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Earnings Transcript for STCN - Q3 Fiscal Year 2011

Executives: Joseph Lawler - Executive Chairman, Chief Executive Officer, President, Chairman of Business Development Committee and Member of Technology Committee Steven Crane - Chief Financial Officer and Principal Accounting Officer
Analysts: Unknown Speaker Aram Fuchs - Fertilemind Capital Unknown Analyst -
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the ModusLink Global Solutions Third Quarter Fiscal 2011 Conference Call. [Operator Instructions] As a reminder this conference is being recorded, Tuesday, June 7, 2011. Your speakers for today are Joseph Lawler, Chairman, President and Chief Executive Officer; and Steven Crane, Chief Financial Officer. I'd now like to turn the conference over to Steven Crane. Please go ahead, sir.
Steven Crane: Thank you, Demetra. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions' Fiscal 2011 Third Quarter Conference Call. I'm Steve Crane, CFO, and I'm joined today by Joe Lawler, Chairman, President and CEO. In just a few moments, Joe will share his thoughts on the company's financial performance and the market environment over the past quarter and provide an update on our strategic initiatives. After Joe's comments, I'll review in more detail our fiscal 2011 third quarter results, 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 in this call represent 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 Investor section of our website. I'd now like to turn this call over to Joe Lawler. After our formal remarks, we'll be happy to take your questions. Joe?
Joseph Lawler: Thank you, Steve, and good afternoon. I'll begin with a few comments regarding our third quarter before Steve provides a more detailed financial overview. Our financial results reflect the headwinds that we have talked about in recent quarters as we continue to see uneven demand for the technology and consumer electronics products we handle on behalf of our clients. However, revenue for the third quarter was in line with the expectations we talked about during our last investor call. We made good progress, growing revenue from new programs and executing the plans we outlined last quarter to put ModusLink on a trajectory of sustained growth in revenue and profits. Today, I'll provide an update regarding the actions we are taking to achieve that objective. In addition, after paying a one-time special dividend of $40 million, our balance sheet remains strong with $120 million in cash, cash equivalents and marketable securities at the end of the third quarter, and no outstanding debt. This liquidity positions us with the means to invest in our business where needed. For the quarter, I'll start by discussing the revenue from new programs, which consists of client programs we've been executing for less than 12 months and then I'll go on to revenue from our Base business, which consists of programs we've been executing for 12 months or more. Revenue from new programs increased 20%, primarily due to programs secured in prior quarters as a result of our sales and marketing initiatives. We are encouraged by our progress over the last few quarters to build back to the record revenue from new programs that we achieved in fiscal 2009 before the full effects of the recession were felt. We believe that level is needed to achieve sustainable growth in consolidated revenue. Through the first 9 months of fiscal 2011, we nearly reached the amount of revenue from new programs in all of fiscal 2010. However, as I outlined during our last investor call, we need to accelerate our progress to achieve sustainable growth of revenue and profit in fiscal 2012 and beyond. I'll come back to the specific actions we're taking to drive top line growth after Steve's detailed financial review. Revenue from Base business in the third quarter was 5% lower compared with the same quarter last year. The pressure on pricing and the reduction in the amount of packaging materials used by clients continues to be reflected in our revenue results in the Americas, Europe and Asia regions. And speaking of Asia, I would like to make a special reference to our operations in Japan. ModusLink's operations in Japan are relatively small and total approximately 40 employees. We have 2 operations in Japan. One is a small co-location presence in Fukushima that closed following the earthquake on March 11 and has been reopened. The second where most of our employees in Japan work is our Solution Center located about an hour southwest of Tokyo. That facility withstood the earthquake and had minimal damage. Thankfully, none of our employees in Japan were injured and the facility is back in operation. Activity is lower than pre-earthquake levels but to a degree that is not material to our overall Asia business. Operationally, we've been able to fully support the clients we serve from our operations in Japan. However, the supply side situation for our technology and consumer electronics clients is clearly more difficult to assess for ModusLink, and the marketplace where parts shortages have affected volumes in some of our Asia operations. The lower revenue in Asia impacted our overall revenue mix and gross margin for the third quarter. Also affecting gross margin was price pressure due to after effects of the recession. Although the current pricing environment is better than 12 to 24 months ago, it's still very challenging. Gross margin was 9.8% of revenue for the third quarter and was slightly below our expectations, primarily due to the revenue levels in our operations in Asia. We continue to expect gross margin percentage the second half of the year to be greater than what we reported for the first half of the fiscal year, and to show more improvement in fiscal 2012. We're not satisfied with these margin levels. However, we are confident in our ability to improve gross margin percentage in future periods. Our plans to invest in the business, to grow revenue are essential for achieving that objective as well as continued focus on continuous improvement initiatives, work mix management and cost reduction actions. I'll address these topics in a few minutes. Before I do, Steve will give you a more complete financial review.
