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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from
Commission file number: 1-31949
I-SECTOR CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0515249
(State of incorporation) (I.R.S. Employer
Identification No.)
6401 SOUTHWEST FREEWAY
HOUSTON, TEXAS 77074
Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (713) 795-2000
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
As of November 15, 2004, there were 5,150,554 shares of common stock, $.01 par
value per share, outstanding.
1
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements - I-Sector Corporation
(Unaudited):
Condensed Consolidated Balance Sheets at December 31, 2003 and
September 30, 2004
Condensed Consolidated Statements of Income for the three months ended
September 30, 2003 and 2004
Condensed Consolidated Statements of Income for the nine months ended
September 30, 2003 and 2004
Condensed Consolidated Statement of Stockholders' Equity for the nine
months ended September 30, 2004
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2003 and 2004
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
I-SECTOR CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
December 31, September 30,
2003 2004
------------ -------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents ...................................................... $ 2,172 $ 4,424
Accounts receivable - trade, net of allowance of $612 and $1,342 .............. 9,757 27,014
Accounts receivable - affiliates ............................................... 16 16
Accounts receivable - other .................................................... 29 23
Notes receivable, net of allowance of $373 and $346 ............................ 676 1,580
Inventory ...................................................................... 1,038 1,420
Cost and estimated earnings in excess of billings .............................. 1,452 1,693
Other current assets ........................................................... 943 427
-------- --------
Total current assets ...................................................... 16,083 36,597
-------- --------
Property and equipment, net of accumulated depreciation of $1,887 and $2,269 ........ 1,271 1,789
Notes receivable, net of allowance of $250 and $250 ................................. 252 330
Patent license rights, net of accumulated amortization of $265 and $348 ............. 849 767
Other intangible assets, net of accumulated amortization of $335 and $548 ........... 435 455
Deferred offering costs ............................................................. 317 --
-------- --------
Total Assets ......................................................... $ 19,207 $ 39,938
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current portion of long-term debt ............................ $ 1,784 $ 6,210
Accounts payable ............................................................... 6,524 12,175
Billings in excess of cost and estimated earnings .............................. 262 78
Accrued expenses ............................................................... 2,676 4,574
Net liabilities related to discontinued operations ............................. 557 642
Deferred revenue ............................................................... 556 1,053
-------- --------
Total current liabilities .................................................. 12,359 24,732
-------- --------
Long-term debt ...................................................................... 229 157
Minority interest ................................................................... -- 218
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
no shares issued .......................................................... -- --
Common stock, $.01 par value, 15,000,000 shares authorized,
4,762,809 and 5,148,954 issued ............................................. 48 51
Additional paid in capital ...................................................... 10,853 17,156
Additional paid in capital - other .............................................. 337 162
Treasury stock, at cost 811,800 and 0 shares .................................... (1,373) --
Retained deficit ................................................................ (3,246) (2,538)
-------- --------
Total stockholders' equity ................................................. 6,619 14,831
-------- --------
Total Liabilities and Stockholders' Equity ............................ $ 19,207 $ 39,938
======== ========
See notes to condensed consolidated financial statements
3
I-SECTOR CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Three months ended September 30,
--------------------------------
2003 2004
---------- ----------
Revenue:
Products ................................................. $ 16,302 27,255
Services ................................................. 2,264 2,826
Custom projects .......................................... 2,415 2,531
---------- ----------
Total revenue ...................................... 20,981 32,612
---------- ----------
Cost of goods and services:
Products ................................................. 14,066 23,331
Services ................................................. 1,396 1,849
Custom projects .......................................... 728 1,323
---------- ----------
Total cost of goods and services ................... 16,190 26,503
---------- ----------
Gross profit ................................... 4,791 6,109
Selling, general and administrative expenses .................... 4,621 5,456
---------- ----------
Operating income ................................................ 170 653
Interest and other income (expense), net ........................ (11) 17
---------- ----------
Income from continuing operations before income tax benefit ..... 159 670
Income tax expense (benefit) .................................... (12) 2
Net income from continuing operations before minority interest .. 171 668
Minority interest ............................................... -- (50)
---------- ----------
Net income from continuing operations ........................... 171 618
Gain on disposal of discontinued operations, net of taxes ....... 23 --
---------- ----------
Net income ...................................................... $ 194 $ 618
========== ==========
Net income per share
Basic:
Net income from continuing operations before minority interest .. $ 0.04 $ 0.13
Minority interest ............................................... -- (0.01)
Gain on disposal of discontinued operations, net of taxes ....... 0.01 --
---------- ----------
Net income per share ............................................ $ 0.05 $ 0.12
========== ==========
Diluted:
Net income from continuing operations before minority interest .. $ 0.03 $ 0.12
Minority interest ............................................... -- (0.01)
Gain on disposal of discontinued operations, net of taxes ....... 0.01 --
---------- ----------
Net income per share ............................................ $ 0.04 $ 0.11
========== ==========
Shares used in computing net income per share:
Basic ........................................................... 3,703,206 5,148,837
---------- ----------
Diluted ......................................................... 3,974,298 5,547,912
---------- ----------
See notes to condensed consolidated financial statements
4
I-SECTOR CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Nine months ended September 30,
--------------------------------
2003 2004
---------- ----------
Revenue:
Products ........................................................ $ 35,655 $ 54,058
Services ........................................................ 5,282 7,879
Custom projects ................................................. 5,995 6,837
---------- ----------
Total revenue ................................................... 46,932 68,774
---------- ----------
Cost of goods and services:
Products ........................................................ 31,181 46,472
Services ........................................................ 3,852 5,187
Custom projects ................................................. 2,104 3,171
---------- ----------
Total cost of goods and services ................................ 37,137 54,830
---------- ----------
Gross profit .......................................... 9,795 13,944
Selling, general and administrative expenses ........................... 11,556 13,191
---------- ----------
Operating income (loss) ................................................ (1,761) 753
Interest and other income, net ......................................... 93 10
---------- ----------
Income (loss) from continuing operations before income tax benefit ..... (1,668) 763
Income tax benefit ..................................................... (93) --
---------- ----------
Net income (loss) from continuing operations before minority interest .. (1,575) 763
Minority interest ...................................................... -- (56)
---------- ----------
Net income (loss) from continuing operations ........................... (1,575) 707
Gain on disposal of discontinued operations, net of taxes .............. 39 1
---------- ----------
Net income (loss) ...................................................... $ (1,536) $ 708
========== ==========
Net income (loss) per share
Basic:
Net income (loss) from continuing operations before minority interest .. $ (0.43) $ 0.16
Minority interest ...................................................... -- (0.01)
Gain on disposal of discontinued operations, net of taxes .............. 0.01 --
---------- ----------
Net income (loss) per share ............................................ $ (0.42) $ 0.15
========== ==========
Diluted:
Net income (loss) from continuing operations before minority interest .. $ (0.43) $ 0.15
Minority interest ...................................................... -- (0.01)
Gain on disposal of discontinued operations, net of taxes .............. 0.01 --
---------- ----------
Net income (loss) per share ............................................ $ (0.42) $ 0.14
========== ==========
Shares used in computing net income (loss) per share:
Basic .................................................................. 3,643,346 4,572,124
---------- ----------
Diluted ................................................................ 3,643,346 5,014,378
---------- ----------
See notes to condensed consolidated financial statements
5
I-SECTOR CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
(Unaudited)
$.01 par value Additional
Common Stock Additional Paid-In
-------------------- Paid-In Capital - Treasury Retained
Shares Amount Capital Other Stock Deficit Total
---------- ------ ---------- ---------- ---------- --------- --------
Balance at December 31, 2003 ....... $4,762,809 $ 48 $ 10,853 $ 337 $ (1,373) $ (3,246) $ 6,619
Revaluation of consultant options .. -- -- -- (200) -- -- (200)
Exercise of common stock options ... 47,945 -- 61 25 -- -- 86
Proceeds from offering of Units,
net of offering costs of $1,145 .... 1,150,000 11 7,536 -- -- -- 7,547
Issuance of INX common stock
net of minority interest ........... -- -- 71 -- -- -- 71
Retirement of treasury stock ....... (811,800) (8) (1,365) -- 1,373 -- --
Net income ......................... -- -- -- -- -- 708 708
---------- ------ -------- ------ -------- -------- --------
Balance at September 30, 2004 ...... 5,148,954 $ 51 $ 17,156 $ 162 $ -- $ (2,538) $ 14,831
========== ====== ======== ====== ======== ======== ========
See notes to condensed consolidated financial statements
6
I-SECTOR CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months ended September 30,
--------------------------------
2003 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .................................................... $ (1,536) $ 708
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Minority interest .............................................. -- 56
Net gain (loss) from discontinued operations ................... (39) 2
Tax expense from discontinued operations ....................... (20) (1)
Depreciation and amortization .................................. 548 667
(Gain) loss on retirement of assets ............................ (157) 24
Bad debt expense ............................................... 1,051 164
Changes in assets and liabilities that provided (used) cash:
Accounts receivable, net ...................................... (4,821) (17,468)
Accounts receivable, affiliates and other ..................... 88 6
Inventory ..................................................... (661) (382)
Income tax receivable ......................................... 488 --
Notes receivable .............................................. (575) (934)
Other current assets .......................................... (38) 480
Accounts payable .............................................. 4,404 5,651
Cost and estimated earnings in excess of billings ............. (661) (241)
Billings in excess of cost and estimated earnings ............. 30 (184)
Other assets .................................................. -- --
Accrued expenses .............................................. 1,354 2,054
Deferred revenue .............................................. 76 497
-------- --------
Net cash used in continuing operations .................. (469) (8,901)
Net operating activities from discontinued operations ............. (231) 85
-------- --------
Net cash used in operating activities ................... (700) (8,816)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds of sale of fixed assets ..................................... 80 --
Acquisition of Digital Precision, Inc (inclusive
of acquisition costs) ......................................... (566) --
Capital expenditures ................................................. (323) (912)
-------- --------
Net cash used in investing activities ................... (809) (912)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options ........................................... 95 86
Proceeds from Unit offering,net ..................................... -- 7,547
Proceeds from borrowings of interest bearing debt ................... -- 7,319
Payments of short and long -term debt ............................... (123) (2,972)
-------- --------
Net cash provided by (used in) in financing activities... (28) 11,980
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ....................... (1,537) 2,252
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .......................... 3,491 2,172
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................. $ 1,954 $ 4,424
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest ............................................ $ - $ 55
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
Revaluation of options granted to consultants ..................... $ 78 $ (200)
Other receivable for proceeds of sale of fixed assets ............. 30 --
Recognition of additional purchase price on Digital Precision
acquisition Through issuance of INX common stock .............. -- 234
See notes to condensed consolidated financial statements
7
I-SECTOR CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share amounts)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
I-Sector Corporation and subsidiaries ("I-Sector" or the "Company") is
engaged in selling and supporting IP telephony solutions as well as related
network infrastructure, their computer-telephony software, and performing
remote-enabled managed services for the information and communication technology
used by their customers:
o Internetwork Experts, Inc. ("INX") is a network professional
services and integration organization focused on delivering
comprehensive Cisco-centric IP telephony solutions to clients
ranging from mid-size to large enterprises along with other
communications solutions. IP communications solutions include
design and implementation, ongoing support and applications
enablement. Supporting practice areas include network
architecture, security, and wireless. To provide these services,
INX employs highly trained IP communications consultants and
network engineering staff who are trained and experienced in
both large, complex network infrastructure technology and IP
communications technology.
o Stratasoft, Inc. ("Stratasoft") creates and markets software
related to the integration of computer and telephone
technologies. This software is used by professional contact
centers and other complex, high-volume telephony environments
and is marketed under the trade name "Stratasoft." Stratasoft
intends to use its computer telephony software development
expertise to create and market new software products that
enhance Cisco-centric IP telephony solutions.
o Valerent, Inc. ("Valerent") provides information technology
solutions that lower its client's expense by utilizing
centralized, remote enabled computing management tools which
predict, announce and manage service interruptions.
Additionally, Valerent provides customers with traditional
computer services such as on-site and carry-in computer repair,
application support, operating system and network migration
services, turn-key outsourced IT helpdesk solutions, technical
staff augmentation for IT helpdesk operations, and helpdesk
solutions consulting services.
The condensed consolidated financial statements presented herein as of and
for the three-month and nine-month periods ended September 30, 2003 and 2004 are
unaudited; however, all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position, results of
operations, and cash flows for the periods covered have been made and are of a
normal, recurring nature. The results of the interim periods are not necessarily
indicative of results for the full year. The consolidated balance sheet as of
December 31, 2003 is derived from audited consolidated financial statements but
does not include all disclosures required by accounting principles generally
accepted in the United States of America. Although management believes the
disclosures are adequate, certain information and disclosures normally included
in the notes to the financial statements have been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission. These interim statements should be read in conjunction with the
consolidated financial statements and notes thereto included in I-Sector's 2003
annual report on Form 10-K.
I-Sector's significant accounting policies are as follows:
USE OF ESTIMATES - The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amount
of revenue and expense during the reporting period. Actual results could differ
from these estimates.
REVENUE RECOGNITION - I-Sector has a number of different revenue
components, which vary between its reportable operating segments. Each
reportable operating segment has more than one revenue component, and revenue is
recognized differently for each component (or "stream") of revenue earned by
operating segment. The material revenue streams earned by I-Sector, some of
which are earned by more than one operating segment, and some by only one
operating segment, are:
Products Revenue. Three of I-Sector's operating segments earn revenue from
product shipments. Product shipment revenue occurs when products
manufactured by other parties are purchased and resold to a customer and
such products are contracted for independently of material services.
I-Sector recognizes revenue from product shipments when the product is
shipped or delivered to the customer. In all three segments, the four
criteria for revenue recognition have been met because: (1) there are
written, executed contracts, or in the case of INX and Valerent, in some
situations there are binding purchase orders; (2) delivery has occurred or
services have been rendered; (Stratasoft, however, recognizes revenue on
the percentage of completion method, as described below.) (3) the price is
fixed or determinable, and (4) collectibility is reasonably assured. Each
of I-Sector's business segments performs credit research prior to
extending
8
credit. In Stratasoft's business segment, a substantial portion of the
total contract price is received in cash or letter of credit when the unit
is installed.
Services Revenue. All of I-Sector's operating segments earn revenue from
providing stand-alone services revenue. This revenue consists of billings
for engineering and technician time, programming services, which are
provided on either an hourly basis or a flat-fee basis, support contracts
and the service component of maintenance and repair service ticket
transactions. These services are contracted for separately from any
product sale, and are generally completed in less than three months.
Service revenues are recognized when the service is performed and when
collection is reasonably assured. Two of I-Sector's segments sometimes
earn agency fee revenue from various sources, the primary source of which
is referring customers to other organizations for which an agency fee is
received. This revenue is recognized at the earlier of when payment is
received or when notification of amounts due is received from the entity
paying such agency fee and collectibility is reasonably assured.
