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Executives

Joseph Lawler – Chairman, President and CEO

Steven Crane – Chief Financial Officer

ModusLink Global Solutions, Inc. (MLNK) F3Q10 (Qtr End 04/30/2010) Earnings Call June 8, 2010 5:00 PM ET

Operator

Hello. And welcome to the ModusLink Global Solutions Third Quarter 2010 Operating Results Conference Call. At the company’s request, this conference is being recorded. Please note that all lines will be in a listen-only mode until the question-and-answer portion of today’s conference call. (Operator Instructions)

Now, I will 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. Crane.

Steven Crane

Thank you, Tracy. Good afternoon, everyone. And thank you for joining us for ModusLink Global Solutions fiscal 2010 third quarter conference call. I’m Steve Crane, CFO and I’m joined today by Joe Lawler, Chairman, President and CEO.

In just a few moments, Joe will share his thoughts and 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’ll review in more detail our fiscal 2010 third quarter results, which we released earlier today. Before we start, I want to remind you this call is being broadcast as a live webcast from our website at www.moduslink.com.

Please also note that the information we’re 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’ll 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 measure 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 Investor section of our website.

I’d now like to turn this call over to Joe Lawler. After our formal remarks, we’ll be happy to take your questions. Joe?

Joseph Lawler

Thanks, Steve, and good afternoon. Overall, the third quarter was a difficult one for us. As we anticipated, financial results for the third quarter reflect lower revenue from new engagements compared with the third quarter of fiscal 2009, which was a record year for revenues from new business.

However, revenues for the third quarter were below our expectations as we continued to see the effects from the time it’s taking to start up new programs and bring them to the point they’re generating significant revenue. We also experienced lower than anticipated unit volumes from certain programs, caution from clients about building inventory levels in the supply chain and the effects of some client’s cost reduction programs.

That said, we are encouraged that over the past couple of quarters, we’ve seen signs of stabilization in our business. Revenues from base business in the third quarter were about flat, compared with the third quarter last year, which is much better than the year-over-year declines we experienced in five of the past six quarters.

And despite lower revenue in the quarter, we continue to generate positive free cash flow from operations with our reduced cost structure and ongoing cost management focus we have a strong cash generating business and have positioned ourselves to perform well in the future. Before handing the call back over to Steve for detailed financial review, there are a few additional observations regarding our operating results for the third quarter.

Starting with revenues, I’ll comment on both base business, which are programs we’ve been executing for 12 months or more and new business which are new programs we’ve been executing for less than 12 months.

Revenues from base business in the third quarter were approximately flat compared to last year and we saw higher unit volumes in some of our engagements which is encouraging. However, many of the products we handled are sold through retail stores and we continue to see clients being very cautious and waiting until there’s a clear demand signal before adding inventories to the supply chain.

We see this dynamic supported by data issued by the U.S. Department of Commerce, which indicates that the ratio of inventories to sales in the retail sector has trended lower, which is an indication that retail supply chains are leaner relative to sales at this stage of the economic recovery.

We’re very encouraged by the reported increase in consumer spending in the U.S. and we’re seeing the positive effects in some of our client’s engagements. An offset to that positive has been our client’s focus on less inventory and lower cost, which has negative near-term effects on our revenue.

For example, pricing pressure has been more significant than we’ve seen in recent quarters, especially surrounding the program renewal process. This requires us to remain focused on pricing our services at levels that meet our criteria for profitability while enabling clients to meet their cost objectives.

Another example is form factor change, which reduces the amount of materials in the consumer’s package or reduces the size of the package as a means to reduce supply chain cost. Over many years, we have earned a reputation for leadership in proactively addressing form factor changes.

Challenges surrounding inventories, pricing and form factor are normal in our business, but we are seeing them have more of an impact in the current environment as we move through the early stages of economic recovery.

Revenue from new business in the third quarter was expectedly lower than the same period in fiscal 2009 and was $16 million versus $44 million in last year’s Q3. It’s important to note that fiscal 2009 was a record year for revenues from new business for ModusLink.

As we’ve talked about on each of the last few calls, in the spring of 2009, when economic concerns were near their highest, clients began to delay their decisions to outsource or change suppliers until volumes stabilized. And we’ve been in the process of building back toward those higher levels of new business we saw last year.

In the meantime, the sales process and the process of on-boarding new engagements continue to be longer than we experienced before the economy sharply declined and therefore accurately forecasting revenues from new business has been particularly difficult.

We’re taking steps to accelerate the time to on-board new programs and expect new business to be a primary engine for our future revenue growth. For example, we’ve centralized on-boarding activities to a single functional area, streamlined processes to connect new programs into our global IT system and we centralized global planning so the process of data integrity, bill of material management and procurement management can be done consistently at a lower cost and in a more predictable process. While not all delays are in our control, these steps will overtime enable to us on-board new business faster and in a more predictable manner.

Gross margin for the third quarter was lower than in the third quarter of last year, primarily due to the lower revenue this quarter as well as higher costs related to on-boarding new engagements.

For the first nine months of this fiscal year gross margin percentage was 13%, which is the midpoint of our previously stated target operating range and represents good margin expansion, compared with 11.8% in the same nine-month period last year. In addition, we continue to manage expenses aggressively to maximize margin performance and generate free cash flow from operations.

I’ll make some additional comments about our progress driving new revenues and our ongoing strategy in a few minutes. But before I do, Steve will give you a more complete financial overview.

Steven Crane

Thanks, Joe. For the third quarter of fiscal 2010, ModusLink Global Solutions reported net revenue of $213.7 million, a decrease of 7.7%, compared to net revenue of $231.5 million for the same period one year ago. Base business revenue was $197.5 million, an increase of $9.4 million or 5%, compared to the third quarter of last year.

