UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 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 0-22972
CELLSTAR CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 75-2479727
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1730 Briercroft Court
Carrollton, Texas 75006
Telephone (972) 466-5000
(Address, including zip code and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports 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 ____
On April 5, 2002, there were 12,028,425 outstanding shares of Common Stock,
$0.01 par value per share.
1
CELLSTAR CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION Number
------ --------------------- ------
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (unaudited)
February 28, 2002 and November 30, 2001 3
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three months ended February 28, 2002 and 2001 4
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (unaudited)
Three months ended February 28, 2002 5
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Three months ended February 28, 2002 and 2001 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 12
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 20
PART II - OTHER INFORMATION
------- -----------------
Item 1. LEGAL PROCEEDINGS 21
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 21
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CellStar Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
(Amounts in thousands, except share data)
February 28, November 30,
2002 2001
------------ ------------
Assets
------
Current assets:
Cash and cash equivalents $ 86,753 47,474
Restricted cash 35,576 41,820
Accounts receivable (less allowance for doubtful accounts of
$57,104 and $57,359, respectively) 198,284 216,002
Inventories 146,535 218,927
Deferred income tax assets 32,547 35,915
Prepaid expenses 20,105 18,614
------------ ------------
Total current assets 519,800 578,752
Property and equipment, net 18,648 19,340
Goodwill (less accumulated amortization of $7,798 and $7,423, respectively) 21,749 22,060
Deferred income tax assets 18,102 18,102
Other assets 6,225 7,816
------------ ------------
Total assets $584,524 646,070
============ ============
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Notes payable $102,881 52,644
5% Senior subordinated convertible notes 39,148 -
5% Convertible subordinated notes 21,384 150,000
Accounts payable 169,183 228,958
Accrued expenses 31,238 21,804
Income taxes payable 7,915 4,767
Deferred income tax liabilities 633 3,687
------------ ------------
Total current liabilities 372,382 461,860
12% Senior subordinated notes 12,374 -
Other long-term liabilities 5,791 -
------------ ------------
Total liabilities 390,547 461,860
------------ ------------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 200,000,000 shares authorized;
12,028,425 shares issued and outstanding 120 120
Additional paid-in capital 82,443 82,443
Accumulated other comprehensive loss - foreign currency
translation adjustments (15,075) (13,447)
Retained earnings 126,489 115,094
------------ ------------
Total stockholders' equity 193,977 184,210
------------ ------------
Total liabilities and stockholders' equity $584,524 646,070
============ ============
See accompanying notes to unaudited consolidated financial statements.
3
CellStar Corporation and Subsidiaries
Consolidated Statements of Operations
Three months ended February 28, 2002 and 2001
(Unaudited)
(Amounts in thousands, except per share data)
2002 2001
-------------- --------------
Revenues $ 629,243 645,158
Cost of sales 594,589 608,365
-------------- --------------
Gross profit 34,654 36,793
Selling, general and
administrative expenses 31,229 28,934
-------------- --------------
Operating income 3,425 7,859
-------------- --------------
Other income (expense):
Equity in loss of
affiliated companies - (700)
Gain on sale of assets - 933
Interest expense (3,022) (5,089)
Other, net 242 2,740
-------------- --------------
Total other income (expense) (2,780) (2,116)
-------------- --------------
Income before income taxes
and extraordinary gain 645 5,743
Provision for income taxes 187 1,551
-------------- --------------
Income before extraordinary gain 458 4,192
Extraordinary gain on early extinguishment of
debt, net of tax 10,937 -
-------------- --------------
Net income $ 11,395 4,192
============== ==============
Net income per share:
Basic:
Income before extraordinary gain $ 0.04 0.35
Extraordinary gain on early extinguishment
of debt, net of tax 0.91 -
-------------- --------------
Net income $ 0.95 0.35
============== ==============
Diluted:
Income before extraordinary gain $ 0.04 0.35
Extraordinary gain on early extinguishment
of debt, net of tax 0.86 -
-------------- --------------
Net income $ 0.90 0.35
============== ==============
See accompanying notes to unaudited consolidated financial statements.
4
CellStar Corporation and Subsidiaries
Consolidated Statement of Stockholders' Equity and Comprehensive Income
Three months ended February 28, 2002
(Unaudited)
(In thousands)
Accumulated
Common Stock Additional other
----------------- paid-in comprehensive Retained
Shares Amount capital loss earnings Total
-------- ------ ---------- ------------- -------- -------
Balance at November 30, 2001 12,028 $ 120 82,443 (13,447) 115,094 184,210
Comprehensive income:
Net income - - - - 11,395 11,395
Foreign currency translation adjustment - - - (1,628) - (1,628)
-------
Total comprehensive income 9,767
-------- ------ ---------- ------------- -------- -------
Balance at February 28, 2002 12,028 $ 120 82,443 (15,075) 126,489 193,977
======== ====== ========== ============= ======== =======
See accompanying notes to unaudited consolidated financial statements.
5
CellStar Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Three months ended February 28, 2002 and 2001
(Unaudited)
(In thousands)
2002 2001
--------- ---------
Cash flows from operating activities:
Net income $ 11,395 4,192
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and impairment of assets 2,100 2,871
Equity in loss of affiliated companies - 700
Gain on sale of assets - (933)
Extraordinary gain on early extinguishment of debt,
net of tax (10,937) -
Deferred income taxes 314 (2,247)
Changes in operating assets and liabilities
net of effects from disposition of business and from
extraordinary gain:
Accounts receivable 16,113 93,152
Inventories 72,392 62,014
Prepaid expenses (1,491) 4,024
Other assets 39 445
Accounts payable (59,775) (157,826)
Accrued expenses 3,721 2,472
Income taxes payable (3,004) (994)
--------- ---------
Net cash provided by operating activities 30,867 7,870
--------- ---------
Cash flows from investing activities:
Proceeds from sale of assets - 2,237
Change in restricted cash 6,244 865
Purchases of property and equipment (727) (1,676)
Acquisition of business, net of cash acquired (89) -
Investment in joint venture - (735)
--------- ---------
Net cash provided by investing activities 5,428 691
--------- ---------
Cash flows from financing activities:
Borrowings on notes payable 221,403 7,728
Repayments on notes payable (171,166) (38,288)
Payments on 5% convertible subordinated notes (47,205) -
Additions to deferred loan costs (48) (1,306)
--------- ---------
Net cash provided by (used in) financing activities 2,984 (31,866)
--------- ---------
Net increase (decrease) in cash and cash equivalents 39,279 (23,305)
Cash and cash equivalents at beginning of period 47,474 77,023
--------- ---------
Cash and cash equivalents at end of period $ 86,753 53,718
========= =========
See accompanying notes to unaudited consolidated financial statements
6
CellStar Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
(1) Basis for Presentation
Although the interim consolidated financial statements of CellStar
Corporation and subsidiaries (the "Company") are unaudited, Company
management is of the opinion that all adjustments (consisting of only
normal recurring adjustments) necessary for a fair statement of the results
have been reflected therein. Operating revenues and net income for any
interim period are not necessarily indicative of results that may be
expected for the entire year.
These statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's Annual
Report on Form 10-K for the year ended November 30, 2001.
Certain prior period financial statement amounts have been reclassified to
conform to the current year presentation.
On February 12, 2002, the stockholders approved a one-for-five reverse
stock split. The reverse stock split was effective February 22, 2002. Where
appropriate, share numbers in this Form 10-Q have been adjusted to reflect
the one-for-five reverse stock split.
(2) Net Income Per Share
Basic net income per common share is based on the weighted average number
of common shares outstanding for the relevant period. Diluted net income
per common share is based on the weighted average number of common shares
outstanding plus the dilutive effect of potentially issuable common shares
pursuant to stock options and convertible notes.
7
A reconciliation of the numerators and denominators of the basic and
diluted net income per share computations for the three months ended
February 28, 2002 and 2001, follows (in thousands, except per share data):
2002 2001
------------- -------------
Basic:
Income before extraordinary gain $ 458 4,192
Extraordinary gain on early extinguishment of debt, net of tax 10,937 -
------------- -------------
Net income $ 11,395 4,192
============= =============
Weighted average number of shares outstanding 12,028 12,028
============= =============
Income per share before extraordinary gain $ 0.04 $ 0.35
Extraordinary gain per share on early extinguishment of debt,
net of tax 0.91 -
------------- -------------
Net income per share $ 0.95 $ 0.35
============= =============
Diluted:
Income before extraordinary gain $ 458 $ 4,192
Extraordinary gain on early extinguishment of debt, net of tax 10,937 -
------------- -------------
Net income 11,395 4,192
Interest on 5% convertible subordinated notes, net of
tax effect - -
------------- -------------
Adjusted net income $ 11,395 4,192
============= =============
Weighted average number of shares outstanding 12,028 12,028
Effect of dilutive securities:
Stock options - 1
5% Senior convertible notes 697 -
5% Convertible subordinated notes - -
------------- -------------
Weighted average number of share outstanding including
effect of dilutive securities 12,725 12,029
============= =============
Income per share before extraordinary gain $ 0.04 0.35
Extraordinary gain per share on early extinguishment of debt
net of tax 0.86 -
------------- -------------
Net income per share $ 0.90 0.35
============= =============
Options outstanding at February 28, 2002 and 2001, to purchase 1.5 million
and 1.0 million shares of common stock for the three months ended February
28, 2002 and 2001 were not included in the computation of diluted earnings
per share (EPS) because their inclusion would have been anti-dilutive.
The $39.1 million of 5% senior convertible notes issued in the exchange
offer (footnote 5) are convertible into 7.8 million shares of the Company's
common stock on or before November 30, 2002 and are considered as dilutive
securities beginning February 20, 2002. The 5% convertible subordinated
notes were not dilutive for the three months ended February 28, 2002 and
2001, respectively.
(3) Segment and Related Information
The Company operates predominately within one industry, wholesale and
retail sales of wireless telecommunications products. The Company's
management evaluates operations primarily on income before interest and
income taxes in the following reportable geographical regions:
Asia-Pacific, North America, Latin America, including Mexico and the
Company's Miami, Florida operations ("Miami"), and Europe. Revenues and
operations of Miami are included in Latin America since Miami's product
sales are primarily for export to
8
South American and Caribbean countries, either by the Company or through
its exporter customers. The Corporate segment includes headquarter
operations, income and expenses not allocated to reportable segments and
interest expense on the Company's domestic revolving line of credit and 5%
convertible subordinated notes. Corporate segment assets primarily consist
of cash, cash equivalents and deferred income tax assets. Intersegment
sales and transfers are not significant.
Segment asset information as of February 28, 2002, and November 30, 2001,
follows (in thousands):
Asia- North Latin
Pacific America America Europe Corporate Total
--------- --------- --------- -------- --------- ---------
Total assets
February 28, 2002 $264,102 117,267 117,691 43,061 42,403 584,524
November 30, 2001 263,268 143,598 130,481 48,885 59,838 646,070
Segment operations information for the three months ended February 28, 2002
and 2001, follows (in thousands):
Asia- North Latin
Pacific America America Europe Corporate Total
--------- --------- --------- -------- --------- ---------
Three months ended
February 28, 2002
Revenues from external customers $351,073 144,876 86,214 47,080 - 629,243
Income (loss) before
interest and income taxes 10,503 415 (2,009) (468) (5,154) 3,287
Three months ended
February 28, 2001:
Revenues from external customers 298,522 146,522 139,068 61,046 - 645,158
Income (loss) before
interest and income taxes 4,472 4,278 3,189 121 (2,738) 9,322
2002 2001
-------------- ------------
Income before interest and income taxes per segment information $ 3,287 9,322
Interest expense per the consolidated statements of operations (3,022) (5,089)
Interest income included in other, net in the consolidated statements of operations 380 1,510
-------------- ------------
Income before income taxes per the consolidated statements of operations $ 645 5,743
============== ============
(4) Notes Payable
Notes payable consisted of the following at February 28, 2002 and November
30, 2001 (in thousands):
2002 2001
---------- ----------
Revolving credit facility $ 40,239 -
Peoples' Republic of China ("PRC") credit facilities 50,680 39,078
Peoples' Republic of China ("PRC") notes payable 5,799 5,799
Taiwan notes payable 6,163 7,767
---------- ----------
$ 102,881 52,644
========== ==========
As of September 28, 2001, the Company had negotiated and finalized a new,
five-year, $60.0 million Loan and Security Agreement ("the Facility") with
a bank and terminated its previous multicurrency
9
revolving credit facility. On October 12, 2001 the Company finalized an
amendment to the Facility increasing the commitment amount from $60.0
million to $85.0 million.
