-----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, Dm8/4GHRhvfnwuCjyaElkgFUbtyyfdUvAsQom8x0fT775YWGGSblwt8uA9LdfL4u +mhHFLp1Yg8eyuiRlSYodw== 0001020017-98-000013.txt : 19980430 0001020017-98-000013.hdr.sgml : 19980430 ACCESSION NUMBER: 0001020017-98-000013 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980429 SROS: NASD 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/A SEC ACT: SEC FILE NUMBER: 000-21479 FILM NUMBER: 98603364 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/A 1 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR o 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 24, 1998, as reported on NASDAQ National Market System, was approximately $11,591,000. The number of shares of Common Stock, $.01 Par Value, outstanding as of March 24, 1997 was 4,454,411. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders are incorporated by reference into Part III, Items 10, 11, 12, and 13. PART I Item 1. Business Special Notice Regarding Forward-Looking Statements THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS OR THE FUTURE FINANIAL PERFORMANCE OF THE COMPANY, INCLUDING BUT NOT LIMITED TO STATEMENTS CONTAINED IN ITEM 1 - "FACTORS WHICH AFFECT FUTURE OPERATING RESULTS," "ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "PROPERTIES" AND "BUSINESS." READERS ARE CAUTIONED THAT SUCH STATEMENTS, WHICH MAY BE IDENTIFIED BY WORDS INCLUDING "ANTICIPATES," "BELIEVES," "INTENDS," "ESTIMATES," "EXPECTS" "PLANS" AND OTHER SIMILAR EXPRESSIONS, ARE ONLY PREDICTIONS OR ESTIMATIONS AND ARE SUBJECT TO KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES, OVER WHICH THE COMPANY HAS LITTLE OR NO CONTROL. IN EVALUATING SUCH STATEMENTS, READERS SHOULD CONSIDER THE VARIOUS FACTORS IDENTIFIED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING MATTERS SET FORTH IN "FACTORS WHICH MAY AFFECT THE FUTURE OPERATING RESULTS," WHICH COULD CAUSE ACTUAL EVENTS, PERFORMANCE OR RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH STATEMENTS. GENERAL Allstar Systems, Inc. (the "Company") is a regional provider of computer and telecommunications hardware and software products and related services. The Company primarily markets its products and services in Texas from five locations in the Houston, Dallas-Fort Worth, El Paso and Austin metropolitan areas and through a small, recently opened office in McAllen, Texas. During 1997, the Company's customer base of approximately 2,700 accounts was comprised primarily of mid-sized customers and regional offices of larger customers in commercial, educational and governmental sectors. The Company positions itself to provide its customers with single-source solutions for both their computer and telecommunications needs by offering a broad range of products and services and by providing the expertise to support integrated computer and telecommunications applications. The Company's revenue is derived from sales of Computer Products, IT Services, Telecom Systems and CTI Software. The Company is an authorized reseller of computer products from Compaq, Hewlett-Packard, IBM, Microsoft, Novell and other leading manufacturers. The Company has long-standing relationships with leading aggregators and wholesale distributors of computer hardware and software products which enable the Company to provide its customers with competitive product pricing and ready product availability. IT Services include system design, installation, integration and support services. With respect to Telecom Systems, the Company markets, installs and services telecommunications equipment, including PBX telephone systems from NEC, Inter-tel and Mitel. In 1995, the Company introduced its proprietary CTI Software products which facilitate computer and telephone integration, primarily for telemarketing, call center and other high volume calling applications. The Company was incorporated in 1983 as a Texas corporation and was reincorporated in 1996 as a Delaware corporation. The Company's executive offices are located at 6401 Southwest Freeway, Houston, Texas 77074 and its telephone number is (713) 795-2000. The market for computer products and services has experienced significant growth in recent years and the use of such products and services within organizations has been impacted by several concurrent trends. The introduction of LANs and WANs has allowed organizations to supplement or replace expensive, centralized mainframe computer systems with more flexible and affordable PC-based client/server platforms. The emergence of widely accepted industry standards for hardware and software has increased the acceptance of open architecture LANs and WANs which can and frequently do contain products from numerous manufacturers and suppliers. Rapid technological improvements in computer hardware and the introduction of new software operating systems have also created the need to expand or upgrade existing networks and systems. At the same time, price decreases have made such networks and systems affordable to a larger number of organizations. The Company believes that these trends have increased the general demand for computer products and related information technology services. Distribution channels for computer products changed significantly beginning in the early 1990s. During that period, many manufacturers of computers began to scale back their sales forces and, in order to ensure the continued wide distribution of their products, started to offer their products to wholesale computer distributors which previously had sold only software and peripheral equipment. In addition, manufacturers also began allowing resellers to purchase products from more than one aggregator or distributor, a practice known as "open sourcing. " Expanding computer sales to distributors and allowing open sourcing intensified price competition among suppliers. The Company believes that, in general, the manufacturers of its primary product lines are continuing to rely to a large degree on resellers of computer products to distribute a significant portion of their products to end-users. Distribution patterns may continue to evolve, however, and any future changes may significantly affect the Company's business. The advent of open architecture networks has also impacted the market for information technology services. Wider use of complex networks involving a variety of manufacturer's equipment, operating systems and applications software has made it increasingly difficult to diagnose problems and maintain the technical knowledge and repair parts necessary to provide support services. The Company believes that increased outsourcing of more sophisticated support services by business and institutional customers has resulted from the technical complexities created by multi-manufacturer and supplier network systems and rapid technological change. Increasingly, organizations seeking computer products often require prospective vendors not only to offer products from many manufacturers and suppliers, but to have available and proficient service expertise to assist them in product selection, system design, installation and post-installation assistance and service. The Company believes that the ability to offer customers a comprehensive solution to their information technology needs, including the ability to work within its customers' corporate environments as integral members of their management information system staff, are increasingly important in the marketplace. Telecommunications systems have evolved in recent years from simple analog telephone systems to sophisticated digital systems, with modern digital systems featuring voice processing, automated attendant, voice and fax mail, automatic call distribution and call accounting. The ability to interface these new digital phone systems to the user's PC-based computer systems now allows these telephone systems to interact with the user's computerized data to create powerful business solutions. New features, such as "caller ID" that is coupled with a digital telephone system and integrated with a computer system, can provide automatic look-up and display of account information while the user is receiving a new call, thereby increasing productivity and the level of customer service. Computerized "call accounting" allows an organization with integrated telephone and computer systems to track telephone usage and long distance toll billing and easily interface that data with computerized accounting and billing systems. Integrated voice and facsimile handling allows a user to retrieve, send and manage voice and facsimile messages on his computer screen. Computerized telephone number listings allow the user to look up telephone numbers on the computer and then have the computer dial the number automatically. For more complex call center applications, computer systems can manage out-bound calling campaigns while automatically blending in-bound calls to available agents in order to enhance agent productivity. The Company believes that the evolution of the digital telephone system to a more open architecture, aided by standards established by Microsoft and Novell for the interface of telephone and computer technologies, is causing rapid industry change. This change is creating demand for digital telephone systems which adhere to these new industry standards. These digital telephone systems, along with the many software products which are rapidly becoming available for use in CTI, require sophisticated installation and integration service capability. The Company believes that the trend toward CTI is likely to continue and that integrated voice, data and video communication will become more affordable. As the technology and management of telecommunications and computer systems converge over the next decade, the Company expects that growth opportunities will be presented for companies able to provide and service the latest integrated telecommunications and computer technologies. BUSINESS STRATEGY The Company's goals include continuing the growth of its regionally-based business while preparing the Company to become a national provider of computer and telephone hardware and software products and related services. To achieve its objectives, the Company intends to pursue these key strategies: Expand Geographically. The Company intends to open additional offices within Texas and in new regions to service existing customers and attract new customers. The Company opened new offices in Austin, Texas in the third quarter of 1997 and in McAllen and El Paso late in 1997. The Company intends to open other offices in Texas and other regions as opportunities and circumstances warrant. Increase Telecom Systems And CTI Software Businesses. The Company began offering Telecom Systems in 1994 in its Houston office and CTI Software in 1995 to capitalize on the growing trend in CTI. The Company expanded Telecom Systems operations to the Dallas-Fort Worth market in the second half of 1997. The Company intends to expand its Telecom Systems operations to (i) all of its offices, (ii) pursue acquisitions of regional telephone system resellers with established customer bases in targeted markets, and (iii) increase the variety and capabilities of its CTI Software products through internal development and acquisitions of complementary software products. Implement Internet-Based National Marketing Program. The Company intends to implement a new method of marketing its Computer Products on a nationwide basis. By accessing an Internet home page currently under development, the Company's sales representatives and customers will be able to obtain product pricing and availability data, enter or change orders and access customer account status information. The Company plans to employ experienced sales representatives in selected metropolitan markets who will be supported by the new Internet-based system and by a national sales support call center performing order entry and customer service functions. After utilizing the Internet-based system to support its direct sales force the Company expects to establish customer relationships in new markets under the trade name "800 PC Deals." The Company then intends to establish branch offices in certain of these markets. Implementation of this strategy was anticipated to begin in the second half of 1997 but has been deferred indefinitely until the Company can better ascertain the potential profitability of this program and further develop its Internet based marketing systems. There can be no assurance that the Company will complete the development of the Internet system and if developed whether the Company will implement the marketing program. PRODUCTS AND SERVICES The Company's revenues are derived from the marketing of technological information systems. Management of the Company believes that such revenues are reliant upon the ability to offer related services (which comprise less than 10 % of revenues) on those products. For the convenience of the reader the products offered and the related services have been provided below. COMPUTER PRODUCTS The Company offers its customers a wide variety of computer hardware and software products available from over 600 manufacturers and suppliers. The Company's products include desktop and laptop computers, monitors, printers and other peripheral devices, operating system and application software, network products and mid-range host and server systems including the IBM RS6000 and DEC Alpha systems. The Company is an authorized reseller of products from a number of leading manufacturers of computer hardware, software and networking equipment, including Compaq, Hewlett-Packard, IBM, Microsoft and Novell. Products manufactured by Compaq, Hewlett-Packard and IBM in the aggregate accounted for approximately 53.7%, 58.9%, and 56.8%, for 1995, 1996 and 1997, respectively, of the Company's total inventory purchases. There can be no assurance that the Company will continue to resell such manufacturers' products in the future; however, the Company believes that its relations with all of its major product manufacturers and distributors are satisfactory. IT SERVICES IT Services are provided by the Company both in conjunction with and separately from its Computer Products sales. The Company typically prices its IT Services on a time and materials basis or under fixed fee service contracts, depending on customer preference and the level of service commitment required. In markets where the Company does not maintain branch offices, it often subcontracts for necessary technical personnel, particularly where required for larger scope or prolonged duration contracts. The Company's IT Services include the following: Information Systems Support. The Company is an authorized warranty service provider for many popular computer and computer peripheral products and provides hardware repair and maintenance services, complex network diagnostic services, end user support services and software diagnostic services. The Company also offers complete outsourcing of a customer's computer and network management and technical support needs on a contract basis. The Company provides on-site service parts stocking, help desk assistance and fixed asset management and tracking. Contract Systems Engineer, Technician And Programmer Staffing. The Company provides short-term supplemental technical staffing, including hardware and software technicians, help desk personnel, systems and network engineers and programming staff. Systems Engineering. The Company provides systems engineering services including information technology consulting, LAN/WAN design, on-site and remote network administration, new technology feasibility and impact analyses and disaster recovery plan analyses. Information Technology Project Management. The Company provides project management services for major hardware and software upgrades and conversions, roll-outs of major new hardware and software installations and large network installations, including multiple city WAN implementations. Telecommunications And Data Systems Cabling. The Company provides networking and telecommunications cabling services required for all major networking topologies, including fiber optic cabling. The Company also offers cabling services for adding to, moving or changing existing network systems. Contract Programming Services. Recently, the Company has begun to offer contract programming services, primarily related to SQL database design and implementation, client server applications and Internet site development. IT Staffing Services. In January 1997 the Company, through its wholly-owned subsidiary IT Staffing, Inc., began providing technical personnel for temporary and permanent positions to it customers. The Company recruits and places personnel for a wide variety of technical positions related principally to computing hardware and software skill sets. To support and maintain the quality of these services and to maintain vendor accreditation necessary to resell and service its significant product lines, the Company's technical staff participate in various certification and authorization programs sponsored by hardware manufacturers and software suppliers. The Company currently has attained several certifications and authorizations, most notably as a Microsoft Solution Provider and a Novell Platinum Reseller. The Company's ability to attract and retain qualified professional and technical personnel is critical to the success of its IT Services business. TELECOM SYSTEMS The Company began its Telecom Systems business in 1994 to capitalize on the trend toward CTI. The Company currently markets, installs and services 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 and wireless communications. The Company resells PBX systems manufactured by NEC and Mitel and smaller "key systems," including products from Macrotel, NEC and Winn Communications. Wireless products include products from Uniden and Spectralink. Software products include voice mail products from Active Voice and AVT, interactive voice response applications from AVT and call center activity reporting products from Taske. Prior to 1997, the Company marketed Telecom Systems only from its Houston office. During the second half of 1997, the Company expanded Telecom Systems sales to its Dallas office. The Company intends to expand the marketing of its Telecom Systems products into each new office as they are established. The Company also intends to expand its Telecom Systems products, particularly in the area of CTI products, as suitable new products become available for resale. CTI SOFTWARE The Company develops and markets proprietary CTI Software, which integrates business telephone systems and networked computer systems, under the trade name "Stratasoft. " CTI Software is designed to improve the efficiency of call center, both inbound and outbound and other high volume calling applications. Basic products offered by the Company are typically customized to suit a customer's particular needs and are often bundled with computer hardware supplied by the Company at the customer's request. The Company entered the CTI Software business in late 1995 by acquiring two CTI products, currently sold under the names StrataDial and StrataVoice, from a corporation owned by the individual who presently manages the Company's CTI Software operations. A new product, Strata-Interactive, has also been developed by the Company. The Company now markets these three CTI Software products, which are described below: 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 ("ACD") of the PBX 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 which 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. During 1997, the Company sold and installed 48 StrataDial systems. 