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ModusLink Global Solutions, Inc. (NASDAQ:MLNK)

F3Q09 Earnings Call

June 9, 2009 5:00 pm ET

Executives

Joseph C. Lawler - Chairman of the Board, President, Chief Executive Officer, Director

Steven G. Crane - Chief Financial Officer

Analysts

Ryan Gaines - Springhouse

Larry Smith - Private Investor

Mark Breuer - Private Investor

Allan Young - Analyst

Tom Price - Halogen

Operator

Hello and welcome to the ModusLink Global Solutions third quarter 2009 operating results conference call. At the company’s request, this conference is being recorded. (Operator Instructions) Now I would like to turn the call over to Mr. Joseph Lawler, Chairman, President, and CEO; and to Mr. Steven Crane, Chief Financial Officer. Please go ahead, Mr. Lawler.

Steven G. Crane 

Thank you, Lamont. Good afternoon, everyone and thank you for joining us for ModusLink Global Solutions fiscal 2009 third quarter conference call. I am Steve Crane, CFO and I am 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 will review in more detail our fiscal 2009 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 are 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 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 will 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 would now like to turn this call over to Joe Lawler. After our formal remarks, we will be happy to take your questions. Joe.

Joseph C. Lawler 

Thank you, Steve and good afternoon. There are several key points that I would like to cover during today’s call. First, we continue to be in the midst of the worst economic environment we have experienced. As a result, we continue to see lower unit volumes moving through the supply chain compared with this time last year.

Second, despite this market environment, we remain confident in our business model and value proposition. Revenue growth from new engagements was strong in the quarter, supported by a robust pipeline of new opportunities as our clients have an ongoing need to realize savings and efficiencies in their supply chains.

Third, the actions initiated in the fall to right-size the company had a positive impact on our financial results this quarter. Primarily due to our cost cutting initiatives, we saw improvement in gross margin percentage and a reduction in selling, general, and administrative costs, compared with the third quarter last year. In fact, over the past three quarters, we’ve made good progress improving gross margin from 9.6% in Q1 to 12.4% in Q2 and now 14% in Q3.

In addition, selling, general and administrative costs were $31 million in Q1, $26 million in Q2, and now $22 million in Q3. We are pleased with this progress and these actions have contributed to improving operating income.

Fourth, we maintained a strong balance sheet despite the weak economic conditions and cash increased by $32 million to $167 million at the end of Q3. I want to cover each of these four points in some detail.

As our investors know, ModusLink and its clients are operating in unprecedented market conditions with softness in the economy and a pull-back in consumer spending being felt globally. When demand for our client’s products slows, it in turn results in lower volumes moving through the supply chain, which translates to lower production and assembly volumes as our clients work to minimize inventory risk. This dynamic is resulting in lower base volume from existing clients and therefore lower revenue in the third quarter when compared to the same quarter last year.

When the economy eventually recovers, we expect to see increases in our base business volumes. Despite these lower volumes, we continued to see significant revenue growth from new engagements in the quarter, which increased approximately $16 million, or 61% over last year’s Q3.

Revenue from new engagements was 18% of total revenue compared with 11% of total revenue in the third quarter of last year. As I mentioned earlier, we view revenue from new engagements as an important indicator of the strength of our value proposition and the effectiveness of our sales and marketing efforts. Our pipeline of new opportunities continues to be robust as we move into our fiscal fourth quarter. We expect that new business revenue will continue to be strong in the fourth quarter; however, we expect it to be below the unusually high new business revenue reported in the fourth quarter of the prior year.

The full fiscal year 2009, we continue to expect revenue from new engagements will be significantly higher compared with what we achieved in fiscal 2008.

The acquisitions of ModusLink Open Channel Solutions acquired during the fiscal third quarter of last year and ModusLink PTS acquired in fiscal fourth quarter of last year contributed approximately $17 million of revenue during the quarter compared with $2 million from OCS in the third fiscal quarter of last year. Both of these acquisitions are highly strategic and are contributing to our improving financial performance.

We are also encouraged with the increase in gross margin in the third quarter, which improved to 14% of revenue compared with 12.9% in the third fiscal quarter of last year. This 110 basis points improvement was due to the benefits from our cost reduction initiatives as well as the acquisitions of OCS and PTS. Since new business represented 18% of our revenues in this quarter, and only 11% of revenues in last year’s fiscal third quarter, the 14% gross margin is a good result because new business margins in the first few quarters are typically lower due to start-up costs and inefficiencies that are offset later.