Fundings under the Facility are limited by a borrowing base test, which is
measured weekly. Interest on borrowings under the Facility is at the London
Interbank Offered Rate or at the bank's prime lending rate, plus an
applicable margin. The Facility is also secured by a pledge of 100% of the
outstanding stock of all U.S. subsidiaries and 65% of the outstanding stock
of all first tier foreign subsidiaries. The Facility is further secured by
the Company's domestic accounts receivable, inventory, property, plant and
equipment and all other domestic real property and intangible assets. The
Facility contains, among other provisions, covenants relating to the
maintenance of minimum net worth and certain financial ratios, exchanging,
refinancing or extending of the Company's 5% convertible subordinated
notes, dividend payments, additional debt, mergers and acquisitions and
disposition of assets.
At February 28, 2002, the Company's operations in China had two lines of
credit, one for USD $12.5 million and the second for RMB (Chinese People's
Currency) 316 million (approximately USD $38.2 million), bearing interest
at 7.16%, and from 5.28% to 5.56% respectively. The loans have maturity
dates through September 2002. The lines of credit are partially
collateralized by U.S. dollar cash deposits and accounts receivable from
the Company's operations in China. The cash deposits were made via
intercompany loans from the operating entity in Hong Kong as a mechanism to
secure repatriation of these funds. At February 28, 2002, the U.S. dollar
equivalent of $50.7 million had been borrowed against the lines of credit
in China. As a result of this method of funding operations in China, the
consolidated balance sheet at February 28, 2002 reflects USD $35.6 million
in cash that is restricted as collateral on these advances and a
corresponding USD $50.7 million in notes payable. At February 28, 2002,
China also had a $5.8 million promissory note to a bank which matures
December 2002 and bears interest at 5.85%. In addition, the Company has
notes payable in Taiwan totaling $6.2 million, which matured December 2001
and have been extended with payments through August 2002 by oral agreement
of the parties, and bears interest at 4.03%.
Based upon current and anticipated levels of operations, the Company
anticipates that its cash flows from operations, together with amounts
available under its Facility and existing unrestricted cash balances, will
be adequate to meet its anticipated cash requirements in the foreseeable
future. In the event that existing unrestricted cash balances, cash flows
and available borrowings under the Facility are not sufficient to meet
future cash requirements, the Company may be required to reduce planned
expenditures or seek additional financing. The Company can provide no
assurances that reductions in planned expenditures would be sufficient to
cover shortfalls in available cash or that additional financing would be
available or, if available, offered on terms acceptable to the Company.
(5) Exchange Offer
On January 14, 2002, the Company filed an S-4 registration statement (the
"Exchange Offer"), with the Securities and Exchange Commission ("SEC"),
offering to exchange, for each $1,000 principal amount of its existing 5%
Convertible Subordinated Notes (the "Subordinated Notes") due October 2002,
$366.67 in cash and, at the election of the holder, one of the following
options: a) $400.94 principal amount of 12% Senior Subordinated Notes due
January 2007 (the "Senior Notes") or, b) $320.75 principal amount of Senior
Notes and $80.19 principal amount of 5% Senior Subordinated Convertible
Notes due November 2002 (the "Senior Convertible Notes") or, c) $400.94
principal amount of Senior Convertible Notes.
On February 20, 2002, the Company completed its exchange offer for its $150
million of Subordinated Notes due October 2002. Holders owning $128.6
million of Subordinated Notes exchanged them for $47.2 million in cash,
$12.4 million of Senior Notes due January 2007, and $39.1 million of Senior
Convertible notes due November 2002. Holders owning $21.4 million of the
Subordinated Notes did not exchange them, and they are now subordinate to
the Company's Facility, the Senior Notes and the Senior Convertible Notes.
The Company realized a pre-tax extraordinary gain on early extinguishment
of debt of $17.1 million during the first quarter of fiscal 2002 ($10.9
million after-tax) as a result of the exchange. The exchange was accounted
for as a troubled debt restructuring in accordance with Financial
Accounting Standards Board Statement No. 15. Accordingly the total future
interest payments of $8.8 million on the Senior Notes and Senior
Convertible Notes have been accrued upon completion of the exchange and are
included in accrued expenses ($3.0 million) and other long-term liabilities
($5.8 million) in the
10
accompanying February 28, 2002 balance sheet. The Company will not
recognize these payments as interest expense in future periods.
The following summarizes the gain on early extinguishment of debt (in
millions):
Face amount of Subordinated Notes exchanged $ 128.6
Deferred loan costs related to Subordinated Notes exchanged (0.5)
----------
Book value of Subordinated Notes 128.1
Consideration and expenses
Cash 47.2
Senior Convertible Notes issued 39.1
Senior Notes issued 12.4
Future interest payments on notes issued 8.8
Expenses incurred 3.5
----------
Gain on exchange 17.1
Taxes 6.2
----------
Gain, net of tax $ 10.9
==========
The Senior Convertible Notes are mandatorily convertible into the Company's
common stock on November 30, 2002, and bear interest at 5%, payable
semi-annually in arrears, in either cash or stock, at the Company's option,
on August 15, 2002, and November 30, 2002. In the event of bankruptcy the
Senior Convertible Note holders are entitled to cash equal to the face
value of the Senior Convertible Note plus accrued interest. The Senior
Convertible Notes are convertible into the Company's common stock at a
conversion price of $5.00 per share (adjusted for the effect of the
one-for-five reverse stock split effective on February 22, 2002) and may be
converted at any time prior to maturity at the option of the holders.
The $39.1 million in Senior Convertible Notes issued in the Exchange Offer
are convertible into 7.8 million shares of the Company's common stock.
The Senior Notes mature January 15, 2007, and bear interest at 12%, payable
in cash in arrears semi-annually on February 15 and August 15, commencing
August 15, 2002. The Senior Notes contain certain covenants that restrict
the Company's ability to incur additional indebtedness, make investments,
loans and advances, declare dividends or certain other distributions,
create liens, enter into sale-leaseback transactions, consolidate, merge,
sell assets and enter into transactions with affiliates.
(6) Contingencies
Refer to Part II, Item 1, "Legal Proceedings".
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company reported net income, including an extraordinary gain on early
extinguishment of debt, of $11.4 million, or $0.90 per diluted share, for the
first quarter of 2002, compared with net income of $4.2 million, or $0.35 per
diluted share, for the same quarter last year. Net income before the
extraordinary gain was $0.5 million, or $0.04 per diluted share for the quarter
ended February 28, 2002. Revenues for the quarter ended February 28, 2002 were
$629.2 million, a decrease of $16.0 million compared to $645.2 million in 2001.
Gross profit decreased from $36.8 million in 2001 to $34.7 million in 2002.
Selling, general and administrative expenses for the first quarter of 2002 were
$31.2 million compared to $28.9 million in 2001.
