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Earnings Transcript for STCN - Q2 Fiscal Year 2013

Executives: Steven G. Crane - Chief Financial Officer and Principal Accounting Officer John J. Boucher - Chief Executive Officer and President
Analysts: Sam Rebotsky
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Modus Second Quarter Fiscal 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, March 7, 2013. I would now like to turn the conference over to Mr. Steven Crane, Chief Financial Officer. Please go ahead, sir.
Steven G. Crane: Thanks, Tadeus. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions Investor Conference Call. I'm Steve Crane, CFO, and I'm joined today by ModusLink's new President and Chief Executive Officer, John Boucher. In just a few moments, John will share his thoughts on the company and its financial performance. After John's comments, I will review in more detail our second quarter results for fiscal 2013, which we released earlier today. Before we start, I want to remind you that this call is being broadcast as a live webcast from our website at www.moduslink.com. Please also note that the information we're about to discuss includes forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties. The company's actual results could differ materially from those discussed herein. Factors that could contribute to such differences include, but are not limited to, those items noted and included in the company's SEC filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking information that is provided by the company on this call represents the company's outlook as of today, and we do not undertake any obligation to update forward-looking statements made by us. Subsequent events and developments may cause the company's outlook to change. During this call, we'll be referring to non-GAAP measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measure can be found in our earnings release issued earlier today, a copy of which is posted in the Investors section of our website. I'd now like to turn this call over to John Boucher. After our formal remarks, we'll be happy to take any questions you might have. John?
John J. Boucher: Thank you, Steve, and thanks, everyone, for joining the call today. I'm very pleased to be with you today and very excited about being with ModusLink. I come to ModusLink from the supply chain services industry where I've spent the majority of my 30-year career thus far. I have a passion for the business with a long, strong relationship with supply chain, financial and operational acumen, along with many years of commercial experience with our end markets. The recent years have been very difficult for ModusLink. End market volume reductions across its core client base has made the past few years very challenging, especially for employees and shareholders. The company has managed a range of corporate actions and short-term corrective actions addressing underperformance. Despite these challenges, ModusLink continued to deliver superior customer service across its global operating network and continues to have a solid base of loyal clients with certainly representing an excellent opportunity for us going forward. I'd like to now share several reasons why I joined the company. ModusLink has a strong global brand and is recognized for its long history of excellent customer service. The company has assembled a comprehensive integrated network of global supply chain centers with strong capabilities such as direct order fulfillment, build to order, configure to order, product returns and repair, e-commerce, call centers and entitlement management, which are all specifically designed to address our clients' challenges with time and cost to market on a global scale. ModusLink also has a long-term relationship across a great client base, which includes some of the world's best brands. Since joining the company in January 2013, I've spent the majority of my time in the field visiting solution centers, talking to clients, employees and shareholders. I'm pleased with my initial assessment of the operating units, client teams, processes and capabilities. However, there are a number of areas of the business we need to improve in order for the company to achieve sustainable profitability, growth and improvements to our cash flow. We must improve the efficiency of the company's operations, specifically across the procure to pay and inventory management processes. We need to increase our inventory turns, reduce the required working capital. We must continue to provide excellent customer care with our existing book of business and drive growth with our additional service capabilities for them. In the past few weeks, I visited many of our U.S. operations and European operations. Over the next 60 days, I'll continue to travel to our operations across Asia, meet with our regional management teams, clients and suppliers. I will also continue to work closely with the extended management team as we develop our longer-term strategic plan for the company. In the meantime, we're working to ensure that we have the right leadership, focus and management systems in place to deliver on a number of near-term actions required to drive predictability to the financial results, improvements to our balance sheet, profitable growth while continuing to deliver excellent client service. Now I'll briefly comment on some short-term focus that we're working on. First, we will continue to drive our operating and SG&A costs down, in line with changes to the business conditions. Second, evaluate the work we're performing across the entire operating network to eliminate waste, improve utilization. Thirdly, we'll improve our asset efficiency and take a hard look at all aspects of working capital, specifically around the supply chain practices to increase inventory velocity and drive down inventory levels. And fourthly, as a result of providing excellent services and value, ModusLink has maintained a long-term relationship with many of our clients. We'll build on this strength and make changes to our organization to further align with our clients to drive growth through additional programs and services. Turning the company around and achieving profitable growth will not happen immediately. It'll take some time, continued dedication of our senior leadership team and all of our employees to execute to one plan across the company. I'm pleased about the rate of improvements from recent actions and initiatives which we had preceded as plans. In recent months, the executive leadership team made the right decisions to focus the organization on its core supply chain operations, which include the divestiture of the company's Tech for Less operation and take in recent workforce reduction actions. Some of these actions, as well as the company's previous initiatives, have had a positive effect on the financial results for the second quarter. I'll touch on a few of these highlights before turning the call over to Steve for a more detailed review. Total revenue for the second quarter increased approximately 20% compared to the same period last year. A significant portion of this was driven from prior wins currently ramping and generating revenue for us. We benefited from increased unit volumes in several clients that resulted in total revenue exceeding the company's expectations. Gross margin also improved and was 10% compared to 9.1% for the same period last year. The gross margin improvement was primarily due to the higher revenue and positive effects on our recent cost reductions. SG&A expenses remain high due to costs related to the restatement, review of strategic alternatives and other initiatives the company undertook. As Steve will explain in a moment, SG&A expenses included costs related to actions that we do not expect to reoccur. I'll now turn the call to Steve to talk -- to walk through the financials in greater detail.