Our cost reduction programs had a positive effect on selling, general and administrative expenses this quarter. Compared to the third quarter of last year, SG&A declined approximately $7 million, or 24% to $22 million this quarter. Looked at differently, SG&A was reduced to 9.5% of revenue in the third quarter versus 12.1% in the same period last year on lower revenues.

Improved gross margin and reduced expenses resulted in a significant improvement in both operating income and non-GAAP operating income. Our initiatives to right-size our organization are ongoing. When the market eroded rapidly at the outset of our fiscal year, we quickly took action to lower our cost structure, which at the time was designed to support much higher revenue projections than we are experiencing now. I will briefly outline those ongoing actions along with an update on our progress.

First, we are accelerating the consolidation of finance, client management, and production planning functions. We expect continued benefit from these actions in the fourth quarter and we will realize a full year’s benefit in fiscal 2010.

Second, we have removed layers and functions in our organization that were sized for significantly higher revenue levels. We saw reduced expenses from these actions in the third quarter and expect to continue to see benefits the remainder of the second half.

At the end of our fiscal year, our full-time employee headcount will be 17% lower than the previous year. These reductions are driving nearly 55% of the planned cost savings, with most of the headcount reductions being in the Americas and Europe.

Third, as part of the simplification strategy, we are prioritizing sales and marketing efforts by focusing on five key solutions to drive the majority of our revenue and gross margin versus 18 solutions in fiscal 2008. This change enables us to focus our organization on the key revenue and profit drivers and speed the selling and on-boarding process.

Fourth, we are accelerating our lean sigma initiatives to increase labor productivity levels and drive lower costs, especially in direct labor, and we continue to see benefit from these programs.

Fifth, as a result of the volume softness referred to above, we are reducing excess capacity in our solution centers by shutting down sites in the Americas and Europe where cost reduction efforts cannot offset the profit impact of lower volumes. That said, as the economy begins to recover to higher levels of activity, we believe the reduced capacity can still accommodate growth as a result of our lean sigma initiatives.

Our cost reduction initiatives are on track and going well. We continue to expect these initiatives to reduce our combined cost of sales and SG&A expenses by more than $20 million this fiscal year, which will result in more than $40 million annualized. We continue to expect that our cost reduction initiatives will translate into an annualized 15% to 20% reduction in SG&A and support improved gross margins going forward.

Importantly, we expect our structure will be better aligned with current unit volumes and position ModusLink for improved financial performance when the markets eventually recover.

Looking forward, we remain committed to developing our business to be able to deliver 5% to 7% operating income in the future, grow cash from operations and generate attractive returns on invested capital.

We have a lot of work ahead of us and we are facing strong headwinds in this challenging market environment. However, we remain confident in our value proposition, which continues to resonate with clients. Clients have a strong need to reduce costs and they do so through outsourcing select parts of their supply chain so they can focus on their core competencies. ModusLink is highly differentiated in the market with the industry’s largest global footprint, an integrated portfolio of supply chain solutions, and experience achieving results from many of the world’s leading technology companies. With over 70% of our revenues coming from Fortune 500 companies, we are positioned for growth when the global economy recovers.

While we remain focused on effectively managing through this difficult economic environment, we are also working to strengthen our brand as we bring our value proposition to market, which means we maintain the highest levels of client service and implement the core elements of our long-term growth strategy.

Central to our long-term strategy is first increasing new business revenue in our target markets with a focus set of solutions through our sales and marketing efforts. Second, we are expanding existing client relationships by cross-selling and up-selling other solutions. A good example of cross-selling and up-selling is our recently launched environmentally focused solution called the sustainable solution suite. Utilizing our sustainability solution, ModusLink's client, Cisco Systems, was recently quoted as being able to reduce its overall packaging material for certain of its Linksys products by almost 49% without incurring increased costs.

Helping clients in the hardware, software, storage, communications, and consumer electronics markets address complex supply challenges and manage costs in an environmentally responsible way represents a significant long-term opportunity for ModusLink.

And the third component of our long-term strategy is driving efficiencies in our operations to lower costs and improve margins as I’ve outlined today.

Before I make a few final comments on our quarter, I will turn it back to Steve for a more complete financial overview.

