ITEM 2. PROPERTIES
The corporate headquarters of the Company is located at 2000 N.W. 84th Avenue, Miami, Florida, which is also the principal operational facility for its Latin America regional operations and the operations of CHS Latin America, Inc. The Company's subsidiaries operate through approximately 70 locations totalling approximately three million square feet. Most locations consist of an administrative office utilized by the subsidiary and an adjoining or nearby warehouse and distribution facility.
In each of the countries, the size set forth above includes sales, administrative and warehousing functions and may be composed of multiple facilities. The Company considers its existing facilities to be adequate for its foreseeable needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not currently engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth for the periods indicated the high and low closing sales prices of the Company's Common Stock (symbol: CHSE) from January 1, 1996 through June 6, 1996 on the Nasdaq Small-Cap Market and thereafter on the Nasdaq National Market. The Company effected a one-for-two reverse stock split on March 14, 1996. On September 15, 1997, the Company effected a three-for-two forward split for all shareholders of record as of September 2, 1997. All prior amounts have been adjusted to reflect the effects of such splits. Such prices are based on inter-dealer bid and asked prices, without markup, markdown, commissions, or adjustments and may not represent actual transactions.
The last reported sale price of the Common Stock as reported on the Nasdaq National Market on March 23, 1998 was $18.25 per share. As of March 23, 1998, the outstanding Common Stock was held of record by 343 shareholders. The Company believes that it has in excess of 400 beneficial owners.
The Company has never paid cash dividends on its Common Stock and does not anticipate paying cash dividends in the foreseeable future, but intends instead to retain any future earnings for reinvestment in its business. Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon the Company's financial condition, results of operations, capital requirements and such other factors as the Board of Directors deems relevant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources."
In the first quarter of 1997, the Company issued 274,855 shares of its Common Stock in connection with its acquisition of Wyrsch Trading A.G., a Swiss limited liability company, and 3,300,000 shares of its Common Stock in connection with its acquisition of Frank & Walter Computer GmbH, a German corporation. In the third quarter of 1997, the Company issued 4,813,432 shares of its Common Stock in connection with its acquisition of Karma International, S.A., a Luxembourg corporation, and 283,288 shares of its Common Stock in connection with its acquisition of CompExpress Informatica Ltda, a Brazilian corporation. Each of the aforementioned issuances of Common Stock were made without registration under the Securities Act of 1933, as amended (the "Securities Act"), in reliance upon the exemptions from registration afforded by Section 4(2) of the Securities Act.
In January 1998, the Company implemented a Common Stock Purchase Rights Plan and distributed one right (a "Right") for each share of the Company's Common Stock outstanding. Each Right has an initial exercise price of $100 for one-one thousandth of a share of the Company's Series A junior participating preferred stock. The Rights are not exercisable or transferable, apart from the Company's Common Stock, until after a person or group acquires, or has the right to acquire, beneficial ownership of 15% or more of the Company's Common Stock (which threshold may, under certain circumstances, be reduced to 10%) or announces a tender or exchange offer to acquire such percentage of the Company's Common Stock. Upon such occurrence, each Right (other than Rights owned by such person or group) will entitle the holder to purchase from the Company, or the particular acquiring person or group under certain circumstances and conditions, the number of shares of the Company's, or such person's or group's, Common Stock having a market value equal to twice the exercise price of the Right. The Rights are redeemable by the Company's Board of Directors under certain circumstances.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following tables set forth certain financial data for each year in the five year period ended December 31, 1997. The information presented as of and for the years ended December 31, 1993, 1994, 1995, 1996 and 1997, is derived from the audited consolidated financial statements of the Company, which statements have been audited by Grant Thornton LLP, independent public accountants. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING INFORMATION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO CONTAINED ELSEWHERE HEREIN.
"FORWARD-LOOKING" INFORMATION
This Form 10-K contains certain "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which represent the Company's expectations of beliefs, including, but not limited to, statements concerning gross margins, the effect of Karma's results on operating expenses and sales of the Company's products. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company's control, and actual results may differ materially depending on a variety of important factors, including the level of acquisition opportunities available to the Company and the Company's ability to efficiently price and negotiate such acquisitions on a favorable basis, the financial condition of the Company's customers, the failure to properly manage growth and successfully integrate acquired companies and operations, changes in economic conditions, demand for the Company's products and changes in competitive environment.
The Company cautions that the factors described above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements of the Company made by or on behalf of the Company. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all of such factors. Further, management cannot assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
OVERVIEW
CHS distributes microcomputer products, including personal computers, peripherals, networking products and software in 39 countries, primarily in Western Europe, Eastern Europe and Latin America. The Company has pursued and expects to continue to pursue an aggressive strategy of growth through acquisitions of distributors in these and other regions. Together with growth in its existing business, such acquisitions have enabled the Company to significantly increase net sales and achieve strong operating results. From 1993 to 1997, the Company's net sales increased from $146.4 million to $4.8 billion. The Company attributes these increases in sales to its acquisitions, increased consumer demand for the Company's products and an expansion of the range of products offered.
The Company derives all of its operating income and cash flow from its operating subsidiaries, most of which are organized and operated outside the United States. Generally, the Company purchases its inventory with a combination of United States dollars and local currency and sells in local currency. The Company seeks to limit its exposure to the risk of currency fluctuations through hedging. See "--Currency Risk Management."
The following table sets forth acquisitions made by the Company, the service areas of the operations acquired and the dates as of which the results of operations of the acquired company were included in the Company's financial statements during 1995 to 1997.
- ---------------- (1) The names are those by which the Company refers to its subsidiaries and are not necessarily the legal names of the entities. (2) The Company owns 65% of this company.
(3) Deemed by the Company to be part of one acquisition.
(4) The Company owns 51% of this company.
(5) Deemed by the Company to be part of one acquisition.
(6) The Company acquired a 16% interest in CHS Czechia in January 1993 and acquired the remaining 84% in October 1995.
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, the percentage of net sales represented by certain items in the Company's Consolidated Statements of Earnings:
1997 COMPARED TO 1996
NET SALES. Net sales increased $2.9 billion, or 156.3%, from $1.9 billion in 1996 to $4.8 billion in 1997 due principally to acquisitions and, to a lesser extent, internal growth. Of the increase in net sales, newly acquired subsidiaries (including existing CHS companies for the first nine months of 1997 which were integrated with companies acquired from Merisel) contributed $2.5 billion. Net comparable sales of subsidiaries consolidated for both 1996 and 1997 grew $371.3 million or 28.0%. This growth is attributed to increased consumer demand for microcomputer products offered by the Company.
GROSS PROFIT. Gross profit increased $215.6 million, or 164.4%, from $131.1 million in 1996 to $346.7 million in 1997 due principally to acquisitions and, to a lesser extent, internal growth. Gross profit on a comparable basis for subsidiaries consolidated for both 1996 and 1997 increased $42.4 million, or 48.3%. Newly acquired subsidiaries (including existing CHS companies for the first nine months of 1997 which were integrated with companies acquired from Merisel) contributed $173.1 million of increased gross profit.
