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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, 1997
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-21479
ALLSTAR SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 76-0515249
(State of Incorporation) (I.R.S. Employer Identification No.)
6401 Southwest Freeway
Houston, TX 77074
(Address of principal executive offices) (Zip code)
(Registrant's telephone number including area code: (713) 795-2000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK, $.01 Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes __x__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the closing price of the Common Stock on March 24,
1998, as reported on NASDAQ National Market System, was approximately
$11,591,000.
The number of shares of Common Stock, $.01 Par Value, outstanding as of
March 24, 1997 was 4,454,411.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive Proxy Statement for the 1998 Annual
Meeting of Shareholders are incorporated by reference into Part III, Items 10,
11, 12, and 13.
PART I
Item 1. Business
Special Notice Regarding Forward-Looking Statements
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO
FUTURE EVENTS OR THE FUTURE FINANIAL PERFORMANCE OF THE COMPANY, INCLUDING BUT
NOT LIMITED TO STATEMENTS CONTAINED IN ITEM 1 - "FACTORS WHICH AFFECT FUTURE
OPERATING RESULTS," "ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS," "PROPERTIES" AND "BUSINESS." READERS ARE
CAUTIONED THAT SUCH STATEMENTS, WHICH MAY BE IDENTIFIED BY WORDS INCLUDING
"ANTICIPATES," "BELIEVES," "INTENDS," "ESTIMATES," "EXPECTS" "PLANS" AND OTHER
SIMILAR EXPRESSIONS, ARE ONLY PREDICTIONS OR ESTIMATIONS AND ARE SUBJECT TO
KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES, OVER WHICH THE COMPANY HAS LITTLE OR
NO CONTROL. IN EVALUATING SUCH STATEMENTS, READERS SHOULD CONSIDER THE VARIOUS
FACTORS IDENTIFIED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING MATTERS SET
FORTH IN "FACTORS WHICH MAY AFFECT THE FUTURE OPERATING RESULTS," WHICH COULD
CAUSE ACTUAL EVENTS, PERFORMANCE OR RESULTS TO DIFFER MATERIALLY FROM THOSE
INDICATED BY SUCH STATEMENTS.
GENERAL
Allstar Systems, Inc. (the "Company") is a regional provider of
computer and telecommunications hardware and software products and related
services. The Company primarily markets its products and services in Texas from
five locations in the Houston, Dallas-Fort Worth, El Paso and Austin
metropolitan areas and through a small, recently opened office in McAllen,
Texas. During 1997, the Company's customer base of approximately 2,700 accounts
was comprised primarily of mid-sized customers and regional offices of larger
customers in commercial, educational and governmental sectors. The Company
positions itself to provide its customers with single-source solutions for both
their computer and telecommunications needs by offering a broad range of
products and services and by providing the expertise to support integrated
computer and telecommunications applications.
The Company's revenue is derived from sales of Computer Products, IT
Services, Telecom Systems and CTI Software. The Company is an authorized
reseller of computer products from Compaq, Hewlett-Packard, IBM, Microsoft,
Novell and other leading manufacturers. The Company has long-standing
relationships with leading aggregators and wholesale distributors of computer
hardware and software products which enable the Company to provide its customers
with competitive product pricing and ready product availability. IT Services
include system design, installation, integration and support services. With
respect to Telecom Systems, the Company markets, installs and services
telecommunications equipment, including PBX telephone systems from NEC,
Inter-tel and Mitel. In 1995, the Company introduced its proprietary CTI
Software products which facilitate computer and telephone integration, primarily
for telemarketing, call center and other high volume calling applications.
The Company was incorporated in 1983 as a Texas corporation and was
reincorporated in 1996 as a Delaware corporation. The Company's executive
offices are located at 6401 Southwest Freeway, Houston, Texas 77074 and its
telephone number is (713) 795-2000.
The market for computer products and services has experienced
significant growth in recent years and the use of such products and services
within organizations has been impacted by several concurrent trends. The
introduction of LANs and WANs has allowed organizations to supplement or replace
expensive, centralized mainframe computer systems with more flexible and
affordable PC-based client/server platforms. The emergence of widely accepted
industry standards for hardware and software has increased the acceptance of
open architecture LANs and WANs which can and frequently do contain products
from numerous manufacturers and suppliers. Rapid technological improvements in
computer hardware and the introduction of new software operating systems have
also created the need to expand or upgrade existing networks and systems. At the
same time, price decreases have made such networks and systems affordable to a
larger number of organizations. The Company believes that these trends have
increased the general demand for computer products and related information
technology services.
Distribution channels for computer products changed significantly
beginning in the early 1990s. During that period, many manufacturers of
computers began to scale back their sales forces and, in order to ensure the
continued wide distribution of their products, started to offer their products
to wholesale computer distributors which previously had sold only software and
peripheral equipment. In addition, manufacturers also began allowing resellers
to purchase products from more than one aggregator or distributor, a practice
known as "open sourcing. " Expanding computer sales to distributors and allowing
open sourcing intensified price competition among suppliers. The Company
believes that, in general, the manufacturers of its primary product lines are
continuing to rely to a large degree on resellers of computer products to
distribute a significant portion of their products to end-users. Distribution
patterns may continue to evolve, however, and any future changes may
significantly affect the Company's business.
The advent of open architecture networks has also impacted the market
for information technology services. Wider use of complex networks involving a
variety of manufacturer's equipment, operating systems and applications software
has made it increasingly difficult to diagnose problems and maintain the
technical knowledge and repair parts necessary to provide support services. The
Company believes that increased outsourcing of more sophisticated support
services by business and institutional customers has resulted from the technical
complexities created by multi-manufacturer and supplier network systems and
rapid technological change. Increasingly, organizations seeking computer
products often require prospective vendors not only to offer products from many
manufacturers and suppliers, but to have available and proficient service
expertise to assist them in product selection, system design, installation and
post-installation assistance and service. The Company believes that the ability
to offer customers a comprehensive solution to their information technology
needs, including the ability to work within its customers' corporate
environments as integral members of their management information system staff,
are increasingly important in the marketplace.
Telecommunications systems have evolved in recent years from simple
analog telephone systems to sophisticated digital systems, with modern digital
systems featuring voice processing, automated attendant, voice and fax mail,
automatic call distribution and call accounting. The ability to interface these
new digital phone systems to the user's PC-based computer systems now allows
these telephone systems to interact with the user's computerized data to create
powerful business solutions. New features, such as "caller ID" that is coupled
with a digital telephone system and integrated with a computer system, can
provide automatic look-up and display of account information while the user is
receiving a new call, thereby increasing productivity and the level of customer
service. Computerized "call accounting" allows an organization with integrated
telephone and computer systems to track telephone usage and long distance toll
billing and easily interface that data with computerized accounting and billing
systems. Integrated voice and facsimile handling allows a user to retrieve, send
and manage voice and facsimile messages on his computer screen. Computerized
telephone number listings allow the user to look up telephone numbers on the
computer and then have the computer dial the number automatically. For more
complex call center applications, computer systems can manage out-bound calling
campaigns while automatically blending in-bound calls to available agents in
order to enhance agent productivity.
The Company believes that the evolution of the digital telephone system
to a more open architecture, aided by standards established by Microsoft and
Novell for the interface of telephone and computer technologies, is causing
rapid industry change. This change is creating demand for digital telephone
systems which adhere to these new industry standards. These digital telephone
systems, along with the many software products which are rapidly becoming
available for use in CTI, require sophisticated installation and integration
service capability. The Company believes that the trend toward CTI is likely to
continue and that integrated voice, data and video communication will become
more affordable. As the technology and management of telecommunications and
computer systems converge over the next decade, the Company expects that growth
opportunities will be presented for companies able to provide and service the
latest integrated telecommunications and computer technologies.
BUSINESS STRATEGY
The Company's goals include continuing the growth of its
regionally-based business while preparing the Company to become a national
provider of computer and telephone hardware and software products and related
services. To achieve its objectives, the Company intends to pursue these key
strategies:
Expand Geographically. The Company intends to open additional offices within
Texas and in new regions to service existing customers and attract new
customers. The Company opened new offices in Austin, Texas in the third quarter
of 1997 and in McAllen and El Paso late in 1997. The Company intends to open
other offices in Texas and other regions as opportunities and circumstances
warrant.
Increase Telecom Systems And CTI Software Businesses. The Company began offering
Telecom Systems in 1994 in its Houston office and CTI Software in 1995 to
capitalize on the growing trend in CTI. The Company expanded Telecom Systems
operations to the Dallas-Fort Worth market in the second half of 1997. The
Company intends to expand its Telecom Systems operations to (i) all of its
offices, (ii) pursue acquisitions of regional telephone system resellers with
established customer bases in targeted markets, and (iii) increase the variety
and capabilities of its CTI Software products through internal development and
acquisitions of complementary software products.
Implement Internet-Based National Marketing Program. The Company intends to
implement a new method of marketing its Computer Products on a nationwide basis.
By accessing an Internet home page currently under development, the Company's
sales representatives and customers will be able to obtain product pricing and
availability data, enter or change orders and access customer account status
information. The Company plans to employ experienced sales representatives in
selected metropolitan markets who will be supported by the new Internet-based
system and by a national sales support call center performing order entry and
customer service functions.
After utilizing the Internet-based system to support its direct sales
force the Company expects to establish customer relationships in new markets
under the trade name "800 PC Deals." The Company then intends to establish
branch offices in certain of these markets. Implementation of this strategy was
anticipated to begin in the second half of 1997 but has been deferred
indefinitely until the Company can better ascertain the potential profitability
of this program and further develop its Internet based marketing systems. There
can be no assurance that the Company will complete the development of the
Internet system and if developed whether the Company will implement the
marketing program.
PRODUCTS AND SERVICES
The Company's revenues are derived from the marketing of technological
information systems. Management of the Company believes that such revenues are
reliant upon the ability to offer related services (which comprise less than 10
% of revenues) on those products. For the convenience of the reader the products
offered and the related services have been provided below.
COMPUTER PRODUCTS
The Company offers its customers a wide variety of computer hardware
and software products available from over 600 manufacturers and suppliers. The
Company's products include desktop and laptop computers, monitors, printers and
other peripheral devices, operating system and application software, network
products and mid-range host and server systems including the IBM RS6000 and DEC
Alpha systems. The Company is an authorized reseller of products from a number
of leading manufacturers of computer hardware, software and networking
equipment, including Compaq, Hewlett-Packard, IBM, Microsoft and Novell.