Steven G. Crane 

Thank you, Joe. For the third quarter of fiscal 2009, ModusLink Global Solutions reported net revenue of $231.5 million. This compared to net revenue of $239.2 million for the same period one year ago.

Revenue from our base business declined $38.8 million or 18.4% over last year; however, new business revenue increased by $16.3 million, or 61%. In addition, our recent acquisitions of OCS and PTS contributed $16.9 million. This compares to $2.1 million in the third quarter last year, which only included revenues from OCS, which was acquired approximately midway through the third quarter.

Looking at the results geographically, Asia revenue increased to $76.8 million from $70.9 million in the prior year period, primarily due to higher volumes from a significant customer. In the Americas, revenue increased to $83.7 million from $76 million in the third quarter of fiscal 2008 due mainly to the contributions of OCS and PTS.

Europe was particularly affected by the lower volume of consumer goods moving through our facilities, as well as by foreign exchange translation as the dollar strengthened against the Euro. As a result, revenue in Europe decreased 23.1% from $92.2 million in the third quarter last year to $70.9 million in the third quarter this year.

The company’s gross margin increased 5% in dollar terms to $32.4 million in the third quarter of fiscal 2009 from $30.9 million in the third quarter of fiscal 2008. As a percentage of revenue, gross margin increased to 14% in the third quarter of fiscal 2009 from 12.9% in the third quarter of fiscal 2008. As Joe outlined, this improvement in gross margin percentage was primarily driven by benefits from our cost reduction initiatives and the addition of OCS and PTS.

However, as we move into our fourth quarter, it’s worth noting to our investors that over the last two years, our fourth quarter gross margin has been one to two percentage points below our third quarter on average due to work mix and seasonality.

Operating expenses decreased to $29.7 million from $30.9 million a year ago, an improvement of 3.7%. The lower operating expenses reflect a $7.1 million, or 24.3% reduction in SG&A. This significant reduction is primarily due to our ongoing cost reduction initiatives as Joe discussed earlier in the call.

Also included in operating expenses for the third quarter of fiscal 2009 were restructuring expenses of $6.4 million, which compares with $974,000 reported in the year-ago period. This increase reflects the significant cost reduction initiatives we have implemented in this year.

Our plans to cut costs and streamline our operations are ongoing and included reducing headcount, shutting and restructuring the facilities, and simplifying our service offerings. We continue to expect a total of $10 million to $12 million of restructuring costs for the second half of this fiscal year. Through these actions, we expect to reduce our overall cost by more than $20 million this fiscal year, net of restructuring charges, and by over $40 million on an annualized basis. We expect these efforts will position us for improved profitability when the economy returns to more normal conditions.

For the third quarter of fiscal 2009, the company recorded operating income of $2.7 million, a good improvement compared to operating income of $10,000 in the third quarter of fiscal 2008.

Other income declined by $1.3 million to a loss of $1.4 million in the third quarter of fiscal 2009, from a loss of $70,000 in the third quarter of fiscal 2008. This change resulted primarily from a decline in interest income from lower interest rates and a lower average cash balance compared to this time last year. It also includes a loss of $1.8 million related to the equity method of accounting in a small impairment charge related to an @Ventures related holding. This loss was partially offset by a gain of $2.6 million related to the sale of our interest in Food Buy, one of our @Venture portfolio holdings.

As our longer term shareholders know, liquidity events are hard to predict and shouldn’t be expected to recur in comparable quarters.

As a result of the above, the company’s pretax income for the third quarter of fiscal year 2009 was $1.3 million, versus a pretax loss of $60,000 in the third quarter of fiscal year 2008.

The company reported a tax expense of $3.2 million for the quarter, which is approximately the same as during the third quarter of fiscal 2008. We continue to evolve and drive our tax strategy to both support our business strategies and to maximize the use of our U.S. net operating loss carry-forwards.

With all of the above factors for the third quarter of fiscal 2009, ModusLink Global Solutions reported a net loss of $1.9 million, or $0.04 per share, compared to a net loss of $2.6 million, or $0.05 per share in the third quarter of fiscal 2008.

Non-GAAP operating income represents total operating income excluding net charges related to depreciation, restructuring, and amortization of intangibles, stock-based compensation, and non-cash charges. ModusLink's non-GAAP operating income for the third quarter of fiscal 2009 was $16.1 million versus non-GAAP operating income of $7.6 million for the same period in fiscal 2008, an increase of 112.5% as a result of all the factors mentioned earlier.

