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Systemax Inc (NYSE:SYX)

Q3 2008 Earnings Call

November 05, 2008; 05:00 pm ET

Executives

Richard Leeds - Chairman and Chief Executive Officer

Larry Reinhold - Executive Vice President and Chief Financial Officer

Gilbert Fiorentino - Chief Executive of Systemax Technology Product Segment, including Tiger Direct, Comp USA and Masco

Denise Roche - Brainerd Communicators

Analysts

Dorsey Gardner - Kelso Management

John Fick - D Cap

Operator

Good afternoon ladies and gentlemen and welcome to Systemax Inc’s third quarter 2008 earnings teleconference call. During the presentation all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. (Operator Instructions) As a reminder this conference call is being recorded today November 5, 2008. At this time I would like to turn the call over to Denise Roche of Brainerd Communicators; please go ahead.

Denise Roche

Thank you, Operator. Welcome to the Systemax third quarter 2008 conference call. I’m here today with Richard Leeds, Chairman and Chief Executive Officer of Systemax; Gilbert Fiorentino, Chief Executive of Systemax Technology Product Segment, which includes Tiger Direct, Comp USA and Masco; and Larry Reinhold, Executive Vice President and Chief Financial Officer.

This discussion may include certain forward-looking statements. It should be understood that actual results could differ materially from those projected due to a number of factors including those described under the caption Forward-Looking Statements in the company’s annual report on Form 10-K. This call is the property of and is copyright by Systemax Inc. I will now turn the call over to Mr. Richard Leeds.

Richard Leeds

Good afternoon and thank you for joining us on today’s call. I’m pleased to report that Systemax delivered good revenue growth and a solidly profitable third quarter, despite a challenging economic, retail and IT spending environment.

Consolidated sales grew by more than 7% to $739 million, a third quarter record, driven by our two key business segments technology and investor products. Technology Products sale which include computers, computer supplies and consumer electronics grew over 8% to $676 million.

Growth was driven by sales of laptops, computer monitors, desktop computers and high definition television. In our Investor Products group which includes the general handling equipment, storage equipment and consumable industrial items, sales increased approximately 3% to $63 million, primarily as a result of increasing incident sale.

On a consolidated basis we saw lower margins in the quarter due to higher costs associated with the opening of our eighteen new stores. Sixteen CompUSA branded stores, one store in Canada which opened in May and a store in South Florida that is in the works. These new stores are key components of the retail strategy we are building to compliment our online technology product sales.

Our gross margin for the quarter was 15.8% compared to 16.1% in the third quarter of 2007. Our operating income decreased 28% versus the same period in 2007. This translated into a 2.5% operating margin compared to 3.8% in the third quarter of 2007.

With the stores now fully staffed, operational costs have reached normalized levels. Our SG&A while higher year-over-year increased just 3% from the second quarter ‘08 level. With an expanded retail presence now established, we have a higher fixed cost base, but we are in an excellent position to generate leverage on that base as we grow sales.

Net income for the quarter was $11.3 million with $0.30 per diluted share, a 36% decrease in the third quarter of 2007. EPS was negatively impacted by lower interest income, unfavorable foreign exchange affects, a higher tax rate and higher operating expenses. Larry will provide further details later on this call.

As we all know the economic environment and outlook has deteriorated considerably in the last few months. While no retailer will be immune to substantial affects of the slower economy, there are three key factors that support our market positioning and ability to continue to drive sales; one, is the unique combination of quality and value that we stand for and for which the Tiger Brand in particular is what we know; two, is our diverse channels and three is the investments we’ve made in the business.

The strategic build out of our Tiger Direct and CompUSA presence and their innovative new retail system that Gilbert would talk more about in a moment, recall retail of 2.0. Its desire’s to translate what our customers love best about researching our products online, the store environment, dramatically change in the way consumers shop for electronic goods. We can’t predict what will happen to consumer and IT spending in the coming months, but we are feeling very good about our market position and the opportunities we have created for long-term growth.

I will now turn the call over to Gilbert to discuss highlights for our technology products segment including Tiger Direct, CompUSA and Masco.

Gilbert Fiorentino

Thanks Richard and good afternoon everybody. The technology products group once again produced solid results performing better than the overall industry, with net sales growing more than 8% versus the third quarter of 2007.