Products manufactured by Compaq, Hewlett-Packard and IBM in the aggregate
accounted for approximately 53.7%, 58.9%, and 56.8%, for 1995, 1996 and 1997,
respectively, of the Company's total inventory purchases. There can be no
assurance that the Company will continue to resell such manufacturers' products
in the future; however, the Company believes that its relations with all of its
major product manufacturers and distributors are satisfactory.
IT SERVICES
IT Services are provided by the Company both in conjunction with and
separately from its Computer Products sales. The Company typically prices its IT
Services on a time and materials basis or under fixed fee service contracts,
depending on customer preference and the level of service commitment required.
In markets where the Company does not maintain branch offices, it often
subcontracts for necessary technical personnel, particularly where required for
larger scope or prolonged duration contracts. The Company's IT Services include
the following:
Information Systems Support. The Company is an authorized warranty service
provider for many popular computer and computer peripheral products and provides
hardware repair and maintenance services, complex network diagnostic services,
end user support services and software diagnostic services. The Company also
offers complete outsourcing of a customer's computer and network management and
technical support needs on a contract basis. The Company provides on-site
service parts stocking, help desk assistance and fixed asset management and
tracking.
Contract Systems Engineer, Technician And Programmer Staffing. The Company
provides short-term supplemental technical staffing, including hardware and
software technicians, help desk personnel, systems and network engineers and
programming staff.
Systems Engineering. The Company provides systems engineering services including
information technology consulting, LAN/WAN design, on-site and remote network
administration, new technology feasibility and impact analyses and disaster
recovery plan analyses.
Information Technology Project Management. The Company provides project
management services for major hardware and software upgrades and conversions,
roll-outs of major new hardware and software installations and large network
installations, including multiple city WAN implementations.
Telecommunications And Data Systems Cabling. The Company provides networking and
telecommunications cabling services required for all major networking
topologies, including fiber optic cabling. The Company also offers cabling
services for adding to, moving or changing existing network systems.
Contract Programming Services. Recently, the Company has begun to offer contract
programming services, primarily related to SQL database design and
implementation, client server applications and Internet site development.
IT Staffing Services. In January 1997 the Company, through its wholly-owned
subsidiary IT Staffing, Inc., began providing technical personnel for temporary
and permanent positions to it customers. The Company recruits and places
personnel for a wide variety of technical positions related principally to
computing hardware and software skill sets.
To support and maintain the quality of these services and to maintain
vendor accreditation necessary to resell and service its significant product
lines, the Company's technical staff participate in various certification and
authorization programs sponsored by hardware manufacturers and software
suppliers. The Company currently has attained several certifications and
authorizations, most notably as a Microsoft Solution Provider and a Novell
Platinum Reseller. The Company's ability to attract and retain qualified
professional and technical personnel is critical to the success of its IT
Services business.
TELECOM SYSTEMS
The Company began its Telecom Systems business in 1994 to capitalize on
the trend toward CTI. The Company currently markets, installs and services
business telephone systems, including large PBX systems and small key systems,
along with a variety of related products including hardware and software
products for data and voice integration, wide area connectivity and telephone
system networking and wireless communications. The Company resells PBX systems
manufactured by NEC and Mitel and smaller "key systems," including products from
Macrotel, NEC and Winn Communications. Wireless products include products from
Uniden and Spectralink. Software products include voice mail products from
Active Voice and AVT, interactive voice response applications from AVT and call
center activity reporting products from Taske.
Prior to 1997, the Company marketed Telecom Systems only from its
Houston office. During the second half of 1997, the Company expanded Telecom
Systems sales to its Dallas office. The Company intends to expand the marketing
of its Telecom Systems products into each new office as they are established.
The Company also intends to expand its Telecom Systems products, particularly in
the area of CTI products, as suitable new products become available for resale.
CTI SOFTWARE
The Company develops and markets proprietary CTI Software, which
integrates business telephone systems and networked computer systems, under the
trade name "Stratasoft. " CTI Software is designed to improve the efficiency of
call center, both inbound and outbound and other high volume calling
applications. Basic products offered by the Company are typically customized to
suit a customer's particular needs and are often bundled with computer hardware
supplied by the Company at the customer's request. The Company entered the CTI
Software business in late 1995 by acquiring two CTI products, currently sold
under the names StrataDial and StrataVoice, from a corporation owned by the
individual who presently manages the Company's CTI Software operations. A new
product, Strata-Interactive, has also been developed by the Company. The Company
now markets these three CTI Software products, which are described below:
Stratadial. StrataDial is a predictive dialer software product for outbound call
center applications such as sales and promotion, collections, surveys, lead
generation and announcements that require personal contact. StrataDial features
inbound/outbound call blending without requiring an automated call distribution
feature ("ACD") of the PBX telephone system. StrataDial collects campaign
specific data during the telephone call and provides comprehensive on line
reporting and statistical analysis of the campaign data. StrataDial also
features open architecture which allows easy interaction with the customer's
other database applications. Dialing parameters and campaign characteristics can
be changed without shutting down the dialer, as is required with many competing
products. During 1997, the Company sold and installed 48 StrataDial systems.
Stratavoice. StrataVoice is an outbound dialing product designed for high volume
applications that do not require human interaction. StrataVoice applications
include appointment confirmation and setting, court appearance notification,
surveys, community notification such as school closings and emergency
evacuation, employee updates, absenteeism notification, telemarketing and market
research. A telephone system utilizing StrataVoice dials a computerized list of
numbers and can ask the contacted person a number of questions, including
branching to other questions and statements based on responses. StrataVoice also
allows the contacted person to leave messages. Scripting tools are included that
allow the user to develop campaigns. The system builds a database of respondent
data and has comprehensive response reporting capabilities. During 1997, the
Company sold and installed 122 StrataVoice systems.
Strata-Interactive. Strata-Interactive is an interactive voice response ("IVR")
software product which allows telephone calls to access computer information at
any time using a simple touch-tone telephone. Applications for IVR technology
vary and include insurance coverage verification and claims reporting, utility
company account information and outage reporting, bank account information and
on-line transactions, and shipment verification and tracking information.
Strata-Interactive is based upon open architecture and is designed to work with
networked computers. The first beta version of the product was delivered to a
customer in June 1996. In 1997, the Company began integrating the
Strata-Interactive components into the Strata-Dial and Strata-Voice products.
The Company expects the majority of the Strata-Interactive product will be
marketed as a component of Strata-Dial.
SALES AND MARKETING
DIRECT SALES
The Company markets its products and services primarily through direct
sales representatives. Direct sales representatives are teamed with in-house
customer service representatives and are assigned to specific customer accounts.
The Company believes that direct sales lead to better account penetration and
management, better communications and long-term relationships with its
customers. The Company's sales personnel, including account managers and
customer service representatives, are partially compensated, and in some cases
fully compensated, on the profitability of accounts which they participate in
developing. The Company believes that its past and future growth will depend in
large measure on its ability to attract and retain qualified sales
representatives and sales management personnel. The Company promotes its
products and services through general and trade advertising, participation in
trade shows and telemarketing campaigns. The Company believes that a significant
portion of new customers of its Computer Products and IT Services businesses
originates through word-of-mouth referrals from existing customers and industry
members, such as manufacturer's representatives. Additionally, Telecom Systems
sales personnel seek to capitalize on the many customer relationships developed
by the Company's Computer Products and IT Services personnel. By virtue of their
computer business contacts, Computer Products and IT Services personnel often
learn at a relatively early stage that their customers may soon be in the market
for telecommunications equipment and services. Sales leads developed by this
synergy are then jointly pursued. CTI Software is marketed by direct sales
representatives to organizations using telemarketing, call centers or other high
volume telecommunications functions. In addition, StrataVoice is marketed
through resale arrangements between the Company and a VAR.
INTERNET-BASED SALES SUPPORT SYSTEM
The Company has been developing an Internet-based sales support system
that will be used by its entire sales force, however the Company does not intend
to activate the sales support until additional development occurs. The system
will allow sales representatives to access information on product pricing and
availability, enter and track specific orders and monitor customer account
information. Sales representatives will be able to access the system from their
desktop computers at the Company's offices or on the Internet. The system will
also allow selected customers to enter and manage their own orders on-line. The
Company believes that when implemented this sales support system will enhance
the productivity and flexibility of its sales force and improve its customer
service.
800 PC DEALS
The Company intends to use its proposed Internet-based sales support
system to cost-effectively expand its marketing efforts for Computer Products on
a national level under the trade name 800 PC Deals. Specifically, the Company
intends to employ sales representatives with local experience in targeted
metropolitan markets to establish customer relationships utilizing the new
system. The Company also plans to operate a national sales support call center
to serve sales representatives and customers. Initially, the Company intends to
fulfill a large portion of orders in these new markets by drop shipping product
directly from suppliers to customers. Once sufficient customer relationships are
established and market knowledge is developed, the Company may seek to establish
a branch office in a market. No definitive schedule has been established for the
commencement of operations as 800 PC Deals.
There can be no assurance that the new system will function as expected
or, if so, that its implementation will enable the marketing approach of 800 PC
Deals to be successful. Many factors could influence the performance of 800 PC
Deals, including competition by others using similar systems, technical
difficulties in the implementation of the new Internet-based system, lack of
customer or supplier acceptance and the inability of local, direct sales
representatives to successfully market Computer Products through 800 PC Deals.
CUSTOMERS
The Company focuses its marketing efforts on mid-sized customers and
regional offices of larger customers located in or near the metropolitan areas
in Texas in which the Company maintains offices. The Company occasionally
provides Computer Products and IT Services in markets where the Company does not
have an office, typically to branch operations of customers with which the
Company has an established relationship. The Company's customer base is not
concentrated in any industry group. Over 2,700 customers purchased products or
services from the Company during 1997. In 1997, the largest single customer
constituted 4.8% of total revenues, however in prior years the Company's largest
customer has constituted as high as 11.2% of revenues.
The Company has only a small amount of backlog relative to total
revenues because the Company has no long-term commitments by customers to
purchase products or services from the Company. Although the Company has service
contracts with many of its large customers, such service contracts are
project-based and/or terminable upon relatively short notice. A significant
reduction in orders from any of the Company's largest customers could have a
material adverse effect on the Company's financial condition and results of
operations.
