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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-21479
I-SECTOR CORPORATION
(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 Regu lation 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. |_|
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 June 28,
2002, as reported on NASDAQ Small Cap Market, was approximately $3,470,992.
The number of shares of Common Stock, $.01 Par Value, outstanding as of
March 21, 2003 was 3,709,689.
DOCUMENTS INCORPORATED BY REFERENCE
PART I
All monetary amounts discussed in Items 1 through 7 are in thousands.
Item 1. Business
SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
"SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. ALL STATEMENTS INCLUDED IN THIS ANNUAL REPORT, OTHER THAN STATEMENTS THAT
ARE PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS
MAY BE IDENTIFIED BY WORDS INCLUDING, BUT NOT LIMITED TO, "ANTICIPATE,"
"APPEAR," "BELIEVE," "COULD," "ESTIMATE," "EXPECT" "HOPE," "INDICATE," "INTEND,"
"LIKELY," "MAY," "MIGHT," "PLAN," "POTENTIAL," "SEEK," "SHOULD," "WILL,"
"WOULD," AND OTHER VARIATIONS OR NEGATIVE EXPRESSIONS THEREOF. THESE
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO KNOWN AND UNKNOWN RISKS AND
UNCERTAINTIES. NUMEROUS FACTORS, INCLUDING FACTORS THAT THE COMPANY HAS LITTLE
OR NO CONTROL OVER, MAY AFFECT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE EXPRESSED IN THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN. IN
EVALUATING SUCH STATEMENTS, READERS SHOULD CONSIDER THE VARIOUS FACTORS
IDENTIFIED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING MATTERS SET FORTH IN
ITEM 1. "RISKS RELATED TO OUR BUSINESS STRATEGY," WHICH COULD CAUSE ACTUAL
EVENTS, PERFORMANCE OR RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH
STATEMENTS.
GENERAL
I-Sector Corporation ("I-Sector" or the "Company") is a holding company and
conducts substantially all of its operations through its subsidiaries. Our
subsidiaries are engaged in various aspects of information and communications
technology business. In 2002, our revenue from continuing operations was derived
through three primary subsidiary companies:
o Valerent, Inc provides information technology solutions that both lower the
client's expense and increase the quality and efficiency of their
experience by utilizing centralized, remote-enabled computing management
tools which predict, announce and manage service interruptions. Valerent,
Inc. was formerly known as Allstar Solutions, Inc.
o Internetwork Experts, Inc is a network professional services and
integration organization with areas of practice that include large-scale
enterprise network engineering consulting, network security, network
management, wireless networking, IP Telephony.
o Stratasoft, Inc. develops and is engaged in marketing software products for
computer-telephony integration, including products for professional call
center and other high volume calling applications.
I-Sector's filings with the SEC are available without charge on our website
at http://www.I-Sector.com/information/sec.htm.
BUSINESS STRATEGY
Our strategy is to utilize our capital resources to build a portfolio of
highly focused subsidiary companies, each of which will be involved in an area
of information and/or communications technology that we believe provides an
opportunity for such subsidiary company to become a dominate force in, and to
achieve superior results in. While the information and communications technology
industries have been in a recession for approximately the past two years, we
believe that these industries will rebound, as they are vital areas of the world
economy that have, and will continue to, go through significant change due to
technological advances. We believe that we can produce higher rates of growth,
and better financial performance, by providing our products and services through
focused, specialized companies, each branded to pursue a specialized mission and
each led by a separate, focused, management team with financial incentives tied
to their company's financial performance. We plan to continue to expand each of
our three current subsidiary companies through internally generated sales and
possibly through the acquisition of compatible and synergistic companies. We
will also continue to evaluate the possibility of entering new lines of business
either by starting new subsidiary companies or by acquiring other companies. We
intend to focus our growth efforts in niche industry areas that we believe hold
the greatest opportunity for growth and profitability. Each of our three current
subsidiary companies is executing a unique business strategy.
Valerent, Inc.
Valerent, Inc. ("Valerent"), previously named Allstar Solutions, Inc.
("Allstar"), which started as the services side of our former computer reselling
organization, has been transforming itself into a provider of specialized
information technology solutions and intends to grow its revenue by aggressively
adding additional specialized solutions offerings that reduce their customers
costs of supporting their IT infrastructure while improving the efficiency and
quality of support, as well as by rapidly expanding its sales force. By offering
highly specialized competence in the niche solutions areas that it operates in,
Valerent intends to be able to gain market share against its competitors by
offering better solutions and better support for such solutions than its
competitors. Valerent is headquartered in Houston and has a branch office in
Dallas. In markets where it does not maintain branch offices, Valerent often
subcontracts for necessary technical personnel, particularly where required for
larger scope or prolonged duration contracts. Valerent typically targets
customers that are medium to larger corporate clients as well as state and local
government organizations.
Internetwork Experts, Inc.
Internetwork Experts, Inc. ("INX") intends to rapidly become the leading
regional network professional services organization by offering highly
specialized technical services of the highest quality and competence, thereby
rapidly commanding a significant presence in the network services and equipment
markets. By aggressively positioning itself as one of the most technically
competent provider of network professional services, INX intends to rapidly be
included in a large percentage of the large network consulting and network
implementation projects in the markets that it serves. By concentrating its
efforts on Cisco technology, INX intends to build loyalty with the leading
network equipment manufacturer and more easily achieve superior technical
competence as compared to the competition. By rapidly increasing its sales
staff, INX intends to pursue a rapid growth path for the foreseeable future. INX
is headquartered in Dallas and has a branch office in Houston. INX typically
targets customers that are large corporate clients and communications firms that
utilize large complex network infrastructures, as well as state and local
government organizations.
Stratasoft Inc.
Stratasoft, Inc. ("Stratasoft") intends to continue to further develop its
existing suite of software products for professional call centers and high
volume calling applications and to further strengthen the market share gains
that it has made over the past several years. By upgrading the software products
to take advantage of newer technology, such as voice-over-IP, Stratasoft is
continuing to increase the features and functionality that it can offer its
clients. Stratasoft markets its products through its own sales account managers
as well as a network of resellers. Stratasoft plans to increase the number of
both sales accounts managers and resellers going forward, thereby driving
expected future revenue growth. In addition, a concentrated effort to sell its
products in markets other than the U.S. is expected to continue to add
incremental new growth opportunities. Stratasoft is headquartered in Houston,
but markets its products nationally and internationally. Stratasoft's customers
are typically call center companies or companies or organizations that operate a
call center, and includes political and non-profit organizations.
PRODUCTS AND SERVICES
We currently provide all of our products and services, and produce all of
our revenue, through our three wholly owned subsidiary companies, further
details of which are provided below.
Valerent, Inc.
Valerent offers a variety of service offerings related to the cost
reduction and performance improvement through Internet-based service and support
of computing technology. The services that Valerent offers include:
o Systems management including operating system and data migration
services
o Data life cycle support including client roll back and recovery
services
o Security management and monitoring
o Internet usage monitoring and management
o Helpdesk solutions consulting.
o Turn-key outsourcing of the IT helpdesk function
o Network support and network management
o IT project management
o Network design and implementation
o Technical staff augmentation for IT helpdesk operation
Valerent typically prices its services on a time and materials basis, under
fixed price project pricing or under fixed fee service contracts, depending on
customer preference and the level of service commitment required. To support and
maintain the quality of these services and to maintain the vendor accreditation
necessary to service their significant product lines, Valerent's technical staff
participates in various certification and authorization programs sponsored by
hardware manufacturers and software suppliers.
Internetwork Experts, Inc.
INX is a provider of network infrastructure professional services and an
integration firm with practice areas in network design and implementation,
voice/data convergence and network management and security: INX provides
solutions for large-scale and complex networks based primarily on products and
technology from Cisco Systems, Inc. The company provides consulting services in
the following disciplines:
o Network baseline assessment
o Design/architecture
o Implementation
o Network management
o Project management
o Network security
o Knowledge transfer
Specific technologies in which INX offers expertise include:
o Routing
o Switching (LAN/MAN/WAN)
o Virtual Private Networks (VPN)
o Voice over X (VoX)
o Wireless
o Security
o IP Telephony
o Wireless networks
INX's client base includes many vertical markets such as healthcare, legal,
banking, energy and utilities, hospitality, transportation, legal, manufacturing
and entertainment, education as well as local, state and federal government. In
addition to its direct sales model INX also provides technical consulting and
project management services as a sub-contractor for companies such as IBM, EDS
and Qwest.
Stratasoft, Inc.
Stratasoft develops and markets computer telephony software, which
integrates business telephone systems and networked computer systems, under the
trade name "Stratasoft". Stratasoft's products are designed to maximize the
efficiency of a professional contact center or other type of high volume calling
application, for both inbound and outbound calls. Stratasoft offers custom
contact center solutions that do not require excessive, labor-intensive
implementation and professional service augmentation. Our complete call center
product offering allows end users to rapidly customize their business
applications and positions them to effectively compete in today's business
climate. Stratasoft's software products can be bundled with computer hardware
supplied by either Stratasoft or one of their value added resellers should the
customer request this configuration. Stratasoft currently has two primary
computer-telephony software products, which are marketed under the trade names
StrataDial and StrataVoice:
o The StrataDial. VC2 - Virtual Contact Center suite provides the
customer with the following essential telephony applications: outbound
predictive dialing, inbound automatic call distribution, voice mail
and auto attendant applications, and text-to-speech capabilities
Web-based text chatting, e-mail management and routing, fax on demand,
an interactive voice response system and rapid application development
tools. The product's true open architecture design allows for easy
integration with existing in-house systems and software applications,
thereby minimizing customer acquisition expenses and capitalizing on
existing technology investments. StrataDial.VC2 delivers robust, yet
easy-to-use, global contact center functionality to worldwide
companies seeking an affordable and flexible communications solution.
