (i) declare such excess rents under any sublease or such additional consideration for any assignment to be due and payable by Tenant to Landlord as additional rent hereunder, or (ii) elect to cancel this Lease as to the space assigned or sublet and, at Landlord's option, enter into a lease directly with such assignee or subtenant, without liability to Tenant. (c) Landlord shall have the right to transfer and assign, in whole or in part, all of its rights and obligations hereunder and in the Building and Land and in such event and upon assumption by the transferee of Landlord's obligations hereunder (any such transferee to have the benefit of, and be subject to, the provisions of this Lease), no further liability or obligation shall thereafter accrue against Landlord hereunder and Tenant agrees to look solely to the successor in interest of Landlord for the performance of such obligations. (d) No assignment or sublease shall release Tenant or Tenant's guarantor from any obligations hereunder. In the event Tenant is in default under this Lease, then Landlord, in addition to any other remedies, may collect all rents coming due directly from any subtenant and apply same against any sums due Landlord by Tenant, but Tenant shall not be released from any further liability or obligations because of such collections by Landlord. (e) If Tenant is a corporation and if at any time during the Lease Term the person or persons who own the voting shares at the time of the execution of this Lease cease for any reason to own a majority of such shares, including but not limited to merger, consolidation or other reorganization involving another corporation, or if Tenant is a partnership and if at any time during the Lease Term the general partner or partners who own the general partnership interests in the partnership at the time of the execution of this Lease cease for any reason to own a majority of such interests (except as the result of transfers by gift, bequest or inheritance to or for the benefit of members of the immediate family of such original shareholder(s) or partner(s)), such an event shall be deemed to be an assignment requiring Tenant to comply with the terms hereof. The preceding sentence shall not apply whenever Tenant is a corporation the outstanding stock of which is listed on a recognized security exchange or if at least eighty percent (80%) of its voting stock is owned by another corporation, the voting stock of which is so listed. 7. Use and Occupancy. Tenant covenants and agrees that the Building shall be used and occupied by Tenant only for the Permitted Use set forth in Item 8 of the Basic Lease Provisions and for no other purpose and agrees to use and maintain the Building in a clean, careful, safe and proper manner and to comply with all applicable state, federal and municipal laws, ordinances, orders, rules and regulations. Tenant agrees not to commit waste nor suffer or permit waste to be committed on or in the Building or the Land. 8. Alterations and Additions by Tenant. Tenant shall not make or allow to be made any alterations, improvements or additions in or to the Building without first obtaining the written consent of Landlord, and all alterations, additions and improvements made to or fixtures or other improvements placed in or upon the Building, whether temporary or permanent in character, by either party (except only moveable office furniture and equipment not attached to the Building) shall be deemed a part of the Building and with respect to Tenant's alterations, additions, improvements and fixtures, they shall remain Tenant's property until the expiration or earlier termination of the Lease at which time they shall become the property of Landlord without compensation to Tenant. Alterations, improvements and additions in and to the Building requested by Tenant shall be in accordance with plans and specifications which have been previously submitted to and approved in writing by Landlord. Such work shall be performed at Tenant's expense and accomplished either by Landlord or by contractors and subcontractors approved in writing by Landlord. If such work is performed by Landlord, Landlord shall be entitled to a construction supervision fee in the amount of five percent (5%) of the cost of any alterations, improvements or additions. If such work is not performed by Landlord, then all work performed by other contractors and subcontractors shall be subject to the following conditions: (a) A certificate of insurance for each contractor and subcontractor must be submitted to the Landlord for approval prior to commencement of construction; (b) Tenant must insure that all workmen will be cooperative with Building personnel and comply with all Building rules and regulations; (c) All construction must be done in a good and workmanlike manner and shall be subject to approval by Landlord in its sole discretion upon completion; (d) Lien releases in recordable form from each contractor and subcontractor must be submitted to the Landlord within five (5) days after completion; and (e) All construction must comply with all applicable governmental laws, rules and regulations. 9. Repair and Maintenance by Tenant. This is intended to be a "Triple Net" lease and in addition to the obligations of Tenant to pay for all Property Taxes (as hereinafter defined) and insurance as provided in Sections 14 and 15 hereof, Tenant is responsible, at its sole cost and expense for all maintenance, repairs and replacements (including, without limitation, those of a capital nature) to the Building and Land, including, but not by way of limitation, all items set forth in this Section 8. Tenant will not in any manner deface or damage the Building or Land and will pay as additional rent on demand the cost of replacing any damage done to the Building or Land except damage caused by the gross negligence or willful misconduct of Landlord. Tenant shall, at its own cost and expense, throughout the term hereof, keep and maintain in good repair, all structural and non-structural portions of the Building and Land, including but not limited to the roof, foundation, structural soundness of the exterior walls, including cleaning and painting thereof. Tenant shall keep and maintain in good repair all windows, window glass, plate glass (including cleaning of all glass), doors, fixtures, equipment, Elevators (as hereinafter defined) and HVAC (as hereinafter defined) and all other machinery located in the Building and/or on the Land. Tenant shall pay for all license, permits, use and inspections in connection with the Building and Land during the Lease Term. Furthermore, Tenant shall keep the plumbing working, closets, pipes and fixtures belonging thereto in good repair, and keep the water pipes and connections free from ice and all other obstructions, to the satisfaction of Landlord and any government authority having jurisdiction over the Building or the Land during the term hereof. It shall be the obligation of Tenant to keep and maintain in good repair, the sidewalks, parking lots, driveways and curbs, service facilities, signage, landscaping, sprinkler systems, Elevators, including all alterations and work required to have the Building and Land comply with all Environmental Laws and all laws, ordinances and regulations applicable to the Building and Land. Tenant shall, at its sole cost and expense, during the term hereof make all alterations, improvements or additions to the Building and Land that may be required on account of any existing or future laws or regulations. It is specifically understood that Landlord shall have no obligation for maintenance or repair of the Building or Land and shall incur no liability or expense in regard thereto. Tenant shall insure that the heating, ventilating and air conditioning equipment serving the Building ("HVAC") is in good operating order and condition on the Commencement Date and Tenant shall maintain