One of I-Sector's segments, INX, has certain fixed and flat fee services
contracts that extend over three months or more, and are accounted for on
the percentage of completion method of accounting. The percentage of
revenue recognized in any particular period is determined on the basis of
the relationship of the actual hours worked to estimated total hours to
complete the contract. Revisions of the estimated hours to complete are
reflected in the period in which the facts necessitating the revisions
become known. When a contract indicates a loss, a provision is made for
the total anticipated loss.
Custom Project Revenue. One of I-Sector's segments, Stratasoft, earns
revenue from projects that are recognized using the percentage of
completion method of accounting for such revenue. The majority of
Stratasoft's revenue consists of system sales in which it bundles its
proprietary software, along with third-party hardware products and
material related software customization services, installation, training
services, warranty services and incidental post contract support ("PCS")
together under a single contract with the customer. PCS is insignificant
on such contracts for one year or less, and therefore, we have determined
that the value of such PCS should not be unbundled from the project
revenue as set forth in paragraph 59 of SOP 97-2. Accordingly, such PCS
revenue is recognized together with the project revenue, and the estimated
cost to provide the PCS is accrued. The value of the PCS is determinable
within the contract, which defines the period that the PCS is granted and
offers renewals at stated amounts, thereby defining the value of the PCS.
The software customization, together with the hardware customization and
integration, represent a significant modification, customization and/or
production of the product and, therefore, the entire arrangement is
required to be accounted for using the percentage of completion method of
accounting pursuant to SOP 81-1. The percentage of revenue recognized in
any particular period is determined principally on the basis of the
relationship of the cost of work performed on the contract to estimated
total costs. The percentage-of-completion method relies on estimates of
total expected contract revenue and costs. The Company follows this method
since reasonably dependable estimates of the revenue and costs applicable
to various stages of a contract can be made. Revisions of estimates are
reflected in the period in which the facts necessitating the revisions
become known. When a contract indicates a loss, a provision is made for
the total anticipated loss. The following reflects the amounts relating to
uncompleted contracts at:
December 31, September 30,
2003 2004
------------ -------------
Costs incurred on uncompleted contracts ............. $ 1,019 $ 1,611
Estimated earnings .................................. 3,117 4,518
-------- --------
4,136 6,129
Less: Billings to date .............................. (2,946) (4,514)
-------- --------
Total $ 1,190 $ 1,615
======== ========
Included in accompanying balance sheets under
the following captions:
Cost and estimated earnings in excess of billings ... $ 1,452 $ 1,693
Billings in excess of cost and estimated earnings ... (262) (78)
-------- --------
Total ............................................... $ 1,190 $ 1,615
======== ========
During the nine months ending September 30, 2004, Stratasoft deferred $685
of revenue for software products sold on notes that are not initially due
within twelve months and revenue to resellers of $45. Also during the
second quarter of 2004, the company reversed deferred revenue of $398 due
to cancellation of a reseller transaction that was originally deferred in
full at December 31, 2003. Revenue from resellers and notes in excess of
twelve months is recognized in the accounting periods that payments from
the customer are received.
9
VENDOR INCENTIVES - From time to time, the Company participates in
programs provided by suppliers that enable it to earn incentives. These
incentives are generally earned based upon sales volume, sales growth and
customer satisfaction levels. The amounts earned under these programs are
recorded as a reduction of cost of goods when earned and determinable. The
amount of vendor incentives recognized can vary significantly between quarterly
and annual periods. The Company believes it generally understands the related
incentive programs and factors in anticipated rebates as it bids for work with
customers. During the three-month period ended September 30, 2004, the Company
recognized $1,613 in vendor incentives. During the nine-month period ended
September 30, 2004, the Company recognized $2,235 in vendor incentives. Vendor
incentives of $622 related to the six-month measurement period ended January 31,
2004, and vendor incentives of $1,613 related to the seven-month measurement
period ended September 1, 2004.
WARRANTY RESERVE - I-Sector records a warranty reserve related to certain
software products sold by its Stratasoft subsidiary. That reserve is classified
in accrued expenses and is amortized over the life of the warranty, which is
generally twelve months, against actual warranty expenditures. This warranty
reserve relates to the estimate of warranty obligations from sales of
Stratasoft's call center telephony systems, which consist of Stratasoft's
software, configured hardware components as well as telephone support relating
to Stratasoft's software products. Stratasoft incurs numerous types of costs
related to the warranty work, which includes labor cost of technicians and
programmers, hardware cost, the cost of developing and uploading software
patches related to "bug fixes," telephone support, and hardware parts cost
related to defective hardware sold as a part of a complete Stratasoft system.
The majority of these costs are individually insignificant amounts for which the
cost/benefit relationship does not warrant tracking, but which we periodically
assess and continue to estimate at approximately five percent of Stratasoft
sales. As the actual costs are not tracked, Stratasoft amortizes the recorded
amounts to cost of goods over the average life of the contractual warranty
period as costs are believed to be incurred ratably over the warranty period.
The difference between the actual warranty costs incurred and the amount of
amortization is not considered to be materially different. The following table
depicts the activity in the warranty reserve:
Nine Months
Ended
September 30,
-------------
2004
-------------
Balance, beginning of the period.... $ 302
Additions to reserve................ 384
Expenses offset against reserve..... (314)
----------
Balance, end of period.............. $ 372
==========
STOCK-BASED COMPENSATION - The Company has elected to account for
stock-based compensation using the intrinsic value method of accounting in
accordance with Accounting Principles Bulletin ("APB") No. 25 "Accounting for
Stock Issued to Employees." Under this method no compensation expense is
recognized when the number of shares granted is known and the exercise price of
the stock option is equal to or greater than the fair value of the common stock
on the grant date. The Company has recorded no stock-based compensation
associated with stock options granted to employees and directors in its
consolidated statement of operations. I-Sector and its subsidiaries apply the
fair value method as prescribed by SFAS No. 123, as interpreted and amended, for
stock and stock options issued to non-employees and during the three and nine
month periods ended September 30, 2004, recorded a $10 expense and a $29
benefit, respectively. If compensation cost for all option issuances had been
determined consistent with the fair value method, I-Sector's per share
profitability would have changed to the pro-forma amounts indicated below for
the three and nine month periods ended September 30, 2003 and 2004.
10
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2003 2004 2003 2004
------- ------- ------- -------
Basic:
Net income (loss) as reported ................................... $ 194 $ 618 $(1,536) $ 708
Deduct:
Total stock-based employee compensation determined under
fair value based method for all awards, net of
related tax effects ...................................... 5 22 29 67
------- ------- ------- -------
Pro forma net income (loss) ..................................... $ 189 $ 596 $(1,565) $ 641
======= ======= ======= =======
Diluted:
Net income (loss) as reported ................................... $ 194 $ 618 $(1,536) $ 708
Deduct:
Adjustment for subsidiary dilution .............................. 44 41 -- 32
Total stock-based employee compensation determined under
fair value based method for all awards, net of
related tax effects ...................................... 5 22 29 67
------- ------- ------- -------
Pro forma net income (loss) ..................................... $ 145 $ 555 $(1,565) $ 609
======= ======= ======= =======
Earnings per share:
Basic - as reported ............................................. $ 0.05 $ 0.12 $ (0.42) $ 0.15
Basic - pro forma ............................................... $ 0.05 $ 0.12 $ (0.43) $ 0.14
Diluted - as reported ........................................... $ 0.04 $ 0.11 $ (0.42) $ 0.14
Diluted - pro forma ............................................. $ 0.04 $ 0.10 $ (0.43) $ 0.12
EARNINGS PER SHARE - Basic net income per share is computed on the basis
of the weighted-average number of common shares outstanding during the periods.
Diluted net income per share is computed based upon the weighted-average number
of common shares plus the assumed issuance of common shares for all potentially
dilutive securities using the treasury stock method (See Note 4).
FAIR VALUE OF FINANCIAL INSTRUMENTS - I-Sector's financial instruments
consist of cash and cash equivalents, accounts receivable and accounts payable
for which the carrying values approximate fair values given the short-term
maturity of the instruments. The carrying value of the Company's debt
instruments approximate their fair value based on estimates of rates offered to
the Company for instruments with the same maturity dates and security
structures.
ACCOUNTING PRONOUNCEMENTS - In January 2003, the FASB issued FASB
Interpretation 46 ("FIN 46"), "Consolidation of Variable Interest Entities - An
Interpretation of ARB No. 51." FIN 46 addresses consolidation by business
enterprises of variable interest entities. This Interpretation applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. On December 17, 2003, the
FASB issued FIN 46(R), providing a deferral of the application of FIN 46 for
interests held by public entities in a variable interest entity or potential
variable interest entity until fiscal periods ending after March 15, 2004. The
Company has assessed the impact of FIN 46 on its financial statements,
particularly its relationship with Allstar Equities, Inc., and adoption of this
statement did not have an impact on the Company's financial statements.
2. DISCONTINUED OPERATIONS
On November 6, 2001, I-Sector approved a plan to sell or close its IT
Staffing business. A sale was finalized on December 31, 2001. Under the terms of
the sale I-Sector received a note receivable for $52. The note receivable bore
interest at 5% per annum and was collectible in installments based on the total
monthly revenue of the buyer over 24 months beginning in March, 2002. In 1999,
I-Sector decided to sell both its computer products reselling business and its
PBX telephone systems dealer business. During the three and nine months
specified below, I-Sector recognized a gain (loss) on disposal, net of income
tax provision, of these three businesses as follows:
11
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2003 2004 2003 2004
------ ------ ------ ------
IT Staffing, Inc. (net of taxes of $- and $-, respectively
for three months ended) and ($14 and $ -, respectively for
nine months ended) ........................................... $ -- $ -- $ 26 $ --
Computer Products Division (net of taxes of $(20) and $-,
respectively for three months ended) and ($(27) and $2,
respectively for nine months ended) .......................... (39) -- (53) 2
Telecom Division (net of taxes and taxes of $31 and $-,
respectively for three months ended) and ($33 and $(1),
respectively for nine months ended) .......................... 62 -- 66 (1)
------ ------ ------ ------
Gain on disposal of discontinued operations, net of taxes .... $ 23 $ -- $ 39 $ 1
====== ====== ====== ======
The balance sheet caption "Net liabilities related to discontinued
operations" contains $557 and $642 at December 31, 2003 and September 30, 2004,
respectively, of estimated future expenses related to the winding up of the
Telecom Division and the Computer Products Division, and includes amounts
related to settlement of pending litigation and to Telecom warranties. An
additional $85 relating to the rebate repayment claims from a former vendor was
reclassified from accrued liabilities to net liabilities related to discontinued
operations during the nine month period ended September 30, 2004.
3. SEGMENT INFORMATION
I-Sector has four reportable segments: INX, Stratasoft, Valerent and
Corporate. Corporate is not a revenue generating operating segment. The
accounting policies of the business segments are the same as those for I-Sector.
I-Sector evaluates performance of each segment based on operating income.
Management considers trade accounts receivable and inventory and not total
assets in their decision-making. Inter-segment sales and transfers are not
significant and are shown in the Eliminations column in the table below. The
following tables show the results of the four reportable segments:
For the quarter ended September 30, 2004:
INX Stratasoft Valerent Corporate Eliminations Consolidated
-------- ---------- -------- --------- ------------ ------------
Revenue:
Products ................... $ 27,179 $ -- $ 288 $ -- $ (212) $ 27,255
Services ................... 1,516 -- 1,310 -- -- 2,826
Custom projects ............ -- 2,531 -- -- -- 2,531
-------- -------- -------- -------- -------- --------
Total revenue ..................... 28,695 2,531 1,598 -- (212) 32,612
-------- -------- -------- -------- -------- --------
Cost of goods and
Services:
Products ................... 23,251 -- 292 -- (212) 23,331
Services ................... 1,099 -- 750 -- -- 1,849
Custom projects ............ -- 1,323 -- -- -- 1,323
-------- -------- -------- -------- -------- --------
Cost of goods and services .. 24,350 1,323 1,042 -- (212) 26,503
-------- -------- -------- -------- -------- --------
Gross profit ...................... 4,345 1,208 556 -- -- 6,109
Selling, general and
administrative expenses ........... 3,332 1,419 522 183 -- 5,456
-------- -------- -------- -------- -------- --------
Operating income (loss) ........... $ 1,013 $ (211) $ 34 $ (183) $ -- 653
-------- -------- -------- -------- -------- --------
Interest and other income, net............................................................... 17
--------
Income from continuing operations before income taxes........................................ 670
Income tax expense........................................................................... 2
--------
Net income from continuing operations before minority interest............................... 668
Minority interest............................................................................ (50)
Gain on disposal of discontinued operations, net of taxes.................................... -
--------
Net income .................................................................................. $ 618
========
Selected Balance Sheet Information:
Trade accounts
Receivable, net ............. $ 24,773 $ 1,186 $ 966 $ 89 $ -- $ 27,014
-------- -------- -------- -------- -------- ========
Inventory ......................... $ 668 $ 691 $ 61 $ -- $ -- $ 1,420
-------- -------- -------- -------- -------- --------
12
For the quarter ended September 30, 2003:
INX Stratasoft Valerent Corporate Eliminations Consolidated
-------- ---------- -------- --------- ------------ ------------
Revenue:
Products ................... $ 15,954 $ -- $ 515 $ -- $ (167) $ 16,302
Services ................... 1,392 -- 877 -- (5) 2,264
Custom projects ............ -- 2,415 -- -- -- 2,415
-------- -------- -------- -------- -------- --------
Total revenue ..................... 17,346 2,415 1,392 -- (172) 20,981
-------- -------- -------- -------- -------- --------
Cost of goods and
Services:
Products ................... 13,758 -- 474 -- (166) 14,066
Services ................... 795 -- 606 -- (5) 1,396
Custom projects ............ -- 728 -- -- -- 728
-------- -------- -------- -------- -------- --------
Cost of goods and services .. 14,553 728 1,080 -- (171) 16,190
-------- -------- -------- -------- -------- --------
Gross profit ...................... 2,793 1,687 312 -- (1) 4,791
Selling, general and
administrative expenses ........... 2,126 1,754 455 287 (1) 4,621
-------- -------- -------- -------- -------- --------
Operating income (loss) ........... $ 667 $ (67) $ (143) $ (287) $ -- 170
-------- -------- -------- -------- --------
Interest and other income, net..................................................................... (11)
--------
Income from continuing operations before income taxes.............................................. 159
Income tax benefit................................................................................. (12)
--------
Net income from continuing operations.............................................................. 171
Gain on disposal of discontinued operations, net of taxes.......................................... 23
--------
Net income......................................................................................... $ 194
========
Selected Balance Sheet Information:
Trade accounts
receivable, net ............. $ 9,281 $ 795 $ 710 $ -- $ -- $ 10,786
-------- -------- -------- -------- -------- --------
Accounts receivable retained from discontinued operations, net..................................... 165
--------
Total accounts receivable, net..................................................................... $ 10,951
========
Inventory ......................... $ 812 $ 702 $ 29 -- $ -- $ 1,543
-------- -------- -------- -------- -------- --------
13
For the nine months ended September 30, 2004:
INX Stratasoft Valerent Corporate Eliminations Consolidated
-------- ---------- -------- --------- ------------ ------------
Revenue:
Products ................... $ 53,594 $ -- $ 1,127 $ -- $ (663) $ 54,058
Services ................... 4,054 -- 3,825 -- -- 7,879
Custom projects ............ -- 6,837 -- -- -- 6,837
-------- -------- -------- -------- -------- --------
Total revenue ..................... 57,648 6,837 4,952 -- (663) 68,774
-------- -------- -------- -------- -------- --------
Cost of goods and
Services:
Products ................... 46,073 -- 1,062 -- (663) 46,472
Services ................... 2,833 -- 2,354 -- -- 5,187
Custom projects ............ -- 3,171 -- -- -- 3,171
-------- -------- -------- -------- -------- --------
Cost of goods and
services ................. 48,906 3,171 3,416 -- (663) 54,830
-------- -------- -------- -------- -------- --------
Gross profit ...................... 8,742 3,666 1,536 -- -- 13,944
Selling, general and
administrative expenses ........... 7,534 3,570 1,398 689 -- 13,191
-------- -------- -------- -------- -------- --------
Operating income (loss) ........... $ 1,208 $ 96 $ 138 $ (689) $ -- 753
-------- -------- -------- -------- --------
Interest and other income, net.......................................................................... 10
--------
Income from continuing operations before income taxes................................................... 763
Income tax benefit...................................................................................... -
--------
Net income from continuing operations before minority interest.......................................... 763
Minority interest....................................................................................... (56)
Gain on disposal of discontinued operations, net of taxes............................................... 1
--------
Net income ............................................................................................. $ 708
========
For the nine months ended September 30, 2003:
INX Stratasoft Valerent Corporate Eliminations Consolidated
-------- ---------- -------- --------- ------------ ------------
Revenue:
Products ................... $ 34,795 $ -- $ 1,219 $ -- $ (359) $ 35,655
Services ................... 2,725 -- 2,562 -- (5) 5,282
Custom projects ............ -- 5,995 -- -- -- 5,995
-------- -------- -------- -------- -------- --------
Total revenue ..................... 37,520 5,995 3,781 -- (364) 46,932
-------- -------- -------- -------- -------- --------
Cost of goods and
Services:
Products ................... 30,448 -- 1,090 -- (357) 31,181
Services ................... 2,068 -- 1,789 -- (5) 3,852
Custom projects ............ -- 2,104 -- -- -- 2,104
-------- -------- -------- -------- -------- --------
Cost of goods and
services ................. 32,516 2,104 2,879 -- (362) 37,137
-------- -------- -------- -------- -------- --------
Gross profit ...................... 5,004 3,891 902 -- (2) 9,795
Selling, general and
administrative expenses ........... 4,518 4,694 1,551 795 (2) 11,556
-------- -------- -------- -------- -------- --------
Operating income (loss) ........... $ 486 $ (803) $ (649) $ (795) $ -- (1,761)
-------- -------- -------- -------- --------
Interest and other income, net.......................................................................... 93
--------
Loss from continuing operations before income taxes..................................................... (1,668)
Income tax benefit...................................................................................... (93)
--------
Net loss from continuing operations..................................................................... (1,575)
Gain on disposal of discontinued operations, net of taxes............................................... 39
--------
Net loss................................................................................................ $ (1,536)
========
International sales accounted for $163, less than 1.0%, and $681 or
3.2% of consolidated revenues and 6.4% and 28.2% of the Stratasoft segment
revenues in the three months ended September 30, 2004 and 2003, respectively. In
the nine months ended September 30, 2004 and 2003, international sales accounted
for $1,382 or 2.0% and $2,627 or 5.6% of consolidated revenues and 20.2% and
43.8% of the Stratasoft segment sales, respectively. International sales are
derived primarily from Canada, the United Kingdom, Germany, Greece, India,
Egypt, The Philippines, Caribbean and Japan.
