FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-21479
I-SECTOR CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0515249
(State of incorporation) (I.R.S. Employer Identification No.)
6401 SOUTHWEST FREEWAY
HOUSTON, 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___
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Title Outstanding
Common Stock, $.01 par value per share As of August 13, 2001
3,629,525 shares outstanding
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
June 30, December 31,
2002 2001
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,616 $ 3,434
Accounts receivable, net 5,921 4,302
Accounts receivable - affiliates 225 250
Accounts receivable - other 56 21
Notes Receivable 901 169
Inventory 723 587
Cost and estimated earnings in excess of billings 1,001 1,695
Income taxes receivable 1,330 151
Other current assets 215 302
Total current assets 11,988 10,911
Property and equipment 1,233 1,226
Intangible assets 1,258 1,356
Other assets 54 55
Total $ 14,533 $ 13,548
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt $ 237 $ 213
Accounts payable 2,749 1,772
Billings in excess of cost and estimated earnings 53 72
Accrued expenses 2,118 2,091
Net liabilities related to discontinued operations 438 654
Deferred service revenue 98 126
Total current liabilities 5,693 4,928
Long term debt 306 410
Deferred credit - stock warrants 195 195
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,
4,441,325 and 4,441,325 shares issued at
June 30, 2002 and December 31, 2001 44 44
Additional paid in capital 10,184 10,184
Treasury stock (811,800 and 591,800 shares, at cost)
at June 30, 2002 and December 31, 2001 (1,373) (1,187)
Retained earnings (516) (1,026)
Total stockholders' equity 8,339 8,015
Total $ 14,533 $ 13,548
See notes to consolidated financial statements
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Ended June 30,
2002 2001
Total revenue $ 10,260 $ 5,399
Cost of sales and services 8,553 4,119
Gross profit 1,707 1,280
Selling, general and administrative expenses 2,014 2,544
Operating loss (307) (1,264)
Interest and other income (7) 61
Loss from continuing operations before
benefit for income taxes (314) (1,203)
Benefit for income taxes (7) (159)
Net loss from continuing operations (307) (1,044)
Discontinued Operations:
Net loss from discontinued operations, net of taxes (41)
Gain on disposal, net of taxes 12 348
Net loss $ (295) $ (737)
Net income (loss) per share:
Basic and Diluted:
Net loss from continuing operations $ (0.08) $ (0.26)
Net loss from discontinued operations (0.02)
Gain on disposal, net of taxes 0.00 0.09
Net loss per share $ (0.08) $ (0.19)
Weighted average shares outstanding:
Basic and Diluted 3,733,481 3,905,944
See notes to consolidated financial statements
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
Six Months Ended June 30,
2002 2001
Total revenue $ 19,468 $ 10,000
Cost of sales and services 15,527 7,626
Gross profit 3,941 2,374
Selling, general and administrative expenses 4,636 5,363
Operating loss (695) (2,989)
Interest and other income (2) 157
Loss from continuing operations before
(benefit ) for income taxes (697) (2,832)
Benefit for income taxes (1,189) (122)
Net income (loss) from continuing operations 492 (2,710)
Discontinued Operations:
Net loss from discontinued operations, net of taxes (112)
Gain on disposal, net of taxes 18 348
Net income (loss) $ 510 $ (2,474)
Net income (loss) per share:
Basic:
Net income (loss) from continuing operations $ 0.13 $ (0.69)
Net loss from discontinued operations (0.03)
Gain on disposal, net of taxes 0.00 0.09
Net income (loss) per share $ 0.13 $ (0.63)
Diluted:
Net income (loss) from continuing operations $ 0.13 $ (0.69)
Net loss from discontinued operations (0.03)
Gain on disposal, net of taxes 0.00 0.09
Net income (loss) per share $ 0.13 $ (0.63)
Weighted average shares outstanding:
Basic 3,791,182 3,926,002
Diluted 3,794,563 3,926,002
See notes to consolidated financial statements
I-SECTOR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended June 30,
2002 2001
Net income (loss) $ 510 $ (2,474)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Net loss from discontinued operations 112
Gain on disposal of discontinued operations (18) (348)
Depreciation and amortization 324 300
Loss on retirement of assets 15
Current tax benefit (10) (179)
Changes in assets and liabilities that provided
(used) cash:
Accounts receivable, net (1,619) (418)
Accounts receivable - affiliates 25 22
Accounts receivable - other (35) 61
Inventory (113) 212
Income tax receivable (1,179)
Notes receivable (756)
Other current assets 87 72
Cost and estimated earnings in excess of billings 694
Other assets 60
Accounts payable 977 (806)
Accrued expenses 27 573
Billings in excess of cost and estimated earnings (19) 70
Deferred service revenue (28) (21)
Net cash used in continuing operating
activities (1,119) (2,764)
Net operating activities from discontinued activities (211) (319)
Net cash used in operating activities (1,330) (3,083)
Cash flows from investing activities:
Acquisition costs (50)
Capital expenditures (223) (136)
Proceeds from sales of discontinued operations 525
Net cash used in investing activities: (223) 339
Cash flows from financing activities:
Purchase of treasury stock (186) (162)
Payments on long-term debt (80)
Net cash used in financing activities: (266) (162)
Net decrease in cash and cash equivalents (1,818) (2,906)
Cash and cash equivalents at beginning of period 3,434 8,346
Cash and cash equivalents at end of period $ 1,616 $ 5,440
Supplemental disclosures of cash flow information:
Cash paid for interest $ 0 $ 0
Cash paid for taxes $ 0 $ 0
See notes to consolidated financial statements
I-SECTOR CORPORATION AND SUBSIDIARIES
NOTES TO 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") are engaged in the
business of providing computer services and of selling associated hardware and
telephony software products. I-Sector's operations are conducted through three
segments:
o Allstar Solutions, Inc. ("Allstar"), a wholly-owned subsidiary, provides
customers with turn-key outsourced IT helpdesk solutions, helpdesk
solutions consulting services, on-site and carry-in computer repair,
application support, operating system support and network migration
services, network support and management, network design and
implementation, IT project management, and technical staff augmentation for
IT helpdesk operations.
o Internetwork Experts, Inc. ("INX"), a wholly-owned subsidiary, is a network
infrastructure professional services provider and an integrator of network
infrastructure products manufactured by Cisco Systems, Inc. ("Cisco").