SUPPLY AND DISTRIBUTION
The Company relies on aggregators and distributors of computer
hardware, software and peripherals to supply a majority of its Computer
Products. Although the Company uses many industry suppliers, the Company
purchases its Computer Products chiefly from two suppliers, Inacom and Ingram,
to obtain competitive pricing, better product availability and improved quality
control. The Company attempts to develop strategic arrangements with its
principal suppliers, including the coordination of drop shipment orders, the
outsourcing of certain computer configuration services, national roll-out and
installation projects and the sharing of product information. Telecommunications
hardware and software products are generally purchased by the Company on an
as-needed basis directly from the original equipment manufacturer.
The Company's largest supplier of Computer Products is Inacom, a
leading computer products aggregator. Inacom markets and distributes computer
products and provides various services on a wholesale basis through a network of
franchisees and resellers and also markets its products directly to end-users.
During 1995, 1996 and 1997, the Company purchased from Inacom approximately
36.6%, 57.0% and 51.4%, respectively, of its total inventory purchases. The
Company purchases Computer Products and obtains drop shipping and other services
from Inacom pursuant to an agreement entered into in August 1996 (the "Inacom
Agreement"). Under the Inacom Agreement, the Company is required to purchase at
least 80% of its Computer Products from Inacom, but only to the extent that such
products are made available within a reasonable period of time at reasonably
competitive pricing. Pricing from Inacom is generally based on Inacom's cost
plus a negotiated markup. With certain exceptions, the Company is entitled to
volume discounts at agreed upon levels. The term of the Inacom agreement expires
on December 31, 2001, and automatically renews for successive one year periods
unless notice of non-renewal is given 60 days prior to the end of the renewal
period. A cancellation fee of $570,500 will be payable by the Company in the
event of non-renewal or early termination of the Inacom Agreement by either
party.
The Company's second largest supplier of computer products is Ingram.
The Company also purchases its Computer Products from Ingram on a cost-plus
basis. During 1995, 1996 and 1997, the Company purchased from Ingram
approximately 20.6%, 14.7% and 20.0% respectively, of its total inventory
purchases. The Company's agreement with Ingram provides for volume discounts at
agreed upon levels. The agreement with Ingram may be terminated by either party
upon 30 days prior written notice.
Due to intense price competition among computer products resellers, the
price and shipping terms received by the Company from its suppliers, especially
Inacom and Ingram, are critical to the Company's ability to compete in Computer
Products. From time to time the availability of certain products has been
limited. Although the Company has not experienced unusual product availability
problems and has been generally satisfied with the product pricing and terms
available from its principal suppliers, there can be no assurance that such
relationships will continue or that, in the event of a termination of its
relationship with either Inacom or Ingram, or both, it would be able to obtain
an alternative supplier or suppliers without a material disruption in the
Company's ability to provide competitively priced products to its customers.
The Company maintains standard authorized dealership agreements from
many leading manufacturers of computer and telecommunications hardware and
software. Under the terms of these authorized dealership agreements, the Company
is entitled to resell associated products to end-users and to provide warranty
service. The Company's status as an authorized reseller of key product lines is
essential to the operation of the Company's business. In general, the authorized
dealer agreements do not require minimum purchases and include termination
provisions ranging from immediate termination to termination upon 90 days prior
written notice. Some of such agreements are conditioned upon the continuation of
the Company's supply arrangement with Inacom or another major wholesaler
acceptable to the manufacturer.
The Company operates a warehouse at its Houston and Dallas offices for
the purpose of receiving, warehousing, configuration and shipping products. The
Company plans to consolidate its two warehouses into one central regional
warehouse located in the Dallas-Fort Worth metropolitan area in order to achieve
further productivity and efficiency enhancements.
During 1995, the Company began an initiative to drop ship a higher
percentage of its orders directly from the supplier to customer in order to
lower its distribution costs and freight costs. This initiative has resulted in
the percentage of drop shipped orders (measured by the cost of goods drop
shipped as a percentage of total cost of goods) growing from 5. 1% during the
six months ended June 30, 1995 to 18.1% during 1996 and 23.9% in 1997. While the
Company does not believe that it is in its best interest to drop ship all
orders, it does intend to continue to move more of its Computer Products
distribution toward drop shipments.
MANAGEMENT INFORMATION SYSTEMS
The Company depends on its customized MIS to manage most aspects of its
business. The Company's MIS provides its sales staff, customer service
representatives and certain customers with product price, information and
availability from its principal suppliers' warehouses throughout the United
States. The Company utilizes its MIS to rapidly source product from a wide range
of suppliers. Purchase order expediting features including overdue shipment and
partial shipment reporting enable the Company to identify and resolve supplier
and or freight carrier problems quickly. The purchasing systems are real time,
allowing buyers to act within minutes on a newly received and credit-approved
sales order. The Company's MIS contain productivity tools for sales lead
generation, including integration between telemarketing and prospect database
management. Sales management features include a variety of reports available for
any combination of customer, salesperson, sales team and office criteria. The
Company uses its MIS to manage service contracts, service calls and work orders,
engineer and technician scheduling and time tracking, service parts acquisition
and manufacturer warranties. Reporting can also be generated for project
profitability, contract and customer analysis, parts tracking and employee time
tracking.
During the first quarter of 1998 the Company commenced a conversion of
its MIS to a more powerful computing platform which will allow the Company to
improve and enhance its MIS. The new system will allow the Company to expand it
uses and more fully integrate its operations with the MIS. While the Company
expects the system conversion to be fully implemented with only normal debugging
and reprogramming, a failure to fully implement the conversion with only minimal
disruption of its operation could have an adverse effect on the Company's
results of operations and financial condition.
The system conversion was implemented as a general upgrading of the
Company's MIS and was not for the purpose of achieving Year 2000 compliance. The
Company believes its prior MIS was, and its new MIS is, Year 2000 compliant.
Accordingly, the Company does not believe that Year 2000 compliance will have a
material adverse effect on its results of operations or financial condition. It
is possible that the Company could be impacted if its significant suppliers or
customers do not successfully and timely achieve Year 2000 compliance with
respect to their own computer systems. The Company has inquired of its two major
suppliers as to the status of their Year 2000 compliance and has been advised
that they expect to achieve Year 2000 compliance. If, contrary to the Company's
expectations, it or the significant suppliers and customers fail to achieve Year
2000 compliance in a timely manner, the Company's results of operations and
financial condition could be materially and adversely effected.
EMPLOYEES
As of December 31, 1997, the company employed approximately 363
individuals. Of these, approximately 81 were employed in sales, marketing and
customer service, 153 were employed in engineering and technical positions and
129 were employed in administration, finance and MIS. The Company believes that
its ability to recruit and retain highly skilled and experienced technical,
sales and management personnel has been, and will continue to be, critical to
its ability to execute its business plans. None of the Company's employees are
represented by a labor union or are subject to a collective bargaining
agreement. The Company believes that its relations with its employees are good.
COMPETITION
The markets in which the Company competes are all intensely competitive
and changing rapidly. The Company believes that the principal competitive
factors in the business activities in which it operates include relative price
and performance, product availability, technical expertise, adherence to
industry standards, financial stability, service, support and reputation. The
Company believes that it has many direct and indirect competitors in each of its
businesses, none of which is dominant in the Company's geographic markets. The
Company's competitors include major computer products and telephone equipment
manufacturers, aggregators and distributors, including certain manufacturers,
aggregators and distributors which supply products to the Company. Other
competitors include established national, regional and local resellers, systems
integrators, telephone systems dealers, computer-telephony VARs and other CTI
software suppliers. Some of the Company's current and potential competitors have
longer operating histories and financial, sales, marketing, technical and other
competitive resources which are substantially greater than those of the Company.
As the markets in which the Company competes have matured, product
price competition has intensified and is likely to continue to intensify. Such
price competition could adversely affect the Company's financial condition and
results of operations. There can be no assurance that the Company will be able
to continue to compete successfully with existing or new competitors.
HISTORY AND REINCORPORATION
The Company was incorporated under Texas law in 1983 under the name
Technicomp Corp. On June 30, 1993, the Company changed its name to
Allstar-Valcom, Inc. and then again, on December 28, 1993, the Company changed
its name to Allstar Systems, Inc. On December 27, 1993, the Company engaged in a
merger in which it was the surviving corporation. In the merger, Allstar
Services, Inc. and R. Cano, Inc. , both of which were affiliated with the
Company, were merged with and into Allstar Systems, Inc. in order to streamline
the business. In 1995, Company formed a wholly owned subsidiary, Stratasoft,
Inc. , to purchase and develop its CTI Software. See "Certain Relationships and
Related Transactions--Acquisition of Stratasoft Products. The Company effected a
reincorporation and merger in the State of Delaware through which the 328,125
shares of the Company's predecessor, Allstar Systems, Inc. , a Texas
corporation, which were outstanding prior to the merger, will be converted into
approximately 2,675,000 shares of the newly incorporated Delaware corporation
(the "Reincorporation"). The effect of the Reincorporation on the number of
shares outstanding prior to the Reincorporation was similar in effect to an
approximately 8.15-for-1 stock split.
FACTORS WHICH MAY AFFECT FUTURE RESULTS OF OPERATION
Risk Of Low Margin Business
The Company's past growth in net income has been fueled primarily by
sales growth rather than increased gross profit margins. Given the significant
levels of competition that characterize the computer reseller market, it is
unlikely that the Company will be able to increase gross profit margins in its
core business of reselling computer products which accounted for approximately
86% of the Company's total revenue in 1997. Moreover, in order to attract and
retain many of its larger customers, the Company frequently must agree to volume
discounts and maximum allowable markups that serve to limit the profitability of
sales to such customers. Accordingly, to the extent that the Company's sales to
such customers increase, the Company's gross profit margins may be reduced and,
therefore, any future increases in net income will have to be derived from
continued sales growth or effective expansion into higher margin businesses,
neither of which can be assured. Furthermore, low margins increase the
sensitivity of the Company's results of operations to increases in operating
expenses, including costs of financing. Any failure by the Company to maintain
or increase its gross profit margins and sales levels could have a material
adverse effect on the Company's financial condition and results of operations.
Dependence On Availability Of Credit; Interest Rate
The Company's business activities are capital intensive in that the
Company is required to finance accounts receivable and inventory. In order to
obtain necessary working capital, the Company relies primarily on lines of
credit under which the available credit and credit limits are dependent on the
amount and quality of the Company's accounts receivable and inventory. As a
result, the amount of credit available to the Company may be adversely affected
by factors such as delays in collection or deterioration in the quality of the
Company's accounts receivable, inventory obsolescence, economic trends in the
computer industry, interest rate fluctuations and the lending policies of the
Company's lenders. Many of these factors are beyond the Company's control. Any
decrease or material limitation on the amount of capital available to the
Company under its credit lines and other financing arrangements would limit the
ability of the Company to fill existing sales orders, purchase inventory or
expand its sales levels and, therefore, would have a material adverse effect on
the Company's financial condition and results of operations. In addition, any
significant increases in interest rates will increase the cost of financing to
the Company and would have an adverse effect on the Company's financial
condition and results of operations. The inability of the Company to have
continuous access to such financing at reasonable costs would materially and
adversely impact the Company's financial condition and results of operations.