a commercially reasonable preventative maintenance contract for the HVAC system, acceptable to Landlord, during the term hereof. Tenant shall make all necessary repairs and replacements of the HVAC system which are not covered (or would not be covered) under such preventative maintenance contract, including capital expenditures for repair or replacement of the HVAC systems serving the Building. Without diminishing such obligation of Tenant and in addition to any other remedies Landlord may have, if Tenant fails to make such repairs and replacements within fifteen (15) days after notice to Tenant from Landlord, Landlord may, at its option, make such repairs and replacements and Tenant shall pay Landlord the cost thereof as additional rent on demand. Likewise, Tenant shall at its sole cost and expense, insure that the elevators and all equipment and fixtures related thereto (collectively the "Elevators") are in good operating order and condition and comply with all governmental requirements as of the Commencement Date and Tenant shall maintain a commercially reasonable preventive maintenance contract for the Elevators, acceptable to Landlord, during the term hereof and insure that the same continue to comply with all applicable rules, regulations and ordinances of any governmental authority having jurisdiction over the Building. Tenant shall make all necessary repairs and replacements of the Elevators which are not covered (or would not be covered) under this preventive maintenance contract, including capital expenditures for repairs or replacement of the Elevators. Without diminishing such obligations of Tenant, and in addition to any other remedies Landlord may have, if Tenant fails to make such repairs and replacements within fifteen (15) days after notice to Tenant from Landlord, Landlord may, at its option, make such repairs and replacements and Tenant shall pay Landlord the cost thereof of additional rent on demand. However, nothing set forth in this Section 8, or elsewhere in this Lease shall impose any obligation upon Landlord to make any such repairs or replacements and Landlord shall have no liability to Tenant, its agent, employees, contractors or invitees for failure to make such repairs and/or replacement or for any damage, loss or injury (including death) arising therefrom, and Tenant hereby indemnifies and holds Landlord harmless from any and all damage, cost, or liabilities which may arise by virtue of any loss, damage, injury (including death) or liability arising from such election by Landlord not to repair or replace. Tenant shall maintain, at its sole cost and expense, a janitorial service contract and a pest control contract covering the Building, acceptable to Landlord, during the Lease Term. 10. Mechanic's Liens. Tenant will not permit any mechanic's or materialman's lien to be placed upon the Building or improvements thereon or the Land during the term hereof caused by or resulting from any work performed, materials furnished or obligations incurred by or at the request of Tenant. Nothing contained in this Lease shall be deemed or construed in any way as constituting the consent or request of Landlord, express or implied, by inference or otherwise, to any contractor, subcontractor, laborer or materialman for the performance of any labor or the furnishing of any materials that would give rise to the filing of any mechanic's, materialman's or other lien against the interest of Landlord in the Land or the Building. In the case of the filing of any lien on the interest of Landlord or Tenant in the Building or Land, Tenant shall cause the same to be discharged of record or adequately bonded within twenty (20) days after the filing of same. If Tenant shall fail to discharge or adequately bond around such lien within such period, then, in addition to any other right or remedy of Landlord, Landlord may, but shall not be obligated to, discharge the same either by paying the amount claimed to be due or by procuring the discharge of such lien by deposit in court or bonding. Any amount paid by Landlord for any of the aforesaid purposes, or for the satisfaction of any other lien not caused or claimed to be caused by Landlord, together with all reasonable legal and other expenses of Landlord in defending any such action or procuring the discharge of such lien, shall be paid by Tenant to Landlord as additional rent on demand. 11. Indemnity and Non-Liability. Landlord will not be liable for and Tenant will indemnify and hold Landlord harmless from all suits, liability, fines, claims, demands, actions, damages, losses, costs and expense, including, but not limited to, Landlord's reasonable attorneys' fees, for any injury or death to persons, any loss or damage to property or any loss of or damage to Tenant's business caused wholly or in part by (i) the negligence of, (ii) an act, omission or misconduct of, (iii) a breach of this Lease by or (iv) the use or occupancy of the Building or Land by, Tenant, its employees, agents, servants, contractors, licensees, invitees or subtenants. Unless caused by the gross negligence or willful misconduct of Landlord, Landlord shall not be liable or responsible for any loss or damage to property or death or injury to persons occasioned by any event, including, without limitation, theft, fire, act of God, injunction, defects in the Building, riot, strike, war, court order, other governmental action or other matter or the leakage or failure of any pipes, wiring or fixture or the backing up of any drains. 12. Certain Rights Reserved by Landlord. In addition to Landlord's rights under the Building Rules and Regulations attached hereto as Exhibit "A", Landlord shall have the following rights, exercisable without notice and without liability to Tenant for damage or injury to property, person or business and without effecting an eviction, constructive or actual, or disturbance of Tenant's use or possession or giving rise to any claim for set-off or abatement of rent: (a) To change the Building's name or street address; (b) To install, affix and maintain any and all signs on the exterior and interior of the Building; (c) To enter upon the Building at reasonable hours to exercise its rights hereunder or inspect same or to show the Building to prospective lenders or purchasers, and, during the last twelve (12) months of the Lease Term, to show them to prospective tenants at reasonable hours and, if they are vacated, to prepare them for reoccupancy; (d) To retain at all times, and to use in appropriate instances, keys to all doors within and into the Building; (e) To decorate and to make repairs, alterations, additions, changes or improvements, whether structural or otherwise, in and about the Building, or any other part thereof, without any obligation to do so, and for such purposes to enter upon the Building and, during the continuance of any of said work, to temporarily close doors, entryways, public space and corridors in the Building; (f) To interrupt or temporarily suspend Building services and facilities and to change the arrangement and location of entrances or passageways, doors and doorways, corridors, elevators, stairs, toilets or other public parts of the Building, all without abatement of rent or affecting any of Tenant's obligations hereunder, so long as access to the Building is not unreasonably restricted; (g) To take all such reasonable measures as Landlord may deem advisable for the security of the Building and its occupants. Notwithstanding the foregoing, Landlord shall not be obligated to provide any security measures and Landlord shall not be liable to Tenant or Tenant's employees, customers or invitees for any damage, cost or expense which occurs for any reason in the event any provided security measure is not properly installed, monitored or maintained or any such service is not properly provided, nor shall Landlord be liable to Tenant or Tenant's employees, customers or invitees for any damage or loss caused by theft, burglary, assault, vandalism or any other crime. Landlord strongly encourages Tenant to secure Tenant's own insurance in excess of the amounts required elsewhere in this Lease and/or to provide Tenant's own security measures to protect against the above occurrences if Tenant desires additional coverage for such risks. 