INX's areas of practice include network baseline assessment, network
design/architecture, implementation, network security audits and firewall
design, network management, project management and knowledge transfer.
o Stratasoft, Inc. ("Stratasoft"), a wholly-owned subsidiary, creates and
markets software related to the integration of computer and telephone
technologies. Stratasoft's products are designed to improve the efficiency
of a professional call center or other type of high volume calling
application, for both inbound and outbound calls.
A substantial portion of I-Sector's sales and services are authorized under
arrangements with product manufacturers. I-Sector's operations are dependent
upon maintaining its approved status with such manufacturers. Should I-Sector's
approved status lapse, revenues and gross profit could be adversely affected.
The condensed consolidated financial statements presented herein as of and
for the three months and six months ended June 30, 2002 and 2001 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. Accounting measurements at interim dates inherently involve greater
reliance on estimates than at year-end. The results of the interim periods are
not necessarily indicative of results for the full year. The consolidated
balance sheet at December 31, 2001 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
disclosure normally included in the notes to the financial statements has been
condensed or omitted as permitted by the rules and regulations of the Securities
and Exchange Commission.
Reclassifications - Certain amounts in the consolidated financial
statements presented herein have been reclassified to conform to current year
presentation.
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 - Revenue from the sale of products is recognized when
the product is shipped. Service income is recognized as the services are
performed. Revenues resulting from installations of systems including equipment
and software for which duration is in excess of three months and that require
substantial modification or customization are recognized using the
percentage-of-completion method. The percentage of revenue recognized on each
contract is determined principally on the basis of the relationship of the cost
of work performed on the contract to estimated total costs. Revisions of
estimates are reflected in the period in which the facts necessitating the
revisions become known; when a contract indicates a loss, a provision is made
for the total anticipated loss.
The following reflects the amounts relating to uncompleted contracts at
June 30, 2002 and December 31, 2001:
Costs incurred on uncompleted contracts $ 730 $ 995
Estimated earnings 1,518 1,930
2,248 2,925
Less: Billings to date 1,300 1,158
Cost and estimated earnings in excess of billings $ 1,001 $ 1,695
Billings in excess of cost and estimated earnings $ 53 $ 72
Accounting Pronouncements -
In April 2002, The Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4,44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS No. 145, among other things, amends SFAS No. 4 and
SFAS No. 64, to require that gains and losses from the extinguishments of debt
generally be classified within continuing operations. The provisions of SFAS No.
145 are effective for fiscal years beginning after May 15, 2002 and early
application is encouraged. The Company does not believe that the adoption of
SFAS No. 145 will have a significant impact on its financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 replaces Emerging
Issues Task Force (EITF" Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity". This standard
requires companies to recognized costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This statement is effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does not
believe that the adoption of SFAS No. 146 will have a significant impact on its
financial statements.
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, $50 for the ongoing
operations of IT Staffing, Inc. and $2 for certain fixed assets of I-Sector. The
note receivable bears interest at 5% per annum and is collectible in
installments based on the total monthly revenue of the buyer over 24 months
beginning in March, 2002. A disposal loss, including an estimate of the
operating results from the measurement date, November 6, 2001 to the closing
date of the sale of $17, and estimates for impairment of assets caused by the
disposal decision of $43, totaling $11 (net of income tax savings of $5), was
recognized in 2001. A loss of $1 (net of tax benefit of $1) recognized in the
quarter ended June 30, 2002. I-Sector has retained accounts receivable of $82
and $0, net of reserves, at December 31, 2001 and June 30, 2002, respectively.
The balance sheet caption "Net Liabilities related to discontinued operations"
contains $80 and $37 at December 31, 2001 and June 30, 2002, respectively.
Previously, on March 16, 2000, I-Sector entered into an agreement to sell
certain assets of and the ongoing operations of its Computer Products Division.
The sale transaction closed on May 19, 2000 after shareholder and other required
consents were obtained. Additionally on November 2, 1999, I-Sector approved a
plan to sell or close its Telecom Division and that business was sold on March
16, 2000.
During the quarter ended June 30, 2002, I-Sector recognized a net gain
(loss) on disposal of these three businesses as follows:
IT Staffing, Inc. (net of tax benefit of $1) $ (1)
Computer Products Division (net of taxes of $4) 8
Telecom Division (net of tax of $3) 5
Net gain on disposal $ 12
The balance sheet caption "Net Liabilities related to discontinued
operations" contains $438 and $654 at June 30, 2002 and December 31, 2001,
respectively, of estimated future expenses related to the winding up of the IT
Staffing business, the Telecom Division and the Computer Products Division, and
includes amounts related to settlement of pending litigation and to Telecom
warranties.
3. SEGMENT INFORMATION
I-Sector has four reportable segments: Allstar, INX, Stratasoft and
Corporate. Corporate is not an 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 views 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
Elimination column in the following table. The tables below show the results of
the four reportable segments:
For the quarter ended June 30, 2002:
Allstar INX Stratasoft Corporate Elimination Consolidated
Total revenue $ 1,227 $ 7,430 $ 1,657 $ $ (54) $10,260
Cost of sales and services 914 6,822 871 (54) 8,553
Gross profit 313 608 786 0 1,707
Selling, general and
administrative expenses 501 691 675 147 0 2,014
Operating (loss) income $ (188) $ (83) $ 111 $ (147) $ 0 (307)
Interest and other income (7)
Loss before benefit for income tax (314)
Benefit for income tax (7)
Net loss from continuing operations (307)
Net gain on disposal, net of taxes 12
Net loss $ (295)
Accounts receivable, net $ 717 $ 4,080 $ 1,122 $ 2 $ 0 $ 5,921
Inventory $ 63 $ 168 $ 492 $ 0 $ 0 $ 723
For the quarter ended June 30, 2001:
Allstar INX Stratasoft Corporate Elimination Consolidated
Total revenue $ 1,178 $ 2,646 $ 1,590 $ 1 $ (16) $ 5,399
Cost of sales and services 982 2,326 826 (14) (1) 4,119
Gross profit (loss) 196 320 764 15 (15) 1,280
Selling, general and
administrative expenses 741 783 653 382 (15) 2,544
