CELLSTAR CORP filed this 10-Q on 10/13/2000.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company reported a net loss of $13.3 million, or $0.22 per diluted share, for the third quarter
of 2000 compared with net income of $15.0 million, or $0.25 per diluted share, for the same
quarter last year. In the third quarter of 2000, the Company divested its majority interest in its Brazil
joint venture, announced its intent to divest its Venezuela operations, continued to phase out a major
portion of its North America and Miami redistributor business, and experienced substantially
reduced international trading operations conducted by its U.K. subsidiary. In addition, the Company
experienced a decline in gross margins primarily due to competitive margin pressures.
Special Cautionary Notice Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements relating to such matters
as anticipated financial performance and business prospects. When used in this Quarterly Report,
the words "should," "may," "intends," "expects," "anticipates," "will" and similar expressions are
intended to be among the statements that identify forward-looking statements. From time to time,
the Company may also publish forward-looking statements. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the
terms of the safe harbor, the Company notes that a variety of factors, including foreign currency
risks, revaluation, devaluation and fluctuations in relative exchange rates, political instability, changes
in foreign laws, regulations and tariffs, new technologies, system implementation difficulties,
competition, handset shortages or overages, customer and vendor relationships, unstable channels
of distribution, margin pressures, seasonality, inventory obsolescence and availability, "gray market"
resales, and inflation could cause the Company's actual results and experience to differ materially
from anticipated results or other expectations expressed in the Company's forward-looking
statements.
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Results of Operations
The following table sets forth certain unaudited consolidated statements of operations data for the
Company expressed as a percentage of revenues for the three and nine months ended August 31,
2000 and 1999:
Three months Nine months
ended August 31, ended August 31,
---------------- ----------------
2000 1999 2000 1999
------ ------ ------- ------
Revenues 100.0% 100.0 100.0 100.0
Cost of sales 96.2 91.5 95.5 91.5
------ ------ ------- ------
Gross profit 3.8 8.5 4.5 8.5
Selling, general and administrative expenses 5.4 4.4 7.0 4.8
Impairment of assets 0.7 - 0.3 -
Restructuring charge - - - 0.1
------ ------ ------- ------
Operating income (loss) (2.3) 4.1 (2.8) 3.6
Other income (expense):
Equity in income (loss) of
affiliated companies - - - 0.4
Gain on sale of assets 1.0 - 0.4 0.5
Interest expense (0.9) (0.8) (0.8) (0.9)
Other, net - 0.2 - (0.1)
------ ------ ------- ------
Total other income (expense) 0.1 (0.6) (0.4) (0.1)
------ ------ ------- ------
Income (loss) before income taxes (2.2) 3.5 (3.2) 3.5
Provision (benefit) for income taxes (0.1) 0.8 (0.8) 0.8
------ ------ ------- ------
Net income (loss) (2.1)% 2.7 (2.4) 2.7
====== ====== ======= ======
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Three Months Ended August 31, 2000 Compared to Three Months Ended August 31, 1999
Revenues. The Company's revenues increased $69.6 million, or 12.4%, from $560.2 million to
$629.8 million.
Revenues in the Asia-Pacific Region increased $66.7 million, or 32.7%, from $204.1 million to
$270.8 million. The Company's operations in the People's Republic of China, including Hong Kong
("PRC"), provided $185.6 million in revenue, an increase of $46.8 million or 33.7%, from $138.8
million. This increase was due to continued strong demand in the PRC and the build-up of sales
channels. The Company's operations in Taiwan provided $61.3 million of revenue, an increase of
$10.2 million, from $51.1 million. This increase is due to the introduction of high-end handsets in
2000. In the Philippines, revenues for the quarter increased $9.8 million to $11.4 million due to
carrier promotions and receipt by the Company in the fourth quarter of 1999 of certain distribution
rights to Nokia products in the Philippines.
North America Region revenues were $155.7 million, up 66.4% from $93.5 million for the prior
year. The region was the Company's second largest revenue contributor for the third quarter 2000.
