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To: men mailman who wrote (1195)3/29/1999 7:08:00 AM
From: John J. Frawley  Respond to of 1494
Miami Herald --- Time to reboot? - Business Section

In just six years, Claudio Osorio grew CHS Electronics into a worldwide distributor of
computers. Its stock soared and the future looked bright. But shrinking margins and an accounting scandal have Osorio on the hot seat and CHS in a slump.
Fast-moving CHS finds itself at a sudden standstill

Herald Business Writer

t's still a young company, founded in 1993, and like so many others that sell computers or wire the unwired, CHS Electronics of Miami laid claim to industrial eminence with relative ease.

Only two companies in the world distribute more computer goods than CHS, whose headquarters is under the flight path at Miami International Airport. Fortune magazine named CHS last year as one of the nation's jackrabbits in profit growth. And as CHS wolfed down companies in an almost never-ending meal, its chairman and chief executive, Claudio Osorio, ruminated openly last September about taking CHS to $20 billion in sales by 2000.

But the road to global omnipotence is lined with detours and booby traps, as CHS is finding out in 1999. The one-two punch of a PC market slowdown and an in-house accounting scandal has CHS lying flat on its back. The resulting evacuation by investors last Monday felled CHS shares to a new all-time low of $3.

''I was never concerned about anything until yesterday's announcement that there was basically fraud within the company,'' said Robert Damron, an analyst and former CHS fan with Cleary Gull & Reiland in Milwaukee. ''Once I saw that, I jumped off the bandwagon.''

It was a Black Monday indeed for Osorio, CHS' Venezuelan founder. Osorio, 40, first had to break the news of the alleged accounting shenanigans by a high-ranking executive who resigned -- which forced the retraction of $44.6 million in profits during three quarters. Then he had to announce the sacrifice of 600 employees, through layoffs, to help ensure future profits. By day's end, the plunge in stock price cost CHS 35 percent of its market value, or $116 million.

Digging out of its hole, analysts say, won't be a simple matter for CHS.

For one, it was the company's rapid growth that attracted investors in the first place and Osorio has now declared a moratorium on acquisitions until new internal controls are in place. Second, PC sales are subsiding and distributor profit margins are thinner than they already were. Finally, CHS' low stock price will make it difficult, if not impossible for CHS to resume acquisitions and achieve Osorio's goal of $20 billion in sales by 2000.

''This is a company that's been growing through aggressive acquisition, and this (the accounting irregularities) puts a halt to selling stock or issuing stock for acquisitions,'' said Bob Mancuso, who as manager of the Glenmede Small Cap mutual fund liquidated its 250,000 CHS shares last Monday. ''It puts their credibility down to zero.''

Smelling like a rose

A year ago, CHS appeared to be swimming in roses. Fueled by acquisitions and high demand for PCs in Europe and Latin America, CHS' first-quarter sales in 1998 doubled and its profits tripled from the year before. The growth pushed CHS into the No. 320 spot on the Fortune 500. CHS moved its stock from the Nasdaq to the New York Stock Exchange.

It was quite an ascent for both CHS and Osorio. A former sporting goods merchant and computer importer in Venezuela, Osorio began selling computers in Europe and buying distributors there. He moved the company to Miami in 1993. Today, CHS has $11 billion in annual revenue, about 6,000 employees and about 150,000 customers -- computer resellers -- in 46 countries, the notable exception being the United States.

But sharks began viewing CHS a year ago as one tasty tuna.

Short-sellers, who profit from declines in share prices, attacked CHS' fourth-quarter 1997 earnings, saying they were propped up by unexpected tax benefits abroad. Later they stressed that CHS needed a larger-than-expected gain from foreign currency exchange to beat analysts' earnings estimates for the first quarter of 1998.

The nasty second-guessing of CHS' numbers dragged down the company's stock price and prompted Osorio to wage war against the short-sellers. The Dow Jones News Service quoted Osorio as saying that the shorts cause an ''incorrect perception in the market.'' He said they will ''have to be ready to swing indefinitely against an ocean of revenue and profits.''

CHS never got a chance to deliver any fatal blows, however. The stock market crash last summer swept CHS shares down to its previous low of $4.50. The stock roared back, only to be held in check by the currency crisis in Brazil and slumping PC sales in Latin America -- where CHS derives 13 percent of its revenue.

But the prospect of economic and PC market slowdowns was nothing compared to the disaster that struck Feb. 24.

Rattled investors

Osorio announced that auditors had found discrepancies between the value of manufacturer rebates to CHS and how they were posted on CHS' books. Osorio offered no further details other than that a special audit was under way. He did say it looked as if CHS would post 47 cents a share in profits for the fourth quarter -- far below the 66 cents analysts had expected.

That's all it took to rattle investors who were already hypersensitized to technology sector indicators. CHS shares lost 23 percent of their value Feb. 24, dropping to $7.81.

All was quiet until the company came out last Monday with its final, audited 1998 results. It was worse than everyone expected. The rebate discrepancies forced CHS to go back and reduce its earnings in the second and third quarters of 1998. And as for that 47 cent-a-share forecast Osorio made in February? The final tally was 23 cents.