13. Fire or Other Casualty. If the Building or any part thereof shall be damaged by fire or other casualty, Tenant shall give prompt written notice thereof to Landlord. In case the Building shall be so damaged by fire or other casualty that substantial alteration or reconstruction of the Building shall, in Landlord's sole opinion, be required, Landlord may, at its option, terminate this Lease and the term and estate hereby granted by notifying Tenant in writing of such termination within thirty (30) days after the date of such damage, in which event the rent hereunder shall be abated as of the date of such damage. If Landlord does not elect to terminate this Lease or if, in Landlord's sole opinion, substantial alteration or reconstruction of the Building is not required, Landlord shall repair and restore the Building to substantially the same condition in which it was immediately prior to the happening of the casualty, except that Landlord shall not be required to rebuild, repair or replace any part of Tenant's furniture or furnishings or of fixtures and equipment owned or removable by Tenant under the provisions of the Lease. Notwithstanding the foregoing, Landlord's obligation to restore the Building shall not require Landlord to expend for such repair and restoration work more than the insurance proceeds actually received by the Landlord as a result of the casualty. Landlord shall not be liable for any inconvenience or annoyance to Tenant or injury to the business of Tenant resulting in any way from such damage or the repair thereof. If any other portion of the Building is damaged by fire or other casualty resulting from the fault or negligence of Tenant or any of Tenant's agents, employees or invitees, the rent hereunder shall not be diminished and Tenant shall be liable to Landlord for the cost of the repair and restoration of the Building caused thereby to the extent such cost and expense is not covered by insurance proceeds. 14. Condemnation. If all of the Building and Land, or so much of the same as would, in Landlord's sole opinion, materially interfere with the parties' continued efficient and/or economically feasible use of the remainder, shall be taken for any public or quasi-public use under any governmental law, ordinance or regulation or by right of eminent domain or should be sold to the condemning authority in lieu of condemnation, then Landlord may, at its option, terminate this Lease as of the date when physical possession of the Building or Land is taken by the condemning authority. If Landlord does not terminate this Lease, the rent payable hereunder shall be diminished by an amount representing that part of said rent as shall properly be allocable to the portion of the Building which was taken or sold. Landlord shall receive the entire award from any taking or condemnation and Tenant shall have no claim thereto for any reason relating to the taking or condemnation. 15. Taxes. Tenant shall be liable for and shall pay, prior to becoming delinquent, all taxes levied or assessed against Tenant's personal property, furniture, alterations, improvements or fixtures in the Building including any sales and use taxes associated with materials and/or services in connection with the Building. Tenant shall pay to Landlord (or directly to the taxing authority if required by Landlord) the Property Taxes (as hereinafter defined) for each tax year of the term hereof. Property Taxes shall be prorated for any partial tax year within the term based on the actual number of days elapsed. Promptly after receipt of a property tax bill, Landlord shall provide Tenant with a copy of the same. Tenant shall pay all Property Taxes prior to when such Property Taxes are delinquent. Tenant shall deliver evidence to Landlord, in the form of a copy of the check to the taxing authorities, of payment of such Property Taxes prior to the same becoming delinquent. "Property Taxes" means the real estate taxes levied on the Building and Land including any interest or penalty charges payable with respect to any such taxes by virtue of Tenant's late payment or non-payment of all or any portion of Property Taxes. Property Taxes shall also include betterments and special and general assessments levied or imposed against the Buildings, Land and/or Building. Property Taxes shall also include any tax, excise, surcharge or assessment levied by any governmental taxing authority upon or against the rents payable hereunder by Tenant in lieu of any Property Taxes. Notwithstanding the foregoing, Tenant shall have no obligation to pay any income taxes, sales taxes, excess profit taxes, franchise, capital stock, inheritance or estate taxes, license fees, inspection fees or permit fees levied against Landlord. 16. Waiver of Subrogation and Insurance. (a) Each party hereto hereby waives any and every claim which arises or may arise in its favor and against the other party hereto, or anyone claiming through or under them, by way of subrogation or otherwise, for any and all loss of or damage to any of its property (whether or not such loss or damage is caused by the fault or negligence of the other party or anyone for whom said other party may be responsible), which loss or damage is covered by valid and collectible fire and extended coverage insurance policies, to the extent that such loss or damage is insurable under said insurance policies. Said waivers shall be in addition to, and not in limitation or derogation of, any other waiver or release contained in this Lease with respect to any loss or damage to property of the parties hereto. (b) Tenant shall at its sole cost and expense, procure and maintain throughout the term of this Lease a policy or policies of insurance insuring Tenant against (i) any and all liability for injury to or death of a person or persons and for damage to or destruction of property occasioned by or arising out of or in connection with the use or occupancy of the Building or by the condition of the Building (including the contractual liability of Tenant to indemnify Landlord contained herein) with a limit of not less than $1,000,000 for each occurrence and $5,000,000 in the aggregate, (ii) fire and extended coverage insurance covering Tenant's personal property and movable trade fixtures in the Building to the extent of full replacement value, and (iii) worker's compensation insurance as required by the State of Texas. Whenever good business practice, in Landlord's reasonable judgment, indicates the need of additional insurance coverage or different types of insurance in connection with the Building or Tenant's use and occupancy thereof, Tenant shall, upon request, obtain such insurance at Tenant's expense and provide Landlord with evidence thereof. Additionally, Tenant shall at all times during the Lease Term maintain in effect a policy or policies of insurance covering the Building for 100% of replacement cost or in such amounts as Landlord may from time to time determine, providing protection against perils included within the standard Texas form of fire and extended coverage insurance policy, together with insurance against sprinkler damage, vandalism, malicious mischief, business interruption, and such other risks as Landlord may from time to time determine and with any such deductibles as Landlord may from time to time determine. All insurance shall be written by an insurance company or companies satisfactory to Landlord and licensed to do business in the State of Texas with Landlord and any other party in interest from time to time designated by Landlord named as an additional insured without restriction. If Tenant has an umbrella or excess policy, Tenant will name Landlord as an additional insured without restriction on all insurance required pursuant to the Lease and on all layers of umbrella or excess policies. Tenant shall obtain a written obligation on the part of each insurance company to notify Landlord at least thirty (30) days prior to cancellation of all required premium to this Section 16(b) such insurance. Such policies or duly executed certificates of insurance relating thereto shall be promptly delivered to Landlord within five (5) days after the execution of this Lease and renewals thereof as required shall be delivered to Landlord at least thirty (30) days prior to the expiration of the respective policy terms. If Tenant fails to comply with the foregoing requirements relating to insurance, Landlord may, at its sole option, obtain such insurance and Tenant shall pay as additional rent to Landlord on demand the premium cost thereof. 