The company believes that non-GAAP operating income or loss provides investors with a useful supplemental measure of the company’s operating performance by excluding the impact of non-cash charges and restructuring activities. Each of the excluded items was excluded because they may be considered to be of a non-operational or non-cash nature. Historically, the company has recorded significant impairment and restructuring charges. Non-GAAP operating income or loss does not have any standardized definition and therefore is unlikely to be comparable to similar measures presented by other reporting companies. Non-GAAP operating income and loss should not be evaluated in isolation of or as a substitute for the company’s financial results prepared in accordance with generally accepted accounting principles of the United States.

As of April 30, 2009, our balance sheet remains very strong. At April 30, 2009, we had working capital of approximately $236.7 million, compared with $238.7 million at July 31, 2008, and $217.4 million at January 31, 2009.

Included in working capital as of April 30, 2009 was cash, cash equivalents, and marketable securities totaling $167.8 million compared to cash, cash equivalents and marketable securities totaling $135.7 million at January 31, 2009, and $162.1 million at July 31, 2008. We continue to have no outstanding bank debt.

As Joe mentioned, given the economic uncertainty, we have focused on reducing expenses and maintaining the strength of our balance sheet. As a result of our efforts, we continued to generate cash during the third quarter with free cash flow from operations of $16 million. In addition to the free cash flow from operations, an @Ventures related liquidity event generated another $16.7 million of cash.

Looking forward, we expect to continue to generate positive free cash flow from operations in the fourth quarter.

Overall, ModusLink increased its cash position by $32.1 million in the third quarter, primarily driven by the factors described earlier. With more than $167 million in cash and no debt, we continue to be supported by a strong balance sheet which is an important asset in a market where financial strength and liquidity are key competitive differentiators.

With our cost reduction initiatives taking effect, we believe that we are in an improved position to repurchase ModusLink shares while maintaining the strength of our balance sheet. Therefore, ModusLink's board of directors has authorized a repurchase of up to $15 million of the company’s common stock from time to time over the next 12 months. While we believe there is still a significant amount of uncertainty in the market, we also believe that shares of ModusLink are a very attractive investment for the company and the repurchase plan reflects management’s commitment to increasing value for our shareholders.

Looking forward to the fourth quarter, as Joe noted, we expect a difficult economic environment will continue to impact our revenues from existing engagements. Also, we expect that new business revenue in the fourth quarter will be strong but below the unusually high new business revenue reported in the fourth quarter of the prior year. Given these current views, we expect that revenues for the fourth quarter of 2009 will be down from the fourth quarter of 2008 but similar to revenues that we are reporting today for the third quarter of 2009.

Overall, we are encouraged with revenue growth from new engagements, which we continue to expect to be higher fiscal 2009 over fiscal 2008. Continuing to add new business and reduce expenses while maintaining a strong balance sheet will enable us to benefit as the market environment improves.

I will now turn it back to Joe.

Joseph C. Lawler 

So in summary, we are encouraged with the progress reflected in our third quarter results, although we continue to be very cautious in this economy. We expect the difficult economic environment to persist over the coming quarters, which translates into lower unit volumes moving through the supply chain, relative to last year, and clients delaying decisions regarding new programs.

Despite the difficult environment, we are seeing revenue growth from new engagements as customers continue to seek opportunities to drive cost reduction and efficiencies in their supply chain. Our initiatives to right-size our operations have resulted in a positive impact on gross margin and SG&A costs in the third quarter.

We are focusing on maintaining the strength of our balance sheet and generating cash, and importantly, as we manage through the economic challenges, we are continuing to execute our long-term strategy. Especially in markets like these, clients require innovative solutions, exceptional client service, and a financially strong partner, all qualities that differentiate ModusLink in the marketplace.

With that said, I look forward to speaking with you again on our next earnings call. Now Steve and I are happy to answer any questions you may have. So Lamont, if you could open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ryan [Gaines] with Springhouse.

Ryan Gaines - Springhouse

Can you talk a little bit about gross margins? I understand your comments about the fourth quarter possibly getting a little bit softer but as you look out into the new year, where could you see gross margins going? Obviously the cost cuts have been pretty impressive and you ran 14%. I just wanted to see what you think kind of longer term.