(See Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations).
Highly Competitive Business
The Company is engaged in business activities that are intensely
competitive and rapidly changing. The Company believes that the principal
competitive factors in the business in which it operates are relative price and
performance, product availability, technical expertise, adherence to industry
standards, financial stability, service support and reputation. Price
competition has intensified, particularly in the Company's Computer Products and
IT Services businesses, and is likely to continue to intensify. Such price
competition could materially adversely affect the Company's financial condition
and results of operations. The Company's competitors include major computer
products and telephone equipment manufacturers, aggregators and distributors,
including certain manufacturers, aggregators and distributors which supply
products to the Company. Other competitors include established national,
regional and local resellers, systems integrators, telephone systems dealers,
computer-telephony VARs and other CTI software suppliers. Some of the Company's
current and potential competitors have longer operating histories and financial,
sales, marketing, technical and other competitive resources which are
substantially greater than those of the Company. As a result, the Company's
competitors may be able to adapt more quickly to changes in customer needs or to
devote greater resources than the Company to sales and service of its products.
Such competitors could also attempt to increase their presence in the Company's
markets by forming strategic alliances with other competitors of the Company,
offer new or improved products and services to the Company's customers or
increase their efforts to gain and retain market share through competitive
pricing.
Management Of Growth; Regional Concentration
The Company has experienced rapid growth which has and may continue to
put strains on the Company's management and operational resources. The Company's
ability to manage growth effectively will require it to continue to implement
and improve its operational, financial and sales systems, to develop the skills
of its managers and supervisors and to hire, train, motivate and manage its
employees. The Company's future growth, if any, is expected to require the
addition of new management personnel and the development of additional expertise
by existing management personnel. The failure to do so could materially
adversely affect the Company's financial position and results of operation.
Within the next 12 months, the Company intends to open new offices. The Company
also plans to relocate its Dallas-Fort Worth office and consolidate
substantially all of its warehouse and distribution operations in the
Dallas-Fort Worth metropolitan area. The Company anticipates that it will incur
substantial costs in connection with these new office openings, including
expenditures for furniture, fixtures and equipment. Additional burdens on the
Company's working capital are also expected in connection with the start-up of
such operations. Any significant disruption or unanticipated expenses in
connection with these plans could also have a material adverse effect on the
Company's financial condition and results of operations. For the foreseeable
future, the Company expects that it will continue to derive most of its total
revenue from customers located in or near the metropolitan areas in Texas in
which the Company maintains offices. Accordingly, an economic downturn in any of
those metropolitan areas, or in the region in general, would likely have a
material adverse effect on the Company's financial condition and results of
operations.
Dependence On Key Personnel
The success of the Company for the foreseeable future will depend
largely on the continued services of key members of management, leading
salespersons and technical personnel. The Company is particularly dependent upon
James H. Long, founder, Chairman of the Board, President and Chief Executive
Officer of the Company, because of his knowledge of the Company's operations,
industry knowledge, marketing skills and relationships with major vendors and
customers.
The Company does not maintain key personnel life insurance on any of
its executive officers or salespersons other than Mr. Long. The Company's
success also depends in part on its ability to attract, hire, train and retain
qualified managerial, technical and sales and marketing personnel at a
reasonable cost, particularly those involved in providing systems integration,
support services and training. Competition for such personnel is intense. The
Company's financial condition and results of operations could be materially
adversely affected if the Company were unable to attract, hire, train and retain
qualified personnel.
Dependence On Continued Authorization To Resell And Provide Manufacturer-
Authorized Services
The Company's future success in both product sales and services depends
largely on its continued status as an authorized reseller of products and its
continued authorization as a service provider. With respect to the Company's
computer hardware and software product sales and service, the Company maintains
sales and service authorizations with many industry-leading manufacturers,
including Compaq, Hewlett-Packard, IBM, Microsoft, NEC and Novell. In addition,
some of such agreements are based upon the Company's continued supply
relationship with Inacom or another aggregator or distributor approved by such
manufacturers. With respect to the Company's Telecom Systems business, the
Company maintains sales and service authorizations with industry-leading
manufacturers, including Active Voice, AVT, NEC, Inter-tel and Mitel. Without
such sales and service authorizations, the Company would be unable to provide
the range of products and services currently offered by the Company. In
addition, loss of manufacturer authorizations for products that have been
financed under the Company's credit facilities constitutes an event of default
under such credit facilities. In general, the agreements between the Company and
its products manufacturers either provide for fixed terms or for termination on
30 days prior written notice. Failure to maintain such authorizations could have
a material adverse effect on the Company's financial position and its results of
operations.
Dependence On Suppliers
The Company's business depends upon its ability to obtain an adequate
supply of products and parts at competitive prices and on reasonable terms. The
Company's suppliers are not obligated to have product on hand for timely
delivery to the Company nor can they guarantee product availability in
sufficient quantities to meet the Company's demands. The Company procures a
majority of computers, computer systems, components and parts primarily from
Inacom and Ingram in order to obtain competitive pricing, maximize product
availability and maintain quality control. Any material disruption in the
Company's supply of products would have a material adverse effect on the
Company's financial condition and results of operations.
Rapid Technological Change
The business in which the Company competes is characterized by rapid
technological change and frequent introduction of new products and product
enhancements. The Company's success depends in large part on its ability to
identify and obtain products that meet the changing requirements of the
marketplace. There can be no assurance that the Company will be able to identify
and offer products necessary to remain competitive or avoid losses related to
obsolete inventory and drastic price reductions. The Company attempts to
maintain a level of inventory required to meet its near term delivery
requirements by relying on the ready availability of products from its principal
suppliers. Accordingly, the failure of the Company's suppliers to maintain
adequate inventory levels of products demanded by the Company's existing and
potential customers and to react effectively to new product introductions could
have a material adverse effect on the Company's financial condition and results
of operations. Because certain products offered by the Company are subject to
manufacturer or distributor allocations, which limit the number of units
available to the Company, failure of the Company to gain sufficient access to
such new products or product enhancements could also have a material adverse
effect on the Company's financial condition and results of operations.
Reliance On Key Customers
The Company's top ten customers (which have varied from year to year)
accounted for 27.9%, 33.2% and 21.2% of the Company's revenue during 1995, 1996
and 1997, respectively. Based upon historical results and existing relationships
with customers, the Company believes that a substantial portion of its total
revenue and gross profit will continue to be derived from sales to existing
customers. There are no long-term commitments by such customers to purchase
products or services from the Company. Product sales by the Company are
typically made on a purchase order basis. A significant reduction in orders from
any of the Company's largest customers could have a material adverse effect on
the Company's financial condition and results of operations. Similarly, the loss
of any one of the Company's largest customers or the failure of any one of such
customers to pay on a timely basis could have a material adverse effect on the
Company's financial condition and results of operations. There can be no
assurance that the Company's largest customers will continue to place orders
with the Company or that orders by such customers will continue at their
previous levels. There can be no assurance that the Company's service customers
will continue to enter into service contracts with the Company or that existing
contracts will not be terminated.
Reliance On Management Information Systems
The Company's success is largely dependent on the accuracy, quality and
utilization of the information generated by its customized management
information systems, which affects its ability to manage its sales, accounting,
inventory and distribution systems. The Company anticipates that it will
continually need to refine and enhance its management information systems as the
Company grows and the needs of its business evolves. In view of the Company's
reliance on information and telephone communication systems, any interruption or
errors in these systems could have a material adverse effect on the Company's
financial condition and results of operations. (See Item 1 - Business
"Management Information Systems").
Acquisition Risk
The Company intends to pursue potential acquisitions of complementary
businesses. The success of this strategy depends not only upon the Company's
ability to acquire complementary businesses on a cost-effective basis, but also
upon its ability to integrate acquired operations into its organization
effectively, to retain and motivate key personnel and to retain customers of
acquired firms. No specific acquisitions are being negotiated or planned as of
the date of this annual report and there can be no assurance that the Company
will be able to find suitable acquisition candidates or be successful in
acquiring or integrating such businesses. Furthermore, there can be no assurance
that financing required for any such transactions will be available on
satisfactory terms.
Control By Existing Stockholders
James H. Long, founder, Chairman of the Board, President and Chief
Executive Officer of the Company owns 47.6% of the outstanding Common Stock and
Mr. Long will have the ability to control the election of a majority of the
members of the Company's Board of Directors, prevent the approval of certain
matters requiring the approval of at least two-thirds of all stockholders and
exert significant influence over the affairs of the Company.
Anti-Takeover Considerations
The Company's Certificate of Incorporation and Bylaws contain certain
provisions that may delay, deter or prevent a change in control of the Company.
Among other things, these provisions authorize the board of directors of the
Company to issue shares of preferred stock on such terms and with such rights,
preferences and designations as the board of directors of the Company may
determine without further stockholder action and limit the ability of
stockholders to call special meetings or amend the Company's Certificate of
Incorporation or Bylaws. Each of these provisions, as well as the Delaware
business combination statute could, among other things, restrict the ability of
certain stockholders to effect a merger or business combination or obtain
control of the Company.
Absence Of Dividends
The Company expects to retain cash generated from operations to support
its cash needs and does not anticipate the payment of any dividends on the
Common Stock for the foreseeable future. In addition, the Company's credit
facilities prohibit the declaration or payment of dividends, unless consent is
obtained from each lender.
GLOSSARY OF NAMES AND TECHNICAL TERMS
COMPANY NAMES
3Com......................... 3Com Corporation
AVT.......................... Applied Voice Technology
Active Voice................. Active Voice Corporation
Aspen........................ Aspen System Technologies, Inc.
Compaq....................... Compaq Computer Corporation
DEC.......................... DEC Digital Equipment Corporation
DFS.......................... Deutsche Financial Services Corporation
Epson........................ Epson America, Inc.
Hewlett-Packard.............. Hewlett-Packard Company
IBM.......................... International Business Machines Corporation
IBMCC........................ IBM Credit Corporation
ILC.......................... International Lan and Communications, Inc.
Inacom....................... Inacom Corp.
Ingram....................... Ingram Micro, Inc.