17. Surrender Upon Termination. At the expiration or termination of this Lease, whether caused by lapse of time or otherwise, Tenant shall at once remove all furniture, movable trade fixtures and equipment and surrender possession of the Building and Land and deliver the Building and Land to Landlord in as good repair and condition as at the Commencement Date, reasonable wear and tear and damages or destruction by fire or other insured casualty excepted, and shall deliver to Landlord all keys to the Building. Tenant, or Landlord at Tenant's expense, shall repair any damage to the Building or the Building and Land caused by any such removal. All furniture, movable trade fixtures and equipment installed by Tenant not removed at the expiration of this Lease or within fifteen (15) days after any other termination shall thereupon be conclusively presumed to have been abandoned by Tenant and Landlord may, at its option, take over the possession of such property and either (a) declare same to be the property of Landlord by written notice thereof to Tenant, or (b) at the sole risk, cost and expense of Tenant, remove the same or any part thereof in any manner that Landlord shall choose and dispose of the same without incurring liability to Tenant or any other person. 18. Events of Default by Tenant. (a) The occurrence of any of the following events shall be deemed to be an event of default by Tenant under this Lease: (i) Tenant shall fail to pay when due hereunder any installment of rent or any other sum of money payable by Tenant to Landlord; or (ii) Tenant shall fail to comply with or observe any other term, provision or covenant of this Lease, and Tenant has not cured such failure (except for the failure to pay rent) within twenty (20) days after the occurrence of such failure; or (iii) Tenant shall become insolvent, or shall make a transfer in fraud of creditors, or shall make an assignment for the benefit of creditors, or Tenant shall admit in writing its inability to pay its debts as they become due, or Tenant shall file a petition under any section or chapter of the Bankruptcy Reform Act of 1978, as amended, or under any similar law or statute of the United States or any State thereof, or Tenant shall be adjudged bankrupt or insolvent in proceedings filed against Tenant thereunder, or a petition or answer proposing the adjudication of Tenant as a bankrupt or its similar law shall be filed in any court and such petition or answer shall not be discharged within sixty (60) days after the filing thereof, or a receiver or trustee shall be appointed for all or substantially all of the assets of Tenant or of the Building or of any of Tenant's property located thereon; or (iv) The leasehold estate hereunder shall be taken or attempted to be taken by execution or other process of law in any action against Tenant; or (v) Tenant shall abandon or vacate any substantial portion of the Building for a period of time in excess of five (5) days without written permission of Landlord; or (vi) The liquidation, termination, dissolution, forfeiture of right to do business or death of Tenant or any Guarantor. (b) If an event of default shall have occurred, Landlord shall have, in addition to such other rights or remedies as are contained within this Lease or at law or in equity, the right at its election, then or any time thereafter while such event of default shall continue, to pursue any one or more of the following remedies: (i) Terminate this Lease by giving notice thereof to Tenant, in which event Tenant shall immediately surrender the Building to Landlord and if Tenant fails to do so, Landlord may without prejudice to any other remedy which it may have for possession or arrearages in rent, enter upon and take absolute possession of the Building. Tenant hereby agrees to pay to Landlord on demand the amount of all loss and damage which Landlord may suffer by reason of such termination, whether through inability to relet the Building on satisfactory terms or otherwise, including loss of rental for the remainder of the Lease Term and interest thereon at the Past Due Rate from the date of the default. (ii) Enter upon and take absolute possession of the Building without terminating this Lease. Landlord may (but shall be under no obligation to) relet the Building or any part thereof for the account of Tenant, in the name of Tenant or Landlord or otherwise, without notice to Tenant, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Lease) and on such conditions (which may include concessions or free rent) and for such uses as Landlord in its absolute discretion may determine and Landlord may collect and receive any rents payable by reason of such reletting. Tenant covenants and agrees to pay Landlord on demand all reasonable expenses necessary to relet the Building which shall include the cost of renovating, repairing and altering the Building for a new tenant or tenants, advertisements and brokerage fees, and Tenant further covenants and agrees to pay Landlord on demand any deficiency that may arise by reason of such reletting together with interest on all sums due thereon at the Past Due Rate from the date of the default. Landlord shall not be responsible or liable for any failure to relet the Building or any part thereof or for any failure to collect any rent due upon any such reletting. No such re-entry or taking of possession of the Building by Landlord shall be construed as an election on Landlord's part to terminate this Lease unless a written notice of such termination is given to Tenant pursuant to subparagraph 17(b)(i) above. (iii) Make such payments and/or take such action and do whatever Tenant is obligated to do under the terms of this Lease. Tenant covenants and agrees to reimburse Landlord on demand for any expenses which Landlord may incur in thus affecting compliance with Tenant's obligations under this Lease together with interest thereon at the Past Due Rate from the date paid by Landlord, and Tenant further agrees that Landlord shall not be liable for any damages resulting to Tenant from such action, whether caused by the negligence of Landlord or otherwise. (iv) Collect, from time to time, by suit or otherwise, each installment of rent or other sum as it becomes due hereunder, or to enforce, from time to time, by suit or otherwise, any other term or provision hereof on the part of Tenant required to be kept or performed. (v) Terminate this Lease by giving Tenant notice thereof, in which event Tenant shall pay to Landlord the sum of (1) all rent accrued hereunder through the date of termination, and (2) an amount equal to (A) the total rent that Tenant would have been required to pay for the remainder of the Lease Term discounted to present value at a rate of seven percent (7%) per annum, minus (B) the then present fair rental value of the Building for such period, similarly discounted at a rate of seven