14
4. EARNINGS PER SHARE
Basic EPS is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding for the period. Diluted EPS
is based on the weighted-average number of shares outstanding during each period
and the assumed exercise of dilutive stock options and warrants less the number
of treasury shares assumed to be purchased from the proceeds using the average
market price of the Company's common stock for each of the periods presented.
For the nine months ended September 30, 2003, I-Sector's potentially
dilutive options of 201,473 were not used in the calculation of diluted earnings
since the effect of potentially dilutive securities in computing a loss per
share is antidilutive.
The potentially dilutive options of the Company's wholly-owned
subsidiary, INX, (see Note 9) did not impact the calculation of I-Sector's
earnings per share for the six months ended September 30, 2003 since the effect
would have been antidilutive for the quarters ended September 30, 2003 and 2004.
Net income from continuing operations for purposes of computing the income per
share decreased $44 and $41, respectively, for the quarters ended September 30,
2003 and 2004 and $32 for the nine months ended September 30, 2004 for the
assumed exercise of INX options under the treasury method.
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
Numerator for basic earnings per share:
Net income (loss) from continuing operations
before minority interest ....................... $ 171 $ 668 $ (1,575) $ 763
Minority interest .............................. -- (50) -- (56)
Gain (loss) on disposal of discontinued
operations, net of taxes ....................... 23 -- 39 1
----------- ----------- ----------- -----------
Net income (loss) .............................. $ 194 $ 618 $ (1,536) $ 708
=========== =========== =========== ===========
Numerator for diluted earnings per share:
Net income (loss) from continuing operations ... $ 171 $ 668 $ (1,575) $ 763
Minority interest .............................. -- (50) -- (56)
INX income attributable to potential minority
interest net income (loss) from continuing
operations used in computing loss per share .... (44) (41) -- (32)
Gain on disposal of discontinued
operations, net of taxes ....................... 23 -- 39 1
----------- ----------- ----------- -----------
Net income (loss) .............................. $ 150 $ 577 $ (1,536) $ 676
=========== =========== =========== ===========
Denominator for basic earnings per
share - weighted-average shares
outstanding .................................... 3,703,206 5,148,837 3,643,346 4,572,124
Effect of dilutive securities:
Shares issuable from assumed conversion of
Common stock options and restricted stock ...... 271,092 399,075 -- 442,254
----------- ----------- ----------- -----------
Denominator for diluted earnings per
share - weighted-average shares outstanding .... 3,974,298 5,547,912 3,643,346 5,014,378
=========== =========== =========== ===========
5. DEBT
On September 27, 2001, Stratasoft signed a note payable to a third
party for $725, payable in monthly installments through February 2007. The note
does not bear interest and I-Sector has imputed interest at 5.5% to record the
debt and related patent license asset and has recorded interest expense of $4
and $2 in the three month periods and $13 and $9 in the nine month periods ended
September 30, 2003 and 2004, respectively. This note is collateralized by
Stratasoft's patent license assets and Stratasoft has granted a security
interest in its pending patent application and the next two patent applications
filed by Stratasoft. In connection with this note payable, I-Sector has
short-term debt maturing within one year of $68 and $77 at December 31, 2003 and
September 30, 2004, respectively; and long-term debt of $184 and $132 at
December 31, 2003 and September 30, 2004, respectively.
In October 2001, I-Sector signed a non-interest bearing note payable
for $39 payable in monthly installments through October 2004. In connection with
this note payable, I-Sector has short-term debt maturing within one year of $10
and $1 at December 31, 2003 and September 30, 2004, respectively.
15
In December 2003, I-Sector signed a 36-month non-cancelable capital
lease for the purchase of equipment. I-Sector imputed interest at 10% to record
the debt on which I-Sector has recorded $0 interest expense for the three month
period ending September 30, 2004. In connection with this capital lease,
I-Sector has recorded short-term debt maturing within one year of $18 and $17 at
December 31, 2003 and September 30, 2004, respectively; and long-term debt of
$45 and $25 at December 31, 2003 and September 30, 2004, respectively.
I Sector and Textron revised the Floorplan Loan agreement on September
30, 2004 to increase the floorplan line of credit to $25,000. Under the revised
agreement the aggregate outstanding principal amount of all Floorplan Loans
shall not, at any time, exceed the sum of (a) 80% of the aggregate net invoice
prices of all Eligible Receivable plus (b) (i) for so long as the Borrower is
discharging its undertakings in respect of the Master Dallas Independent School
District Contract (DISD) or any DISD Receivable is owing to it, 90% of the
invoice price of (1) all Floorplanned Inventory and (2) all DISD Inventory that
is Eligible Inventory, provided that the sum of the amounts in clauses (1) and
(2) above shall be limited to the lesser of $9,000 or 35% of the net invoice
prices of all outstanding Eligible Receivables and (ii) after the Borrower has
discharged its undertakings in respect of the Master DISD Contract and all DISD
Receivables owing to it have been paid, the least of (1) 90% of the invoice
price of all Floorplanned Inventory, (2) 30% of the net invoice prices of all
outstanding Eligible Receivables and (3) $6,000. Borrower shall, within two (2)
Business Days of the aggregate outstanding principal amount of the Floorplan
Loans exceeding at any time the aforesaid sum, prepay the Floorplan Loans in an
aggregate principal amount sufficient so that this covenant shall not be
violated. Inventory floor plan borrowings are reflected in accounts payable in
the accompanying consolidated balance sheets, except for $1,688 and $6,115 that
is interest bearing and is reflected in short term debt in the accompanying
consolidated balance sheets at December 31, 2003 and September 30, 2004,
respectively. Borrowings accrue interest at the prime rate (4.75% at September
30, 2004) plus 2.5% on outstanding balances that extend beyond the vendor
approved free interest period. This agreement is collateralized by substantially
all of I-Sector's assets except its patent license assets. The loan agreement
contains restrictive covenants measured at each quarter end and requires
I-Sector to maintain minimum tangible capital funds; maintain indebtedness to
tangible capital funds ratio; minimum working capital; minimum cash on hand;
minimum current ratio; and minimum earnings before interest, taxes, depreciation
and amortization (EBITDA). The agreement requires that I-Sector enter into a
Memorandum of Understanding (MOU) by November 15, 2004 with Micro System
Enterprise, Inc. (MSE) and Textron among other members of the DISD consortium
regarding the payment procedures under the Master DISD Contract when such
agreement has been finalized among such parties. At September 30, 2004, I-Sector
was in compliance with those loan covenants effective at that date and
anticipates that it will be able to comply with its loan covenants for the next
twelve months. In the event I-Sector does not maintain compliance, it would be
required to seek waivers from Textron and Silicon Valley Bank (a participating
partner with Textron) for those events, which, if not obtained, could accelerate
repayment and require I-Sector to seek other sources of finance. At September
30, 2004, I-Sector had $16,008 outstanding on inventory floor plan finance
borrowings, and the remaining credit availability was $8,287, subject to
borrowing limitations as described above.
6. COMMITMENTS AND CONTINGENCIES
In August 2002, Inacom Corp. ("Inacom") filed a lawsuit in the District
Court of Douglas County, Nebraska styled Inacom Corp v. I-Sector Corporation,
f/k/a Allstar Systems, Inc., claiming that I-Sector owed the sum of
approximately $570 to Inacom as a result of Inacom's termination of a Vendor
Purchase Agreement between Inacom and I-Sector. I-Sector believes that the claim
is without merit and intends to vigorously contest the demand.
In March 2003, I-Sector and other parties were notified of a demand for
return of payments relating to the business activities of a call center
customer. In March 2004, I-Sector was informed by the claimant that claims will
not be pursued at this time. I-Sector believes that the claims against it, if
re-initiated, are without merit and intends to vigorously contest any demands
related to this matter.
I-Sector is also party to other litigation and claims which management
believes are normal in the course of its operations. While the results of such
litigation and claims cannot be predicted with certainty, I-Sector believes the
final outcome of such matters will not have a material adverse effect on its
results of operations or financial position.
7. RELATED PARTY TRANSACTIONS
The Company leases office space from Allstar Equities, Inc., a Texas
corporation ("Equities"), a company wholly owned by I-Sector's Chief Executive
Officer. On December 1, 1999, Equities purchased the Company's corporate office
building and executed a direct lease with us with an expiration date of December
31, 2004. In conjunction with Equities obtaining new financing on the building,
a new lease was executed with the Company on February 1, 2002 with an expiration
date of January 31, 2007. The lease has rental rates of $37 per month.
16
From time to time, I-Sector makes short-term loans and travel advances
to its non-executive employees. The balance of approximately $16 and $16
relating to these loans and advances is included in the Company's consolidated
balance sheets and reported as part of accounts receivable - other at December
31, 2003 and September 30, 2004, respectively.
8. INTANGIBLE ASSETS
On April 7, 2003, I-Sector's subsidiary, INX, acquired certain assets
and liabilities of one of its competitors, Digital Precision, Inc. ("Digital
Precision"). Under the terms of the purchase, INX acquired fixed assets valued
at $63, inventory valued at $101 and intellectual property, customer lists,
trademarks, trade names and service marks, contract rights and other intangibles
of Digital Precision valued at $376, as well as assumed certain operating leases
of equipment and office space in Austin, Texas and Dallas, Texas with a net
future obligation of $548. The office space in Dallas, TX was subleased with
future rentals of $234. The intangibles are subject to amortization and have a
three year expected life. The purchase price was $540 in cash and, contingent
upon the retention of certain key employees, the obligation to issue 1,800,000
shares of INX common stock in April 2004. The contingency was resolved in April
2004, and I-Sector recognized a minority interest related to the issuance of
INX's common stock (see Note 11) resulting in additional paid-in capital net of
intangible assets of $71. The results of operations of Digital Precision
subsequent to April 7, 2003 are included in I-Sector's consolidated statements
of operations.
9. STOCK OPTION PLANS
The company has three stock-based incentive plans, the 1996 Incentive
Stock Plan, the 1996 Non-Employee Director Stock Option Plan and the Incentive
Plan. Under the Incentive Plan, all I-Sector employees, including officers,
consultants and non-employees directors are eligible to participate.