Steven G. Crane: Thanks, John. Before I begin, please note that as previously reported, the company sold its Tech for Less operations on January 11, 2013. Therefore and according to generally accepted accounting principles, revenue and results from continuing operations exclude the results of Tech for Less, which have been reclassified to discontinued operations in the company's statements of operations for all periods. Any references to financial results in my prepared remarks have been adjusted to exclude discontinued operations unless noted. For the second quarter of fiscal year 2013, ModusLink reported net revenue of $203.4 million, an increase of $34 million or 20.1% compared to net revenue of $169.4 million for the same period 1 year ago. These revenue results were higher than we expected and the increase is primarily due to a better-than-expected increase in revenue from new programs that commenced in recent quarters, while revenue from the company's base business also showed growth. Revenue generated from new programs for the second quarter was $44.6 million compared to $14.1 million reported in the second quarter of fiscal 2012. Revenue from new programs increased in all regions and was primarily driven by a program in Europe for a consumer products client, which commenced in the third quarter of fiscal 2012. The increased revenue from new programs was also due to an engagement with a consumer electronics client that commenced new programs in recent quarters and contributed to revenue in all regions and an engagement with a communications equipment client that contributed to revenue in the Americas and Europe. Also contributing to the strong revenue results was base business revenue, which increased by 2.3% for the second quarter compared to the same quarter last year. Contributing to the relative stability in base business revenue was growth in revenue from a program supporting a major product launch for a software client, as well as increased revenue from an aftermarket services program. Although not a major negative contributor to the second quarter results, as the market pressures experienced by clients related to the PC market continue, we remain cautious about its potential impact on our results in the future. In addition, the company expects that the level of revenue in the second quarter from the major product launch from the software client will not continue in the third quarter of fiscal 2013. Based on those factors, we do not expect the year-over-year revenue growth we experienced this quarter to repeat in the third quarter. Revenue in Europe increased 33.7% to $67.8 million from $50.7 million in the second quarter of fiscal '12, primarily due to increased revenue from the large client supply chain program in the consumer products marketplace and a significant software client, both of which I noted a moment ago. Revenue in Asia increased 18.1% to $60.4 million from $51.1 million in the second quarter of fiscal 2012, primarily due to revenue contributions from the software client and the new program from a consumer electronics client. Revenue in the Americas increased 13.8% to $67.7 million from $59.5 million in the second quarter of fiscal 2012, which was primarily due to revenue from new programs from a consumer products client and a communications equipment client, both of which I previously noted. ModusLink's gross margin was $20.3 million or 10% of revenue in the second quarter of fiscal 2013 compared to $15.4 million or 9.1% of revenue in the second quarter of fiscal 2012. The increase in gross margin as a percentage of revenue was primarily due to higher revenue and the effects of our cost reduction actions. Total SG&A for the second quarter of fiscal 2013 was $23.7 million, which is comparable to $23.2 million in the second quarter of the previous year. Included in the SG&A for the second quarter of fiscal 2013 were expenses of $4.6 million related primarily to the restatement process and other professional fees. Restructuring expenses for the second quarter of fiscal 2013 were $4.8 million, which compared to $4.5 million in the second quarter of fiscal 2012. Restructuring expenses in the second quarter of fiscal 2013 related to previously announced cost reduction actions and included employee severance and other costs. We are on track with our previously announced plans to reduce total annualized employee costs by $20 million to $24 million. Since the beginning of fiscal 2013, ModusLink has reduced its overall workforce by approximately 8%. For the second quarter of fiscal 2013, the company recorded an operating loss of $8.5 million compared to an operating loss of $12.5 million in the second quarter of fiscal 2012. Excluding net charges related to depreciation, amortization of intangible assets, impairment of goodwill and intangible assets, share-based compensation restructuring, the company reported non-GAAP operating income of $219,000 for the second quarter of fiscal 2013 compared to a non-GAAP operating loss of $3.3 million for the same period in fiscal 2012. Other expense for the second quarter of fiscal 2013 was $3.2 million compared to other income of $0.6 million in the second quarter of fiscal 2012. Other expenses for the second quarter of fiscal 2013 was comprised primarily of losses and a noncash impairment charge associated with the company's @Ventures portfolio and also included foreign exchange transaction losses compared to foreign exchange transaction gains in the second quarter of 2012. With all the above factors impacting the second quarter of fiscal 2013, net loss for the second quarter of fiscal 2013 was $12.6 million or $0.29 per share compared to a net loss of $12.9 million or $0.30 per share for the same period in fiscal 2012. Turning to cash flow for the second quarter of fiscal 2013, net cash used for operating activities of continued operations was $4.9 million compared to $10.2 million in the same period in fiscal 2012. As of January 31, 2013, the company had working capital of $99.1 million compared to $113.5 million at July 31, 2012. Included in working capital as of January 31, 2013, were cash, cash equivalents and marketable securities totaling $51.8 million compared to $52.5 million at July 31, 2012. Our cash position for the second quarter of fiscal 2013 was higher than our expectations due to the timing of working capital. The company concluded the quarter with no outstanding bank debt. Thank you, and I'll now turn it back to John.
John J. Boucher: Thank you, Steve. In summary, we delivered improved results in the second quarter across both revenue and gross margin. In addition, we've taken actions and see a path for continued reductions in expenses to improve profitability. However, turning the company around and achieving profitable growth will require us to effectively develop and deploy our long-term strategic plan. While the near term we will focus on improved profitability, improved asset utilization and putting the company on a path to growth and value creation. I look forward to updating you on the progress, and I'm pleased to have the opportunity to serve both ModusLink and our shareholders. With that, we'll now open the call for any questions that you may have. Tadeus, you can open the call.
Operator: [Operator Instructions] And the first question comes from the line of Richard Nicole [ph].
Unknown Analyst: I'm looking at your balance sheets released with your earnings statements today and it looks like current assets have been reduced about $70 million for the period of January 31, 2012, to the period of January 31, 2012 (sic) [2013]. About $34 million of that is cash and I wonder if I could have an explanation for where that -- those assets went. And I understand perhaps you're not prepared to answer that today, but if you can't today, perhaps you'd be prepared at the annual meeting next week.
Steven G. Crane: So Richard, I think I can answer that. Just in general, over the last year, the company has been, overall, not earning money. So that's a drain in the cash. On top of that, we have gone through an expensive restatement process that has also negatively impacted the cash. So that's why our efforts are all built around, what can we do to drive operating expenses down, what can we do to improve our working capital. So we are working on plans to get that turned around. But you're absolutely right in that observation that the cash has come down.
Unknown Analyst: I appreciate that. Could I have some more specifics maybe at the meeting next week?
Steven G. Crane: Sure. We can get that.
Operator: And the next question comes from the line of Sam Rebotsky with SER Asset Management.
Sam Rebotsky: John, hopefully, you could succeed in making the company profitable. You've indicated that $20 million to $24 million is expected to be cut. Has any of this been cut so far? And what do we expect the cut for the balance of the year? And what do you -- you increased your sales significantly and we still weren't breakeven. What kind of number do we need to break even?
Steven G. Crane: Okay. Sam, this is Steve Crane. Maybe I'll take that kind of one at a time. So in terms of the reduction of the operating expenses by $20 million to $24 million, so we announced a reduction in force in our -- in the first quarter call and we also announced really one in this quarter. And -- so most of those cost reduction actions to get to that $20 million to $24 million have already occurred. So that answers the first question. Your second question was...
John J. Boucher: Well, we had higher revenues in the second quarter. We had onetime nonrecurring...
Steven G. Crane: That's a good question. So look, we did point out, Sam, that we had about $4.6 million in our SG&A in the quarter. So if you look at the quarter, we lost, on an operating basis, $8.5 million. If you add back the restructuring, which was $4.8 million, you add back the kind of unique charges of SG&A with the restatement of $4.6 million. We're back to a breakeven before that. So those 2 things definitely negatively impacted the quarter.
Sam Rebotsky: So what number do you think you need to break even?
Steven G. Crane: I'd say, this is about the number right here that we need to break even.
