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Executives

Cory Kinger

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

Sarang Vora - Janney Montgomery Scott LLC, Research Division

Systemax (SYX) Q2 2013 Earnings Call August 6, 2013 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to your Systemax Inc. Second Quarter 2013 Financial Results Conference. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Cory Kinger of Brainerd Communicators. Cory, please go ahead.

Cory Kinger

Thank you, Nova. Welcome to the Systemax Second 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 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 on 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. In the quarter, we have continued strong performance from our Industrial Products Group and made additional progress in a number of operating initiatives. However, our technology businesses and consolidated results remain unacceptable.

Our entire management team is focused on improving our performance and we continue to address the top line erosion and bottom line losses in our technology businesses. In this regard, while North American Technology performance remained weak in absolute terms, driven by 4 consumer channel results, we cut our second quarter adjusted operating loss in half from last year and we saw our best bottom line results since Q1 of 2012.

In our EMEA Technology business, our performance was disappointing across all of our markets. And while the overall market remains soft, we underperformed in several geographies, including United Kingdom. We are making substantial investments in transforming our EMEA Technology business to operate on a pan-European basis and lower its cost structure and losses even in the interim are not acceptable.

On a consolidated basis, we delivered improved gross margins, but clearly, we have more work to do to strengthen our overall performance and return to profitability and that is our primary focus.

Industrial products had another outstanding quarter as revenue was up 15%, outpacing the industry. Top line growth was broad-based across product and category lines as it continued its benefit from our strategy to expand our SKU count. We delivered improved profitability from an 80 basis point expansion of our adjusted operating margins, which was driven by efficiency gains at our New Jersey distribution center, as well as improved SG&A leverage.

We continue to execute on our growth strategy for industrial and recently launched a branded e-commerce marketplace. The launch of this new commission-based business is a significant and strategic initiative that allows us to further capitalize on our Global Industrial brand, expand our vendor and selling relationships and broaden the products we offer our customers.

At the time of today's call, these marketplace sellers are offering more than 27,000 SKUs, representing new categories such as educational tools, training materials, scientific supplies and office decor. We've been very pleased with the launch and its results so far.

The performance of our European Tech business was disappointing, as we recorded a revenue decline of 7% on a constant-currency basis in the quarter. We have implemented a number of initiatives in Europe, specifically investments in sales agents in United Kingdom, which are ramping slower than anticipated. We are currently undertaking actions to improve our sales performance, further drive operating efficiencies and optimize pricing.

Our European shared services facility has just starting operations and is now managing certain functions of our European businesses. We're pleased with our early results and given the expected benefits, our Board of Directors has approved the expansion of the support functions that this center will provide to certain of our European businesses beyond our initial plan. These additional back-office functions will be transitioned to the facility over the next 18 months and will further improve our operational efficiencies and lower our cost structure.

In North American Tech, total revenue declined 8% during the quarter. However, we improved product margins and cut our adjusted operating loss in half from the year-ago period as we continue to rightsize the business, improve our freight performance and take steps to drive operational efficiencies. North American B2B Tech revenue declined 1% for the quarter, a modest sequential improvement from the first quarter of 2013. Overall, the B2B demand environment remains relatively soft.

Consumer Technology revenue declined 15% in the quarter, reflecting our continued challenges in our consumer channels. While we believe our performance in the computer category once again outpaced the industry, overall, our Consumer Electronics business continues to lag the market. The improvements of our customer operations remains a continuing focus area for our management and we've closed 4 underperforming retail stores. We continually evaluate our retail store operations and we'll take additional actions if necessary to improve our performance. In addition, we recently launched the new mobility sites specifically designed to improve the expansion of smartphone shoppers and drive more traffic to our website.

In closing, we are seeing some positive results from our initiative to improve our business performance and as reflected in part, a modest gain we saw in our consolidated gross margin for the quarter. However, we're not satisfied with our financial results. And the proactive steps we have taken to drive operating efficiencies, reduce costs and strengthen sales efforts are ongoing. We're pursuing our growth strategy, which includes a number of opportunities in our B2B businesses and we continue to make prudent investments to strengthen our competitiveness. With a strong balance sheet and cash of $138 million, we remain well-positioned to continue to execute our strategic plan and drive our operating performance.

Thank you. And with that, I'll pass the call to Larry.

Lawrence P. Reinhold

Thank you, Richard. Turning first to our consolidated revenue. Second quarter 2013 consolidated sales were $805.8 million, a decline of 5.1% and off 5.0% on a constant-currency basis, compared to the second quarter of 2012. Sales for the quarter were led by continued growth in our B2B operations, which was more than offset by weakness in our consumer business.