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. During 1997, the Company sold and installed 122 StrataVoice systems. Strata-Interactive. Strata-Interactive is an interactive voice response ("IVR") software product which allows telephone calls to access computer information at any time using a simple touch-tone telephone. Applications for IVR technology vary and include insurance coverage verification and claims reporting, utility company account information and outage reporting, bank account information and on-line transactions, and shipment verification and tracking information. Strata-Interactive is based upon open architecture and is designed to work with networked computers. The first beta version of the product was delivered to a customer in June 1996. In 1997, the Company began integrating the Strata-Interactive components into the Strata-Dial and Strata-Voice products. The Company expects the majority of the Strata-Interactive product will be marketed as a component of Strata-Dial. SALES AND MARKETING DIRECT SALES The Company markets its products and services primarily through direct sales representatives. Direct sales representatives are teamed with in-house customer service representatives and are assigned to specific customer accounts. The Company believes that direct sales lead to better account penetration and management, better communications and long-term relationships with its customers. The Company's sales personnel, including account managers and customer service representatives, are partially compensated, and in some cases fully compensated, on the profitability of accounts which they participate in developing. The Company believes that its past and future growth will depend in large measure on its ability to attract and retain qualified sales representatives and sales management personnel. The Company promotes its products and services through general and trade advertising, participation in trade shows and telemarketing campaigns. The Company believes that a significant portion of new customers of its Computer Products and IT Services businesses originates through word-of-mouth referrals from existing customers and industry members, such as manufacturer's representatives. Additionally, Telecom Systems sales personnel seek to capitalize on the many customer relationships developed by the Company's Computer Products and IT Services personnel. By virtue of their computer business contacts, Computer Products and IT Services personnel often learn at a relatively early stage that their customers may soon be in the market for telecommunications equipment and services. Sales leads developed by this synergy are then jointly pursued. CTI Software is marketed by direct sales representatives to organizations using telemarketing, call centers or other high volume telecommunications functions. In addition, StrataVoice is marketed through resale arrangements between the Company and a VAR. INTERNET-BASED SALES SUPPORT SYSTEM The Company has been developing an Internet-based sales support system that will be used by its entire sales force, however the Company does not intend to activate the sales support until additional development occurs. The system will allow sales representatives to access information on product pricing and availability, enter and track specific orders and monitor customer account information. Sales representatives will be able to access the system from their desktop computers at the Company's offices or on the Internet. The system will also allow selected customers to enter and manage their own orders on-line. The Company believes that when implemented this sales support system will enhance the productivity and flexibility of its sales force and improve its customer service. 800 PC DEALS The Company intends to use its proposed Internet-based sales support system to cost-effectively expand its marketing efforts for Computer Products on a national level under the trade name 800 PC Deals. Specifically, the Company intends to employ sales representatives with local experience in targeted metropolitan markets to establish customer relationships utilizing the new system. The Company also plans to operate a national sales support call center to serve sales representatives and customers. Initially, the Company intends to fulfill a large portion of orders in these new markets by drop shipping product directly from suppliers to customers. Once sufficient customer relationships are established and market knowledge is developed, the Company may seek to establish a branch office in a market. No definitive schedule has been established for the commencement of operations as 800 PC Deals. There can be no assurance that the new system will function as expected or, if so, that its implementation will enable the marketing approach of 800 PC Deals to be successful. Many factors could influence the performance of 800 PC Deals, including competition by others using similar systems, technical difficulties in the implementation of the new Internet-based system, lack of customer or supplier acceptance and the inability of local, direct sales representatives to successfully market Computer Products through 800 PC Deals. CUSTOMERS The Company focuses its marketing efforts on mid-sized customers and regional offices of larger customers located in or near the metropolitan areas in Texas in which the Company maintains offices. The Company occasionally provides Computer Products and IT Services in markets where the Company does not have an office, typically to branch operations of customers with which the Company has an established relationship. The Company's customer base is not concentrated in any industry group. Over 2,700 customers purchased products or services from the Company during 1997. In 1997, the largest single customer constituted 4.8% of total revenues, however in prior years the Company's largest customer has constituted as high as 11.2% of revenues. The Company has only a small amount of backlog relative to total revenues because the Company has no long-term commitments by customers to purchase products or services from the Company. Although the Company has service contracts with many of its large customers, such service contracts are project-based and/or terminable upon relatively short notice. A significant reduction in orders from any of the Company's largest customers could have a material adverse effect on the Company's financial condition and results of operations. SUPPLY AND DISTRIBUTION The Company relies on aggregators and distributors of computer hardware, software and peripherals to supply a majority of its Computer Products. Although the Company uses many industry suppliers, the Company purchases its Computer Products chiefly from two suppliers, Inacom and Ingram, to obtain competitive pricing, better product availability and improved quality control. The Company attempts to develop strategic arrangements with its principal suppliers, including the coordination of drop shipment orders, the outsourcing of certain computer configuration services, national roll-out and installation projects and the sharing of product information. Telecommunications hardware and software products are generally purchased by the Company on an as-needed basis directly from the original equipment manufacturer. The Company's largest supplier of Computer Products is Inacom, a leading computer products aggregator. Inacom markets and distributes computer products and provides various services on a wholesale basis through a network of franchisees and resellers and also markets its products directly to end-users. During 1995, 1996 and 1997, the Company purchased from Inacom approximately 36.6%, 57.0% and 51.4%, respectively, of its total inventory purchases. The Company purchases Computer Products and obtains drop shipping and other services from Inacom pursuant to an agreement entered into in August 1996 (the "Inacom Agreement"). Under the Inacom Agreement, the Company is required to purchase at least 80% of its Computer Products from Inacom, but only to the extent that such products are made available within a reasonable period of time at reasonably competitive pricing. Pricing from Inacom is generally based on Inacom's cost plus a negotiated markup. With certain exceptions, the Company is entitled to volume discounts at agreed upon levels. The term of the Inacom agreement expires on December 31, 2001, and automatically renews for successive one year periods unless notice of non-renewal is given 60 days prior to the end of the renewal period. A cancellation fee of $570,500 will be payable by the Company in the event of non-renewal or early termination of the Inacom Agreement by either party. The Company's second largest supplier of computer products is Ingram. The Company also purchases its Computer Products from Ingram on a cost-plus basis. During 1995, 1996 and 1997, the Company purchased from Ingram approximately 20.6%, 14.7% and 20.0% respectively, of its total inventory purchases. The Company's agreement with Ingram provides for volume discounts at agreed upon levels. The agreement with Ingram may be terminated by either party upon 30 days prior written notice. Due to intense price competition among computer products resellers, the price and shipping terms received by the Company from its suppliers, especially Inacom and Ingram, are critical to the Company's ability to compete in Computer Products. From time to time the availability of certain products has been limited. Although the Company has not experienced unusual product availability problems and has been generally satisfied with the product pricing and terms available from its principal suppliers, there can be no assurance that such relationships will continue or that, in the event of a termination of its relationship with either Inacom or Ingram, or both, it would be able to obtain an alternative supplier or suppliers without a material disruption in the Company's ability to provide competitively priced products to its customers. The Company maintains standard authorized dealership agreements from many leading manufacturers of computer and telecommunications hardware and software. Under the terms of these authorized dealership agreements, the Company is entitled to resell associated products to end-users and to provide warranty service. The Company's status as an authorized reseller of key product lines is essential to the operation of the Company's business. In general, the authorized dealer agreements do not require minimum purchases and include termination provisions ranging from immediate termination to termination upon 90 days prior written notice. Some of such agreements are conditioned upon the continuation of the Company's supply arrangement with Inacom or another major wholesaler acceptable to the manufacturer. The Company operates a warehouse at its Houston and Dallas offices for the purpose of receiving, warehousing, configuration and shipping products. The Company plans to consolidate its two warehouses into one central regional warehouse located in the Dallas-Fort Worth metropolitan area in order to achieve further productivity and efficiency enhancements. During 1995, the Company began an initiative to drop ship a higher percentage of its orders directly from the supplier to customer in order to lower its distribution costs and freight costs. This initiative has resulted in the percentage of drop shipped orders (measured by the cost of goods drop shipped as a percentage of total cost of goods) growing from 5. 1% during the six months ended June 30, 1995 to 18.1% during 1996 and 23.9% in 1997. While the Company does not believe that it is in its best interest to drop ship all orders, it does intend to continue to move more of its Computer Products distribution toward drop shipments. MANAGEMENT INFORMATION SYSTEMS The Company depends on its customized MIS to manage most aspects of its business. The Company's MIS provides its sales staff, customer service representatives and certain customers with product price, information and availability from its principal suppliers' warehouses throughout the United States. The Company utilizes its MIS to rapidly source product from a wide range of suppliers. Purchase order expediting features including overdue shipment and partial shipment reporting enable the Company to identify and resolve supplier and or freight carrier problems quickly. The purchasing systems are real time, allowing buyers to act within minutes on a newly received and credit-approved sales order. The Company's MIS contain 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. The Company uses its MIS to manage 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. During the first quarter of 1998 the Company commenced a conversion of its MIS to a more powerful computing platform which will allow the Company to improve and enhance its MIS. The new system will allow the Company to expand it uses and more fully integrate its operations with the MIS. While the Company expects the system conversion to be fully implemented with only normal debugging and reprogramming, a failure to fully implement the conversion with only minimal disruption of its operation could have an adverse effect on the Company's results of operations and financial condition. The system conversion was implemented as a general upgrading of the Company's MIS and was not for the purpose of achieving Year 2000 compliance. The Company believes its prior MIS was, and its new MIS is, Year 2000 compliant. Accordingly, the Company does not believe that Year 2000 compliance will have a material adverse effect on its results of operations or financial condition. It is possible that the Company could be impacted if its significant suppliers or customers do not successfully and timely achieve Year 2000 compliance with respect to their own computer systems. The Company has inquired of its two major suppliers as to the status of their Year 2000 compliance and has been advised that they expect to achieve Year 2000 compliance. If, contrary to the Company's expectations, it or the significant suppliers and customers fail to achieve Year 2000 compliance in a timely manner, the Company's results of operations and financial condition could be materially and adversely effected. EMPLOYEES As of December 31, 1997, the company employed approximately 363 individuals. Of these, approximately 81 were employed in sales, marketing and customer service, 153 were employed in engineering and technical positions and 129 were employed in administration, finance and MIS. The Company believes that its ability to recruit and retain highly skilled and experienced technical, sales and management personnel has been, and will continue to be, critical to its ability to execute its business plans. None of the Company's employees are represented by a labor union or are subject to a collective bargaining agreement. The Company believes that its relations with its employees are good. COMPETITION The markets in which the Company competes are all intensely competitive and changing rapidly. The Company believes that the principal competitive factors in the business activities in which it operates include relative price and performance, product availability, technical expertise, adherence to industry standards, financial stability, service, support and reputation. The Company believes that it has many direct and indirect competitors in each of its businesses, none of which is dominant in the Company's geographic markets. The Company's competitors include major computer products and telephone equipment manufacturers, aggregators and distributors, including certain manufacturers, aggregators and distributors which supply products to the Company. Other competitors include established national, regional and local resellers, systems integrators, telephone systems dealers, computer-telephony VARs and other CTI software suppliers. Some of the Company's current and potential competitors have longer operating histories and financial, sales, marketing, technical and other competitive resources which are substantially greater than those of the Company. As the markets in which the Company competes have matured, product price competition has intensified and is likely to continue to intensify. Such price competition could adversely affect the Company's financial condition and results of operations. There can be no assurance that the Company will be able to continue to compete successfully with existing or new competitors. HISTORY AND REINCORPORATION The Company was incorporated under Texas law in 1983 under the name Technicomp Corp. On June 30, 1993, the Company changed its name to Allstar-Valcom, Inc. and then again, on December 28, 1993, the Company changed its name to Allstar Systems, Inc. On December 27, 1993, the Company engaged in a merger in which it was the surviving corporation. In the merger, Allstar Services, Inc. and R. Cano, Inc. , both of which were affiliated with the Company, were merged with and into Allstar Systems, Inc. in order to streamline the business. In 1995, Company formed a wholly owned subsidiary, Stratasoft, Inc. , to purchase and develop its CTI Software. See "Certain Relationships and Related Transactions--Acquisition of Stratasoft Products. The Company effected a reincorporation and merger in the State of Delaware through which the 328,125 shares of the Company's predecessor, Allstar Systems, Inc. , a Texas corporation, which were outstanding prior to the merger, will be 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. FACTORS WHICH MAY AFFECT FUTURE RESULTS OF OPERATION Risk Of Low Margin Business The Company's past growth in net income has been fueled primarily by sales growth rather than increased gross profit margins. Given the significant levels of competition that characterize the computer reseller market, it is unlikely that the Company will be able to increase gross profit margins in its core business of reselling computer products which accounted for approximately 86% of the Company's total revenue in 1997. Moreover, in order to attract and retain many of its larger customers, the Company frequently must agree to volume discounts and maximum allowable markups that serve to limit the profitability of sales to such customers. Accordingly, to the extent that the Company's sales to such customers increase, the Company's gross profit margins may be reduced and, therefore, any future increases in net income will have to be derived from continued sales growth or effective expansion into higher margin businesses, neither of which can be assured. Furthermore, low margins increase the sensitivity of the Company's results of operations to increases in operating expenses, including costs of financing. Any failure by the Company to maintain or increase its gross profit margins and sales levels could have a material adverse effect on the Company's financial condition and results of operations. Dependence On Availability Of Credit; Interest Rate The Company's business activities are capital intensive in that the Company is required to finance accounts receivable and inventory. In order to obtain necessary working capital, the Company relies primarily on lines of credit under which the available credit and credit limits are dependent on the amount and quality of the Company's accounts receivable and inventory. As a result, the amount of credit available to the Company may be adversely affected by factors such as delays in collection or deterioration in the quality of the Company's accounts receivable, inventory obsolescence, economic trends in the computer industry, interest rate fluctuations and the lending policies of the Company's lenders. Many of these factors are beyond the Company's control. Any decrease or material limitation on the amount of capital available to the Company under its credit lines and other financing arrangements would limit the ability of the Company to fill existing sales orders, purchase inventory or expand its sales levels and, therefore, would have a material adverse effect on the Company's financial condition and results of operations. In addition, any significant increases in interest rates will increase the cost of financing to the Company and would have an adverse effect on the Company's financial condition and results of operations. The inability of the Company to have continuous access to such financing at reasonable costs would materially and adversely impact the Company's financial condition and results of operations. (See Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations). Highly Competitive Business The Company is engaged in business activities that are intensely