On February 20, 2002, the Company completed its exchange offer for its $150
million 5% Convertible Subordinated Notes (the "Subordinates Notes") due October
2002. Holders owning $128.6 million of Subordinated Notes exchanged them for
$47.2 million in cash, $12.4 million of 12% Senior Subordinated Notes (the
"Senior Notes") due January 2007, and $39.1 million of 5% Senior Subordinated
Convertible Notes (the "Senior Convertible Notes") due November 2002. Holders
owning $21.4 million of the Subordinated Notes did not exchange them, and they
are now subordinate to the Company's domestic credit facility, the Senior Notes
and the Senior Convertible Notes.
The Company realized a pre-tax extraordinary gain on early extinguishment of
debt of $17.1 million during the first quarter of fiscal 2002 ($10.9 million
after-tax) as a result of the exchange. The exchange was accounted for as a
troubled debt restructuring in accordance with Financial Accounting Standards
Board Statement No. 15.
Cautionary Statements
The Company's success will depend upon, among other things, economic and
wireless market conditions, and its ability to improve its operating margins,
continue to secure an adequate supply of competitive products on a timely basis
and on commercially reasonable terms, service its indebtedness and meet covenant
requirements, secure adequate financial resources, continually turn its
inventories and accounts receivable, successfully manage growth (including
monitoring operations, controlling costs, maintaining adequate information
systems and effective inventory and credit controls), manage operations that are
geographically dispersed, achieve significant penetration in existing and new
geographic markets, and hire, train and retain qualified employees who can
effectively manage and operate its business.
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 the markets the Company can enter;
inflation; changes in laws related to foreign ownership of businesses abroad;
foreign tax laws; changes in cost of and access to capital; changes in
import/export regulations, including enforcement policies; "gray market"
resales; and tariff and freight rates. Such risks, and political and other
factors beyond the control of the Company, including trade disputes among
nations, internal political or economic instability in any nation where the
Company conducts business, and terrorist acts, could have a material adverse
effect on the Company.
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 the Quarterly Report, the words "estimates", "may", "intends",
"expects", "anticipates", "could", "should", "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 those listed
under "Cautionary Statements" above, 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.
12
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 months ended February 28, 2002 and 2001:
2002 2001
----- -----
Revenues 100.0% 100.0
Cost of sales 94.5 94.3
----- -----
Gross profit 5.5 5.7
Selling, general and administrative expenses 5.0 4.5
----- -----
Operating income 0.5 1.2
Other income (expense):
Equity in loss of affiliated companies - (0.1)
Gain on sale of assets - 0.1
Interest expense (0.5) (0.8)
Other, net 0.1 0.5
----- -----
Total other income (expense) (0.4) (0.3)
Income before income taxes and extraordinary gain 0.1 0.9
Provision for income taxes 0.0 0.2
----- -----
Income before extraordinary gain 0.1 0.7
Extraordinary gain on early extinguishment of debt, net of tax 1.7 -
----- -----
Net income 1.8% 0.7
===== =====
Three Months Ended February 28, 2002 Compared to Three Months Ended February 28,
2001
Revenues. The Company's revenues decreased $16.0 million, or 2.5%, from $645.2
million to $629.2 million.
Revenues in the Asia-Pacific Region increased $52.6 million, or 17.6%, from
$298.5 million to $351.1 million. The Company's operations in the People's
Republic of China, including Hong Kong ("PRC"), provided $308.9 million in
revenues, an increase of $54.6 million, or 21.5%, from $254.3 million. Growth in
the PRC, where market penetration of handsets is approximately 10% of the total
population, was driven by increased market penetration. Revenues from the
Company's operations in Singapore increased $14.0 million to $31.1 million, or
82.3%, due to carrier promotions introduced last year and increased sales to
customers in the India, Malaysia, and Middle Eastern markets. Revenues from
Taiwan decreased $11.9 million, or 83.4% to $2.4 million. The Company's supplier
base in Taiwan is limited, and there are no compelling new products from its
major supplier. The Company's operations in Taiwan were also affected by
economic and political turmoil in the country and the high market penetration
rate. Revenues in the Philippines declined from $12.9 million to $8.5 million,
primarily due to a large customer purchasing directly from the manufacturer.
North American Region revenues were $144.9 million, a decrease of $1.6 million
compared to $146.5 million in 2001. Early in the first quarter of 2001, the
Company converted a major U.S. account to a consignment basis with fulfillment
fees. Revenues for the quarter ended February 28, 2001 on a comparable basis
were $115.7 million. The conversion to consignment did not significantly impact
net income, but reduced inventory risk and the need for working capital. By
converting to consignment basis, the Company is not required to purchase and
hold inventory for this customer and therefore eliminates the Company's exposure
to declines in market prices. The increase of $29.2 million, after adjusting for
the conversion to consignment, was primarily attributable to market expansion by
a regional carrier customer.
The Company's operations in the Latin America Region provided $86.2 million of
revenues, compared to $139.1 million in 2001, a 38.0% decrease. Revenues in
Mexico, the region's largest revenue contributor, were $45.4 million compared to
$76.1 million in 2001 due to reduced business with a large carrier customer.
Revenues from the Company's Miami export operations were $13.4 million compared
to $10.6 million in the first quarter a year ago, primarily due to increased
business with customers in Central America and the Caribbean.
13
Combined revenues from CellStar's Argentina, Chile, Colombia and Peru operations
were $27.4 million in 2002 and $51.1 million in 2001. The decline is a result of
significant promotional activity during the first quarter of 2001 by a major
carrier in Colombia.
The Company's European Region operations recorded revenues of $47.1 million, a
decrease of $13.9 million from $61.0 million in 2001. The handset market in
Europe is highly penetrated and is increasingly driven by replacement sales,
which are depressed due to delays in the rollout and acceptance of new handset
technologies and services.
Gross Profit. Gross profit decreased $2.1 million from $36.8 million to $34.7
million. Gross profit as a percentage of revenues was 5.5% for the quarter ended
February 28, 2002, compared to 5.7% for the prior year quarter.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $2.3 million from $28.9 million to $31.2
million. This increase is primarily attributable to an increase in payroll and
benefits, including $1.1 million in senior management transition costs,
advertising and marketing, and insurance premiums. These increases were
partially offset by a decrease in bad debt expense from $3.7 million to $1.7
million. Selling, general and administrative expenses as a percentage of
revenues were 5.0% and 4.5%, for the first quarter of 2002 and 2001,
respectively.
Gain on Sale of Assets. During the first quarter ended 2001, the Company
recorded a gain on sale of assets of $0.9 million in 2001 primarily associated
with the sale of its Venezuela operations in December 2000.