INX is the only I-Sector subsidiary with an incentive stock option plan
in place. All other subsidiary plans except for INX were terminated in December
2003. The INX plan has not been presented to the stockholders of I-Sector for
approval. INX has granted incentive awards under its incentive plan, and such
awards have been granted to certain employees and to management of INX. Under
INX's plan such options typically vest ratably over three to five years. In
December 2003, the Company amended option agreements with INX's two most senior
executives to convert to a fixed 5-year vesting schedule from a vesting schedule
that was determined based on the percentage of attainment of predefined
financial goals by INX. No stock-based compensation was recorded as the exercise
price equaled or exceeded management's estimated fair value of the INX common
stock. Any unvested INX stock options may vest immediately upon the occurrence
of a liquidity event for that subsidiary. Of the options, 5,434,000 contain an
exercise restriction which allows only vested options to be exercised upon the
occurrence of a liquidity event or one month prior to the option's expiration
date. The INX options expire ten years after the grant date if they are not
exercised. The INX stock option grants are subject to dilution when I-Sector
purchases additional shares of the subsidiary stock in order to keep the
subsidiary sufficiently capitalized. INX has 8,261,038 options granted and
outstanding, of which 4,145,766 are vested and 1,364,598 are exercisable at
September 30, 2004. The outstanding options have exercise prices ranging from
$0.01 to $0.25 per share with a weighted average of $0.17 per share. There are
no shares in INX's plan available to be issued at September 30, 2004, and INX's
plan has been amended, effective December 31, 2003, so that no further options
may be granted under the plan. The tables below reflect the ownership of INX at
September 30, 2004 and summarize the potential dilutive effect on I-Sector's
ownership in INX if all options granted at September 30, 2004 were fully vested
and option grants were exercised, and include the effects of the issuance of
stock in April 2004 relating to INX's acquisition of certain assets and
liabilities of Digital Precision, Inc. The table does not assume any repurchase
of shares with proceeds from option exercises.
Percent of
INX Common Stock Total
---------------- ----------
Ownership of INX shares at September 30, 2004:
Common Stock owned by I-Sector ....................... 21,834,333 92.4%
Common Stock owned by others ......................... 1,800,000 7.6%
---------- ---------
Total Common Stock Outstanding ....................... 23,634,333 100.0%
========== =========
Potential Future I-Sector Dilution of Ownership:
Common Stock owned by I-Sector at September 30, 2004 .. 21,834,333 68.5%
Common Stock owned by others at September 30,2004 ..... 1,800,000 5.6%
Options granted and outstanding at September 30,
2004 (1)(2)(3)(4) ..................................... 8,261,038 25.9%
---------- ---------
Total at September 30, 2004 ........................... 31,895,371 100.0%
========== =========
(1) Options granted and outstanding at September 30, 2004 include option
grants for 4,100,000 shares of INX common stock granted to the two
senior executives of INX and vesting of these option grants was
performance-based relating to the percentage of predefined financial
goals attained by INX while these two senior executives remain
employed. In December 2003, these option agreements were amended to
convert to a fixed 5-year vesting schedule.
17
(2) Included in the option grants outstanding at September 30, 2004 are
grants for 1,881,692 shares of INX common stock granted to key
employees related to the acquisition Digital Precision, Inc. Grants for
500,000 of these shares vested April 2003. The balance of the grants
for 1,381,692 shares, which were granted in November 2003, vest over
three years, starting in April 2004
(3) During the quarter ended December 31, 2003, INX granted fully vested
options to purchase 1,200,000 shares of INX common stock to the CEO and
Chairman of the Board of I-Sector Corporation. Such option grant was
voluntarily canceled by the CEO and Chairman of the Board of I-Sector
Corporation in February, 2004 in connection with the issuance of a
warrant for 1.2 million shares to I-Sector on similar terms. During the
year ended December 31, 2003, INX granted fully vested options to
purchase 300,000 shares to the President and CEO of INX. In addition,
INX granted options vesting over three years to various other employees
during the year ended December 31, 2003.
(4) The remainder of the shares included in INX option grants outstanding
at September 30, 2004 vest over either three or five years based upon
continued employment by INX of the individuals to whom such grants have
been made. All options granted by INX expire in ten years if
unexercised.
10. WARRANTS
On May 7, 2004 I-Sector issued warrants to the underwriters to purchase
up to 50,000 units at an exercise price equal to $19.92 per unit. These warrants
are exercisable during the four-year period beginning May 7, 2005 which is one
year from the date of the prospectus. Pursuant to NASD Rule 2710(g), these
warrants cannot be sold, transferred, assigned, pledged or hypothecated by any
person for a period of one year following the effective date of the offering,
except to any NASD member participating in the offering, to bona fide officers,
by operation of law or if we are reorganized, so long as the securities so
transferred remain subject to the same transfer restriction for the remainder of
the one-year period. The holder of the representative's warrant will have, in
that capacity, no voting, dividend or other stockholder rights.
11. MINORITY INTEREST
During April 2004, INX ceased to be a wholly-owned subsidiary as the
result of the issuance of INX common stock to the former owners of Digital
Precision, which INX acquired in April 2003. In connection with that
acquisition, INX agreed to issue to the seller 1.8 million shares of INX common
stock as additional purchase consideration for their business if certain
employees remain employed through April 4, 2004, the first anniversary of the
acquisition. These conditions were met and the INX common stock was issued in
April 2004. At the time of issuance of INX common stock I-Sector recognized an
additional customer list value of $234 determined by using the valuation model
of INX common stock that yielded a per share value of $0.13 and is amortizing
this amount over two years. When the issuance of INX stock occurred, I Sector's
ownership percentage of INX's common stock declined to 92.38% and I-Sector
recognized $162 of minority interest in its balance sheet at that time.
12. COMPLETION OF PUBLIC OFFERING
On May 12, 2004, the Company closed a public offering of 500,000 Units.
The Units began trading on May 7, 2004, on the American Stock Exchange under the
symbol ISR.U. Each Unit consists of two shares of common stock and one warrant
to purchase one share of common stock at a price of $12.45. The Units were
offered at a public offering price of $16.60 per Unit resulting in $8,300 of
proceeds less 9% underwriter discount of $747 and underwriter expenses of $9 for
a net amount of $7,544 before additional offering expenses. On June 2, 2004, the
underwriters exercised their option to purchase 75,000 additional Units to cover
over-allotments resulting in $1,245 of proceeds less 9% underwriter discount of
$112 for a net amount of $1,133 before additional offering expenses. The Company
paid approximately $1,145 of additional offering expenses associated with the
public offering as of September 30, 2004. Net proceeds after all discounts and
expenses were approximately $7,547.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is qualified in its entirety by, and should be
read in conjunction with, our consolidated financial statements, including the
notes thereto included elsewhere in this Form 10-Q and our annual report on Form
10-K for the fiscal year ended December 31, 2003 previously filed with the
Securities and Exchange Commission.
SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
relating to future events or our future financial performance including, but not
limited to, statements contained in Item 2. - "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Readers are
cautioned that any statement that is not a statement of historical fact,
including but not limited to, statements which may be identified by words
including, but not limited to, "anticipate," "appear," "believe," "could,"
"estimate," "expect," "hope," "indicate," "intend," "likely," "may," "might,"
"plan," "potential," "seek," "should," "will," "would," and other variations or
negative expressions thereof, are predictions or estimations and are subject to
known and unknown risks and uncertainties. Numerous factors, including factors
that we have little or no control over, may affect I-Sector's actual results and
may cause actual results to differ materially from those expressed in the
forward-looking statements contained herein. In evaluating such statements,
readers should consider the various factors identified in I-Sector's annual
report on Form 10-K, as filed with the Securities and Exchange Commission
including the matters set forth in Item 1. - "Factors Which May Affect The
Future Results Of Operations," which could cause actual events, performance or
results to differ materially from those indicated by such statements.
GENERAL
We are a leading regional provider of IP telephony and other network
infrastructure and related implementation and support services. The IP telephony
industry is characterized by rapidly evolving and competing technologies. We
compete with larger and better financed entities. Our three principal offices
are located in Texas, and we primarily market to potential customers
headquartered in, or making purchasing decisions from, Texas. Our long-term
goal, however, is to become one of the leading national providers of
Cisco-centric network and IP telephony solutions to enterprises.
We begin Management's Discussion and Analysis of Financial Condition
and Results of Operations with an overview of our strategies for achieving this
goal and becoming profitable. From a financial perspective, these operating
strategies have a number of important implications for our results of operations
and financial condition.
STRATEGY
We plan to improve profitability by implementing the strategies
discussed below. We believe that our strategies will allow us to continue to
increase total revenues. We also believe our strategies will enable us to
improve our gross profit in 2004 by improving our gross margins on INX revenue.
At the same time, we will seek to contain the growth of relatively fixed
components of our selling, and, general and administrative expenses relative to
the growth of revenue so that those components become a relatively smaller
percentage of total revenues. Although selling expenses can generally be
expected to increase in proportion as our revenues increase, we believe that if
we are successful in implementing our strategies, many general and
administrative expenses (such as management salaries, administrative wages and
professional expenses) will decrease as a percentage of our total revenues.
Initially, however, these expenses have increased more rapidly than revenue as
personnel were hired in anticipation of increased demand.
Our key operating strategies are as follows:
o seeking larger, full scale IP telephony implementation
projects, as opposed to smaller pilot projects;
o increasing the gross revenues from our higher gross margin
operations, such as services and Stratasoft custom projects,
as opposed to product sales, which typically produce smaller
gross margins;
o aligning ourselves with Cisco as our exclusive supplier for
the network and IP telephony equipment and technology that we
offer;
o expanding geographically by acquiring complementary businesses
and by opening our own offices; and
o developing and marketing our own computer telephony software
that operates with and augments Cisco-centric IP telephony
products.
19
If we are successful in obtaining larger, full scale IP telephony
implementation projects, we expect that our gross revenues from both products
and services will increase because these projects, by their nature, typically
require a substantially higher level of our services and more products than do
smaller projects. Larger projects, however, can strain our financial resources.
Increases in the size and volume of IP telephony projects we undertake
can also challenge our cash management. For example, larger projects can reduce
our available cash by causing us to carry higher levels of inventory. Larger
projects can also require us to invest our available cash in labor costs. This
is because, in some cases, we do not receive payments from our customers for
extended periods of time. Until customers pay us, all the cash we previously
expended in labor and products on the project remains invested. We expect that
greater amounts of our cash will become invested in accounts receivable in the
future if we are successful in growing our business as we intend.
To meet our cash requirements to support planned growth, we expect to
rely on capital provided from our operations and our credit facility, which is
collateralized by our accounts receivable and substantially all of our assets.
During May 2004, we raised capital through a public offering with net proceeds
of $7.5 million. We used the net proceeds of this offering primarily for working
capital and to repay interest-bearing debt.
Although over 75% of our revenue in 2003 was attributable to product
sales, the gross profit margins on sales of our services have been substantially
higher than those for sales of products, with the exception of sales of our
proprietary Stratasoft software products. In 2003, for example, the gross profit
margin on sales of products by INX was 12.4%, while the gross profit margin on
sales of services by INX for that year was 29.6%. We plan to increase revenue
from services, particularly our post-implementation services for IP Telephony.
The success of this aspect of our strategy largely depends on our ability to
attract and retain highly skilled and experienced employees.
For the last three years, the largest component of our total cost of
sales and service has been purchases of Cisco-centric IP telephony products by
INX. The majority of those purchases were directly from Cisco. We typically
purchase from various wholesale distributors only when we cannot timely purchase
products directly from Cisco. Our reliance on Cisco as the primary supplier for
the network and IP telephony equipment and technology we offer means that our
results of operations from period to period depend substantially on the terms
upon which we are able to purchase these products from Cisco and, to a much
lesser extent, from wholesale distributors of Cisco's products. Therefore, our
ability to manage the largest component of our cost of sales and service is very
limited and depends to a large degree on maintaining and growing our
relationship with Cisco. Our cost of products purchased from Cisco can be
substantially influenced by whether Cisco sponsors sales incentive programs and
whether we qualify for such incentives.
We plan to also grow our business in other geographic areas through
strategic acquisitions of similar businesses or by opening our own offices. This
aspect of our strategy can affect our financial condition and results of
operations in many ways. The purchase price for business acquisitions and the
costs of opening offices may require substantial cash and may require us to
incur long term debt. The expenses of a geographic expansion in an area may well
exceed the revenues attributable to a new business or office for some time, even
if it performs as we expect. Additionally, it is possible that our acquisition
activities may require that we record substantial amounts of goodwill if the
consideration paid for an acquisition exceeds the estimated fair value of the
net identified tangible and intangible assets acquired. To the extent an
acquisition results in goodwill, we will reevaluate the realization of that
goodwill at least annually and adjust it as appropriate. The resulting
adjustment could result in significant non-cash charges to earnings in future
periods.
Developing new or substantially improved computer telephony software
products will likely require us to expend cash and record software development
expenses. Software development costs will likely be expensed because we expect
to incur substantially all costs prior to achieving technological feasibility in
developing a new or substantially improved software product.
MINORITY INTEREST IN INX
Since its formation in 2000 and until April 2004, INX has been our
wholly-owned subsidiary. In April 2004, INX ceased to be a wholly-owned
subsidiary as the result of the issuance of INX common stock to the former
owners of Digital Precision, Inc., which INX acquired in April 2003. In
connection with that acquisition, we agreed to issue to the seller 1.8 million
shares of INX common stock as additional purchase consideration for their
business if certain employees remained employed through April 4, 2004, the first
anniversary of the acquisition. These conditions were met and the INX stock was
issued in April 2004. At the time of issuance of that INX common stock, I-Sector
recognized additional customer list value of $234,000 as an intangible asset to
be amortized over a two year period. When that issuance occurred, our ownership
percentage of INX's common stock declined to approximately 92.4% and I-Sector
recognized $162,000 of minority interest in its balance sheet upon issuance.
INX has also granted stock options to employees of INX to acquire INX
common stock pursuant to a stock option plan for INX employees. Additionally, we
were granted a warrant that entitles us to acquire an additional 1.2 million
shares of INX
20
common stock. The exercise prices for the INX options and our warrant range from
$0.01 to $0.25 with a weighted average exercise price of $0.17. We estimate that
I-Sector's ownership in INX could be reduced to 69.5%, assuming that all of the
INX options are exercised, we exercise our warrant and there are no other
changes in INX's equity.
While the existence of the unexercised INX options and the contingent
obligation to issue INX stock did not result in a minority interest for
accounting purposes through March 2004, the actual issuance of INX stock in
April 2004 resulted in a minority interest. Since I-Sector owns 92.4% of INX's
stock at September 30, 2004, its interest in INX's future profits and losses
have been reduced for the minority share. Under accounting principles generally
accepted in the United States of America, I-Sector's consolidated financial
statements in future periods will reflect a minority interest adjustment of the
otherwise reportable profits and losses of INX by the percentage of minority
ownership in INX. I-Sector's percentage share of any cash dividends or other
distributions paid by INX to its stockholders will likewise be reduced by the
percentage of minority ownership in INX. Additionally, if the percentage of
minority ownership of INX's stock grows as a result of future exercises of INX
options, that increase will cause a corresponding decrease in the reportable
share of INX's profits and losses included in our consolidated financial
statements, and our share of cash dividends and other distributions from INX. At
September 30, 2004, we reflect income attributable to minority interest of
$56,000 in our income statement and a minority interest balance of $218,000 in
our balance sheet.
Unlike the boards of directors of our wholly-owned subsidiaries, the
board of directors of INX is required to be mindful of the interests of INX's
minority stockholders, in addition to our interests, when considering whether to
approve business and financing transactions involving INX. For example, we may
be unable to cause the assets of INX to be pledged as collateral for
indebtedness if the proceeds of that indebtedness disproportionately benefit us
or our other wholly-owned subsidiaries in relation to INX. Conflicts of interest
may reduce our flexibility in structuring business and financing transactions
beneficial to us and our wholly-owned subsidiaries.