Gross margin increased from 7.1% in 1996 to 7.3% in 1997. The change in gross margin was due to increased early payment discounts and vendor rebates offset to some extent by lower gross margins of the recently acquired Karma operations. The Company utilized more early payment discount opportunities as a result of the cash generated by its public equity offering in July 1997. Additionally, the Company's growth has resulted in more favorable volume rebates with certain key vendors. The increase in gross margin attributable to early payment discounts (0.2%) and volume rebates (1.4%) was offset by the fact that the Karma operation has a lower gross margin due to the nature of the products sold. The Company expects that 1998 gross margins will be lower than in 1997 due to the impact of having the Karma operations included in the entire year and due to continued competitive pressures. Although the Company has been achieving higher gross margins (10.5% and 9.3% in 1996 and 1997, respectively) in its Eastern European operations than in other areas, the Company expects gross margins in Eastern Europe to continue to decline due to increased competition and a Company strategy to increase sales through more competitive pricing. The Company expects that the impact on gross profit due to decreased gross margins in this geographic area will be fully offset by increased sales.
OPERATING EXPENSES. Operating expenses as a percentage of net sales declined from 5.5% in 1996 to 5.4% in 1997. Included were the expenses of maintaining a minimally utilized warehouse in the Netherlands in 1997 and $1.4 million in Merisel restructuring expenses in 1996. In 1998 the warehouse is expected to be utilized for distribution of universal products (E.G., mass storage and components). The
comparative operating expense ratios without these items would have been 5.4% for 1997 and 5.4% for 1996. The Company expects that the inclusion of Karma's results for a full year will result in operating expenses being a lower percentage of net sales based on the lower operating expenses of Karma. Operating expenses for both periods include the results of foreign currency transactions. Such results were a net gain of $1.2 million in 1997 and $1.6 million in 1996.
NET INTEREST EXPENSE. Net interest expense increased $15.6 million, or 183.7%, from $8.5 million in 1996 to $24.1 million in 1997. The increase is directly related to the increase in average loan amounts outstanding.
INCOME TAXES. Income taxes as a percentage of earnings before income taxes and minority interest in subsidiaries decreased from 29.9% in 1996 to 21.5% in 1997. The change is due to a higher proportion of income earned in jurisdictions with lower tax rates and the use of net operating loss carryforwards, offset, to a certain extent, by losses in subsidiaries with no tax benefit and non deductible goodwill amortization. The Company expects to have an effective tax rate lower than the statutory United States tax rate in 1998 principally due to its ability to use remaining net operating loss carryforwards from certain subsidiaries and the proportion of income expected in jurisdictions with lower tax rates.
1996 COMPARED TO 1995
NET SALES. Net sales increased $918.8 million, or 98.1%, from $936.7 million in 1995 to $1.9 billion in 1996 due principally to acquisitions and, to a lesser extent, internal growth. Of the increase in net sales, subsidiaries not included in both 1995 and 1996 contributed $640.7 million. Net comparable sales of subsidiaries consolidated for both 1995 and 1996 grew $278.1 million or 29.7%. This growth is attributed to increased consumer demand for microcomputer products offered by the Company and the expansion of sales by the Company's subsidiaries to include a full range of products.
GROSS PROFIT. Gross profit increased $63.1 million, or 92.8%, from $68.0 million in 1995 to $131.1 million in 1996 due principally to acquisitions and, to a lesser extent, internal growth. Gross profit on a comparable basis for subsidiaries consolidated for both 1995 and 1996 increased $13.6 million, or 20.0%. Subsidiaries not included in both 1995 and 1996 contributed $49.5 million of gross profit.
Gross margin decreased from 7.3% in 1995 to 7.1% in 1996. The decrease was due to lower gross margins from subsidiaries located in Western Europe, particularly those operations acquired from Merisel, which, as a result of high volumes of sales by those entities, had a significant impact on the Company's gross margin as a whole. The Company attributes the decrease in gross margins to competitive pressures in this region, especially in Germany. The Company's subsidiaries in Germany had the lowest gross margins of all its European subsidiaries in 1996. The Company expects that overall gross margin may continue to decline in 1997 due to continued competitive pricing pressures and the fact that the gross margins of the acquired Merisel companies have been generally lower than that of the Company and will be included in the consolidation for the full year. In addition, the acquisition of Frank & Walter, which operates in Germany, where gross margins are generally lower, will also impact overall gross margin. The gross margin of the combined Merisel companies for the nine months ended September 30, 1996 was 7.0%.
OPERATING EXPENSES. Operating expenses as a percentage of net sales declined from 6.1% in 1995 to 5.5% in 1996. The decline was due to efficiencies gained through increased sales volume and the Company's efforts to control costs. The reduction was achieved even though a provision of $1.4 million was made for restructuring costs incurred by CHS (consisting of severance costs for CHS employees, write-off of CHS leasehold improvements and lease termination costs of CHS closed facilities) to implement consolidation in markets in which a CHS company previously existed and a company was acquired from Merisel. The operating expense ratio without such charge would have been 5.4% for the year.
NET INTEREST EXPENSE. Net interest expense increased $3.8 million, or 81.2%, from $4.7 million in 1995 to $8.5 million in 1996. The increase is directly related to the increase in average loan amounts outstanding.
INCOME TAXES. Income taxes as a percentage of earnings before income taxes and minority interest in subsidiaries increased slightly from 29.4% in 1995 to 29.9% in 1996. Management does not believe this change is significant. The difference between this tax rate and the statutory United States tax rate is due to the utilization of net operating loss carryforwards and lower foreign tax rates, offset to some extent by losses in subsidiaries with no tax benefit and non-deductible goodwill amortization.
SEASONALITY
The Company typically experiences variability in its net sales and net income on a quarterly basis as a result of many factors, including the condition of the microcomputer industry in general, shifts in demand for software and hardware products and industry announcements of new products or upgrades. Sales in Europe in the first and fourth quarters of each year are typically higher than in the second and third quarters. In Latin America, sales in the third and fourth quarters of each year are typically higher than in the first and second quarters.
LIQUIDITY AND CAPITAL RESOURCES
Net cash of $248.5 million and $99.1 million was used in operating activities in the years ended December 31, 1997 and 1996, respectively. In both years, cash was used principally due to increases in inventories, trade accounts receivable and amounts due from affiliates, offset in 1996 by increases in accounts payable. In 1997, cash was also used to lower accounts payable and accrued expenses. Net cash used in investing activities in 1997 and 1996 included $19.5 million and $11.6 million, respectively, related to fixed asset additions. In addition, $201.5 million and $26.9 million were used in acquisitions during the years ended December 31, 1997 and 1996, respectively. Net cash of $507.2 million and $163.3 million was provided by financing activities in the years ended December 31, 1997 and 1996, respectively, due principally to proceeds of equity public offerings totalling $428.2 million in 1997 and $50.6 million in 1996. Furthermore, net borrowings from banks totalled $74.7 million and $112.5 million in the years ended December 31, 1997 and 1996, respectively.
Certain of the Company's United States based subsidiaries are parties to a Loan and Security Agreement providing for revolving credit advances and the issuance of letters of credit against eligible accounts receivable and inventory up to a maximum of $60 million. Amounts outstanding bear interest, at the election of the borrowers, at either a variable market rate based on the prime rate of the lender or LIBOR. The agreement limits the ability of the borrowers to pay dividends to the Company. The agreement matures in October 1999 and is secured by a lien on essentially all of the borrowers' assets. The agreement contains certain restrictive covenants. During November and December 1997, the borrowers were in violation of requirements to deposit receipts in specified accounts. The lender has waived these violations. The Company has guaranteed this indebtedness.