This time, investors bolted in a full-fledged stampede. CHS' stock fell from $6 a share to $3.93 3/4 and was the fourth-biggest loser that day in U.S. markets. Three brokerages cut their ratings on CHS to ''hold,'' a Wall Street euphemism for sell. A dozen law firms filed class-action lawsuits on behalf of shareholders.

''The magnitude of the restatement doesn't surprise me,'' said Jeff Matthews of Ram Partners in Greenwich, Conn., a longtime CHS short-seller. ''This is a company that has always touted its decentralized structure as a strength. They've always been asked why they don't have a fully integrated MIS (management information systems) system. They've always said you don't need it as long as you have controls and you audit your entities. They also said they use Lotus Notes, but no one with half a brain on Wall Street ever believed you could control operations spread all around the world with Lotus Notes.''

Mancuso of the Glenmede Small Cap Fund echoed those concerns. ''Our biggest concern with the company had been its decentralized mode of management,'' he said. ''I don't think they were watching all their operations closely enough.''

In a conference call last Monday, Osorio pinned the blame on one person, Pasquale Giordano, executive vice president of CHS' European operations. From his office in Paris, Giordano oversaw a market that accounted for an estimated 80 percent of the company's earnings. The five-year company veteran resigned March 19 and could not be reached for comment.

Craig Toll, CHS' chief financial officer, said Giordano was responsible for the recording, documentation and collection of vendor rebates. Osorio wouldn't say what motivated Giordano to inflate rebates, an act that would have the effect of lowering CHS' product costs and raising its profit margins.

One electronics industry executive, who didn't want to be named, said there are numerous bonuses or money incentives that could be tied to a business unit's gross profits and sales. He said vendors routinely offer rebates to their distributors.

''The price competition for competing products is so intense that you might buy something for $10, knowing that the best retail price you're going to get is $5, but the manufacturer gives you $6 credit toward the next purchase,'' he said. ''They're constantly churning products to move it. It's nothing illegal or illegitimate. It's promotion.''

No checks and balances

What the analysts didn't like was the level of autonomy enjoyed by Giordano, one of four executive vice presidents under Osorio.

''Where were the checks and balances, the internal controls and systems to catch something like this?'' asked Damron of Cleary Gull & Reiland. ''There was clearly too much unilateral power with this one individual and he was able to overstate the rebates for a three-quarter period before it was caught by an outside -- not an inside -- auditor.''

Osorio declined to be interviewed last week, but said in the conference call that the incident hadn't affected the company's sales, cash reserves, inventory or relations with vendors. Employee relations are another matter. About 600, or 10 percent of its work force, will be laid off. CHS wouldn't provide a timetable or geographic breakdown of the layoffs, although it said most would be in Europe.

Those employees who remain will have to get used to some serious belt-tightening. Operations and warehouses will be combined or closed. Spending will be scrutinized or capped. Hiring will stop. Osorio said the goal is to cut spending by $40 million across the board in 1999.

Even if the profit-padding scheme hadn't occurred, an austerity plan would likely have been in order at CHS.

Almost all computer makers are reporting declines in first-quarter sales. Many customers are delaying purchases until Y2K issues are settled, while others have already upgraded their machines and can run today's software programs. Analysts also expect a slowdown in Latin America.

Dataquest, a market research firm in San Jose, Calif., has forecast 6.5 percent growth for PC sales in Latin America in 1999. That's down from 10 percent in 1998 and 1997.

Makers use direct sales

Luis Anavitarte, Dataquest's senior analyst for Latin America, said he thinks no-name clones -- or ''white boxes'' as they are called in Latin America -- will do well in 1999. He also observes that PC makers are engaging in more direct sales to their Latin customers.

''If you are a distributor and six or seven of your major partners are using direct sales, bypassing you as a distributor, you have to think about what you're going to do about this,'' Anavitarte said. ''We see them moving white boxes as a result, both finished clones and components.''

CHS' bigger rivals, Ingram Micro of Santa Ana, Calif., and Tech Data of Clearwater, have already acknowledged that PC sales are cooling off from a hot 1998. Tech Data said its 1999 earnings will be hurt by a PC price war that has made the market a near-breakeven proposition. Ingram Micro responded to the slump by announcing 1,400 layoffs, 10 percent of its work force.

Ingram Micro and Tech Data haven't fared much better in the stock market than CHS. Like CHS, both stocks sunk to new 52-week lows last week.

CHS needn't worry about its competitors' problems, and shelving the acquisition strategy was a no-brainer, given the company's heavy debt load and low stock price. After years of go-go growth and easy profits, 1999 will be a real test of Osorio's management abilities. Osorio himself has a lot at stake. He owns 12.5 percent of CHS' stock. He earned $1.8 million in 1997.

''Now it's a highly risky situation because they have a lot of debt,'' Matthews said. ''They operate in a highly competitive, low-margin business and there's not a lot of room for error.''

Osorio said last Monday that he will be resuming day-to-day control of the company. It didn't exactly elicit a standing ovation. Like the short-sellers before them, CHS analysts will be guided by skepticism in 1999.

''They need to put several quarters of audited results to show momentum and that the company is back on track,'' Damron said.