Operating (loss) income $ (545) $ (463) $ 111 $ (367) $ 0 (1,264)
Interest and other income 61
Loss before provision for income tax (1,203)
Benefit for income tax (159)
Net loss from continuing operations (1,044)
Net loss from discontinued operations,
net of taxes (41)
Net gain on disposal, net of taxes 348
Net loss $ (737)
Accounts receivable, net $ 812 $ 1,856 $ 1,992 $ (4) $ 0 $ 4,656
Accounts receivable retained from
discontinued operations, net 235
Total accounts receivable, net $ 4,891
Inventory $ 61 $ 84 $ 545 $ 0 $ 0 $ 690
Inventory retained from discontinued
operations 2
Total Inventory $ 692
For the six months ended June 30, 2002:
Allstar INX Stratasoft Corporate Elimination Consolidated
Total revenue $ 2,692 $13,143 $ 3,828 $ $ (195) $19,468
Cost of sales and services 2,064 11,950 1,708 (195) 15,527
Gross profit 628 1,193 2,120 0 3,941
Selling, general and
administrative expenses 1,154 1,480 1,686 316 0 4,636
Operating (loss) income $ (526) $ (287) $ 434 $ (316) $ 0 (695)
Interest and other income (2)
Loss before benefit for income tax (697)
Benefit for income tax (1,189)
Net income from continuing operations 492
Net gain on disposal, net of taxes 18
Net income $ 510
For the six months ended June 30, 2001:
Allstar INX Stratasoft Corporate Elimination Consolidated
Total revenue $ 2,394$ 4,364 $ 3,272 $ (3) $ (27) $10,000
Cost of sales and services 2,062 4,040 1,536 (12) 7,626
Gross profit (loss) 332 324 1,736 (3) (15) 2,374
Selling, general and
administrative expenses 1,681 1,391 1,399 907 (15) 5,363
Operating (loss) income $(1,349) $(1,067) $ 337 $ (910) $ 0 (2,989)
Interest and other income 157
Loss before provision for income tax (2,832)
Benefit for income tax (122)
Net loss from continuing operations (2,710)
Net loss from discontinued operations,
net of taxes (112)
Net gain on disposal, net of taxes 348
Net loss $(2,474)
International sales accounted for $716 or 7.0% and $1,458 or 7.5% of
consolidated revenues and 43.2% and 45.7% of the Stratasoft segment revenues in
the three months and six months ended June 30, 2002, respectively. In the three
months and six months ended June 30, 2001 international sales accounted for $204
or 3.8% and $478 or 1.8% of consolidated revenues and 12.8% and 14.6% of the
Stratasoft segment revenues. International sales are derived from Southern Asia,
Africa, United Kingdom and Canada.
The following table represents the reconciliation of products and services
included in total revenues:
Reconciliation of Products and Services
Three Months Ended June 30,
2002 2001
Product revenue $ 8,924 $ 3,784
Service revenues 1,336 1,615
Total revenues $10,260 $ 5,399
Six Months Ended June 30,
2002 2001
Product revenue $16,563 $ 6,917
Service revenues 2,905 3,083
Total revenues $19,468 $ 10,000
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.
The potentially dilutive options of 30,817 for the three months ended June
30, 2002 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 totaling 1,190 for the six months
ended June 30, 2002 were calculated under the treasury stock method.
There were warrants to purchase 176,750 shares of common stock for the
three months and six ended June 30, 2002 and 2001 which were not included in
computing diluted earnings per share because the inclusion would have been
antidilutive.
5. CURRENT DEBT OBLIGATIONS
On September 27, 2001, Stratasoft, a subsidiary of I-Sector, 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 asset and has recorded interest of
$8 and $16 in the three months and six months ended June 30, 2002. This note is
collaterized by Stratasoft's patent assets and Stratasoft has granted a security
interest to its pending patent application and the next two patent applications
filed by Stratasoft. In connection with this note payable, I-Sector has reported
short-term debt maturing within one year of $224 and long-term debt of $289 at
June 30, 2002.
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 reported short-term debt maturing within one
year of $13 and long-term debt of $17 at June 30, 2002.
On January 31, 2002 I-Sector entered into a credit agreement with Textron
Financial Corporation ("Textron") for a revolving line of credit (the "Textron
Facility"). The initial total credit available under the Textron facility was
$2,500 subject to borrowing base limitations that are generally computed as 80%
of eligible accounts receivable, and 90% of identifiable inventory purchased
under this agreement and 40% of all other inventory. On June 19, 2002 Textron
increased the total credit available under the Textron facility to $4,000. In
connection with the increase in the credit line, a modification was made to the
borrowing base limitations that restricted the eligibility of accounts
receivable for collateralization by disallowing as eligible any customer's
receivables in their entirety that have balances over 90 days old and that
exceed 25% of their total balance. I-Sector may use up to $500 of the line for
working capital advances under approved conditions. Borrowings accrue interest
at the prime rate plus 2.5% on outstanding balances that extend beyond the
vendor approved free interest period and on working capital advances from date
of advance. This agreement is collaterized by substantially all of I-Sector's
assets except its patent assets. The agreement contains restrictive covenants,
which require us to maintain minimum tangible capital funds and a minimum debt
to tangible capital funds ratio. At June 30, 2002 I-Sector was in compliance its
loan covenants. Inventory floor plan borrowings are reflected in accounts
payable on the accompanying balance sheets. At June 30, 2002, I-Sector had $337
outstanding on inventory floor plan finance borrowings, $0 outstanding on
working capital advances and had total credit availability of $3,663.
6. LITIGATION
In July 2000, Benchmark Research and Technology, Inc. made a verbal claim
against I-Sector, claiming that I-Sector breached its contract with Benchmark,
and that I-Sector was negligent and breached various warranties, committed fraud
and violated the Deceptive Trade Practices Act. The case was mediated in
November 2000 but no agreement was reached. I-Sector knows of no lawsuit being
filed. In July, 2002 Benchmark offered to settle with I-Sector for $40 and
I-Sector is studying the offer. In the event that the settlement is not
accepted, I-Sector intends to vigorously contest the demand.
In October 2000, I-Sector's wholly-owned subsidiary, Stratasoft, Inc.,
filed suit in the Harris County Texas County Court of Law against its customer
Accelerated Telemarketing for a remaining balance of $47 on its contract.
Thereafter, Accelerated Telemarketing filed a separate legal action claiming
breach of contract, breach of warranty, violation of the Deceptive Trade
Practices Act and other claims. In July 2002, Stratasoft and Accelerated
Telemarketing reached agreement in principle to settle the legal actions
pending. Such settlement agreement is anticipated to have no future impact to
net income.
In October 2001, Inacom Corp. wrote a demand letter 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 is unaware
of a formal lawsuit being filed, although one has been threatened. I-Sector
believes that the demand is without merit and intends to vigorously contest the
demand.