Operating income decreased by 23% versus the same period last year. Revenue growth was driven by our North American operations where sales growth was 12.9% over the prior year. This growth was tempered by sales in Europe which were relatively flat compared to last year.

In North America, we continue to efficiently implement our near term strategy of integrating our CompUSA branded stores and website. Our initiative to co-brand CompUSA with our established Tiger Direct business continues to progress and we are progressing with our plans to reconfigure each CompUSA store layout over the coming months to more closely reflect the layout of our Tiger Direct stores which has proven popular with consumers. This means more emphasis on PC component categories, improved merchandising of TVs and consumer electronics and spotlight focus on our in-store technical services.

Our total stores count for both Tiger Direct and CompUSA stands at 29 with 24 in the United States and five in Canada. We currently have plans to open one more store in South Florida in early 2009. Our CompUSA retail locations contributed $42 million to our top line in the third quarter representing more than 45% of all in-store sales we received in the third quarter. Further, sales improved each month through the quarter. Although the retail sector is facing challenging times, we maintain positive expectations for the CompUSA branded assets.

The retail environment is continuously changing and our tech savvy consumers continue to demand more product information both when shopping online or at our stores. To stay competitive, we have to stay ahead of our consumers. As Richard mentioned earlier we are melding the advantages of online shopping experience with the instant gratification of the retail brick and mortar experience through our retail 2.0 initiative.

Essentially we are applying our successful website platform to our physical retail stores. We have set ourselves apart from the larger consumer electronics chains in our commitment to serving a different customer base, one that is more knowledgeable. Our customers are not looking for the most convenient prepackaged offering, but seek the best products based on their own research and technical aptitude.

What has made our ecommerce businesses so successful over the years is our customer’s ability to learn about the products and conduct their research directly on our websites. With the retail 2.0 initiative, we have moved this information into the physical retail store.

Now customers won’t have to rely solely on floor personnel to answer detailed questions about a product, instead computer kiosks placed at the end of every isle enable customers to immediately access the detailed information on a particular product and its operations, capabilities, specifications, brand value, customer reviews and other value in the market place.

In addition every computer, every monitor and every television in our stores is also online and provides detail product information about the product they are physically touching. So customers can test these items right in the store to decide whether it meets their needs and our trained associates are there if they need help. Additionally we will offer free in-store workshops every weekend on various topics like how to build a PC or how to upgrade a PC.

The new Retail 2.0 program has been rolled out in our flagship Dadeland store in Florida and has been very well received by our customers and by our vendor partners. Looking forward we intend to launch this new platform in each of our stores over the next eight to twelve months. While each launch has marginal associated expenses, these are offset by the many benefits we received.

First we will see some cost savings from time saved in-staffed product education. We will also improve our customers buying experience and satisfaction with their purchases, which will generate increased customer loyalty and lower returns. Furthermore this new store layout offers the potential for other revenue generating opportunities including advertising and cross selling of complementary products with that initial product that the customer is looking to purchase.

I’d now like to update you on our internet properties. We are pleased that our CompUSA and Tiger Direct online businesses continue to do well. Traffic on Tiger Direct.com continued to grow in the third quarter as we saw a 9% increase in total traffic over the third quarter of 2007.

Tiger Direct ranked number 36 in stores favorite 50 list for 2008 which ranks consumers favorite online retailers and speaking about Tigerdirect.com in the survey they say “tech geeks know this is the source for quality gadgets galore.” The Tigerdirect.com website continues to rank in the hit wise top ten as it has for ten of the last eleven consecutive quarters.

We’ve also successfully converted the CompUSA website into an entirely new e-commerce site with improved content, more attractive layout and many new functionalities. In the third quarter CompUSA.com received over 926,000 visits per week a 17% increase from the second quarter.

Overall our online sites continue to offer enhanced web content with over 105,000 user reviews, almost 35,000 user generated questions and answers and 32 million views of our video content that we produced ourselves. We’ve recently launched subtitles to our video content in both English and Spanish allowing for wider viewership in the US and international to Hispanic customers.

Our video content will be further enhanced in the fourth quarter as we rollout a new HT enabled player which will allow full screen viewing on our websites. External syndication of our in-house produced videos has tripled since re-running our video as computer TV.

