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Systemax (NYSE:SYX)

Q3 2013 Earnings Call

October 29, 2013 5:00 pm ET


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


Anthony C. Lebiedzinski - Sidoti & Company, LLC


Good day, ladies and gentlemen, and welcome to the Systemax Inc. Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, today's program is being recorded.

I would now like to introduce your host for today's program, Mr. Mike Smargiassi. Please go ahead, sir.

Michael Smargiassi

Thank you. Welcome to the Systemax Third 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 reoccurring and non-reoccurring 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 on the company's website and will be filed with the SEC in a Form 8-K. This call is a 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. The quarter was once again led by strong results from our Industrial Products Group, which delivered double-digit improvement on the top line and significant improvement on the bottom line. The performance of our technology business, both in Europe and North America, remain a key area of focus for our management team. While overall results remain disappointing, there are a number of bright spots in the quarter as we continue to make progress in our initiatives to improve our profitability and strengthen our long-term performance.

On a consolidated basis, we further expanded gross margins, driven by gains in both our Industrial Products and Technology Products segment. The Industrial Products Group delivered 14% revenue growth, a 160-basis-point expansion in adjusted operating margin and a 40% increase in adjusted operating income in the quarter. Top line growth remains broad-based as we continue to expand our product and category offerings, as well as our private label selection.

Our New Jersey distribution center, which opened last year, delivered the operational efficiencies we planned. The launch of Industrial's branded e-commerce marketplace is on track, and we're pleased with its initial success. We have a number of sellers up and running and have a solid pipeline of new sellers. Feedback has been very positive, with sellers highlighting the unique value we provide given our B2B market focus.

In our EMEA technology business, our results mirrored the second quarter as revenue declined 6% on a constant-currency basis. France delivered modest improvement in revenue and solid gross profit gains, and our Netherlands operation outperformed its local market. That said, all our other markets underperformed.

We have continued the conversion to a Pan-European operating structure with centralized leadership and a shared service center for our back-office functions, which will facilitate deeper business relationships with our multinational vendors and customers and more importantly, lower our cost structure. These investments are expected to significantly improve our operating performance. While these transformations are taking place, we'll be incurring additional costs due to the duplicative nature of the conversion.

In North American Technology, total revenue declined 13% during the quarter. However, we narrowed our adjusted operating loss from the year ago period as we made additional progress in our efforts to rightsize the business, including reducing our SG&A and improving our freight performance. North American B2B technology revenue declined 8% for the quarter primarily due to the impact of exiting the PC manufacturing business. We continue to make investments in our sales organization and expand our product offering, including a broader software selection, which we're supporting with a dedicated sales team.

Consumer technology revenue declined 16% on a same-store basis in the quarter. Our consumer performance continues to be challenged, especially online. We're moving aggressively to improve our results and are making progress on a number of fronts. We continue expanding the number of private label SKUs we offer and are seeing increased sales of these products.

On the Technology side, we're making investments to improve our back-end systems, which will enhance the functionality of our websites and allow us to more efficiently and quickly expand our SKU and category offerings. This has been a proven model of success in our Industrial Products Group, and we expect it to be successful in our Technology business as well. Finally, we are focused on strengthening our web and retail channels to maximize their performance during the upcoming holiday sales season.

In summary, we're not satisfied with our financial results and are taking proactive steps to improve our business performance. Our entire team remains focused on driving operating efficiencies, rightsizing our operations and executing on our sales and growth initiatives, with the goal of continued expansion of consolidated profitability and returning our technology businesses to the historical profitability levels. We continue to make investments in key areas of the business, which we believe enhances our long-term performance. Our balance sheet is very strong, with more than $173 million of cash. We are well positioned to execute on our strategic plan.

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

Lawrence P. Reinhold

Thank you, Richard. Turning first to our consolidated revenue. Third quarter 2013 total sales were $791.8 million, a decline of 6.5% and off 6.8% on a constant-currency basis compared to the third quarter of 2012.

Sales for the quarter were led by continued growth in our Industrial Products Group, which was more than offset by weakness in our technology businesses.

Looking at our revenue by channel. Third quarter B2B channel sales were $528.3 million, an increase of 0.2% or a decline of 0.5% on a constant-currency and same-store basis. Our consumer sales were $263.5 million, a decrease of 17.5% or 15.6% on a constant-currency and same-store basis.

Turning to our reporting segments. The Industrial Products Group had another strong quarter as revenue increased 13.9% year-over-year to $125.7 million, with growth across both core and new product categories. Gross profit increased in the quarter, and we delivered gross margin gains as we benefited from improving freight and warehouse efficiencies, driven by the distribution center we opened last year. These gains affirm our decision to invest in the expansion of our distribution infrastructure.