Inter-tel.................... Inter-tel, Inc.
Macrotel..................... Macrotel International Corporation
Microsoft.................... Microsoft Corporation
Mitel........................ Mitel, Inc.
NEC.......................... NEC America, Inc.
Novell....................... Novell, Inc.
Taske........................ Taske Technology, Inc.
Uniden....................... Uniden America Corporation
All company names and trade names are the legal property of their
respective owners.
TECHNICAL TERMS
Aggregator................... A company that purchases directly from
manufacturers in large quantities, maintains
inventory, breaks bulk and resells to
distributors, resellers and value-added resellers
Configuration................ The customization of equipment to a customer's
specifications which may include the loading of
software, adding of memory or combining
different manufacturers' equipment in such a
way that it will be compatible as an integrated
system
CTI.......................... Computer and telephone integration
IVR.......................... Interactive voice response
LAN.......................... Local-area network
MIS.......................... Management information systems
Open architecture networks... Networks based on industry standard technical
specifications that enable
the system to operate with
hardware and software from
different manufacturers
meeting those standards
PBX.......................... Private branch exchange
PC........................... Personal computer
Price protection............. A voluntary policy by a manufacturer that when
a decrease in the price of its product is
instituted, the manufacturer will rebate the
Company for the difference between the new
price and the price paid by the Company for
product in its inventory
Roll-out..................... Single sale involving a large volume of similar
products to be delivered on a pre-specified
timetable
SQL.......................... Structured query language
VAR (Value-added reseller)... A company that purchases equipment or software
from a manufacturer, aggregator or distributor,
provides value added services to their
clients including network management,
configuration systems integration and
training and subsequently resells the
enhanced product
WAN.......................... Wide-area network
Item 2. Properties
FACILITIES
The Company does not own any real property and currently leases all of
its existing facilities. The Company subleases its headquarters and Houston
office which are housed in a free standing building of approximately 48,000
square feet. The Houston office sublease expires on December 31, 1998. The
Company expects to enter into a new leasing arrangement for the same facility
during 1998. The Company's Dallas office is housed in a free-standing building
of approximately 20,000 square feet. The Dallas facility lease expired on
September 30, 1997 and has been extended to June 30, 1998. The Company expects
to either renew the existing lease for an additional term of more than one year
or to relocate to different facilities within the Dallas-Ft. Worth metropolitan
area. The Company also leases a storage facility of approximately 7,000 square
feet in Houston. The lease on this warehouse expires on April 14, 1998 and the
Company intends to extend such lease on a month-to-month basis after expiration
of the lease. The Company added offices in Austin, McAllen and El Paso, Texas
during 1997. The Company has leased interim offices in each of those cities
under leases expiring in less than one year. The Company intends to lease other
facilities in these cities as its business expands. The Company believes that
suitable facilities will be available as needed.
INTELLECTUAL PROPERTY
The Company's success depends in part upon its proprietary technology,
including its Stratasoft software. The Company relies primarily on trade secrecy
and confidentiality agreements to establish and protect its rights in its
proprietary technology. Additionally, the Company filed and received copyright
protection for StrataDial and StrataVoice. The Company also applied and received
registration of Stratasoft, StrataDial, StrataVoice as trademarks and intends to
apply for registration of 800 PC Deals as a trademark. There can be no assurance
that the Company's present protective measures will be adequate to prevent
unauthorized use or disclosure of its technology or independent third party
development of the same or similar technology. While the Company's competitive
position could be affected by its ability to protect its proprietary and trade
secret information, the Company believes other factors, such as the technical
expertise and knowledge of the Company's management and technical personnel and
the timeliness and quality of support services provided by the Company, to be
more significant in maintaining the Company's competitive position.
The Company's various authorization agreements with manufacturers
generally permit the Company to refer to itself as an authorized dealer of the
respective manufacturer's products and to use their trademarks and trade names
for marketing purposes, but prohibit other uses. The Company considers the use
of these trademarks and trade names in its marketing efforts to be important to
its business.
Item 3. Legal Proceedings
On July 13, 1996, a former customer brought suit against the Company in
the 152nd Judicial District Court of Harris County, Texas. The plaintiff alleges
that the Company failed to provide and complete promised installation and
configuration of certain computer equipment within the time promised by the
Company. Based on these allegations, the plaintiff is suing for breach of
contract, negligence, negligent misrepresentation and other statutory violations
and is seeking actual monetary damages of approximately $3 million and treble
damages under the Texas Deceptive Trade Practices Act. The Company intends to
vigorously defend such action. The effect of an unfavorable outcome could have a
material adverse effect on the Company's results of operations and its financial
condition.
The Company is from time to time involved in routine litigation
incidental to its business. The Company believes that none of such proceedings,
including current proceedings, individually or in the aggregate will have a
materially adverse effect on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders, through the solicitation
of proxies or otherwise.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
On July 7, 1997 the Company completed its initial public offering of it
Common Stock. The shares are traded on the Nasdaq National Market under the
symbol "ALLS".
High Low
Fiscal 1997
Third quarter (Commencing July 7, 1997) 8 6
Fourth quarter 7 1/2 3 15/16
As of March 13, 1998 there were 15 holders of record of the Company's
common stock. The Company has never declared or paid any cash dividends on its
Common Stock. The Company currently anticipates that it will retain all earnings
for use in its business operations. The payment of dividends is prohibited under
the Company's credit agreements, unless approved by the lenders.
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
The following sets forth the selected data of the Company for the five
years ended December 31, 1997.
Year ended December 31
(In Thousands except share and per share amounts)
1993 1994 1995 1996 1997
Operating Data:
Total revenue $49,536 $64,076 $91,085 $120,359 $129,167
Cost of sales and services 42,289 55,541 79,857 104,302 111,126
------- ------- ------- ------- -------
Gross Profit 7,247 8,535 11,228 16,057 18,041
Selling, general and administrative expenses 6,060 7,448 9,149 12,284 14,386
------- ------- ------- ------- -------
Operating income 1,187 1,087 2,079 3,773 3,655
Interest expense (net of other income) 644 764 1,218 1,183 685
------- ------- ------- ------- -------
Income before provision for income taxes 543 323 861 2,590 2,970
Provision for income taxes 229 140 342 987 1,126
------- ------- ------- ------- -------
Net Income $ 314 $ 183 $ 519 $ 1,603 $ 1,844
======== ======== ======== ========= =========
Supplemental Data:
Net income per share:
Basic $ 0.15 $ 0.07 $ 0.19 $ 0.60 $ 0.52
Diluted.................................... $ 0.15 $ 0.07 $ 0.19 $ 0.60 $ 0.52
Weighted average shares outstanding............. 2,120,242 2,554,808 2,675,000 2,675,000 3,519,821
As of December 31
1993 1994 1995 1996 1997
Balance Sheet Data:
Working Capital................................. $1,307 $1,363 $1,732 $2,291 $12,824
Total Assets.................................... 17,431 19,077 24,266 24,720 33,183
Short-term borrowings(1)........................ 6,896 8,972 9,912 9,975 1,572
Long-term debt.................................. 43 -0- -0- -0- -0-
Stockholders' equity............................ 2,022 2,205 2,724 4,327 14,723
(1) See Note 5 to the Company's Consolidated Financial Statements. Short-term
borrowings do not include amounts recorded as floor plan financing which are
included in accounts payable.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is qualified in its entirety by, and should be
read in conjunction with, the Company's Consolidated Financial Statements,
including the Notes thereto, included elsewhere in this Annual Report on Form
10-K.
Overview
The Company was formed in 1983 to engage in the business of reselling
computer hardware and software products and providing related services. To date,
most of its revenue has been derived from Computer Products sales. In addition,
the Company derives revenue from providing IT Services to purchasers of Computer
Products and other customers. The Company operated from a single office in
Houston, Texas until 1992 when it opened a branch office in Dallas, Texas. In
1994, the Company began offering Telecom Systems in its Houston office. In the
fourth quarter of 1995, the Company acquired and began marketing CTI Software.
During 1997 the Company opened offices in Austin, McAllen and El Paso, Texas to
expand, initially, its Computer Products and IT Services divisions.
The Company's gross margin varies substantially between each of its
businesses. The Company's Computer Products sales have produced a gross margin
ranging from 10.4% to 10.7% over the three year period ended December 31, 1997,
reflecting the commodity nature of the Computer Products market. The gross
margin for IT Services, which reflects direct labor costs, has ranged from 30.4%
to 37.6% over the same period. This variation is primarily attributable to the
pricing and the mix of services provided, and the level of utilization of
billable technical staff. The gross margin for Telecom Systems, which includes
both product sales and services, has varied between 23.0% and 35.5% during the
last three years. This variation reflects the different mix of product sales and
the amount of services-related revenue from period to period and competitive
pricing of Telecom products. The gross margin for CTI Software was 40.2% in 1996
versus 43.0% in 1997, primarily due to the amount expended by the Company to
acquire and develop the software relative to the level of revenue produced. CTI
Software accounted for approximately 1.1% of the Company's revenues in 1996
compared to 1.7% in 1997.
In order to reduce freight costs and selling, general and administrative
expenses associated with product handling, the Company began in 1995 to drop
ship a higher percentage of orders directly from its suppliers to its customers.
This initiative has resulted in the percentage of drop shipped orders (measured
by the cost of goods dropped shipped as a percentage of total cost of goods)
growing from 9.0% in 1995 to 18.1% in 1996 and to 23.9% in 1997. While the
Company does not believe that it is in its best interest to drop ship all
orders, it does intend to increase the volume of drop shipments in Computer
Products with the expectation of reducing its freight, distribution and
administrative costs related to these revenues.
A significant portion of Company's selling, general and administrative
expenses relate to personnel costs, some of which are variable and others of
which are relatively fixed. The Company's variable personnel costs are
substantially comprised of sales commissions, which are typically calculated
based upon the Company's gross profit on a particular sales transaction and thus
generally fluctuate with the Company's overall gross profit. The remainder of
the Company's selling, general and administrative expenses are relatively more
fixed and, while still somewhat variable, do not vary with increases in revenue
as directly as do sales commissions.
Manufacturers of many of the computer products resold by the Company have
consistently reduced unit prices near the end of a product's life cycle, most
frequently following the introduction of newer, more advanced models. While the
major manufacturers of computer products have a policy of providing price
protection to resellers when prices are reduced, on occasion, and particularly
during 1994, manufacturers introduced new models of their products and then
reduced the price of, or discontinued, the older models without price
protection. In these instances, the Company often sells the older models at
reduced prices, which adversely affects gross margin. Additionally,
manufacturers have developed specialized marketing programs designed to improve
or protect the manufacturer's market share. These programs often involve the
granting of rebates to resellers to subsidize sales of computer products at
reduced prices. While these programs generally enhance revenues they also
generally result in lower margins being realized by the reseller. The Company
has participated in a number of these programs in recent years.