Steven Crane: Thank you, Joe. For the third quarter of fiscal 2011, ModusLink Global Solutions reported net revenue of $207.1 million, a decrease of $6.6 million or 3.1%, compared to net revenue of $213.7 million for the same period one year ago. Revenue from new programs was $20.9 million, an increase of $3.5 million or 20.1% when compared to the third quarter of last year. As Joe noted, this increase is a result of new programs secured in previous quarters that are now generating revenue. Base business revenue was $186.2 million, a decrease of $10.1 million or 5.1%, compared to the third quarter of last year. The decline in revenue from Base business reflects pricing and clients using fewer materials in their packaging which we've talked about in recent quarters as affecting our results in Asia in particular. Geographically, revenue in the Americas decreased 3.4% to $70.8 million, compared to $73.2 million in the same quarter of fiscal 2010, primarily due to pricing and lower volumes from certain client programs. Revenue in Europe increased 2.1% to $63.7 million, compared to $62.4 million in the same quarter of last year. The startup of new programs has had a positive impact on our revenue in Europe. Revenue in Asia decreased 5% to $57.1 million from $60.1 million in the third quarter of fiscal 2010. ModusLink's gross margin decreased to $20.2 million or 9.8% of revenue in the third quarter of fiscal 2011 from $24.6 million or 11.5% of revenue in the third quarter of fiscal 2010. Total selling, general & administrative cost for the third quarter of fiscal 2011 was $20.8 million, a 2.8% decline compared to $21.4 million in the third quarter of the previous year. The lower selling, general & administrative expenses were primarily due to lower employee-related costs as we stayed focused on minimizing our operating expenses in light of this challenging conditions. Restructuring expense for the third quarter of fiscal 2011 was $0.00, compared to an expense of $260,000 in the year ago period. For the third quarter of fiscal 2011, and as a result of the factors I just discussed, the company recorded an operating loss of $1.6 million, compared to operating income of $1.3 million in the third quarter of fiscal 2010. Excluding net charges related to depreciation, amortization of intangible assets, share-based compensation and restructuring, the company reported non-GAAP operating income of $4.3 million for the third quarter of fiscal 2011, compared to $8.3 million for the same period of fiscal 2010. Other expense for the third quarter of 2011 was $2.1 million, compared to an expense of $1.4 million in the third quarter of 2010. Other expense in both periods was comprised principally of foreign exchange transaction losses and equity method losses related to our ventured-capital investments. The company recorded a tax expense of $1.3 million for the quarter, compared to $900,000 in the third quarter of fiscal 2010. We continue to evolve and drive our tax strategy to both support our business strategy and to maximize the use of our U.S. net operating losses. With all of the above factors impacting the third quarter of fiscal 2011, ModusLink recorded a net loss of $5.1 million or $0.12 per share, compared to net income of $3.4 million or $0.08 per share in the third quarter of fiscal 2010. Included in results for the third quarter of fiscal 2010 was a loss from discontinued operations of $2.3 million or $0.05 per share related to a facility no longer being utilized for operations by the company. Our balance sheet continues to be strong. As of April 30, 2011, the company had working capital of approximately $189.3 million, compared to $222.6 million at July 31, 2010, and $221.3 million at April 30, 2010. Included in working capital as of April 30, 2011, were cash, cash equivalents and marketable securities totaling $119.3 million compared to $161.6 million at July 31, 2010, and $160.2 million at April 30, 2010. In the third quarter of fiscal 2011, ModusLink paid a special one-time cash dividend of $40 million in aggregate, which is funded by cash on the company's balance sheet. The special dividend was paid to ModusLink's stockholders on March 31, 2011. The company concluded the quarter with no outstanding bank debt. Turning to cash flow. For the third quarter of fiscal 2011, free cash flow from operations was $2.1 million, compared to $535,000 in the same period in 2010. Looking forward, and as we discussed last quarter, the company expects that its clients will remain cautious about managing their supply chain given the general uncertainties surrounding consumer spending and the company expects to experience similar