We gained efficiencies as we stocked additional SKUs, improved inventory turns and expanded our private label offering. This resulted in a significant improvement in operating leverage, with non-GAAP operating income growing 40% to $10.9 million. At the end of the quarter, Global industrial SKUs totaled $835,000, up 6.5% sequentially and up 36% compared to a year ago.

Sales for our Technology Products segment, which includes our European and North American operations, declined 9.6% to $665 million and 10.0% on a constant-currency basis. While non-GAAP operating loss was $3.5 million. Within our Technology Group, we've closed a number of underperforming retail stores and continued the expansion of our European shared services center. As such, during the third quarter, we incurred $5.6 million in special charges related to these activities.

Looking at our Technology Group segment on a geographical basis. In Europe, revenue declined 4.3% in the quarter or 6.1% on a constant-currency basis. Our operations in France, Netherlands and Ireland delivered modest revenue growth in the quarter, which was offset by a single-digit decline in the U.K. and double-digit declines in our smaller markets.

SG&A increases reflect investments in new sales agents, which have yet to leverage at the expected pace required to deliver enhanced profitability, as well as a temporary overlap in costs as we are transitioning functions to our shared service center. Operating margins declined driven by the top line sales decline and incremental SG&A and transition costs.

In North America, our Technology Products Group's revenue declined 12.5% for the quarter. This decline was primarily in our consumer channels, particularly online. The business benefited from numerous improvement initiatives and reduced its SG&A spending by more than 15%. This resulted in a decrease in its adjusted operating loss by over 20% despite the revenue decline.

In retail, our total store count at September 30 was 36, reflecting the closure of 2 stores in Texas and 1 store in Chicago during the quarter. While the review and evaluation of our store footprint is ongoing, as we enter the holiday sales season, we do not anticipate any additional store closures in 2013. From a product standpoint, results were soft across most product categories, specifically consumer electronics. We remain focused on continuing to improve our bottom line performance and capitalizing on our efforts to optimize freight and manage SG&A.

Consolidated gross margin improved to 14.9% from 14.0% last year. Key drivers of the increase included the growth of our Industrial Products Group and the higher gross margin within this business unit, as well as gross margin expansion in Europe, led by our operations in France. This margin expansion was partially offset by a small decline in gross margin in our North American technology segment.

Overall SG&A reflects planned investments to support our strategic initiatives, and as a percentage of sales, SG&A increased by approximately 60 basis points over last year. The primary drivers of the SG&A increase were investments in our European transformation and in sales agents in certain European locations, which resulted in costs outpacing sales performance in the quarter. In North America, we saw an improvement in our SG&A leverage in both our technology and industrial groups as we executed on both cost reduction and growth initiatives.

Consolidated non-GAAP operating margin doubled to 0.4% compared to 0.2% last year. Nonrecurring and recurring adjustments during the quarter were $6.8 million on a pretax basis or $0.12 per diluted share on an after-tax basis, using an assumed tax rate of 35% for the quarter. Non-GAAP operating income doubled to $3.0 million compared to $1.5 million last year. GAAP operating results were a loss of $3.8 million compared to a loss of $1.9 million last year. GAAP net loss was $11.6 million or $0.31 per diluted share compared to income of $14.0 million or $0.38 per diluted share in Q3 of 2012. As a reminder, last year's GAAP results included approximately $15.1 million of tax valuation allowance reversals, which positively impacted net income per diluted share by $0.41.

As of September 30, our balance sheet included $345.3 million of working capital and $173.3 million in cash. The current ratio at September 30, 2013, was 1.8:1, and total debt was $6.0 million.

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

Question-and-Answer Session


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

Anthony C. Lebiedzinski - Sidoti & Company, LLC

So first, on the e-commerce marketplace, just wondering if you could just say how much did that launch contribute to your results in the quarter. I'm not sure if you can share exact numbers, but if you could kind of give some high-level commentary on your expectations going forward for that, that would be great.

Richard Leeds

Anthony, it's Richard. The -- I'm assuming you're talking about the industrial marketplace.

Anthony C. Lebiedzinski - Sidoti & Company, LLC


Richard Leeds

Yes. So there -- that model is we book the commission. Okay, we're not booking the entire sale. So the numbers would be very, very small because of that. It's just the commission that gets booked.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay, okay. And then, how do you see that segment going forward? I mean, I know it's just off -- you just started that, but I mean, kind of your expectations for that for 2014 and beyond.