I-Sector had filed a claim to collect on a note receivable from E Z Talk
Communications ("E Z Talk") and had recently entered into arbitration
discussions with E Z Talk. In July, 2002 E Z Talk filed a lawsuit to set aside
the arbitration and claiming damages of $250. I-Sector intends to vigorously
contest the suit.
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.
7. INCOME TAX BENEFIT
On March 9, 2002, President Bush signed into law the Job Creation and
Worker Assistance Act of 2002. The new law provides for the carryback of net
operating losses for any taxable year ending during 2001 and 2002 to each of the
5 tax years preceding the loss year. Previously, a net operating loss was only
eligible to be carried back to the 2 years preceding the year of loss. As a
result of the change in the carryback period, I-Sector recognized a tax benefit
of $1,179 in the six months ended June 30, 2002. On July 26, 2002 the Company
received $1,123 in tax refunds.
8. RELATED PARTY TRANSACTIONS
I-Sector has from time to time made payments on behalf of Allstar Equities,
Inc., a Texas corporation ("Equities"), which is wholly-owned by its President
and Chief Executive Officer, on his behalf personally, for taxes, property and
equipment. Effective on December 1, 1999 a note payable by Equities was signed
for $336 for 60 monthly installments of $7. The note bears interest at 9% per
year. At June 30, 2002 and December 31, 2001, the Company's receivables from
Equities amounted to approximately $122 and $159, respectively. Additionally,
from time to time the Company has made payments to unrelated parties, primarily
for use of a credit card, for transactions that either wholly or partially
benefit the Company's President and Chief Executive Officer and which therefore
are accounted for as indebtedness from him to the Company and on which he pays
interest of 6% per annum on the average outstanding balance. The balance of
approximately $95 and $80 is included in the Company's balance sheet and
reported as part of Accounts receivable - affiliates at June 30, 2002 and
December 31, 2001, respectively.
In order to comply with the Sarbanes-Oxley Act of 2002, the Company has
determined that the payments for the President and Chief Executive Officer's use
of a credit card for transactions that wholly or partially benefit him may be
deemed to constitute a demand loan. Therefore, in order to be in complete
compliance, the Company has recently made a demand for repayment of the such
balances related to the President and CEO's personal credit card usage, which is
discussed above and is classified in Accounts Receivable - affiliates in the
Company's balance sheet at June 30, 2002 and December 31, 2001.
The Company leases office space from Equities. 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
new lease has rental rates reduced from $37,692 to $37,192 per month.
From time to time I-Sector obtains an independent survey of real estate
rental rates and consult with real estate consulting firms to determine market
rates of facilities that are comparable to the Houston headquarters facility.
The Company believes that the rental rate and other terms of our lease from
Equities are at least as favorable as those that could be obtained in an
arms-length transaction with an unaffiliated third party.
The Company furnishes a company-owned automobile for the President and
Chief Executive Officer's business and personal use.
From time to time I-Sector makes short-term loans and travel advances to
its employees. The balance of approximately $8 and $11 relating to these loans
and advances is included in the Company's balance sheet and reported as part of
Accounts receivable - affiliates at June 30, 2002 and December 31, 2001,
respectively.
Each of I-Sector's subsidiaries has a stock incentive plan in place. One of
the subsidiaries has granted to certain employees and to management of such
subsidiary as an incentive award. Under its plan such options vest ratably over
three to five years. The quantity of incentive options granted to management
personnel are determined based on the percentage of predetermined financial
goals that they attain. Any unvested stock options vest immediately upon the
occurrence of a liquidity event for that subsidiary. The options expire ten
years after the grant date if they are not exercised. The stock option grants
are subject to dilution when I-Sector purchases additional shares of the
subsidiary stock in order to keep the subsidiary capitalized. At June 30, 2002,
5,449,500 options granted by that subsidiary are outstanding with an issue price
of $ .01, which represents potential dilution of I-Sectors investment in that
subsidiary of 22.9%.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
I-SECTOR CORPORATION
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 Form 10-K, previously
filed with the Securities and Exchange Commission. All monetary amounts
discussed in Items 2 through 5 are in thousands.
Overview
Our revenue is derived from three segments. Allstar Solutions, Inc.
("Allstar") provides customers with on-site and carry-in computer repair,
application support, operating system and network migration services, turnkey
outsourced IT helpdesk solutions, technical staff augmentation for IT helpdesk
operations and helpdesk solutions consulting services. Internetwork Experts,
Inc. ("INX") focuses on the design, deployment and support of networking
infrastructure. INX provides professional services for customers that have
large-scale network infrastructure requirements that are Cisco centric. The
areas of practice for INX include network design, implementation, turnkey
support, security audits and firewall design, network infrastructure management
and network infrastructure consulting services. Stratasoft, Inc. ("Stratasoft")
develops and markets proprietary software that integrates business telephone
systems and networked computer systems. Stratasoft's basic products are
sometimes customized to suit a customer's particular needs and are sometimes
bundled with computer hardware supplied by us at the customer's request.
Stratasoft products include software for call center management, both in-bound
and out-bound, as well as interactive voice response software.
Allstar and INX market our services to businesses in Texas from locations
in the Houston and Dallas-Fort Worth metropolitan areas. Stratasoft markets its
products worldwide through a direct sales force and an authorized dealer
network. During the three months ended June 30, 2002, Allstar and INX produced
12.0% and 72.4% of total revenues, while Stratasoft produced 16.1% of total
revenues. During the six months ended June 30, 2002, Allstar and INX produced
13.8% and 67.5% of total revenues, while Stratasoft produced 19.7% of total
revenues. Gross margin varies substantially between each of these business
segments.
On November 6, 2001 we determined to exit the IT Staffing business.
Effective December 31, 2001, the business was sold to Echelon Staffing, Inc., a
corporation formed by the former President of It Staffing. Under the terms of
the sale we received a note for $52, of which $50 was for the ongoing operations
and $2 for certain fixed assets relating to this business. The note bears
interest at 5% per annum and is collectible in installments based on the total
monthly revenue of the buyer over 24 months beginning in March 2002. In the
three month period ended December 31, 2001, we recognized a disposal loss of $11
(net of tax of $5), including an estimated loss for the operating results from
the measurement date, November 6, 2001 to the closing date of the sale of $37,
and estimates for impairment of assets caused by the disposal decision of $34.
We retained accounts receivable of $82, net of reserves and liabilities related
to the IT Staffing business at December 31, 2001. Retained accounts receivable
are $0 at June 30, 2002.