Inacom is the largest supplier of products sold by the Company. Purchases
from Inacom accounted for approximately 36.6%, 57.0% and 51.4% of the Company's
total product purchases in 1995, 1996 and 1997, respectively. In August 1996,
the Company renewed its long-term supply arrangement with Inacom and agreed to
purchase at least 80% of its Computer Products from Inacom, but only to the
extent that such products are made available within a reasonable period of time
at reasonably competitive pricing. Inacom does not carry certain product lines
sold by the Company and Inacom may be unable to offer reasonable product
availability and reasonably competitive pricing from time to time on those
product lines that it carries. The Company thus expects that less than 80% of
its total purchases will be made from Inacom, and that any increase or decrease
over historical levels in the percentage of products it purchases from Inacom
under the new Inacom agreement will not have any material impact on the
Company's results of operations.
Results of Operations
The following table sets forth, for the periods indicated, certain
financial data derived from the Company's consolidated statements of operations
and indicates the percentage of total revenue for each item.
Year ended December 31,
-----------------------------------------------------------------------
1995 1996 1997
---------------------- --------------------- --------------------
Amount % Amount % Amount %
(Dollars in thousands)
Operating Data(1):
Revenue
Computer Products.............. $81,654 89.6 $107,251 89.1 $111,145 86.0
IT Services.................... 7,900 8.7 7,996 6.6 10,474 8.1
Telecom Systems................ 1,458 1.6 3,824 3.2 5,403 4.2
CTI Software................... 73 1,288 1.1 2,145 1.7
-------- ---- -------- ---- ------- ----
0.1
Total revenue............... 91,085 100.0 120,359 100.0 129,167 100.0
Gross Profit(1)
Computer Products.............. 8,466 10.4 11,172 10.4 11,832 10.7
IT Services.................... 2,404 30.4 3,008 37.6 3,875 37.0
Telecom Systems................ 335 23.0 1,359 35.5 1,412 26.1
CTI Software................... 23 31.5 518 40.2 922 43.0
-------- ---- -------- ---- ------- ----
Total Gross Profit........... 11,228 12.3 16,057 13.3 18,041 13.9
Selling, general and
administrative expenses........ 9,149 10.0 12,284 10.2 14,386 11.1
-------- ---- -------- ---- ------- ----
Operating income............... 2,079 2.3 3,773 3.1 3,655 2.8
Interest expense (net of
other income).................. 1,218 1.3 1,183 1.0 685 .5
-------- ---- -------- ---- ------- ----
Income before provision
for income taxes............. 861 1.0 2,590 0.8 2,970 2.3
Provision for income taxes........ 342 0.4 987 0.8 1,126 0.9
-------- ---- -------- ---- ------- ----
Net income..................... 519 0.6 1,603 1.3 1,844 1.4
======== ==== ======== ==== ======= ====
Per Office Data(1)(2):
Houston Office:
Revenue...................... 53,095 58.3 57,929 48.1 65,614 50.8
Gross profit................. 6,880 13.0 9,470 16.4 9,356 14.3
Dallas Office:
Revenue...................... 37,990 41.7 62,430 51.9 61,698 47.8
Gross profit................. 4,348 11.5 6,587 10.6 8,518 13.8
Austin Office:
Revenue...................... 1,855 1.4
Gross profit................. 167 9.0
(1) Percentages shown are percentages of total revenue, except gross profit
percentage which represent gross profit by each product category as a
percentage of revenue for each such category.
(2) Revenue realized in the McAllen and El Paso offices during 1997 were
insignificant.
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Total Revenue. Total revenue increased by $8.8 million (7.3%) from $120.4
million in 1996 to $129.2 million in 1997. Revenue from Computer Products, which
comprised 86.0% of total revenue, increased by $3.9 million (3.6%). The increase
in Computer Products revenue was generally attributable to increased sales to
new and existing customers. Revenue in Computer Products did not grow as
expected in 1997 principally due to insufficient capital resources during the
first half of 1997 and the inability of the newly added sales personnel to
attain the level of revenue production normally expected of new personnel.
Revenue from IT Services increased by $2.5 million (31.0%) from $8.0 million in
1996 to $10.5 million in 1997. The increase was due primarily to sales to new
customers and increases in services provided to existing customers as a result
of customers' increased out-sourcing of their technical support requirements.
Revenue from IT Services as a percentage of total revenue increased from 6.6% in
1996 to 8.1% in 1997 due to the higher growth rate in IT Services revenues
relative to the growth rate of Computer Products revenues in 1997. Revenue from
Telecom Systems, which comprised 4.2% of total revenue, increased by $1.6
million (41.3%). This increase in Telecom Systems revenue was primarily the
result of adding new customers, of which one customer accounted for $1.3 million
(81.2%) of the increase. Sales of CTI Software increased 66.5% from $1.3 million
in 1996 to $2.1 million in 1997. The increased revenues were primarily the
result of sales to new customers.
Gross Profit. Gross profit increased by $2.0 million (12.4%) from $16.0
million in 1996 to $18.0 million in 1997, while gross margin increased from
13.3% in 1996 to 13.9% in 1997. The gross margin for Computer Products increased
from 10.4% in 1996 to 10.7% in 1997, reflecting the continuation of highly
competitive market conditions for Computer Products.
The gross margin from IT Services increased from 37.6% in 1996 to 37.0%
in 1997. This decrease in gross margin was primarily attributable increases,
expressed as a percentage of revenue, in the cost of the billable technical
staff which is due to the relative scarcity of qualified technical staff in the
information technology industry. These cost increases were almost fully offset
by increases in the prices being charged for services which is also due to the
relative scarcity of qualified technical staff in the information technology
industry. In 1996 the Company commenced the implementation of a program to
replace less profitable hardware maintenance and repair services with a variety
of services that were expected to generate higher gross margins. This program
resulted in the elimination of certain IT Services customer relationships which
had been producing lower than average gross margin. The loss of this lower
margin revenue was offset by revenues from new IT Services customers and from
existing customers at higher gross margins.
The gross margin for Telecom Systems sales decreased from 35.5% in 1996
to 26.1% in 1997. In 1997, Telecom Systems bid on and won the installation of
several large systems. As a result of the competitive bidding process employed
by certain customers these large systems were projects which had lower than
normal margins. In addition, gross margin decreased in 1997 due to the purchase
of a large system by a single customer at a lower than usual margin.
CTI Software sales resulted in a gross margin of 43.0% in 1997, an
increase from 40.2% in 1996. This reflected slightly lower, as a percentage of
revenue, installation costs and development costs in 1997 compared to 1996.
Selling, General and Administrative Expenses . Selling, general and
administrative expenses increased by $ 2.1 million (17.1%) from $12.3 million in
1996 to $14.4 million in 1997. As a percentage of total revenue, selling,
general and administrative expenses increased from 10.2% in 1996 to 11.1% in
1997. Of the dollar increase, $1.5 million was attributable to increased
temporary and permanent personnel, principally in non-sales personnel. Other
costs which grew at a rate in excess of the rate of growth in revenues includes
expenses relating to becoming and being a publicly held corporation and
professional fees. The increase as a percentage of total revenue resulted
primarily from increased expenditures for those expenses which do not fluctuate
with gross profit or revenues.
Operating Income. Operating income decreased by $118,000 (3.1 %) from $3.8
million in 1996 to $3.7 million in 1997. Operating income decreased as a
percentage of total revenue from 3.1% in 1996 to 2.8% in 1997 largely due to
increases in selling, general and administrative expenses.
Interest Expense (Net of Other Income). Interest expense (net of other
income) decreased by $498,000 (42.1%). Interest expense decreased due to the
reduction of outstanding debt by applying the proceeds of the Company's initial
public offering to the reduction of debt.
Net Income. Net income, after a provision for income taxes totaling
$1,126,000 ( reflecting an effective tax rate of 37.9% compared to 38.1% in
1996), increased by $241,000 from $1.6 million in 1996 to $1.8 million in 1997.
Net income increased as a percentage of total revenue from 1.3% in 1996 to 1.4%
in 1997.
Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995
Total Revenue. Total revenue increased by $29.3 million (32.1%) from
$91.1 million in 1995 to $120.4 million in 1996. Revenue from Computer Products,
which comprised 89.1% of total revenue, increased by $25.6 million (31.3%). The
increase in Computer Products revenue was generally attributable to increased
sales to new and existing customers resulting from the hiring of additional
sales personnel. Revenue from IT Services increased by $96,000 (1.2%) from $7.9
million in 1995 to $8.0 million in 1996. The marginal increase was primarily the
result of the Company's implementation of a program at the beginning of 1996 to
replace less profitable hardware maintenance and repair services with a variety
of services that were expected to generate higher gross margins. This program
resulted in the elimination of certain IT Services customer relationships which
had been producing lower than average gross margin. The loss of this lower
margin revenue was offset, however, by sales to new IT Services customers and to
existing customers, generally at higher gross margins than those earned on sales
to the former customers. Revenue from IT Services as a percentage of total
revenue decreased from 8.7 % in 1995 to 6.6% in 1996 due to both the minimal
growth in IT Services revenues and to growth in the Company's three other
business categories. Revenue from Telecom Systems, which comprised 3.2% of total
revenue, increased by $2.4 million (162.3%). This increase in Telecom Systems
revenue was primarily the result of hiring additional sales personnel and adding
new customers, of which one customer accounted for $699,000 (29.5%) of the
increase, and expanding advertising and marketing efforts. Sales of CTI
Software, which commenced during the fourth quarter of 1995, contributed total
revenue of $1.3 million during 1996, which comprised 1.1% of the Company's total
revenue.
Gross Profit. Gross profit increased by $4.8 million (43.0%) from $11.2
million in 1995 to $16.1 million in 1996, while gross margin increased from
12.3% in 1995 to 13.3% in 1996. The gross margin for Computer Products remained
consistent at 10.4% for both periods. The gross margin from IT Services
increased from 30.4% in 1995 to 37.6% in 1996. As noted above, this increase was
primarily attributable to the replacement of less profitable IT Services
business with more profitable business from new and existing IT Services
customers. The gross margin for Telecom Systems sales increased from 23.0 % in
1995 to 35.5% in 1996. In 1995, Telecom Systems was generally selling products
and services at lower gross margin than in the 1996 period in order to gain
market share during its first year of operation. In addition, gross margin for
Telecom Systems increased in 1996 due to the purchase of a large, complex system
by a single customer at a higher than usual margin. CTI Software sales resulted
in a gross margin of 40.2% in 1996, which was the first full year of operations
for the Company's CTI Software business.