headwinds that have influenced its financial performance in the recent quarters. For the fourth quarter of fiscal 2011, the company expects revenue to be similar to revenue reported in the third quarter of fiscal 2011. In addition, the company continues to expect to complete the fiscal year with gross margin as a percentage of revenue in the second half of fiscal 2011, higher than results in the first half of the year. In the meantime, we remain focused on improving our financial results through investing in sales and marketing, focusing on reducing cost and we continue to analyze every aspect of our infrastructure and processes to identify opportunities for cost reduction and improve efficiency. We're also be focusing on improving the financial performance of our Aftermarket Services-related businesses and continuing to maintain a strong balance sheet and effectively manage our working capital. Thank you, and I'll now turn it back to Joe.
Joseph Lawler: Thank you, Steve. We have a lot of work ahead of us to improve our financial results. In the context of the overall market opportunity and the strong reputation we have with Fortune 1000 clients, our focus is on improving revenue growth and driving more cost reduction and free cash flow generation in the short and long term. With a sale cycle of 9 to 18 months, it will take time to see the full effects of our action plans. So even though, we still have a full quarter remaining in fiscal 2011, I'd like to provide our shareholders with the sense of what to expect for the new fiscal year. We will continue to manage our business toward a consolidated gross margin of 12% to 14%, and operating margin of 5% on an annual basis as a long term target. Our expectations for fiscal 2012 are for improvements over fiscal 2011 but we will not get all the way to those targets during fiscal '12. On our last investor call, I spoke about our plans for putting ModusLink on a trajectory of long-term growth. And specifically, investing in sales and marketing, reducing operating cost and our plans for improving the results from Aftermarket services. I'll now provide an update on those initiatives. We've been taking actions to improve the performance of Tech for Less and PTS, which along with our returns management capabilities make up our Aftermarket solutions. At TFL, we downsized operations, changed the leadership and are improving how we buy process and sell product. Similarly, at PTS, we have restructured those operations, improve the pipeline of new business opportunities and are seeing improvements there as well. As a result of those initiatives, we have removed $3 million of annual cost from these businesses. In addition, our search for new leader for TFL is ongoing. We have a lot of work ahead of us to further improve results from our Aftermarket service offerings but we're confident that we're taking the appropriate steps. As noted earlier, we continue to manage cost as we have done in recent quarters. For the first 9 months of fiscal 2011, selling, general & administrative is down 7% year-over-year supported by cost reduction activities. We are analyzing every aspect of our infrastructure and processes to identify opportunities for further cost reduction. The initiatives to reduce costs are expected to help us invest in areas such as sales and marketing, which will drive future revenue growth and margin improvement. In the near term, we expect sales and marketing investments to increase the quantity and quality of opportunities we have in our pipeline and further increase our conversion rates. These investments include key hires in sales and marketing. Specifically, we are currently growing our client-facing team within our sales and marketing organization, and by the end of this fiscal year, we plan to increase our sales organization by 30% to 30-quota-barring sales people. The increase in sales and marketing investment is necessary to restore new business revenue to the pre-recessionary levels needed for ongoing top line growth. We've also added a dedicated senior human -- senior level human resources professional to help us maximize the return on investment in sales and marketing, improve efficiency across the organization and plan resources for the ramp up of new client programs. Previously, this position was eliminated as part of our cost reduction initiatives in fiscal 2009. We're also increasing our major account planning programs to accelerate our ability to identify and close new programs from existing clients. Our client base is comprised mainly of Fortune 1000 technology and consumer electronics brands with global supply chains. Although, many outsourced significant