Our ability to attract and retain qualified professional and technical
personnel is critical to the success of all of our services operations. The most
significant portion of the costs associated with the delivery of services is
personnel costs. Therefore, in order to be successful, our billable rates must
be in excess of the personnel costs and our margin is dependent upon maintaining
high utilization of our service personnel. In addition, the competition for high
quality personnel has generally intensified, causing both our and other service
provider's personnel costs to increase. In markets where we do not maintain
branch offices, we often subcontract for necessary technical personnel.
A significant portion of our cost of services for each of our service
businesses is comprised of labor. Labor cost related to permanent employees has
a somewhat fixed nature such that higher levels of service revenue produces
higher gross margin while lower levels of service revenue produces less gross
margin. Management of labor cost is important in order to prevent erosion of
gross margin.
A significant portion of our selling, general and administrative expenses
in all of our businesses relate to personnel costs, some of which are variable
and others of which are relatively fixed. Our variable personnel costs are
substantially comprised of sales commissions, which are typically calculated
based upon our gross profit on a particular sales transaction and thus generally
fluctuate with our overall gross profit. The remainder of selling, general and
administrative expenses are relatively fixed and does not vary in proportion to
increases in revenue as directly.
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 the 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 the 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.
Three Months Ended June 30, 2002 Compared To Three Months Ended June 30, 2001
The following table sets forth, for the periods indicated, certain
financial data derived from our unaudited consolidated statements of operations
for the three months ended June 30, 2002 and 2001. The discussion below relates
only to our continuing operations, unless otherwise noted.
Three months ended June 30,
2002 2001
Amount % Amount %
Revenue
Allstar $ 1,227 12.0 $ 1,178 21.8
INX 7,430 72.4 2,646 49.0
Stratasoft 1,657 16.1 1,590 29.4
Corporate 1 0.0
Elimination (54) (0.5) (16) (0.2)
Total revenue 10,260 100.0 5,399 100.0
Gross profit (loss):
Allstar Systems, Inc. 313 25.5 196 16.6
INX 608 8.2 320 12.1
Stratasoft 786 47.4 764 48.1
Corporate 0 N/A 15 N/A
Elimination 0 0.0 (15) 93.8
Total gross profit 1,707 16.6 1,280 23.7
Selling, general and administrative expenses:
Allstar 501 40.8 741 62.9
INX 691 9.3 783 29.6
Stratasoft 675 40.8 653 41.1
Corporate 147 N/A 382 N/A
Elimination 0 0.0 (15) 93.8
Total selling, general and
administrative Expenses 2,014 19.6 2,544 47.1
Operating (loss) income:
Allstar (188) (15.3) (545) (46.3)
INX (83) (1.1) (463) (17.5)
Stratasoft 111 6.7 111 7.0
Corporate (147) N/A (367) N/A
Total operating (loss) income (307) (3.0) (1,264) (23.4)
Interest and other income 7 (0.1) 61 1.1
Loss before benefit for income taxes (314) (3.1) (1,203) (22.3)
Benefit for income taxes (7) (0.1) (159) (2.9)
Net loss from continuing operations (307) (3.0) (1,044) (19.3)
Discontinued operations:
Net loss from discontinued operations (41) (0.8)
Gain on disposal 12 0.1 348 6.4
Net loss $ (295) (2.9) $ (737) (13.7)
TOTAL REVENUE. Total revenue, net of intercompany eliminations, increased
by $4,861 (90.0%) to $10,260 in 2002 from $5,399 in 2001.
Allstar revenue increased by $49 (4.2%) to $1,227 in 2002 from $1,178 in
2001. As a percentage of total revenue Allstar revenue decreased to 12.0% in
2002 from 21.8% in 2001. The increase in Allstar revenue was primarily
attributable to increased software product sales in the quarter ended June 30,
2002.
INX revenue increased by $4,784 (180.8%) to $7,430 in 2002 from $2,646 in
2001. As a percentage of total revenue, INX revenue increased to 72.4% in 2002
from 49.0% in 2001. Of the increase in revenues, $3,271 was attributed to the
Houston office where INX put in place new management and new sales team, and
$1,513 was attributed to the Dallas office. The achievement of gold status with
Cisco, its primary product line manufacturer, which allows INX to purchase
directly from Cisco at lower pricing levels and which enhances INX's
relationship with Cisco in the areas of lead generation, joint marketing and
technical support also contributed to increased sales volume for the overall
company. While INX expects continued revenue growth, it does not anticipate the
same growth rate it experienced in the three months ended June 30, 2002.
Stratasoft revenue increased by $67 (4.2%) to $1,657 in 2002 from $1,590 in
2001. Stratasoft revenue, as a percentage of total revenue, decreased to 16.1%
in 2002 from 29.4% in 2001. Stratasoft's increased revenues were primarily the
result of increased sales in the international sector, better recognition of
Stratasoft products in the market place, the expansion of the sales staff and
dealer network and to increased advertising and marketing efforts. Stratasoft's
international sales accounted for 43.2% of Stratasoft's revenues in the quarter
ended June 30, 2002 as compared to 12.8% in the same quarter of 2001.
GROSS PROFIT. Gross profit increased by $427 (33.4%) to $1,707 in 2002 from
$1,280 in 2001. Gross margin decreased to 16.6% in 2002 from 23.8% in 2001.
Allstar gross profit increased by $117 (59.7%) to $313 in 2002 from $196 in
2001. Gross margin for Allstar increased to 25.5% in 2002 from 16.6% in 2001.
Allstar cost of service consists primarily of labor cost for which we
experienced improved labor utilization in 2002.
INX gross profit increased $288 (90.0%) to $608 in 2002 from $320 in 2001.
Gross margin for INX decreased to 8.2% in 2002 from 12.1% in 2001. INX's product
gross profit has increased $369 to $706 in 2002 from $337 in 2001 due to both
sales volume increase offset by lower gross margin rates (9.8% in 2002 compared
to 15.7% in 2001). INX's gross profit on its service component decreased to a
loss of $98 in 2002 as compared to $17 in 2001 with gross margin rates of
(38.9%) in 2002 as compared to (3.4%) in 2001. The cause of the 2002 loss is
primarily due to customers delaying planned service projects.
Stratasoft gross profit increased by $22 (2.9%) to $786 in 2002 from $764
in 2001 as revenue increased by 4.2%. Gross margin for Stratasoft decreased to
47.4% in 2002 from 48.1% in 2001. The increased gross profit is consistent with
the increased sales volume. Gross margin is also 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 cost of goods component.