The Company's subsidiaries typically enter into revolving credit agreements with financial institutions in their countries of operations. At December 31, 1997, the aggregate amount available under these agreements was $445.4 million and $348.3 million was then outstanding. Such agreements are usually for a term of one year and are secured by the receivables of the borrower. The weighted average interest rate at December 31, 1997 was 7.3%. The Company typically guarantees these loans. The Company has also guaranteed the obligations of certain of its subsidiaries to manufacturers.
The Company derives all of its operating income and cash flow from its subsidiaries and relies on payments from, and intercompany borrowings with, its subsidiaries to generate the funds necessary to meet its obligations. In certain countries, exchange controls may limit the ability of the Company's subsidiaries to make payments to the Company. Restrictions in financing or credit arrangements may also limit access to such earnings. Certain of the Company's subsidiaries are parties to financing agreements that limit the ability of such subsidiaries to make payments to the Company. In the year ended December 31, 1997, the contribution of such subsidiaries to the Company's consolidated EBITDA was 16%. Claims of creditors of the Company's subsidiaries will generally have priority as to the assets and cash flow of such subsidiaries over the claims of the Company or its creditors. See Note F to the Consolidated Financial Statements.
The Company has completed a risk assessment of the ability of its information systems to operate in light of the "year 2000 problem." Based on the assessment, the Company has developed an action plan, which principally consists of replacing existing non-compliant systems with new systems. The Company believes it is feasible to acquire such new systems before the year 2000 and that the cost of such systems are within its capital cost budget and financing capabilities.
The Company's principal need for additional cash in 1998 will be for the purchase of additional inventory to support growth and to take greater advantage of available cash discounts offered by certain of the Company's vendors for early payment and to pay amounts due to sellers of businesses. The Company anticipates funding this cash requirement partially through the Note Offering, the New Credit Facility and its subsidiaries' existing bank credit lines and through additional credit facilities, but there can be no assurance that financing will be available on terms acceptable to the Company. The unavailability of such financing could adversely affect the growth of the Company.
INFLATION
The Company operates in certain countries that have experienced high rates of inflation and hyperinflation. However, inflation did not have any meaningful impact on the Company's results of operations during the year ended December 31, 1997 nor during the three-year period ended December 31, 1997, and the Company does not expect that it will have a material impact during 1998.
ASSET MANAGEMENT
INVENTORY. The Company's goal is to achieve high inventory turns and maintain a low number of SKUs and thereby reduce the Company's working capital requirements and improve return on equity. The Company's strategy to achieve this goal is to both manage its inventory effectively and achieve high order fill rates.
To reduce the risk of loss to the Company due to vendor price reductions and slow moving or obsolete inventory, the Company's contracts with its vendors generally provide price protection and stock rotation privileges, subject to certain limitations. Price protection allows the Company to offset the accounts payable owed to a particular vendor if such vendor reduces the price of products the Company has purchased within a specified period of time and which remain in inventory. Stock rotation permits the Company to return to the vendor for full credit, with an offsetting purchase order for new products, predetermined amounts of inventory purchased within a specified period of time. Such credit is typically used to offset existing invoices due without incurring re-stocking fees.
ACCOUNTS RECEIVABLE. The Company manages its accounts receivable to balance the needs of its customers to purchase on credit with its desire to minimize its credit losses. Bad debt expense as a percentage of the Company's net sales for each of the years ended 1996 and 1997 was 0.2%. The Company's credit losses have been minimized by its extensive credit approval process and the use of credit insurance and factoring by its Western European subsidiaries. In its sales to customers in Latin America, the Company often receives post-dated checks at the time of sale. Customers who qualify for credit are typically granted payment terms appropriate to the customs of each country.
CURRENCY RISK MANAGEMENT
FUNCTIONAL CURRENCY. The Company's functional currency, as defined by Statement of Financial Accounting Standards ("SFAS") No. 52, is the United States dollar. Most of the Company's subsidiaries use their respective local currencies as their functional currency and translate assets and liabilities using the exchange rates in effect at the balance sheet date and results of operations using the average exchange rates prevailing during the year. Translation effects are reflected in the cumulative foreign currency translation adjustment in equity. The Company's exposure under these translation rules, which is unhedged, may affect the carrying value of its foreign net assets and therefore its equity and net tangible book value, but not its net income or cash flow. Exchange differences arising from transactions and balances in currencies other than the functional currency are recorded as expense or income in the subsidiaries and the Company and affect the Statements of Earnings.
HEDGING AND CURRENCY MANAGEMENT ACTIVITIES. The Company attempts to limit its risk of currency fluctuations through hedging where possible. In the year ended December 31, 1997, a significant amount of the purchases of products by the Company were made in United States dollars and approximately 88% of Company sales were made in currencies other than the United States dollar. The primary currencies in which sales were made were the German mark (29% of sales), the French franc (10%) and the British pound (9%). At December 31, 1997, approximately $271.6 million of accounts payable were attributable to foreign currency liabilities denominated in currencies other than the subsidiaries' functional currencies. Of these, $229.3 million were denominated in United States dollars and $26.2 million were denominated in German marks. Approximately 39% of these liabilities were unhedged. The most significant unhedged amounts were recorded in Czechian korunas ($24.7 million), Hong Kong dollars ($21.7 million), Polish zlotys ($14.2 million), Argentine pesos ($13.6 million), and Mexican pesos ($10.6 million).
CHS Finance, a wholly owned subsidiary of the Company, engages in central treasury functions including hedging activities related to foreign currency for the Company and short-term working capital loans to the Company's subsidiaries to enable them to take advantage of early payment discounts offered by certain vendors. These loans are denominated in the functional currency of the borrowing subsidiary or United States dollars. Generally, CHS Finance hedges its receivables denominated in currencies other than its functional currency, the Swiss franc. It attempts to limit the amount of unhedged receivables to an amount which approximates the total unhedged liabilities. The Company intends to review this policy periodically and may modify it in the future.
Through both hedging activities coordinated by CHS Finance and subsidiary hedging activities, the Company makes forward purchases of United States dollars in an attempt to hedge certain European currencies and reduce exposure to fluctuations in exchange rates. Additionally, in certain countries in Eastern Europe and in Latin America where it is not practical to make forward purchases, to minimize exposure to currency devaluations, the Company has adopted a policy of attempting to match accounts receivable with accounts payable and to limit holdings of local currencies. In these countries, the Company attempts to sell products at the United States dollar equivalent rate. Factors which affect exchange rates are varied and no reliable prediction methods are available for definitively determining future exchange rates. In general, countries make an effort to maintain stability in rates for trade purposes. There can be no assurance that these asset management programs will be effective in limiting the Company's exposure to these risks.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 130, "Comprehensive Income" in June 1997. SFAS No. 130 requires that changes in the amounts of items that bypass the income statement and are only reported within a balance in shareholders' equity be included in a separate financial statement. The only item that qualifies as a component of comprehensive income currently bypassing the statement of income is the foreign currency translation adjustment. SFAS No. 130 becomes effective for fiscal years beginning after December 15, 1997. The Company believes that the adoption of this standard will not have an effect on the Company's financial position or result of operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company appear beginning at page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors of the Company.
The information required regarding the identification of the Company's directors is incorporated by reference to the information contained in the Proxy Statement for the 1998 Annual Meeting of Shareholders of the Company.
(b) Executive Officers of the Company.