Joseph C. Lawler 

We continue to be focused on that sort of 12% to 14% range that we have been talking about for quite some time. We think that’s a competitive gross margin level that allows us to select and win the kinds of business that we feel is going to be appropriate to drive the other metrics that we’ve talked about, operating income, for example, revenue growth as markets recover. And I think the 12% to 14% continues to be our target range. We are very pleased with the progress that we’ve made so far and we’ll continue to push on that.

Ryan Gaines - Springhouse

Okay, and then just a couple more -- new business opportunities, another strong quarter -- Joe, do you feel like that’s more people who are new to outsourcing, or are you taking from other outsourcers who maybe are having difficult times? Can you talk a little bit about that?

Joseph C. Lawler 

Yes, I really feel that we are seeing both. I am pleased with the number of new logos that we are getting, so clients that have not been outsourcing with us and some that have been in-sourcing and are starting to move to an outsourcing model.

I’d say the biggest issue and concern that I have on the new business front is really just that the slow-down in making decisions, a lot of clients, because of the volume reductions, because of the changes in transportation costs, it affects the economic model associated with supply chain outsourcing and that has caused a number of clients to just slow down their decision making until they can get a little more accuracy around the unit volume forecasts. But where we are seeing wins in the marketplace, I think we are winning it from current -- we are winning new business from current clients, we are winning new business from new logos as well. We will have on-boarded more new logos in fiscal ’09 than in any year prior.

Ryan Gaines - Springhouse

And then in terms of the @Ventures, was that an opportunistic sale on your part? Was it -- how did that come about? Just anymore color on that.

Steven G. Crane 

I think these are, as you know, that these tend to be very early stages in investments and they typically take several years to mature and come to fruition. So we don’t really have much control over these things. As we said, they happen. There’s no planning. It’s more opportunistically when they reach a certain maturity level and that’s exactly what happened here.

Ryan Gaines - Springhouse

And will we know which venture or which company was sold, or what happened?

Steven G. Crane 

It was a company called Food Buy that has been invested in by @Ventures several, several years ago.

Ryan Gaines - Springhouse

Okay. And then last question -- I don’t know if we spoke about it recently but the target used to be kind of 5% to 7% operating margins and obviously a lot has happened in the last six months but is that something you still think is a good framework or -- if you could just comment on that.

Joseph C. Lawler 

Yes, absolutely -- in fact, in my comments, when you go back and listen -- I don’t know if you were on for the full call but you can go back and listen to some of my comments, I did specifically mention that continues to be our absolute focus. We’d like to see a little bounce-back in base business volumes, which would help but getting the cost structure where we’ve got it with a little bit of base business volume up-tick, we remain confident that that 5% to 7% operating income is achievable.

Ryan Gaines - Springhouse

Let me just sneak one more in -- on the SG&A cost saves, it’s been real impressive. Do you feel like you are -- I know you reiterated the $40 million. Are you finding more than you thought when you set that up three to six months ago or is it kind of right on plan?

Joseph C. Lawler 

I’d say we’re right on plan, maybe slightly ahead, Brian. As we indicated, we did move from a $40 million to a more than $40 million comment in our recent couple of calls because as you get into these things, you do find opportunities. Things tend to build on themselves. Our team, our global team has been extraordinarily focused on cost reduction, both at the cost of sales line and in the SG&A line, so we’re on a journey here. It’s not just -- this isn’t a one-time event. We’re on a journey to keep pushing those costs to lower levels as best we can.

Ryan Gaines - Springhouse

Great. Thanks, guys, great quarter.

Operator

Your next question comes from the line of Larry Smith with Moduslink.

Larry Smith - Private Investor

Joe, Steve, are you there? I wish I was with ModusLink, I’d be making more than a private investor. The guy said with ModusLink. I have been on so many of these calls. I want to congratulate you. This is a great quarter. A couple of things -- you mentioned Cisco. That seems to be a new client. I was going to ask you if that is a new name and I wanted to ask you, Brian, the previous caller, mentioned Food Buy -- a couple of things I would like to ask. Is there any new developments in clean technology? One other thing -- do we benefit from the footprint in the emerging markets that seem to be really doing well these days? And do we have any analysts covering us? Thinking that we’re at 371 in cash and if you add the ad ventures investments, even at a very illiquid level, they are basically giving us no value for your ongoing business that seems to be getting better. But I’ll shut up and listen to you.