Stratasoft's decreased gross margin rate is primarily due to changing the mix of
product sales to include a reduced hardware component.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $530 (20.8%) to $2,014 in 2002 from $2,544
in 2001. As a percentage of revenue, these expenses decreased by 27.5%, to 19.6%
of revenue in 2002 from 47.1% of revenue in 2001. Bad debt expense decreased by
$237 and legal expense decreased by $129 in 2002 as compared to 2001. Overall,
our sales compensation was down by $69 in 2002 as compared to 2001.
Administrative wages decreased by $58 in 2002 as compared to 2001, primarily due
to efforts to reduce overhead at Corporate and throughout the subsidiaries.
General office expenses decreased $43 in 2002 as compared to 2001.
INTEREST AND OTHER INCOME (NET). Interest income decreased by $46 to $15 in
2002 compared to interest income of $61 in 2001, primarily due to the reduction
of invested available cash, lower interest rates on invested cash. Additionally,
imputed interest expense of $8 and loss on disposition of assets of $14 were
incurred in 2002 as compared to $0 in 2001.
DISCONTINUED OPERATIONS. On December 31, 2001 we sold our IT Staffing
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. During 1999 we sold our Telecom Systems
business. As a consequence of these events, the operations of these businesses
are reported as discontinued operations. For the quarters ended June 30, 2002
and 2001, respectively, loss from discontinuing operations was $0 and $41 (net
of tax benefit of $0 and $18) and the gain on disposal related to these business
was $12 and $348, net of taxes of $7 and $179.
NET INCOME (LOSS). Net loss on continuing operations in the quarters ended
June 30, 2002 and 2001 was $307 and $1,044, respectively. No tax benefit had
been recorded for the loss in the three months ended June 30, 2002 and 2001
because, due to our recurring losses, a valuation allowance was recorded.
Six Months Ended June 30, 2002 Compared To Six Months Ended June 30, 2001
The following table sets forth, for the periods indicated, certain
financial data derived from our unaudited consolidated statements of operations
for the six months ended June 30, 2002 and 2001. The discussion below relates
only to our continuing operations, unless otherwise noted.
Six months ended June 30,
2002 2001
Amount % Amount %
Revenue
Allstar $ 2,692 13.8 $ 2,394 23.9
INX 13,143 67.5 4,364 43.6
Stratasoft 3,828 19.7 3,272 32.7
Corporate (3) (0.0)
Elimination (195) (1.0) (27) (0.2)
Total revenue 19,468 100.0 10,000 100.0
Gross profit (loss):
Allstar Systems, Inc. 628 23.3 332 13.9
INX 1,193 9.1 324 7.4
Stratasoft 2,120 55.4 1,736 53.1
Corporate 0 N/A (3) N/A
Elimination 0 0.0 (15) (55.6)
Total gross profit 3,941 20.2 2,374 23.7
Selling, general and administrative expenses:
Allstar 1,154 42.9 1,681 70.2
INX 1,480 11.3 1,391 31.9
Stratasoft 1,686 44.0 1,399 42.8
Corporate 316 N/A 907 N/A
Elimination 0 0.0 (15) (55.6)
Total selling, general and
administrative Expenses 4,636 23.8 5,363 57.6
Operating (loss) income:
Allstar (526) (19.5) (1,349) (56.3)
INX (287) (2.2) (1,067) (24.5)
Stratasoft 434 11.3 337 10.3
Corporate (316) N/A (910) N/A
Total operating (loss) income (695) (3.6) (2,989) (29.9)
Interest and other income 2 0.0 157 1.6
Loss before benefit for income taxes (697) (3.6) (2,832) (28.3)
Benefit for income taxes (1,189) (6.1) (122) (1.2)
Net income (loss) from continuing operations 492 2.5 (2,710) (27.1)
Discontinued operations:
Net loss from discontinued operations (112) (1.1)
Gain on disposal 18 0.1 348 3.5
Net income (loss) $ 510 2.6 $(2,474) (24.7)
TOTAL REVENUE. Total revenue increased by $9,468 (94.7%) to $19,468 in 2002
from $10,000 in 2001.
Allstar revenue increased by $298 (12.4%) to $2,692 in 2002 from $2,394 in
2001. As a percentage of total revenue Allstar revenue decreased to 13.8% in
2002 from 23.9% in 2001. The increase in Allstar revenue was primarily
attributable to increased software product sales in the six months ended June
30, 2002.
INX revenue increased by $8,779 (201.2%) to $13,143 in 2002 from $4,364 in
2001. As a percentage of total revenue, INX revenue increased to 67.5% in 2002
from 43.6% in 2001. Of the increase in revenues, $6,213 was attributed to the
Houston office where INX put in place new management and new sales team, and
$2,566 was attributed to the Dallas office. The achievement of gold status with
Cisco, its primary product line manufacturer, which allows INX to purchase
directly from Cisco at lower pricing levels and which enhances INX's
relationship with Cisco in the areas of lead generation, joint marketing and
technical support also contributed to increased sales volume for the overall
company. While INX does expect continued revenue growth, it is not anticipated
that its growth will be at the same rate as it has experience in the six month
period ended June 30, 2002.
Stratasoft revenue increased by $556 (17.0%) to $3,828 in 2002 from $3,272
in 2001. Stratasoft revenue, as a percentage of total revenue, decreased to
19.7% in 2002 from 32.7% in 2001. Stratasoft's increased revenues were primarily
the result of increased sales in the international sector, better recognition of
Stratasoft products in the market place, the expansion of the sales staff and
dealer network and to increased advertising and marketing efforts. Stratasoft's
international sales accounted for 38.1% of Stratasoft's revenues in the six
months ended June 30, 2002 as compared to 14.6% in the same six months of 2001.
GROSS PROFIT. Gross profit increased by $1,567 (66.0%) to $3,941 in 2002
from $2,374 in 2001. Gross margin decreased to 20.2% in 2002 from 23.7% in 2001.
Allstar gross profit increased by $296 (89.2%) to $628 in 2002 from $332 in
2001. Gross margin for Allstar increased to 23.3% in 2002 from 13.9% in 2001.
Allstar cost of service consists primarily of labor cost for which we
experienced improved labor utilization in 2002.
INX gross profit increased $869 (268.2%) to $1,193 in 2002 from $324 in
2001. Gross margin for INX increased to 9.1% in 2002 from 7.4% in 2001. INX's
product gross profit increased due to both sales volume increase offset by lower
gross margin rates. INX's gross profit on its service component decreased to a
loss of $203 in 2002 as compared to a loss of $176 in 2001 with gross margin
rates of (32.3%) in 2002 as compared to (21.4%) in 2001. The cause of the 2002
loss is primarily due to customers delaying planned service projects.
