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Systemax (NYSE:SYX)

Q1 2013 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Michael Smargiassi - Managing Director

Richard Leeds - Chairman, Chief Executive Officer and Member of Executive Committee

Lawrence P. Reinhold - Chief Financial Officer, Executive Vice President and Director

Analysts

Anthony C. Lebiedzinski - Sidoti & Company, LLC

David S. Strasser - Janney Montgomery Scott LLC, Research Division

Operator

Good day, ladies and gentlemen. Welcome to Systemax First Quarter 2013 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. Now, I'll turn the call over to your host, Mike Smargiassi from Brainerd Communicators. Please begin.

Michael Smargiassi

Thank you, operator. Welcome to the Systemax First Quarter 2013 Earnings Conference Call. I'm here today with Richard Leeds, Chairman and Chief Executive Officer of Systemax; 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 and quarterly reports on Form 10-Q. I would like to highlight the non-GAAP metrics that are included in today's press release. The company believes that by excluding certain recurring and nonrecurring adjustments from comparable GAAP measures, investors have an additional meaningful measurement of the company's performance. As a result, this call will include a discussion of certain non-GAAP financial measures. The company has provided a reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures in today's press release. The press release is available in the company's website and will be filed with the SEC in a Form 8-K. This call is the property of and is copyrighted by Systemax Inc. I will now turn the call over to Mr. Richard Leeds.

Richard Leeds

Good afternoon, and thank you for joining us today. On an overall basis, I am pleased that we substantially improved the performance of the business from what we reported in Q4. However, an operating loss, no matter how small, is still unacceptable to us, and we are working diligently to improve the business. Our balance sheet and cash position remain extremely strong and this provides us the resources to continue our operating improvement initiatives.

In the first quarter, our Industrial Products Group once again delivered a solid performance, driving growth in our B2B channel overall. Our B2B technology operations in Europe and North America were down modestly, and we witnessed continued softness in our consumer operations. On a sequential basis, we saw bottom line improvements at our Industrial Products business and now our operating loss in North American Tech, as you start to see some additional benefits of our ongoing performance initiatives.

Industrial Products continue to deliver strong growth, with strong top and bottom line results. Revenue was up 17% in the quarter, and we outpaced the industry and gained additional market share. The expansion of our SKU count remains a strategic priority, and our recent efforts are focused on the broadening of key product categories as we look to further strengthen our positions across current lines.

Margins improved on a sequential basis, as we mitigated some freight profitability and as our new distribution center in New Jersey continue to increase its efficiency. We see numerous growth opportunities for Industrial and are making additional investments in our advertising, sales teams and operating infrastructure.

Revenue in our European Tech business declined 1% on a constant currency basis in a challenging economic environment for the region overall. We continue to invest in the business and we look to strengthen our sales teams, upgrade our infrastructure and better position our operations to capture the opportunities we see in the region.

In the past year, we have significantly expanded our sales organization, particularly in the U.K., and built out our pan-European management and operational capabilities. While these efforts bring increased additional costs which are reflected in the quarter, there are key components in our growth strategy that are expected to benefit our long-term performance. The buildout of our Hungary shared services facility remains on track to be completed in a few months, and this center will drive operational and cost efficiencies in the second half of the year.

In North American Tech, total revenue declined 8% during the quarter. However, we did see improvements on a monthly basis throughout the period, with March delivering our best performance, and we're now at our operating loss on a sequential quarter basis. North American B2B Tech revenue declined 3% for the first quarter, which was an improvement from the fourth quarter. The demand environment remains soft, and we have realigned a number of sales offices in the past year to improve long-term efficiencies.

Consumer technology sales remain weak, with revenue declining 11% in the quarter. However, sales of the consumer-focused laptops and desktops outpaced the overall market as we have been able to successfully transition our consumer customers from our Systemax-branded PCs to our Tier 1 vendor partners. These gains more than offset by weak consumer electronics results. We continue to lag the market in the CE category, and this is a focus area for our management team.

The operating environment remains challenging across our technology businesses from both a competitive and demand perspective. That said, we see growth opportunities specifically in our B2B businesses both in Europe and North America. We are focused on strengthening our operations, executing on our growth strategy and improving our financial results. We have a number of proactive actions we are executing on to optimize our performance, including strengthening our sales teams, cost initiatives and change the leadership in North American Tech. While our overall results have been disappointing, our diversity across market, channel and customers enabled us to show solid growth in key areas while we execute on plans for improving performance in North American Tech. We have nearly $135 million in the bank, we are working hard to improve the business, and we're making investments to drive our long-term performance. Thank you. And with that, I pass the call to Larry.

Lawrence P. Reinhold

,

Thank you, Richard. Turning first to our consolidated revenue. First quarter 2013 consolidated sales were $880.7 million, a decline of 3.6% and off 3.4% on a constant currency basis compared to the first quarter of 2012. Sales for the quarter reflect continued growth in our B2B operations, which was more than offset by weakness in our consumer business.