Contributions of capital to INX by us, in the form of stock purchases,
which may be necessary to fund INX's growth, could increase our percentage
ownership of INX, but would require capital resources that could be used in
other parts of our business. Because of the minority interest and the potential
increase in the minority interest in INX, we will be required to make capital
contributions to INX on a basis that is, in the good faith judgment of our board
of directors, fair to us and the holders of the minority interest.
Minority stock ownership in INX could also subject us to lawsuits from
its minority stockholders complaining of our actions with respect to INX and its
minority stockholders, even if the actions complained of are ultimately
determined to have been proper. For example, if we choose to cause INX to merge
with, or sell all or substantially all of its assets to, another entity, the
minority stockholders of INX may bring lawsuits seeking to block the transaction
or seeking to exercise statutory dissenters' rights with respect to the
transaction. Whether or not successful, any such actions would cause us to incur
litigation costs and potentially reduce the benefit of any such transaction to
us.
The common stock of INX is not publicly-traded. Accordingly, any shares
of INX common stock issued, including those issued to the former owners of
Digital Precision or upon exercise of INX options, are, and will be for the
foreseeable future, relatively illiquid. For this reason, and to eliminate the
other consequences of having a minority interest in a subsidiary, we believe
that in the future we will offer to exchange INX common stock and stock options
for our common stock or options to acquire our common stock. If we conclude such
a transaction, the aggregate ownership percentage of our common stock by our
stockholders immediately before the conversion or exchange transaction will be
reduced by the percentage of post-transaction ownership acquired by the former
minority stockholders of INX through such exchange transaction. Their
post-transaction ownership may be further reduced by subsequent exercises of
I-Sector stock options that we may choose to exchange for INX stock options.
We cannot predict the percentage of ownership reduction to our
stockholders that may result from any future exchange or conversion of INX stock
and INX options. The ownership reduction resulting from any such transaction
may, however, be significant. We believe this may be the case principally
because:
o we expect that the total number of shares of our common stock
that we would be required to issue in any such transaction
would be approximately equivalent in value, as determined at a
future date, to the value of the INX stock and INX options to
be exchanged at such future date;
o the historical financial effect of INX on our business is
significant, as compared with our other subsidiaries; and
o we expect INX will continue to generate most of our revenue.
If in the future we propose to exchange or convert INX common stock and
INX options into I-Sector common stock or options, we intend to utilize a
special committee of our independent directors to negotiate any exchange ratio
for the transaction with the principal INX minority stockholders and option
holders. The facts and circumstances that the special committee may choose to
consider and the relative weights to be accorded them in negotiating the
relative values of our common stock and INX
21
stock and in negotiating the exchange ratio for any future transaction are
matters that we intend to delegate to the discretion of the special committee.
Accordingly, we cannot presently quantify the amount of any future ownership
reduction that our stockholders may experience in an exchange transaction with
INX stockholders and option holders.
Under some circumstances, we may be required by accounting principles
generally accepted in the United States of America to record substantial
non-cash expenses if we choose to exchange INX stock or INX options into our
common stock or options. We are not now able to determine the amount or timing
of any such charges. This is because those matters will largely depend upon the
timing and terms on which any future exchange would occur, particularly the
exchange ratio negotiated at the time. Because most of our revenues in 2003 were
generated by INX and our expectation is that this will continue for the
foreseeable future, we believe that any resulting non-cash expense charges could
be substantial. Any such future non-cash expense charges could materially and
adversely affect our financial results of operations.
If we determine to undertake a transaction to exchange INX stock or INX
options into our common stock or stock options, we also plan to submit any such
transaction to our stockholders for their approval, even if not required by
Delaware law or the rules of the American Stock Exchange. Even if we believe
that such transaction is in our best interest, our stockholders may refuse to
approve it. If that were to occur, it could disappoint the expectations of those
INX minority stockholders and INX option holders in favor of the transaction,
some of who are currently, and are expected to remain, key employees. This could
cause employee morale and retention problems for us.
RESULTS OF OPERATIONS
Overview
Sources of Revenue. Our revenue is derived from three segments
represented by our three operating subsidiaries, INX, Stratasoft and Valerent.
During the quarter ended September 30, 2004, INX, Stratasoft and Valerent
accounted for 87.9%, 7.8% and 4.9%, respectively, of total consolidated revenue,
and (0.6)% of subsidiary revenue was eliminated in consolidation due to
inter-company transactions. During the nine months ended September 30, 2004,
INX, Stratasoft and Valerent accounted for 83.8%, 9.9% and 7.2%, respectively,
of total consolidated revenue, and (0.9)% of subsidiary revenue was eliminated
in consolidation due to inter-company transactions.
INX revenue consists of product and service revenue. Product revenue
consists of reselling Cisco products and limited amounts of complementary
products by other manufacturers. Service revenue is generated by fees from a
variety of implementation and support services. Product prices for INX are set
by the market for Cisco products, and provide our lowest gross margins. Service
revenue for INX has recently provided a higher gross margin that has generally
increased over the past several years as the cost of INX's technical resources,
which are reflected as a cost of service, has decreased as a percentage of
services revenue. Also, certain fixed and flat fee service contracts that extend
over three months or more are accounted for on the percentage of completion
method of accounting. Historically, the majority of INX's services revenue has
been generated from implementation services, which is project oriented and tends
to be volatile. As the number, frequency and size of INX projects has grown, INX
has achieved better utilization of its engineering resources resulting in
improved gross margins or services. The normal sales cycles for corporate
customers typically ranges from three to six months depending on the nature,
scope and size of the deal involved. However, our direct experience with school
districts involved in E-Rate funding (a governmental funding program for
schools) indicates that the sales lead time is generally about six to twelve
months. In mid-2003, INX introduced Netsurant, its branded support service that
consists primarily of customer service personnel and a support center, and such
new support service offering required an upfront fixed cost to operate a network
operations center to monitor customer's systems. This has created negative gross
margins from this new Netsurant service offering, which we expect will continue
until such time as Netsurant support services revenue exceeds the fixed cost of
operating the network operations center. Eventually, we are hopeful that the
Netsurant support offering could further improve overall services gross margins.
Through September 30, 2004, Netsurant service revenue was not significant.
INX is currently experiencing payment delays associated with the large
DISD project that we announced during June 2004. This project contributed $10.7
million of product revenue to our third quarter and $1.5 million of product
revenue during the second quarter. The amount owed to us as of September 30,
2004 is $12.2 million of accounts receivable. These payment delays are due to
administrative issues within the Schools and Libraries Division of the Universal
Services Administration Corporation (SLD) which is the Federal government
organization that administers the E-Rate program that is funding a majority of
the project. Until the administrative issues causing the payment delays have
been satisfactorily resolved, we recently made the decision to temporarily delay
future product shipments for the DISD project. Since we cannot predict when the
payment delays will be resolved, we do not currently know whether or not we will
recognize any additional product revenue related to this large project during
the fourth quarter. However, if the payment delays are satisfactorily resolved
in a timely manner, then we anticipate that additional product revenue could be
realized during the fourth quarter on the DISD project. Otherwise, we expect the
anticipated product revenue from DISD will be delayed at least until into the
following quarter and maybe into subsequent quarters. In addition to the DISD
project we have several other smaller projects with school districts that are
funded by the E-Rate
22
program, and which payments are also dependent upon a resolution of
administrative issues within SLD. The smaller projects owed accounts receivable
of approximately $1.9 million as of September 30, 2004.
Stratasoft revenue consists primarily of custom project revenue from
the sale of proprietary computer-telephony software. Our Stratasoft revenue is
reported as custom project revenue in our financial statements, because it
consists of products and services which cannot be accounted for separately.
Stratasoft has traditionally provided our highest gross margin since it is
primarily sales of our proprietary computer-telephony software. Our cost of
goods sold for Stratasoft's custom project revenue includes the costs of
developing our computer-telephony software products, installation costs, and the
cost of hardware and other equipment bundled with our software applications and
included in a sale to a customer. Stratasoft revenue also includes sales to
resellers. The sales to resellers are recorded when the sale becomes fixed or
determinable; otherwise revenue from resellers is recorded when payments become
due.
Valerent revenue consists of both product revenue and services revenue.
Product revenue consists of reselling primarily software products, and to a
lesser degree, hardware products, that facilitate Valerent's managed services,
including remote management software products from Altiris, Inc., and security
software products from Network Associates, Inc. Product sales prices for
Valerent are set by the market for these products, and Valerent's product sales
have typically provided lower gross profit margins than its services revenue.
Valerent's services revenue consists of remote and onsite technical assistance
to its customers. Valerent's gross margin on service revenue, much like INX's
implementation services revenue, is subject to variability based upon the
utilization of Valerent's billable technical resources. Recurring service
agreements exist with some customers, but usually with varying terms and
conditions that conform to their year over year business changes and their
specific needs, and while these agreements provide somewhat predictable and
stable sources of revenue, the loss of a recurring agreement could disrupt the
stability of that revenue stream for Valerent.
Gross Profit and Gross Profit Margin. The mix of our various revenue
components, each of which has substantially different levels of gross margin,
materially influences our overall gross profit and gross margin in any
particular quarter. In periods in which service revenue or Stratasoft custom
project revenue are high, as compared to INX and Valerent product sales, our
gross margin generally improves as compared to periods in which we have higher
levels of product sales. Our gross margin for product sales also varies
depending on the type of product sold, the mix of large revenue product
contracts, which typically have lower gross margin, as compared to smaller
revenue product contacts, which typically have higher gross margin.
In addition, our quarterly gross profit and gross margin can be
materially affected by vendor incentives received in certain quarterly periods,
most of which are Cisco incentives received by INX. The incentive programs
sponsored by Cisco currently enable us to qualify for cash rebates or product
pricing discounts. These incentives are generally earned based on sales volume,
sales growth and customer satisfaction levels. The amounts earned under these
programs are recorded as a reduction of cost of goods and can vary significantly
between periods. Currently, incentives by Cisco are paid semiannually, and are
typically paid in the first and third quarters of each calendar year. Incentives
are recognized when we receive payment from the supplier or when we have earned
and can reasonably estimate the amount due from the supplier. During the three
months ended September 30, 2004, we recognized $1.6 million in vendor
incentives, and we accrued $305,000 in commission expense related to the vendor
incentives earned by sales personnel in association with this vendor incentive
program for the quarter. During the nine months ended September 30, 2004, we
recognized $2.3 million in vendor incentives, and approximately $405,000 in
commission expense earned by sales personnel in association with this vendor
incentive program.
A significant portion of our cost of services for each of our service
businesses is comprised of labor. Labor cost related to permanent employees is
generally fixed in the short-term so that higher levels of service revenue
produce higher gross margins while lower levels of service revenue produce lower
gross margins. Our gross margin on services revenue fluctuates from period to
period depending not only upon the prices charged to customers for our services,
but also upon the level of utilization of our technical staff. Management of
labor cost is therefore important in order to maximize gross margin. Our gross
margin is also impacted by such factors as contract size, time and material
pricing versus fixed fee pricing, discounting, vendor incentives and other
business and marketing factors normally incurred during the conduct of business.
Selling, General and Administrative Expenses. Our selling, general and
administrative expenses include both fixed and variable expenses. Relatively
fixed expenses in selling, general and administrative expenses include rent,
utilities, promotion and advertising, and administrative wages. Variable
expenses in selling, general and administrative expenses include sales
commissions and travel, which will usually vary based on our sales and gross
profit. Selling, general and administrative expenses also include expenses which
vary significantly from period to period but not in proportion to sales or gross
profit. These include legal expenses and bad debt expense both of which vary
based on factors that are difficult to predict.
A significant portion of our selling, general and administrative
expenses relate to personnel costs, some of which are variable and others that
are relatively fixed. Our variable personnel costs consist primarily of sales
commissions. Sales commissions are typically calculated based upon our gross
profit on a particular sales transaction and thus generally fluctuate because of
the size of the deal and the mix of associated products and services with our
overall gross profit. Bad debt expense
23
generally fluctuates somewhat in proportion to sales levels, although not always
in the same periods as increases or decreases in sales. Legal expense varies
based on legal issue activity, which can vary substantially from period to
period. The remainder of selling, general and administrative expenses are
relatively fixed and do not vary in direct proportion to increases in revenue.
Acquisition and Disposition. In the second quarter of 2003, INX
acquired the fixed assets, inventory, intellectual property, customer lists,
trademarks, trade names, service marks, contract rights and other intangibles of
Digital Precision. In connection with that acquisition we also assumed leases
for equipment and office space. Our results of operations include those
attributable to Digital Precision on and after April 7, 2003. The initial
purchase price for Digital Precision was $540,000 in cash and contingent
consideration of 1.8 million shares of INX common stock which we agreed to issue
if certain employees remained employed through April 4, 2004, the first
anniversary of the acquisition. In April 2004, we recorded $234,000 of
additional intangible assets in connection with the 1.8 million shares of INX
stock we issued to satisfy the contingent purchase price obligation.
The sale of our computer reselling and PBX telephone systems reselling
business in early 2000 and the sale of our IT Staffing business in 2001 resulted
in a gain on disposal. Since the sale of these businesses, we have realized, in
various periods, income and expense from discontinued operations that has been
primarily a result of litigation expenses and settlement of litigation related
to our discontinued operations. We expect the income and expense from
discontinued operations to decrease over time and to eventually be eliminated
after these matters are fully resolved.
Tax Loss Carryforward. Because of our operating losses in 2003, we have
accumulated a net operating loss carryforward for federal income tax purposes
that, as of September 30, 2004, was approximately $2.4 million and is available
to offset future federal and state taxable income. This carryforward expires in
2023. In addition to potential expiration, there are several factors that could
limit or eliminate our ability to use these carryforwards. For example, under
Section 382 of the Internal Revenue Code of 1986, as amended, use of prior net
operating loss carryforwards is limited after an ownership change. This type of
change could result from the offering we completed during May 2004, either alone
or in combination with other prior or subsequent offerings of equity securities.
If we achieve sustained profitability, which may not happen, the use of net
operating loss carryforwards would reduce our tax liability and increase our net
income and available cash resources. When all operating loss carryforwards have
been used or have expired, we would again be subject to increased tax expense
and reduced earnings due to such tax expense.
Period Comparisons. The following tables set forth, for the periods
indicated, certain financial data derived from our consolidated statements of
operations. Percentages shown in the table below are percentages of total
revenue, except for each individual segment's cost of sales and services, gross
profit, selling, general and administrative expenses, and operating income,
which are percentages of the respective segment's revenue, and the product and
service components of the INX and Valerent segments' cost of goods sold and
gross profit, which are percentages of such segment's respective product and
service revenue.