percent (7%) per annum, after deducting all anticipated costs of reletting and Landlord's expenses for keeping the Building in good order. (c) In order to regain possession of the Building pursuant to this Paragraph 17, Landlord or its agent may, at the expense and liability of the Tenant, alter or change any or all locks or other security devices controlling access to the Building without posting or giving notice of any kind to Tenant. Landlord shall have no obligation to provide Tenant a key or grant Tenant access to the Building so long as Tenant is in default under this Lease. Landlord may, without notice, remove and either dispose of or store, at Tenant's expense, any property belonging to Tenant that remains in the Building after Landlord has regained possession thereof. (d) No repossession or re-entering on the Building or any part thereof by Landlord and no reletting of the Building or any part thereof by Landlord shall terminate this Lease, unless a notice of such intention be given to Tenant. (e) No right or remedy herein conferred upon or reserved to Landlord is intended to be exclusive of any other right or remedy, and each and every right and remedy shall be cumulative and in addition to any other right or remedy given hereunder or now or hereafter existing at law or in equity or by statute. In addition to other remedies provided in this Lease, Landlord shall be entitled, to the extent permitted by applicable law, to injunctive relief in case of the violation, or attempted or threatened violation, of any of the covenants, agreements, conditions or provisions of this Lease, or to a decree compelling performance of any of the other covenants, agreements, conditions or provisions of this Lease, or to any other remedy allowed to Landlord at law or in equity. 19. Events of Default by Landlord. Except as otherwise provided in this Lease, Landlord shall be in default hereunder if there is an act or omission by Landlord which would give Tenant the right to damages from Landlord or the right to terminate this Lease and, upon written notice of such act or omission to Landlord by Tenant, Landlord fails to correct the breach or default within thirty (30) days after the notice, or such longer period of time as may be reasonably necessary provided Landlord has commenced to correct the breach or default within such thirty (30) day period and diligently pursues such to completion. 20. No Implied Waiver. The failure of Landlord to insist at any time upon the strict performance of any covenant or agreement or to exercise any option, right, power or remedy contained in this Lease shall not be construed as a waiver or a relinquishment thereof for the future. A receipt by Landlord of any rent with or without knowledge of the breach of any covenant or agreement contained in this Lease shall not be deemed a waiver of such breach, and no waiver by Landlord of any provision of this Lease shall be deemed to have been made unless expressed in writing and signed by Landlord. 21. Landlord's Lien. Landlord waives any and all statutory or contractual landlord liens Landlord may have against the furniture, fixtures, equipment, inventory or personal property of Tenant located in the Building. 22. Subordination. This Lease and all rights of Tenant hereunder shall be subject and subordinate to any deed of trust, mortgage or other instrument of security which may hereafter cover the Building and the Land or any interest of Landlord therein and to any and all increases, renewals, modifications, consolidations, replacements and extensions thereof and to each advance made or hereafter to be made thereunder and to any subordination, non-disturbance or attornment agreement by the terms of which such holder or holders recognize this Lease and covenant to give Tenant, so long as Tenant attorns to any purchaser or purchasers of the Building and the Land any interest of Landlord therein through foreclosure or other disposition thereof and Tenant is not in default under this Lease, the right of quiet enjoyment of the Building. Tenant shall upon demand and at any time or times execute, acknowledge and deliver to Landlord such other and further instruments and certificates that, in the judgment of Landlord, may be necessary or proper to confirm or evidence such subordination. 23. Quiet Enjoyment. Tenant, upon paying the Base Rent, any additional rent and any other sums required to be paid by the terms of this Lease, and upon performing and observing the covenants and stipulations set forth herein, shall peaceably hold and enjoy the Building during the said term subject to the terms and conditions hereof and to any liens, ordinances, easements, restrictions or covenants to which this Lease is subject. 24. Holding Over by Tenant. Should Tenant or any of its successors in interest continue to hold the Building after the termination of this Lease, whether such termination occurs by lapse of time or otherwise, such holding over shall, unless otherwise agreed by Landlord in writing, constitute and be construed as a tenancy at will, at a daily rental equal to one-thirtieth (1/30th) of an amount equal to the greater of double the amount of the monthly rental payable during the last month prior to the termination of this Lease or one hundred fifty percent (150%) of the market rate for which similar space in the Building is then being leased by Landlord, and upon and subject to all of the other terms, provisions, covenants and agreements on the part of Tenant hereunder except any right to renew this Lease. No payments of money by Tenant to Landlord after the termination of this Lease shall reinstate, continue or extend the term of this Lease and no extension of this Lease after the termination thereof shall be valid unless and until the same shall be reduced to writing and signed by both Landlord and Tenant. Nothing in this Paragraph 27 should be construed as giving Tenant the right to hold over beyond the date of the expiration of this Lease nor preclude Landlord from having the right to dispossess or otherwise terminate Tenant's right of possession. Any tenancy at will is terminable upon notice from Landlord. 25. Building Rules and Regulations. Tenant and Tenant's agents, employees and invitees will comply with all requirements of the Building Rules and Regulations which are attached hereto as Exhibit "A." Landlord shall at all times have the right to change such Building Rules and Regulations or to promulgate other Rules and Regulations in such reasonable manner as may be deemed advisable for the safety, care or cleanliness of the Building and related facilities, and for preservation of good order therein; provided, however, that any such change shall not become effective and a part of this Lease until a copy thereof shall have been delivered to Tenant. Tenant shall further be responsible for the compliance with such Rules and Regulations by the employees, servants, agents, visitors and invitees of Tenant. Landlord shall not be responsible to Tenant for failure of any person to comply with such Rules and Regulations. 