The executive officers of the Company, as well as certain key employees, and their ages as of December 31, 1997, are as follows:
- ---------------- (1) Each of these persons is a key employee, but not an executive officer of the Company.
CLAUDIO OSORIO (full name--Claudio Eleazar Osorio Rodriguez), the founder of the Company's current business and operations, has served as the Chairman of the Board, President, and Chief Executive Officer of the Company since 1993. Mr. Osorio has served as President of Comtrad since 1988. He is a director of Comtrad and the President and a director of CHI.
ALVIN PERLMAN has been a director of the Company since 1993 and Executive Vice President--Vendor and Banking Relations since August 1997. From 1994 until August 1997 he was the Executive Vice President--Latin American Region of the Company. He has served for the past five years as the Chief Executive Officer of Zemex Electronics, Inc., d/b/a CHS Promark, and was the sole owner of CHS Promark prior to its acquisition by the Company in June 1994. Mr. Perlman served as a director of CHI from November 1994 until October 1997.
CARSTEN FRANK has been a director of the Company since May 1997 and has been Executive Vice President--Asian Region of the Company since March 1, 1998. From March 1997 until February 28, 1998, he was the Executive Vice President--European Region of the Company. Mr. Frank founded Frank & Walter in 1988 and has served as such company's Managing Director since its formation. Frank & Walter was acquired by the Company in March 1997.
CLIFFORD DYER has been the Executive Vice President--Latin American Region of the Company since August 1997. From January 1997 until July 1997 he was the Chief Operating Officer--Latin American Region. From February 1987 until it was acquired by the Company in October 1996, Mr. Dyer was President of Merisel Latin America, Inc. and was responsible for all Latin American
operations. He was the founder in 1982 of the predecessor company to Merisel Latin America, Inc. Prior to 1982, Mr. Dyer was President of GTE Venezuela and held directorships in various companies.
CRAIG TOLL has been the Vice President of Finance of the Company since August 1997 and has been the Chief Financial Officer of the Company since July 1994 and its Treasurer since June 1995. Mr. Toll was self-employed as a consultant to CHS Promark from April 1994 to June 1994. For over five years prior to April 1994, Mr. Toll was a partner in the accounting firm of Deloitte & Touche.
ANTONIO BOCCALANDRO has been the Chief Officer of Mergers and Acquisitions of the Company since August 1997 and has been a director and the Secretary of the Company since 1993. He was Treasurer of the Company from December 1993 to June 1995. He has also been employed in various capacities by Comtrad since 1988. Mr. Boccalandro became a director of Comtrad in 1990 and he has been a director of CHI since June 1994.
PASQALE GIORDANO has been the Executive Vice President--European Region of the Company since March 1, 1998. From January 1, 1997 until February 28, 1998 he was Chief Operating Officer--European Region. From January 1989 through December 31, 1996, Mr. Giordano was the President and Chief Operating Officer of CHS Promark. Prior to such service, he was a Vice President of CHS Promark in charge of its New York office. From 1988 until he joined CHS Promark in 1989, Mr. Giordano was Vice President of the electronics division of Abraham & Strauss, a division of Federated Department Stores, Inc.
ARTURO OSORIO has been the Chief Operating Officer of the Latin American Region since September 1997. Mr. Osorio was the General Manager and Northern Regional Director for CHS Promark from 1994 to 1996 and Director of Sales from 1996 to August 1997. Mr. Osorio occupied various positions in sales and management for Comtrad from 1988 to 1994.
ALVI MAZON has been the Chief Operating Officer--Karma Operations of the Company since August 1997. From September 1990 through July 1997, Mr. Mazon was the Managing Director of Karma.
ZBYNEK KRAUS has been a director of the Company since March 1996 and, since 1993, the General Manager of the Company's Czech Republic operation. From January to December 1996, Mr. Kraus served as Vice President--East European Region of the Company. From 1990 to 1993, he was an owner and the sales director of the Czech Republic operation.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required in response to this item is incorporated by reference to the information contained in the Proxy Statement for the 1998 Annual Meeting of Shareholders of the Company.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required in response to this item is incorporated by reference to the information contained in the Proxy Statement for the 1998 Annual Meeting of Shareholders of the Company.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required in response to this item is incorporated by reference to the information contained in the Proxy Statement for the 1998 Annual Meeting of Shareholders of the Company.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of this Report.
(1) Financial Statements
See "Item 8. Financial Statements and Supplementary Data" for Financial Statements included under this Annual Report on Form 10-K.
(2) Financial Statement Schedules
(3)
- ---------------- (1) Incorporated herein by this reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
(2) Incorporated herein by this reference from the Company's registration statement on Form 10 filed with the Securities and Exchange Commission on May 26, 1994 and the amendments thereto filed on August 1, 1994, September 9, 1994, December 2, 1994 and January 12, 1995.
(3) Incorporated herein by this reference from the Company's Registration Statement on Form S-1 (File No. 333-03864).
(4) Incorporated herein by this reference from the Company's Current Report on Form 8-K filed on October 18, 1996.
(5) Incorporated herein by this reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1996.
(6) Incorporated herein by this reference from the Company's Registration Statement on Form S-3 (File No. 333-29779).
(7) Filed herewith.
(b) Reports on Form 8-K
During the last quarter of the period covered by this Report, the Company filed a current report on Form 8-K dated October 13, 1997, as amended by Form 8-K/A dated October 31, 1997, which included information pursuant to Item 2, Acquisition or Disposition of Assets, relating to the acquisition of the assets described in such report.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, as amended (the "Act"), the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
CHS ELECTRONICS, INC.
By: /s/ Claudio Osorio ------------------------------------- Claudio Osorio President
Dated: March 24, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders CHS Electronics, Inc.
We have audited the accompanying consolidated balance sheet of CHS Electronics, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CHS Electronics, Inc. as of December 31, 1997 and 1996, and the consolidated results of its operations and its consolidated cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
GRANT THORNTON LLP
Miami, Florida March 12, 1998
CHS ELECTRONICS, INC.
CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
The accompanying notes are an integral part of these statements.
CHS ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF EARNINGS (In thousands, except share data)
The accompanying notes are an integral part of these statements.
CHS ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1997 (In thousands)
The accompanying notes are an integral part of these statements.
CHS ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
(CONTINUED)
CHS ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED) (In thousands)
Non cash investing and financing activities:
These statements of cash flows do not include non-cash investing and financing transactions associated with the common stock issued for various acquisitions. The components of the transactions in each year are as follows:
In 1996, $13.7 million was credited to additional paid-in capital representing additional consideration paid by Comtrad, Inc. under acquisition agreements for subsidiaries now held by the Company.
In 1995, a $5.2 million reduction in receivable from affiliate was charged to additional paid-in capital.
The accompanying notes are an integral part of these statements.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997
NOTE A--SUMMARY OF ACCOUNTING POLICIES
1. NATURE OF OPERATIONS
The Company is an international distributor of computer equipment, peripherals and software. The products are sold, principally to resellers, primarily in Western Europe, South America and Eastern Europe.
2. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its subsidiaries, wholly owned and majority owned. All significant intercompany accounts and transactions have been eliminated in consolidation.