With the evolution of the Multi-Point Contact Center, our customers
are leveraging the power of the StrataDial.VC2 product suite to
increase their productivity and return on investment. The product
allows our clients to contact additional customers and prospects
quickly keeping the customers' preferred choice of contact in mind.
o StrataVoice is an outbound dialing product designed for high volume
calling applications that do not require human interface. Strata Voice
applications include; appointment confirmation and setting, court
appearance notification, opinion 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 queries the contacted individual., The system has the
ability to branch to other questions and statements based on
designated responses. StrataVoice also allows the contacted individual
to leave messages. Scripting tools allow the user to develop
customized campaigns. The system builds a database of respondent data
and comprehensive response reporting capabilities.
FINANCIAL INFORMATION BY BUSINESS SEGMENT
See Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations" for financial information on revenue and operating
income of each business segment.
SALES AND MARKETING
All of our subsidiary companies utilize sales personnel, including account
managers and customer service representatives, to sell their products and/or
services. These sales personnel are partially compensated, and in some cases are
solely compensated, on either the revenue or the profitability of sales that
they participate in developing. In addition, Stratasoft markets its products
through a network of value added resellers, who typically integrate their
products and services with Stratasoft's software products to provide a complete
solution. The subsidiary companies promote their products and services through
general and trade advertising, participation in trade shows and telemarketing
campaigns.
CUSTOMERS
The focus of the various subsidiary companies' marketing efforts varies, as
does the makeup of each company's customer base. Valerent's customer base
consists primarily of small to larger commercial clients as well as state and
local governmental organizations, primarily in Houston and Dallas. INX's
customers are typically larger corporate organizations or communications
companies that utilize large network infrastructures, a majority of which are
located in, or make significant network infrastructure decisions in, Dallas or
Houston, but for which work is performed nationally. Stratasoft's customers are
typically call center companies or companies or organizations that operate a
call center, and includes political and non-profit organizations. A majority of
Stratasoft's customers have historically been located in the United States, but
Stratasoft has increasingly sold and installed its call center systems in
several other countries. In 2000, 2001 and 2002, approximately 3.9%, 42.9% and
28.2%, respectively, of Stratasoft's revenues, and 1.7%, 13.2% and 4.4%,
respectively, of consolidated revenues, were with customers outside the U.S,
including customers in India, the United Kingdom, Canada and the Philippines. We
had no single customer that represented 10% or greater of our total continuing
revenues in the years ended December 31, 2002, 2001 or 2000, however we had a
group of end user customers related to a single reseller that represented 10.0%
of our total continuing revenues in 2001.
SUPPLY AND DISTRIBUTION
We purchase limited amounts of computing and communications equipment that
is sold in conjunction with Stratasoft's software products and by INX as part of
turn-key network infrastructure solutions. We have historically relied on
wholesale distributors to supply a majority of these products. We have typically
purchased the majority of our products from three primary suppliers in order to
obtain competitive pricing, better product availability and improved quality
control. INX purchases the majority of the Cisco products that it resells
directly from Cisco. In addition, Valerent and INX purchase or exchange service
parts, such transactions typically being with the product manufacturer or its
authorized parts distributor. All of our subsidiaries attempt to keep minimal
inventory on hand, and to purchase inventory only as needed to fulfill orders.
MANAGEMENT INFORMATION SYSTEMS
We utilize an internally developed, highly customized management
information system ("MIS") to manage most aspects of our business. All of our
subsidiary companies utilize our MIS, which is customized to their specific
needs. We use our MIS to manage accounts payable, accounts receivable and
collections, general ledger, sales order processing, purchasing, service
contracts, service calls and work orders, engineer and technician scheduling and
time tracking, service parts acquisition and manufacturer warranties, and
project management. Reporting can be generated for project profitability,
contract and customer analysis, parts and inventory tracking and employee time
tracking. The system provides for separate company accounting and also for
consolidation of all subsidiary company financial information.
EMPLOYEES
As of December 31, 2002 we employed approximately 146 individuals. Of
these, approximately 27 were employed in sales, marketing and customer service,
77 were employed in engineering and technical positions and 42 were employed in
administration, finance and MIS. We believe that our ability to recruit and
retain highly skilled and experienced technical, sales and management personnel
has been, and will continue to be, critical to our ability to execute our
business plans. None of our employees are represented by a labor union nor are
any subject to a collective bargaining agreement. We believe that our relations
with our employees are good.
RECENT ORGANIZATIONAL CHANGES
We sold our Telecom Systems business on March 16, 2000 and we sold our
Computer Products Division on May 19, 2000. In July 2000, we separated our
former IT Services business into three separate businesses, each of which is a
wholly owned subsidiary corporation. One of these subsidiary companies was IT
Staffing, Inc., which had already been operated as a wholly owned subsidiary
since 1997. We contributed the non-IT Staffing remaining components of the
former IT Services business to two newly formed corporations, Allstar Computer
Services Inc. and Synergy Helpdesk Solutions, Inc. Effective June 30, 2001, we
merged Synergy Helpdesk Solutions, Inc. into Allstar Computer Services, Inc. and
subsequently renamed the resulting company Allstar Solutions, Inc. In July 2000,
we also formed another wholly owned subsidiary, Internetwork Sciences
Corporation. In October 2000 Internetwork Sciences Corporation acquired certain
assets and the ongoing operations of an unrelated company, Internetwork Experts,
Inc., and adopted the name of the acquired firm by changing its legal name to
the latter. In February 2003 Allstar Solutions, Inc. was renamed Valerent, Inc.
in conjunction with a change in its strategy.
RISKS RELATED TO OUR BUSINESS STRATEGY
Executing our business strategy involves many risks including, but not
limited to, the following:
Risks of Potential Future Acquisitions and Investments
Our business may depend in the future on the successful acquisition and the
integration and performance of businesses that we acquire. Our strategy involves
the substantial risk that we will not find suitable businesses to acquire on
terms we believe are commercially reasonable and that the new businesses we
choose to enter or the acquisitions that we choose to make will not provide the
benefits we expect. Our future business prospects should therefore be considered
in light of the risks, expenses, problems and delays inherent in acquiring a new
business. We cannot be certain that we will identify and assess these risks.
Some of the acquisition and operating risks that could adversely affect us
include the following:
o We may be unsuccessful in identifying new business opportunities,
completing and financing acquisitions and start-ups on favorable terms
and in subsequently operating the businesses profitably.
o Competition for the acquisition of companies in the information and
communication sector will likely be intense. Our competitors for
suitable new businesses may have greater financial, personnel and
technical resources than us, which may put us at a disadvantage in
finding and concluding acquisitions. These competitive limitations may
compel us to select less attractive acquisitions than if we had
greater resources at our disposal.
o Businesses in the information and communication sector are the general
focus of our new business expansion strategy. Businesses in this
sector often have an undeveloped or unproven product, technology or
marketing strategy, which may prove unsuccessful.
o We may choose to acquire or invest in a business that is financially
unstable or that is in the early stages of development, including one
without earnings or positive cash flow, which may require substantial
additional capital infusions to support.
o Because we plan to seek new businesses with growth potential, there is
a substantial likelihood that the new business will be in competition
with much larger, more established and better capitalized competitors,
thus putting it at a competitive disadvantage.
o Our success in a new business will also depend on our ability to
integrate a new business and its personnel with our existing business
and personnel with a minimum of disruption to both existing and new
enterprises, including management information systems. We also may be
unable to attract and retain new, qualified personnel to operate and
grow our new businesses.
o If we choose to make a strategic investment by acquiring a minority
interest in a business, we may lack sufficient control to influence
the operations and strategy of the business and thus will depend on
that entity's management for our success. Additionally, if we choose
to make an investment in a publicly traded company such investment
would also be subject to market risks.
Concentration of International Revenues
During 2002 and 2001 we have recognized revenues on the
percentage-of-completion basis for several projects associated with one reseller
in South Asia. International revenues represent 4.4% and 13.2% of consolidated
revenues in 2002 and 2001, respectively. We have risk to the extent that this
group of customers have not paid us or issued contractual letters of credit up
to the level of cost and earnings recognized and inherent risks related to the
frequent estimates and management judgment associated with the
percentage-of-completion method of accounting.
Project Completion
Our Stratasoft subsidiary recognizes its project revenues on the basis of
percentage-of-completion for projects that have a duration in excess of three
months. The percent complete is calculated based on a ratio of total costs
incurred to estimated total costs for each project. Revisions of estimates are
reflected in the period in which the facts necessitating the revisions become
known.
Uncertain Revenue Sources
In order to reach profitability from our existing businesses we will have
to grow the revenues. The relatively high level of operating expenses remaining
after the divestiture of Computer Products has contributed to operating losses,
which were expected to continue until new revenues could be generated to offset
some of the loss of revenues from the businesses that have been sold. During
2001 and 2002 we experienced significant revenue growth that resulted in
reductions of our losses each quarter but we were unable to reach profitability
by the quarter ended December 31, 2002.
Possible Need For Additional Financing
We may be required to obtain cash to supplement our available capital to
acquire a new business and for working capital to run existing businesses and
any businesses we acquire. We have no commitments to provide any such additional
capital and we may be unable to raise capital on terms we consider acceptable.
If we use debt financing for our existing businesses or to acquire new
businesses, we will be subject to the risks inherent in debt financing. Some of
these include:
o Interest rate fluctuations;
o Inability to obtain additional debt financing;
o Insufficiency of cash flow to pay interest and principal; and
o Restrictive debt covenants imposed by lenders that may limit or
prohibit business activities we consider desirable.
We may seek to raise equity capital to meet our future cash needs. We may
also issue additional shares of our common stock or other equity securities to
acquire new businesses. If we do issue additional equity securities, some of the
possible adverse effects include:
o The percentage of our common stock owned by existing stockholders
could be substantially reduced;
o Possible increases in the number of shares of our common stock that
are considered restricted stock for federal and state securities laws
purposes, the actual or potential future sale of which could adversely
affect the price of our common stock; and
o We may be required to issue preferred stock which could have rights,
privileges and preferences superior to those of our existing
stockholders.
Dependence on Our Three Subsidiaries
Our existing three subsidiary companies are currently our only revenue
producing business segments. Because of that, our ability to be successful in
these areas of business takes on a much greater significance to us than in the
past. We plan to concentrate our efforts on growing these businesses. The risk
exists that we may be unable to accomplish this improvement, and the operations
of these businesses alone may not enable us to operate profitably.