Selling, General and Administrative Expenses . Selling, general and
administrative expenses increased by $ 3.1 million (34.3%) from $9.1 million in
1995 to $12.3 million in 1996. As a percentage of total revenue, selling,
general and administrative expenses increased from 10.0% in 1995 to 10.2% in
1996. Of the dollar increase, $1.2 million was attributable to increased sales
compensation due to increased gross profits and an increase in the number of
sales personnel and $1.0 million was attributable to increases in non-sales
personnel costs. The increase as a percentage of total revenue resulted
primarily from increased gross margins and the related increase in the variable
component of selling, general and administrative expenses that fluctuates with
gross profit, and from the increase in bad debt expense, a portion of which was
due to actual losses and a portion of which was due to increases in reserves for
potential future losses.
Operating Income. Operating income increased by $1.7 million (81.5 %)
from $2.1 million in 1995 to $3.8 million in 1996. Operating income increased as
a percentage of total revenue from 2.3% in 1995 to 3.1% in 1996.
Interest Expense (Net of Other Income). Interest expense (net of other
income) decreased by $35,000 (2.9%). Interest expense remained substantially
unchanged compared to the increase in revenue due to decreased leverage
resulting from increased use of equity and increased asset turns, together with
advance payments for a large purchase by a single customer in 1996. The
prepayments resulted in reduced accounts receivable and a related reduction in
borrowing.
Net Income. Net income, after a provision for income taxes totaling
$987,000 ( reflecting an effective tax rate of 38.1% compared to 39.7% in 1995),
increased by $1.1 million from $519,000 in 1995 to $1.6 million in 1996. Net
income increased as a percentage of total revenue from 0.6% in 1995 to 1.3% in
1996.
Quarterly Results of Operations
The following table sets forth certain unaudited quarterly financial
information for each of the Company's last eight quarters and, in the opinion of
management, includes all adjustments (consisting of only normal recurring
adjustments) which the Company considers necessary for a fair presentation of
the information set forth therein. The Company's quarterly results may vary
significantly depending on factors such as the timing of large customer orders,
timing of new product introductions, adequacy of product supply, variations in
the Company's product costs, variations in the Company's product mix, promotions
by the Company, seasonal influences and competitive pricing pressures.
Furthermore, the Company generally experiences a higher volume of orders of
Computer Products in the fourth quarter, which the Company attributes to
year-end capital spending by its customers. Any decrease in the number of
year-end orders experienced by the Company may not be offset by increased
revenues in the Company's first three quarters. The results of any particular
quarter may not be indicative of results for the full year or any future period.
1996 1997
------------------------------------- -------------------------------------
(In thousands, except per share amounts)
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Total Revenue $25,948 $32,202 $29,187 $33,022 $26,593 $32,239 $31,914 $38,423
Cost of sales and service 22,727 28,234 24,669 28,672 22,762 27,312 27,777 33,277
------- ------- ------- ------- ------- ------- ------- -------
Gross Profit 3,221 3,968 4,518 4,350 3,831 4,927 4,137 5,146
Selling, general and
administrative expenses 2,674 2,992 3,319 3,299 3,135 3,839 3,439 3,974
------- ------- ------- ------- ------- ------- ------- -------
Operating Income 547 976 1,199 1,051 696 1,088 698 1,172
Interest expense (net of
other income) 297 285 338 263 289 309 82 5
------- ------- ------- ------- ------- ------- ------- -------
Income before provision
for income taxes 250 691 861 788 407 779 616 1,167
Provision for income taxes 111 223 362 291 154 310 236 424
------- ------- ------- ------- ------- ------- ------- -------
Net income $ 139 $ 468 $ 499 $ 497 $ 253 $ 469 $ 380 $ 742
======= ======= ======= ======= ======= ======= ======= =======
Net income per share $0.05 $0.17 $0.19 $0.19 $0.09 $0.17 $0.09 $0.17
Liquidity and Capital Resources
Historically, the Company has satisfied its cash requirements principally
through borrowings under its lines of credit and through operations. The Company
maintains a cash position sufficient to pay only its immediately due obligations
and expenses. When the amount of cash available falls below its immediate needs,
the Company requests advances under its credit facility. As the Company's total
revenue has grown, the Company has obtained increases in its available lines of
credit to enable it to finance its growth. The Company's working capital was
$1.7 million, $2.3 million and $12.8 million at December 31, 1995, 1996 and
1997, respectively. The increase in working capital from 1996 to 1997 was
attributable to the receipt of net proceeds from a public offering of the
Company's common stock in July, 1997 and net earnings. As of December 31, 1997,
the Company had total borrowing capacity, based on its collateral base under its
credit facility of approximately $23.8 million versus $18.8 million at December
31, 1996. At December 31, 1997 the Company had unused borrowing capacity of
approximately $18.6 million versus $1.2 million at December 31, 1996.
Cash Flow
Operating activities used net cash totaling $123,000 during 1995 and
provided net cash totaling $89,000 and $2.0 million during 1996 and 1997,
respectively. Net cash used in 1995 was primarily due to working capital
requirements to finance increased accounts receivable and inventory. In 1996,
net cash was provided from operations due primarily to the combined effect of
significantly increased net income, a relatively small year-to-year increase in
accounts receivable and a year-to-year decrease in inventory. During 1997, net
cash was provided from operations due primarily to net income increased levels
of trade accounts payable and accrued expenses which more than offset increases
in accounts receivable.
Trade accounts receivable increased $4.4 million, $695,000 and $7.2
million during 1995, 1996 and 1997, respectively. Inventory increased $21,000 in
1995 and decreased $545,000 and $162,000 in 1996 and 1997, respectively.
Net cash used in operating activities during 1995 of $ 123,000 was net of
an accrual of $1.4 million for a delinquent Texas sales tax liability for the
period June 1995 to November 1995. Interest was accrued on the liability;
however, all penalties were waived by the state. The delinquency resulted from a
programming error in the Company's accounting system that has since been
corrected. In September 1996, the Company paid the state the agreed upon sales
taxes. Had the sales taxes been timely paid, net cash used in operations during
1995 would have been approximately $1.5 million and net cash provided by
operations in 1996 would have been $1.5 million.
Investing activities used cash totaling $458,000, $952,000 and $992,000
during 1995, 1996 and 1997, respectively. The Company's investing activities
that used cash during these periods were primarily related to capital
expenditures. During the next twelve months, the Company expects to incur an
estimated $1.0 million for capital expenditures, a majority of which is expected
to be incurred for leasehold improvements and other capital expenditures in
connection with the planned consolidation of its warehouse facilities into a
single facility in the Dallas-Fort Worth area, the relocation of its Dallas
branch office and the opening of branch offices in McAllen, El Paso and San
Antonio, Texas. All or a portion of the $1.0 million in capital expenditures
currently budgeted by the Company for such purposes are presently expected to be
financed from net cash flow from operations or borrowings under the Company's
line of credit. The actual amount and timing of such capital expenditures may
vary substantially depending upon, among other things, the actual facilities
selected, the level of expenditures required to render the facilities suitable
for the Company's purposes and the terms of lease arrangements pertaining to the
facilities.
Financing activities provided cash totaling $940,000, $63,000 and
$344,000 during 1995 , 1996 and 1997, respectively. In July, 1997, the Company
received $8.7 million net proceeds from the sale of Common Stock in a public
offering. Those proceeds were used to reduce the outstanding balance under the
Company's line of credit. The primary source of cash from financing activities
in other periods has been borrowings on the Company's lines of credit. The lines
of credit have been used principally to finance increases in accounts
receivable.
Asset Management
The Company's cash flow from operations has been affected primarily by
the timing of its collection of trade accounts receivable. The Company typically
sells its products and services on short-term credit terms and seeks to minimize
its credit risk by performing credit checks and conducting its own collection
efforts. The Company had trade accounts receivable, net of allowance for
doubtful accounts, of $15.8 million, $16.5 million and $23.8 million at December
31, 1995, 1996 and 1997, respectively. The number of days' sales outstanding in
trade accounts receivable was 45 days, 40 days and 53 days for years 1995, 1996
and 1997, respectively. The increase in days' sales outstanding was caused by a
general slow down in payments by the Company's customers. To improve this
condition the Company has increased its collection staff and added an
experienced credit manager. Bad debt expense as a percentage of total revenue
for the same periods was 0.1%, 0.2% and 0.2%. The Company's allowance for
doubtful accounts, as a percentage of trade accounts receivable, was 2.8%, 1.3%
and 1.0% at December 31, 1995, 1996 and 1997, respectively.
The Company manages its inventory in order to minimize the amount of
inventory held for resale and the risk of inventory obsolescence and decreases
in market value. The Company attempts to maintain a level of inventory required
to reach only its near term delivery requirements by relying on the ready
availability of products from its principal suppliers. Manufacturers of the
Company's major products generally provide price protection, which reduces the
Company's exposure to decreases in prices. In addition, its suppliers generally
allow for returns of excess inventory, which, on a limited basis, are made
without material restocking fees. Inventory turnover for 1995, 1996 and 1997 was
14.6 times, 19.2 times and 21.5 times, respectively.
Prior Debt Obligations
Throughout 1997, the principal source of liquidity for the Company, in
addition to its cash provided from operations, was its revolving line of credit
with IBMCC (the "IBMCC Facility"). On February 27, 1998 the Company executed
agreements with Deutsche Financial Services ("DFS") for a revolving line of
credit which will replace the IBMCC Facility as the Company's principal source
of liquidity and the IBMCC Facility will be converted into a credit facility for
the purchase of IBM branded computer products. The credits facilities described
herein as the "Old IBMCC Facility" and the "Old DFS Facility" set forth the
provisions of the credit facilities in effect during 1997 and prior periods. The
credit facilities described as the "New DFS Facility" and the "New IBMCC
Facility" set forth the provisions of those facilities after the implementation
of the revolving credit agreement with DFS dated February 27, 1998. The total
credit available under the Old IBMCC Facility was $20.0 million, subject to
borrowing base limitations which were generally computed as a percentage of
various classes of eligible accounts receivable and qualifying inventory.