programs to ModusLink, we only managed a small portion of their total value chain processes. We see much more opportunity to grow our programs with existing clients and making these investments in sales and marketing our essential for accomplishing that goal and position ourselves to achieve revenue growth for fiscal 2012 and beyond. The third quarter was one of our strongest sales quarters since the beginning of the economic downturn. We closed several significant programs in the third quarter that will contribute to revenue in the coming year. For example, we were awarded supply chain programs from Logitech for solution in Europe, Lenovo in Asia and we're awarded our very first program with a major Japan-based imaging products brand to support one of its products in Europe. These new programs demonstrate how our strong client satisfaction ratings position us for program expansion with current and new clients. We also recently begun the on-boarding process for a new Aftermarket Services program for one of our largest clients. From our operations in Asia, ModusLink will manage a spare parts fulfillment program inclusive of returns and repair processing. Our team is working to onboard the programs I just described as efficiently as possible, and certainly we look forward to their future contributions. We are encouraged by this recent success and believe we have a compelling long term opportunity for our services. As global brands continue to be challenged to effectively manage the complexities of a global value chain in order to achieve greater speeds of market and reduce cost, we believe that our value proposition and client service achievements will continue to resonate with clients. We also believe that supply chain risk management will increasingly be recognized by boards of directors as part of enterprise risk management. The recent crisis in Japan has brought this into focus as the events challenged a number of companies lacking supply chain flexibility. In summary, our results reflect the effects of the headwinds we've discussed in recent quarters. Despite these challenges, we believe we have a solid plan in place and are focused on executing against it to put ModusLink on a trajectory to achieve sustainable improvement in revenue in -- and profits and increase shareholder value. Now Steve and I are happy to answer any questions you may have. So Demetra, if you would open up the lines for questions.
Steven Crane: And Joe, if I could just -- to clarify as pointed out to me in my comments that I just wanted to clarify before all the shareholders that I made a comment that in the third quarter of fiscal 2011, ModusLink recorded net loss of $5.1 million or 12% -- $0.12 per share. That's correct but I said compared to net income of $3.4 million. It actually should have been compared to a net loss of $3.4 million. So I just want to make that clarification, and with that...
Joseph Lawler: Which is correct in the tables and the release that we have released earlier today. So Demetra, over to you for questions.
Operator: [Operator Instructions] And our first question comes from the line of Sam Urabotski [ph] with SER Asset Management.
Unknown Analyst - : I guess the dollar dividend was helpful but -- and you speak of the fourth quarter, the revenue being similar to the current quarter. Does that mean you will have a -- when you had some charges in the fourth quarter, that you'll have a loss in the fourth quarter I assume?
Steven Crane: We didn't say anything about that. What we did say was the company expects to complete fiscal year with the gross margin as a percentage of revenue in the second half fiscal 2011, higher than results in the first half of the year. So those are the forward-looking statements, Sam, that we've made.
Unknown Analyst - : Well, I thought you said that the outlook -- did I read it properly, the fourth quarter, that the outlook -- expect revenue be similar revenue reported in the third quarter. So you'll have the same like the current quarter. Is that what you mean with the similar revenue and you have to achieve a higher profitability than the current quarter where there's the loss, though? To be profitable...
Steven Crane: Yes, it's correct that we -- that the outlook was for similar revenue and then we gave outlook for the gross margin but we haven't gone beyond that, Sam. It will depend on mix...
Joseph Lawler: Sam, the only other thing we said in our comments in the script today was that we also expected that gross margin in the second half would be greater than gross margin in the first half. So you can do your own math as you'd like to figure out what the gross margin is for Q4.