Looking at our revenue by channel. Second quarter B2B channel sales were $527.6 million, an increase of 1.3% or 1.5% on a constant currency and same-store basis. Our sales in our consumer channels were $278.2 million, a decrease of 15.3% or 15.2% on a constant-currency basis.

Turning to our external financial reporting segments. The Industrial Products Group had a strong quarter, with revenue increasing 15.3% year-over-year to $118.6 million, with growth in both core and new product categories and from its Canadian operations. Gross profit dollars increased in the quarter and we delivered gross margin percent improvement as our new distribution center gained efficiencies, stocking additional SKUs, improving inventory turns and allowing us to expand our private label products into new lines.

We also drove additional improvements in our freight processes. The improved gross margins and operating cost efficiencies helped drive significant operating leverage as non-GAAP operating income improved 26% to $11.1 million. At the end of the quarter, Global Industrial SKUs totaled 784,000, up 8.3% sequentially and up 36% compared to last year.

Sales for our Technology Product segment, which includes both our European and North American operations, declined 8.0% to $685.8 million and 7.9% on a constant-currency basis, while non-GAAP operating loss was $7.9 million. Within our Technology Group, we're undertaking a number of restructuring efforts, including the expansion of our European shared services center, as well as the closure of several underperforming retail stores in North America. As such, during the second quarter, we incurred $2.7 million in special charges related to these activities and we anticipate that additional onetime exit severance and startup costs will aggregate between $19 million and $20 million during the second half of 2013 and through the end of 2014.

Looking at our Technology Group segment on a geographical basis. In Europe, revenue declined 7.4% in the quarter or 7.3% on a constant-currency basis. Our operations in France and Ireland delivered modest revenue growth in the quarter, which was offset by a slight decline in the U.K., our largest market, and larger declines in our smaller markets. Gross margins contracted due primarily to mix changes.

SG&A increased as reflected investments in new sales agents, which we have yet to leverage into traditional sales and gross profit, above the cost of these new agents. Operating margins declined, driven by the effect of reduced gross margin and incremental selling and administrative costs.

In North America, our Technology Products Group's revenue declined 8.2% for the quarter on a constant-currency basis and reflects a 12.6% decline in our consumer business and a 0.9% decline in our B2B operations. On the bottom line, we had our best performance in the past year, as we benefited from the progress of our operating initiatives and cut our adjusted operating loss in half from last year.

In retail, our total store count at June 30 was 39 reflecting the closure of an underperforming store in the Delaware during the quarter. In July, we closed 2 stores in Texas and we're closing 1 additional store in Chicago during August, which will bring our total store count to 36. We continue to evaluate each of our store locations and in the case of these most recent closings, made the decision to exit leases early.

From a product standpoint, results were soft across most product categories and in particular, in consumer electronics. We remain focused on improving our bottom line performance and we're continuing to capitalize on our efforts to optimize freight to manage SG&A.

Consolidated gross margin improved 60 basis points to 14.5% from 13.9% last year. Key drivers of the increase included the growth of our Industrial Products Group and the higher gross margin within this business unit; the performance of North American Technology, which benefited from improvements in product margin, freight performance and operational efficiencies; and improvement in freight margins on a consolidated basis. This was partially offset by declining margin performance in Europe.

Overall, SG&A reflects planned investments to support our strategic initiatives. And as a percentage of sales, SG&A increased by approximately 100 basis points over last year. The primary drivers of the SG&A increase were investments in the sales staff in Europe, which resulted in costs outpacing sales performance in the quarter. Within our North America Technology segment, reductions in operating expenses were offset by volume declines within the quarter leading to a slight decline in leverage.

Consolidated non-GAAP operating margin was a negative 0.3% compared to a positive 0.2% last year. Nonrecurring and recurring adjustments during the quarter were $4.6 million on a pretax basis, or $0.08 per diluted share on an after-tax basis, using a normalized tax rate of 35% for the quarter.

Non-GAAP operating results were a loss of $2.2 million compared to income of $1.6 million last year. Non-GAAP net income totaled a loss of $3.1 million or $0.08 per diluted share. GAAP operating results were a loss of $6.8 million compared to a loss of $2.0 million last year. GAAP net loss was $6.1 million or $0.16 per diluted share compared to $2.3 million or $0.06 per diluted share. As of June 30, our balance sheet included $347.2 million of working capital and $138.6 million cash. The current ratio at June 30, 2013, was 1.9:1 and total debt was $6.8 million.