Equity in Loss of Affiliated Companies. Equity in loss of affiliated companies
was $0.7 million in 2001 due to losses from the Company's 49% minority interest
in CellStar Amtel. As a result of the continuing deterioration in the Malaysia
market, the Company is in the process of divesting its ownership in CellStar
Amtel. Until the divestiture is finalized, the Company will be required to
recognize future losses, if any, of CellStar Amtel up to the amount of debt and
payables of CellStar Amtel guaranteed by the Company. The Company currently does
not anticipate that any further losses will be recognized.
Interest Expense. Interest expense decreased to $3.0 million from $5.1 million.
The decrease was primarily a result of lower borrowing levels and a lower
interest rate on the Company's domestic credit facility.
Other, Net. Other, net decreased $2.5 million, from income of $2.7 million to
income of $0.2 million, primarily due to a gain of $1.1 million in the first
quarter of 2001 on foreign currencies related to European operations compared to
a loss of $0.1 million in 2002 and to a reduction in interest income from $1.5
million in 2001 compared to $0.4 million in 2002.
Income Taxes. Income tax expense decreased from an expense of $1.6 million in
2001 to an expense of $0.2 million in 2002 primarily due to lower pre-tax
income. The Company's annual effective tax rate was 29% for the first quarter of
2002 compared to 27% for the first quarter of 2001.
Critical Accounting Policies
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Note 1 of the Notes to the Consolidated Financial
Statements, included in the Company's Annual Report on Form 10-K for the year
ended November 30, 2001, includes a summary of the significant accounting
policies and methods used in the preparation of the Company's Consolidated
Financial Statements. The following is a brief discussion of the more critical
accounting policies and methods used by the Company.
(a) Significant Estimates
Management of the Company has made a number of estimates and assumptions related
to the reporting of assets and liabilities in preparation of the consolidated
financial statements in conformity with generally accepted accounting
principles. The most significant estimates relate to the allowance for doubtful
accounts, the reserve for inventory obsolescence, the deferred tax asset
valuation allowance and the determination of the recoverability of goodwill.
In determining the adequacy of the allowance for doubtful accounts, management
considers a number of factors including the aging of the receivable portfolio,
customer payment trends, financial condition of the customer, economic
conditions in the customer's country, and industry conditions. In some years,
the Company has experienced significant amounts of bad debt, including $51.5
million in fiscal year 2000. In 2000, the decline in the redistributor market,
the decision to exit the Brazil market, and the competitive market conditions
significantly
14
impacted bad debt expense. Actual amounts could differ significantly from
management's estimates.
In determining the adequacy of the reserve for inventory obsolescence,
management considers a number of factors including the aging of the inventory,
recent sales trends, industry market conditions, and economic conditions. In
assessing the reserve, management also considers price protection credits or
other incentives the Company expects to receive from the vendor. In some years,
the Company has experienced significant amounts of inventory obsolescence,
including $32.3 million in fiscal year 2000. After a supply shortage in 1999,
there was an oversupply of product resulting in intense price competition in
2000 which significantly impacted obsolescence. Actual amounts could differ
significantly from management's estimates.
In assessing the realizability of deferred income tax assets, management
considers whether it is more likely than not that the deferred income tax assets
will be realized. The ultimate realization of deferred income tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred income tax liabilities, projected future taxable
income, and tax planning strategies in making this assessment. Based on the
level of historical taxable income and projections for future taxable income
over the periods in which the deferred income tax assets are deductible,
management determines if it is more likely than not that the Company will
realize the benefits of these deductible differences. The amount of the deferred
income tax asset considered realizable, however, could be reduced in the near
term if estimates of future taxable income during the carry-forward period are
reduced.
The Company does not provide for U.S. Federal income taxes or tax benefits on
the undistributed earnings and/or losses of its international subsidiaries
because earnings are reinvested and, in the opinion of management, should
continue to be reinvested indefinitely. At February 28, 2002, the Company had
not provided U.S. Federal income taxes on earnings of international subsidiaries
of approximately $188.9 million. On distribution of these earnings in the form
of dividends or otherwise, the Company would be subject to both U.S. income
taxes and certain withholding taxes in the various international jurisdictions.
Determination of the related amount of unrecognized deferred U.S. income tax
liability is not practicable because of the complexities associated with this
hypothetical calculation.
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired and is amortized using the straight-line method over 20 years.
The Company assesses the recoverability of this intangible asset by determining
the estimated future cash flows related to such acquired assets. In the event
that goodwill is found to be carried at an amount that is in excess of estimated
future operating cash flows, then the goodwill will be adjusted to a level
commensurate with a discounted cash flow analysis using a discount rate
reflecting the Company's average cost of funds.
Management's estimates of future cash flows are based in part upon prior
performance, industry conditions, economic conditions, and vendor and customer
relationships. Changes in these factors or other factors could result in
significantly different cash flow estimates and an impairment charge. In 1999,
due to changing market conditions in Poland, the Company considered the
remaining $4.5 million in goodwill related to its Poland operations to be
impaired. In 2000, due to the current and expected future economic conditions in
Venezuela, the Company considered the goodwill related to the Venezuela
operations impaired and recorded a $3.9 million impairment charge. In 2000, a
major customers proposed change to an existing contract that adversely changed
the long-term prospects of the Peru operations resulted in the Company recording
a goodwill impairment charge of $6.4 million.
At February 28, 2002, the Company had goodwill, net of accumulated amortization,
of $21.7 million related to its Asia-Pacific operations ($13.0 million) and its
Europe operations ($8.7 million).
The Financial Accounting Standards Board has issued Statements No. 141 and No.
142 which will impact the Company's accounting policy for goodwill. A more
complete discussion of Statements No. 141 and No. 142 is included in
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the caption Accounting Pronouncements Not Yet Adopted in this
Form 10-Q.
(b) Revenue Recognition
For the Company's wholesale business, revenue is recognized when the customer
takes title and assumes risk of loss. If the customer takes title and assumes
risk of loss upon shipment, revenue is recognized on the shipment date. If the
customer takes title and assumes risk of loss upon delivery, revenue is
recognized on the delivery date. In accordance with contractual agreements with
wireless service providers, the Company receives an activation commission for
obtaining subscribers for wireless services in connection with the Company's
retail operations. The agreements contain various provisions for additional
commissions ("residual commissions") based on subscriber usage. The agreements
also provide for the reduction or elimination of activation commissions if
subscribers deactivate service within stipulated periods. The Company recognizes
revenue for activation commissions on the wireless service providers' acceptance
of subscriber contracts and residual commissions when earned and provides an
allowance for estimated wireless service deactivations, which is reflected as a
reduction of accounts receivable and revenues in the accompanying consolidated
financial statements. The Company recognizes fee service revenue when the
service is completed.