Stratasoft gross profit increased by $384 (22.1%) to $2,120 in 2002 from
$1,736 in 2001 as revenue increased by 17.0%. Gross margin for Stratasoft
increased to 55.4% in 2002 from 53.1% in 2001. The increased gross profit is
consistent with the increased sales volume. Gross margin is also 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 cost of goods
component. Stratasoft's increased gross margin rate is primarily due to changing
the mix of product sales to include a reduced hardware component.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $727 (13.6%) to $4,636 in 2002 from $5,363
in 2001. As a percentage of revenue, these expenses decreased by 33.8%, to 23.8%
of revenue in 2002 from 57.6% of revenue in 2001. Bad debt expense decreased by
$46 and legal expense decreased by $161 in 2002 as compared to 2001. Overall,
our sales compensation was up by $202 in 2002 as compared to 2001.
Administrative wages, contract labor and benefits decreased by $447, general
office expenses decreased by $124, employee education decreased by $74,
utilities decreased by $40, auto expenses decreased by $21 and travel decreased
by $15 in 2002 as compared to 2001, primarily due to efforts to reduce overhead
at Corporate and throughout the subsidiaries.
INTEREST AND OTHER INCOME (NET). Interest income decreased by $126 to $27
in 2002 compared to interest income of $153 in 2001, primarily due to the
reduction of invested available cash, lower interest rates on invested cash.
Additionally, imputed interest expense of $15 and loss on disposition of assets
of $16 were incurred in 2002 as compared to $0 in 2001.
DISCONTINUED OPERATIONS. On December 31, 2001 we sold our IT Staffing
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. During 1999 we sold our Telecom Systems
business. As a consequence of these events, the operations of these businesses
are reported as discontinued operations. For the six months ended June 30, 2002
and 2001, respectively, loss from discontinuing operations was $0 and $112 (net
of tax benefit of $0 and $55) and the gain on disposal related to these business
was $18 and $348, net of taxes of $10 and $179.
NET INCOME (LOSS). Net income on continuing operations in the six months
ended June 30, 2002 was $492. The net loss for the six months ended June 30,
2001 was $2,710. No tax provision (benefit) had been recorded for the six months
ended June 30, 2002 and 2001 because, due to our recurring losses, a valuation
allowance was recorded.
Liquidity and Capital Resources
Our working capital was $6,295 and $5,983 at June 30, 2002 and December 31,
2001, respectively. As of June 30, 2002, we had outstanding inventory floor plan
financings of $337 and available borrowing base of $3,663 under our Textron
Finance Division credit facility. We expect to satisfy our capital and debt
requirements from our existing cash balances, cash generated by our operations
through collection of our accounts receivables and borrowings under our credit
facilities.
Cash Flow
Operating activities used net cash totaling $1,330 during the six months
ended June 30, 2002. Operating activities used net cash during the period
primarily due to an increase in accounts receivable of $1,619, increase in
income tax receivable of $1,179, and increase in notes receivable of $756 and an
increase in inventory of $113, offset by a decrease in cost and estimated
earnings in excess of billings of $694, and a increase in accounts payable of
$977. Additionally, the uses of cash were offset by cash produced from
continuing operations of $795 and used by discontinued operations of $179.
Investing activities used cash totaling $223 during the six months ended
June 30, 2002 and financing activities used cash totaling $266.
Asset Management
Our cash flow from operations has been affected primarily by the timing of
our collection of accounts receivable. We have typically sold our products and
services on short-term credit terms and seek to minimize our credit risk by
performing credit checks and conducting our own collection efforts. We had
accounts receivable, net of allowance for doubtful accounts, of $4,302 and
$5,921 at June 30, 2002 and December 31, 2001, respectively. We have a note
receivable from Echelon Staffing, Inc., a corporation formed by the former
President of It Staffing. The balance on the note at June 30, 2002 is $49.
Collections on the note as contingent on the operating revenues of Echelon. We
intend to monitor the note and will record a reserve if and when it appears to
be uncollectible.
Current Debt Obligations
Historically, we have satisfied our cash requirements principally through
borrowings under our lines of credit and through operations. On January 31, 2002
we entered into a credit agreement with Textron Financial Corporation
("Textron") for a revolving line of credit (the "Textron Facility"). The total
credit available under the Textron facility is $4,000 subject to borrowing base
limitations that are generally computed as 80% eligible accounts receivable and
90% of identifiable inventory purchased under this agreement and 40% of all
other inventory. In connection with the increase in the credit line, a
modification was made to the borrowing base limitations that restricted the
eligibility of accounts receivable for collateralization by disallowing as
eligible any customer's receivables in their entirety that have balances over 90
days old and that exceed 25% of their total balance. We may use up to $500 of
the line for working capital advances under approved conditions. Borrowings
under the accrue interest at the prime rate plus 2.5% on outstanding balances
that extend beyond the vendor approved free interest period and on working
capital advances from date of advance. Inventory floor plan borrowings are
reflected in accounts payable on the accompanying balance sheets. At June 30,
2002, we had $337 outstanding on inventory floor plan finance borrowings, $0
outstanding on working capital advances and had total credit availability of
$3,663.
This agreement is collaterized by substantially all of our assets except
our patent assets. The agreement contains restrictive covenants, which require
us to maintain minimum tangible capital funds of $4,000,000 and a minimum debt
to tangible capital funds ratio of 2 to 1. At June 30, 2002 we were in
compliance with all of the loan covenants.
Critical Accounting Policy
Revenue Recognition - Revenue from the sale of products is recognized when
the product is shipped. Service income is recognized as the services are earned.
Revenues resulting from installations of equipment and software contracts for
which duration is in excess of three months and that require substantial
modification or customization are recognized using the percentage-of-completion
method. The percentage of revenue recognized is determined principally on the
basis of the relationship of the cost of work performed on the contract to
estimated total costs. Revisions of estimates are reflected in the period in
which the facts necessitating the revisions become known; when a contract
indicates a loss, a provision is made for the total anticipated loss. The
percentage-of-completion method relies on estimates of total expected contract
revenue and costs. We follow this method since reasonably dependable estimates
of the revenue and costs applicable to various stages of a contract can be made.
During 2002 and 2001 our subsidiary, Stratasoft, recognized revenues on the
percentage-of-completion basis for several projects associated with one reseller
in South Asia I-Sector has risk to the extent that this group of customers have
not paid or issued contractual letters of credit up to the level of cost and
earnings recognized. On the projects in South Asia we required a cash payment or
letter of credit from the customer prior to shipping the product. Additionally,
Stratasoft has had revenues derived from Africa, the United Kingdom, and Canada.