North American revenues benefited from strong promotional activity by several customers, as well
as the addition of new customers and expanded markets in several areas.
Latin America Region revenues were $136.6 million for the third quarter ended August 31, 2000,
an 11.6% decrease from the prior year revenues of $154.6 million. Revenues in Brazil declined
$22.2 million from the prior year quarter. In August 2000, the Company completed its divestiture of
its 51% interest in its Brazilian operations (see "International Operations"). Revenues in Venezuela
declined $7.5 million, reflecting continuing market softness caused by political and economic
instability. In the third quarter 2000, the Company decided to divest its Venezuela operations (see
"International Operations") which the Company intends to sell. Revenues from the Miami export
operations were down $18.2 million, reflecting the Company's decision to phase out a major
portion of its redistributor channel, and the declining export market due to increasing availability of
in-country manufactured product. The Company began phasing out a major portion of its
redistributor business in the Miami and North American operations in the second quarter 2000 due
to the volatility of the redistributor business, the relatively lower margins and higher credit risks.
Also, supply shortages in the third and fourth quarters of 1999 significantly weakened the
redistributor channel, reducing the number of financially viable redistributors and creating operating
and financial difficulties for others. Combined revenues for the third quarter for the redistributor
business were $15.5 million in 2000 and $35.3 million in 1999. Revenues in Mexico increased
$27.2 million, or 53.4%. This increase can primarily be attributed to a carrier whose relationship
with the Company has grown significantly from the prior year. Combined revenues from CellStar's
Argentina, Chile, Colombia and Peru operations increased to $18.8 million from $16.0 million in the
year-earlier quarter.
Revenues for the Europe Region decreased to $66.7 million, or 38.2%, in the third quarter from
$108.0 million in the prior comparable quarter, due to the Company's decision to curtail its U.K.
international trading operations (see "International Operations"). Quarterly results included a $6.1
million increase in revenues from Sweden, as well as an increase in revenues of $5.5 million from the
Company's operations in The Netherlands, which was acquired in the third quarter of 1999.
Gross Profit. Gross profit decreased $23.5 million, or 49.3%, from $47.7 million to $24.2 million.
Gross margins were significantly lower in the third quarter of the current year primarily due to the
Company's commitment to defend market share in the face of intense industry price competition.
Based on last year's handset shortages and industry forecasts of higher demand, manufacturers
significantly increased production in 2000. However, worldwide handset sales, while significantly
higher this year, are still below industry forecasts. This has resulted in a surplus of product driving
stronger-than-usual competition for market share, mainly in the Asia-Pacific Region and, to a lesser
extent, in Latin America.
Gross margins also reflected the ongoing execution during the quarter of the Company's plan to
reduce the levels and improve the quality of its inventory. In particular, this effort focused in the U.S.
and Latin America on
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sales of analog, satellite and older-model handsets and accessories, often at a discount, which
lowered overall gross margins for the quarter.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased $9.1 million, or 36.7% from $24.7 million to $33.8 million. The increase was principally
due to bad debt expense of $3.9 million, up from $0.5 million for the third quarter last year. The
increase in selling, general and administrative expenses was also attributable to costs associated with
business expansion activities. Overall selling, general and administrative expenses as a percentage of
revenues increased to 5.4% from 4.4%.
Impairment of Assets. In the third quarter 2000, the Company decided to exit its Venezuela
operations. The Company recorded a $4.9 million impairment charge to reduce the carrying value
of certain Venezuelan assets, primarily goodwill, to their estimated fair value (see "International
Operations").
Gain on Sale of Assets. In the third quarter of 2000, the Company recorded a pre-tax gain of $6.0
million from the completion of the divestiture of its 51% ownership interest in its Brazil joint venture
(see "International Operations"). During the third quarter 2000, the Company also completed the
sale of its Poland operations and recognized a pre-tax gain of $0.2 million.
Interest Expense. Interest expense increased to $5.7 million from $4.4 million primarily due to
higher interest rates and higher levels of borrowing.