With that, we'd like to open the call to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Anthony Lebiedzinski from Sidoti & Company.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Within the consumer channel, you have multiple segments: retail stores, consumer websites, call centers, TV shopping. Can you give us any set of color as to how sales were within each of those subsegments or just a little bit of color would be helpful?

Richard Leeds

Yes. Okay, Anthony, most of our consumer business, again, is in North America Tech. And there's really 3 pieces to that: Web; retail stores; and then we have the smaller TV shopping channels, which we talked about in the past. I would say, during the quarter, our same-store retail results were actually not too bad. Relatively speaking, our Web sales were a bit more challenged than the special channels. Again, that's a very small part of the business now and that business has sort of shifted to other places.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And as far as your retail store base, how many of your leases are coming up within the next 12 months or so, as far as where you could possibly close those at lease maturity rather than incurring these exit costs?

Lawrence P. Reinhold

It's a -- I won't get into the details of that, Anthony, we've -- our leases on retail stores generally, when you sign them, they run 5 to 10 years and there's a -- they have their maturities. And we're, again, as we said before, we're going to look at our retail store performance. And we made the decision on these 4 underperforming stores. And that's it.

Richard Leeds

This is Richard. I will say that we have been able to negotiate some better wins, as well, in this process.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And what are your thoughts on the sustainability of the gross margin improvement that you saw in the second quarter?

Richard Leeds

I don't know there's any really -- we're not aware of anything that's out there in the market that's going to dramatically change that. So I don't think we're aware of any significant new pricing pressure other than the fact that we operate most of our business in a very, very intensely competitive environment. And certainly, in the consumer business, we get into Q4 and that's a cyclical market. We have made some success. And we had a disruption in our private label business and our tech business a couple of years ago and we've made good progress in bringing that business back. And as that comes back, private label products carry a much higher inherent gross margin than branded products.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

And lastly, as far as vendor rebates, what are you seeing there lately from your vendors?

Richard Leeds

So I mean, it's relatively stable. Because if you want to think of it this way, it's almost on a percentage of purchases basis. So that remains relatively stable on that basis but we'd always like it to be higher.

Okay. If there's no other calls, we thank you, and look forward to talking to you next quarter. Bye.

Operator

One moment. Sir, we have a question. We have a question from the line of David Strasser of Janney Capital Markets.

Sarang Vora - Janney Montgomery Scott LLC, Research Division

This is Sarang for David Strasser. There have been press articles more recently about circuitcity.com up for sale. So I had like 2 questions related to that. Is it just the name that is up for sale, the domain, or it goes along with the database of customers that you acquired from Circuit City, the e-mail list and stuff like that? And my second question, which is more fundamental is, one of the reasons you acquired circuitcity.com was to build your company electronic business. How should we think of the -- like what is your strategy to rebuild this e-business after you part away from circuitcity.com?

Richard Leeds

Okay. Well, the first part of your question, related to the Circuit City, the price you've seen out related to Circuit City process, we did hire and engaged an outside firm, Hilco Streambank, to see if they could monetize these assets that we own. And we made the decision in Q4 last year to consolidate things under the TigerDirect brand, so that obviously opened up the opportunity to see if we could monetize these. There, you could certainly contact Hilco Streambank to look at the assets that they're -- how they're marketing, et cetera. But we'll see. They've got a time period that they're working with potential buyers on that and we'll see if anything significant comes out of that. With regards to our consumer business, overall, we're certainly looking into adding new categories. We have -- we've got a focused new merchant team that's focusing on new categories in both CE and other categories. And I think our hope to rebuild the consumer electronics business that we have is inherent on expanding our product offering.

Sarang Vora - Janney Montgomery Scott LLC, Research Division

Okay. It will be all under tigerdirect.com, though, right, going forward?

Richard Leeds

Well, we operate a number of brands. TigerDirect is certainly the largest brand and what we think is a primary brand. If we decide that -- we own other brands, if we decide we want to use another brand for a specific purpose and we think the business will benefit from it, then we will. But again, we made a decision that Tiger is our primary brand and I don't really see any change to that for the foreseeable future.

Operator

And at this time, we have no further questions in queue. I would like to turn the program back to you, sir, for closing comments.

Richard Leeds

Okay. Well, thank you very much for the call, and we look forward to speaking to you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect. Have a wonderful day.

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