15
(c) Vendor Credits
The Company recognizes price protection credits and other incentives from
vendors when such credits are received in writing, or if the credits are based
on sell-through to customers, when the credits have been received in writing and
the related product is sold. Vendor credits, excluding sell-through credits, are
applied against inventory and cost of goods sold, depending on whether the
related inventory is on-hand or has been previously sold at the time the credits
are received in writing. Sell-through credits are recorded as a reduction in
cost of goods sold in the period received.
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 the markets the Company can enter;
inflation; changes in laws related to foreign ownership of businesses abroad;
foreign tax laws; changes in cost of and access to capital; changes in
import/export regulations, including enforcement policies; "gray market"
resales; tariffs and freight rates. Such risks, and political and other factors
beyond the control of the Company, including trade disputes among nations,
internal political or economic instability in any nation where the Company
conducts business, and terrorist acts, could have a material adverse effect on
the Company.
Revenues from the Company's operations in the PRC, including Hong Kong, were
$308.9 million and $254.3 million for the quarter ended February 28, 2002 and
2001 respectively. As the availability in China of in-country manufactured
product increases, sales to the Company's Hong Kong based customers that ship
products to the remainder of China may decrease. Additionally, the Company's
primary supplier in Hong Kong has recently significantly reduced the supply of
product available in Hong Kong to encourage the purchase in China of in-country
manufactured product. Revenues from the Hong Kong operation were $26.7 million
and $39.6 million for the quarter ended February 28, 2002 and 2001,
respectively.
In December 2001, the Argentine government removed the fixed exchange rate
maintained between the Argentine peso and the U.S. dollar. Based upon the
Company's current level of operations in Argentina, there was not a significant
impact as a result of the Argentine peso devaluation in the first quarter of
2002. The Company expects to continue to monitor and evaluate the economic and
wireless market outlook in Argentina.
In the fourth quarter of 2000, the Company recorded a non-cash goodwill
impairment charge of $6.4 million related to the operations in Peru due to a
major carrier customer's proposed changes to an existing contract that adversely
changed the long-term prospects of the Peru operations. Since the second quarter
of 2001, the Company has incurred losses in its operations in Peru.
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. As a result of the
curtailment, the Company experienced a reduction in revenues for the U.K.
operation after the first quarter of 2000 compared to 1999. Since the
curtailment, the Company has experienced operating losses in its U.K. operation.
In 2000 and 2001, the Company incurred losses of $1.8 million and $0.7 million,
respectively related to its minority interest in CellStar Amtel. As a result of
the continuing deterioration in the Malaysia market, the Company is in the
process of divesting its 49% ownership in CellStar Amtel. The carrying value of
the investment at February 28, 2002 was zero. Until the divestiture is
finalized, the Company will be required to recognize future losses, if any, of
CellStar Amtel up to the amount of debt and payables of CellStar Amtel
guaranteed by the Company. The Company currently does not anticipate any further
losses to be recognized.
During the fourth quarter of 2001, the Company recorded a $3.0 million charge
for a value added tax prepaid asset in the Company's Mexico operations for which
the recoverability is uncertain.
16
Liquidity and Capital Resources
The following table summarizes the Company's contractual obligations at February
28, 2002 (amounts in thousands):
Payments Due By Period
----------------------------------------------
Less than One to Four to More than
Total One Year Three Years Five Years Five Years
-------- --------- ----------- ---------- ----------
Notes payable $102,881 102,881 - - -
Senior Convertible Notes - - -
(mandatorily convertible) 39,148 39,148 - - -
Subordinated Notes 21,384 21,384 - - -
Senior Notes 12,374 - - 12,374 -
Operating leases 8,339 3,647 3,278 1,244 170
-------- --------- ----------- ---------- ----------
Total $184,126 167,060 3,278 13,618 170
======== ========= =========== ========== ==========
During the period ended February 28, 2002, the Company relied primarily on cash
available at November 30, 2001, funds generated from operations and borrowings
under its revolving credit facilities to fund working capital, capital
expenditures and expansions.
At February 28, 2002, the Company's operations in China had two lines of credit,
one for USD $12.5 million and the second for RMB (Chinese People's currency) 316
million (approximately USD $38.2 million), bearing interest at 7.16%, and from
5.28% to 5.56% respectively. The loans have maturity dates through September
2002. The lines of credit are partially collateralized by U.S. dollar cash
deposits and accounts receivable from the Company's operations in China. The
cash deposits were made via intercompany loans from the operating entity in Hong
Kong as a mechanism to secure repatriation of these funds. At February 28, 2002,
the U.S. dollar equivalent of $50.7 million had been borrowed against the lines
of credit in China. As a result of this method of funding operations in China,
the consolidated balance sheet at February 28, 2002 reflects USD $35.6 million
in cash that is restricted as collateral on these advances and a corresponding
USD $50.7 million in notes payable. At February 28, 2002, China also had a $5.8
million promissory note to a bank which matures December 2002 and bears interest
at 5.85%. In addition, the Company has notes payable in Taiwan totaling $6.2
million, which matured December 2001, and have been extended with payments
through August 2002 by oral agreement of the parties and bear interest at 4.03%.
As of September 28, 2001, the Company had negotiated and finalized a new,
five-year, $60.0 million Loan and Security Agreement ("the Facility") with a
bank and terminated the previously existing facility. On October 12, 2001 the
Company finalized an amendment to the Facility increasing the commitment amount
from $60.0 million to $85.0 million.
Fundings under the Facility are limited by a borrowing base test, which is
measured weekly. Interest on borrowings under the Facility is at the London
Interbank Offered Rate or at the bank's prime lending rate, plus an applicable
margin. The Facility is also secured by a pledge of 100% of the outstanding
stock of all U.S. subsidiaries and 65% of the outstanding stock of all first
tier foreign subsidiaries. The Facility is further secured by the Company's
domestic accounts receivable, inventory, property, plant and equipment and all
other domestic real property and intangible assets. The Facility contains, among
other provisions, covenants relating to the maintenance of minimum net worth and
certain financial ratios, exchanging, refinancing or extending of the Company's
5% convertible subordinate notes, dividend payments, additional debt, mergers
and acquisitions and disposition of assets. At April 5, 2002, the Company had
$38.1 million in borrowings and $24.3 million in availability under the
Facility.
At November 30, 2001, long-term debt consisted of $150.0 million of the
Company's Subordinated Notes which are convertible into a 1.1 million shares of
common stock at $138.34 per share (adjusted for the effect of the one-for-five
reverse stock split effective on February 22, 2002) at any time prior to
maturity.