Unknown Analyst - : Okay. In order to -- I mean, I'm sorry, I was a little late in the conference call but was your pipeline better than the previous quarter or are you seeing more visibility, more -- or do you have to cut expenses to sort of help you deal with the situation?
Joseph Lawler: Well, Sam, you didn't miss any comments about the pipeline specifically, I didn't make any specific comments in my remarks about the pipeline. But our pipeline continues to be in good shape, strong, improving over the past couple of years now since we hit the low points of the recession. We feel good about the quality of opportunities that are in that pipeline as well. The issue is it just takes time to get a number of these opportunities over the finish line and then to get them on-boarded. So our focus really is on -- we are adding salespeople so we have more feet on the street, focused on getting some of these opportunities closed as quickly as we possibly can and then efficiently getting them on-boarded. While we're doing that and getting that top line going, we are consistently looking at opportunities to drive further cost reduction initiatives either because of capacity, excesses in facilities or because of other continuous improvement opportunities that we execute really day in and day out in our operation. So it's both, Sam, it's getting the top line moving. That does require some further investment and it's continuing to focus on cost take out, both of which will help the financials in the longer run.
Unknown Analyst - : Well, that sounds good. And now the sales, the rewards are based on profitability of sales. Presumably, you're looking at the type of sales and the allocation of payments relative to the profitability of the sales, not just for sales, et cetera?
Joseph Lawler: Yes, that's a very good question, Sam. We are -- our commission structure -- there are multiple elements of our overall compensation structure where managers are -- our management is specifically compensated based on revenue, operating income and free cash flow. That's how their incentive structure works. And with our sales organization, our sales organization is focused on specific deals. Steve and I and our senior management review the P&Ls on every deal to ensure that it meets revenue targets, gross margin targets, operating income targets, working capital targets.
Unknown Analyst - : Okay. And just one other question. With your significant tax loss, are you been looking at deals even though you have to become profitable? That's the most significant thing. Are there any significantly profitable entities that would fit into ModusLink to permit you to use you tax loss carry forward? And are they cost effective? Are you seeing things? Are you looking at things?
Joseph Lawler: Nothing that we can report on at this time, Sam. Our focus is really on the things that we've talked about in this call. It is fixing the acquisitions that we have made right now, getting them --because they are Americas-based acquisitions, TFL and PTS, really getting their profitability going again after we've had some challenging year and a half or 2 years with those post-recession and doing everything we possibly can to improve profitability in the Americas. I understand your question whether there are other opportunities but our primary focus is really around getting that -- those things fixed in the short term.
Unknown Analyst - : Okay. And now, has management decided to be able to buy any stock in the open market with the stock at these levels, or for the corporation to do that?
Joseph Lawler: All of that is reported. Post the dividend -- post-dividend payment, I think you saw that management did in fact go into the market and buy some.
Operator: [Operator Instructions] And our next question comes from the line of Aram Fuchs with Fertilemind Capital.
Aram Fuchs - Fertilemind Capital: Yes, I was wondering -- a couple accounting questions. When is a -- if a U.S.-based company is having you ship product from Asia to the States or Asia to somewhere else, what geography is that posted in, in your income statement?
Joseph Lawler: It would be posted in the area in which the work is done. So if the Asian products are handled and serviced out of Asia, they would be recognized in Asia. If they're shipped to the U.S. and we handle the product, service the product in the U.S., then it would be recognized in the U.S.
Aram Fuchs - Fertilemind Capital: And then on Tech for Less, if you're handling returns for a company, what -- how do you determine transfer pricing into Tech for Less? How do we -- how do you get the gross margin? And is it -- does that, I mean, it seems to be a bit arbitrary and perhaps it makes the line item profitability of those operations less relevant?
Joseph Lawler: Yes. What we do at Tech for Less, so the business model right now is that we're acquiring inventory typically from big-box retailers. So we have established what our purchase price is there. So it's -- there's no arbitrariness. We know exactly what it is. And then the revenue is whatever we end up selling those products for. So I think it is, actually, it is fairly clear. So right now, there is no allocation of any cost or revenues between TFL, Tech for Less and other parts of the organization.