3. FOREIGN CURRENCY TRANSLATION
For purposes of preparation of its financial statements, the Company uses local currencies as the functional currencies except in highly inflationary countries. For subsidiaries where the local currency is the functional currency, assets and liabilities are translated into United States dollars at the exchange rate in effect at the end of the year. Revenues and expenses of these subsidiaries are translated at the average exchange rate during the year. The aggregate effect of translating the financial statements of foreign subsidiaries is included in a separate component of shareholders' equity entitled cumulative foreign currency translation adjustment. In the normal course of business, the Company advances funds to certain of its foreign subsidiaries, which are not expected to be repaid in the foreseeable future. Translation adjustments resulting from these advances are included in cumulative foreign currency translation adjustment. For entities in highly inflationary countries, the U.S. dollar is considered the functional currency and a combination of current and historical rates are used in translating assets, liabilities, revenues and expenses. The related exchange adjustments are included in earnings.
4. CASH EQUIVALENTS
For the purpose of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
5. CONCENTRATION OF CREDIT RISK
The Company's credit risk on trade receivables is diversified over a wide geographic area and many customers. The largest customer accounts for less than 1% of sales. The Company performs ongoing credit evaluations of its customers. In South America, the Company obtains guarantees from its customers in some cases. The Company uses credit insurance in several locations (covering $281 million in receivables at December 31, 1997) and factoring without recourse in other locations to mitigate risk. The Company provides for estimated credit losses at time of sale based upon factors surrounding the credit risk of specific customers, historical trends and other information.
6. INVENTORIES
Inventories, consisting of finished products, are stated at the lower of cost or market, with cost being determined principally by current replacement cost, which approximates the first-in first-out method.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE A--SUMMARY OF ACCOUNTING POLICIES--(CONTINUED)
7. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. Leasehold improvements and capital leases are amortized over the lives of respective leases or the service lives of the improvements whichever is shorter.
The straight-line and accelerated methods of depreciation are followed for financial reporting purposes. The useful lives are as follows:
Expenditures for renewals and improvements that significantly extend the useful life of an asset are capitalized. The costs of software used in business operations are capitalized and amortized over their expected useful lives. Expenditures for maintenance and repairs are charged to operations when incurred. When assets are sold or retired, the cost of the asset and the related accumulated depreciation are removed from the accounts and any gain or loss is recognized at such time.
8. INCOME TAXES
The Company utilizes the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, ACCOUNTING FOR INCOME TAXES. Under the liability method specified by SFAS No. 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the current enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities.
The Company intends to invest the undistributed earnings of substantially all of its foreign subsidiaries indefinitely. At December 31, 1996 and 1997, the cumulative amount of undistributed earnings on which the Company has not recognized United States income taxes was approximately $13 million and $53 million, respectively. However, it is anticipated that United States income taxes on such amounts would be partially offset by available foreign income tax credits.
9. REVENUE RECOGNITION
The Company recognizes sales upon shipment, as there is no significant post-sale obligation and collectibility is reasonably assured. Income from vendor rebates, discounts, and cooperative advertising is recognized when earned, as a reduction of the cost of inventory sold or as a reduction of operating expenses.
10. COST IN EXCESS OF ASSETS, ACQUIRED, NET
The cost in excess of assets acquired is being amortized to earnings over a 20 year period on a straight-line basis. The Company evaluates its goodwill in accordance with SFAS No. 121, "ACCOUNTING
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE A--SUMMARY OF ACCOUNTING POLICIES--(CONTINUED)
FOR IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF," to determine potential impairment by comparing the carrying value to undiscounted future cash flows of the related assets. The Company modifies or adjusts the value of a subsidiary's goodwill if an impairment is indicated by the difference between the undiscounted cash flows and the carrying value. The Company considers a history of operating losses to be a primary indicator of potential impairment. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are largely independent of cash flows of other groups of assets. Assets are generally grouped at the country level of operations. The Company deems an asset to be impaired if a forecast of undiscounted future operating cash flows directly related to the asset, including disposal value if any, is less than its carrying amount. All of the Company's goodwill is identified with the assets acquired and falls under the scope of SFAS No. 121. Accumulated amortization was $2.2 million and $10.8 million at December 31, 1996 and 1997, respectively.
11. EARNINGS PER COMMON SHARE
The Company has adopted SFAS No. 128, EARNINGS PER SHARE. In accordance with this statement, basic earnings per share is computed by dividing net earnings by the weighted averaged number of common shares outstanding. Diluted earning per share includes the dilution caused by common stock options and the shares that would be issued in existing earn outs based upon applying the earn out multiple to annualized actual earnings and dividing by the market price at period end. The weighted average number of shares for basic earnings per share was 10,618,183, 15,243,672, and 33,527,256 in 1995, 1996, and 1997 respectively. The weighted average number of shares used in the diluted computation was 11,521,859, 15,656,178, and 36,592,368 in 1995, 1996, and 1997 respectively. All share and per share information has been restated for a three to two stock split effective in September 1997.
The following table illustrates the reconciliation of the income and weighted average number of shares of the basic and diluted earnings per share computations (amounts in thousands, except per share amounts):
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE A--SUMMARY OF ACCOUNTING POLICIES--(CONTINUED)
12. STOCK OPTIONS
Options granted under the Company's 1994 Stock Option Plan, the 1996 and 1997 Chief Executive Officer stock option plans and the 1996 Directors and Officers stock option plan are accounted for under APB Opinion 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. As to grants requiring shareholder approval, the Company considers the date of grant to be the date of action by the Board of Directors when, on such date, shareholder approval is deemed to be perfunctory.
13. USE OF ESTIMATES
In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Actual results could differ from those estimates.
NOTE B--ACQUISITIONS
In 1997 the Company made 15 acquisitions, of which three were significant. On October 3, 1997, the Company completed the acquisition of Santech Micro Group ASA ("Santech"), pursuant to which it acquired 97.4% of the capital stock of Santech for approximately $125 million. The Company expects to acquire the remainder of the shares at the same per share price. Santech is the largest distributor of microcomputer products in Scandinavia with operations in Norway, Sweden and Denmark and had revenues of $718 million in 1996. Santech distributes the products of the same vendors as other
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE B--ACQUISITIONS--(CONTINUED)
subsidiaries of the Company. The acquisition of Santech has been accounted for under the purchase method and, accordingly the results of Santech have been included in the consolidated operating results since the date of acquisition. The acquisition of Santech resulted in the recognition of $109.1 million of goodwill.
Santech's operating results during 1996 and 1997 were adversely impacted as a result of restructuring its operations after a July 1996 merger. Operating results were also impacted adversely by the implementation of a new computer system in the first six months of 1997. The adverse impact included costs associated with reduction in the number of its product lines and the number of employees from 450 to 320. The Company believes that these factors have been addressed and that these issues should not have a material adverse impact on Santech's or the Company's future operations.
On August 4, 1997, the Company completed the acquisition of Karma International S.A. ("Karma"). Karma is a distributor of personal computer components to over 10,000 customers in Europe, the Middle East and Asia. The purchase price for Karma was $160 million and was funded through (i) $74 million in cash and (ii) 4,813,432 shares of unregistered Common Stock. Karma's product line includes mass storage products, CPUs, memory chips, motherboards, sound, video and other cards and monitors. Karma operates in 18 countries through 28 offices in Europe, the Middle East Asisa. Karma had net sales of approximately $700 million in 1996. Karma existing management continues to operate Karma as a subsidiary of CHS. One representative of Karma was elected to the Board of Directors of CHS with an additional member to be nominated in 1998. The acquisition of Karma has been accounted for under the purchase method and, accordingly the results of Karma have been included in the consolidated operating results since the date of acquisition. The acquisition of Karma resulted in the recognition of $123.0 million of goodwill.