Sam Rebotsky: This is their number? Okay.
Steven G. Crane: Yes, in light of the extraordinary expenses that we talked about.
Sam Rebotsky: Okay, okay. I have one other follow-up. There was a lot -- as everybody knows, there was a lot of attempt for Steel Partners to come on board. And they seem to be coming on board based on the vote taken and the dealings was -- the concern, everybody's concern, was the tax loss carryforward. I'm very much interested in, hopefully, that we make sure that the tax loss carryforward is harvested. I would like to understand what -- where initially we thought that the increase in the number of shares to the Steel Partners group would sort of negate the NOL. Have we gotten a tax opinion from outside counsel that the increase in the number of shares that's allocated them will not damage the NOL? And hopefully, the -- I would like to see the board make sure that ModusLink considers -- continues profitable, once it becomes profitable, and all shareholders get to benefit the harvest of this NOL, which is indicated $2 billion. So I'd like some answers there.
Steven G. Crane: Sure. On your first question, Sam, the part about the triggering of the NOL, which is under Section 382 of the tax code, we have absolutely monitored that throughout this process to ensure that the investment by Steel Partners would not negatively impact our ability to get at that as a corporation. So we are absolutely covered there. I think that just overall, the board felt that Steel's investment is in the best interest of the company and its shareholders. There are a number of reasons for that. We felt that the -- the board felt that the commitment of new capital at a premium was a good thing for shareholders. The board also felt that the increase in the company's cash balances from that equity injection would enhance our customers' and vendors' assessments of the company's financial strength. And finally, we do believe that the addition of the Steel Partners people may assist the company in realizing greater value from the company's NOL tax assets that we all want to and all our shareholders want to do.
Sam Rebotsky: And just one further comment. I really hope that the Steel Partners' experience -- in fact, one of the other investments, Teleglobal [ph], which was DGTC, had a substantial tax loss carryforward. The company was -- all the pieces was sold and there was a significant reverse split. Hopefully, this doesn't happen here, that we manage to hold on to this NOL and make everything -- all the benefits available to all shareholders.
Operator: [Operator Instructions] The next question comes from the line of Fred Reese [ph] with Janney Montgomery Scott.
Unknown Analyst: My first read of the proxy material, there was a deal with Clinton that was on the Clinton Group that was on the table and you decided to go with Steel Partners instead. Could you just maybe -- why was this better versus what the Clinton Group was offering?
Steven G. Crane: Yes, I -- Fred, I think that we spent a lot of time on putting that language into the proxy. I think I just want to -- not respond to that but just point you to the proxy. I think clearly, as I said, the board determined that the Steel investment was in the best interest of the company and its shareholders for the reasons that I just articulated. But I don't think I'd want to go beyond that. I think what we have to say is in that proxy.
Unknown Analyst: Okay. Fair enough. The challenges to bring the company to profitability, are they the same in the 3 major economic regions that you serve? Or are they different challenges with each region?
Steven G. Crane: In some sense, it's the same. It is getting revenue. It's getting cost out. And a lot of our customers deal with us because we deal -- do deal with them on a global basis. A lot of our big customers, we operate with them and certainly more than one and sometimes in all 3 regions across the globe.
John J. Boucher: Many of the changes we're going to make in the management system and the processes that we use in supply chain is going to drive efficiency across all regions. So it's really the same from that regard. On the client base and the growth base, it'll be the same. As well, it'll be diversified across the regions. We have a rather large diversified customer base that we plan to grow with, as well as bringing on new clients, but it'll certainly be in all regions.
Unknown Analyst: The 2 customers, 1 in Europe and 1 in Asia, that resulted in such a big jump in the incremental revenues, is that business priced so that you have margin and is profitable?
Steven G. Crane: It is. Yes, it is profitable. So much of our business is volume driven, obviously. Typically, the higher the volumes, the better the margins. And the other thing, too, Fred, is typically when we're on-boarding a business, it's less profitable in the beginning and then gets more profitable. So it's a mix of many factors.
Unknown Analyst: Right, right. And one last question, if I may. Did I read in the proxy that Steel Partners is prevented from buying -- increasing their percentage interest over 30% for some period of time? Did I catch that right?
Steven G. Crane: You did catch that right, Fred, yes.
Operator: And there are no further questions at this time, sir. I would now like to turn the call back over to management. Please continue with your presentation.
John J. Boucher: Thank you, Tadeus. If there's no other questions, we look forward to talking again next quarter. And we'll see you then.
Steven G. Crane: Thank you. Bye-bye.
Operator: Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.