Aram Fuchs - Fertilemind Capital: Most of the merchandise is purchased from independent third parties? I was under the impression that the purpose of the acquisition was to be able to offer that to your current customer base?
Joseph Lawler: It is and we are still working on that strategy and going forward. But right now, as I said, it's as I described. So we're picking it up all from independent third parties.
Aram Fuchs - Fertilemind Capital: Okay, that's helpful. And then you seem to be using this metric cash flow from operations minus PP&E expenditures. I'm curious, depreciation is constantly more than PP&E expenditures, usually in most stable corporations, it's roughly equal. Is that -- do you have such sufficient capacity that you think PP&E expenditures will remain substantially below depreciation for the medium term?
Joseph Lawler: Yes. Let me just give you the historical context of why that is and a lot of it because we did a SAP implementation several years ago, so what's happening is we stopped investing in that back in fiscal 2008 but that -- depreciation is still winding its way through the P&L and so our levels of CapEx, or capital expenditures, are running roughly about a percentage and a half of our revenue. And I think that's where we see the business is, somewhere in that neighborhood.
Operator: [Operator Instructions] And our next question comes from the line of Larry Derany. [ph]
Unknown Speaker: I've been seeing some activity in @Venture capital area and some in the alternative fuel area. And I noticed cobalt did a recent capital raise. Anything exciting in that part of the portfolio?
Joseph Lawler: Larry, you ask a lot of good questions about our @Ventures and because we are a minority shareholder in those businesses, and frankly, as we've indicated in the past, are working to find good exits for those businesses. We're not out there promoting our positions at all but there are some exciting things that are going on in those portfolio businesses. We would just encourage you and others that are interested in them to refer to the website where each of the logos are posted there and you can get a little more information directly. But since we are a minority shareholder, we're not either trying to promote or make too many comments. There are a number -- because these are clean technology investments, there are number of interesting things that are going on in those various portfolio businesses but I would refer you to the website and then their individual websites to get the most current information rather than just trying to comment on.
Operator: And our next question is a follow-up question from the line of Aram Fuchs with Fertilemind Capital.
Aram Fuchs - Fertilemind Capital: Yes, 2 questions on the top line. You mentioned that you are expanding your sales and marketing team by 30%, is it -- I think that's where the number was, is there a specific geography that you are focused on?
Joseph Lawler: That's correct, you recalled that accurately. It's actually multi-geography. We are putting new sales folks on -- and booked in all 3 of our regions. So in Asia, in the Americas and in Europe, and also in our -- across our e-Business Aftermarket Services and Supply Chain businesses. So it really does cut across all of our business, we see opportunities for growing the pipeline, closing more business faster in all regions and across each of the solutions.
Aram Fuchs - Fertilemind Capital: And then GSI Commerce recently has deal with eBay, they're mainly focused on apparel. I'm just curious, you have mentioned that you're in previous quarters, you're expanding into communications hardware. Is there anything that makes you think that you could get out of electronics or expand far from electronics and take advantage of some possible merger integration issues?
Joseph Lawler: Well, that's a very good question and a good insight into our e-Business model. Our e-Business activities where we will manage websites take orders that come through those websites, managed the financial transactions and then execute the fulfillment for those orders out of our solution centers, is being done for both current technology clients but also for some alternative clients in the retail space as well. I would commented in the past that our business is e-Business and our Aftermarket Services business are less than 20%. So it is a small part of our total business today but it is a strategic offering that we take to both our current technology customers but also because of our footprint. And some of the core capabilities in our e-Business we are, in fact, taking them to other clients and other market spaces as well. So we think it does represent a very interesting opportunity for the longer term.
Operator: [Operator Instructions] And I'm showing no questions at this time.
Joseph Lawler: Okay. Thanks then, Demetra. Let me just close at our conference call today. Steve and I thank you for participating, and we look forward to speaking with you again on our next earnings call. So Demetra, you can close the call. Thank you.
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.