On March 20, 1997, the Company completed the acquisition of Frank & Walter Computer GmbH ("Frank & Walter") for 3,300,000 unregistered shares of Common Stock. Frank & Walter had net sales of approximately $686 million in 1996. The results of operations of Frank & Walter have been included in the Company's financial statements since January 1, 1997. The Company believes that Frank & Walter was, at the time of acquisition, the fourth largest computer distributor in Germany with over 10,000 active dealers. As a result of this acquisition, the Company believes it is the largest distributor of microcomputer products in Germany. Carsten Frank, the founder of Frank & Walter, has become a director of CHS and the CHS executive vice president responsible for the Company's European operations. The acquisition of Frank & Walter has been accounted for under the purchase method and, accordingly the results of Frank & Walter have been included in the consolidated operating results since the date of acquisition. The amounts preliminarily allocated to assets acquired and liabilities assumed resulted in a recognition of $27.6 million of goodwill. During 1997 an appraisal of certain acquired assets was performed. As a result of the appraisal, goodwill was decreased by $1.0 million.
The Company completed other acquisitions during 1997 which were considered not to be significant. Such acquisitions have been accounted for under the purchase method and accordingly, the results of such acquired entities have been included in the consolidated operating results since their acquisition dates.
In 1996 the Company acquired eighteen companies in as many countries. The largest acquisition was of seven companies comprising the European and Latin American businesses of a competitor,
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE B--ACQUISITIONS--(CONTINUED)
Merisel, Inc. These seven companies were acquired for cash and debt assumptions. The total consideration paid was approximately $148 million consisting of $30 million of cash and $118 million of debt assumed or refinanced. The Company financed the acquisition primarily through borrowing or factoring at each subsidiary acquired. Approximately $11 million was owed to Merisel at December 31, 1996. The acquisition has been accounted for as a purchase, effective as of September 30, 1996. Therefore, operations of these companies are included only in the 1996 fourth quarter. The cost of the acquisition has been allocated to the assets acquired based on their fair values. This initially resulted in approximately $10.5 million of goodwill. In the second and third quarters of 1997, certain reserves initially established were determined not to be required, resulting in a reduction of goodwill to $4.6 million.
The Company has now completed the consolidation of the former Merisel and CHS operations in the five countries where each had operations. The Company accrued approximately $12.8 million for the consolidation activities. The reserve consists of severance costs--$.4 million, lease termination--$4.1 million, writeoff of leasehold improvements and computer systems--$4.9 million, and accounts receivable and other costs--$3.4 million. Through December 31, 1997, $8.8 million has been charged against this reserve. The Company's original intent to dispose of the former Merisel warehouse located in the Netherlands has been revised as a result of the Karma acquisition and the Company now intends to relocate Karma's existing warehouse in the Netherlands to the former Merisel warehouse.
In June 1996, the Company acquired 100% of an unaffiliated company in Russia for consideration based on a multiple of that company's net income in 1996. The acquisition was initially recorded at no consideration, which approximated the value of net assets acquired. Subsequently, the agreement was modified to measure the value of the Company based 50% on 1996 results and 50% on 1997 results. The 1996 portion is payable in cash and was paid in 1997 and the 1997 portion is payable in cash or stock at the seller's option. In 1996 and 1997, $20.6 and $25.3 million was recorded as purchase price and goodwill.
In April 1996, the Company acquired 100% of an unaffiliated company in Switzerland for consideration based on the acquired company's results in 1996. The consideration was based on a multiple of 1996 net earnings but not less than $1.7 million. The acquisition was initially recorded at $1.7 million resulting in no goodwill. Subsequently, the agreement was modified to base the price on results through September 30, 1996. In the 1996 fourth quarter, 274,855 shares of common stock were issued and goodwill of $870,000 was recorded.
In March 1996, the Company acquired six companies from Comtrad, Inc., an affiliate, for a reduction of indebtedness of $7.8 million. These acquisitions have been accounted for as an exchange between entities under common control in a manner similar to a pooling of interests. Accordingly, these acquisitions have been included in the accompanying financial statements from the date acquired by Comtrad. The companies in Bulgaria, Croatia, Lithuania and Romania were started by Comtrad in 1993 and 1994 for a minimal investment and have insignificant operations. They are treated as if Comtrad acquired them on December 31, 1994. Sixty-five percent of a company in Slovakia was acquired in early 1994 for a minimal investment and 1994 results were insignificant. The remaining 35% was acquired by Comtrad for a contingent payment in shares of common stock to be based on 1996 results. This acquisition has been recorded as of December 31, 1994 based on the cost of the 65% interest acquired
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE B--ACQUISITIONS--(CONTINUED)
with the remaining cost to be recorded as goodwill when known. The contingent amount, which was insignificant, was recorded in 1997. Comtrad acquired the Brazil company in November 1994 for Comtrad common shares valued at $762,000. The acquisition was recorded by the Company as of December 31, 1994 at this value, resulting in goodwill of $2.5 million. An additional amount of $240,000 was paid by Comtrad in 1996 to complete its acquisition of this company, which had the effect of increasing goodwill to $2.8 million.
In February 1996, the Company acquired 51% of an unaffiliated company in Hungary for consideration based on 51% of the book value of equity at December 31, 1996 plus a multiple of 51% of 1996 net earnings. Based on 1996 results, the purchase price was fixed at $17.6 million resulting in goodwill of $15.8 million. The sellers elected to receive the proceeds in cash rather than stock. In the second quarter of 1997 the agreement was modified to measure the value of the company based 75% on 1996 results and 25% on 1997 results. The 1996 amount was paid in 1997. As a result, goodwill in 1996 was reduced by $3.8 million. The 1997 amount, estimated at $5.6 million, was recorded in 1997 and increased goodwill.
In 1995, the Company acquired nine companies in as many countries. Eight of these were acquired from Comtrad Holdings, Inc. ("CHI") or Comtrad (a wholly owned subsidiary of CHI) and have been accounted for as an exchange between entities under common control in a manner similar to a pooling of interests. Accordingly, these acquisitions have been included in the accompanying financial statements from the date acquired by Comtrad or CHI. The acquisition of the company in the Czech Republic was partially (16%) from Comtrad and partially from an individual. The portion from Comtrad was valued at Comtrad's basis of $758,000. The portion purchased from the unrelated individual has been accounted for as a purchase. Results of the remaining 84% of the Czech Republic company have been included in the accompanying financial statements from October 1, 1995. Information about the pooled acquisitions is shown below:
The Company acquired 84% of the Czech Republic company from an individual by issuing 483,000 shares which were valued at their market value of $3,246,000. This produced goodwill of $2.4 million.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE B--ACQUISITIONS--(CONTINUED)
The following represents the unaudited pro forma results of operations assuming all significant 1997 and 1996 acquisitions had taken place on January 1, 1996 (amounts in thousands, except per share amounts):
Pro forma adjustments have been made to eliminate non-recurring loss in the operations acquired from Merisel and to add goodwill amortization and interest expense on the amounts payable to selling stockholders at 7.5%. The pro forma information is not necessarily indicative of the actual results of operation that would have occurred had the acquisitions taken place on January 1, 1996, or of results which may occur in the future.