Joseph C. Lawler 

Okay, let me tick down through those, Larry. As far as Cisco is concerned, we have in the past talked about Linksys, which is a business acquired by Cisco back a few years ago and Linksys has been a good and important client for us. As we said before, it’s very difficult for us to publish the list of clients that we work with. I talk at a high level about 70% of our revenues comings with Fortune 500 clients but generally speaking, we are a partner behind the curtain executing their supply chains and not out there making announcements about what we do. In this particular instance, because Cisco wanted to talk about the environmentally focused activities within Linksys on packaging redesign and since we were the -- really the creator, the designer of that particular solution, they wanted to get out there and talk about it and so we were able to use their name in connection with that particular sustainability suite of solutions.

As far as clean tech is concerned, you know, clean tech’s like a lot of early stage investments has been hit pretty hard over the past six to nine months, as everything from oil costs and the focus has shifted frankly a little bit from clean tech to some other priorities. We think that will probably rebound in the quarters ahead. Food Buy was not in the clean tech fund. Our clean tech fund is really ad ventures five and Food Buy really sat outside of that particular fund, so there’s been little activity in the clean tech fund over the past couple of quarters.

As far as emerging market footprint, you can see in our releases that in Asia, our business continues to be strong. There are other emerging markets that our footprint does not extend into at the time being and that will probably remain the case until we see a couple of quarters of -- a couple more quarters of stability in the marketplaces, but we -- we like our position in Asia. We think there are opportunities to extend that. We like our position in Eastern Europe. We think there are opportunities to extend that and while we export a fair amount of business into South America, we don’t have a footprint that extends into that region at this time. We think those are opportunities for the future.

And what I think was your last question, the analyst coverage, we do not have formal analyst coverage at this point. I am sure many of you on the call have read recent articles about how even analysts are getting cut back, pulled back, fewer analysts covering fewer companies and I think we are very challenged to get our story out and our mission has been to control the things that we can control and as our metrics improve, we think there will be opportunities for coverage in the future but at this point in time, there’s nobody telling the story other than us through these types of opportunities and occasional conference calls and various institutional meetings that we do with investors.

Steve, anything you want to add on the analyst coverage side?

Steven G. Crane 

No, I think that you said it very well -- I mean, we do go out and we target sell-side analysts. We call on them. We hope to get them on board. We tell our story, so we are out there beating the bushes and doing what we can but as Joe said, it’s a tough environment, even for them.

Joseph C. Lawler 

Next question, Lamont.

Operator

Your next question comes from the line of Mark [Breuer] with ModusLink.

Mark Breuer - Private Investor

No, I do not have a question. I don’t know why the caller said that.

Joseph C. Lawler 

All right. Lamont, back to you -- any other questions?

Operator

Your next question comes from the line of Allan Young with [inaudible] Capital Management.

Allan Young - Analyst

Good afternoon. I just want to echo everyone’s sentiments -- great quarter. Great to see the gross margin move up. You talked about 110 basis points improvement due to cost reductions and acquisitions. Can you give us anymore detail as to how much came from what source and how the base business did in the quarter?

Joseph C. Lawler 

It’s a good question. Steve may want to chime in here. I think we can’t give you more than we’ve given you right now. There’s a combination of things that are going on in the third quarter and we are really not able to bridge those very specifically but let me just comment on them again.

Base business was soft in the quarter, and that really hurts margins. Base business tends to be the things that we run for -- you know, business that we’ve run for multiple quarters. It tends to be things we do very well and we generate a lot of margin from it. So our margin gets hurt when our base business drops.

The flip side is new business was strong -- that’s good and bad. When we start up new business, which was 18% of our revenues in the quarter versus 11% last year, that typically weights down the impact of our margin in the first quarter or two.

Third is the acquisitions -- the acquisitions, OCS and PTS acquisition tend to weight up our margins. We like the margins in those two businesses. While they were only $17 million in revenue in the quarter, they do tend to help our margins and are stronger than the base business.

Allan Young - Analyst

So you’re saying though, however, that the new business, as in the past, did weight down margins because of start-up costs and inefficiencies?

Joseph C. Lawler 

Yeah, new business typically in its first quarter when we started up, it tends to --

Allan Young - Analyst

Sure.