26. Estoppel Certificate and Tenant's Financial Statements. Tenant will, at any time and from time to time, upon not less than twenty (20) days' prior request by Landlord or any successor of Landlord or by the holder of any deed of trust or mortgage covering the Land and Building or any interest of Landlord therein, execute, acknowledge and deliver to Landlord an estoppel certificate in writing executed by Tenant certifying that this Lease is the entire agreement between the parties; that this Lease is in full force and effect and specifying any modifications; the dates to which the rent has been paid and that no rent under this Lease has been paid more than thirty (30) days in advance of its due date; that the Tenant has unconditionally accepted the Building; that any improvements required by the terms of this Lease to be made by Landlord have been completed to the satisfaction of Tenant; that the address for notices to be sent to Tenant is as set forth in this Lease; that Tenant, as of the date of such certificate, has no charge, lien or claim of offset, deduction or counterclaim under this Lease or otherwise against rents or other charges due or to become due hereunder; that Landlord, any such successor or holder, and any assignee of any such entity may rely upon the estoppel certificate being given by Tenant; and either stating that to the knowledge of the signer of such certificate no default of Landlord exists hereunder or specifying each such default of which the signer may have knowledge; it being intended that any such certificate by Tenant may be relied upon by any prospective purchaser or mortgagee of the Building. In addition to the matters described above, the above-described certificate shall include and Tenant shall certify as to matters regarding the Lease as reasonably requested by Landlord. 27. Limitation of Liability. The liability of Landlord to Tenant for any default by Landlord under the terms of this Lease shall be limited to the then interest of Landlord in the Building and Land and Landlord, its officers, directors, employees, agents and partners shall not be personally liable for any deficiency. This clause shall not be deemed to limit or deny any remedies which Tenant may have in the event of default by Landlord hereunder which do not involve the personal liability of Landlord. Notwithstanding anything contained in this Lease to the contrary, in the event Landlord sells, assigns, transfers, or conveys its interest in the Land and the Building, Landlord shall have no liability for any acts or omissions that occur after the date of said sale, assignment, transfer, or conveyance. 28. Notices. Each provision of this Lease or of any applicable governmental law, ordinance, regulation or other requirement with reference to the sending, mailing or delivery of any notice or with reference to the making of any payment by Tenant to Landlord, shall be deemed to be complied with when and if the following steps are taken: (a) Any notice or document delivered to Landlord by Tenant, including all rent and other payments required to be made by Tenant to Landlord hereunder shall be payable to Landlord in Harris County, Texas, at the address hereinbelow set forth, or at such other address as Landlord may specify from time to time by written notice delivered in accordance herewith: Allstar Equities, Inc. 6401 Southwest Freeway Houston, Texas 77074 Attention: James H. Long (b) Any notice or document delivered by Landlord to Tenant hereunder shall be delivered to Tenant at the address hereinbelow set forth, or at such other address as Tenant may specify from time to time by written notice delivered in accordance herewith: Allstar Systems, Inc. 6401 Southwest Freeway Houston, Texas 77074 Attention: Donald R. Chadwick (c) Any notice or document required to be delivered hereunder shall be deemed to be delivered, whether actually received or not, seventy-two (72) hours after deposit in the United States mail, postage paid, certified mail, return receipt requested and addressed to the respective party at the respective addresses set out above or at such other address as they have theretofore specified by written notice. 29. Use Tax. Notwithstanding any other provision herein, Tenant shall pay as and when they become due and before the same become delinquent any and all licenses, charges, and other fees of every kind and nature arising out of or in connection with the Building, including but not limited to license fees, business license tax, the amount of any privilege, sales, excise, or other tax (other than income) imposed upon rentals herein provided to be paid by Tenant or upon the Landlord in an amount measured by such rentals received by Landlord. 30. Examination of Lease. The submission of this document for examination and negotiation does not constitute an offer to lease, or a reservation of, or option for, the Building. This document becomes effective and binding only upon the execution and delivery hereof by Landlord or Landlord's authorized agent and Tenant. 31. Severability. Each and every covenant and agreement contained in this Lease is, and shall be construed to be, a separate and independent covenant and agreement. If any term or provision of this Lease or the application thereof to any person or circumstances shall to any extent be invalid and unenforceable, the remainder of this Lease, or the application of such term or provision to persons or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby and in lieu of such invalid or unenforceable clause, there shall be added as a part of this Lease a clause as similar in terms to such invalid or unenforceable clause as may be possible and be legal, valid and enforceable. 32. No Merger. There shall be no merger of this Lease or of the leasehold estate hereby created with the fee estate in the Building or any part thereof by reason of the fact that the same person may acquire or hold, directly or indirectly, this Lease or the leasehold estate hereby created or any interest in this Lease or in such leasehold estate as well as the fee estate in the Building or any interest in such fee estate. 33. Force Majeure. Whenever a period of time is herein prescribed for action to be taken by Landlord, Landlord shall not be liable or responsible for, and there shall be excluded from the computation for any such period of time, any delays due to strikes, acts of God, shortages of labor or materials, war, governmental laws, regulations, restrictions or other cause of any kind whatsoever which is beyond the control of Landlord. 34. Joint and Several Liability. If there is more than one Tenant, the obligations hereunder imposed upon Tenant shall be joint and several. If there is a guarantor of Tenant's obligations hereunder, the obligations of Tenant shall be joint and several obligations of Tenant and such guarantor, and Landlord need not first proceed against Tenant hereunder before proceeding against such guarantor, nor shall any such guarantor be released from its guarantee for any reason whatsoever, including, but not limited to, any amendment of this Lease, any forbearance by Landlord or waiver of any of Landlord's rights, the failure to give Tenant or such guarantor any notices or the release of any party liable for the payment of Tenant's obligations hereunder. 35. Entire Agreement and Amendment. This Lease contains the entire agreement between the parties hereto with respect to the subject matter hereof and supersedes any and all prior and contemporaneous agreements, understandings, promises and representations made by either party to the other concerning the subject matter hereof and the terms applicable hereto. Landlord's agents have made no representations or promises with respect to the Building except as herein expressly set forth and no rights, easements or licenses are acquired by Tenant by implication or otherwise except as expressly set forth in the provisions of this Lease. This Lease shall not be altered, waived, amended or extended except by a written agreement signed by the parties hereto unless otherwise expressly provided herein. Neither this Lease nor a memorandum of this Lease shall be recorded in the public records of the county in which the Building is located without the prior written consent of Landlord. 36. Paragraph Headings. The paragraph headings contained in this Lease are for convenience only and shall in no way enlarge or limit the scope or meaning of the various and several paragraphs hereof. 37. Binding Effect. Except as otherwise provided in the Lease, all of the covenants, agreements, terms and conditions to be observed and performed by the parties hereto shall be applicable to, binding upon and inure to the benefit of their respective heirs, personal representatives, successors and their assigns. 