Other, Net. Other, net decreased from income of $0.9 million in the third quarter of 1999 to income
of $0.3 million in 2000. This decrease was primarily due to the revaluations of foreign currency
related to the Company's European operations.
Income Taxes. Income tax expense decreased from a provision of $4.2 million in 1999 to a benefit
of $0.8 million in 2000 due to the losses incurred in 2000. The annual effective tax rate increased to
24.0% from 22.0%. The higher effective tax rate was attributable to changes in the geographical mix
of income (loss) before income taxes.
17
Nine Months Ended August 31, 2000 Compared to Nine Months Ended August 31, 1999
Revenues. The Company's revenues increased $135.1 million, or 8.2%, from $1,645.9 million to
$1,781.0 million.
Revenues in the Asia-Pacific Region increased $212.7 million, or 40.0%, from $531.4 million to
$744.1 million. The Company's operations in the PRC provided $506.8 million in revenue, an
increase of $145.2 million, or 40.2%, from $361.6 million. This increase was due to continued
strong demand in the PRC and the build-up of sales channels. The Company's operations in Taiwan
provided $163.6 million of revenue, an increase of $32.7 million, or 25.0%, from $130.9 million.
Demand in Taiwan increased due to the introduction of new high-end handsets in the first quarter of
2000, and although there was a slowdown in the second quarter of 2000 due to political uncertainty
and Taiwan's relationship with the PRC, the third quarter rebounded with a $10.2 million increase
over the prior year quarter. In the Philippines, revenues increased $32.3 million to $42.5 million due
to carrier promotions and receipt by the Company in the fourth quarter of 1999 of certain
distribution rights to Nokia products in the Philippines.
North American Region revenues were $336.1 million, an increase of $39.6 million, or 13.3% when
compared to $296.5 million in 1999. North American revenues benefited from strong promotional
activity by several customers, as well as the addition of new customers and expanded markets in
several areas.
The Latin America Region provided $452.4 million of revenues, compared to $511.7 million, or an
11.6% decrease. Revenues in Mexico increased $118.4 million due primarily to increased carrier
business. Revenues for Brazil were down $127.2 million from last year. In 1999, the recently
completed privatization of the telecommunications industry was driving rapid growth in carrier sales.
In 2000, sales to the Company's major customer in Brazil were greatly reduced due to the
increased availability of in-country manufactured product. In August 2000, the Company completed
the divestiture of its 51% interest in its Brazilian operations (see "International Operations").
Revenues from the Venezuela operations declined $31.4 million. The decline was a result of the
effects of the torrential floods in late 1999, the positive impact on last year's first quarter of a special
carrier promotion, and market softness in 2000 caused by political and economic instability. In the
third quarter 2000, the Company decided to exit its Venezuela operations (see "International
Operations). Revenues from the Company's operations in Miami decreased $37.3 million from
1999 as increased product availability from in-country manufacturers in Latin America continued to
reduce export sales from Miami. The Company began phasing out a major portion of its
redistributor business in its Miami and North American operations in the second quarter 2000, due
to the volatility of the redistributor business, the relatively lower margins, and higher credit risks.
Also, supply shortages in the third and fourth quarters of 1999 significantly weakened the
redistributor channel, reducing the number of financially viable redistributors and creating operating
and financial difficulties for others. Combined revenues from the redistributor business were $47.0
million, and $94.9 million in 2000 and 1999, respectively. Combined revenues from the operations
in Argentina, Chile, Colombia and Peru increased $18.4 million from $39.2 million in 1999 to $57.6
million in 2000.
The Company's Europe Region recorded revenues of $248.5 million, a decrease of $57.8 million,
or 18.9%, from $306.3 million, primarily due to the Company's decision to curtail its U.K.
international trading operations in April 2000 (see "International Operations"). Revenues from
Sweden increased $1.5 million to $89.6 million in 2000. Revenues from The Netherlands, which
was acquired in the third quarter of 1999, were $22.7 million.
Gross Profit. Gross profit decreased $60.5 million, or 43.1% from $140.4 million to $79.9 million.