We maintain allowances for doubtful accounts and notes receivable for
estimated losses resulting from the inability of our customers to make required
payments. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.
Related Party Transactions
We have from time to time made payments on behalf of Allstar Equities,
Inc., a Texas corporation ("Equities"), which is wholly-owned by our President
and Chief Executive Officer, on his behalf personally, for taxes, property and
equipment. Effective on December 1, 1999 a note payable by Equities was signed
for $336 for 60 monthly installments of $7. The note bears interest at 9% per
year. At June 30, 2002 and December 31, 2001, the Company's receivables from
Equities amounted to approximately $122 and $159, respectively. Additionally,
from time to time the Company has made payments to unrelated parties, primarily
for use of a credit card, for transactions that either wholly or partially
benefit our President and Chief Executive Officer and which therefore are
accounted for as indebtedness from him to the Company and on which he pays
interest of 6% per annum on the average outstanding balance. The balance of
approximately $95 and $80 is included in the Company's balance sheet and
reported as part of Accounts receivable - affiliates at June 30, 2002 and
December 31, 2001, respectively.
In order to comply with the Sarbanes-Oxley Act of 2002, we have determined
that the payments for the President and Chief Executive Officer's use of a
credit card for transactions that wholly or partially benefit him may be deemed
to constitute a demand loan. Therefore, in order to be in complete compliance,
the Company has recently made a demand for repayment of the such balances
related to the President and CEO's personal credit card usage, which is
discussed above and is classified in Accounts Receivable - affiliates in the
Company's balance sheet at June 30, 2002 and December 31, 2001.
We lease office space from Equities. On December 1, 1999 Equities purchased
our 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 rental rates reduced from
$37,692 to $37,192 per month.
From time to time we obtain an independent survey of real estate rental
rates and consult with real estate consulting firms to determine market rates of
facilities that are comparable to our Houston headquarters facility. We believe
that the rental rate and other terms of our lease from Equities are at least as
favorable as those that could be obtained in an arms-length transaction with an
unaffiliated third party.
We furnish a company-owned automobile for the President and Chief Executive
Officer's business and personal use.
From time to time we make short-term loans and travel advances to our
employees. The balance of approximately $8 and $11 relating to these loans and
advances is included in the Company's balance sheet and reported as part of
Accounts receivable - affiliates at June 30, 2002 and December 31, 2001,
respectively.
Each of our subsidiaries has a stock incentive plan in place. One of our
subsidiaries has granted to certain employees and to management of such
subsidiary as an incentive award. Under its plan such options vest ratably over
three to five years. The quantity of incentive options granted to management
personnel are determined based on the percentage of predetermined financial
goals that they attain. Any unvested stock options vest immediately upon the
occurrence of a liquidity event for that subsidiary. The options expire ten
years after the grant date if they are not exercised. The stock option grants
are subject to dilution when I-Sector purchases additional shares of the
subsidiary stock in order to keep the subsidiary capitalized. At June 30, 2002,
5,449,500 options granted by that subsidiary are outstanding with an issue price
of $ .01, which represents potential dilution of I-Sectors investment in that
subsidiary of 22.9%.
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 three months ended June 30, 2002, a one-percent increase in interest
rates paid by us on our floating rate debt would not have resulted in an
increase in interest for the period.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In July 2000, Benchmark Research and Technology, Inc. made a verbal claim
against I-Sector, claiming that we breached our contract with Benchmark, and
that we were negligent and breached various warranties, committed fraud and
violated the Deceptive Trade Practices Act. The case was mediated in November
2000 but no agreement was reached. We know of no lawsuit being filed. In July,
2002 Benchmark offered to settle with us for $40 and we are studying the offer.
In the event that the settlement is not accepted, we intend to vigorously
contest the demand.
In October 2000, our wholly-owned subsidiary, Stratasoft, filed suit in the
Harris County Texas County Court of Law against its customer Accelerated
Telemarketing for a remaining balance of $47 on its contract. Thereafter,
Accelerated Telemarketing filed a separate legal action claiming breach of
contract, breach of warranty, violation of the Deceptive Trade Practices Act and
other claims. In July 2002, we reached agreement in principle with Accelerated
Telemarketing to settle the legal actions pending. Such settlement agreement is
anticipated to have no future impact to net income.
In October 2001, Inacom Corp. wrote a demand letter claiming that we owed
the sum of approximately $570 to Inacom as a result of termination of a Vendor
Purchase Agreement between Inacom and us. We are unaware of a formal lawsuit
being filed, although one has been threatened. We believe that the demand is
without merit and intend to vigorously contest the demand.
We had filed a claim to collect on a note receivable from E Z Talk
Communications ("E Z Talk") and had recently entered into arbitration
discussions with E Z Talk. In July, 2002 E Z Talk filed a lawsuit to set aside
the arbitration and claiming damages of $250. I-Sector intends to vigorously
contest the suit.
We are 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. We believe the final outcome of such
matters will not have a materially adverse effect on its results of operations
or financial position.
ITEM 5. OTHER INFORMATION
We disclosed in our Proxy Statement and Notice of Annual Meeting of
Stockholders to be held August 8, 2002, that our Secretary of the Board, our
retired former Chief Financial Officer, Mr. Donald R. Chadwick, is serving as a
member of our Audit Committee. Mr. Chadwick does not yet meet the three years of
non-employee status requirement for independence. We are relying on the
Marketplace Rule 4350D2B for his appointment to the Audit Committee since he is
not a current employee.
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.
August 13, 2002 By: /s/ JAMES H. LONG
Date James H. Long, Chief Executive Officer,
Chief Financial Officer, President and
Chairman of the Board
By: /s/ PATRICIA L. WINSTEAD
Patricia L. Winstead, Vice President and
Controller, Chief Accounting Officer
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of I-Sector Corporation (the
"Company") on Form 10-Q for the period ending June 30, 2002 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, James
H. Long, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C.
1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that:
1) The Report fully complies with the requirements of section 13 (a) or 15 (d)
of the Securities Exchange Act of 1934; and 2) The information contained in the
Report fairly presents, in all material respects, the financial condition and
result of operations of the Company.
I-Sector Corporation.
August 13, 2002 By: /s/ JAMES H. LONG
Date James H. Long, Chief Executive Officer,
Chief Financial Officer, President and
Chairman of the Board