Borrowings were available under the Old IBMCC Facility for floor plan financing
of inventory from approved manufacturers (the "Old Inventory Line"). Available
credit under the Old IBMCC Facility, net of Inventory Line advances, was used by
the Company primarily to carry accounts receivable and for other working capital
and general corporate purposes (the "Old Accounts Line"). Borrowings under the
Old Accounts Line bore interest at the fluctuating prime rate plus 2.0% per
annum. Under the Old Inventory Line, IBMCC paid the Company's inventory vendors
directly, generally in exchange for negotiated financial incentives. Typically,
the financial incentives received were such that IBMCC does not charge interest
to the Company until approximately 30 days after the transaction is financed, at
which time the Company was required to either pay the full invoice amount of the
inventory purchased from corporate funds or to borrow under the Accounts Line
for the amount due to IBMCC. Inventory Line advances not paid within 30 days
after the financing date bear interest at the fluctuating prime rate plus 6.0%.
IBMCC was permitted to fix a minimum prime rate for the IBMCC Facility of not
less than the average prime rate in effect at the time the minimum prime rate is
set but did not do so. IBMCC was authorized to change, on 30 days notice, the
computation of the borrowing base and to disqualify accounts receivable upon
which advances have been made and require repayment of such advances to the
extent such disqualifications cause the Company's borrowings to exceed the
reduced borrowing base.
The Old IBMCC Facility was collateralized by a security interest in
substantially all of the Company's assets, including its accounts receivable,
inventory, equipment and bank accounts. The Company's Chief Executive Officer
and principal stockholder personally guaranteed the Company's indebtedness to
IBMCC. Collections of the Company's accounts receivable were required to be
applied through a lockbox arrangement to repay indebtedness to IBMCC; however,
IBMCC customarily released a portion of the Company's daily collections to the
extent that they exceed the daily estimated borrowing base.
Through most of 1995, the Company's credit limit under the Old IBMCC
Facility was $15.0 million. From October 1995 through February 1996, IBMCC
extended a temporary increase in the credit limit to $22.5 million and in April
1996 increased the base credit limit to $20.0 million. Effective September 1996,
the Company was notified by IBMCC that it had received further temporary credit
limit adjustments consisting of increases to $30.0 million from September 1996
through February 1997, $28.0 million in March 1997, $25.0 million in April 1997,
and returning to the base limit of $20.0 million thereafter. At December 31,
1997, the total indebtedness of the Company under the Old IBMCC Facility was
$4.3 million of which $1.6 million was outstanding under the Accounts Line and
$1.1 million was outstanding under the Inventory Line. The Company's remaining
available credit at December 31, 1997, based on its borrowing base was
approximately $18.6 million.
The Company had a $3.0 million credit facility with Deutsche Financial
Services (the "Old DFS Facility") for the purchase of inventory from certain
suppliers. From October 1995 through May 1996, the Company received a temporary
increase in the available credit line to $6.0 million and on or about November
15, 1997 this facility was increased to $10.0 million in anticipation of
increased usage of this facility for inventory purchases. As in the case of the
Old IBMCC Inventory Line, advances under the Old DFS Facility were typically
interest free for 30 days after the financing date for transactions in which
adequate financial incentives are received by DFS from the vendor. Within 30
days after the financing date, the full invoice amount for inventory financed
through DFS is required to be paid by the Company. On or about November 15, 1997
DFS extended to interest free period for advances under the Old DFS Facility to
40 days. Amounts remaining outstanding thereafter bear interest at the
fluctuating prime rate (but not less than 6.5%) plus 6.0%. DFS retains a
security interest in the inventory financed. The Old DFS Facility is immediately
terminable by either party by written notice to the other. At December 31, 1997,
the amount outstanding under the DFS Facility was $9.4 million.
The Company was required to comply with certain key financial and other
covenants under the Old IBMCC Facility and Old DFS Facility. During 1994 and
1995 and the first seven months of 1996, the Company was in default of certain
financial covenants and certain other covenants under the Old IBMCC Facility and
Old DFS Facility. For example, the Company was required under the Old IBMCC
Facility to maintain during 1995 the following financial ratios: net profits
after taxes to revenue of at least 0.5%; annualized revenues to working capital
of more than zero but no greater than 35.0 to 1; and total liabilities to
tangible net worth of more than zero but no more than 12.0 to 1. The ratios
actually attained by the Company for the year ended December 31, 1995, were
approximately 0.57%, 43.9 to 1 and 12.7 to 1, respectively. The Old DFS
Facility, for instance, requires that at all times the Company's indebtedness
for borrowed money and capital lease obligations divided by its tangible net
worth plus subordinated debt not exceed 8.0 to 1, but at June 30, 1996, the
actual ratio attained by the Company was approximately 9.18 to 1. In addition to
financial ratio covenants, the Company has violated other covenants under both
credit facilities, including timely filing of periodic financial reports and
covenants prohibiting certain transactions with subsidiaries and other
affiliates. IBMCC and DFS have, however, waived defaults when requested by the
Company from time to time. Most recently, IBMCC and DFS waived certain defaults
in August 1996 through December 31, 1996. Additionally, both lenders liberalized
certain financial covenants in connection with their waivers. DFS increased the
maximum permitted ratio for indebtedness for borrowed money plus capital lease
obligations to tangible net worth plus subordinated debt to 9.5 to 1 through
December 31, 1996, reverting to 8.0 to 1 thereafter. IBMCC increased the maximum
permissible ratio of annualized revenue to working capital to 56.0 to 1 through
1996 and to 52.0 to 1 thereafter, reserving the right to further change the
ratio upon notice to the Company. Throughout 1997, the Company was in compliance
with the key financial and other covenants under both the Old IBMCC Facility and
the Old DFS Facility.
New Credit Facilities.
The total credit available under the New DFS Facility is $30.0 million,
subject to borrowing base limitations which are generally computed as a
percentage of various classes of eligible accounts receivable and qualifying
inventory. Credit available under the New DFS Facility for floor plan financing
of inventory from approved manufacturers (the "Inventory Line") is $20.0
million. Available credit under the New DFS Facility, net of Inventory Line
advances, is $10.0 million, which is used by the Company primarily to carry
accounts receivable and for other working capital and general corporate purposes
(the "Accounts Line"). Borrowings under the Accounts Line bear interest at the
fluctuating prime rate minus 1.0% per annum. Under the Inventory Line, DFS pays
the Company's inventory vendors directly, generally in exchange for negotiated
financial incentives. Typically, the financial incentives received are such that
DFS does not charge interest to the Company until 40 days after the transaction
is financed, at which time the Company is required to either pay the full
invoice amount of the inventory purchased from corporate funds or to borrow
under the Accounts Line for the amount due to DFS. Inventory Line advances not
paid within 40 days after the financing date bear interest at the fluctuating
prime rate plus 5.0%. For purposes of calculating interest charges the minimum
prime rate under the New DFS Facility is 7.00%. DFS may change the computation
of the borrowing base and to disqualify accounts receivable upon which advances
have been made and require repayment of such advances to the extent such
disqualifications cause the Company's borrowings to exceed the reduced borrowing
base.
The New DFS Facility is collateralized by a security interest in
substantially all of the Company's assets, including its accounts receivable,
inventory, equipment and bank accounts. Collections of the Company's accounts
receivable are required to be applied through a lockbox arrangement to repay
indebtedness to DFS; however, DFS has amended the lockbox agreement to make such
arrangements contingent upon certain financial ratios. Provided the Company is
in compliance with its debt to tangible net worth covenant, the Company has
discretion over the use and application of the funds collected in the lockbox.
If the Company exceeds that financial ratio, DFS may require that lockbox
payments be applied to reduce the Company's indebtedness to DFS. If in the
future DFS requires that all lockbox payments be applied to reduce the Company's
indebtedness, the Company would be required to seek funding from DFS or other
sources to meet substantially all of its cash needs.
Effective with the implementation of the New DFS Facility the Company
will have a $2.0 million credit facility with IBMCC (the "New IBMCC Facility")
for the purchase of IBM branded inventory from certain suppliers. As in the case
of the Old IBMCC Inventory Line, advances under the New IBMCC Facility are
typically interest free for 30 days after the financing date for transactions in
which adequate financial incentives are received by IBMCC from the vendor.
Within 30 days after the financing date, the full invoice amount for inventory
financed through IBMCC is required to be paid by the Company. Amounts remaining
outstanding thereafter bear interest at the fluctuating prime rate (but not less
than 6.5%) plus 6.0%. IBMCC retains a security interest in the inventory
financed. The New IBMCC Facility is immediately terminable by either party by
written notice to the other.
Under the New DFS Facility the Company is required to maintain (i) a
tangible net worth of $10.0 million, (ii) a ratio of debt minus subordinated
debt to tangible net worth of 4 to 1 and (iii) a ratio of current tangible
assets to current liabilities of not less than 1.4 to 1. The covenants under the
New IBMCC Facility remain unchanged from the Old IBMCC Facility.
Both the IBMCC Facility and the DFS Facility prohibit the payment of
dividends unless consented to by the lender.
Year 2000 Compliance
During the first quarter of 1998 the Company commenced a conversion of
it MIS to a more powerful computing platform which will allow the Company to
improve and enhance its MIS. The new system will allow the Company to expand it
uses and more fully integrate its operations with the MIS. While the Company
expects the system conversion to be fully implemented with only normal debugging
and reprogramming, a failure to fully implement the conversion with only minimal
disruption of its operation could have an adverse effect on the Company's
results of operations and financial condition.
The system conversion was implemented as a general upgrading of the
Company's MIS and was not for the purpose of achieving Year 2000 compliance. The
Company believes its prior MIS was, and its new MIS is, Year 2000 compliant.
Accordingly, the Company does not believe that Year 2000 compliance will have a
material adverse effect on its results of operations or financial condition. It
is possible that the Company could be impacted if its significant suppliers or
customers do not successfully and timely achieve Year 2000 compliance with
respect to their own computer systems. The Company has inquired of its two major
suppliers as to the status of their Year 2000 compliance and has been advised
that they expect to achieve Year 2000 compliance. If, contrary to the Company's
expectations, it or the significant suppliers and customers fail to achieve Year
2000 compliance in a timely manner, the Company's results of operations and
financial condition could be materially and adversely effected.
Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
and SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information. SFAS No. 130 establishes standards for reporting and displaying of
comprehensive income and its components. SFAS No. 131 establishes standards for
the way that public business enterprises report information about operating
segments and related information in interim and annual financial statements.
SFAS No. 130 and 131 are e