The decrease in gross profit is due to $29.2 million in inventory obsolescence primarily as a result of
price declines during the second quarter and $3.2 million in third party theft and fraud losses related
to the U.K. international trading operations, also in the second quarter. The decrease in gross profit
as a percentage of revenues can also be attributed to a shift in geographic revenue mix, lack of
digital handsets in North America, global industry price competition including an oversupply of
analog handsets in North America and an oversupply of handsets in Asia
18
Pacific, and to a lesser degree, the Company's inventory improvement actions. The Company's
commitment to defend market share in the face of intense global industry price competition,
particularly in the Asia Pacific Region, negatively impacted the gross margin percentage. Based on
last year's handset shortages and industry forecasts of higher demand, manufacturers significantly
increased production in 2000. However, worldwide handset sales, while significantly higher this
year, are still below industry forecasts. This has resulted in a surplus of product driving
stronger-than-usual competition for market share, mainly in the Asia-Pacific Region and to a lesser
extent in Latin America.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased $45.5 million, or 57.8% from $78.7 million to $124.1 million. This increase was primarily
due to bad debt expense of $33.3 million, up from $7.3 million for the same period last year. The
increase was primarily from certain U.S.-based accounts receivable from Brazilian importers, the
collectibility of which deteriorated significantly in the second quarter of 2000, and which were
further affected by the Company's decision to divest its majority interest in its joint venture in Brazil
and the phase out of a major portion of the redistributor business in its Miami and North America
operations. The increase in selling, general and administrative expenses was also attributable to
costs associated with business expansion activities and professional expenses. Overall selling,
general and administrative expenses as a percentage of revenues increased to 7.0% from 4.8%.
Impairment of Assets. In the third quarter 2000, the Company decided to exit its Venezuela
operations. The Company recorded a $4.9 million impairment charge to reduce the carrying value
of certain Venezuelan assets, primarily goodwill, to their estimated fair value (see "International
Operations").
Restructuring Charge. The Company's results of operations include a pre- tax restructuring charge
of $3.0 million in 1999 associated with the reorganization and consolidation of the management for
the Company's Latin American and North American Regions as well as the centralization of
management in the Asia-Pacific Region.
Equity in Income (Loss) of Affiliated Companies. Equity in income (loss) of affiliated companies
decreased from income of $5.9 million in 1999 to a loss of $0.8 million in 2000. In February 1999,
the Company sold part of its equity investment in Topp Telecom, Inc. ("Topp") to a wholly owned
subsidiary of Telefonos de Mexico S.A. de C.V. ("TelMex"). At the closing, the Company also sold
a portion of its debt investment to certain other shareholders of Topp. As a result of these
transactions, the Company recorded a pre-tax gain of $5.8 million. In September 1999, the
Company sold its remaining debt and equity interest in Topp to the TelMex subsidiary for a pre-tax
gain of $26.1 million.
Gain on Sale of Assets. In the third quarter of 2000, the Company recorded a pre-tax gain of $6.0
million, from the completion of the divestiture of its 51% ownership interest in its Brazil joint venture
(see "International Operations"). During the third quarter 2000, the Company also completed the
sale of its Poland operations and recognized a pre-tax gain of $0.2 million. In 1999, the Company
recorded a pre-tax gain of $8.2 million associated with the sale of its prepaid operations in
Venezuela and the sale of the Company's retail stores in the Dallas-Fort Worth and Kansas City
areas.
Interest Expense. Interest expense decreased from $14.5 million in 1999 to $14.4 million in 2000.
Other, Net. Other, net changed from an expense of $1.4 million to income of $0.7 million. This
change was primarily due to a $2.6 million foreign currency transaction loss realized in 1999 from
the conversion of U.S. dollar denominated debt in Brazil into a Brazilian real denominated credit
facility.
Income Taxes. Income tax expense decreased from $12.6 million in 1999 to a benefit of $13.7
million in 2000 due to the losses incurred in 2000. The Company's effective tax rate increased to
24.0% from 22.0%. The higher effective tax rate was attributable to changes in the geographical mix
of income (loss) before income taxes.