In the third quarter we added Samsung consumer electronics and Boson Acoustics to our extensive list of direct Tier I consumer electronics manufacturers in an effort to further solidify Tiger Direct and CompUSA as a major player in the higher margin world of home entertainment consumer electronics.

Panasonics, Samsung and Boson Acoustics are also direct purchasing relationships which not only improved service on product availability to our customer but also had increased sales margins. In addition we recently signed a contract with Zip Express to provide nationwide installation services for consumer of HT TV, home theatre and the like.

Furthermore, Tiger Direct was approved to participate in the government compound redemption program for DTV set top boxes to convert to the new digital signal which will begin in February 2009 by government mandate, and we are doing very well with that program by the way.

Turning to product sales, revenue from components cables and accessories and software were all double digits compared to the same period one year ago. In the computer category we continue to lead the industry in growth. Sales of notebook and desktop computers increased 39% and 26% versus the national average of 10% and 0.1% respectively according to the MPD group.

Our North American B-to-B group has been hard at work expanding into new areas. The B-to-B group business-to-business group works in partnership with our brick and mortar stores to provide customized service to small business customers, a market that we believe is underserved.

During the third quarter we established a local CompUSA B to B office in Texas which contributed $1.6 million in sales in its first quarter of operations. In addition our specialized software team which is focused on software licensing established two new large account reseller relationships. This referral program allows our staff to generate sales of enterprise level software licenses from software one and Softmart.

As we have previously said this is a very exciting market for us because it offers less competition, a higher barrier to enter due to the complexity of products and access to larger customers in terms of who is buying these large count reseller licenses.

In Europe our revenues were flat in the quarter, down 4% after taking into account exchange rates. Our European business continues to be strong and outbound B to B which now represents 70% of our European sales with the other 30% coming from our inbound and internet business.

Looking at customer satisfaction levels, both Tiger and CompUSA excelled in the third quarter. Tiger’s reseller ratings which include customer satisfaction, likelihood of future purchase and overall customer scores were at a all time high.

Tiger is a current and two-time biz rate circle of excellence winner and with the price galore we’ve earned a gold award standard designation with over 37,000 lifetime reviews and an overall satisfaction score of 4.7 out of a possible 5. CompUSA meanwhile earned its highest ever reseller rating for overall customer satisfaction and earned a price grabber satisfaction rating of 4.6 out of a possible 5.

In summary, we are pleased with the results of our technology products group and the progress that we’ve made in strengthening this business. With our new retail strategy, enhancing our customer’s experience and continued integration of the CompUSA brand, we feel confident in the long-term growth potential in our continued success.

With that I’ll pass the call back to Richard.

Richard Leeds

Thanks Gilbert. Despite the slowdown in the US industrial manufacturing sectors, our industrial products division which includes global industrial and Nextel industries once again posted increased sales. In the third quarter, the division experienced net sales growth of approximately 3% to $63 million versus the same period one year ago.

Our customer base continues to grow as we had approximately 27,000 new buyers during the period. This growth is partially attributable to the online advertising campaign we initiated during the quarter that led to a significant increase in traffic for our websites as well as contributed to a 3% reduction in advertising costs. In addition to new business we continue to see high levels of customer attention and an increase in their satisfaction with our low price tough quality product selection.

With respect to our product selection, we continuously monitor popularity of each of our skews. This enables us to popular them, our inventory with items that are in great demand and scale back with discontinued sales on items that are not producing adequate turnover.

As a result of our operating efficiencies operating income grew about 11% over $7 million in the quarter compared to the same period last year. Our efforts have helped us increase our product selection on the web by 54% versus the third quarter of 2007.

New end visitors to our global industrial website were up approximately 35% versus this time last year. The growth generated from our websites parlays nicely with our outbound telemarketing sales force and traditional catalogue mailing.

Our average rent size for all categories grew by 3%, another indication that our strategy is working and subsequent to the quarter end we reorganized and refocused our wholesale software business which we had hoped to be further along in its developments.

I’ll now turn this call over to Larry to discuss more detailed financial results for the quarter.