17
On January 14, 2002, the Company filed an S-4 registration statement with the
Securities and Exchange Commission offering to exchange, for each $1,000
principal of the Subordinated Notes $366.67 in cash and, at the election of the
holder, one of the following options: a) $400.94 principal amount of Senior
Notes due January 2007 or, b) $320.75 principal amount of Senior Notes and
$80.19 principal amount of Senior Convertible Notes due November 2002 or, c)
$400.94 principal amount of Senior Convertible Notes.
On February 20, 2002, the Company completed its exchange offer for its
Subordinated Notes. Holders owning $128.6 million of Subordinated Notes
exchanged them for $47.2 million in cash, $12.4 million of Senior Notes and
$39.1 million of Senior Convertible Notes. Holders owning $21.4 million of the
Subordinated Notes did not exchange them, and they are now subordinate to the
Company's Facility, the Senior Notes and the Senior Convertible Notes.
The Senior Convertible Notes are mandatorily convertible into the Company's
common stock on November 30, 2002, and bear interest at 5%, payable
semi-annually in arrears, in either cash or stock, at the Company's option, on
August 15, 2002, and November 30, 2002. In the event of bankruptcy the Senior
Convertible Note holders are entitled to cash equal to the face value of the
Senior Convertible Note plus accrued interest. The Senior Convertible Notes are
convertible into the Company's common stock at a split adjusted conversion price
of $5.00 per share (adjusted for the effect of the one-for-five reverse stock
split effective on February 22, 2002) and may be converted at any time prior to
maturity at the option of the holders. The $39.1 million of Senior Convertible
Notes are convertible into 7.8 million shares of common stock and are considered
as dilutive securities in calculating earnings per share in the first quarter of
2002.
The Senior Notes mature January 15, 2007, and bear interest at 12%, payable in
cash in arrears semi-annually on February 15 and August 15, commencing August
15, 2002. The Senior Notes contain certain covenants that restrict the Company's
ability to incur additional indebtedness; make investments, loans and advances;
declare dividends or certain other distributions; create liens; enter into
sale-leaseback transactions; consolidate; merge; sell assets and enter into
transactions with affiliates.
Cash, cash equivalents, and restricted cash at February 28, 2002 were $122.3
million, compared to $89.3 million at November 30, 2001. The cash balance at
February 28, 2002 was unusually high due to a cash receipt of approximately
$15.0 million on February 28, 2002 and the timing of approximately $10.0 million
in quarter-end cash disbursements.
Compared to November 30, 2001, accounts receivable decreased from $216.0 million
to $198.3 million at February 28, 2002. Inventories declined to $146.5 million
at February 28, 2002, from $218.9 million at November 30, 2001. Management has
worked aggressively to reduce accounts receivable and inventory levels through
tightening of credit policies, aggressive collection efforts, and better
purchasing and inventory management. Accounts payable declined to $169.2 million
at February 28, 2002 compared to $229.0 million at November 30, 2001, primarily
due to lower inventory levels.
Based upon current and anticipated levels of operations, the Company anticipates
that its cash flows from operations, together with amounts available under its
Facility and existing unrestricted cash balances, will be adequate to meet its
anticipated cash requirements in the foreseeable future. In the event that
existing unrestricted cash balances, cash flows and available borrowings under
the Facility are not sufficient to meet future cash requirements, the Company
may be required to reduce planned expenditures or seek additional financing. The
Company can provide no assurances that reductions in planned expenditures would
be sufficient to cover shortfalls in available cash or that additional financing
would be available or, if available, offered on terms acceptable to the Company.
Accounting Pronouncements Not Yet Adopted
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("Statement") No. 141, "Business
Combinations." Statement No. 141 changes the accounting for business
combinations to eliminate the pooling-of-interests method and requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. This statement also requires intangible assets that arise
from contractual or other legal rights, or that are capable of being separated
or divided from the acquired entity, be recognized separately from goodwill.
Existing intangible assets and goodwill that were acquired in a prior purchase
business combination must be evaluated and any necessary reclassifications must
be made in order to conform with
18
the new criteria in Statement No. 141 for recognition apart from goodwill. The
Company does not expect the adoption of this statement to have a material impact
on its consolidated results of operations or financial position.
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible
Assets." Statement No. 142 addresses the initial recognition and measurement of
intangible assets acquired (other than those acquired in a business combination,
which is addressed by Statement No. 141) and the subsequent accounting for
goodwill and other intangible assets after initial recognition. Statement No.
142 eliminates the amortization of goodwill and intangible assets with
indefinite lives. Intangible assets with lives restricted by contractual, legal,
or other means will continue to be amortized over their useful lives. Adoption
of this statement will also require the Company to reassess the useful lives of
all intangible assets acquired, and make any necessary amortization period
adjustments. Goodwill and other intangible assets not subject to amortization
will be tested for impairment annually, or more frequently if events or changes
in circumstances indicate that the asset might be impaired. Statement No.142
requires a two-step process for testing goodwill for impairment. First, the fair
value of each reporting unit will be compared to its carrying value to determine
whether an indication of impairment exists. If an impairment is indicated, then
the fair value of the reporting unit's goodwill will be determined by allocating
the unit's fair value to its assets and liabilities (including any unrecognized
intangible assets) as if the reporting unit had been acquired in a business
combination. The amount of impairment for goodwill and other intangible assets
will be measured as the excess of its carrying value over its fair value.
Goodwill and intangible assets acquired after June 30, 2001 will be immediately
subject to the impairment provisions of this statement. For goodwill and other
intangible assets acquired on or before June 30, 2001, the Company is required
to adopt Statement No. 142 no later than the beginning of fiscal 2003. The
Company has not yet determined the impact of the adoption of this statement will
have on its consolidated results of operations or financial position.
In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement
Obligations, which addresses financial accounting and reporting obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The standard applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and (or) normal use of the asset. Statement No. 143
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made. The fair value of the liability is added to the carrying
amount of the associated asset and this additional carrying amount is
depreciated over the life of the asset. The liability is accrued at the end of
each period through charges to operating expense. If the obligation is settled
for other than the carrying amount of the liability, the Company will recognize
a gain or loss on settlement. The Company is required to adopt the provisions of
Statement No. 143 no later than the beginning of fiscal year 2003, with early
adoption permitted. The Company does not expect the adoption of this statement
to have a material effect on its consolidated results of operations or financial
position.