19
International Operations
The Company's foreign operations are subject to various political and economic risks including, but
not limited to, the following: political instability, economic instability, currency controls, currency
devaluations, exchange rate fluctuations, potentially unstable channels of distribution, increased
credit risks, export control laws that might limit markets the Company can enter, inflation, changes in
laws related to foreign ownership of business abroad, foreign tax laws, trade disputes among
nations, changes in cost of capital, changes in import/export regulations, including enforcement
policies, "gray market" resales, and tariff and freight rates. Such risks and other factors beyond the
control of the Company in any nation where the Company conducts business could have a
materially adverse effect on the Company.
During the second half of 1998, the Company's sales from Miami to customers exporting into South
American countries began to decline as a result of increased in-country manufactured product
availability in South America, primarily Brazil. The Company expects to focus efforts on servicing
large, financially sound carrier partners from the Company's Latin American subsidiaries.
Since 1998, the Company's Brazilian operations were primarily conducted through a
majority-owned joint venture. Following an extensive review of its operations in Brazil, the
Company concluded that its joint venture structure, together with foreign exchange risk, the high
cost of capital in that country, alternative uses of capital, accumulated losses, and the prospect of
ongoing losses, were not optimal for success in that market. As a result, in the second quarter of
2000 the Company elected to exit the Brazil market and to divest its 51% interest in its joint
venture. In August 2000, the Company completed its divestiture of its 51% interest in its joint
venture (see footnote 5 to the consolidated financial statements for a summary of the results of the
Brazil operations). The Company has also fully reserved certain U.S.- based accounts receivable
from Brazilian importers in the second quarter of 2000, the collectibility of which significantly
deteriorated in the second quarter of 2000, and which were further affected by the decision, in the
second quarter, to exit Brazil.
During the quarter ended August 31, 2000, the Company decided, based upon the current and
future economic and political outlook in Venezuela, to divest its operations in Venezuela and to
focus its resources on more profitable, lower risk, growth markets. For the quarter ended August
31, 2000, the Company recorded an impairment charge of $4.9 million to reduce the carrying value
of certain Venezuelan assets, primarily goodwill, to their estimated fair value (see footnote 6 to the
consolidated financial statements for a summary of the results of the Venezuela operations).
In April 2000, the Company curtailed a significant portion of its U.K. international trading
operations following third party theft and fraud losses. The trading business involves the purchase of
products from suppliers other than manufacturers and the sale of those products to customers other
than network operators or their dealers and other representatives. The Company experienced a
reduction in revenues for the Europe Region in the second and third quarters of 2000 compared to
1999 and anticipates a reduction in revenues during the balance of the year ending November 30,
2000. For the quarter ended May 31, 2000, the Company recorded a $4.4 million charge
consisting of $3.2 million from third party theft and fraud losses during the purchase, transfer of title
and transport of six shipments of wireless handsets, and $1.2 million in inventory obsolescence
expense for inventory price reductions incurred while the international trading business was curtailed
pending investigation. The Company is negotiating to obtain an insurance settlement and is pursuing
legal action where appropriate. However, the ultimate recovery in relation to these losses, if any,
cannot be determined at this time.
In the third quarter of 2000, the Company completed the sale of its operations in Poland and
recognized a gain of $0.2 million.
20
Liquidity and Capital Resources
During the nine months ended August 31, 2000, the Company relied primarily on cash available at
November 30, 1999, cash generated from operations, and borrowings under its Multicurrency
Revolving Credit Facility (the "Facility") to fund working capital, capital expenditures and
expansions. At October 2, 2000, the Company had available less than $1.0 million of unused
borrowing capacity under the Facility.
Compared to November 30, 2000, accounts receivable decreased $29.6 million, inventories
increased $34.0 million and accounts payable increased $19.7 million. This decrease in accounts
receivable was due to increased collections and to additions to the allowance for doubtful accounts.
The increase in inventory is primarily to support increased sales activity in the PRC and Mexico.
The increase in accounts payable is primarily due to increased sales activity in North America.
Effective August 25, 2000, the Company sold its 51% inte |