Lawrence Reinhold

Thank you, Richard. Consolidated sales for the third quarter were $739 million, up 7.6% from $687 million in the third quarter of 2007. Gross margin was 15.8% compared to 16.1% in the third quarter of 2007 and net income for the quarter was $11.3 million or $0.30 per diluted share down 36% versus the same period last year.

Interest income was down due to lower cash balances as a result of the cash used to acquire and build out our CompUSA operation, to pay a special dividend and to repurchase shares. Income tax expense in the quarter was $7.4 million.

Technology product sales were $676 million, an increase of 8.1% versus of third quarter of 2007 and represented 91% of the company’s overall revenue. Operating income in the third quarter from our technology products group was $21.3 million, a decrease of 23% over Q3 of last year.

During the third quarter of 2008 net sales from industrial products was $63 million, an increase of 3% over the third quarter of last year and operating income for the quarter was $7.3 million a increase of a 11%.

Turning to our geographical breakdown our total North American sales were $512 million, an increase of 11% from the third quarter of last year, represented 69.3% of our total sales in the quarter. Our total European sales were $227 million flat on a year-over-year basis and represented 30.7% of total sales in the quarter. Excluding exchange rates effects European sales would have decreased by approximately 4% in the third quarter compared to last year.

During the third quarter our SG&A expense decreased 90 basis points to 13.2% of revenue versus the third quarter of last year. This increase is mostly attributable to additional employee costs associated with the reopening of the CompUSA stores and related expenses and growth in our other businesses. In total since we purchased the CompUSA assets we have hired more than 700 employees as staff to the stores.

Moving to the balance sheet, the company continues to maintain a strong financial position. As of September 30, 2008 our balance sheet reflected $247.4 million of working capital and $73.3 million in cash. Cash balance for the quarter increased by 10% versus last quarter and our current ratio at the end of the quarter was 1.7 to 1.

Additionally our $120 million credit facility remains undrawn giving us over $180 million of cash and available liquidity at the end of the quarter. During the quarter we generated $12.8 million in the operating cash flow and ended the quarter with $276 million of inventory.

During the quarter we purchased about 220,000 shares of the company’s common stock at an average price of $15.04 per share, pursuant to the stock repurchase plan approved by our board of directors in May.

Our effective tax rate in the third quarter was 39.5%, up from 34.5% in 2007 due principally to higher taxable income in the UK in 2008 as a result of reversing a net operating loss evaluation allowance in the fourth quarter of last year.

With that we would like to open the call up for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dorsey Gardner - Kelso Management

Dorsey Gardner - Kelso Management

I was curious with the web hosting business, any numbers on that? It’s been running pretty heavily expenses and I’m wondering if it’s starting to pay off or where are you in the development of that business?

Richard Leeds

This is Richard, I’ll take that question. Obviously in this economic environment you reevaluate the investments that we make and we look at the hosting business that inspired us that it was time for us to restructure that business and bring down the headcount a little bit and refocus it to make sure that as we go through this that we’re in line with what our goal is. It’s still continuing to have a fairly significant loss that we are not happy about and that’s really the reason for the restructuring and refocusing.

Dorsey Gardner - Kelso Management

Do you still feel it has a future?

Richard Leeds

Yes we do. Obviously as I said in an economic environment like this, it forces you to reevaluate your investments, but it’s a business that we initially went into thinking that it was a good business and we’re refocusing towards a road to a successful future.

Dorsey Gardner - Kelso Management

Okay and if I could ask a further question on CompUSA; what kind of sales would be possible in a CompUSA store when they’re configured?

Richard Leeds

Gilbert you want to take this one?

Gilbert Fiorentino

Well that’s a tough question. Every store, location is important. The rollout of our Retail 2.0 program could be a landscape-changing event that we hope to see as we start to measure the results from the new program. There are just so many possibilities I don’t know that I could really answer that to be honest.

Dorsey Gardner - Kelso Management

Okay and is it possible for a national footprint if it works or I guess your idea is to just go slowly and walk before you run, is that pretty much your strategy?

Gilbert Fiorentino

We of course will be very conservative in the way we expand the business, but what I love about the retail business is that if you have a business plan that you can prove that works, the scalability of a retail business plan could be unlimited in terms of being able to open stores and expand your footprint and expand your business in scalability where no matter how hard you work with a equal landscape on the internet for example, growing internet business at rates that are greater than the competition, means you worked very hard, you acquire market share and you continue to give customers great deals and great service; but a proven business plan at retail, it could be great, it could be just so exciting for us.