24
---------------------------------------------
Three months ended September 30,
---------------------------------------------
2003 2004
-------------------- ---------------------
Amount % Amount %
-------- -------- --------- ---------
(DOLLARS IN THOUSANDS)
Revenue:
INX product ....................................... $ 15,954 76.0 $ 27,179 83.3
INX service ....................................... 1,392 6.6 1,516 4.6
-------- -------- -------- --------
Total INX revenue ........................ 17,346 82.6 28,695 87.9
-------- -------- -------- --------
Stratasoft - Custom projects ...................... 2,415 11.5 2,531 7.8
-------- -------- -------- --------
Valerent product .................................. 515 2.5 288 0.9
Valerent service .................................. 877 4.2 1,310 4.0
-------- -------- -------- --------
Total Valerent revenue ................... 1,392 6.7 1,598 4.9
Eliminations revenue .......................... (172) (0.8) (212) (0.6)
-------- -------- -------- --------
Total revenue ....................... 20,981 100.0 32,612 100.0
Cost of sales and service:
INX product ....................................... 13,758 86.2 23,251 85.5
INX service ....................................... 795 57.1 1,099 72.5
-------- -------- -------- --------
Total INX cost of sales and service ...... 14,553 83.9 24,350 84.9
Stratasoft - Custom projects ...................... 728 30.1 1,323 52.3
-------- -------- -------- --------
Valerent product .................................. 474 92.0 292 101.4
Valerent service .................................. 606 69.1 750 57.3
-------- -------- -------- --------
Total Valerent cost of sales and service.. 1,080 77.6 1,042 65.2
Eliminations of cost of sales and service ...... (171) 99.4 (212) 100.0
-------- -------- -------- --------
Total cost of sales and service ..... 16,190 77.2 26,503 81.3
Gross profit:
INX product ................................... 2,196 13.8 3,928 14.5
INX service ................................... 597 42.9 417 27.5
-------- -------- -------- --------
Total INX gross profit ................... 2,793 16.1 4,345 15.1
Stratasoft - Custom projects ...................... 1,687 69.9 1,208 47.7
-------- -------- -------- --------
Valerent product .................................. 41 8.0 (4) (1.4)
Valerent service .................................. 271 30.9 560 42.7
-------- -------- -------- --------
Total Valerent gross profit .............. 312 22.4 556 34.8
-------- -------- -------- --------
Eliminations gross profit ...................... (1) (0.6) -- 0.0
-------- -------- -------- --------
Total gross profit ................. 4,791 22.8 6,109 18.7
Selling, general and administrative expenses:
INX ............................................... 2,126 12.3 3,332 11.6
Stratasoft ........................................ 1,754 72.6 1,419 56.1
Valerent .......................................... 455 32.7 522 32.7
Corporate ......................................... 287 N/A 183 N/A
Eliminations ...................................... (1) N/A -- N/A
-------- -------- -------- --------
Total selling, general and administrative expenses .. 4,621 22.0 5,456 16.7
Operating income (loss):
INX ............................................... 667 3.8 1,013 3.5
Stratasoft ........................................ (67) (2.8) (211) (8.3)
Valerent .......................................... (143) (10.3 34 2.1
Corporate ......................................... (287) N/A (183) N/A
-------- -------- -------- --------
Total operating income ................... 170 0.8 653 2.0
Interest and other income (expense), net ........... (11) (0.1) 17 0.0
-------- -------- -------- --------
Income from continuing operations before income taxes 159 0.8 670 2.0
Income tax expense (benefit) ........................ (12) (0.1) 2 0.0
-------- -------- -------- --------
Net income from continuing operations before minority
interest .......................................... 171 0.8 668 2.0
Minority interest ................................... -- 0.0 (50) (0.1)
Discontinued operations:
Gain on disposal, net of taxes ...................... 23 0.1 -- 0.0
-------- -------- -------- --------
Net income .......................................... $ 194 0.9 $ 618 1.9
======== ======== ======== ========
25
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
Total Revenue. Our total revenue, net of intercompany eliminations,
increased by $11.6 million, or 55.4%, from $21.0 million to $32.6 million.
INX revenue increased by $11.4 million, or 65.4%, from $17.3 million to
$28.7 million. As a percentage of total revenue, INX revenue increased 5.3% from
82.6% to 87.9%. Product revenue increased $11.2 million, or 70.0% from $16.0
million to $27.2 million. INX service revenue increased $124,000 or 8.9% from
$1.4 million to $1.5 million. The increase in product sales is attributed to the
adoption of IP telephony technology by our customers requiring equipment
upgrades for implementation and our performance of the DISD contract. Product
sales to DISD have been delayed until we have a resolution of the payment issues
impacting this project, and we expect lower product revenue from the DISD
project in subsequent quarters until this issue is resolved. The increase in
services is attributed to an increase in the number of IP Telephony projects
which have higher service content than traditional network infrastructure
projects, as well as the IP telephony service contract in Iraq.
Stratasoft revenue increased by $116,000, or 4.8%. As a percentage of
total revenue, Stratasoft revenue decreased from 11.5% to 7.8%. Stratasoft's
international sales accounted for 6.4% of Stratasoft's revenue as compared to
28.2% in 2003. Stratasoft has its own internally managed sales force, but it
also utilizes dealer agreements from time to time with certain established
resellers in domestic and international markets that do not require the
continued involvement of our personnel. Stratasoft derived $182,000 or 7.2% of
its revenue from sales to resellers during the quarter which compares with
$104,000 or 4.3% of its revenue in 2003.
Valerent revenue increased by $206,000, or 14.8%, from $1.4 million to
$1.6 million. As a percentage of total revenue, Valerent revenue decreased from
6.7% to 4.9%. The increase in Valerent revenue was primarily attributable to
increased service revenue of $433,000 and offset by a decrease in product sales
of $227,000. The increase in service revenue is primarily attributable to
development of Altiris enabled remote managed services. to be operated by
clients and the delivery by Valerent of remote managed services for clients,
which was primarily related to Valerent making changes to its business model so
that it no longer pursued certain non-strategic sources of services revenue.
Gross Profit. Our total gross profit increased by $1.3 million, or
27.5%, from $4.8 million to $6.1 million. However, our gross margin decreased
from 22.8% to 18.7%, primarily due to the lower gross margin of our INX and
Stratasoft subsidiaries which is discussed below, as well as an increase, as
percentage of total revenue of product sales revenue as compared to service
revenue and custom project revenue each of which of higher gross margin than
product sales..
INX gross profit increased $1.5 million, or 55.6%, from $2.8 million to
$4.3 million. INX's gross margin decreased from 16.1% to 15.1%. INX's gross
profit on its product sales component increased $1.7 million or 78.9%, from $2.2
million to $3.9 million due to increased product sales revenue attributable to
DISD and a vendor incentive program rebate of $1.6 million . INX's gross profit
on its service component decreased $180,000, from $597,000 to $417,000, and
service gross margin decreased from 42.9% to 27.5%, as a result of lower margin
DISD service revenue.
Stratasoft gross profit decreased by $479,000, or 28.4%, from $1.7
million to $1.2 million. Stratasoft's gross margin decreased from 69.9% to
47.7%. Stratasoft gross profit was impacted by the mix of sales between "systems
sales," which include a hardware component, as compared to "software only"
sales, which do not have a hardware component. Stratasoft's decreased gross
profit is primarily due to a decreased "software only" component relative to the
"systems sales" component of total Stratasoft sales and to the deferral of
revenue associated with notes in excess of twelve months.
Valerent gross profit increased by $244,000, or 78.2%, from $312,000 to
$556,000. Valerent's gross margin increased from 22.4% to 34.8%. Valerent's cost
of service consists primarily of fixed labor cost that does not fluctuate
directly with changes in revenue. Valerent improved its utilization of its labor
pool by reducing the number of technicians employed, relative to revenue, and
lowered its fixed cost, which contributed to improved gross profits.
26
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $835,000, or 18.1% from $4.6 million to
$5.5 million. As a percentage of total revenue, these expenses decreased 5.3%,
from 22.0% to 16.7%.
These expenses were primarily increased by the following:
o Sales compensation increased $414,000 due to additional
personnel and increased commissions generated from the increase
in gross profit.
o Administrative compensation expense increased $258,000 due to
bonuses of $125,000 and the hiring of additional personnel at
INX in Houston and Dallas, Texas; and for the addition of the
San Antonio, Texas office. Stratasoft hired personnel in
Houston, Texas.
o General office expenses increased $146,000 due to our Dallas,
Texas office relocation expenses and general office expenses.
o Office rent increase $93,000 due to the relocation of our
Dallas, Texas offices and the addition of the San Antonio,
Texas office
o Contract labor expense increased $55,000 due to $30,000
contracted programming work for Stratatsoft and $25,000 of
contracted marketing work for Valerent.
o Payroll tax expense increased $50,000 in line with the increase
in compensation expenses.
o Entertainment increased $45,000 primarily from a $25,000
customer seminar for Stratasoft, a $10,000 increase in meals
for Valerent traveling technicians and $10,000 in corporate
entertainment.
o Travel increased $42,000 primarily from increased international
travel for Stratasoft and increased technician travel for INX
and Valerent.
o Depreciation increased $35,000 due to asset additions and the
Digital Precision acquisition in April 2003 and the additional
purchase value for the Digital Precision intangible of April
2004.
o Shareholder relations increased $16,000 due to attending
investor conferences and visiting investor groups. Employee
education increase $14,000 due to INX technician training and
Stratasoft programmer training.
o Telephone and communication expenses increased $13,000
primarily due to INX office growth and relocation.
These expenses were primarily decreased by the following:
o Bad debt expense decreased $191,000 due to the recoveries of
bad debt and decreases in allowances based on the aging of
receivables and credit worthiness of customers.
o Legal and professional fees decreased $133,000 primarily
because of the settlement of Stratasoft's EEOC claim in the
prior year.
o Promotion and advertising decreased $22,000 due to the
reduction of Stratasoft's promotional programs.
We expect our future selling, general and administrative expenses
to increase as we ramp up for compliance with the provisions of the
Sarbanes--Oxley Act of 2002 as well as our continued ramp up for the anticipated
revenue growth expected within our INX subsidiary.
Operating Profit. Operating profit increased $483,000 or 284.1% from
$170,000 to $653,000, primarily due to the $1.4 million increase in gross profit
being offset by the $835,000 increase in selling, general and administrative
expenses. INX's operating profit increased $346,000, or 51.9% from $667,000 to
$1.0 million. Stratasoft's operating profit decreased $144,000, or 214.9% from a
loss of $67,000 to a loss of $211,000. Valerent's operating profit increased
$177,000, from a loss of $143,000 to a profit of $34,000. The operating loss for
the Corporate Segment decreased $104,000, from a loss of $287,000 to a loss of
$183,000.
Interest and Other Income, Net. Interest and other income, net,
increased by $28,000 from expense of $11,000 to income of $17,000. Our total
borrowings under the Textron credit facility increased from $7.8 million to $16
million and the interest bearing portion of our borrowings increased from zero
to $6.1 million from June 30, 2004 to September 30, 2004, respectively. During
the quarter interest expense of $16,000 and a $2,000 loss on disposition of
assets was offset by foreign exchange gains of $18,000 and interest income of
$17,000.
Minority interest. Income attributable to minority interest increased
from $0 to $50,000. During April 2004 the company issued 1,800,000 shares of INX
common stock pursuant to the Digital Precision purchase agreement of April 2003.
Approximately 7.6% of INX's net income is deducted from the consolidated net
income of I-Sector as a result of their minority interest in INX.
Net income. Net income increased $424,000, or 218.6% from $194,000 to
$618,000. The income tax expense for the period was $2,000, and there is a net
operating tax loss carryforward of approximately $2.4 million as of September
30, 2004, but net deferred tax assets are fully offset by a valuation allowance
at September 30, 2004.
27
Discontinued Operations. During 1999, we discontinued our Telecom
Systems business. On March 16, 2000, we entered into an agreement to sell
certain assets of, and the ongoing operation of, our Computer Products Division.
The sale transaction closed on May 19, 2000. On December 31, 2000, we sold our
IT Staffing business. As a consequence of these events, the operations of these
businesses are reported as discontinued operations. For the quarter ended
September 30, 2003, the gain (loss) on disposal related to these three
businesses was $56,000, ($33,000) and $0, net of taxes and tax benefits of
$29,000, ($17,000) and $0 for a net total of $35,000. For the quarter ended
September 30, 2004 the gain on disposal related to these three businesses was
negligible. The gains and/or losses on disposal in 2003 and 2004 related to
these discontinued operations are primarily related to collections of accounts
receivables retained when these businesses were sold.
28
---------------------------------------------
Nine months ended September 30,
---------------------------------------------
2003 2004
-------------------- --------------------
Amount % Amount %
---------- ------ --------- -------
(DOLLARS IN THOUSANDS)
Revenue:
INX product ...................................... $ 34,795 74.1 $ 53,594 77.9
INX service ...................................... 2,725 5.8 4,054 5.9
-------- -------- -------- --------
Total INX revenue ...................... 37,520 79.9 57,648 83.8
-------- -------- -------- --------
Stratasoft - Custom projects ..................... 5,995 12.8 6,837 9.9
-------- -------- -------- --------
Valerent product ................................. 1,219 2.6 1,127 1.6
Valerent service ................................. 2,562 5.5 3,825 5.6
-------- -------- -------- --------
Total Valerent revenue ................. 3,781 8.1 4,952 7.2
Eliminations revenue ......................... (364) (0.8) (663) (0.9)
-------- -------- -------- --------
Total revenue ...................... 46,932 100.0 68,774 100.0
Cost of sales and service:
INX product ...................................... 30,448 87.5 46,073 86.0
INX service ...................................... 2,068 75.9 2,833 69.9
-------- -------- -------- --------
Total INX cost of sales and service .... 32,516 86.7 48,906 84.8
Stratasoft - Custom projects ..................... 2,104 35.1 3,171 46.4
-------- -------- -------- --------
Valerent product ................................. 1,090 89.4 1,062 94.2
Valerent service ................................. 1,789 69.8 2,354 61.5
-------- -------- -------- --------
Total Valerent cost of sales and service 2,879 76.1 3,416 69.0
Eliminations of cost of sales and service .... (362) 99.5 (663) 100.0
-------- -------- -------- --------
Total cost of sales and service .... 37,137 79.1 54,830 79.7
Gross profit:
INX product .................................. 4,347 12.5 7,521 14.0
INX service .................................. 657 24.1 1,221 30.1
-------- -------- -------- --------
Total INX gross profit ................. 5,004 13.3 8,742 15.2
Stratasoft - Custom projects ..................... 3,891 64.9 3,666 53.6
-------- -------- -------- --------
Valerent product ................................. 129 10.6 65 5.8
Valerent service ................................. 773 30.2 1,471 38.5
-------- -------- -------- --------
Total Valerent gross profit ............ 902 23.9 1,536 31.0
-------- -------- -------- --------
Eliminations ..................................... (2) (0.5) -- 0.0
-------- -------- -------- --------
Total gross profit ................. 9,795 20.9 13,944 20.3
Selling, general and administrative expenses:
INX .............................................. 4,518 12.0 7,534 13.1
Stratasoft ....................................... 4,694 78.3 3,570 52.2
Valerent ......................................... 1,551 41.0 1,398 28.2
Corporate ........................................ 795 N/A 689 N/A
Eliminations ..................................... (2) N/A -- N/A
-------- -------- -------- --------
Total selling, general and administrative expenses . 11,556 24.6 13,191 19.2
Operating income (loss):
INX .............................................. 486 1.3 1,208 2.1
Stratasoft ....................................... (803) (13.4) 96 1.4
Valerent ......................................... (649) (17.2) 138 2.8
Corporate ........................................ (795) N/A (689) N/A
Eliminations ..................................... -- N/A -- N/A
-------- -------- -------- --------
Total operating income (loss) ........... (1,761) (3.8) 753 1.1
Interest and other income, net ..................... 93 0.2 10 0.0
-------- -------- -------- --------
Income (loss) from continuing operations before
income taxes ..................................... (1,668) (3.6) 763 1.1
Income tax benefit ................................. (93) (0.2) -- 0.0
-------- -------- -------- --------
Net income (loss) from continuing operations before
minority interest ................................ (1,575) (3.4) 763 1.1
Minority interest .................................. -- 0.0 (56) (0.0)
Discontinued operations:
Gain on disposal, net of taxes ..................... 39 0.1 1 0.0
-------- -------- -------- --------
Net income (loss) .................................. $ (1,536) (3.3) $ 708 1.0
======== ======== ======== ========
29
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2004
Total Revenue. Our total revenue, net of intercompany eliminations,
increased by $21.9 million, or 46.5%, from $46.9 million to $68.8 million.