38. Brokerage. Tenant and Landlord represent and warrant to each other that such party has not had any dealing with any realtor, broker or agent in connection with this Lease or the negotiation thereof. Landlord and Tenant each agree to indemnify and hold the other harmless from and against any and all costs, expenses or liability, including, but not limited to, reasonable attorneys' fees, resulting from any breach of this representation or warranty. 39. Hazardous Waste. The term "Hazardous Substances," as used in this Lease, shall mean any pollutant, contaminant, toxic or hazardous waste, radioactive material or other substance, the use and/or the removal of which is required or the use of which is restricted, prohibited or penalized by any "Environmental Law," which term shall mean any federal, state or local statute, ordinance, regulation or other law of a governmental or quasi-governmental authority relating to pollution or protection of the environment or the regulation of the storage or handling of Hazardous Substances. Tenant hereby agrees that: (a) no activity will be conducted at the Building or Land that will produce any Hazardous Substance; (b) neither the Building nor the Land will not be used in any manner for the storage of any Hazardous Substance; and (c) Tenant will not permit any Hazardous Substance to exist on the Building or Land and if any Hazardous Substances currently exist or exist at any time during the Lease Term or subsequent to the Lease Term (provided such existed during the Lease Term) the same shall be immediately removed, with proper disposal, and all required clean-up procedures shall be diligently undertaken by Tenant at its sole cost pursuant to all Environmental Laws. If at any time during or after the term of this Lease, the Building and/or the Land is found to be contaminated with Hazardous Materials, Tenant shall diligently institute proper and thorough clean-up procedures, at Tenant's sole cost. Tenant agrees to indemnify and hold Landlord harmless from all claims, demands, actions, liabilities, costs, expenses, damages, penalties and obligations of any nature arising from or as a result of any contamination of the Building and/or Land with Hazardous Substances. The foregoing indemnification and the responsibilities of Tenant shall survive the termination or expiration of this Lease. 40. Applicable Law. This Lease shall be governed in all respects by the laws of the State of Texas. 41. Authority. In the event Tenant is a corporation, professional association, partnership or other form of organization other than an individual, then each individual executing or attesting this Lease on behalf of Tenant hereby covenants, warrants and represents that (a) such individual is duly authorized to execute or attest and deliver this Lease on behalf of Tenant in accordance with the organizational documents of Tenant; (b) this Lease is binding upon Tenant; (c) Tenant is duly organized and legally existing in the state of its organization and is qualified to do business in the state in which the Building is located; (d) upon request, Tenant will provide Landlord with true and correct copies of all organizational documents of Tenant and any amendments thereto; and (e) the execution and delivery of this Lease by Tenant will not result in a breach of, or constitute a default under, any mortgage, deed of trust, lease, loan, credit agreement, partnership agreement or other contract or instrument to which Tenant is a party or by which Tenant may be bound. 42. Riders and Exhibits. The following number Exhibits and Riders are attached hereto and incorporated herein by reference as if copies herein in full: Exhibit "A": Building Rules and Regulations Exhibit "B": Secretary of State Financing Statement 43. TIME. TIME IS OF THE ESSENCE IN THIS LEASE AND IN EACH AND ALL OF THE PROVISIONS HEREOF. 44. In the event of any legal action or proceeding brought by either party against the other party arising out of this Lease, the prevailing party shall be entitled to recover reasonable attorneys' fees and costs incurred in such action or proceeding and such fees and costs shall be included in any judgment rendered in such action or proceeding. IN WITNESS WHEREOF, this Lease is hereby executed in multiple originals as of the date first above set forth. LANDLORD: ALLSTAR EQUITIES, INC. By: ____________________________________ James H. Long, President TENANT: ALLSTAR SYSTEMS, INC. By: ____________________________________ Donald R. Chadwick, Chief Financial Officer Approved by Initials: Date: EXHIBIT "A" BUILDING RULES AND REGULATIONS In addition to the covenants of the parties set out in the Lease, the parties agree to observe the following standards for the mutual safety, cleanliness and convenience of the Building and the Land. As specified in the Lease, these rules are subject to change from time to time. 1. No birds, animals (except seeing-eye dogs), reptiles or any other creatures shall be brought into or about the Building. 2. Nothing shall be swept or thrown into the corridors, halls, elevator shafts or stairway. Tenant shall keep the Building and Land neat and clean. 3. Corridor doors, when not in use, shall be kept closed. 4. No bicycles or similar vehicles will be allowed in the Building or on the Land except in those areas specifically designated by Landlord for such purposes. 5. Sidewalks, doorways, vestibules, halls, stairways and similar areas shall not be obstructed by Tenant or its officers, agents, servants and employees, or used for any purpose other than ingress and egress to and from the Building, or for going from one part of the Building to another part of the Building. No furniture shall be placed in front of the Building or in any lobby or corridor without written consent of Landlord. 6. Landlord has the right to evacuate the Building in the event of an emergency or catastrophe. 7. Tenant shall not place, install or operate any stoves or cooking equipment in the Building or in any part of the Building without the prior written approval of Landlord. 8. No signs, posters, advertisements or notices shall be painted or affixed on any of the windows, doors or other parts of the Building except in such color, size and style and in such places as shall be first approved in writing by Landlord. 9. No portion of the Building shall be used for the purpose of lodging rooms or any immoral or unlawful purposes. 10. Vending machines or dispensing machines of any kind will not be placed in the Building by Tenant unless prior written approval has been obtained from Landlord. 11. Landlord's prior written approval must be obtained for installation of any solar screen material, window shades, blinds, drapes, awnings, window ventilators or other similar equipment and any window treatment of any kind whatsoever. Landlord will control all internal lighting that may be visible from the exterior of the Building. 12. Tenant shall exercise reasonable precautions in the protection of its personal property from loss or damage by keeping doors to unattended areas locked. Tenant will lock all office doors leading to public corridors and turn off all lights and any appliances at the close of the working day. Landlord shall not be responsible for any lost or stolen personal property, equipment, money or jewelry from the Building, Land or parking areas regardless of whether loss occurs when such area is locked against entry. 13. At no time shall Tenant permit or shall Tenant's agents, employees, contractors, guests or invitees smoke in any common area of the Building unless such common area has been declared a designated smoking area by Landlord. 