competitive and rapidly changing. The Company believes that the principal competitive factors in the business in which it operates are relative price and performance, product availability, technical expertise, adherence to industry standards, financial stability, service support and reputation. Price competition has intensified, particularly in the Company's Computer Products and IT Services businesses, and is likely to continue to intensify. Such price competition could materially adversely affect the Company's financial condition and results of operations. The Company's competitors include major computer products and telephone equipment manufacturers, aggregators and distributors, including certain manufacturers, aggregators and distributors which supply products to the Company. Other competitors include established national, regional and local resellers, systems integrators, telephone systems dealers, computer-telephony VARs and other CTI software suppliers. Some of the Company's current and potential competitors have longer operating histories and financial, sales, marketing, technical and other competitive resources which are substantially greater than those of the Company. As a result, the Company's competitors may be able to adapt more quickly to changes in customer needs or to devote greater resources than the Company to sales and service of its products. Such competitors could also attempt to increase their presence in the Company's markets by forming strategic alliances with other competitors of the Company, offer new or improved products and services to the Company's customers or increase their efforts to gain and retain market share through competitive pricing. Management Of Growth; Regional Concentration The Company has experienced rapid growth which has and may continue to put strains on the Company's management and operational resources. The Company's ability to manage growth effectively will require it to continue to implement and improve its operational, financial and sales systems, to develop the skills of its managers and supervisors and to hire, train, motivate and manage its employees. The Company's future growth, if any, is expected to require the addition of new management personnel and the development of additional expertise by existing management personnel. The failure to do so could materially adversely affect the Company's financial position and results of operation. Within the next 12 months, the Company intends to open new offices. The Company also plans to relocate its Dallas-Fort Worth office and consolidate substantially all of its warehouse and distribution operations in the Dallas-Fort Worth metropolitan area. The Company anticipates that it will incur substantial costs in connection with these new office openings, including expenditures for furniture, fixtures and equipment. Additional burdens on the Company's working capital are also expected in connection with the start-up of such operations. Any significant disruption or unanticipated expenses in connection with these plans could also have a material adverse effect on the Company's financial condition and results of operations. For the foreseeable future, the Company expects that it will continue to derive most of its total revenue from customers located in or near the metropolitan areas in Texas in which the Company maintains offices. Accordingly, an economic downturn in any of those metropolitan areas, or in the region in general, would likely have a material adverse effect on the Company's financial condition and results of operations. Dependence On Key Personnel The success of the Company for the foreseeable future will depend largely on the continued services of key members of management, leading salespersons and technical personnel. The Company is particularly dependent upon James H. Long, founder, Chairman of the Board, President and Chief Executive Officer of the Company, because of his knowledge of the Company's operations, industry knowledge, marketing skills and relationships with major vendors and customers. The Company does not maintain key personnel life insurance on any of its executive officers or salespersons other than Mr. Long. The Company's success also depends in part on its 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. The Company's financial condition and results of operations could be materially adversely affected if the Company were unable to attract, hire, train and retain qualified personnel. Dependence On Continued Authorization To Resell And Provide Manufacturer- Authorized Services The Company's future success in both product sales and services depends largely on its continued status as an authorized reseller of products and its continued authorization as a service provider. With respect to the Company's computer hardware and software product sales and service, the Company maintains sales and service authorizations with many industry-leading manufacturers, including Compaq, Hewlett-Packard, IBM, Microsoft, NEC and Novell. In addition, some of such agreements are based upon the Company's continued supply relationship with Inacom or another aggregator or distributor approved by such manufacturers. With respect to the Company's Telecom Systems business, the Company maintains sales and service authorizations with industry-leading manufacturers, including Active Voice, AVT, NEC, Inter-tel and Mitel. Without such sales and service authorizations, the Company would be unable to provide the range of products and services currently offered by the Company. In addition, loss of manufacturer authorizations for products that have been financed under the Company's credit facilities constitutes an event of default under such credit facilities. In general, the agreements between the Company and its products 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 the Company's financial position and its results of operations. Dependence On Suppliers The Company's business depends upon its ability to obtain an adequate supply of products and parts at competitive prices and on reasonable terms. The Company's suppliers are not obligated to have product on hand for timely delivery to the Company nor can they guarantee product availability in sufficient quantities to meet the Company's demands. The Company procures a majority of computers, computer systems, components and parts primarily from Inacom and Ingram in order to obtain competitive pricing, maximize product availability and maintain quality control. Any material disruption in the Company's supply of products would have a material adverse effect on the Company's financial condition and results of operations. Rapid Technological Change The business in which the Company competes is characterized by rapid technological change and frequent introduction of new products and product enhancements. The Company's success depends in large part on its ability to identify and obtain products that meet the changing requirements of the marketplace. There can be no assurance that the Company will be able to identify and offer products necessary to remain competitive or avoid losses related to obsolete inventory and drastic price reductions. The Company attempts to maintain a level of inventory required to meet its near term delivery requirements by relying on the ready availability of products from its principal suppliers. Accordingly, the failure of the Company's suppliers to maintain adequate inventory levels of products demanded by the Company's existing and potential customers and to react effectively to new product introductions could have a material adverse effect on the Company's financial condition and results of operations. Because certain products offered by the Company are subject to manufacturer or distributor allocations, which limit the number of units available to the Company, failure of the Company to gain sufficient access to such new products or product enhancements could also have a material adverse effect on the Company's financial condition and results of operations. Reliance On Key Customers The Company's top ten customers (which have varied from year to year) accounted for 27.9%, 33.2% and 21.2% of the Company's revenue during 1995, 1996 and 1997, respectively. Based upon historical results and existing relationships with customers, the Company believes that a substantial portion of its total revenue and gross profit will continue to be derived from sales to existing customers. There are no long-term commitments by such customers to purchase products or services from the Company. Product sales by the Company are typically made on a purchase order basis. A significant reduction in orders from any of the Company's largest customers could have a material adverse effect on the Company's financial condition and results of operations. Similarly, the loss of any one of the Company's largest customers or the failure of any one of such customers to pay on a timely basis could have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that the Company's largest customers will continue to place orders with the Company or that orders by such customers will continue at their previous levels. There can be no assurance that the Company's service customers will continue to enter into service contracts with the Company or that existing contracts will not be terminated. Reliance On Management Information Systems The Company's success is largely dependent on the accuracy, quality and utilization of the information generated by its customized management information systems, which affects its ability to manage its sales, accounting, inventory and distribution systems. The Company anticipates that it will continually need to refine and enhance its management information systems as the Company grows and the needs of its business evolves. In view of the Company's reliance on information and telephone communication systems, any interruption or errors in these systems could have a material adverse effect on the Company's financial condition and results of operations. (See Item 1 - Business "Management Information Systems"). Acquisition Risk The Company intends to pursue potential acquisitions of complementary businesses. The success of this strategy depends not only upon the Company's ability to acquire complementary businesses on a cost-effective basis, but also upon its ability to integrate acquired operations into its organization effectively, to retain and motivate key personnel and to retain customers of acquired firms. No specific acquisitions are being negotiated or planned as of the date of this annual report and there can be no assurance that the Company will be able to find suitable acquisition candidates or be successful in acquiring or integrating such businesses. Furthermore, there can be no assurance that financing required for any such transactions will be available on satisfactory terms. Control By Existing Stockholders James H. Long, founder, Chairman of the Board, President and Chief Executive Officer of the Company owns 47.6% of the outstanding Common Stock and Mr. Long will have the ability to control the election of a majority of the members of the Company's 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 the affairs of the Company. Anti-Takeover Considerations The Company's Certificate of Incorporation and Bylaws contain certain provisions that may delay, deter or prevent a change in control of the Company. Among other things, these provisions authorize the board of directors of the Company to issue shares of preferred stock on such terms and with such rights, preferences and designations as the board of directors of the Company may determine without further stockholder action and limit the ability of stockholders to call special meetings or amend the Company's 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. Absence Of Dividends The Company expects to retain cash generated from operations to support its cash needs and does not anticipate the payment of any dividends on the Common Stock for the foreseeable future. In addition, the Company's credit facilities prohibit the declaration or payment of dividends, unless consent is obtained from each lender. GLOSSARY OF NAMES AND TECHNICAL TERMS COMPANY NAMES 3Com......................... 3Com Corporation AVT.......................... Applied Voice Technology Active Voice................. Active Voice Corporation Aspen........................ Aspen System Technologies, Inc. Compaq....................... Compaq Computer Corporation DEC.......................... DEC Digital Equipment Corporation DFS.......................... Deutsche Financial Services Corporation Epson........................ Epson America, Inc. Hewlett-Packard.............. Hewlett-Packard Company IBM.......................... International Business Machines Corporation IBMCC........................ IBM Credit Corporation ILC.......................... International Lan and Communications, Inc. Inacom....................... Inacom Corp. Ingram....................... Ingram Micro, Inc. Inter-tel.................... Inter-tel, Inc. Macrotel..................... Macrotel International Corporation Microsoft.................... Microsoft Corporation Mitel........................ Mitel, Inc. NEC.......................... NEC America, Inc. Novell....................... Novell, Inc. Taske........................ Taske Technology, Inc. Uniden....................... Uniden America Corporation All company names and trade names are the legal property of their respective owners. TECHNICAL TERMS Aggregator................... A company that purchases directly from manufacturers in large quantities, maintains inventory, breaks bulk and resells to distributors, resellers and value-added resellers Configuration................ The customization of equipment to a customer's specifications which may include the loading of software, adding of memory or combining different manufacturers' equipment in such a way that it will be compatible as an integrated system CTI.......................... Computer and telephone integration IVR.......................... Interactive voice response LAN.......................... Local-area network MIS.......................... Management information systems Open architecture networks... Networks based on industry standard technical specifications that enable the system to operate with hardware and software from different manufacturers meeting those standards PBX.......................... Private branch exchange PC........................... Personal computer Price protection............. A voluntary policy by a manufacturer that when a decrease in the price of its product is instituted, the manufacturer will rebate the Company for the difference between the new price and the price paid by the Company for product in its inventory Roll-out..................... Single sale involving a large volume of similar products to be delivered on a pre-specified timetable SQL.......................... Structured query language VAR (Value-added reseller)... A company that purchases equipment or software from a manufacturer, aggregator or distributor, provides value added services to their clients including network management, configuration systems integration and training and subsequently resells the enhanced product WAN.......................... Wide-area network Item 2. Properties FACILITIES The Company does not own any real property and currently leases all of its existing facilities. The Company subleases its headquarters and Houston office which are housed in a free standing building of approximately 48,000 square feet. The Houston office sublease expires on December 31, 1998. The Company expects to enter into a new leasing arrangement for the same facility during 1998. The Company's Dallas office is housed in a free-standing building of approximately 20,000 square feet. The Dallas facility lease expired on September 30, 1997 and has been extended to June 30, 1998. The Company expects to either renew the existing lease for an additional term of more than one year or to relocate to different facilities within the Dallas-Ft. Worth metropolitan area. The Company also leases a storage facility of approximately 7,000 square feet in Houston. The lease on this warehouse expires on April 14, 1998 and the Company intends to extend such lease on a month-to-month basis after expiration of the lease. The Company added offices in Austin, McAllen and El Paso, Texas during 1997. The Company has leased interim offices in each of those cities under leases expiring in less than one year. The Company intends to lease other facilities in these cities as its business expands. The Company believes that suitable facilities will be available as needed. INTELLECTUAL PROPERTY The Company's success depends in part upon its proprietary technology, including its Stratasoft software. The Company relies primarily on trade secrecy and confidentiality agreements to establish and protect its rights in its proprietary technology. Additionally, the Company filed and received copyright protection for StrataDial and StrataVoice. The Company also applied and received registration of Stratasoft, StrataDial, StrataVoice as trademarks and intends to apply for registration of 800 PC Deals as a trademark. There can be no assurance that the Company's present protective measures will be adequate to prevent unauthorized use or disclosure of its technology or independent third party development of the same or similar technology. While the Company's competitive position could be affected by its ability to protect its proprietary and trade secret information, the Company believes other factors, such as the technical expertise and knowledge of the Company's management and technical personnel and the timeliness and quality of support services provided by the Company, to be more significant in maintaining the Company's competitive position. The Company's various authorization agreements with manufacturers generally permit the Company to refer to itself as an authorized dealer of the respective manufacturer's products and to use their trademarks and trade names for marketing purposes, but prohibit other uses. The Company considers the use of these trademarks and trade names in its marketing efforts to be important to its business. Item 3. Legal Proceedings On July 13, 1996, a former customer brought suit against the Company in the 152nd Judicial District Court of Harris County, Texas. The plaintiff alleges that the Company failed to provide and complete promised installation and configuration of certain computer equipment within the time promised by the Company. Based on these allegations, the plaintiff is suing for breach of contract, negligence, negligent misrepresentation and other statutory violations and is seeking actual monetary damages of approximately $3 million and treble damages under the Texas Deceptive Trade Practices Act. The Company intends to vigorously defend such action. The effect of an unfavorable outcome could have a material adverse effect on the Company's results of operations and its financial condition. The Company is from time to time involved in routine litigation incidental to its business. The Company believes that none of such proceedings, including current proceedings, individually or in the aggregate will have a materially adverse effect on the Company. 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 On July 7, 1997 the Company completed its initial public offering of it Common Stock. The shares are traded on the Nasdaq National Market under the symbol "ALLS". High Low Fiscal 1997 Third quarter (Commencing July 7, 1997) 8 6 Fourth quarter 7 1/2 3 15/16 As of March 13, 1998 there were 15 holders of record of the Company's common stock. The Company has never declared or paid any cash dividends on its Common Stock. The Company currently anticipates that it will retain all earnings for use in its business operations. The payment of dividends is prohibited under the Company's credit agreements, unless approved by the lenders. Item 6. Selected Financial Data SELECTED FINANCIAL DATA The following sets forth the selected data of the Company for the five years ended December 31, 1997.