NOTE C--ALLOWANCE FOR DOUBTFUL ACCOUNTS
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE D--PROPERTY AND EQUIPMENT
NOTE E--INCOME TAXES
The components of earnings before income taxes and minority interest in subsidiaries consist of the following:
The provision for income taxes consists of the following:
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE E--INCOME TAXES--(CONTINUED)
Deferred tax assets (liabilities) are comprised of the following:
The major elements contributing to the difference between taxes at the U.S. federal statutory tax rate and the effective tax rate are as follows:
At December 31, 1997, the Company has net operating loss carry forwards in certain foreign jurisdictions that expire as follows:
In assessing the realization of net operating loss carryforwards, management considers whether it is more likely than not that some portion or all of these net operating loss carryforwards will not be
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE E--INCOME TAXES--(CONTINUED)
realized. The ultimate realization of these net operating loss carryforwards and other deferred tax assets are dependent upon the generation of future taxable income during the periods prior to the expiration of the operating loss carryforwards. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the operating loss carryforward periods, management believes it is more likely than not the Company will not realize the benefits of all of these net operating loss carryforwards and other deferred tax assets. Accordingly, a valuation allowance has been established since the full realization of such benefits was not likely. Subsequently recognized tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 1997 will be allocated to income from continuing operations or goodwill.
NOTE F--NOTES PAYABLE AND LONG TERM DEBT
Several of the Company's subsidiaries have short-term credit lines with local banks. As of December 31, 1997, the aggregate amount available under these agreements was $385.4 million, and $302.0 million was outstanding under these facilities. Generally, borrowings under such lines are collateralized by receivables or inventory. The lines are principally of one year duration and are renewable by the banks. Some of these lines contain restrictions on dividends to the parent company. In 1997, the maximum and average amounts outstanding were $395.2 million and $289.2 million, respectively. The weighted average interest rate at December 31, 1997 was 7.3%.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE F--NOTES PAYABLE AND LONG TERM DEBT--(CONTINUED)
The Company's long-term debt consists of the following:
During November and December 1997, the borrowers were in violation of requirements to deposit funds in specific accounts pursuant to the $60 million revolving credit agreement. The lender has waived these violations.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE F--NOTES PAYABLE AND LONG TERM DEBT--(CONTINUED)
Scheduled maturities of long-term debt are as follows (in thousands):
NOTE G--CONCENTRATIONS
The Company's operations are substantially all outside the United States. In 1997, the largest amount of sales occurred in Germany, which comprised 29% of total sales. The Company also had sales of almost 9% in each of France and England. While these countries are considered politically stable, there is risk that economic difficulties in any of these countries could adversely affect the Company's business. The Company also has operations in less politically stable countries.
Most of the Company's sales are made in local currencies other than the U.S. dollar in 1997. The largest amounts of sales were in German marks (29%), French francs (10%) and British pounds (9%). In some countries, certain purchases and the resulting payables are in currencies (principally the U.S. dollar) different than the functional currency. Further, certain subsidiaries have loans receivable or payable denominated in currencies other than their functional currency. Transaction gains and losses on these receivables and liabilities are included in the determination of earnings for the relevant periods. In 1995, 1996 and 1997 foreign currency gains were $74,000, $1,559,000 and $1,219,000, respectively.
The Company enters into foreign exchange contracts to hedge groups of foreign currency transactions on a continuing basis for periods consistent with its committed exposure. The foreign exchange contracts are valued at market and generally have maturities which do not exceed six months. Gains and losses on foreign exchange contracts are intended to offset losses and gains on assets, liabilities and transactions being hedged. As a result, the Company does not anticipate any material adverse effect due to exchange rate movements over the short term period covered by these contracts. At December 31, 1997, the face value of foreign exchange forward contracts against trade payables was $104.9 million, which approximated the fair market value of the contracts. At December 31, 1997, approximately $271.6 million of accounts payable were attributable to foreign currency liabilities denominated in currencies other than the subsidiaries' functional currencies (principally $229.3 million in U.S. dollars and $26.2 million in German marks). The largest unhedged amounts of trade payables were in subsidiaries in Hong Kong, Czech Republic, Poland, Argentina and Mexico.
In some countries there are risks of continuing periodic devaluations or of large devaluations. In these countries, no hedging mechanism exists. The Company has risks in these countries that such devaluations could cause economic loss and negatively impact future sales since its product cost would increase in local terms after such devaluations. The Company attempts to limit its economic loss through structural mechanisms of limiting its holdings of local currency and receivables to the amount of its local currency payables.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE G--CONCENTRATIONS--(CONTINUED)
The Company has a major supplier, Hewlett-Packard (HP), whose products accounted for 35%, 34%, and 19% and of sales for 1995, 1996 and 1997 respectively. No other vendor accounted for more than 10% of sales in any year except in 1996, in which one vendor was 12%. HP has the right to terminate its distribution agreement with any Company subsidiary if the subsidiary is unable to cure, within a reasonable period of time, any violation of the agreement after having received notice from HP of the violation. Each Company subsidiary has the right to terminate the HP agreement on 90 days notice. Each Company subsidiary believes that its relationship with HP is good, and has no reason to believe that its distribution arrangement will not be a long-term relationship. No assurance can be given, however, that HP will renew each Company subsidiary's agreement at the time of its annual review or in subsequent years. Management has not formulated alternative plans of action in the event the HP contracts are terminated. The amounts outstanding to HP at December 31, 1996 and 1997 were $70 million and $80 million, respectively.
NOTE H--LEASE OBLIGATIONS AND OTHER CONTINGENCIES
The Company leases equipment, offices, sales and warehouse space under non-cancelable leases. The following is a schedule by years of the minimum rental commitments remaining on leased property and equipment (in thousands) with terms greater than one year:
Total rental expense was $2,503,000, $6,715,000 and $14,542,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Rental expense includes approximately $734,000 annually for monthly rent due on a CHS facility in Germany under a lease agreement dated November 1993 with a term of 17 years. CHS Germany has the option to purchase the leased property at both the end of the seventh year of the lease term, and at the end of the lease, for the net book value of the property as calculated under applicable German tax laws. The option prices at the end of the seventh and seventeenth year would approximate $5.6 million and $2.8 million, respectively. In addition, the lessor has the right to adjust the minimum rental payments at the end of 1999 if certain economic conditions prevail.
The Company is involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not currently engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on the Company.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE I--RELATED PARTY TRANSACTIONS
A member of the Board of Directors and shareholder of the Company also serves as a member of the Board of Directors of a company which supplies product to the Company. This Company also has ownership interests in other companies which do business with the Company. Transactions with these related parties in 1997 were as follows (in thousands):
The rebates received pertain to vendor rebates passed from such related parties to the Company. The net amount of trade receivable due from such parties at December 31, 1997 was $12,193,000.
At December 31, 1996 and 1997, the Company carried a receivable from Comtrad and Comtrad Holdings, Inc. (CHI) in an amount of $3.2 million and $17.4 million, respectively. In 1997 this receivable is in the form of a promissory note which Comtrad and CHI has agreed to collateralize with 5,487,203 shares of CHS owned by Comtrad and CHI. Interest rate charged on the promissory note is at prime rate. The amount is due on demand. Interest charged to Comtrad was $438,000, $86,000 and $684,000 in 1995, 1996 and 1997 respectively. In 1995 the Company owed amounts to Comtrad which were subsequently extinguished. Interest paid to Comtrad was $126,000 in 1995.