Adverse Changes in Our Industry
The information technology and communications our industries are undergoing
rapid changes that may adversely affect us. If we do not successfully adapt our
business strategy to these new conditions, there is a risk that we may be unable
to compete and be profitable in the future.
Highly Competitive Business
We have been engaged in business activities that are highly competitive and
rapidly changing. Price competition could have a material adverse effect on our
financial condition and results of operations. Our competitors include major
information technology service organizations, resellers and distributors,
including certain manufacturers and distributors that supply products to us.
Other competitors include systems integrators, computer-telephony value-added
resellers and other computer-telephony software suppliers.
U. S. Regional Concentration
For the foreseeable future, we expect that we will continue to derive most
of our revenue from customers located within the geographic regions into which
we market. Accordingly, an economic downturn in any of those metropolitan areas
within the region in general, would likely have a material adverse effect on our
financial condition and results of operations.
Dependence on Key Personnel
Our success for the foreseeable future will depend largely on the continued
services of key members of management, leading salespersons and technical
personnel. We do not maintain key personnel life insurance on any of our
executive officers or salespersons other than our Chairman and Chief Executive
Officer. Our success also depends in part on our ability to attract, hire, train
and retain qualified managerial, technical and sales and marketing personnel at
a reasonable cost. Competition for such personnel is intense. Our financial
condition and results of operations could be materially adversely affected if we
are unable to attract, hire, train and retain qualified personnel.
Dependence on Continued Authorization to Resell and Provide
Manufacturer-Authorized Services
Our future success in our services businesses depends largely on our
continued status as an authorized reseller and/or service provider. We maintain
sales and service authorizations with many industry-leading product
manufacturers. Without such sales and service authorizations, we would be unable
to provide the range of services that we currently offer. In addition, INX's
ability to resell Cisco network products is dependent upon its Cisco
authorization. Valerent's ability to sell and utilize Altiris products for its
solutions is dependent upon its Altiris authorization. In general, the
agreements between our product manufacturers and us either have fixed terms or
provide for termination on 30 days prior written notice. Failure to maintain
such authorizations could have a material adverse effect on our financial
condition and our results of operations.
Dependence on Suppliers
Our business depends upon our ability to obtain an adequate supply of
products and parts at competitive prices and on reasonable terms. Our suppliers
are not obligated to have product on hand for timely delivery to us nor can they
guarantee product availability in sufficient quantities to meet our demands. Any
material disruption in our supply of products could have a material adverse
effect on our financial condition and results of operations.
Inventory Obsolescence
The business in which we compete is characterized by rapid technological
change and frequent introduction of new products and product enhancements. Our
success with respect to the product sales portion of our business depends in
large part on our ability to identify and obtain products that meet the changing
requirements of the marketplace. There can be no assurance that we will be able
to identify and offer products necessary to remain competitive or avoid losses
related to obsolete inventory and drastic price reductions. We attempt to
maintain a level of inventory required to meet our near term delivery
requirements by relying on the ready availability of products from our principal
suppliers. Accordingly, the failure of our suppliers to maintain adequate
inventory levels of products demanded by our existing and potential customers
and to react effectively to new product introductions could have a material
adverse effect on our financial condition and results of operations.
Reliance on MIS
Our success is largely dependent on the accuracy, quality and utilization
of the information generated by our customized MIS, which affects our ability to
manage our sales, projects, accounting and inventory. We anticipate that we will
continually need to refine and enhance our management information systems as we
grow and the needs of our business evolve.
Control by Existing Stockholders
James H. Long, founder, Chairman of the Board, President and Chief
Executive Officer, owns 56.2% of the outstanding Common Stock and Mr. Long will
have the ability to control the election of the members of our board of
directors, prevent the approval of certain matters requiring the approval of
either a majority of stockholders or at least two-thirds of all stockholders and
exert significant influence over our affairs.
Anti-Takeover Considerations
Our Certificate of Incorporation and Bylaws contain certain provisions that
may delay, deter or prevent a change in our control. Among other things, these
provisions authorize our board of directors to issue shares of preferred stock
on such terms and with such rights, preferences and designations as the board of
directors may determine without further stockholder action and limit the ability
of stockholders to call special meetings or amend our Certificate of
Incorporation or Bylaws. Each of these provisions, as well as the Delaware
business combination statute could, among other things, restrict the ability of
certain stockholders to effect a merger or business combination or obtain
control of the company.
Risks Related to Patent Infringement
Stratasoft settled a patent infringement lawsuit in September 2001, and as
part of the settlement agreement has obtained cross-licensing rights on patents
filed by the plaintiff in such lawsuit. It is possible that other companies may
also believe that Stratasoft's products infringe upon their patents. Patent
infringement litigation is complex and expensive and future assertions of patent
infringement by other companies, such could have a material adverse effect on
our financial performance, financial condition and our results of operations.
Absence of Dividends
We expect to retain any cash generated from operations to support our cash
needs and do not anticipate the payment of any dividends on the Common Stock for
the foreseeable future.
Item 2. Properties
FACILITIES
We do not own any real property and currently lease all of our existing
facilities. We lease our Houston office that is housed in a freestanding
building of approximately 48,000 square feet. On November 30, 1999, the building
was acquired by a corporation owned by the Chairman, Chief Executive Officer and
President of the Company. A new lease at reduced rental rates was signed on
February 1, 2002, which expires on January 31, 2007. Our Dallas office is a
space of approximately 8,960 square feet. The Dallas facility lease term began
July 2000 and expires in July 2003.
Item 3. Legal Proceedings
We are party to litigation and claims that management believes are normal
in the course of our operations; while the results of such litigation and claims
cannot be predicted with certainty, we believe the final outcome of such matters
will not have a material adverse effect on our results of operations or
financial position.
In August 2002, Inacom Corp. filed a lawsuit in the District Court of
Douglas County, Nebraska styled Inacom Corp. v. I-Sector Corporation, f/k/a
Allstar Systems, Inc., claiming that I-Sector owed the sum of approximately $570
to Inacom ("Inacom") as a result of Inacom's termination of a Vendor Purchase
Agreement between Inacom and I-Sector. I-Sector believes that the demand is
without merit and intends to vigorously contest the demand.
I-Sector had filed a claim to collect on a note receivable from E Z Talk
Communications ("E Z Talk") and had recently entered into arbitration
discussions with E Z Talk. In July, 2002 E Z Talk filed a lawsuit to set aside
the arbitration and claiming damages of $250. A mediation meeting was held in
November 2002, as required under the contract, however no agreement was reached.
At March 7, 2003 the parties have reached agreement in principle to settle.
The Equal Employment Opportunity Commission ("EEOC") filed a Charge of
Discrimination against Stratasoft on behalf of Jennifer R. Bond on August 1,
2002 in the EEOC Minneapolis, Minnesota office. I-Sector believes that the
charge is without merit and intends to vigorously contest the charge.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders, through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year covered by this report
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's shares are traded on the NASDAQ Small Cap Market. Prior to
July 11, 2000 our shares traded under the symbol "ALLS". Upon the change of our
corporate name on July 11, 2000, our stock began trading under the symbol
"ISEC". Below are ranges of the stock trading price:
High Low
Fiscal 2001
First quarter 1.188 0.875
Second quarter 1.250 0.980
Third quarter 1.100 0.900
Fourth quarter 1.040 0.600
Fiscal 2002
First quarter 0.970 0.670
Second quarter 2.140 0.661
Third quarter 2.290 1.330
Fourth quarter 2.000 1.050
As of March 21, 2003, there were 48 shareholders of record. Management
estimates that there are approximately 795 beneficial holders of our common
stock. We have never declared or paid any cash dividends on our Common Stock. On
March 21, 2003, the closing sales price of our Common Stock as reported by
NASDAQ was $1.91 per share. We currently anticipate that we will retain all
earnings for use in our business operations.
Securities authorized for issuance under equity compensation plans
The following table describes at December 31, 2002 information with respect
to stock compensation plans (including individual compensation arrangements)
under which equity securities are authorized for issuance:
Stock Compensation plans previously approved by security holders:
Name of Plan Number of Securities Weighted Options Remaining
To be Issued Upon Average Available for Future
Exercise of Outstanding Exercise Issuance
Options Price
1996 Incentive Stock Plan 382,312 1.47 60,188
Director Plan 97,000 1.47 3,000
2000 Stock Incentive Plan 85,090 1.47 314,910
I-Sector has no stock compensation plans not previously approved by
security holders.
Excluded from the table above are stock incentive plans for I-Sector's
subsidiaries. Each of I-Sector's subsidiaries has a stock incentive plan in
place and have reserved for issuance a combined 6,500,000 shares of common stock
for subs. The subsidiary plans have not been presented to the shareholders of
I-Sector for approval. One of the subsidiaries has granted to certain employees
and to management of such subsidiary an incentive award. Under its plan such
options vest ratably over three to five years. The options granted in 2002 were
granted to management personnel. The quantity of incentive options granted in
2002 to management personnel that vest each year is determined based on the
percentage of predetermined financial goals that they attain and none vest prior
to March 31, 2003. Any of the 2002 options granted to the management personnel
that become eligible for vesting, but do not vest due to financial performance
as compared to predefined goals, are forfeited and will no longer be eligible
for vesting. Any unvested stock options vest immediately upon the occurrence of
a liquidity event for that subsidiary. The options expire ten years after the
grant date if they are not exercised. All of the options, with the exception of
the 2002 grant to management personnel, cannot be exercised unless there is a
liquidity event during the ten year option term. The 2002 grant to management
personnel may be exercised if there is no liquidity event within 30 days prior
to the expiration of the ten year term. The stock option grants are subject to
dilution when I-Sector purchases additional shares of the subsidiary stock in
order to keep the subsidiary sufficiently capitalized. At December 31, 2000,
2001 and 2002, respectively, options for 1,300,000, 1,388,500 and 5,444,499
shares of stock were granted by those subsidiaries of which 0, 433,333 and
642,833 were vested. On the date of issuance, these shares had an exercise price
equal to their fair market values. These subsidiaries determine fair market
value at the date of issuance using a market valuation approach based upon a
discounted cash flows methodology. The fair values of these issuances were
$0.07, $0.20 and $0.15 in 2000, 2001 and 2002, respectively. At December 31,
2002 there are 1,055,501 stock options in the subsidiary's plan available to be
issued.