Year ended December 31 (In Thousands except share and per share amounts) 1993 1994 1995 1996 1997 Operating Data: Total revenue $49,536 $64,076 $91,085 $120,359 $129,167 Cost of sales and services 42,289 55,541 79,857 104,302 111,126 ------- ------- ------- ------- ------- Gross Profit 7,247 8,535 11,228 16,057 18,041 Selling, general and administrative expenses 6,060 7,448 9,149 12,284 14,386 ------- ------- ------- ------- ------- Operating income 1,187 1,087 2,079 3,773 3,655 Interest expense (net of other income) 644 764 1,218 1,183 685 ------- ------- ------- ------- ------- Income before provision for income taxes 543 323 861 2,590 2,970 Provision for income taxes 229 140 342 987 1,126 ------- ------- ------- ------- ------- Net Income $ 314 $ 183 $ 519 $ 1,603 $ 1,844 ======== ======== ======== ========= ========= Supplemental Data: Net income per share: Basic $ 0.15 $ 0.07 $ 0.19 $ 0.60 $ 0.52 Diluted.................................... $ 0.15 $ 0.07 $ 0.19 $ 0.60 $ 0.52 Weighted average shares outstanding............. 2,120,242 2,554,808 2,675,000 2,675,000 3,519,821
As of December 31 1993 1994 1995 1996 1997 Balance Sheet Data: Working Capital................................. $1,307 $1,363 $1,732 $2,291 $12,824 Total Assets.................................... 17,431 19,077 24,266 24,720 33,183 Short-term borrowings(1)........................ 6,896 8,972 9,912 9,975 1,572 Long-term debt.................................. 43 -0- -0- -0- -0- Stockholders' equity............................ 2,022 2,205 2,724 4,327 14,723
(1) See Note 5 to the Company's Consolidated Financial Statements. Short-term borrowings do not include amounts recorded as floor plan financing which are included in accounts payable. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is qualified in its entirety by, and should be read in conjunction with, the Company's Consolidated Financial Statements, including the Notes thereto, included elsewhere in this Annual Report on Form 10-K. Overview The Company was formed in 1983 to engage in the business of reselling computer hardware and software products and providing related services. To date, most of its revenue has been derived from Computer Products sales. In addition, the Company derives revenue from providing IT Services to purchasers of Computer Products and other customers. The Company operated from a single office in Houston, Texas until 1992 when it opened a branch office in Dallas, Texas. In 1994, the Company began offering Telecom Systems in its Houston office. In the fourth quarter of 1995, the Company acquired and began marketing CTI Software. During 1997 the Company opened offices in Austin, McAllen and El Paso, Texas to expand, initially, its Computer Products and IT Services divisions. The Company's gross margin varies substantially between each of its businesses. The Company's Computer Products sales have produced a gross margin ranging from 10.4% to 10.7% over the three year period ended December 31, 1997, reflecting the commodity nature of the Computer Products market. The gross margin for IT Services, which reflects direct labor costs, has ranged from 30.4% to 37.6% over the same period. This variation is primarily attributable to the pricing and the mix of services provided, and the level of utilization of billable technical staff. The gross margin for Telecom Systems, which includes both product sales and services, has varied between 23.0% and 35.5% during the last three years. This variation reflects the different mix of product sales and the amount of services-related revenue from period to period and competitive pricing of Telecom products. The gross margin for CTI Software was 40.2% in 1996 versus 43.0% in 1997, primarily due to the amount expended by the Company to acquire and develop the software relative to the level of revenue produced. CTI Software accounted for approximately 1.1% of the Company's revenues in 1996 compared to 1.7% in 1997. In order to reduce freight costs and selling, general and administrative expenses associated with product handling, the Company began in 1995 to drop ship a higher percentage of orders directly from its suppliers to its customers. This initiative has resulted in the percentage of drop shipped orders (measured by the cost of goods dropped shipped as a percentage of total cost of goods) growing from 9.0% in 1995 to 18.1% in 1996 and to 23.9% in 1997. While the Company does not believe that it is in its best interest to drop ship all orders, it does intend to increase the volume of drop shipments in Computer Products with the expectation of reducing its freight, distribution and administrative costs related to these revenues. A significant portion of Company's selling, general and administrative expenses relate to personnel costs, some of which are variable and others of which are relatively fixed. The Company's variable personnel costs are substantially comprised of sales commissions, which are typically calculated based upon the Company's gross profit on a particular sales transaction and thus generally fluctuate with the Company's overall gross profit. The remainder of the Company's selling, general and administrative expenses are relatively more fixed and, while still somewhat variable, do not vary with increases in revenue as directly as do sales commissions. 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 the major manufacturers of computer products have a policy of providing price protection to resellers when prices are reduced, on occasion, and particularly during 1994, manufacturers introduced new models of their products and then reduced the price of, or discontinued, the older models without price protection. In these instances, the Company often sells the older models at reduced prices, which adversely affects gross margin. 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. The Company has participated in a number of these programs in recent years. Inacom is the largest supplier of products sold by the Company. Purchases from Inacom accounted for approximately 36.6%, 57.0% and 51.4% of the Company's total product purchases in 1995, 1996 and 1997, respectively. In August 1996, the Company renewed its long-term supply arrangement with Inacom and agreed to purchase at least 80% of its Computer Products from Inacom, but only to the extent that such products are made available within a reasonable period of time at reasonably competitive pricing. Inacom does not carry certain product lines sold by the Company and Inacom may be unable to offer reasonable product availability and reasonably competitive pricing from time to time on those product lines that it carries. The Company thus expects that less than 80% of its total purchases will be made from Inacom, and that any increase or decrease over historical levels in the percentage of products it purchases from Inacom under the new Inacom agreement will not have any material impact on the Company's results of operations. Results of Operations The following table sets forth, for the periods indicated, certain financial data derived from the Company's consolidated statements of operations and indicates the percentage of total revenue for each item.
Year ended December 31, ----------------------------------------------------------------------- 1995 1996 1997 ---------------------- --------------------- -------------------- Amount % Amount % Amount % (Dollars in thousands) Operating Data(1): Revenue Computer Products.............. $81,654 89.6 $107,251 89.1 $111,145 86.0 IT Services.................... 7,900 8.7 7,996 6.6 10,474 8.1 Telecom Systems................ 1,458 1.6 3,824 3.2 5,403 4.2 CTI Software................... 73 1,288 1.1 2,145 1.7 -------- ---- -------- ---- ------- ---- 0.1 Total revenue............... 91,085 100.0 120,359 100.0 129,167 100.0 Gross Profit(1) Computer Products.............. 8,466 10.4 11,172 10.4 11,832 10.7 IT Services.................... 2,404 30.4 3,008 37.6 3,875 37.0 Telecom Systems................ 335 23.0 1,359 35.5 1,412 26.1 CTI Software................... 23 31.5 518 40.2 922 43.0 -------- ---- -------- ---- ------- ---- Total Gross Profit........... 11,228 12.3 16,057 13.3 18,041 13.9 Selling, general and administrative expenses........ 9,149 10.0 12,284 10.2 14,386 11.1 -------- ---- -------- ---- ------- ---- Operating income............... 2,079 2.3 3,773 3.1 3,655 2.8 Interest expense (net of other income).................. 1,218 1.3 1,183 1.0 685 .5 -------- ---- -------- ---- ------- ---- Income before provision for income taxes............. 861 1.0 2,590 0.8 2,970 2.3 Provision for income taxes........ 342 0.4 987 0.8 1,126 0.9 -------- ---- -------- ---- ------- ---- Net income..................... 519 0.6 1,603 1.3 1,844 1.4 ======== ==== ======== ==== ======= ==== Per Office Data(1)(2): Houston Office: Revenue...................... 53,095 58.3 57,929 48.1 65,614 50.8 Gross profit................. 6,880 13.0 9,470 16.4 9,356 14.3 Dallas Office: Revenue...................... 37,990 41.7 62,430 51.9 61,698 47.8 Gross profit................. 4,348 11.5 6,587 10.6 8,518 13.8 Austin Office: Revenue...................... 1,855 1.4 Gross profit................. 167 9.0
(1) Percentages shown are percentages of total revenue, except gross profit percentage which represent gross profit by each product category as a percentage of revenue for each such category. (2) Revenue realized in the McAllen and El Paso offices during 1997 were insignificant. Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996 Total Revenue. Total revenue increased by $8.8 million (7.3%) from $120.4 million in 1996 to $129.2 million in 1997. Revenue from Computer Products, which comprised 86.0% of total revenue, increased by $3.9 million (3.6%). The increase in Computer Products revenue was generally attributable to increased sales to new and existing customers. Revenue in Computer Products did not grow as expected in 1997 principally due to insufficient capital resources during the first half of 1997 and the inability of the newly added sales personnel to attain the level of revenue production normally expected of new personnel. Revenue from IT Services increased by $2.5 million (31.0%) from $8.0 million in 1996 to $10.5 million in 1997. The increase was due primarily to sales to new customers and increases in services provided to existing customers as a result of customers' increased out-sourcing of their technical support requirements. Revenue from IT Services as a percentage of total revenue increased from 6.6% in 1996 to 8.1% in 1997 due to the higher growth rate in IT Services revenues relative to the growth rate of Computer Products revenues in 1997. Revenue from Telecom Systems, which comprised 4.2% of total revenue, increased by $1.6 million (41.3%). This increase in Telecom Systems revenue was primarily the result of adding new customers, of which one customer accounted for $1.3 million (81.2%) of the increase. Sales of CTI Software increased 66.5% from $1.3 million in 1996 to $2.1 million in 1997. The increased revenues were primarily the result of sales to new customers. Gross Profit. Gross profit increased by $2.0 million (12.4%) from $16.0 million in 1996 to $18.0 million in 1997, while gross margin increased from 13.3% in 1996 to 13.9% in 1997. The gross margin for Computer Products increased from 10.4% in 1996 to 10.7% in 1997, reflecting the continuation of highly competitive market conditions for Computer Products. The gross margin from IT Services increased from 37.6% in 1996 to 37.0% in 1997. This decrease in gross margin was primarily attributable increases, expressed as a percentage of revenue, in the cost of the billable technical staff which is due to the relative scarcity of qualified technical staff in the information technology industry. These cost increases were almost fully offset by increases in the prices being charged for services which is also due to the relative scarcity of qualified technical staff in the information technology industry. In 1996 the Company commenced the implementation of a program to replace less profitable hardware maintenance and repair services with a variety of services that were expected to generate higher gross margins. This program resulted in the elimination of certain IT Services customer relationships which had been producing lower than average gross margin. The loss of this lower margin revenue was offset by revenues from new IT Services customers and from existing customers at higher gross margins. The gross margin for Telecom Systems sales decreased from 35.5% in 1996 to 26.1% in 1997. In 1997, Telecom Systems bid on and won the installation of several large systems. As a result of the competitive bidding process employed by certain customers these large systems were projects which had lower than normal margins. In addition, gross margin decreased in 1997 due to the purchase of a large system by a single customer at a lower than usual margin. CTI Software sales resulted in a gross margin of 43.0% in 1997, an increase from 40.2% in 1996. This reflected slightly lower, as a percentage of revenue, installation costs and development costs in 1997 compared to 1996. Selling, General and Administrative Expenses . Selling, general and administrative expenses increased by $ 2.1 million (17.1%) from $12.3 million in 1996 to $14.4 million in 1997. As a percentage of total revenue, selling, general and administrative expenses increased from 10.2% in 1996 to 11.1% in 1997. Of the dollar increase, $1.5 million was attributable to increased temporary and permanent personnel, principally in non-sales personnel. Other costs which grew at a rate in excess of the rate of growth in revenues includes expenses relating to becoming and being a publicly held corporation and professional fees. The increase as a percentage of total revenue resulted primarily from increased expenditures for those expenses which do not fluctuate with gross profit or revenues. Operating Income. Operating income decreased by $118,000 (3.1 %) from $3.8 million in 1996 to $3.7 million in 1997. Operating income decreased as a percentage of total revenue from 3.1% in 1996 to 2.8% in 1997 largely due to increases in selling, general and administrative expenses. Interest Expense (Net of Other Income). Interest expense (net of other income) decreased by $498,000 (42.1%). Interest expense decreased due to the reduction of outstanding debt by applying the proceeds of the Company's initial public offering to the reduction of debt. Net Income. Net income, after a provision for income taxes totaling $1,126,000 ( reflecting an effective tax rate of 37.9% compared to 38.1% in 1996), increased by $241,000 from $1.6 million in 1996 to $1.8 million in 1997. Net income increased as a percentage of total revenue from 1.3% in 1996 to 1.4% in 1997. Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995 Total Revenue. Total revenue increased by $29.3 million (32.1%) from $91.1 million in 1995 to $120.4 million in 1996. Revenue from Computer Products, which comprised 89.1% of total revenue, increased by $25.6 million (31.3%). The increase in Computer Products revenue was generally attributable to increased sales to new and existing customers resulting from the hiring of additional sales personnel. Revenue from IT Services increased by $96,000 (1.2%) from $7.9 million in 1995 to $8.0 million in 1996. The marginal increase was primarily the result of the Company's implementation of a program at the beginning of 1996 to replace less profitable hardware maintenance and repair services with a variety of services that were expected to generate higher gross margins. This program resulted in the elimination of certain IT Services customer relationships which had been producing lower than average gross margin. The loss of this lower margin revenue was offset, however, by sales to new IT Services customers and to existing customers, generally at higher gross margins than those earned on sales to the former customers. Revenue from IT Services as a percentage of total revenue decreased from 8.7 % in 1995 to 6.6% in 1996 due to both the minimal growth in IT Services revenues and to growth in the Company's three other business categories. Revenue from Telecom Systems, which comprised 3.2% of total revenue, increased by $2.4 million (162.3%). This increase in Telecom Systems revenue was primarily the result of hiring additional sales personnel and adding new customers, of which one customer accounted for $699,000 (29.5%) of the increase, and expanding advertising and marketing efforts. Sales of CTI Software, which commenced during the fourth quarter of 1995, contributed total revenue of $1.3 million during 1996, which comprised 1.1% of the Company's total revenue. Gross Profit. Gross profit increased by $4.8 million (43.0%) from $11.2 million in 1995 to $16.1 million in 1996, while gross margin increased from 12.3% in 1995 to 13.3% in 1996. The gross margin for Computer Products remained consistent at 10.4% for both periods. The gross margin from IT Services increased from 30.4% in 1995 to 37.6% in 1996. As noted above, this increase was primarily attributable to the replacement of less profitable IT Services business with more profitable business from new and existing IT Services customers. The gross margin for Telecom Systems sales increased from 23.0 % in 1995 to 35.5% in 1996. In 1995, Telecom Systems was generally selling products and services at lower gross margin than in the 1996 period in order to gain market share during its first year of operation. In addition, gross margin for Telecom Systems increased in 1996 due to the purchase of a large, complex system by a single customer at a higher than usual margin. CTI Software sales resulted in a gross margin of 40.2% in 1996, which was the first full year of operations for the Company's CTI Software business. Selling, General and Administrative Expenses . Selling, general and administrative expenses increased by $ 3.1 million (34.3%) from $9.1 million in 1995 to $12.3 million in 1996. As a percentage of total revenue, selling, general and administrative expenses increased from 10.0% in 1995 to 10.2% in 1996. Of the dollar increase, $1.2 million was attributable to increased sales compensation due to increased gross profits and an increase in the number of sales personnel and $1.0 million was attributable to increases in non-sales personnel costs. The increase as a percentage of total revenue resulted primarily from increased gross margins and the related increase in the variable component of selling, general and administrative expenses that fluctuates with gross profit, and from the increase in bad debt expense, a portion of which was due to actual losses and a portion of which was due to increases in reserves for potential future losses. Operating Income. Operating income increased by $1.7 million (81.5 %) from $2.1 million in 1995 to $3.8 million in 1996. Operating income increased as a percentage of total revenue from 2.3% in 1995 to 3.1% in 1996. Interest Expense (Net of Other Income). Interest expense (net of other income) decreased by $35,000 (2.9%). Interest expense remained substantially unchanged compared to the increase in revenue due to decreased leverage resulting from increased use of equity and increased asset turns, together with advance payments for a large purchase by a single customer in 1996. The prepayments resulted in reduced accounts receivable and a related reduction in borrowing. Net Income. Net income, after a provision for income taxes totaling $987,000 ( reflecting an effective tax rate of 38.1% compared to 39.7% in 1995), increased by $1.1 million from $519,000 in 1995 to $1.6 million in 1996. Net income increased as a percentage of total revenue from 0.6% in 1995 to 1.3% in 1996. Quarterly Results of Operations The following table sets forth certain unaudited quarterly financial information for each of the Company's 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. The Company's 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 the Company's product costs, variations in the Company's product mix, promotions by the Company, seasonal influences and competitive pricing pressures. Furthermore, the Company generally experiences a higher volume of orders of Computer Products in the fourth quarter, which the Company attributes to year-end capital spending by its customers. Any decrease in the number of year-end orders experienced by the Company may not be offset by increased revenues in the Company's first three quarters. The results of any particular quarter may not be indicative of results for the full year or any future period. 1996 1997 ------------------------------------- ------------------------------------- (In thousands, except per share amounts) First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Total Revenue $25,948 $32,202 $29,187 $33,022 $26,593 $32,239 $31,914 $38,423 Cost of sales and service 22,727 28,234 24,669 28,672 22,762 27,312 27,777 33,277 ------- ------- ------- ------- ------- ------- ------- ------- Gross Profit 3,221 3,968 4,518 4,350 3,831 4,927 4,137 5,146 Selling, general and administrative expenses 2,674 2,992 3,319 3,299 3,135 3,839 3,439 3,974 ------- ------- ------- ------- ------- ------- ------- ------- Operating Income 547 976 1,199 1,051 696 1,088 698 1,172 Interest expense (net of other income) 297 285 338 263 289 309 82 5 ------- ------- ------- ------- ------- ------- ------- ------- Income before provision for income taxes 250 691 861 788 407 779 616 1,167 Provision for income taxes 111 223 362 291 154 310 236 424 ------- ------- ------- ------- ------- ------- ------- ------- Net income $ 139 $ 468 $ 499 $ 497 $ 253 $ 469 $ 380 $ 742 ======= ======= ======= ======= ======= ======= ======= ======= Net income per share $0.05 $0.17 $0.19 $0.19 $0.09 $0.17 $0.09 $0.17
Liquidity and Capital Resources Historically, the Company has satisfied its cash requirements principally through borrowings under its lines of credit and through operations. The Company maintains a cash position sufficient to pay only its immediately due obligations and expenses. When the amount of cash available falls below its immediate needs, the Company requests advances under its credit facility. As the Company's total revenue has grown, the Company has obtained increases in its available lines of credit to enable it to finance its growth. The Company's working capital was $1.7 million, $2.3 million and $12.8 million at December 31, 1995, 1996 and 1997, respectively. The increase in working capital from 1996 to 1997 was attributable to the receipt of net proceeds from a public offering of the Company's common stock in July, 1997 and net earnings. As of December 31, 1997, the Company had total borrowing capacity, based on its collateral base under its credit facility of approximately $23.8 million versus $18.8 million at December 31, 1996. At December 31, 1997 the Company had unused borrowing capacity of approximately $18.6 million versus $1.2 million at December 31, 1996. Cash Flow Operating activities used net cash totaling $123,000 during 1995 and provided net cash totaling $89,000 and $2.0 million during 1996 and 1997, respectively. Net cash used in 1995 was primarily due to working capital requirements to finance increased accounts receivable and inventory. In 1996, net cash was provided from operations due primarily to the combined effect of significantly increased net income, a relatively small year-to-year increase in accounts receivable and a year-to-year decrease in inventory. 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. Trade accounts receivable increased $4.4 million, $695,000 and $7.2 million during 1995, 1996 and 1997, respectively. Inventory increased $21,000 in 1995 and decreased $545,000 and $162,000 in 1996 and 1997, respectively. Net cash used in operating activities during 1995 of $ 123,000 was net of an accrual of $1.4 million for a delinquent Texas sales tax liability for the period June 1995 to November 1995. Interest was accrued on the liability; however, all penalties were waived by the state. The delinquency resulted from a programming error in the Company's accounting system that has since been corrected. In September 1996, the Company paid the state the agreed upon sales taxes. Had the sales taxes been timely paid, net cash used in operations during 1995 would have been approximately $1.5 million and net cash provided by operations in 1996 would have been $1.5 million. Investing activities used cash totaling $458,000, $952,000 and $992,000 during 1995, 1996 and 1997, respectively. The Company's investing activities that used cash during these periods were primarily related to capital expenditures. During the next twelve months, the Company expects to incur an estimated $1.0 million for capital expenditures, a majority of which is expected to be incurred for leasehold improvements and other capital expenditures in connection with the planned consolidation of its warehouse facilities into a single facility in the Dallas-Fort Worth area, the relocation of its Dallas branch office and the opening of branch offices in McAllen, El Paso and San Antonio, Texas. All or a portion of the $1.0 million in capital expenditures currently budgeted by the Company for such purposes are presently expected to be financed from net cash flow from operations or borrowings under the Company's line of credit. The actual amount and timing of such capital expenditures may vary substantially depending upon, among other things, the actual facilities selected, the level of expenditures required to render the facilities suitable for the Company's purposes and the terms of lease arrangements pertaining to the facilities. Financing activities provided cash totaling $940,000, $63,000 and $344,000 during 1995 , 1996 and 1997, respectively. In July, 1997, the Company received $8.7 million net proceeds from the sale of Common Stock in a public offering. Those proceeds were used to reduce the outstanding balance under the Company's line of credit. The primary source of cash from financing activities in other periods has been borrowings on the Company's lines of credit. The lines of credit have been used principally to finance increases in accounts receivable. Asset Management The Company's cash flow from operations has been affected primarily by the timing of its collection of trade accounts receivable. The Company typically sells its products and services on short-term credit terms and seeks to minimize its credit risk by performing credit checks and conducting its own collection efforts. The Company had trade accounts receivable, net of allowance for doubtful accounts, of $15.8 million, $16.5 million and $23.8 million at December 31, 1995, 1996 and 1997, respectively. The number of days' sales outstanding in trade accounts receivable was 45 days, 40 days and 53 days for years 1995, 1996 and 1997, respectively. The increase in days' sales outstanding was caused by a general slow down in payments by the Company's customers. To improve this condition the Company has increased its collection staff and added an experienced credit manager. Bad debt expense as a percentage of total revenue for the same periods was 0.1%, 0.2% and 0.2%. The Company's allowance for doubtful accounts, as a percentage of trade accounts receivable, was 2.8%, 1.3% and 1.0% at December 31, 1995, 1996 and 1997, respectively. The Company manages its inventory in order to minimize the amount of inventory held for resale and the risk of inventory obsolescence and decreases in market value. The Company attempts to maintain a level of inventory required to reach only its near term delivery requirements by relying on the ready availability of products from its principal suppliers. Manufacturers of the Company's major products generally provide price protection, which reduces the Company's exposure to decreases in prices. In addition, its suppliers generally allow for returns of excess inventory, which, on a limited basis, are made without material restocking fees. Inventory turnover for 1995, 1996 and 1997 was 14.6 times, 19.2 times and 21.5 times, respectively. Prior Debt Obligations Throughout 1997, the principal source of liquidity for the Company, in addition to its cash provided from operations, was its revolving line of credit with IBMCC (the "IBMCC Facility"). On February 27, 1998 the Company executed agreements with Deutsche Financial Services ("DFS") for a revolving line of credit which will replace the IBMCC Facility as the Company's principal source of liquidity and the IBMCC Facility will be converted into a credit facility for the purchase of IBM branded computer products. The credits facilities described herein as the "Old IBMCC Facility" and the "Old DFS Facility" set forth the provisions of the credit facilities in effect during 1997 and prior periods. The credit facilities described as the "New DFS Facility" and the "New IBMCC Facility" set forth the provisions of those facilities after the implementation of the revolving credit agreement with DFS dated February 27, 1998. The total credit available under the Old IBMCC Facility was $20.0 million, subject to borrowing base limitations which were generally computed as a percentage of various classes of eligible accounts receivable and qualifying inventory. Borrowings were available under the Old IBMCC Facility for floor plan financing of inventory from approved manufacturers (the "Old Inventory Line"). Available credit under the Old IBMCC Facility, net of Inventory Line advances, was used by the Company primarily to carry accounts receivable and for other working capital and general corporate purposes (the "Old Accounts Line"). Borrowings under the Old Accounts Line bore interest at the fluctuating prime rate plus 2.0% per annum. Under the Old Inventory Line, IBMCC paid the Company's inventory vendors directly, generally in exchange for negotiated financial incentives. Typically, the financial incentives received were such that IBMCC does not charge interest to the Company until approximately 30 days after the transaction is financed, at which time the Company was 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 IBMCC. Inventory Line advances not paid within 30 days after the financing date bear interest at the fluctuating prime rate plus 6.0%. IBMCC was permitted to fix a minimum prime rate for the IBMCC Facility of not less than the average prime rate in effect at the time the minimum prime rate is set but did not do so. IBMCC was authorized to change, on 30 days notice, the computation of the borrowing base and to disqualify accounts receivable upon which advances have been made and require repayment of such advances to the extent such disqualifications cause the Company's borrowings to exceed the reduced borrowing base. The Old IBMCC Facility was collateralized by a security interest in substantially all of the Company's assets, including its accounts receivable, inventory, equipment and bank accounts. The Company's Chief Executive Officer and principal stockholder personally guaranteed the Company's indebtedness to IBMCC. Collections of the Company's accounts receivable were required to be applied through a lockbox arrangement to repay indebtedness to IBMCC; however, IBMCC customarily released a portion of the Company's daily collections to the extent that they exceed the daily estimated borrowing base. Through most of 1995, the Company's credit limit under the Old IBMCC Facility was $15.0 million. From October 1995 through February 1996, IBMCC extended a temporary increase in the credit limit to $22.5 million and in April 1996 increased the base credit limit to $20.0 million. Effective September 1996, the Company was notified by IBMCC that it had received further temporary credit limit adjustments consisting of increases to $30.0 million from September 1996 through February 1997, $28.0 million in March 1997, $25.0 million in April 1997, and returning to the base limit of $20.0 million thereafter. At December 31, 1997, the total indebtedness of the Company under the Old IBMCC Facility was $4.3 million of which $1.6 million was outstanding under the Accounts Line and $1.1 million was outstanding under the Inventory Line. The Company's remaining available credit at December 31, 1997, based on its borrowing base was approximately $18.6 million. The Company had a $3.0 million credit facility with Deutsche Financial Services (the "Old DFS Facility") for the purchase of inventory from certain suppliers. From October 1995 through May 1996, the Company received a temporary increase in the available credit line to $6.0 million and on or about November 15, 1997 this facility was increased to $10.0 million in anticipation of increased usage of this facility for inventory purchases. As in the case of the Old IBMCC Inventory Line, advances under the Old DFS Facility were typically interest free for 30 days after the financing date for transactions in which adequate financial incentives are received