In 1996, the Company purchased a company in Romania from Comtrad for $375,000. Subsequently, the Company loaned $800,000 to the subsidiary to enable it to purchase an office building. In December 1996, the Company sold this subsidiary back to Comtrad for the original purchase price plus an amount equal to the losses from April to date of sale ($200,000). No gain was recognized on the sale, which had the impact of increasing the amount due from Comtrad by $1.4 million.
In 1995 the Company billed Comtrad $495,000 for actual costs of salaries, space and other administrative costs it incurred on Comtrad's behalf. In 1995, Comtrad billed the Company $887,000 for the Company's share of actual costs incurred by Comtrad for salaries, space and other administrative expenses for shared employees.
A director of the Company served the Company as a management consultant under a consulting agreement specifying payments of $4,000 per month. The agreement was terminated at the end of 1996. In 1995 and 1996, $48,000 and $48,000 respectively was paid under this agreement.
NOTE J--COMMON STOCK AND STOCK OPTION PLANS
In September 1997, the Board approved a 3 for 2 stock split. All share information has been restated to reflect all stock splits. In March 1996, the shareholders approved a reincorporation as a Florida company, a reverse 1 for 2 stock split and the authorization of 5,000,000 shares of preferred stock in such class or series and with such rights as approved by the Board of Directors. Under Florida law, a majority vote by the holders of the preferred stock as well as the holders of common stock is necessary to vote affirmatively on matters of mergers, sales of substantially all the Company's assets, exchanges of stock or changes in the articles of incorporation.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE J--COMMON STOCK AND STOCK OPTION PLANS--(CONTINUED)
In August 1997, the Company completed a public offering of common shares in which the Company sold 21,208,134 shares and selling shareholders sold 1,216,866 shares. The Company's shares were sold at $21.17 per share which raised $428.2 million for the Company net of expenses and commissions.
In June 1996, the Company completed a public offering of common shares in which the Company sold 6,887,308 shares and selling shareholders sold 2,600,191 shares. The Company shares were sold at $8 per share which raised $50.6 million for the Company net of expenses and commissions. As part of the offering the underwriter received warrants entitling the purchase of 450,000 shares of stock in a 4 year period beginning in June 1997 at a price starting at $8.80 and increasing each year.
In August 1994, a Stock Incentive Plan was adopted by the Company's Board of Directors and subsequently approved by the Company's shareholders in June 1995. The maximum number of shares issuable under the Plan has been amended several times and is 2,620,500 at December 31, 1997. Certain of the grants (785,500 at December 31, 1997) are intended to qualify as incentive stock options and the remaining are non-qualified options. All options were issued with an exercise price equal to the market price and have a life of 10 years. Vesting periods are generally 25% a year for four years.
In 1997 the Board of Directors and subsequently the shareholders approved the Directors and Officers 1997 Stock Option Plan. The Plan authorizes options covering up to 1,350,000 shares of CHS Stock to be granted to executive officers and Directors. The options are to be granted at fair market value and generally vest over 3 years. In 1997, 1,275,000 options were granted under this Plan.
In 1997 the Board of Directors and subsequently the shareholders approved the 1997 CEO Stock Option Plan. The plan authorizes options covering up to 750,000 shares of CHS Stock to be issued to the CEO upon approval by the Board of a business acquisition. The options are granted at market value and vest based on the earnings of the acquired company. In 1997 all the options authorized by this plan were granted.
In June 1996, the Board of Directors, and subsequently the shareholders, approved the 1996 Chief Executive Officer Option Plan. The Plan provides for options covering up to 750,000 shares of CHS stock to be issued to the CEO upon the approval by the Board of Directors of a qualifying acquisition, as defined or of any acquisition if recommended by the Compensation Committee and approved by the Board. A qualifying acquisition is one where greater than 50% of the purchase price is comprised of common stock calculated by an earn out formula. The options are granted at market value and vest based on the earnings of the acquired company. In 1996 and 1997, all the options authorized by this plan were granted.
In December 1994, when the estimated fair value was $4.00, the Board granted the Company's Chief Executive Officer non-qualified options to purchase 84,120 shares for which the exercise price is $.67 per share. The vesting period was two years and the options expire in ten years. The compensation element of $280,400 has been amortized to compensation expense in the accompanying financial statements.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE J--COMMON STOCK AND STOCK OPTION PLANS--(CONTINUED)
The Company accounts for its stock options under APB 25. No compensation cost has been recognized as the exercise price of each options does not exceed the fair value of the underlying stock at the date of grant. Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's net earnings per share would have been reduced to the pro forma amounts indicated below.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options pricing model with the following weighted-average assumptions used for grants in 1996 and 1997, respectively; dividend yield of 0% for each year; expected volatility of 70% in 1996 and 67.9% in 1997; risk-free interest rates 6.06% in 1996 and ranging from 5.68% to 6.47% in 1997; and expected lives of 4.5 years for each year.
A summary of the status of the Company's stock option plans as of December 31, 1995, 1996 and 1997 and changes during the years ending on those dates is presented below.
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE J--COMMON STOCK AND STOCK OPTION PLANS--(CONTINUED)
The following information applies to options outstanding at December 31, 1997:
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE K--SEGMENT INFORMATION
The Company's business activities involve the operating segments of distribution of microcomputer equipment and software products. The operating segments are the distribution of universal products (products that represent the basic components of a personal computer without regard to the specific local language, regulatory and technical factors of individual markets) and localized products. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies (Note A). The segments are managed separately since each requires different business and marketing strategies. The geographic areas in which the localized product segments operate are Western Europe, Eastern Europe and Latin America. Net sales, operating income (before interest and income taxes) and identifiable assets by segment were as follows (in thousands):
CHS ELECTRONICS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1997--(CONTINUED)
NOTE L--SUBSEQUENT EVENTS
In January 1998, the Company implemented a Common Stock Purchase Rights Plan and distributed one right (a "Right") for each share of the Company's Common Stock outstanding. Each Right has an initial exercise price of $100 for one-one thousandth of a share of the Company's Series A junior participating preferred stock. The Rights are not exercisable or transferable, apart from the Company's Common Stock, until after a person or group acquires, or has the right to acquire, beneficial ownership of 15% or more of the Company's Common Stock (which threshold may, under certain circumstances, be reduced to 10%) or announces a tender or exchange offer to acquire such percentage of the Company's Common Stock. Upon such occurrence, each Right (other than Rights owned by such person or group) will entitle the holder to purchase from the Company, or the particular acquiring person or group under certain circumstances and conditions, the number of shares of the Company's, or such person's or group's, Common Stock having a market value equal to twice the exercise price of the Right. The Rights are redeemable by the Company's Board of Directors under certain circumstances.
NOTE M--SUMMARIZED QUARTERLY FINANCIAL DATA FOR 1996 AND 1997 (UNAUDITED)
- ---------------- (A) Results for the fourth quarter 1996 include a restructuring charge of $1.4 million ($1.1 million or $.07 per share after tax) for costs incurred by the Company to implement consolidation of its operations with acquired operations from Merisel.
EXHIBIT INDEX
EXHIBIT DESCRIPTION - ------- -----------
21 Subsidiaries of CHS Electronics
27.1 Financial Data Schedule
27.2 Financial Data Schedule
27.3 Financial Data Schedule