Looking at our revenue by channel. First quarter B2B channel sales were $543.8 million, an increase of 1.6% or 2.0% on a constant currency and same-store basis. Our consumer sales were $336.9 million, a decrease of 10.7% on a constant currency and same-store basis.

Turning to our reporting segments. The Industrial Products Group had a solid quarter, with revenue increasing 16.8% year-over-year to $105.6 million, with growth across most product categories and a strong performance from our Canadian operations. Gross profit increased in the quarter and we delivered gross margin gains on a sequential basis, as our new distribution center gained efficiencies and we drove improvements on our freight processes that arose in the second half of 2012.

On the bottom line, Industrial's non-GAAP operating income improved slightly to $8.9 million. This increase reflects improved gross profit performance offset by increased investments in web advertising and on sales representatives. At the end of the quarter, industrial SKUs totaled $724,000, up 8% sequentially and up 38% compared to 1 year ago.

Sales for our Technology Products segment, which includes our European and North American operations, declined 5.8% to $773 million and 5.6% on a constant currency basis, while non-GAAP operating loss was $4.1 million.

Looking at our combined technology group segment on a geographical basis, in Europe, revenue declined 1.5% in the quarter or 1% on a constant currency basis. Our operations in our largest markets, the U.K., France and Holland, generated modest revenue growth in the quarter, which was offset by double-digit declines in our 4 smaller markets combined. SG&A increases reflect investments in new sales agents, as well as the buildout of our leadership team and operating infrastructure to support our pan-European strategy.

In the quarter, we booked $4.3 million in restructuring charges associated with our Hungary shared services center and other previously announced cost-saving efforts. We currently expect to incur a one-time cost in the first half of 2013, totaling between $9 million and $11 million as we construct and open the center.

Capital expenses in the quarter were approximately $1.9 million related to the buildout of our headquarters office in the U.K. and other infrastructure investments.

In North America, our Technology Product Group's revenue declined 8.3% for the quarter on a constant currency basis and reflects an 11.3% decline in our consumer business and a 2.5% decline in our B2B operations.

In retail, our total store count at March 31 was 40, reflecting the closure of an underperforming store in North Carolina during the quarter. From a product standpoint, our computer sales outperformed the industry, and we also had a solid performance from a private label business. Declines were led by our CE products, particularly our TV category. On the bottom line, we have started to see some early signs of stability as we capitalize on recent actions to optimize freight and operating expense, as well as improving vendor support.

Consolidated gross margin declined 40 basis points to 13.9% from 14.3% last year. Key drivers of the decline include competitive pricing pressures within our North American Technology segment; customer mix within our European group, which included a minor shift towards public sector sales in some markets; and product mix shifts within our Industrial segment. This was partially offset by a slight improvement in freight margins across our operations, as well as the growth of our Industrial Products Group and a higher gross margin associated within this business unit.

Overall, SG&A reflects planned investments to support our strategic initiatives. And as a percentage of sales, SG&A increased by 129 basis points over last year. The primary drivers of the SG&A increase were investments in sales staff and head office in Europe to support our pan-European structure, which resulted in costs greatly outpacing sales growth in the quarter. Within our North American Technology segment, reductions in operating expenses were more than offset by volume declines within the quarter, leading to negative leverage. Consolidated non-GAAP operating margin was a negative 0.1% compared to 1.5% in the prior year.

Nonrecurring and recurring adjustments during the quarter were $8.0 million on a pretax basis or $0.15 per diluted share on an after-tax basis using this quarter's effective tax rate of 31.5%. Non-GAAP operating results for a loss of $0.7 million compared to income of $14.0 million last year. GAAP pretax loss of $9.2 million compares to income of $10.8 million last year. Non-GAAP net income totaled a loss of $0.8 million or $0.02 per diluted share. As of March 31, our balance sheet included $351.6 million of working capital and $134.7 million in cash, a decline of $16.0 million from December 31, but an increase of over $20 million from the year-ago period. The current ratio at March 31, 2013, was 1.8:1, and total debt was $7.4 million. With that, we would like to open the call to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Anthony Lebiedzinski of Sidoti & Company.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Just -- I was wondering if you could give us a little bit more color on the monthly trends. Richard, I think you said that March was your best month out of the 3. So if you could just give us maybe a little bit of color, maybe some specific numbers or maybe just so we can put things in perspective as to how your business shaped out during the quarter, that would be very helpful.

Lawrence P. Reinhold

Anthony, it's Larry. I'll take that one. During the quarter, certainly, the business that's been under the most pressure lately, the North American Tech business. While not outlining where we were each month, January was -- February was better than January, March was better than February. It was not a positive bottom line but it was getting closer to breakeven in -- at the end of the quarter.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay, that's helpful. And also within the consumer segment, could you also give us a sense to how sales were within the retail, web, the home shopping channels and so on?