Dorsey Gardner - Kelso Management

I mean its interesting that Best Buy does like $40 billion at retail and about $1 billion direct. So obviously there is a big market out there and with Circuit City, it looks like they are leaving the scene, there won’t be any place to buy electrical the way things are going and so I suspect there could be a very large potential there.

Gilbert Fiorentino

Well, you pointed out the most exciting part about our retail 2.0 program. I can’t confirm or deny whether Best Buy does $1 billion on their internet site or direct, but the $40 billion is a number we know.

So if you consider that the big retailers are doing big numbers at retail, but they are not doing anything especially exciting on the internet and you start to understand that the customer experience on the internet is just so far superior to what they can get at retail, but they still want to go to retail, you start to understand what the idea of retail 2.0 is.

It’s taking this rich customer experience from the internet, bringing it into a retail store differentiating yourself from the others, not only with a better experience, but also with deeper and broader selections and with products that the others don’t sell and it starts to represent not only a differentiator, but a reason why customers come to us where they hopefully will change their buying patterns in the future.

Dorsey Gardner - Kelso Management

This is clearly a troubled area where a lot of people had failed at retail and electronics, I mean it’s an endless number and so obviously you’re going very carefully, but it will be interesting to see how it developed. I’ve been to a couple of your stores and they seem to appear more to sort of the nerd or the gamer or the real technical type as opposed to the retail customer, is that correct?

Gilbert Fiorentino

We have a broader selection of products, so we carry motherboards, we carry video cards, we carry sound cards, we have upgrades available on hard drives and things to differentiate ourselves. We also sell the TVs, the laptop, the desktops, all the other things that customers want, but you really need to differentiate yourself from the retail space today than to just be a “me too.”

Operator

Your next question comes from [John Fick – D Cap].

John Fick – D Cap

I’m not sure if you’re going to give guidance, but I was just wondering what you are thinking in terms of how this holiday seasons is going to play out, what you kind of embedded in your forecast for end demand and then kind of a long shot of that; how that plays into your working capital requirements for carrying inventory, into the holiday season and then lastly kind of what are your capital requirements for rolling out this Retail 2.0 strategy in the bricks and mortar phase?

Richard Leeds

This is Richard. We don’t give guidance, but obviously in an economic environment like today we are really watching closely what we are doing, watching our inventory levels very closely, watching how our customers are responding to our offers very, very closely and we are really trying to act as prudently as possible in this environment. We are not really gearing up for it to be outstanding and we are not really gearing up for it to be terrible. We are trying to gearing up for it to be in the middle of the road and I think that’s really the most prudent thing that we are doing today.

John Fick – D Cap

And so are you consuming work cash from a working capital building stand point and then what about how you manage working capital in the retail bricks and mortar area?

Richard Leeds

Well typically in the fourth quarter our sales increased and we increased our inventory levels corresponding to support the business and in this fourth quarter we’ll be no different. While we have increased our inventory levels because of the additional stores we’ve taken on and the seasonality of the retail sales will be the same as it is for direct [Inaudible]. Does that answer your question?

John Fick – D Cap

And I don’t know how free cash flow was in the quarter, I apologize because I’m in a car, but what’s kind of free cash flow generation and how do you think about free cash flow generated in your model at the rest of this year and next year, broadly speaking, I’m not necessarily looking for guidance?

Richard Leeds

Okay we generated about $19 million in free cash flow in the quarter but we’re obviously will be right without this purchase. We run this business for generally cash and we understand the value of that. We are very prudent with running the business and I think that’s really the way that we want to answer that question. I mean we need to focus on adjusting that economic environment and really balancing our assets the best way that we can.

Operator

And at this time we have no further questions from the phone, so I’ll turn the call back over to Mr. Leeds for any additional or closing remarks.

Richard Leeds

I’d like to thank everybody and we look forward to talking with you next quarter.

Operator

This does conclude today’s teleconference. You may now disconnect and have a great day!

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Source: Systemax Inc Q3 2008 Earnings Call transcript
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