INX revenue increased by $20.1 million, or 53.6%, from $37.5 million to
$57.6 million. As a percentage of total revenue, INX revenue increased from
79.9% to 83.8%. Product revenue increased $18.8 million, or 54.0% from $34.8
million to $53.6 million. INX service revenue increased $1.4 million, or 48.8%
from $2.7 million to $4.1 million. The increase in services is attributed to an
increase in the number of IP Telephony projects which have higher service
content than traditional network infrastructure projects, as well as the IP
telephony service contract in Iraq. The increase in product sales is attributed
to the adoption of IP telephony technology by our customers requiring equipment
upgrades for implementation, and the DISD project. Our product sales for the
DISD project have been delayed because of payment issues, and this delay may
decrease product revenue for subsequent quarters until the payment issues are
resolved and product sales are resumed.
Stratasoft revenue increased by $842,000, or 14.0%. As a percentage of
total revenue, Stratasoft revenue decreased from 12.8% to 9.9%. Stratasoft's
international sales accounted for 20.2% of Stratasoft's revenue as compared to
43.8% in 2003. Stratasoft has its own internally managed sales force, but it
also utilizes dealer agreements from time to time with certain established
resellers in domestic and international markets that do not require the
continued involvement of our personnel. Stratasoft derived $739,000 or 10.8% of
its revenue from sales to resellers during the nine months of 2004 which
compares with $783,000 or 13.1% of its revenue in 2003. Sales to resellers are
included in revenue when the fees are fixed and determinable; otherwise revenue
from resellers is deferred and recognized when the payment becomes due.
Valerent revenue increased by $1.2 million, or 31.6%, from $3.8 million
to $5.0 million. As a percentage of total revenue, Valerent revenue decreased
from 8.1% to 7.2%. The increase in Valerent revenue was primarily attributable
to increased service revenue of $1.3 million offset by a decrease in product
sales of $92,000. The increase in service revenue is primarily attributable to
development of remote services for clients to operate themselves, the sale of
the underlying technology to support remote management, and Valerent delivered
remote managed services on behalf of clients, which was primarily related to
Valerent making changes to its business model so that it no longer pursued
certain non-strategic sources of services revenue. Valerent's business model now
focuses on identifying and developing markets with enterprise customers.
Gross Profit. Our total gross profit increased by $4.1 million, or
42.3%, from $9.8 million to $13.9 million. However, our gross margin has
decreased from 20.9% to 20.3%, primarily due to the decrease in gross margin in
our Stratasoft subsidiary as discussed below, as well as an increase, as
percentage of total revenue of product sales revenue as compared to service
revenue and custom project revenue each of which of higher gross margin than
product sales.
INX gross profit increased $3.7 million, or 74.7%, from $5.0 million to
$8.7 million. INX's gross margin increased from 13.3% to 15.2%. INX's gross
profit on its product sales component increased $3.2 million or 73.0%, from $4.3
million to $7.5 million due to increased product sales revenue and a vendor
incentive program rebate of $2.3 million. INX's gross profit on its service
component increased $564,000, from $657,000 to $1.2 million, and service gross
margin improved from 24.1% to 30.1%, as a result of increased service revenue of
$1.3 million with a somewhat fixed cost of service component due to improved
utilization of technical personnel.
Stratasoft gross profit decreased by $225,000, or 5.8%, from $3.9
million to $3.7 million. Stratasoft's gross margin decreased from 64.9% to
53.6%. Stratasoft gross profit was impacted by the mix of sales between "systems
sales", which include a hardware component, as compared to "software only"
sales, which do not have a hardware component. Stratasoft's decreased gross
profit is primarily due to a decreased "software only" component relative to the
"systems sales" component of total Stratasoft sales and to the deferral of
revenue associated with notes in excess of twelve months. Software only sales
include sales to reseller customers and do not require the continuing
involvement of our personnel.
Valerent gross profit increased by $634,000, or 70.3%, from $902,000 to
$1.5 million. Valerent's gross margin increased from 23.9% to 31.0%. Valerent's
cost of service consists primarily of fixed labor cost that does not fluctuate
directly with changes in revenue. Valerent improved its utilization of its labor
pool by reducing the number of technicians employed, relative to revenue, and
lowered its fixed cost, which contributed to improved gross profits.
30
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $1.6 million, or 14.1% from $11.6 million
to $13.2 million. As a percentage of total revenue, these expenses decreased
5.4%, from 24.6% to 19.2%.
These expenses were primarily increased by the following:
o Sales compensation increased $1.2 million due to additional
personnel as the result of the Digital Precision acquisition in
April 2003 and increased commissions generated from the
increase in gross profit, and it also includes approximately
$405,000 in earned commissions by sales personnel in
association with the Cisco vendor incentive program.
o Administrative compensation expense increased $800,000 due to
bonuses of $288,000, settlement of an EEOC claim for $25,000
the hiring of additional personnel at INX in Houston and
Dallas, Texas; and for the addition of the San Antonio, Texas
office. Stratasoft hired personnel in Houston, Texas and
Canada.
o Payroll tax expense increased $165,000 in line with the
increase in compensation expenses.
o Rents increased $146,000 due to additional office space in
Dallas and San Antonio, Texas.
o General office expense increased $125,000 primarily from office
and employee relocation expenses and increased printing costs.
o Depreciation expense increased $120,000 due to asset additions
and the Digital Precision acquisition in April 2003.
o Shareholder relations expense increased $64,000, due to
employing a shareholder relations firm, attending investor
conferences and visiting investor groups, however this expense
was partially offset by a $165,000 reduction related to the
revaluation of the non-employee stock option compensation for
the investor relation consultant.
o Entertainment expense increased $53,000 due to a customer
seminar sponsored by Stratasoft and employees meals incurred
while traveling.
These expenses were primarily decreased by the following:
o Bad debt expense decreased $887,000 due to recoveries of bad
debt and decreases in allowances based on the aging of
receivables and credit worthiness of customers.
o Insurance expense decreased $102,000 because of policy and rate
changes
o Contract labor expense decreased $58,000 primarily from
Stratasoft terminating contract labor in India offset by
$55,000 for technicians and programmers.
We expect our future selling, general and administrative expenses
to increase as we ramp up for compliance with the provisions of the
Sarbanes--Oxley Act of 2002 as well as our continued ramp up for the anticipated
revenue growth expected within our INX subsidiary.
Operating Profit. Operating profit increased approximately $2.5
million, from a $1.8 million loss to an $753,000 profit, primarily due to the
$4.3 million increase in gross profit being offset by the $1.6 million increase
in selling, general and administrative expenses. INX's operating profit
increased $722,000, or 148.6% from $486,000 to $1.2 million. Stratasoft's
operating profit increased $899,000, or 112.0% from a loss of $803,000 to a
profit of $96,000. Valerent's operating profit increased $787,000 or 121.3%,
from a loss of $649,000 to a profit of $138,000. The operating loss for the
Corporate Segment decreased $106,000 or 13.3%, from a loss of $795,000 to a loss
of $689,000 due to reallocation of professional fees to the subsidiaries.
Interest and Other Income, Net. Interest and other income, net,
decreased by $83,000 or 89.2%, from $93,000 to $10,000, primarily due to the
2003 sale for $80,000 of an internet domain. Our borrowings under the Textron
credit facility increased from $7.6 million to $16 million while the interest
bearing portion of our borrowings increased from $1.7 million at December 31,
2003 to $6.1 million at September 30, 2004. Interest expense of $69,000 and a
$24,000 loss on the disposition of assets was offset by interest income of
$70,000 and foreign exchange gain of $33,000.
Minority interest. Income attributable to minority interest increased
from $0 to $56,000. During April 2004 the company issued 1,800,000 shares of INX
common stock pursuant to the Digital Precision purchase agreement of April 2003.
Approximately 7.6% of INX's net income is deducted from the consolidated net
income of I-Sector as a result of their minority interest in INX.
Net income. Net income increased $2.2 million, or 146.7% from a $1.5
million net loss to net income of $708,000. The income tax benefit for the
period was zero, and there is a net operating tax loss carryforward of
approximately $2.4 million as of September 30, 2004.
31
Discontinued Operations. During 1999, we discontinued our Telecom
Systems business. On March 16, 2000, we entered into an agreement to sell
certain assets of, and the ongoing operation of, our Computer Products Division.
The sale transaction closed on May 19, 2000. On December 31, 2000, we sold our
IT Staffing business. As a consequence of these events, the operations of these
businesses are reported as discontinued operations. For the nine months ended
September 30, 2003, the gain (loss) on disposal related to these three
businesses was $65,000, ($53,000) and $26,000, net of taxes and tax benefits of
$33,000, ($27,000) and $14,000, for a net total of $58,000. For the nine months
ended September 30, 2004 the gain (loss) on disposal related to these three
businesses was ($1,000), $3,000 and $0, net of taxes and tax benefits of
($1,000), $2,000 and $0, for a net total of $1,000. The gains and/or losses on
disposal in 2003 and 2004 related to these discontinued operations are primarily
related to collections of accounts receivables retained when these businesses
were sold.
32
LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity
Our principal sources of working capital are collections from our
accounts and notes receivable, and our credit facility with Textron Financial
Corporation (the "Textron Facility"). We use the Textron Facility to finance the
majority of our purchases of inventory, and to provide working capital when our
cash flow from operations is insufficient. During the nine month period ending
September 30, 2004, we experienced negative cash flow from operating activities
of $8.8 million as compared to $700,000 use for the nine months ended September
30, 2003. Our working capital was $3.7 million and $12.0 million at December 31,
2003 and September 30, 2004, respectively.
During May 2004, we closed a public offering of 500,000 Units. The
Units began trading on May 7, 2004, on the American Stock Exchange under the
symbol ISR.U. Each Unit consists of two shares of common stock and one warrant
to purchase one share of common stock at a price of $12.45. The Units were
offered at a public offering price of $16.60 per Unit resulting in $8.3 million
of proceeds less 9% underwriter discount of $747,000 and underwriter expenses of
$9,000 for a net amount before additional offering expenses of $7.5 million.
During June 2004 the underwriters exercised their option to purchase
75,000 additional Units to cover over-allotments resulting in $1.2 million of
proceeds less 9% underwriter discount of $112,000 for a net amount before
additional offering expenses of $1.1 million. We paid approximately $1.1 million
of additional expenses associated with the public offering as of September 30,
2004. Net proceeds after all underwriter discounts and expenses, and after all
additional offering expenses were approximately $7.5 million.
Accounts and Notes Receivable. The timing of our collection of accounts
and notes receivable and payments of our accounts payable is one of the
principal influences on our cash flow from operations. Payments on the DISD
project have been delayed by administrative issues within the SLD, which
administers the E-Rate funding program of the DISD and other independent school
districts. This has resulted in us carrying accounts receivable balances of
approximately $14.1 million related E-Rate funded work longer than we
anticipated, and it has required us to delay future product shipments until the
E-Rate funded payments begin to occur. Also, it has created interest bearing
debt and decreased our ability to borrow under the Textron Floorplan finance
agreement. We do anticipate receiving payment in full on all E-Rate funded
accounts receivable balances, however, we are not currently able to predict with
any certainty when payment will occur, or the impact it will have on our ability
to finance other projects required to grow our revenue in future periods. We
typically sell our products and services on short-term credit terms. We try to
minimize our credit losses by performing credit checks, obtaining letters of
credit in certain instances, and conducting our own collection efforts.
We had trade accounts receivable, net of allowance for doubtful
accounts, of $9.8 million and $27.0 million at December 31, 2003 and September
30, 2004, respectively.
Our Stratasoft subsidiary has accepted customer notes receivable as
part of its consideration for certain of its custom projects sales. At December
31, 2003 and September 30, 2004, Stratasoft had net notes receivable of $928,000
and $1.9 million, respectively. The following table shows the breakdown of the
total notes receivable:
DECEMBER 31 SEPTEMBER 30
2003 2004
----------- ------------
(DOLLARS IN THOUSANDS)
-------- --------
Current portion of notes receivable, gross ........... $ 1,049 $ 1,926
Allowance for doubtful notes ......................... (373) (346)
------- -------
Current portion of notes receivable, net ............. 676 1,580
------- -------
Long term portion of notes receivable, gross ......... 502 580
Allowance for doubtful notes ......................... (250) (250)
------- -------
Long-term portion of notes receivable, net ........... 252 330
------- -------
Total notes receivable, net .......................... $ 928 $ 1,910
======= =======
Alternatively, our Stratasoft subsidiary also has other sales that
require payment to occur after more than 90 days but less than twelve months
from the date of the sale. Those outstanding balances are classified as accounts
receivable in the accompanying balance sheets.
Inventory. We had inventory of $1.0 million and $1.4 million at
December 31, 2003 and September 30, 2004, respectively. We try to minimize the
amount of inventory on hand to reduce the risk that the inventory will become
obsolete or decline in value. We have been able to do this by relying on the
ready availability of products from our principal suppliers. As noted above, we
rely principally on our Textron Facility to finance our inventory purchases.
33
Textron Facility. On January 31, 2002, we entered into the Textron
Facility to provide financing for our inventory purchases. On September 30,2004
the plan was amended and the maximum credit available under the Textron facility
is presently $25 million and it is collateralized by substantially all of our
assets other than our patent licenses.