Joseph C. Lawler 

-- on-boarding costs, where we are just setting up production lines, assembly lines, and --

Allan Young - Analyst

Which makes sense, and we kept with that pattern. So we could see an increase going forward -- I guess what we are all trying to beat around the bush is sustainability of the gross margin number and we expect it to drop based on the guidance you’ve given us but just trying to get a sense of where we may go.

Joseph C. Lawler 

Yes.

Allan Young - Analyst

On the SG&A side, if I can jump to that, $22 million, is that a good number going forward?

Joseph C. Lawler 

You know, on just the SG&A number, there are some things that are probably going to come back a little bit for us in a normalized year. There are some wage freezes, issues that we’ve had to impose. There are certain incentive plan costs that aren’t going to get paid, certainly aren’t going to paid at the full levels. There probably is a little bit that would come back, so taking that at a straight four times, Allan, would be probably not the right level to be forecasting out in the near-term. But we’re pretty pleased with it for Q3.

Allan Young - Analyst

All right. I guess everyone talks about cutting costs, cutting costs, and then you do so and they say well, you cut too far and -- I’ll ask almost facetiously whether that’s the case and more specifically, have you given any thought to what size revenue base your current cost structure can service?

Joseph C. Lawler 

I think that’s a great question. As I mentioned maybe too briefly in my comments, I think that the things that we have done in the past two, three, four quarters around our lean sigma activities which are really to try to improve -- and I mean significantly improve productivity of our existing assembly lines -- has created capacity for us and the good news is it’s created capacity so that when volumes come back just a little bit, we’ll be able to do those within existing facilities and it’s also enabled us to take a little more cost out from a structural standpoint to shut down some facilities.

Net net, I can’t begin to give you a percentage right now but we’d love to see an up-tick in volumes. We believe that our reduced facility footprint will be able to accommodate pretty good unit increases over the next one to two years.

Allan Young - Analyst

Okay, well, sounds thoughtful. If I could ask about restructuring charges, we’ve had them for an awful lot of quarters -- just with this one, the $6.4 million, what amount of that was cash?

Steven G. Crane 

I think when you think about modeling that, I would say that 85% to 90% of it is going to be cash within the quarter that we take it or over the following quarter, and then the balance is going to be paid out over probably the next year. We actually go into detail on the quarter but we figure the severance related people costs will get paid out fairly quickly and then there’s some remaining lease obligations that get paid out over a period of time. But that ratio is about right.

Allan Young - Analyst

Can you just give me a sense of what remaining accrued restructuring reserve exists to be paid out, or be charged?

Steven G. Crane 

I don’t have it at the top of my head. It is in the queue and we’ll keep going and maybe if I find it, I’ll come back.

Allan Young - Analyst

All right, and then the next question is when are we done on the restructuring charges? I’d love to see that line go away.

Joseph C. Lawler 

We are right there with you, Allan. We would love to see it go away. In fact, as we came into our fiscal ’09, we had de minimis amounts of restructuring planned for the year. We felt that volumes that we would see would work well with the capacity that we had in place. Things changed dramatically and it’s now our intent that we come out of the fiscal year with the vast majority of restructuring behind us. We’ve always -- when I say vast majority, we believe there will always be a certain amount but we’ve always said a couple of million dollars, $2 million or $3 million, is sort of a reasonable expectation in a more normalized environment. So I think we’ve given you the number as to what we think the restructuring will be in the second half, you know what we spent in the third quarter, therefore you are going to know what we expect to spend in the fourth quarter and then we expect that to be minimal as we move into fiscal ’10.

Steven G. Crane 

Allan, let me come back on that question. I found the answer specifically. So the accrual for employee related expenses was about $7.7 million. We expect to have that completely done roughly over the next year, July 31, 2010. There’s about $6.7 million that will be spread out over a longer, the next three or four years.

Allan Young - Analyst

Okay. We are particularly interested in the new business, which I think is great. Was it a number of small firms, one large firm -- how concentrated was the revenue increase?

Joseph C. Lawler 

Widely spread.

Allan Young - Analyst

Great. Is it particularly seasonal or does it match the seasonality of your existing business?

Joseph C. Lawler 

I’d say it looks -- I guess fortunately and unfortunately, it looks pretty much like our normal business.

Allan Young - Analyst

All right. You mentioned new business revenues in this year will be greater than last year -- what -- remind me, what was it in the last year in dollar terms?

Steven G. Crane 

Last year was $110 million for the full year.