Lawrence P. Reinhold

None of them were really a particularly appetizing story. We had declines across all of the channels. The TV shopping is much smaller than it used to be. I don't know if -- I don't have that rate in front of me, the percentage, but it's on a much smaller base than it used to be. But both web and the retail store environment on a same-store basis were down in the double digits.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And you also mentioned that improving vendor support, could you give us a sense to how that is now versus what you've seen in previous quarters?

Richard Leeds

We've seen that it's coming back a little bit but still not where we want it to be. And it's up year-over-year, but we still have -- looking forward to working with our vendor partners and increase support for other various initiatives that we have.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And within the Industrial operating margin decline on a year-over-year basis, is that pretty much mostly because of more drop ship items versus last year?

Richard Leeds

Well, the Industrial business on a sequential basis, we're happy with the progress we made. I think that we identified last quarter that there were certain issues with the freight performance that we started working on in Q1 in earnest, and we've seen improvements as a result of that. Yes, the gross margin was actually a little stronger on a sequential basis, still down from the prior -- on a year-over-year basis, down a little bit, but it was increased over Q4 of last year. The impact of that is primarily drop ship of many, many, many categories of products. But it's just in general carrier lower gross margin.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And do you expect that to kind of stabilize, that margin compression, or how should we think about that?

Richard Leeds

I think that we're continuing to working hard with balancing sales of new products, primarily on a drop ship basis with increased product that we import directly to have the highest gross margin, and then the things that we buy from domestic vendors in stock are somewhere in the middle. To manage all of that, we've got the new distribution center in New Jersey that I think we opened it in June of last year, late Q2. I think as we approach its 1-year anniversary, we think we will have -- it'll be fully up to scale in delivering efficiencies that we're looking for out of that center. And the freight initiatives that I talked about earlier, I think those are very positive trends. So all said, we're hopeful that gross margin performance will stay in -- around where it's at. Hopefully, we can improve it.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And lastly, just looking at the reconciliation for the special charges on your income statement, you have $6.1 million now. Looking at the last page of your press release, you do have a breakdown between severance litigation and new facility start-up costs. So those add up to $6.8 million. So just wondering, are you including some of these charges, actually, within SG&A? Just as to -- wanted to get a better understanding of what's included in that.

Richard Leeds

Well, the -- on a GAAP basis, severance charges are certainly in SG&A. The new facility start-up costs are probably embedded in COGS, and I think -- I mean for the most part, it's SG&A. But that's where they come out on a -- geographically on the P&L statement.

Operator

Our next question is from David Strasser of Janney Montgomery.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

It seems like over the last quarter, so maybe it's been more present reality and maybe [indiscernible], it seems like there has been some shifts amongst the vendors. It seems like Samsung has gained some traction versus Apple. Maybe -- and not only in phones, but even in tablets and so on. You said you had kind of outperformed on PCs and tablets, or notebooks and tablets, or -- I'm sorry, you said notebooks or PCs and tablets, I believe that, too. Have you seen anything from the sort of that shift in vendors? A, do you think that's really happening? And, b, as -- are you getting a benefit out of that? And, c, do you think in some way that a discussion can open with Apple if you sort of look more to maybe potentially different distribution? I mean, I'm not seeing the the best side so -- but it's kind of relative to Apple's [indiscernible] I mean, computer as far as somewhere further back in the store than in the Samsung store and [indiscernible] are going. In China, do you have a sense of this opportunity for you?

Richard Leeds

Yes, yes and yes. We certainly have -- we've seen -- with good results in our core PC categories across most of the vendors, not just the ones you mentioned, but obviously, we worked with [indiscernible] and the products of lots of Tier 1 vendors. Here in North America, we're -- I think as you know, we really don't sell a lot of Apple. We do in other parts of the business. So we've certainly seen good growth with the vendor's products that we do sell, and we think that, that should continue.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

Just from a product standpoint, anything out there that's starting to excite you back-to-school or holiday that could -- whether we'd see that sort of anything in the last few months, we've seen that, that starts to get exciting. I've heard people talk about peripherals that seem to become [indiscernible] back to school, very [indiscernible] experience?

Richard Leeds

Well, we certainly have -- when we visit our vendors, we get an early look at new things that they're working on and they're going to be bringing to market. We clearly wouldn't want to talk about any of those things that we might have seen that are not out yet. There's always new and exciting products coming out. There's a whole host of tablet-related new form factors that we think look really interesting, and we're going to be happy to sell all the good products that -- if we have access to.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

Is it that you're going to be a stronger or weaker product? I mean, if there is any indication for how [indiscernible] to the back half?

Richard Leeds

We're looking forward to a really good back half of the year, David.

Operator

Thank you. This is the Q&A portion of today's conference. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.

Richard Leeds

Thank you all. We'll talk to you next quarter.

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