14. Tenant shall not conduct any auction at the Building nor store goods, wares or merchandise at the Building, except for Tenant's own personal use. EXHIBIT "B" TO BE FILED IN THE OFFICE OF THE SECRETARY OF STATE OF TEXAS FINANCING STATEMENT This instrument is prepared as, and is intended to be, a Financing Statement complying with the formal requisites therefore as set forth in the Texas Business and Commerce Code, Article 9 (also known as the Texas Uniform Commercial Code-Secured Transactions), and in particular Section 9.402 thereof. 1. The name and address of the debtor ("Debtor") is: Allstar Systems, Inc. 6401 Southwest Freeway Houston, Texas 77074 Attention: Donald R. Chadwick 2. The name and address of the secured party ("Secured Party") is: Allstar Equities, Inc. 6401 Southwest Freeway Houston, Texas 77074 Attention: James H. Long 3.This Financing Statement covers the following types of property (the "Real Property") and all proceeds of such Property: All furniture, fixtures, equipment and personal property located at 6401 Southwest Freeway, Houston, Texas 77074. DEBTOR: ALLSTAR SYSTEMS, INC. By: ____________________________________ Donald R. Chadwick, Chief Financial Officer EX-10.35 3 PROMISSORY NOTE PROMISSORY NOTE Effective Date: December 1, 1999 1. Parties "Borrower" means James H. Long, and the person's successors and assigns. "Lender" means Allstar Systems, Inc. and its successors and assigns. 2. Borrower's Promise To Pay; Interest In return for a loan received from Lender, Borrower promises to pay the principal sum of Three Hundred Thirty-five Thousand, Five Hundred Fifty-one and Fourteen /100 Dollars (U.S. $335,551.14), plus interest, to the order of the Lender. Interest will be charged on the unpaid principal, from the date hereof, at the rate nine percent (9%) per annum until the full amount of the principal has been paid. Such interest shall be computed on the basis of a 360 day year consisting of twelve thirty day months. 3. Manner Of Payment (A) Time On the first day of each month beginning on January 1, 2000 Borrower shall make equal monthly installments of principal and interest in an amount equal to that installment of Six Thousand, Nine Hundred Sixty-five and forty-nine/100 Dollars (U.S $6,965.49) which will amortize to loan over Sixty (60) equal monthly installments of principal and interest. Any principal and interest remaining on the first day of December 1, 2004 , will be due on that date, which is called the "Maturity Date" (B) Place Payment shall be made at Allstar Systems, Inc., 6401 Southwest Freeway, Houston, Texas 77074 or such other place as Lender may designate in writing by notice to the Borrower. 4. Borrower's Right to Prepay Borrower has the right to pay the debt evidenced by this Note, in whole or in part, without charge or penalty, on the first day of any month. 5. Borrower's Failure To Pay (A) Late Charge for Overdue Payments If Lender has not received the full monthly payment required by the Security Instrument, as described in Paragraph 3 of this Note by the end of the fifteen calendar days after the payment is due, Lender may collect a late charge in the amount of five per cent (5%) of the overdue amount of each payment. (B) Default If Borrower defaults by failing to pay in full any monthly payment, then Lender may require immediate payment in full of the principal balance remaining due and all accrued interest. Lender may choose not to exercise this option without waiving its rights in the event of any subsequent default (C) Payment of Costs and Expenses If Lender has required immediate payment in full, as described above, Lender may require Borrower to pay costs and expenses including reasonable and customary attorney's fees for enforcing this Note. Such fees and costs shall bear interest from the date of disbursement at the same rate as the principal of this Note. 6. Waivers Borrower and any other person who has obligations under this Note waive the rights of presentment and notice of dishonor. "Presentment" means the right to require Lender to demand payment of amounts due. "Notice of dishonor" means the right to require Lender to give notice to other persons that amounts due have not been paid. 7. Giving Of Notices Unless applicable law requires a different method, any notice that must be given to Borrower under this Note will be given by delivering it or mailing it by first class mail to Borrower at the property address above or at a different address if Borrower has given Lender a notice of Borrower's different address. Any notice that must be given to Lender under this Note will be given by first class mail to Lender at the address stated in Paragraph 4(B) or at a different address if Borrower is given a notice of that different address. 8. Obligations Of Persons Under This Note If more than one person signs this Note, each person is fully responsible and personally obligated to keep all of the promises made in this Note, including the promise to pay the full amount owed. Any person who is a grantor, surety or endorser of this Note is also obligated to do these things. Any person who takes over these obligations, including the obligations of a guarantor, surety or endorser of this Note, is also obligated to keep all of the promises made in this Note. Lender may enforce its rights under this Note against each person individually or against all signatories together. Any one person signing this Note may be required to pay all of the amounts owed under this Note. BY SIGNING BELOW, Borrower accepts and agrees to the terms and covenants contained in this Note. - --------------------------------- ---------------------------------- Witness Signature Borrower Signature _________________________________ James H. Long Witness Name Borrower Name _________________________________ as of December 1, 1999_________ Date Date EX-21 4 SUBSIDIARIES OF THE REGISTRANT Exhibit 21.1 List of Subsidiaries of the Company Name State of Incorporation Stratasoft, Inc Texas IT Staffing, Inc. Delaware Allstar Systems Rio Grande, Inc. Texas EX-23 5 CONSENTS OF EXPERTS AND COUNSEL Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-41001 of Allstar Systems, Inc. and subsidiaries (the "Company") on Form S-8 of our report dated March 17, 2000, appearing in this Annual Report on Form 10-K of the Company for the year ended December 31, 1999. /s/ DELOITTE & TOUCHE LLP Houston, Texas March 22, 2000 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1999 YEAR DEC-31-1999 DEC-31-1999 4,647 0 37,954 (228) 7,442 51,458 5,316 (3,036) 53,916 41,891 0 0 0 44 11,786 53,916 201,817 201,817 179,026 179,026 20,183 0 648 1,960 (686) 1,274 (2,119) 0 0 (845) (0.20) (0.20)
EX-27.2 7 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1998 YEAR DEC-31-1998 DEC-31-1998 2,538 0 35,251 (358) 8,497 47,928 5,327 (2,425) 51,028 38,128 0 0 0 45 14,723 51,028 167,173 167,173 145,039 145,039 23,422 0 351 (1,639) (541) (1,098) 0 0 0 (1,098) (0.25) (0.25)
EX-27.3 8 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1997 YEAR DEC-31-1997 DEC-31-1997 1,581 0 24,540 (249) 4,700 31,090 3,685 (1,672) 33,184 18,266 0 0 0 45 14,723 33,184 129,167 129,167 111,126 111,126 14,386 0 685 2,970 1,126 1,844 0 0 0 1,844 .52 .52
EX-99 9 VALUATION AND QUALIFYING ACCOUNTS Exhibit 99
FINANCIAL STATEMENT SCHEDULE II ALLSTAR SYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS AS OF DECEMBER 31, 1999 (In Thousands) Balance at Charges to Charge to Beginning Costs and Other Other Balance at Description of Year Expenses Accounts Changes End of year Accumulated provision deducted from related assets on balance sheet: Allowance for doubtful accounts receivable: 1997 $ 219 $ 386 (66) $ (290) (A) $ 249 1998 249 3,410 (3,301) (A) 358 1999 358 916 (1,046) (A) 228 Inventory reserves: 1997 $ 111 $ 456 $ (551) (A) $ 16 1998 16 1,900 (1,916) (A) 0 1999 0 512 (511) (A) 1 Reserves other than those deducted from assets on balance sheet: Allowance for doubtful vendor accounts receivable: 1997 $ 200 $ 198 $ (49) (A) $ 349 1998 349 1,049 (1,243) (A) 155 1999 155 1,270 (1,117) (A) 308 (A) Reductions related to amounts written off.
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