Item 6. Selected Financial Data
The following sets forth the selected data of the company for the five
years ended December 31, 2002.
Year ended December 31,
(In thousands except share and per share amounts)
1998 1999 2000 2001 2002
---------- ---------- ---------- ---------- ----------
Operating Data:
Revenue $ 15,408 $ 17,984 $ 17,087 $ 23,620 $ 42,021
Cost of sales and services 10,078 11,806 12,968 17,325 33,752
---------- ---------- ---------- ---------- ----------
Gross profit 5,330 6,178 4,119 6,295 8,269
Selling, general and
administrative expenses 6,637 6,207 9,479 10,573 10,625
---------- ---------- ---------- ---------- ----------
Operating loss 1,307 29 5,360 4,278 2,356
Interest and other income, net (41) (23) (239) (316) (115)
---------- ---------- ---------- ---------- ----------
Loss from continuing operations
before benefit for income taxes 1,266 6 5,121 3,962 2,241
(Benefit) provision for income
taxes (415) 20 (1,493) (87) (1,595)
---------- ---------- ---------- ---------- ----------
Net loss from
continuing operations 851 26 3,628 3,875 646
Discontinued Operations (1):
Net income (loss) from
discontinued operations, net
of taxes (247) 319 195 (167)
Income (loss) on
disposal, net of taxes (1,138) 3,390 337 262
---------- ---------- ---------- ---------- ----------
Net loss $ (1,098) $ (845) $ (43) $ (3,705) $ (384)
========== ========== ========== ========== ==========
Net loss per share
Basic and diluted
Net loss from continuing
operations $ (0.20) $ (0.01) $ (0.90) $ (0.99) $ (0.17)
Net income (loss) from
discontinued operations (0.05) 0.08 0.05 (0.04)
Loss (gain) on disposal (0.27) 0.84 0.08 0.07
---------- ---------- ---------- ---------- ----------
Net loss per share $ (0.25) $ (0.20) $ (0.01) $ (0.95) $ (0.10)
========== ========== ========== ========== ==========
As of December 31,
(In thousands)
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
Balance Sheet Data:
Working Capital $ 9,800 $ 9,567 $ 10,098 $ 5,983 $ 5,540
Total Assets 51,028 54,531 17,142 13,548 15,751
Short-term borrowings 15,958 15,869 -0- 213 157
Long-term debt -0- -0- -0- 410 247
Stockholders' equity $ 12,705 $ 11,830 $ 11,912 $ 8,015 $ 7,640
(1) In 1999 we sold our Telecom division. In 2000 we sold our Computer Products
division. In 2001 we sold our IT Staffing business.
Item 7. 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, our Consolidated Financial Statements, including the
Notes thereto, included elsewhere in this Annual Report on Form 10-K.
Overview
Through 1999, our revenue was historically derived through four primary
segments, IT Services, CTI Software, Computer Products and Telecom Systems, each
of which were historically reported separately. During the year ended December
31, 1999 we discontinued our Telecom Systems business and during the quarter
ended March 31, 2000 we discontinued our Computer Products business. We sold our
Telecom Systems and Computer Products businesses in separate transactions during
the first quarter of 2000. After the sale of these two businesses, in July 2000,
we separated what had been the IT Services business into three separate
businesses, of which one was IT Staffing, Inc. ("IT Staffing") and all of which
are wholly owned subsidiaries. During 2001 we sold our IT Staffing business. We
contributed the remaining components of the former IT Services business to two
newly formed wholly owned corporations, Allstar Computer Services, Inc. ("ACS")
and Synergy Helpdesk Solutions, Inc. ("Synergy"). Effective June 30, 2001 we
merged Synergy into ACS and subsequently renamed that business to Allstar
Solutions, Inc. ("Allstar"). Subsequent to December 31, 2002, we renamed Allstar
to Valerent, Inc. ("Valerent"). In July 2000, we formed another wholly owned
subsidiary, Internetworking Sciences, Inc. ("INX"), a professional services
organization that focuses on the design, deployment and support of large-scale
network infrastructure requirements. In October 2000 INX acquired certain assets
of an unrelated professional service company in the Dallas area, which had a
similar focus, and subsequently underwent a legal name change to Internetwork
Experts, Inc. Our CTI Software business was not affected by the sale of the
Computer Products and Telecom Systems business units, however we are now
referring to this segment by its corporate name, "Stratasoft" rather than "CTI
Software" as we have in the past.
We market our services businesses in Texas from locations in the Houston
and Dallas-Fort Worth metropolitan areas. Stratasoft markets its products
worldwide through a direct sales force and an authorized dealer network. By
operating through these highly focused wholly owned subsidiaries, we believe
that we will offer better customer service, and improve our financial
performance.
Cost of sales and services includes the cost of products sold, amounts paid
to outside contractors for services performed that are related to a particular
sale and the wages and related taxes and employee benefits paid to technical
staff that perform the services that we provide to our customers. A certain
component of total technical staff wages and related costs are of a fixed
nature, and therefore gross margin will vary to the extent that services
revenues fluctuate from period to period.
Gross margin varies substantially between each of these business segments.
Over the past three years gross margin in Valerent has ranged between 19.5% and
24.0% and gross margin for Stratasoft has ranged between 46.4% to 55.5%. As a
newly formed business, INX experienced negative gross margin of 2.3% in 2000,
but improved its gross margin to 11.1 % in 2002.
A significant portion of our selling, general and administrative expenses
relate to personnel costs, some of which are variable and others of which are
relatively fixed. Our variable personnel costs are primarily comprised of sales
commissions, which are typically calculated based upon our gross profit on a
particular sales transaction and thus generally fluctuate with our overall gross
profit. The remainder of our selling, general and administrative expenses are
relatively more fixed and, while still somewhat variable, do not vary with
increases in revenue as do sales commissions.
Discontinued Operations and Sales of Certain Business Units
RECENT SALES OF CERTAIN BUSINESS SEGMENTS
Sale of IT Staffing
On November 6, 2001 we determined to exit the IT Staffing business because
it had been unprofitable and because we believed that the technical staffing
industry was most likely to remain weak for the foreseeable future. Effective
December 31, 2001, the business was sold to Echelon Staffing, Inc., a
corporation owned by our former employee. Under the terms of the sale I-Sector
received a note receivable for $52, of which $50 was for the ongoing operations
and $2 for certain fixed assets relating to this business. The note receivable
bears interest at 5% per annum and is collectible in installments based on the
total monthly revenue of the buyer over 24 months beginning in March 2002. A
disposal loss of $11 (net of tax of $5), including an estimated loss for the
operating results from the measurement date, November 6, 2001 to the closing
date of the sale of $37, and estimates for impairment of assets caused by the
disposal decision of $34 was recognized in 2001. Net loss from discontinued
operations was $107, $167 and $0 (net of taxes of $55, $85 and $0) in 2000, 2001
and 2002, respectively. Additional loss on disposal of $13 (net of tax of $7)
was recognized in 2002. I-Sector retained accounts receivable of approximately
$82 and $0, net of reserves, and liabilities related to the IT Staffing business
at December 31, 2001 and 2002, respectively. Revenue for the IT Staffing
business for the years ended December 31, 2001 and 2002 was $967 and $0,
respectively.
Sale of Computer Products
On March 16, 2000 we entered into an agreement to sell certain assets of
and the ongoing operations of our Computer Products Division, along with certain
assets and operations of our IT Services Division related to our El Paso branch
office. That sale closed on May 19, 2000 after shareholder and other required
approvals were obtained. Under this agreement, assets and operations were sold
to Amherst Computer Products Southwest, L.P., an affiliate of Amherst
Technologies, L.L.C. The terms of the agreement included cash consideration of
$14,779, plus the possibility of receiving a future payment of up to $500 from
an escrow account. In 2000 I-Sector realized a gain of a $3,743, net of taxes,
on the sale. The proceeds of the sale were used to reduce debt. Additional gain
of $346 and $104 (net of taxes of $179 and $53) was recognized in 2001 and 2002,
respectively. The discontinued operations of the Computer Products Division
produced income of $302 in 2000 (net of taxes of $156 in 2000). We retained
accounts receivable of $20,266, net of reserves, fixed assets of $255 and
liabilities related to the Computer Products Division. At December 31, 2001 and
2002, respectively, we had accounts receivable related to the Computer Products
Division of $0 and $332. Fixed assets were redeployed in continuing operations.
In connection with the sale of the Computer Products Division, I-Sector also
sold a portion of the IT Services business located in El Paso, Texas. The El
Paso branch office portion of the IT Services business accounted for revenues of
$955, $(1) and $0 for the years ended December 31, 2000, 2001, and 2002,
respectively. For financial accounting presentation the El Paso services
business was included in the corporate segment of continuing operations for the
years ended December 31, 2000, 2001 and 2002.
Sale of Telecom Systems
On November 2, 1999 we determined to exit the Telecom business and on March
16, 2000, we sold the Telecom Systems segment to Communications World
International, Inc. ("CommWorld"), a publicly traded company (OTC Bulletin
Board: CWII). Under the terms of the sale, for the inventory and operations of
Telecom Systems, we received $250 cash. A disposal loss, including an estimate
of the operating results from the measurement date, November 2, 1999, to the
closing date of the sale of $580, and estimates for impairment of assets caused
by the disposal decision of $558, totaling $1,138 (net of an income tax saving
of $586) was recognized in 1999. The loss from discontinued operations (net of
income tax savings of $505, was $981 in 1999. We retained accounts receivable of
$1.4 million, net of reserves, fixed assets of $30 and liabilities related to
Telecom Systems. At December 31, 2001 and 2002, respectively, the Company had $0
and $100 net accounts receivable related to the Telecom Systems segment. Fixed
assets were redeployed in the continuing operations. During the year ended
December 31, 2000 additional expenses related to the disposal of the Telecom
Division of $344 (net of taxes of $240) was recognized. Gain on Disposal of $0
and $171 (net of taxes of $0 and $88) was recognized in 2001 and 2002
respectively.