Allan Young - Analyst

And you are still working on new names, of course. Are there -- are you close on some? Can you give us a sense for the sales cycle, if you will? I know it’s a little longer but where do we stand in terms of new names [in the mix], if I could put it that way?

Joseph C. Lawler 

Unfortunately, it seems so I guess unhelpful when I tell you we had X number of new logos added but we expect that this year, we will add more new logos than we’ve added in prior years. We don’t tend to give those numbers out, Allan, and I can’t tell you specifically who they are but I will tell you that we are seeing more -- and since we work with large companies anyway, when we pick up a new business, it’s typically a large company. It’s a meaningful logo. It’s somebody that you would know and I am very pleased with the number of new logos that we are seeing in the pipeline.

Allan Young - Analyst

Okay. And just lastly, any additional color you can add on the acquisitions of OCS and PTS and how they are doing below the revenue line?

Joseph C. Lawler 

We are pleased with their performance. We are pleased with their performance. I would say more in the PTS, the after market services phase. We’re starting to gain some nice momentum in the cross-selling, up-selling area. We are pleased with the management team. We’ve got a terrific group of folks there. The core ModusLink people have started to integrate nicely with them. We’ve brought a number of good opportunities. Some of our new business that I’ve referred to has come as a result of the cross-sell, up-sell of after market services/repair type of capabilities and we are building a very nice pipeline in that space.

OCS tends to be more of a niche business, more of a [title] management niche business but we are very pleased with the margin and the performance of that business. It’s very consistent with what our acquisition model was.

Allan Young - Analyst

Okay. I appreciate the response and again, great quarter, love to see it. Thanks very much.

Operator

(Operator Instructions) Your next question comes from the line of Tom Price of [Halogen].

Tom Price - Halogen

Thanks for the question. I’m relatively new to the story, but could you please talk about the tax asset that you have on your balance sheet? And specifically the ways in which you can monetize that asset going forward into the out years?

Steven G. Crane 

We’ve got -- the big one is we’ve got a -- little bit over a $2 billion net operating loss carry-forward here in the U.S. and those are in existence up until the periods 2019 to about 2027, so we’ve got many years left to maximize the value of those. So one of the things that we do is when we are putting together our tax strategies globally always to support our business strategies and that’s the primary driver of those. Secondarily, if you will, is to really maximize the value of the U.S. NOL carry-forward, so we work with outside advisors and spend a lot of time on making sure that we do so.

Tom Price - Halogen

Because that’s in the U.S., has that focus been mostly on U.S. acquisitions that you might be able to do?

Steven G. Crane 

Yeah, it is and so when we look at it this way -- we think of it as okay, number one, to utilize them, let’s earn -- do it the old-fashioned way, which is earn as much money as we can in the U.S., so let’s do everything we can to generate revenues and income in the U.S. and we look at that, our acquisition strategy, through that prism and that’s -- you know, obviously that can really jump-start the returns that we get on our vested capital by bringing it into the U.S. and generating those kind of advantage savings.

So it is driving earnings here in the States through operations and then through the acquisitions is what we do.

Tom Price - Halogen

And a similar, just last question -- you said your returns on invested capital -- can you just tell me again what your ongoing maintenance CapEx is and how you think about capital spending going forward?

Steven G. Crane 

Our CapEx year-to-date is, or our CapEx for the first half of the year, we spent just under $7 million. There was a chunk of that that was -- the bulk of that was for maintenance CapEx, I would say. There was some CapEx in there that we put in there for operational efficiency improvements -- not a whole lot of expansion CapEx, so that’s one of the things that we are really keeping a tight lid on as we manage through these times. So as we look out into the future for this year, our expectation is the second half of the year, we are going to spend approximately the same amount of CapEx in ’09 as we did the first half.

Tom Price - Halogen

Okay, thanks.

Joseph C. Lawler 

Any other questions, Lamont?

Operator

(Operator Instructions)

Joseph C. Lawler 

Okay, Lamont, if we’re not showing anymore questions --

Operator

There are no further questions at this time.

Joseph C. Lawler 

Very good. We thank you all for your time today and we look forward to talking to you on the next earnings call. Thanks, Lamont.

Operator

And this concludes today’s conference call. You may now disconnect.

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Source: ModusLink Global Solutions F3Q09 (Qtr End 4/30/09) Earnings Call Transcript

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