As of September 30, 2004, we owed $16.0 million under the Textron
Facility and had an additional $8.3 million available subject to borrowing base
restrictions. Under the revised agreement the aggregate outstanding principal
amount of all Floorplan Loans shall not, at any time, exceed the sum of (a) 80%
of the aggregate net invoice prices of all Eligible Receivables plus (b) (i) for
so long as the Borrower is discharging its undertakings in respect of the Master
Dallas Independent School District Contract (DISD) or any DISD Receivable is
owing to it, 90% of the invoice price of (1) all Floorplanned Inventory and (2)
all DISD Inventory that is Eligible Inventory, provided that the sum of the
amounts in clauses (1) and (2) above shall be limited to the lesser of $9,000 or
35% of the net invoice prices of all outstanding Eligible Receivables and (ii)
after the Borrower has discharged its undertakings in respect of the Master DISD
Contract and all DISD Receivables owing to it have been paid, the least of (1)
90% of the invoice price of all Floorplanned Inventory, (2) 30% of the net
invoice prices of all outstanding Eligible Receivables and (3) $6,000. Borrower
shall, within two (2) Business Days of the aggregate outstanding principal
amount of the Floorplan Loans exceeding at any time the aforesaid sum, prepay
the Floorplan Loans in an aggregate principal amount sufficient so that this
covenant shall not be violated.
We use the Textron Facility to finance purchases of Cisco products from
Cisco and from certain wholesale distributors. Cisco provides 60-day terms, and
other wholesale distributors typically provide 30-day terms. Balances under the
Textron Facility that are within those respective 60-day and 30-day periods (the
"Free Finance Period") do not accrue interest and are classified as accounts
payable in our balance sheet. We refer to non-interest bearing balances as
"inventory floor plan borrowings."
To the extent that we have credit availability under the Textron
Facility, it gives us the ability to extend the payment terms past the Free
Finance Period. Amounts extended past the Free Finance Period accrue interest
and are classified as notes payable on our balance sheet. These extended payment
balances under the Textron Facility accrue interest at the prime rate (4.75% at
September 30, 2004) plus 2.5%. Because payment cycles of sales to school
districts under the E-Rate program often extend beyond 60 days, and because such
payment cycles have recently extended even further due to administrative issues
with the organization that makes payments to vendors for the E-Rate program, we
expect we will continue to carry extended payment balances under the Textron
Facility for at least the next several quarters. The total outstanding balance
under the Textron Facility at September 30, 2004 was $16.0 million. $9.9 million
of the outstanding balance was within the Free Finance Period and therefore is
reflected as accounts payable in our balance sheet at September 30, 2004. $6.1
million with accrued interest of $15,000 is reflected as notes payable and
accrued expense, respectively, at September 30, 2004.
The Textron Facility contains restrictive covenants that are measured
at each quarter end. These covenants require us to:
o maintain Minimum Tangible Capital Funds of $9.5 million, which
is defined to be the sum of cash, receivables, inventory and
fixed net assets, minus total liabilities, with total
liabilities being defined as accounts payable, accrued expenses
and short- and long-term notes payable;
o maintain a maximum Debt to Tangible Capital Funds ratio of 4.0
to 1;
o maintain Minimum Working Capital of not less than $8.0 million;
o maintain Minimum Cash on Hand of not less than $2.0 million;
o maintain a Current Ratio of not less than 1.25 to 1.0;
o achieve Earnings Before Interest, Tax, Depreciation and
Amortization exceeding $100,000; and
o enter into a Memorandum of Understanding (MOU) by November 15,
2004 with Micro System Enterprise, Inc. (MSE) and Textron among
other members of the DISD consortium regarding payment
procedures under the Master DISD Contract.
At September 30, 2004, we were in compliance with the loan covenants,
and we anticipate that we will be able to comply with the loan covenants during
the next twelve months. If we violate any of the loan covenants, we would be
required to seek waivers from Textron and Silicon Valley Bank (a participating
partner with Textron) for those non-compliance events. If Textron or Silicon
Valley Bank refused to provide waivers, the amount due under the Textron
Facility could be accelerated and we could be required to seek other sources of
financing.
34
Contractual Obligations
The following table summarizes certain of our contractual cash
obligations and related payments due as of September 30, 2004:
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
LESS THAN MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
- ------------------------------------- ------ ------ --------- ----------- -------
Lease obligations (1) ................................ $2,511 $ 193 $1,804 $ 411 $ 103
Textron, interest bearing debt ....................... 6,114 6,114 -- -- --
Other debt obligations ............................... 251 94 157 -- --
------ ------ ------ ------ ------
Total contractual cash obligations ................... $8,876 $6,401 $1,961 $ 411 $ 103
====== ====== ====== ====== ======
(1) Expected payments for base Dallas lease obligation are
approximately $ - for 2004, $157,000 for 2005, $205,000 for 2006, $241,000 for
2007, $255,000 for 2008, $264,000 for 2009 and $110,000 for 2010. Expected
payments for the base San Antonio lease obligation are approximately $17,000 for
2004, $34,000 for 2005, $34,000 for 2006 and $17,000 for 2007. These amounts are
reflected in the contractual obligations schedule shown above.
During the second quarter of 2004 the INX and Valerent Dallas, Texas
offices occupied new office space under a six year lease obligation. The
approximate previous annual lease payment for the INX was $108,000. During the
third quarter INX opened and occupied an office in San Antonio, Texas.
We do not have any material contractual purchase obligations. We
purchase inventory to fulfill in-hand orders from customers and we try to
minimize the amount of inventory on hand to reduce risk that the inventory will
become obsolete or decline in value. We are able to do this by relying on the
ready availability of products from our principal suppliers.
We expect to be able to meet our contractual cash payment obligations
by their due dates through cash generated from operations, augmented, if needed,
by borrowings under the Textron Facility, and through the proceeds from our
public offering.
Cash Flows. During the nine months ended September 30, 2004, our cash
increased by $2.3 million. Operating activities used $8.8 million, investing
activities used $912,000 and financing activities provided $12.0 million.
Operating Activities. Operating activities used $8.8 million in the
nine months ended September 30, 2004 as compared to using cash of $700,000 in
2003. The cash used in 2004 was primarily related to the $10.6 million net
growth of assets over the net growth in liabilities which was offset by $913,000
of non-cash expenses and net income of $836,000.
Changes in asset and liability accounts used $10.6 million. The most
significant use of working capital related to:
o $17.5 million increase in accounts receivable. Days in sales
outstanding increased by 16 days from 57 days at December 31,
2003 to 73 days at September 30, 2004 primarily due to
completion of INX E-Rate funded projects relating to school
districts.
o Notes receivables increased $935,000 due to Stratasoft
accepting two notes as consideration from two of its customers.
o Contracts in progress which increased $425,000 due to an
increase in cost and estimated earnings in excess of billings
of $241,000, which was primarily related to an increase in the
Stratasoft custom projects in process at period-end.
o Inventory increased $382,000 primarily due INX staging Cisco
products for upcoming projects and Stratasoft purchasing dial
logic cards for upcoming projects.
These uses of cash were partially offset by:
o Increases in accounts payable of $5.7 million, which related
primarily to increased purchases of Cisco products for sales by
INX and inventory by Stratasoft.
o The $2.1 million increase in accrued expense is primarily
related to accruing for sales commissions, wages and bonuses;
third party commissions and professional fees.
o The decrease in other current assets of $480,000 primarily
related to the return of bid deposits for INX bids on school
projects and the amortization of prepaid consultant fees.
o The $496,000 increase in deferred revenue results from $685,000
for software products sold on notes that are not due within
twelve months of the note origination, a $48,000 net increase
in unused service revenue, and
35
$45,000 of sales to resellers offset by $398,000 credit to a
reseller in May 2004. Revenue from deferred sales will be
recognized in the accounting periods that payments from the
customer are received.
Investing Activities. Investing activities used $912,000 in 2004
compared to a use of $809,000 for 2003. Our investing activities related to
capital expenditures used $912,000 in 2004. Capital expenditures during both
periods were primarily related to purchases of computer equipment and software,
and to a lesser degree, leasehold improvements. During the next twelve months,
we do not expect to incur significant capital expenditures requiring cash,
except possibly for acquisitions, of which we cannot predict the certainty or
magnitude.
Financing Activities. Financing activities provided $12.0 million in
2004 as compared to using $28,000 in 2003. In 2003, our stock price increased
substantially, resulting in stock option holders exercising stock options, which
provided $95,000 in 2003. During January 2004, the company repaid $1.7 million
of interest-bearing debt under the Textron Facility. During the nine months
ended September 30, 2004, another $1.2 million of debt under the Textron
Facility became interest-bearing in March 2004 and was repaid in May 2004, and
during September 2004 another $6.1 million became interest bearing.
On May 12, 2004 we closed a public offering of 500,000 Units. The Units
began trading on May 7, 2004, on the American Stock Exchange under the symbol
ISR.U. Each Unit consists of two shares of common stock and one warrant to
purchase one share of common stock at a price of $12.45. The Units were offered
at a public offering price of $16.60 per Unit resulting in $7.5 million of
proceeds before additional offering expenses. On June 2, 2004 the underwriters
exercised their option to purchase 75,000 additional Units to cover
over-allotments resulting in $1.1 million of proceeds before additional offering
expenses. We paid $1.1 million of additional offering expenses associated with
the public offering as of September 30, 2004 resulting in net proceeds from the
public offering of $7.5 million. We intend to use the net proceeds of this
offering primarily for working capital and to repay interest-bearing debt.
RELATED PARTY TRANSACTIONS
We lease office space from Allstar Equities, Inc., a Texas corporation
("Equities"), a company wholly owned by James H. Long, our Chief Executive
Officer. On December 1, 1999 Equities purchased our corporate office building
and executed a direct lease with us with an expiration date of December 31,
2004. In conjunction with Equities obtaining new financing on the building, a
new lease was executed with us on February 1, 2002 with an expiration date of
January 31, 2007. The new lease has a rental rate of $37,192 per month.
From time to time we make short-term loans and travel advances to our
employees. The balance of approximately $16,000 and $16,000 relating to these
loans and advances is included in the Company's balance sheet and reported as
part of Accounts receivable - affiliates at December 31, 2003 and September 30,
2004.
36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We incur certain market risks related to interest rate variations
because we hold floating rate debt. Based upon the average amount of debt
outstanding during the nine months ended September 30, 2004, a one-percent
increase in interest rates paid by us on our floating rate debt would have
resulted in a $2,000 increase in interest for the period.
Our business depends upon our ability to obtain an adequate supply of
products and parts at competitive prices and on reasonable terms. Our suppliers
are not obligated to have product on hand for timely delivery to us nor can they
guarantee product availability in sufficient quantities to meet our demands.
INX's business is Cisco centric. Any material disruption in our supply of
products could have a material adverse effect on our financial condition and
results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of certain members of
our management, including our Chairman of the Board, Chief Executive Officer and
principal financial officer, we completed an evaluation of the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) to the Securities Exchange Act of 1934, as
amended (the "Exchange Act")). Based on that evaluation, we and our management
have concluded that, except as discussed in the following paragraph, our
disclosure controls and procedures at the end of the period covered by this
report were effective to ensure that information required to be disclosed by us
in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the SEC, and are designed to ensure that information required
to be disclosed by us in these reports is accumulated and communicated to our
management, as appropriate to allow timely decisions regarding required
disclosures.
In connection with their audit of the consolidated financial statements
for the year ended December 31, 2003, Grant Thornton LLP ("Grant Thornton"), our
independent accountants, identified and reported to the audit committee of the
board of directors certain internal control deficiencies that Grant Thornton
considered to be significant deficiencies under the standards established by the
American Institute of Certified Public Accountants and the SEC. The identified
internal control deficiencies relate to (i) a material weakness involving
contemporaneous documentation of all terms related to revenue transactions and
conclusions regarding customer creditworthiness and (ii) a significant
deficiency with respect to the review of significant agreements by our
accounting personnel in order to monitor compliance with their terms.
We have taken corrective actions to address these internal control
deficiencies, by implementing the following measures:
o established improved procedures for the review of revenue
recognition policies and contract management polices and
procedures;
o held formalized training of finance and sales staff; and
o hired an additional person in our accounting department.
In the nine months of 2004, there have been no other changes in our
internal control over financial reporting that have materially affected, or are
likely to materially affect, our internal control over financial reporting.
37
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 2002, Inacom Corp. ("Inacom") filed a lawsuit in the District
Court of Douglas County, Nebraska styled Inacom Corp v. I-Sector Corporation,
f/k/a Allstar Systems, Inc., claiming that I-Sector owed the sum of
approximately $570,000 to Inacom as a result of Inacom's termination of a Vendor
Purchase Agreement between Inacom and I-Sector. I-Sector believes that the claim
is without merit and intends to vigorously contest the demand.
In March 2003, I-Sector and other parties were notified of a demand for
return of payments relating to the business activities of a call center
customer. In March 2004, I-Sector was informed by the claimant that claims will
not be pursued at this time. I-Sector believes that the claims against it, if
re-initiated, are without merit and intends to vigorously contest any demands
related to this matter.
I-Sector is also party to other litigation and claims which management
believes are normal in the course of its operations. While the results of such
litigation and claims cannot be predicted with certainty, I-Sector believes the
final outcome of such matters will not have a materially adverse effect on its
results of operations or financial position.
38
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) Exhibits
3.1 Bylaws of the Company Incorporated by reference from exhibit
3.1 to Amendment 2 to Form S-1, Registration No. 333-09789,
filed October 3, 1996
3.2 Certificate of Incorporation of the Company Incorporated by
reference from exhibit 3.2 to Amendment 1 to Form S-1,
Registration No. 333-09789, filed September 19, 1996
3.3 Certificate of Amendment to Certificate Incorporated by
reference from exhibit 3.4 to Amendment of Incorporation of
Allstar Systems, Inc., 5 to Form S-1, Registration No.
333-09789, filed dated June 24, 1997 June 26, 1997
3.4 Certificate of Amendment to Certificate Incorporated by
reference from exhibit 3.3 to Form 8-A t of Incorporation of
Allstar Systems, filed December 29, 2003 Inc., dated March 5,
1999.
3.5 Certificate of Amendment to Certificate Incorporated by
reference from exhibit 3.4 to Form 8-A t of Incorporation of
Allstar Systems, Inc. filed December 29, 2003 dated July 10,
2000.
10.1 Loan and Securities Agreement dated September 30, 2004 among
Textron, I-Sector and its subsidiaries.
31.1 Certification of CEO and CFO pursuant to Rule 13a-14(a)
32.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of
James H. Long
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
I-Sector Corporation.
Date November 15, 2004 By: /s/ JAMES H. LONG
-----------------------------
James H. Long, Chief Executive
Officer, Chief Financial Officer,
and Chairman of the Board
By: /s/ JEFFREY A. SYLVESTER
-----------------------------
Jeffrey A. Sylvester, Secretary
and Controller
39