Results of Operations
The following table sets forth, for the periods indicated, certain
financial data derived from our consolidated statements of operations.
Percentages shown in the table below are percentages of total company revenue,
except for each individual segment's gross profit, selling, general and
administrative expenses, and operating income, which are percentages of the
respective segment's revenue.
Year ended December 31,
---------------------------------------------------------
2000 2001 2002
----------------- ----------------- -----------------
Amount % Amount % Amount %
---------------------------------------------------------
(Dollars in thousands)
---------------------------------------------------------
Revenue
Valerent $ 6,946 40.6% $ 5,668 24.0% $ 4,992 11.9%
INX 1,874 11.0 10,775 45.6 30,738 73.1
Stratasoft 6,660 39.0 7,257 30.7 6,569 15.6
Corporate 1,640 9.6 (6) 0.0 0.0
Eliminations (33) (0.2) (74) (0.3) (278) (0.6)
------- ------ ------- ------ ------- ------
Total 17,087 100.0 23,620 100.0 42,021 100.0
Gross profit
Valerent 1,356 19.5 1,265 22.3 1,199 24.0
INX (43) (2.3) 1,112 10.3 3,421 11.1
Stratasoft 3,087 46.4 3,939 54.3 3,649 55.5
Corporate (269) (16.4) 7 (116.7)
Eliminations (12) 36.4 (28) 37.8
------- ------ ------- ------ ------- ------
Total 4,119 24.1 6,295 26.7 8,269 19.7
Selling, general and
administrative expenses
Valerent 3,186 45.9 3,077 54.3 2,236 44.8
INX 935 49.9 3,103 28.8 3,545 11.5
Stratasoft 3,647 54.8 3,021 41.6 3,922 59.7
Corporate 1,723 105.1 1,400 NA 922 NA
Elimination (12) 36.4 (28) 37.8
------- ------ ------- ------ ------- ------
Total 9,479 55.5 10,573 44.8 10,625 25.3
Operating income (loss)
Valerent (1,830) (26.3) (1,812) (32.0) (1,037) (20.8)
INX (978) (52.2) (1,991) (18.5) (124) (0.4)
Stratasoft (560) (8.4) 918 12.6 (273) (4.2)
Corporate (1,992) (121.5) (1,393) NA (922) NA
------- ------ ------- ------ ------- ------
Total (5,360) (31.4) (4,278) (18.1) (2,356) (5.6)
Interest and other income, net (239) 1.4 (316) 0.1 (115) 0.3
------- ------ ------- ------ ------- ------
Loss from continuing
operations before benefit
for income taxes 5,121 30.0 3,962 16.8 2,241 5.3
Benefit for income taxes 1,493 8.7 87 0.4 1,595 3.8
------- ------ ------- ------ ------- ------
Net loss from continuing
operations 3,628 21.2 3,875 16.4 646 1.5
Discontinued operations:
Income (loss) from discontinued
operations, net of taxes 195 1.1 (167) (0.7)
Gain (loss) on disposal,
net of taxes 3,390 19.8 337 1.4 262 0.6
------- ------ ------- ------ ------- ------
Net loss $ 43 0.3% $ 3,705 15.7% $ 384 0.9%
======= ====== ======= ====== ======= ======
Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001
(Dollars in thousands)
Revenue. Total revenue increased $18,401 (77.9%) to $42,021 in 2002 from
$23,620 in 2001. International sales accounted for $1,857 or 4.4% of
consolidated revenues in 2002 as compared to 13.2% in 2001, and were primarily
derived from the Stratasoft segment.
Revenue from Valerent, which comprised 11.9% of total revenues, compared to
24.0% in 2001, decreased $676 (11.9%) to $4,992 in 2002 from $5,668 in 2001. The
decrease in revenue is attributable to the loss of revenue from certain
customers and a decision to not participate in the National Service Network, a
network of information technology organizations that provide service and support
for regional and national customers through the certified services professionals
employed by its participants.
Revenue from INX, which comprised 73.1% of total revenues compared to
45.6% in 2001, increased $19,963 (185.3%) to $30,738 in 2002 from $10,775 in
2001. INX revenue growth is expected to continue to increase in 2003, but not at
as high a rate as in 2002. In November 2001 INX achieved gold status with Cisco,
its primary product line manufacturer which allows INX to purchase directly from
Cisco at lower pricing levels and enhances INX's relationship with Cisco in the
areas of lead generation, joint marketing and technical support. INX's growth in
revenues was primarily in the Houston market where its revenues increased by
$13,499 over 2001 revenues. Revenues in the Dallas market expanded by $6,464
over 2001 revenues. INX is planning to expand into other Texas cities.
Revenue from Stratasoft, which comprised 15.6% of total revenue in 2002,
compared to 30.7% in 2001, decreased $688 (9.5%) to $6,569 in 2002 from $7,257
in 2001. A large portion of booked orders in the fourth quarter of 2002 were
booked late in the quarter, resulting in lower recognized revenues in that
quarter in the current year. Additionally, 2001 included eight large
international projects that were substantially completed during 2001 and were
not replicated in 2002. Stratasoft anticipates continued revenue from this
region of the world and is exerting efforts to increase such sales.
Gross Profit. Gross profit increased $1,974 (31.4%) to $8,269 in 2002 from
$6,295 in 2001, while gross margin decreased to 19.7% in 2002 from 26.7% in
2001. The primary reason for the decrease in gross margins is the rapid growth
in the INX segment that experiences lower gross margins because of a high
proportion of its revenues being derived from product sales.
Valerent gross profit decreased by $66 (5.2%) to $1,199 in 2002 from $1,265
in 2001. Gross margin rates for Valerent were 24.0% in 2002 as compared to 22.3%
in 2001. Valerent's cost of service consists primarily of labor cost, which has
a more fixed nature. In periods when service revenue decreases, it becomes more
important to manage labor cost in order to prevent erosion of gross margin.
Valerent discontinued its relationship with the National Service Network in the
first quarter of 2002 because it could not realize as high of margins on the
work directed its way by that network.
INX gross profit in 2002 was $3,421 as compared to $1,112 in 2001, an
increase of $2,309 (207.6%) for a gross margin rate of 11.1% in 2002 compared to
10.3% in 2001. The increase in gross profit is consistent with an increase in
revenues of $19,963, and with better pricing from Cisco after achieving Cisco
Gold levels, along with higher levels of service revenues.
Stratasoft gross profit decreased by $290 (7.4 %) to $3,649 in 2002 from
$3,939 in 2001. Gross margin rates for Stratasoft were 55.5% in 2002 as compared
to 54.3% in 2001. The decreased gross profit is consistent with a decrease in
revenues of $688. As discussed above, Stratasoft's revenues, and consequently
its gross profit, suffered from a large portion of its booked orders for the
fourth quarter being booked late in the quarter, resulting in lower recognized
revenue and gross profit for both the fourth quarter and the current year.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $52 (0.1%) to $10,625 in 2002 from $10,573 in
2001. As a percentage of total revenue, selling, general and administrative
expenses for continuing operations decreased to 25.3% in 2002 from 44.8% in
2001.
Valerent selling, general and administrative expenses decreased $841,
primarily due to sales and administrative staff reductions, as well as reduced
bad debt expense. INX selling, general and administrative expenses increased
$442, primarily due to increased sales compensation that is consistent with
increased revenues of $19,963. Stratasoft's selling, general and administrative
expenses increased $901 attributable primarily to increased bad debt expense and
to Stratasoft's lower legal expense in 2001 due to settlement of the eshare
lawsuit resulting in an insurance reimbursement of legal fees incurred in the
defense and recorded prior to 2001. Other factors contributing to Stratasoft's
increase include increases in rent, promotion and advertising and insurance.
Corporate selling, general and administrative expenses decreased by $478, also
primarily due to administrative staff reductions. Other contributing factors in
the Corporate decrease are decreases in legal expense, bad debt expense, general
office expenses and utilities.
Operating Loss. Operating loss decreased $1,922 to an operating loss of
$2,356 in 2002 from a loss of $4,278 in 2001 due primarily to the increase in
gross profit of $1,974 and the increase in selling, general and administrative
expenses of $52. Valerent's operating loss decreased $775 to $1,037 in 2002
from $1,812 in 2001. INX's operating loss decreased $1,867 to a loss of $124 in
2002 from $1,991 in 2001. Stratasoft's operating loss of $273 in 2002 compares
to an operating income of $918 in 2001, a decrease of $1,191. The operating loss
for the Corporate Segment decreased $471 to an operating loss of $922 in 2002
compared to an operating loss of $1,393 in 2001.
Interest and other income, net. Interest and other income, net decreased
$201 (63.6%) to income of $115 in 2002 compared to $316 in 2001. During 2001 and
continuing through 2002 interest rates decreased steadily due to attempts by the
national government to stimulate the economy. In addition to the decrease in
interest rates, while the cash balances at year end are comparable, average cash
balances encompassing the entire year for 2001 were higher than for 2002.
Interest income in 2001 was also increased by the recognition of other income of
$65 relating to an insurance reimbursement in September 2001.
Net loss from continuing operations. Net loss from continuing operations
was $646 in 2002 compared to a loss of $3,875 in 2001. A valuation allowance
against deferred tax assets eliminated the income tax benefit in 2001. In March
2002, President Bush signed into law the Job Creation and Worker Assistance Act
of 2002. Under the new law, which provided for the carryback of net operating
losses for any taxable year ending during 2001 or 2002 to each of the 5 tax
years preceding the loss year, we were able to record $1,595 in tax benefit in
2002. A valuation allowance has been recorded against remaining income tax
benefits generated in 2002.
Discontinued operations. In connection with the sale of IT Staffing, we
recognized in 2001 a loss from discontinued operations of $167 (net of taxes of
$85) on the operations prior to the measurement date of November 7, 2001 and we
recognized a loss on disposal of $11 and $13 (net of taxes of $5 and $7) for the
years ended December 31, 2001 and 2002. During 2002 we recognized additional
gain on the sale of the Computer Products Division of $104 (net of taxes of $53)
and in 2001 we recognized additional gain on the sale of the Computer Products
Division of $346, net of taxes of $179. During the year ended December 31, 2002
we recognized additional gain related to the disposal of the Telecom Division of
$171 (net of taxes of $88).