by DFS from the vendor. Within 30 days after the financing date, the full invoice amount for inventory financed through DFS is required to be paid by the Company. On or about November 15, 1997 DFS extended to interest free period for advances under the Old DFS Facility to 40 days. Amounts remaining outstanding thereafter bear interest at the fluctuating prime rate (but not less than 6.5%) plus 6.0%. DFS retains a security interest in the inventory financed. The Old DFS Facility is immediately terminable by either party by written notice to the other. At December 31, 1997, the amount outstanding under the DFS Facility was $9.4 million. The Company was required to comply with certain key financial and other covenants under the Old IBMCC Facility and Old DFS Facility. During 1994 and 1995 and the first seven months of 1996, the Company was in default of certain financial covenants and certain other covenants under the Old IBMCC Facility and Old DFS Facility. For example, the Company was required under the Old IBMCC Facility to maintain during 1995 the following financial ratios: net profits after taxes to revenue of at least 0.5%; annualized revenues to working capital of more than zero but no greater than 35.0 to 1; and total liabilities to tangible net worth of more than zero but no more than 12.0 to 1. The ratios actually attained by the Company for the year ended December 31, 1995, were approximately 0.57%, 43.9 to 1 and 12.7 to 1, respectively. The Old DFS Facility, for instance, requires that at all times the Company's indebtedness for borrowed money and capital lease obligations divided by its tangible net worth plus subordinated debt not exceed 8.0 to 1, but at June 30, 1996, the actual ratio attained by the Company was approximately 9.18 to 1. In addition to financial ratio covenants, the Company has violated other covenants under both credit facilities, including timely filing of periodic financial reports and covenants prohibiting certain transactions with subsidiaries and other affiliates. IBMCC and DFS have, however, waived defaults when requested by the Company from time to time. Most recently, IBMCC and DFS waived certain defaults in August 1996 through December 31, 1996. Additionally, both lenders liberalized certain financial covenants in connection with their waivers. DFS increased the maximum permitted ratio for indebtedness for borrowed money plus capital lease obligations to tangible net worth plus subordinated debt to 9.5 to 1 through December 31, 1996, reverting to 8.0 to 1 thereafter. IBMCC increased the maximum permissible ratio of annualized revenue to working capital to 56.0 to 1 through 1996 and to 52.0 to 1 thereafter, reserving the right to further change the ratio upon notice to the Company. Throughout 1997, the Company was in compliance with the key financial and other covenants under both the Old IBMCC Facility and the Old DFS Facility. New Credit Facilities. The total credit available under the New DFS Facility is $30.0 million, subject to borrowing base limitations which are generally computed as a percentage of various classes of eligible accounts receivable and qualifying inventory. Credit available under the New DFS Facility for floor plan financing of inventory from approved manufacturers (the "Inventory Line") is $20.0 million. Available credit under the New DFS Facility, net of Inventory Line advances, is $10.0 million, which is used by the Company primarily to carry accounts receivable and for other working capital and general corporate purposes (the "Accounts Line"). Borrowings under the Accounts Line bear interest at the fluctuating prime rate minus 1.0% per annum. Under the Inventory Line, DFS pays the Company's inventory vendors directly, generally in exchange for negotiated financial incentives. Typically, the financial incentives received are such that DFS does not charge interest to the Company until 40 days after the transaction is financed, at which time the Company is required to either pay the full invoice amount of the inventory purchased from corporate funds or to borrow under the Accounts Line for the amount due to DFS. Inventory Line advances not paid within 40 days after the financing date bear interest at the fluctuating prime rate plus 5.0%. For purposes of calculating interest charges the minimum prime rate under the New DFS Facility is 7.00%. DFS may change the computation of the borrowing base and to disqualify accounts receivable upon which advances have been made and require repayment of such advances to the extent such disqualifications cause the Company's borrowings to exceed the reduced borrowing base. The New DFS Facility is collateralized by a security interest in substantially all of the Company's assets, including its accounts receivable, inventory, equipment and bank accounts. Collections of the Company's accounts receivable are required to be applied through a lockbox arrangement to repay indebtedness to DFS; however, DFS has amended the lockbox agreement to make such arrangements contingent upon certain financial ratios. Provided the Company is in compliance with its debt to tangible net worth covenant, the Company has discretion over the use and application of the funds collected in the lockbox. If the Company exceeds that financial ratio, DFS may require that lockbox payments be applied to reduce the Company's indebtedness to DFS. If in the future DFS requires that all lockbox payments be applied to reduce the Company's indebtedness, the Company would be required to seek funding from DFS or other sources to meet substantially all of its cash needs. Effective with the implementation of the New DFS Facility the Company will have a $2.0 million credit facility with IBMCC (the "New IBMCC Facility") for the purchase of IBM branded inventory from certain suppliers. As in the case of the Old IBMCC Inventory Line, advances under the New IBMCC Facility are typically interest free for 30 days after the financing date for transactions in which adequate financial incentives are received by IBMCC from the vendor. Within 30 days after the financing date, the full invoice amount for inventory financed through IBMCC is required to be paid by the Company. Amounts remaining outstanding thereafter bear interest at the fluctuating prime rate (but not less than 6.5%) plus 6.0%. IBMCC retains a security interest in the inventory financed. The New IBMCC Facility is immediately terminable by either party by written notice to the other. Under the New DFS Facility the Company is required to maintain (i) a tangible net worth of $10.0 million, (ii) a ratio of debt minus subordinated debt to tangible net worth of 4 to 1 and (iii) a ratio of current tangible assets to current liabilities of not less than 1.4 to 1. The covenants under the New IBMCC Facility remain unchanged from the Old IBMCC Facility. Both the IBMCC Facility and the DFS Facility prohibit the payment of dividends unless consented to by the lender. Year 2000 Compliance During the first quarter of 1998 the Company commenced a conversion of it MIS to a more powerful computing platform which will allow the Company to improve and enhance its MIS. The new system will allow the Company to expand it uses and more fully integrate its operations with the MIS. While the Company expects the system conversion to be fully implemented with only normal debugging and reprogramming, a failure to fully implement the conversion with only minimal disruption of its operation could have an adverse effect on the Company's results of operations and financial condition. The system conversion was implemented as a general upgrading of the Company's MIS and was not for the purpose of achieving Year 2000 compliance. The Company believes its prior MIS was, and its new MIS is, Year 2000 compliant. Accordingly, the Company does not believe that Year 2000 compliance will have a material adverse effect on its results of operations or financial condition. It is possible that the Company could be impacted if its significant suppliers or customers do not successfully and timely achieve Year 2000 compliance with respect to their own computer systems. The Company has inquired of its two major suppliers as to the status of their Year 2000 compliance and has been advised that they expect to achieve Year 2000 compliance. If, contrary to the Company's expectations, it or the significant suppliers and customers fail to achieve Year 2000 compliance in a timely manner, the Company's results of operations and financial condition could be materially and adversely effected. Accounting Pronouncements In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 130 establishes standards for reporting and displaying of comprehensive income and its components. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments and related information in interim and annual financial statements. SFAS No. 130 and 131 are effective for periods beginning after December 15, 1997. These two statements will not have any effect on the Company's 1997 financial statements, however, management is evaluating what, if any additional disclosures may be required when these two statements are implemented. Item 7A. Quantitative and Qualitative disclosures about Market Risk. This item is inapplicable to the Company. Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Financial Statements: Independent Auditor's Report............................................. 27 Consolidated Balance Sheets as of December 31, 1996 and 1997........... 28 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997..,,................................. 29 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997............................... 30 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997..................................... 31 Notes to Consolidated Financial Statements for the years ended December 31, 1995, 1996 and 1997............................... 32 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") at December 31, 1996 and 1997, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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, 1996 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 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. Deloitte & Touche LLP Houston, Texas March 27, 1998 ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1996 AND 1997 In thousands, except share and per shares amounts) ASSETS 1996 1997 ---- ---- Current Assets: Cash and cash equivalents: Restricted cash $ 94 $ 280 Cash 135 1301 ----------- ----------- Total cash and cash equivalents 229 1,581 Accounts receivable - trade, net 16,517 23,759 Accounts receivable - affiliates 140 434 Inventory 4,862 4,700 Deferred taxes 350 212 Deferred offering costs 412 Other current assets 174 404 ----------- ----------- Total current assets 22,684 31,090 Property and equipment, net 1,644 2,013 Other assets 392 81 ----------- ----------- $ 24,720 $ 33,184 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable $ 9,975 $ 1,572 Accounts payable 7,157 12,805 Accrued expenses 2,759 3,565 Income taxes payable 206 82 Deferred service revenue 296 242 ----------- ----------- Total current liabilities 20,393 18,266 Deferred credit - Stock warrants 195 Commitments and Contingencies Stockholders' Equity: Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued Common stock, $.01 par value, 50,000,000 shares authorized, 2,675,000 and 4,454,411 outstanding at December 31, 1996 and 1997, respectively 27 45 Additional paid in capital 1,479 10,013 Retained earnings 2,821 4,665 ----------- ----------- Total stockholders' equity $ 4,327 $ 14,723 ------------ ----------- $ 24,720 $ 33,184 =========== =========== See notes to consolidated financial statements. ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (In thousands, except share and per shares amounts)
Years ended December 31, . 1995 1996 1997 Total revenue .................................................. $ 91,085 $ 120,359 $ 129,167 Cost of goods and services ..................................... 79,857 104,302 111,126 ---------- ---------- ---------- Gross profit ................................. 11,228 16,057 18,041 Selling, general and administrative expenses ................... 9,149 12,284 14,386 ---------- ---------- ---------- Operating income ............................................... 2,079 3,773 3,655 Interest expense and other ..................................... 1,218 1,183 685 ---------- ---------- ---------- Income before provision for income taxes ....................... 861 2,590 2,970 Provision for income taxes ..................................... 342 987 1,126 ---------- ---------- ---------- Net income ..................................................... $ 519 $ 1,603 $ 1,844 ========== ========== ========== Net income per share: Basic ................................................. $ 0.19 $ 0.60 $ 0.52 ========== ========== ========== Diluted ............................................... $ 0.19 $ 0.60 $ 0.52 ========== ========== ========== Weighted average number of shares outstanding: Basic ................................................. 2,675,000 2,675,000 3,519,821 ========== ========== ========== Diluted ............................................... 2,675,000 2,675,000 3,526,787 ========== ========== ========== See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (In thousands, except share and per shares amounts) $.01 Par value No Par Value Additional Common Stock Common Stock Paid-In Retained Shares Amount Shares Amount Capital Earnings Total BALANCE AT JANUARY 1, 1995 328,125 $ 2 $ 1,504 $ 699 $ 2,205 Net income 519 519 ---------- ------ ------------ ---------- --------- BALANCE AT DECEMBER 31, 1995 328,125 2 1,504 1,218 2,724 Issuance of common stock on conversion (see Note 1) 2,675,000 $ 27 (328,125) (2) (25) Net income 1,603 1,603 ---------- ----- ---------- ------ ------------ ---------- --------- BALANCE AT DECEMBER 31, 1996 2,675,000 27 1,479 2,821 4,327 Sale of common stock, net of initial public offering expenses of $2,040 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 4,544,411 $ 45 $ $ 10,013 $ 4,665 $ 14,723 ========== ===== ========== ===== ============ ========== ======== See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (In thousands, except share and per shares amounts)
Years ended December 31, 1995 1996 1997 CASH FLOW FROM OPERATING ACTIVITIES: Net Income .......................................................... $ 519 $ 1,603 $ 1,844 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Gain on disposal of assets .......................................... (1) (11) Depreciation and amortization ....................................... 309 305 623 Deferred tax provision .............................................. (146) (92) 138 Changes in assets and liabilities that provided (used) cash: Accounts receivable - trade, net ........................... (4,437) (695) (7,242) Accounts receivable - affiliates ........................... (80) 153 (294) Inventory .................................................. (21) 545 162 Other current assets ....................................... 4 (507) (230) Other assets ............................................... 311 Accounts payable ........................................... 1,977 (492) 6,060 Accrued expenses ........................................... 1,673 (598) 806 Income taxes payable ....................................... 53 (77) (124) Deferred service revenue ................................... 27 (45) (54) ------- ------- ------- Net cash provided by (used in) operating activities (123) 89 2,000 CASH FLOWS FROM INVESTING ACTIVITES: Capital expenditures ................................................ (518) (965) (992) Proceeds from sale of fixed assets .................................. 60 13 ------- ------- ------- Net cash used in investing activities (458) (952) (992) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in notes payable 940 63 (8,403) Net proceeds from sale of common stock 8,747 ------- ------- ------- Net cash provided from financing activities 940 63 344 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 359 (800) 1,352 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 670 1,029 229 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,029 $ 229 $ 1,581 ======= ========= ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 1,189 $ 1,140 $ 958 ========= ======== ========= Cash paid for income taxes $ 432 $ 1,138 $ 1,032 ========= ======== ========= See notes to consolidated financial statements.