Richard Leeds

Yes. I mean, it's -- we're off to a slow start on purpose because we want to make sure that we get the service level right for both our sellers and for our customers. And so we're doing this very carefully, very planned. But I mean, I think it's a great business model as you could see from a number of people out there that are in the consumer business. And nobody has it, really, in the B2B place -- B2B marketplace yet. So I think it's going to work out really well for us over the long term.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And then switching gears to the technology segment. You mentioned in your press release that you're moving aggressively to improve results. You also mentioned private label. So could you first talk about the steps that you're actually taking. I know you also mentioned store closings, but other than that, what should we expect? And also, if you could just give a number for private label SKU penetration now.

Richard Leeds

Okay. So we're -- hopefully, somebody's looking up for the number on that. But the -- I mean, the strategy going forward is we want to concentrate on making money. And it's a -- we're in the business of doing many, many things right at the same time. I don't think -- there's not 1 magic bullet that's -- to fix our business. We have to do -- like I said, do many things right, and we have a long, long list of things that we need to correct and check them off as we do them. It's anywhere from expanding our product offering to making sure that we're buying the right quantity, to making sure that we're buying at the right price. And that's just a few items on a very long list.

Lawrence P. Reinhold

Anthony, it's Larry. I will -- I'll have to follow up with you on -- because I don't have it in the room with me, the number of private label products. But just recall, in all of our businesses, we sell products that we never touch, that we drop ship. We sell products that we source from domestic vendors, and then we have private label products that we bring ourselves from the manufacturing location. We -- in the -- particularly, in our tech business, the private label business, about 2 years ago, had a severe impact. I'm sure you recall. So it's come back from the depths of 2 years ago. We're solidly making our way back, adding products that we think are the right products to carry, and we have a solid pipeline of new products that we're working on bringing in, and we expect the business will continue to grow.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. That's helpful. And I know you've mentioned, in regards to your store base, that you expect to have 36 stores by the end of 2013. However, as you think about the business from a longer-term perspective, let's say, 2, 3 years from now, where would you see the number of stores that you would have?

Richard Leeds

I mean, that's a moving target. I mean, we're constantly reviewing the stores. So I don't really know if I have -- feel comfortable putting a number out there because times are changing, we're improving our operations in the stores daily. So I wouldn't really like to be out there with a number.

Lawrence P. Reinhold

Anthony, I think that the store count will depend on the store results. So we look at these things. We have a consumer business here in North America. A lot of it that's -- a lot of it's in retail. Certainly, we're in Q4, so we're aggressively promoting products in our stores, and we expect to do that on a go-forward basis. And if -- but if stores don't perform and we don't think they're going to perform in the long term, we'll do what that -- what it takes. Conversely, if we think we want to expand, we will look at expanding as well.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. That makes sense. And lastly, a question for you, Larry. As far as the -- and I may have missed this, but the source of the tax rate. I mean, you had a large tax provision in the quarter even with having a operating loss. So can you just explain that? And also, what should we expect for the fourth quarter and 2014?

Lawrence P. Reinhold

Okay. Well let's see. I don't know if we have enough time tonight to fully discuss it, but I'll...

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Maybe like the Reader's Digest version.

Lawrence P. Reinhold

Yes. So in a nutshell, what happens -- we're a multinational, and so we have operations in a lot of countries around the world. Some of those operations are profitable like, the most noted, our largest outside of the U.S. is in France. And in those areas that we have -- are profitable, we pay taxes. We've got other locations, other countries that we are not as profitable or we're losing money currently. And in some of those locations, we have a tax loss. But we -- because we've had losses for a couple of years that we are not permitted under GAAP to record a tax benefit. So when you consolidate it all together, you add up the tax provisions in these sort of profitable and taxpaying jurisdictions with no tax benefit in some of the -- not all of the, some of the tax jurisdictions where we're losing money, and therefore, you get a very messy effective tax rate. I can't give you exactly -- I'm not -- we don't give any forward guidance, but I will tell you that our Q4 tax provision, which is, at that point, it's for the full year and you kind of know the full year numbers. In the quarters throughout the year, you're making estimates of what you think will happen in the year and then sort of truing up year-to-date. So in Q4, I'm pretty sure that the tax rate will be very complicated and difficult to understand and probably relate very directly to our pretax income. But again, I think it will be a combination of what we just -- what I just tried to articulate. It wasn't very clear. Tax provisions in jurisdictions where we are profitable, tax losses in other ones and with no tax benefit.


[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.

Richard Leeds

Thank you, and we look forward to speaking to you next quarter.


Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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