Year Ended December 31, 2001 Compared to the Year Ended December 31, 2000
(Dollars in thousands)
Revenue. Total revenue increased $6,533 (38.2%) to $23,620 in 2001 from
$17,087 in 2000. International sales accounted for $3,111 or 13.2% of
consolidated revenues in 2001 as compared to 1.7% in 2000, and were primarily
derived from the Stratasoft segment.
Revenue from Valerent, which comprised 24.0% of total revenues, compared to
40.6% in 2000, decreased $1,278 (18.4%) to $5,668 in 2001 from $6,946 in 2000.
The decrease in revenue is attributable to the loss of revenue from certain
customers and the loss of certain categories of revenue associated with and
dependent upon the former Computer Products Division after the sale of the
Computer Products Division in May 2000.
Revenue from INX, which comprised 45.6% of total revenues compared to 11.0%
in 2000, increased $8,901 (475.0%) to $10,775 in 2001 from $1,874 in 2000. INX
was formed in July 2000 and exerted intense efforts to introduce itself to the
market in Dallas and Houston and to form customer relationships. INX revenue
growth is expected to continue to increase in 2002, but not at as high a rate as
in 2001. In October 2000 INX acquired an established service business in Dallas.
The purchase included an established customer list, seven engineers and two
sales staff members. In November 2001 INX achieved gold status with Cisco, its
primary product line manufacturer which allows INX to purchase directly from
Cisco at lower pricing levels and enhances INX's relationship with Cisco in the
areas of lead generation, joint marketing and technical support.
Revenue from Stratasoft, which comprised 30.7% of total revenue in 2001,
compared to 39.0% in 2000, increased $597 (9.0%) to $7,257 in 2001 from $6,660
in 2000. The increased revenues from Stratasoft were primarily the result of
increased sales in the international sector, better recognition of Stratasoft
products in the market place, the expansion of the sales staff and dealer
network and to increased advertising and marketing efforts.
The Corporate segment includes both costs related to the operation of the
corporate entity that are not allocated to any subsidiary company, plus certain
operations that are not on-going because of the sale of the Computer Products
Division (see discussion at Item 1. "Disposition of Computer Products
Business"), and including installation revenues that were related to a certain
customer of our Computer Products Division and revenue from our former El Paso
branch office, which ceased because of the sale of the Computer Products
Division. Corporate revenue, which comprised 0.0% of total revenues in 2001
compared to 9.6% in 2000, decreased by $1,646 (100.4%) in 2001 to $(6) compared
to $1,640 in 2000. The decrease is attributable to the sale of the former IT
Services Division operations of the El Paso office, to the loss of a certain
customer of our former IT Services Division in May 2000 due to the sale of the
Computer Products Division and our corporate restructuring.
Gross Profit. Gross profit increased $2,176 (52.8%) to $6,295 in 2001 from
$4,119 in 2000, while gross margin increased to 26.7% in 2001 from 24.1% in
2000.
Valerent gross profit decreased by $91 (6.7%) to $1,265 in 2001 from $1,356
in 2000. Gross margin rates for Valerent were 22.3% in 2001 as compared to 19.5%
in 2000. Valerent's cost of service consists primarily of labor cost, which has
a more fixed nature. In periods when service revenue decreases, it becomes more
important to manage labor cost in order to prevent erosion of gross margin.
Subsequent to the separation of the IT Services segment into wholly-owned
subsidiary companies in July 2000, Valerent experienced lower labor utilization
related to lower revenue. In addition to the billable technical staff
utilization issue, Valerent had a single large project in 2000 on which gross
profit margin was about 12% below normal levels, which negatively impacted the
overall margin.
INX gross profit in 2001 was $1,112 as compared to a gross loss in 2000 of
$43, an increase of $1,155 (2686.0%) for a gross margin rate of 10.3% in 2001
compared to negative gross margin of 2.3% in 2000. INX was formed in July 2000
and as a newly formed start-up operation in 2000, INX had to have billable
technical staff in place in order to be able to market their services, but was
unable to utilize that technical staff sufficiently to cover their labor cost.
Stratasoft gross profit increased by $852 (27.6%) to $3,939 in 2001 from
$3,087 in 2000. Gross margin rates for Stratasoft were 54.3% in 2001 as compared
to 46.4% in 2000. The increased gross margin was primarily due to changing the
mix of product sales to include a reduced hardware component.
Corporate gross profit increased by $276 (102.6%) to $7 in 2001 compared to
a gross loss of $269 in 2000. The El Paso service business that was sold on May
19, 2000 produced a gross loss of $48 in 2000. We experienced certain costs
related to winding up our service operations in the El Paso branch office that
negatively impacted gross profit. Additionally, the gross margin on
installations for the customer that was lost in the Computer Products Division
sale produced a gross loss of $235 in 2000.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $1,094 (11.5%) to $10,573 in 2001 from $9,479
in 2000. As a percentage of total revenue, selling, general and administrative
expenses for continuing operations decreased to 44.8% in 2001 from 55.5% in
2000.
Valerent selling, general and administrative expenses decreased $109,
primarily due to planned administrative staff reductions. INX selling, general
and administrative expenses increased $2,168. INX was newly formed in July 2000
and their operations, along with the sales staff, have increased steadily since
that time. The INX increase is offset by a decrease of $626 attributable
primarily to Stratasoft's lower legal expense due to settlement of the eshare
lawsuit. Corporate selling, general and administrative expenses decreased by
$323, also primarily due to planned administrative staff reductions.
Operating Loss. Operating loss decreased $1,082 to an operating loss of
$4,278 in 2001 from a loss of $5,360 in 2000 due primarily to the increase in
gross profit of $2,176 offset by the increase in selling, general and
administrative expenses of $1,094. Valerent's operating loss decreased $18 to
$1,812 in 2001 from $1,830 in 2000. INX's operating loss increased $1,013 to a
loss of $1,991 in 2001 from $978 in 2000. Stratasoft's operating income of $918
in 2001 compares to an operating loss of $560 in 2000, an increase of $1,478.
The operating loss for the Corporate Segment decreased $599 to an operating loss
of $1,393 in 2001 compared to an operating loss of $1,992 in 2000.
Interest and other income, net. Interest and other income, net increased
$77 (32.2%) to income of $316 in 2001 compared to $239 in 2000. Subsequent to
the sale of the Computer Products Division in May 2000 cash balances were
invested in interest bearing overnight deposits. Beginning in April 2001, such
cash balances were invested in Euro dollar interest bearing deposits. During
2001 interest rates decreased steadily due to attempts by the national
government to stimulate the economy. The effect of interest rate decreases was
offset somewhat by the recognition of other income of $65 relating to an
insurance reimbursement in September 2001.
Net loss from continuing operations. Net loss from continuing operations
was $3,875 in 2001 compared to a loss of $3,628 in 2001. A valuation allowance
against deferred tax assets eliminated the income tax benefit in 2001. The net
loss for 2000 was after an income tax benefit totaling $1,493 (reflecting an
effective tax rate of 29.2%).
Discontinued operations. In connection with the sale of IT Staffing, we
recognized a loss from discontinued operations of $167 (net of taxes of $85) on
the operations prior to the measurement date of November 7, 2001 and we
recognized a loss on disposal of $11 (net of taxes of $5). During 2001 we
recognized additional gain on the sale of the Computer Products Division of
$346, net of taxes of $179. We experienced net income on the operations of the
Computer Products Division prior to the measurement date, March 16, 2000, of
$302 in 2000, net of taxes of $156 and a gain on disposal of $3,734, net of
taxes of $2,607. During the year ended December 31, 2000 additional expenses
related to the disposal of the Telecom Division of $344 (net of taxes of $240)
was recognized.
Quarterly Results of Operations
The following table sets forth certain unaudited quarterly financial
information for each of our last eight quarters and, in the opinion of
management, includes all adjustments (consisting of only normal recurring
adjustments) which the company considers necessary for a fair presentation of
the information set forth therein. Our quarterly results may vary significantly
depending on factors such as the timing of large customer orders, timing of new
product introductions, adequacy of product supply, variations in our product
costs, variations in our product mix, promotions, seasonal influences and
fluctuations in competitive pricing pressures. The results of any particular
quarter may not be indicative of results for the full year or any future period.