In October 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While Statement No. 144 supersedes FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it
retains many of the fundamental provisions of that Statement. Statement No. 144
becomes effective for fiscal years beginning after December 15, 2001, with early
applications encouraged. The Company does not expect the adoption of this
statement to have a material effect on its consolidated results of operations or
financial position.
19
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Exchange Risk
For the quarter ended February 28, 2002 and 2001, the Company recorded net
foreign currency gains (losses) of $0.2 million and ($0.4) million, respectively
in costs of goods sold. For the quarter ended February 28, 2002 and 2001, the
Company recorded in other income (expense), net foreign currency gains and
(losses) of $(0.1) million and $1.1 million, respectively. The gain in 2001 was
primarily due to the revaluations of foreign currencies related to the European
operations.
The Company manages foreign currency risk by attempting to increase prices of
products sold at or above the anticipated exchange rate of the local currency
relative to the U.S. dollar, by indexing certain of its accounts receivable to
exchange rates in effect at the time of their payment and by entering into
foreign currency hedging instruments in certain instances. The Company
consolidates the bulk of its foreign exchange exposure related to intercompany
transactions in its international finance subsidiary. These transactional
exposures are managed using various derivative alternatives depending on the
length and size of the exposure. The Company continues to evaluate foreign
currency exposures and related protection measures.
The Company does have foreign exchange exposure on the intercompany advances
from the Hong Kong entity to the China entity as the funds have been effectively
converted into RMB (Chinese People's currency). The Company also has foreign
exchange exposure on the RMB lines of credit in China as they are collateralized
by U.S. dollars. For the quarter ended February 28, 2002, $282.2 million, or
44.9%, of the Company's revenues were from the Company's operation in China.
With the exception of intercompany activity, all revenues and expenses of the
China operations are in RMB. The Company does not hold derivative instruments
related to the RMB.
In December 2001, the Argentine government removed the fixed exchange rate
maintained between the Argentine peso and the U.S. dollar. Based upon the
Company's current level of operations in Argentina, there was not a significant
impact in the first quarter of 2002 as a result of the Argentine peso
devaluation.
Derivative Financial Instruments
The Company periodically uses various derivative financial instruments as part
of an overall strategy to manage its exposure to market risk associated with
interest rate and foreign currency exchange rate fluctuations. The Company
periodically uses foreign currency forward contracts to manage the foreign
currency exchange rate risks associated with international operations. The
Company evaluates the use of interest rate swaps and cap agreements to manage
its interest risk on debt instruments, including the reset of interest rates on
variable rate debt. The Company does not hold or issue derivative financial
instruments for trading purposes. The Company's risk of loss in the event of
non-performance by any counterparty under derivative financial instrument
agreements is not significant. Although the derivative financial instruments
expose CellStar to market risk, fluctuations in the value of the derivatives are
mitigated by expected offsetting fluctuations in the matched instruments. The
Company uses foreign currency forward contracts to reduce exposure to exchange
rate risks primarily associated with transactions in the regular course of its
international operations. The forward contracts establish the exchange rates at
which the Company purchases or sells the contracted amount of local currencies
for specified foreign currencies at a future date. The Company uses forward
contracts, which are short-term in nature (45 days to one year), and receive or
pay the difference between the contracted forward rate and the exchange rate at
the settlement date.
At February 28, 2002, the Company had no forward contracts and does not hold any
other derivative instruments.
Interest Rate Risk
The interest rate of the Company's Facility is an index rate at the time of
borrowing plus an applicable margin on certain borrowings. The interest rate is
based on either the agent bank's prime lending rate or the London Interbank
Offered Rate. During the quarter ended February 28, 2002, the interest rates of
borrowings under the Facility ranged from 5.75% to 6.00%. A one percent change
in variable interest rates will not have a material impact on the Company.
The Company manages its borrowings under the Facility each business day to
minimize interest expense. The Company has short-terms borrowings in China as
discussed in Liquidity and Capital Resources. The notes payable in Taiwan bear
interest at 4.03%. The Subordinated Notes have a fixed coupon interest rate of
5.0% and are due in October 2002. The Senior Convertible Notes issued in
February 2002 bear interest at 5.0% and mature November 30, 2002. The Senior
Notes issued in February 2002 bear interest at 12.0% and mature January 15,
2007.
20
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
On October 15, 2001, the Company announced that the results for the three and
six months ended May 31, 2001 would be restated to reflect certain accounting
adjustments. In October 2001, the Company received an inquiry from the SEC
requesting information concerning the restatement of earnings for the quarter
ended May 31, 2001. The Company believes that it has fully responded to such
request.
The Company is a party to various other claims, legal actions and complaints
arising in the ordinary course of business.
Management believes that the disposition of these matters will not have a
materially adverse effect on the consolidated financial condition or results of
operations of the Company.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits.
4.1 Specimen Common Stock Certificate of CellStar Corporation. (1)
10.1 Separation Agreement and Release dated as of December 11, 2001, by and
among CellStar Corporation, CellStar Ltd. and Austin P. Young. (1)(2)
10.2 Employment Agreement, effective as of December 12, 2001, by and among
CellStar Ltd., CellStar Corporation and Robert Kaiser. (1)(2)
10.3 First Amendment to Employment Agreement, effective as of April 2,
2002, by and among CellStar Ltd., CellStar Corporation and Robert
Kaiser. (1)(2)
-----------------------------------
(1) Filed herewith.
(2) The exhibit is a management contract or compensatory plan or
arrangement.
(B) Reports on Form 8-K
None.
21
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLSTAR CORPORATION
/s/ Robert A. Kaiser
--------------------------------------------------
By: Robert A. Kaiser
Senior Vice President, Chief Financial Officer
and Treasurer (Principal Financial Officer)
/s/ Raymond L. Durham
-------------------------------------------------
By: Raymond L. Durham
Vice President, Corporate Controller
(Principal Accounting Officer)
Date: April 11, 2002
22
EXHIBIT INDEX
--------------
Exhibit
No. Description
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4.1 Specimen Common Stock Certificate of CellStar Corporation. (1)
10.1 Separation Agreement and Release dated as of December 11, 2001, by
and among CellStar Corporation, CellStar Ltd. and Austin P. Young.
(1)(2)
10.2 Employment Agreement, effective as of December 12, 2001, by and
among CellStar Ltd., CellStar Corporation and Robert Kaiser. (1)(2)
10.3 First Amendment to Employment Agreement, effective as of April 2,
2002, by and among CellStar Ltd., CellStar Corporation and Robert
Kaiser. (1)(2)
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(1) Filed herewith.
(2) The exhibit is a management contract or compensatory plan or arrangement.
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