ALLSTAR SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (In thousands, except share and per shares amounts) 1. 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. 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. to provide temporary and permanent placement services of technical personnel. All operations of the business are conducted from offices located in Texas. A substantial portion of Allstar's sales and services are authorized under arrangements with product manufacturers and Allstar's operations are dependent upon maintaining its approved status with such manufacturers. As a result of these arrangements and arrangements with its customers, gross profit could be limited by the availability of products or allowance for volume discounts. Furthermore, net income before income taxes could be affected by changes in interest rates which underlie the credit arrangements which are used for working capital (see Note 5). 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. Management provides a reserve for inventory which may be slow-moving or obsolete. 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 $307, $303 ,and $623 for the years ended December 31, 1995, 1996 and 1997, respectively. Impairment of Long-Lived Assets -Allstar records impairment losses on long-lived assets, including goodwill, 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. Federal Income Taxes - Deferred taxes are provided at enacted rates for the temporary differences between the financial reporting bases and the tax bases of assets and liabilities. Earnings per Share - Net earnings per share of common stock are based on the weighted average number of shares of common stock and common stock equivalents, if any, outstanding during each period. In October 1996, the Company 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. The reincorporation had the effect of an 8.15-for-1 split of Allstar's common stock. All applicable share and per share data in the consolidated financial statements and related notes give effect to this reincorporation and resulting stock conversion. In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS 128 requires a dual presentation of basic and diluted earnings per share for entities with complex capital structures. At December 31 1995 and 1996, Allstar had no stock options or similar equity instruments outstanding accordingly SFAS No. 128 had no retroactive effect on the consolidated financial statement for the years then ended. During 1997 Allstar granted options to purchase 200,300 shares, issued 14,286 shares of restricted stock and issued warrants to purchase 176,750 common shares at $9.60 per share to underwriters in connection with a public offering of the common stock. If Allstar had adopted the statement in prior years, earnings per share would have been as follows: 1997 1996 1995 ---- ---- ---- Basic......................................$0.52 $0.60 $0.19 Diluted....................................$0.52 $0.60 $0.19 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 revision become known; when a contract indicates a loss, a provision is made for the total anticipated loss. At December 31, 1996 Allstar had no such contracts in process. At December 31, 1997, Allstar had $868 of such contracts in progress and $401 of revenue has been deferred together with $197 of costs related to those revenues. 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 $13, $96 and $157 in the years ended December 31, 1995, 1996 and 1997, respectively. 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 a maturity of three months or less when purchased. See Note 5 for discussion of restricted cash. Use of Estimates - The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates. Accounting Pronouncements - In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 130 establishes standards for reporting and displaying of comprehensive income and its components. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments and related information in interim and annual financial statements. SFAS No. 130 and 131 are effective for fiscal years beginning after December 15, 1997. These two statements will not have any effect on the Company's 1997 financial statements, however, management is evaluating what, if any additional disclosures may be required when these two statements are implemented. Reclassifications - The accompanying consolidated financial statements for the years presented have been reclassified to give retroactive effect to certain changes in presentation. 2. ACCOUNTS RECEIVABLE Accounts receivable consisted of the following at December 31, 1996 and 1997: 1996 1997 Trade.................................... $16,736 $24,008 Allowances for doubtful accounts......... (219) (249) ------- ------- Total............................... $16,517 $23,759 ======= ======= 3. DEFERRED OFFERING COSTS Deferred offering costs represent amounts incurred by Allstar through December 31, 1996 in preparation of filing an offering document. Allstar completed a public offering of its common stock in 1997 and the deferred offering costs were included as a cost of issuance of the common stock. 4. PROPERTY AND EQUIPMENT Property and equipment consisted of the following at December 31, 1996 and 1997: 1996 1997 Equipment............................. $ 282 $ 339 Computer equipment.................... 1,964 2,870 Furniture and fixtures 294 316 Leasehold improvements 47 55 Vehicles 105 105 ------- ------- $ 2,692 3,685 Accumulated depreciation and amortization (1,048) (1,672) ------- ------- Total $ 1,644 $ 2,013 ======= ======= 5. CREDIT ARRANGEMENTS Allstar had two revolving lines of credit with a commercial finance company which were collateralized by substantially all of Allstar's assets and a personal guarantee of the principal stockholder of Allstar. The aggregate maximum combined lines of credit were $20.0 million and $30.0 million at December 31, 1996 and 1997, respectively. The maximum combined credit limit was subject to borrowing base limitations which were generally computed as a percentage of various classes of eligible accounts receivable and qualifying inventory (as defined). Allstar paid an annual facility fee of $18,000. Under the first revolving line of credit (the "Accounts Line"), outstanding principal and interest were due upon termination of the agreement. Transactions on the Accounts Line are reflected as Notes Payable in the consolidated financial statements. The Accounts Line accrued interest at the prime rate plus 2% (10.25% at December 31, 1996 and 10.50% at December 31, 1997). The agreement required that all payments received from customers on pledged accounts receivable be applied to the outstanding balance on the Accounts Line. Accordingly, accounts receivable payments received in the amount of $94 and $280 at December 31, 1996 and 1997, respectively, but not yet applied to the line of credit, are shown as restricted cash in the accompanying balance sheets. The weighted average interest rate on the Accounts Line for the years ended December 31, 1995, 1996 and 1997 was 12.84%, 10.25% and 10.50%, respectively. The second revolving line of credit (the "Inventory Line") was used by Allstar to floor plan inventory purchases. At December 31, 1996 and December 31, 1997, aggregate borrowings on the Inventory Line were $6,134 and $1,089, respectively. Interest accrues at the prime rate plus 6% (14.50% at December 31, 1997) for all outstanding balances over 30 days. On March 27, 1998, Allstar and the commercial finance company terminated their credit arrangement and entered into a new $2.0 million revolving credit line of credit to floor plan inventory. This line of credit accrues interest at prime plus 6% (14.50% at December 31, 1997) for all outstanding balances over 30 days. In addition, Allstar had a $10.0 million ($3.0 million at December 31, 1996) credit line with another financing company to be used to floor plan inventory purchases. At December 31, 1996 and December 31, 1997, aggregate borrowings on this line were $993 and $9,391, respectively. Interest accrues at the prime rate, which for purposes of this agreement will not fall below 6.5%, plus 6% (14.50% at December 31, 1997) for all outstanding balances over 30 days. Amounts borrowed under the Inventory Line and the $3.0 million line of credit (collectively the "Floor Plan Agreements") are included in accounts payable in the consolidated financial statements. Under the Floor Plan Agreements the financing companies pay Allstar's suppliers directly and maintain a purchase money security interest in the related inventory. Allstar incurred interest expense under the Floor Plan Agreements of $35, $59 and $4 during the years ended December 31, 1995, 1996 and 1997, respectively. The Floor Plan Agreements require payment of interest on a monthly basis and principal on demand. The combined borrowing base under all credit arrangements was $18,841 and $23,871 at December 31, 1996 and 1997, respectively. New Credit Facilities. On February 27, 1998 Allstar entered into a new credit agreement with a commercial finance company.. The total credit available under the new credit facility is $30.0 million, subject to borrowing base limitations which are generally computed as a percentage of various classes of eligible accounts receivable and qualifying inventory. Credit available under the new facility for floor plan financing of inventory from approved manufacturers (the "Inventory Line") is $20.0 million. Available credit under the new facility, net of Inventory Line advances, is $10.0 million, which is used by the Company primarily to carry accounts receivable and for other working capital and general corporate purposes (the "Accounts Line"). Borrowings under the Accounts Line bear interest at the fluctuating prime rate minus 1.0% per annum. Under the Inventory Line interest accrues at prime rate, which for purposes of this agreement will not fall below 7.0%, plus 5% for outstanding balances over 40 days. 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 credit facility is not guaranteed by the principal stockholder of Allstar. The agreement contains restrictive covenants which, among other things, require specific ratios of revenue to working capital, total liabilities to tangible net worth and net profit after tax to revenue. The terms of the agreement also prohibit the payment of dividends, the purchase of Allstar common stock and other similar expenditures, including advances to related parties. 6. INCOME TAXES The provision for income taxes for the years ended December 31, 1995, 1996 and 1997 consisted of the following: 1995 1996 1997 ---- ---- ---- Current Provision (benefit) Federal..................... $ 446 $ 962 $ 848 State......................... 42 117 140 ------ ------ ------ Total current provision.......... 488 1,079 988 Deferred Provision............... (146) (92) 138 ------ ------ --- Total........................ $ 342 $ 987 $1,126 ====== ===== ===== The total provision for income taxes during the years ended December 31, 1995, 1996 and 1997 varied from the U.S. federal statutory rate due to the following: 1995 1996 1997 ---- ---- ---- Federal income tax at statutory rate.. $ 301 $ 907 $1,010 Nondeductible expenses.............. 48 17 24 State income taxes.................. 28 77 92 Other............................... (35) (14) ------ ------ ------ Total............................. $ 342 $ 987 $1,126 ====== ====== ====== Deferred tax assets computed at the statutory rate related to temporary differences at December 31, 1996 and December 31, 1997 were as follows: December 31 December 31, 1996 1997 Deferred tax assets: Accounts receivable.................. $ 142 $ 149 Deferred service revenue............. 69 41 Inventory............................ 139 22 ------ ------- Total deferred tax assets......... $ 350 $ 212 ====== ====== 7. ACCRUED EXPENSES Accrued liabilities consisted of the following as of December 31, 1996 and 1997: 1996 1997 ---- ---- Sales tax payable $1,309 $1,922 Accrued employee benefits, payroll and other related costs 996 962 Accrued interest 209 47 Other 245 634 Total $2,759 $3,565 ====== ====== 8. FRANCHISE FEES Allstar entered into an agreement in May 1989 whereby it became a franchise of Inacom Corp. ("Inacom"). Annual fees, amounting to 0.05% of certain gross sales, were expensed in the period incurred. Allstar obtained a waiver effective January 1, 1995 which eliminated the payment of 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 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, 1995, 1996 and 1997, Allstar charged to expense $0, $44 and $105, respectively, related to this agreement. 9. COMMITMENTS AND CONTINGENCIES Operating Leases - Allstar subleases office space from Allstar Equities, Inc. ("Equities"), a company wholly owned by the principal stockholder of Allstar. In 1996, Allstar renewed its office sublease with monthly rental payments of $31.5 in 1997 and $32 in 1998, plus certain operating expenses through December 1998. Rental expense under this agreement amounted to approximately $372, $372 and $378 during years ended December 31, 1995, 1996 and 1997, respectively. Additionally, minimum annual rentals at December 31, 1996 on other operating leases amount to approximately $126 for 1998, $63 in 1999, and $8 in 2000. Amounts paid during the years ended December 31, 1995, 1996 and 1997 under such agreements totaled approximately $137, $252 and $142, 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 $180 per year are insured by an outside insurance company. Allstar's claim and premium expense for this self-insurance program totaled approximately $67, $193 and $684 for the years ended December 31, 1995, 1996 and 1997, respectively. Allstar maintains a 401(k) savings plan. All full-time employees who have completed 90 days of service with Allstar are eligible to participate in the plan. Allstar also has the option of making additional contributions based on net profitability. Declaration of such contributions is at the discretion of Allstar's Board of Directors. Allstar made no additional contributions to the plan for the years ended December, 1995 and 1997. In 1996 Allstar contributed $136 to the plan. Allstar has filed under the Internal Revenue Service Walk-in Closing Agreement Program (the "Program") to negotiate a settlement regarding the qualified status of the 401(k) savings plan in order to meet the requirements of Section 401(a) of the Internal Revenue Code. Under the Program, any sanction amount negotiated is based upon the total tax liability which could be assessed if the plan were to be disqualified. At December 31, 1997 the Company has accrued $28 for the estimated settlement cost. In 1998, the Internal Revenue Service accepted the settlement and the Company paid $25. On July 13, 1996, a former customer brought suit against the Company in the 152nd Judicial District Court of Harris County, Texas. The plaintiff alleges that the Company failed to provide and complete promised installation and configuration of certain computer equipment within the time promised by the Company. Based on these allegations, the plaintiff is suing for breach of contract and other statutory violations and is seeking actual monetary damages of approximately $3 million and treble damages under the Texas Deceptive Trade Practices Act. The Company is unable to estimate the range of possible recovery by the plaintiff because the suit is still in the early stages of discovery. However, the Company is vigorously defending the action. The effect of an unfavorable outcome could have a material adverse effect on the Company's results of operations and its financial condition. Allstar is party to other litigation and claims which management believes are normal in the course of its operations; while the results of such litigation and claims cannot be predicted with certainty, Allstar believes the final outcome of such matters will not have a materially adverse effect on its results of operations or financial position. 10. STOCK OPTION PLANS In September 1996 Allstar adopted the 1996 Incentive Stock Plan (the "Incentive Plan") and the 1996 Non-Employee Director Stock Option Plan (the "Director Plan"). Under the Incentive Plan, Allstar's Compensation Committee may grant up to 417,500 shares of common stock, which have been reserved for issuance, to certain key employees of Allstar. The Incentive Plan provides for the granting of incentive awards in the form of stock options, restricted stock, phantom stock, stock bonuses and cash bonuses in accordance with the provisions of the plan. Additionally, no shares may be granted after the tenth anniversary of the Incentive Plan's adoption. Allstar has reserved for issuance, under the Director Plan, 100,000 shares of common stock, subject to certain antidilution adjustments. The Director Plan provides for a one-time option by newly elected directors to purchase up to 5,000 common shares, after which each director is entitled to receive an option to purchase up to 2,000 common shares upon each date of re-election to Allstar's Board of Directors. Options granted under the Director Plan have an exercise price equal to the fair market value on the date of grant and generally expire ten years after the grant date. During 1997 Allstar granted options to purchase 200,300 common shares to its directors, officers and employees. The plans activity is summarized below: 1997 Weighted Average Exercise Shares Price Options outstanding at January 1....... 0 $ 0.00 Granted during the year................ 200,300 5.17 Exercised during the year.............. 0 0.00 Canceled during the year............... 0 0.00 ------- ---------- Options outstanding at December 31..... 200,300 $ 5.17 ======= ========== Options exercisable at December 31..... 0 $ 5.17 ======= ========== Options outstanding price range........ $4.625 to $6.00 Option weighted average remaining life. 9.7 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 "Accounting for stock-Based Compensation, ." For purposes of estimating the fair value disclosures below, the fair value of each stock option has been estimated on the grant date with a Black-Scholes option-pricing model using the following weighted-average assumptions: dividend yield of 0%; expected volatility of 76.2%; risk-free interest rate of 6.0%; and expected lives of 10 years of stock options granted. The effects of using the fair value method of accounting on net income and earnings per share are indicated in the pro forma accounts below: Net Income: As Reported.......................................... $ 1,844 Pro forma............................................ $ 1,815 Earnings per share (Basic) As reported.......................................... $ 0.52 Pro forma............................................ $ 0.52 Earnings per share (Diluted) As reported.......................................... $ 0.52 Pro forma............................................ $ 0.51 11. RELATED-PARTY TRANSACTIONS Allstar has from time to time made payments on behalf of Equities and the Company's principal stockholders for taxes, property and equipment. Effective July 1, 1996, Allstar and its principal stockholder entered into a promissory note to repay certain advances, which were approximately $173 at July 1, 1996, in equal annual installments of principal and interest, from August 1997 through 2001. This note bears interest at 9% per year. Also effective July 1, 1996, Allstar and Equities entered into a promissory note whereby Equities would repay the balance of amounts advanced, which were approximately $387 at July 1, 1996, in monthly installments of $6.5, including interest, from July 1996 through November 1998 with a final payment of $275 due on December 1, 1998. This note bears interest at 9% per year. The principal amounts as of December 31, 1996 are classified as Accounts receivable - affiliates and Other assets based on the repayment terms of the promissory notes. The principal amounts as of December 31, 1997 are classified as Accounts receivable - affiliates based on the expectation of repayment within one year. At December 31, 1996 and December 31, 1997, Allstar receivables from these affiliates amounted to approximately $501 and $434, respectively. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure NONE PART III. The following items were to be incorporated by reference to the Company's definitive proxy statement for the 1998 Annual Meeting of Shareholders but are now being filed by this Amendment on Form 10-K/A to the Company's Annual Report on Form 10-K. Item 10. Directors and Executive Officers of the Registrant Directors of the Registrant Listed below are the Directors of the Registrant together with certain information regarding the Directors: Name, Age, Positions held, Period serving as Director, Principal occupation: James H. Long - Chairman of the Board, President Chief Executive Officer April, 1983 to present James H. Long, age 38, 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, Chief Financial Officer, Treasurer, Secretary, September 12, 1996 to present. Donald R. Chadwick, age 54, has been the Chief Financial Officer of the Company since February, 1992. As Chief Financial Officer, his duties include supervision of finance, accounting and controller functions within the Company. G. Chris Andersen, - Director, July 29,1997 to present G. Chris Andersen, age 59, is a principal of Andersen, Weinroth & Co., a merchant banking firm founded in 1996. From 1990 through 1995, he was Vice Chairman of Paine Webber Incorporated. Mr. Andersen is also a director of Terex Corporation, a publicly traded company that manufactures construction equipment and truck trailers; Sunshine Mining Company, a publicly traded company engaged in mining; Headway Corporate Resources, Inc., a publicly traded company providing staffing services; and United Waste Systems, Inc., a publicly traded company engaged in waste management. Richard D. Darrell - Director, July 29, 1997 to present Richard D. Darrell, age 43, has been President of American Technology Acquisition Corporation, a company specializing in mergers, acquisitions, and divestitures of technology related companies, for the last four years. 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 59, 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 for over five years. 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. Donald D. Sykora - Director, July 29, 1997 to present Donald D. Sykora, age 67, was formerly the President and Chief Operating Officer of Houston Industries, Inc. and is currently attached to the Office of the Chairman of Houston Industries, Inc. with responsibility for special projects. Houston Industries is an international holding company with interests in electric and gas utility companies, including Houston Lighting and Power Co., with over 8,000 employees and annual revenues of over $4 billion. Mr. Sykora currently serves on the board of directors of Powell Industries, Inc., a publicly traded company which manufactures electrical equipment and systems; Pool Energy Services, Inc., a publicly traded company which provides oil and gas well servicing; American Residential Services, Inc., a publicly traded company which provides services for heating, ventilation, air conditioning, plumbing, electrical, and indoor air quality systems, and TransTexas Gas Corporation, a publicly traded producer and marketer of natural gas. Executive Officers of the Registrant The executive officers of the Company serve until resignation or removal by the Board of Directors. The Company's executive officers are as follows: Name, age, Positions held, Period serving as Executive Officer: James H. Long - See Directors of the Registrant. Donald R. Chadwick - See Directors of the Registrant. Frank Cano - President, Computer Products Division, September, 1997 to present. Frank Cano, age 33, became the President, Computer Products Division for the Company in September, 1997 and is responsible for the management of the Computer Products 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 51, 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. Shabbir K. Ali - President, IT Services Division, September, 1996 to present Shabbir K. Ali, age 35, has been the President of the IT Services Division since July 1996. From January 1996 to June 1996, Mr. Ali served as Vice President, IT Services Division and between August 1993 and December 1995 as Vice President of Service Operations. Between July 1990 and July 1993 Mr. Ali served as the Company's Operations Manager. Mr. Ali's present responsibilities include the overall management of the Company's IT Services Division. Michael A. Torigian - President, Telecom Systems Division, September, 1996 to present Michael A. Torigian, age 39, has been the President of the Telecom Systems Division since July 1996. Between July 1994 and June 1996 Mr. Torigian served as Vice President, Telecom Systems Division. His current responsibilities include the overall management of the Company's Telecom Systems Division. From July 1992 to May 1994, Mr. Torigian served as Director of Sales for CTWP, Inc., an Austin-based computer, copier and office equipment dealer. William R. Hennessy - President, Stratasoft, Inc., September, 1996 to present. William R. Hennessy, age 39, 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. Ronald J. Burger - Chief Operating Officer - Computer Products, January 1998 to present Ronald J. Burger, age 51, joined the Company as Chief Operating Officer - - Computer Products in January 1998. His responsibilities include overall management of purchasing, warehousing, inventory control and shipping and receiving of inventory products. Prior to joining the Company, Mr. Burger was Vice President and General Manager for Intelligent Electronics Inc., a computer industry aggregator/distributor from April 1996 to February 1997. Prior to that period Mr. Burger was Vice President of Distribution Logistics for National Computer Distributors, a computer industry distributor, from April 1993 to April 1996. Prior to that time, Mr. Burger was VP Distribution and Logistics for Tech Data Corporation, a computer industry distributor. 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, 1997. 1996 and 1995 of (i) the Chief Executive Officer of the Company or (ii) the three most highly compensated executive officers of the Company who were serving as executive officers at the end of 1997 and whose total annual salary and bonus exceeded $100,000 in 1997 (the "Named Executive Officers").
Annual Compensation Long Term Compensation Awards Payouts Name and Principal Other Annual Restricted Underlying LTIP All Other Bonus Compensation Stock Position Year Salary (1) awards Options Payouts Compensation ($) ($) James H. Long 1997 $150,000 - - - - - - CEO (2) 1996 $116,000 $35,000 - - - - - 1995 $40,800 $100,000 - - - - - Donald R. Chadwick 1997 $98,458 $1,500 - $85,716 - - - CFO (3)(4) 1996 $75,000 - - - - - - 1995 $75,000 - - - - - - Frank Cano (4)(5) 1997 $78,125 $22,297 - - - - President, Computer 1996 $73,500 $23,125 - - - - Products 1995 $66,000 - - - - - - William R. Hennessy 1997 $81,400 $73,880 - - - - - President 1996 $74,618 $27,501 - - - - - Stratasoft, Inc. (6) 1995 - - - - - - - (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 - "Certain Relationships and Related Transactions." (3) As of December 31, 1997, Mr. Chadwick owned, in the aggregate, 14,286 shares of restricted Common Stock, with an aggregate value of $58,037. These shares will fully vest on July 7, 1999. Dividends, if any, will not be paid on these shares of restricted Common Stock. (4) Includes $1,500 as consideration for execution of employment agreements. (5) Includes compensation based upon attainment of certain performance goals. (6) Includes compensation based upon gross profit realized.
Employee Options Under the Company's 1996 Incentive Stock Option Plan shares of the Common Stock may be granted to executive officers and other employees. As of December 31, 1997, 200,300 shares were reserved for outstanding options and 217,200 were reserved and remained available for future grants pursuant to the Incentive Stock Option Plan. During 1997, options to purchase 37,000 shares of Common Stock were granted to the Named Executive Officers under the Incentive Stock Option Plan. Option Grants in Last Fiscal Year The following table provides information concerning stock options granted to the Named Executive Officers during the year ended December 31, 1997.
Number of Percent of Potential Value Potential Value at at Shares of Total Assumed Annual Assumed Annual Common Options Rate of Stock Rate of Stock Stock Granted to Exercise Price Price Underlying Employees or base Appreciation for Appreciation for Options in Fiscal Price Expiration Option Term Option Term Granted Year ($/share) Date 5% 10% James H. Long - - - - - - Donald R. Chadwick 13,000 7.2% $6.00 07/07/07 $49,054 $124,312 Frank Cano 16,000 8.9% $6.00 07/07/07 $60,374 $152,999 William R. Hennessy 8,000 4.4% $6.00 07/07/07 $30,187 $76,500
Option Exercises and Year-End Option Values
Number of Value of Securities Unexercised Underlying In-the-money Shares Unexercised Options at Acquired on Value Options at December 31, 1997 Named Executive Officer Exercise Realized December 31, 1997 James H. Long...................... 0 0 0 0 Donald R. Chadwick................. 0 0 13,000 0 Frank Cano......................... 0 0 16,000 0 William R. Hennessy................ 0 0 8,000 0
No options were exercisable at December 31, 1997, none were exercised during 1997 and there were no in-the-money unexercised options at December 31, 1997 Director Compensation Each director who is not an employee is paid $1,000 per meeting attended and $500 per 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. 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 commencing with those directors reelected at the Company's 1998 annual meeting of stockholders. 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 ceasing to be a member of the Company's Board (other than by death). Employment Agreements Each of the 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, $100,000, $75,000 and $81,408, 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's resignation at any time by giving proper notice. The Agreements generally provide that the executive officer will not, for the term of his employment and for a period of either twelve or eighteen months, whichever the case may be, following the end of such executive officer's employment with the Company, compete with the Company, disclose any confidential information of the Company, solicit any of the Company's employees or customers or otherwise interfere with the relations of the Company Compensation Committee Interlocks and Insider Participation None of the members of the Compensation Committee, who are identified in the preceding paragraph, has ever been an employee of the Company nor is there any family relationship between the members of the Compensation Committee and any executive officer. Item 12. Security Ownership of Certain Beneficial Owners and Management Security Ownership of Management The following table sets forth certain information regarding the beneficial ownership of the Common Stock of the Company by (i) all directors of the Company, (ii) the chief executive officer and each of the other executive officers, and (iii) all directors and executive officers as a group.
Name of Amount and Nature of Percent Beneficial Owner Beneficial Owner(1) of Class James H Long............................................ 2,118,600 47.6% Donald R. Chadwick...................................... 24,586 (2) * Frank Cano.............................................. 10,300 (3) * Shabbir K. Ali.......................................... 10,000 * Thomas N McCulley....................................... 300 * Donald D. Sykora........................................ 1,000 * Directors and executive officers as a group(12 persons). 2,164,786 48.6% (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 based solely on information provided to the Company. (2) Includes 14,286 restricted shares and 300 shares owned by his minor children for which Mr. Chadwick disclaims beneficial ownership of the shares owned by his minor children. (3) Includes 300 shares owned by Mr. Cano's spouse for which Mr. Cano disclaims beneficial ownership. * Indicates less than 1%
Security Ownership of Certain Beneficial Owners The following table sets forth certain information regarding the beneficial ownership of the Common Stock of the Company by any person known to the Company to be the beneficial owner of more than five percent of any class of Company's voting securities. Title Of Class Name and Address of Amount and Nature of Percent Beneficial Owner Beneficial Owner of Class Common Stock Kennedy Capital Management Inc. 230,000 5.2% 10829 Olive Blv. St. Louis, MO 63141 Item 13. Certain Relationships and Related Transactions The Company has from time to time made payments on behalf of Allstar Equities, Inc. a Texas corporation ("Equities"), wholly-owned by James H. Long, the Company's Chief Executive Officer, and on behalf of Mr. Long, personally for taxes, property and equipment. Effective July 1, 1996, the Company and Mr. Long entered into a promissory note to repay certain advances, which were approximately $173,000 at July 1, 1996, in equal annual installments of principal and interest, from August 1997 through 2001. This note bears interest at 9% per year. Also effective July 1, 1996, the Company and Equities entered into a promissory note whereby Equities would repay the balance of amounts advanced, which were approximately $387,000 at July 1, 1996, in monthly installments of $6,500, including interest, from July 1996 through November 1998 with a final payment of approximately $275,000 due on December 1, 1998. This note bears interest at 9% per year. At December 31, 1997, the Company's receivables from Mr. Long and Equities amounted to approximately $434,000. The Company subleases office space from Equities. In 1996, Allstar renewed its office sublease with monthly rental payments of $31,500 in 1997 and $32,000 in 1998, plus certain operating expenses through December 1998. Rental expense under this agreement amounted to approximately $378,000 during the year ended December 31, 1997. 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 comparable 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 (1) Consolidated Financial Statements - See Index to Consolidated Financial Statements on Page 27 (2) Consolidated Financial Statements Schedule II Valuation and Qualifying Accounts Exhibit 99.1 (3) Exhibits
3. 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. Laney, Exhibit 10.25 to Form et al. As lessors, and Technicomp Corporation and Allstar Services as S-1 filed Aug. 8, 1996 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 21.1 List of Subsidiaries of the Company. Form 10-K filed Mar. 31, 1998 23.1 Independent Auditors' Consent of Deloitte & Touche LLP,. Form 10-K filed Mar. 31, 1998 27.1 Financial Data Schedule. Form 10-K filed Mar. 31, 1998 99.1 Schedule II Valuation and Qualifying Accounts Form 10-K filed Mar. 31, 1998 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 31, 1998. 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 /s/ Donald R. Chadwick Chief Financial Officer, Secretary and Treasurer and Director (Principal Financial and Accounting Officer) /s/ G. Chris Andersen Director /s/ Richard D. Darrell Director /s/ Jack M. Johnson Director /s/ Donald D. Sykora Director EX-27.1 2 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1997 YEAR DEC-31-1997 DEC-31-1997 1581 0 24540 (249) 4700 31090 3684 (1672) 33184 18266 0 0 0 45 14723 33184 129167 129167 111126 111126 14386 0 685 2970 1126 1844 0 0 0 1844 .52 .52
EX-27.2 3 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1996 YEAR DEC-31-1996 DEC-31-1996 229 0 16876 (219) 4862 22684 2692 (1048) 24720 20393 0 0 0 27 4327 24720 120359 120359 104302 104302 12284 0 1183 2590 987 1603 0 0 0 1603 .60 .60
EX-27.3 4 FINANCIAL DATA SCHEDULE
5 0001020017 ALLSTAR SYSTEMS, INC. 1000 JAN-01-1995 YEAR DEC-31-1995 DEC-31-1995 1029 0 16965 (464) 5407 23274 1703 (717) 24266 21542 0 0 0 2 2724 24266 91085 91085 79857 79857 9149 0 1218 861 342 519 0 0 0 519 .19 .19
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