2001 2002
-------------------------------------- --------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Revenue
Valerent $ 1,216 $ 1,178 $ 1,682 $ 1,592 $ 1,465 $ 1,227 $ 1,291 $ 1,009
INX 1,718 2,646 2,876 3,535 5,713 7,430 8,584 9,011
Stratasoft 1,682 1,590 1,687 2,298 2,171 1,657 1,743 998
Corporate (4) 1 (4) 1
Elimination (11) (16) (47) (141) (54) (11) (72)
------ ------ ------ ------ ------ ------ ------ ------
Total 4,601 5,399 6,241 7,379 9,208 10,260 11,607 10,946
Cost of sales and services
Valerent 1,080 982 1,181 1,160 1,150 914 983 746
INX 1,714 2,326 2,516 3,107 5,128 6,822 7,527 7,840
Stratasoft 710 826 841 941 837 871 781 431
Corporate 14 (14) (5) (8)
Elimination (11) (1) (34) (141) (54) (11) (72)
------ ------ ------ ------ ------ ------ ------ ------
Total 3,507 4,119 4,533 5,166 6,974 8,553 9,280 8,945
Gross Profit
Valerent 136 196 501 432 315 313 308 263
INX 4 320 360 428 585 608 1,057 1,171
Stratasoft 972 764 846 1,357 1,334 786 962 567
Corporate (18) 15 1 9
Elimination (15) (13)
------ ------ ------ ------ ------ ------ ------ ------
Total 1,094 1,280 1,708 2,213 2,234 1,707 2,327 2,001
Selling, general and
administrative expenses
Valerent 940 741 772 624 653 501 569 513
INX 608 783 729 983 789 691 966 1,099
Stratasoft 746 653 715 907 1,011 675 914 1,322
Corporate 525 382 301 192 169 147 170 436
Elimination (13)
------ ------ ------ ------ ------ ------ ------ ------
Total 2,819 2,554 2,517 2,693 2,622 2,014 2,619 3,370
Operating income (loss
Valerent (804) (545) (271) (192) (338) (188) (261) (250)
INX (604) (463) (369) (555) (204) (83) 91 72
Stratasoft 226 111 131 450 323 111 48 (755)
Corporate (543) (367) (300) (183) (169) (147) (170) (436)
------ ------ ------ ------ ------ ------ ------ ------
Total (1,725) (1,264) (809) (480) (388) (307) (292) (1,369)
Interest (income) and other
income, net (96) (61) (116) (43) (5) 7 (3) (114)
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before
provision (benefit) for
income taxes (1,629) (1,203) (693) (437) (383) (314) (289) (1,255)
Provision (benefit) for
income taxes 37 (159) 21 14 (1,182) (7) (406)
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) from
continuing operations (1,666) (1,044) (714) (451) 799 (307) (289) (849)
Discontinued operations:
Net income (loss) from
discontinued operations,
net of tax (71) (41) (41) (14)
Gain (loss) on disposal 348 (11) 6 12 (1) 245
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) $(1,737) $ (737) $ (755) $ (476) $ 805 $ (295) $ (290) $ (604)
====== ====== ====== ====== ====== ====== ====== ======
Net Income (loss) per share:
Basic:
Continuing operations $ (0.41) $ (0.26) $ (0.18) $ (0.12) $ 0.21 $ (0.08) $ (0.08) $ (0.23)
Discontinued operations (0.03) (0.02) (0.02) (0.00)
Gain (loss) on disposal 0.09 (0.00) 0.00 0.00 0.00 0.06
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) per share $ (0.44) $ (0.19) $ (0.20) $ (0.12) $ 0.21 $ (0.08) $ (0.08) $ 0.17
====== ====== ====== ====== ====== ======= ====== ======
Diluted:
Continuing operations $ (0.41) $ (0.26) $ (0.18) $ (0.12) $ 0.21 $ (0.08) $ (0.08) $ (0.23)
Discontinued operations (0.03) (0.02) (0.02) (0.00)
Gain (loss) on disposal 0.09 (0.00) 0.00 0.00 0.00 0.06
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) per share $ (0.44) $ (0.19) $ (0.20) $ (0.12) $ (0.44) $ (0.08) $ (0.08) $ (0.17)
====== ====== ====== ====== ====== ======= ====== ======
Weighted average number of shares outstanding::
Basic 3,945,842 3,905,944 3,853,607 3,853,607 3,849,525 3,733,481 3,629,525 3,629,525
Diluted 3,945,842 3,905,944 3,853,607 3,853,607 3,849,525 3,733,481 3,629,525 3,629,525
Liquidity and Capital Resources
Historically, until the sale of our Computer Products Division in May 2000,
we had satisfied our cash requirements principally through borrowings under our
lines of credit and through operations. We maintained a cash position sufficient
to pay only our immediately due obligations and expenses. Subsequent to the sale
of the Computer Products Division we had sufficient cash on hand to meet our
requirements and have not had to rely on our line of credit. Because of the
significant growth we are experiencing, we have entered into a $2,500 credit
line agreement with Textron Financial Corporation, effective January 31, 2002.
The Textron credit line was subsequently increased to $4,500. In December 2002,
Textron increased the credit line on a temporary basis to $5,500. INX is
concentrating its sales efforts on Cisco technology. While we do buy Cisco
product through wholesale distributors, INX has begun to buy its product direct
through Cisco as its primary supplier in order to obtain competitive pricing and
better product availability. At December 31, 2002 we had outstanding borrowings
of $3,239 and had total credit availability of $2,261 on the Textron line.
Borrowings under the Textron line of credit accrue interest at the prime rate
plus 6% on outstanding balances beyond the vendor approved free interest period.
We have invested our excess cash in interest bearing overnight deposits. Our
working capital was $10,098, $5,983 and $5,539 at December 31, 2000, 2001and
2002, respectively. The decrease in working capital during 2002 is primarily due
to the use of working capital to fund operating losses of Valerent and Corporate
while the decrease in working capital in 2001 is primarily due to the use of
working capital to invest in the growth of our INX subsidiary and their
operating losses during that start-up period. The increase in working capital
during 2000 is primarily due to the collection of receivables related to the
discontinued operations of the Computer Products and the Telecom businesses. The
proceeds of the sale of the Computer Products business were used to pay off our
previous line of credit. At December 31, 2002 we had outstanding borrowings
related to our intangible assets and fixed assets totaling $381.
Cash Flows
Operating activities used net cash totaling $4,453 in 2001 and provided net
cash totaling $5,540 and $809 during 2000 and 2002, respectively. During 2002,
net cash proved by operations resulted from increases in accounts payable of
$3,073 and reductions in cost and earnings in excess of billings of $986, offset
by increases in accounts receivable of $2,223, notes receivable of $793 and
increase in income tax receivable of $337. During 2001, net cash used by
operations resulted from a net loss of $3,705 and an increase in cost and
estimated earnings in excess of billings of $1,695 offset by a decrease in
income taxes receivable of $712 and a decrease in inventory. During 2000, net
cash provided by operations resulted from decreases in accounts receivable that
were offset by reductions in accounts payable and accrued expenses.
Accounts receivable increased $2,223 in 2002 and decreased $30,763 and $171
during 2000 and 2001, respectively. Inventory increased $121 during 2002 and
decreased $160 and $187 in 2000 and 2001, respectively. The reductions in
accounts receivable in 2000 and 2001 were primarily the result of collection of
receivables retained from discontinued operations. The increase in accounts
receivable in 2002 of $2,223 is primarily due to the growth in revenues of our
subsidiary, INX.
Investing activities used cash totaling $347 and $206 during 2002 and 2001,
respectively and provided cash of $14,048 during 2000. Our investing activities
that used cash during these periods were primarily related to capital
expenditures related to leasehold improvements and patent license acquisitions.
In 2000, investing activities primarily related to the proceeds from the sale of
the Computer Products business. During the next twelve months, we do not expect
to incur material capital expenditures.
Financing activities used cash totaling $15,889, $253 and $405 during 2000,
2001 and 2002, respectively. The primary use of cash from financing activities
in 2002 and 2001 was repayments on our notes payable and the purchase of
treasury stock. During 2000 we used the proceeds of the sale of the Computer
Products business to pay off our line of credit. During 2000, 2001 and 2002 we
used $20, $195 and $186, respectively to repurchase shares that were held in
treasury at the end of 2002.
Asset Management
Our cash flow from operations has been affected primarily by the timing of
our collection of accounts receivable. We have typically sold our products and
services on short-term credit terms and seek to minimize our credit risk by
performing credit checks and conducting our own collection efforts. We had
accounts receivable, net of allowance for doubtful accounts of $4,302 and $6,525
(including $82 and $432 relating to discontinued operations) at December 31,
2001 and 2002, respectively
We attempt to manage our inventory in order to minimize the amount of
inventory held for resale and the risk of inventory obsolescence and decreases
in market value. We attempt to maintain a level of inventory required to reach
only our near term requirements by relying on the ready availability of products
from our principal suppliers.
Credit Facilities
At December 31, 2001, we had no credit facility in place. On January 31,
2002 we entered into a credit agreement with Textron Financial Corporation
("Textron") for a revolving line of credit (the "Textron Facility") that is our
principal source of liquidity. The total credit available under the credit
facility is $4,500, subject to borrowing base limitations that are generally
computed as 80% of eligible accounts receivable, 90% of identifiable inventory
purchased under this agreement and 40% of all other inventory. Credit available
under this facility for floor plan financing of inventory from approved
manufacturers is $4,500. In December 2002, Textron increased the credit line on
a temporary basis to $5,500. The temporary increase extended to February 20,
2003. We may use up to $500 of the line for working capital advances under
approved conditions. Borrowings under the line will accrue interest at the prime
rate plus 6% on outstanding balances that extend beyond the vendor approved free
interest period and on working capital advances from date of advance. Inventory
floor plan finance borrowings on the line are reflected in accounts payable on
the accompanying balance sheets.
This agreement, which continues in full force and effect until terminated
by written notice from both, is collateralized by substantially all of our
assets. The agreement contains restrictive covenants, which, among other things,
require us to maintain minimum tangible capital funds and to not exceed a
maximum debt-to-tangible capital funds ratio. At December 31, 2002, we were in
compliance with our loan covenants.
On September 27, 2001 Stratasoft, our subsidiary, signed a note payable to
a third party for $725, payable in monthly installments through February, 2007.
The note does not bear interest and we have imputed interest at 5.5% to record
the debt and related patent asset and recorded interest of $30 and $9 in 2002
and 2001, respectively. This note payable is collateralized by Stratasoft's
patent assets. Stratasoft has granted a security interest in its pending patent
application and the next two patent applications filed by Stratasoft. In
connection with this note payable, we have reported short-term debt maturing
within one year of $144 and $200 and long-term debt of $258 and $388 at December
31, 2002 and 2001, respectively.
In October 2001, we signed a non-interest bearing automobile note payable
for $39 payable in monthly installments through October 2004. In connection with
this note payable, we have reported short-term debt maturing within one year of
$13 and $13 and long-term debt of $11 and $22 at December 31, 2002 and 2001,
respectively. At December 31, 2002 our contractual obligations are as follows:
Payments due by Period
Less
than 1-3 4-5 after 5
Contractual Obligations Total 1 year years years years
Long-term debt $ 403 $ 157 $ 231 $ 15 $ 0
Operating Leases 1,887 511 1,339 37 0
-------- -------- -------- -------- --------
Total $ 2,313 $ 668 $ 1,593 $ 52 $ 0
======== ======== ======== ======== ========
Critical Accounting Policy
Revenue Recognition - Revenue from the sale of products that are resold is
recognized when the product is shipped. Service income is recognized as the
services are earned. Revenues resulting from installations of equipment and
software contracts for which duration is in excess of three months and that
require substantial modification or customization are recognized using the
percentage-of-completion method. The percentage of revenue recognized is
determined principally on the basis of the relationship of the cost of work
performed on the contract to estimated total costs. Revisions of estimates are
reflected in the period in which the facts necessitating the revisions become
known; when a contract indicates a loss, a provision is made for the total
anticipated loss.
The following reflects the amounts relating to uncompleted contracts at
December 31, 2001 and 2002:
Costs incurred on uncompleted contracts $ 600 $ 429
Estimated earnings 2,181 1,478
--------- ---------
2,781 1,907
Less: Billings to date 1,158 1,273
--------- ---------
Cost and estimated earnings in excess of billings $ 1,695 $ 709
========= =========
Billings in excess of cost and estimated earnings $ 72 $ 75
========= =========
During 2002 and 2001 our subsidiary, Stratasoft, recognized revenues on the
percentage-of-completion basis for several projects associated with one reseller
in South Asia. On the projects in South Asia we required a cash payment or
letter of credit from the customer prior to shipping the product. We have risk
to the extent that this group of customers have not paid us or issued
contractual letters of credit up to the level of cost and earnings recognized
and inherent risks that underlie the frequent estimates and management judgment
associated with the percentage-of-completion method of accounting.
Credit and Collections Policy - Inherent in the Company's revenue
recognition policy is the determination of the collectibility of amounts due
from its customers, which requires the Company to use estimates and exercise
judgment. The Company routinely monitors its customer's payment history and
current credit worthiness to determine that collectibility is reasonably
assured. This requires the Company to make frequent judgments and estimates in
order to determine the appropriate period to recognize a sale to a customer and
the amount of valuation allowances required for doubtful accounts. The Company
records provisions for doubtful accounts when it becomes evident that the
customer will not be able to make the required payments either at contractual
due dates or in the future. Changes in the financial condition of the Company's
customers, either adverse or positive, could impact the amount and timing of any
additional provisions for doubtful accounts that may be required.
Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements at December 31, 2002.
Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 145, "Rescission of SFAS No. 4, 44 and 64, Amendment of SFAS No.
13, and Technical Corrections." SFAS No. 145, among other things, amends SFAS
No. 4 and SFAS No. 64, to require that gains and losses from the extinguishments
of debt generally be classified within continuing operations. The provisions of
SFAS No. 145 are effective for fiscal years beginning after May 15, 2002 and
early application is encouraged. The Company does not believe that the adoption
of SFAS No. 145 will have a significant impact on its financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 replaces Emerging
Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity". This
standard requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This statement is effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does not
believe that the adoption of SFAS No. 146 will have a significant impact on its
financial statements.
In February 2003, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation: A Comparison of FASB Statement No. 123, Accounting for Stock-Based
Compensation, and Its Related Interpretations, and IASB Proposed IFRS,
Share-based Payments." SFAS No. 148 amends SFAS 123 to provide alternative
methods of transition for an entity that voluntarily changes to the fair value
based method of accounting for stock-based employee compensation. It also amends
the disclosure provisions of that Statement to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based compensation. The statement also amends
APB Opinion No. 28, "Interim Financial Reporting", to require disclosure about
those effects in interim financial information. The Company has chosen not to
voluntarily change to the fair value based method of accounting for stock-based
employee compensation but has adopted the disclosure rules of SFAS 148.
Future Trends
We expect continued revenue increases in 2003 and beyond, due primarily to
market share gains. While we expect all three of our subsidiary companies to
produce significant revenue growth in 2003, we expect INX to produce the most
rapid growth rates, although not at the same growth rates experienced in 2002.
We expect that this revenue growth in 2003 will be primarily a result of the
prior investments in the form of increased sales and marketing staff and
marketing programs and because of selective growth through acquisition. Valerent
is in a process of changing its direction to focus on technology solutions that
lower its client's cost of supporting their IT infrastructure by providing
remote management tools and automating repetitive and remedial tasks, which we
expect will begin to generate revenue increases by the second quarter of 2003.
For 2003 we expect our business to be positively impacted by a slight
improvement in the depressed general market conditions that we experienced in
2002, due primarily to a likely upswing in the cyclical buying patterns of
customers for technology products. In 2002 we experienced the depressing
combined events of a declining stock market, slowing economy, threats of
terrorist activity and threatened war. We expect these factors to continue to
impact buying patterns of customers for technology products through the first
quarter of 2003, but expect to see an upswing in the general market conditions
in the latter half of 2003.
We expect to be able to contain the growth in selling, general and
administrative expenses as a percentage of revenue, as revenue continues to grow
because of previous investments in sales and marketing, without a further
commensurate increase in sales and marketing expenses and as the increases in
revenues are spread over a relatively fixed corporate administration expense
base.
We have experienced no material impact of inflation and changing prices on
net sales and income from continuing operations in the last three years.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We may incur certain market risks related to interest rate variations in
the future because we hold floating rate debt. We have $3,216 in cash balances
in interest bearing accounts at December 31, 2002. If interest rates decrease by
1% the net loss will increase by $34. If interest rates increase by 1% the net
loss will decrease by $34.
We have no off-balance sheet arrangements or derivative instruments.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements:
Independent Auditors' Report 27
Consolidated Balance Sheets at December 31, 2001 and 2002 28
Consolidated Statements of Operations for the years ended
December 31, 2000, 2001 and 2002 29
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2000, 2001 and 2002 30
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 2001 and 2002 31
Notes to Consolidated Financial Statements for the years
ended December 31, 2000, 2001 and 2002 32
INDEPENDENT AUDITORS' REPORT
To the Stockholders of I-Sector Corporation.:
We have audited the accompanying consolidated balance sheets of I-Sector
Corporation and subsidiaries ("I-Sector") as of December 31, 2001 and 2002, and
the related statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2002. Our audits also
included the financial statement schedule listed in the index at Item 15(a)(2).
These financial statements and the financial statement schedule are the
responsibility of I-Sector's management. Our responsibility is to express an
opinion on these financial statements and the financial statement schedule based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 I-Sector as of December 31,
2001 and 2002, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Houston, Texas
March 21, 2003
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2002
(In thousands, except share and par value amounts)
ASSETS 2001 2002
---- ----
Current Assets:
Cash and cash equivalents $ 3,434 $ 3,491
Accounts receivable, net 4,302 6,525
Accounts receivable - affiliates 250 99
Accounts receivable - other 21 57
Notes receivable 169 898
Inventory 587 781
Cost and estimated earnings
in excess of billings 1,695 709
Income taxes receivable 151 488
Other current assets 302 356
----------- -----------
Total current assets 10,911 13,404
Property and equipment, net 1,226 1,115
Intangible assets 1,356 1,162
Other assets 55 70
----------- -----------
Total Assets $ 13,548 $ 15,751
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long term debt $ 213 $ 157
Accounts payable 1,772 4,844
Billings in excess of cost and
estimated earnings 72 75
Accrued expenses 2,091 1,803
Net liabilities related to
discontinued operations 654 904
Deferred service revenue 126 81
----------- -----------
Total current liabilities 4,928 7,864
Long term debt 410 247
Deferred credit - stock warrants 195
Commitments and Contingencies (See Note 10)
Stockholders' Equity:
Preferred stock, $.01 par value,
5,000,000 shares authorized,
no shares issued
Common stock, $.01 par value,
15,000,000 shares authorized,
4,441,325 issued at December 31,
2001 and 2002, respectively 44 44
Additional paid in capital 10,184 10,379
Treasury stock, at cost, 591,800 and
811,800 shares at December 31,
2001 and 2002, respectively (1,187) (1,373)
Retained earnings (1,026) (1,410)
----------- -----------
Total stockholders' equity 8,015 7,640
----------- -----------
$ 13,548 $ 15,751
=========== ===========
See notes to consolidated financial statements.
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002 (In thousands, except share
and per share amounts)
Years ended December 31,
---------------------------------
2000 2001 2002
Total revenue $ 17,087 $ 23,620 $ 42,021
Cost of goods and services 12,968 17,325 33,752
-------- -------- ---------
Gross profit 4,119 6,295 8,269
Selling, general and administrative expenses 9,479 10,573 10,625
-------- -------- ---------
Operating loss 5,360 4,278 2,356
Interest and other income, net 239 316 115
-------- -------- ---------
Loss from continuing operations before
benefit for income taxes 5,121 3,962 2,241
Benefit for income taxes 1,493 87 1,595
-------- -------- ---------
Net loss from continuing operations 3,628 3,875 646
Discontinued operations:
Net income (loss) from discontinued
operations, net of taxes 195 (167)
Gain on disposal, net of taxes 3,390 337 262
-------- -------- ---------
Net loss $ 43 $ 3,705 $ 384
======== ======== =========
Net income (loss) per share:
Basic and diluted:
Net loss from continuing operations $ (0.90) $ (0.99) $ (0.17)
Net income (loss) from discontinued
operations 0.05 (0.04)
Gain on disposal 0.84 0.08 0.07
-------- -------- ---------
Net loss per share $ (0.01) $ (0.95) $ (0.10)
======== ======== =========
Weighted average number of shares outstanding:
Basic and diluted 4,059,618 3,911,019 3,709,689
========= ========= =========
See notes to consolidated financial statements
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002
(In thousands, except share and per share amounts)
$.01 par value Additional Unearned
Common Stock Paid-In Treasury Equity Retained
Shares Amount Capital Stock Compensation Earnings Total
Balance at January 1,2000 4,441,325 $ 44 $ 10,037 $ (972) $ (1) $ 2,722 $ 11,830
Purchase of treasury stock (20) (20)
Fair value of stock options to
Non-employees 145 145
Net loss (43) (43)
--------- ------ ------- ------- ------- ------- -------
Balance at January 1,2001 4,441,325 $ 44 $ 10,182 $ (992) $ (1) $ 2,679 $ 11,912
Purchase of treasury stock (195) (195)
Satisfaction of restricted stock 1 1
Issuance of restricted stock 2 2
Net loss (3,705) (3,705)
--------- ------ ------- ------- ------- ------- -------
Balance at December 31,2001 4,441,325 44 10,184 (1,187) (1,026) 8,015
Purchase of treasury stock (186) (186)
Stock warrants expired 195 195
Net loss (384) (384)