Within base business revenue, our contributions of $8.9 million from Tech for Less, which was acquired on December 4, 2009, even when excluding revenues from Tech for Less, base business revenues were relatively flat compared to the third quarter of last year.

Revenue from new engagements was $16.2 million, a decline of $27.2 million or 62.7%, when compared to the third quarter of last year. This was an expected decline and as a result of our client’s delayed decision-making that began in the spring and summer of 2009 and delayed start-up of new programs as Joe described. We expect the programs that are experiencing a delayed start-up to begin making a contribution to our revenue performance into the fiscal fourth quarter and into fiscal 2011.

Geographically, revenues in each of our primary regions were lower year-over-year due to lower revenues from new engagements, lower volume from some clients and the other factors we described today. Asia and Europe revenues were particularly affected. Revenue in Asia decreased 20% from $76.6 million to $61.3 million in the third quarter of fiscal 2010.

However, we have seen strength in some engagements in Asia, such as those related to notebook computers although that uplift has been somewhat offset by the performance of other programs in that region. Overall, the Asia market remains strong and we believe the outlook for our services remains strong.

Revenue in Europe decreased 8.5% from $70.9 million in the third quarter last year to $64.9 million in the third quarter this year. We are starting up several significant new engagements in Europe and are monitoring the economic climate in that region very closely.

Revenue in the Americas was lowered by 4.3% from $79.9 million to $76.4 million in the third quarter this year and was supported by strong volumes from a certain client.

ModusLink’s gross margin decreased 24.1% in dollar terms to $24.6 million or 11.5% of revenues in the third quarter of fiscal 2010 from $32.4 million or 14% of revenues in the third quarter of fiscal 2009.

Gross margin percentage for the quarter was lower primarily due to lower revenues in the quarter and costs related to the start-up of new engagements for which we expect to begin generating more meaningful revenue in upcoming quarters.

Operating expenses decreased to $23.3 million in the third quarter of fiscal 2010 from $29.7 million in the same quarter last year. The year ago quarter included restructuring expenses of $6.4 million, compared with $260,000 in the third quarter of this year.

The lower operating expenses also reflect a $565,000 or 2.6% reduction in SG&A, which primarily due to our ongoing cost reduction initiatives. Please note also that the prior year period did not include an operating cost related to Tech for Less which accounted for $1.8 million of the $23.3 million in operating expenses in the current year quarter.

Our restructuring expense was reduced just $260,000 in the third quarter. In line with our cost reduction initiatives, restructuring costs are substantially lower than in fiscal 2009. For the first nine months of fiscal 2010, restructuring charges were $425,000 compared with $13.5 million in the first nine months of fiscal 2009.

As we have noted in the past, in a normalized environment, our expectation is that annual restructuring expenses would be in the range of $2 million to $4 million. For the third quarter of fiscal 2010 and as a result of all of what I have discussed, the company reported operating income of $1.3 million compared to operating income of $2.7 million in the third quarter of fiscal 2009.

Other income or loss for the third quarter of 2010 was a loss of $1.4 million, which is comparable to the same quarter last year. Other income or loss for the third quarter of 2010 was primarily comprised of foreign exchange transaction losses of $1.3 million compared to losses of $2.2 million in the third quarter of 2009.

Other income or loss for the third quarter of 2009 included a $2.6 million gain related to the sale of an equity stake in the @Ventures portfolio, which is not repeated in the third quarter of fiscal 2010. The company recorded a tax expense of $942,000 for the quarter which was a significant improvement compared to tax expense of $3.2 million in the third quarter of fiscal 2009. We continue to evolve and drive our tax strategy to both support our business strategy and to maximize the use of our U.S. NOLs.

With all the above factors for the third quarter of fiscal 2010, ModusLink recorded a net loss of $3.4 million or $0.08 per share, compared to a net loss of $1.9 million or $0.04 per share in the third quarter of fiscal 2009. Third quarter fiscal 2010 results included a loss from discontinued operations of $2.3 million or $0.05 per share, compared to a loss of $68,000 for fiscal 2009.

This loss of $2.3 million was primarily due to updated sublease assumptions for a facility no longer being utilized for operations by the company. 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 fiscal 2010 was $8.3 million versus non-GAAP operating income of $16.1 million for the same period in fiscal 2009. The company believes that non-GAAP operating income or loss provides investors with 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’s 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. We continue to maintain a strong balance sheet. At April 30, 2010, the company had working capital of approximately $221.3 million, compared to $237 million at July 31, 2009 and $236.7 million at April 30, 2010.

Included in working capital, as of April 30, 2010, were cash, cash equivalents, short-term investments and marketable securities totaling $160.2 million compared to $179.2 million at July 31, 2009 and $167.8 million at April 30, 2009. The company has paid $29.6 million net of acquired cash for the acquisition of Tech for Less in December of 2009.

The company concluded the quarter with no outstanding bank debt. Regarding cash flow for the third quarter of fiscal 2010, free cash flow from operations was $535,000, compared to $16 million in the same period in 2009.

For the first nine months of fiscal 2010, free cash flow from operations was $27.2 million, compared to $12.3 million in the same period in 2009. As investors have been following us know, our fiscal second quarter which concluded at the end of January, tends to be our strongest for generating cash flow as we and our clients reduced inventories following the seasonally higher demand around the holidays.

As we have said in the past, given the normal seasonality in our business, we encourage our investors to look at our free cash flow on an annual basis. During the third quarter, we repurchased approximately $2.2 million worth of shares of ModusLink common stock.

Our repurchase program was for $15 million and at the end of the third quarter, we had reached the authorized amount. We are also announcing that ModusLink’s Board of Directors has authorized the repurchase of up to $10 million of the company’s common stock in a new program from time to time over the next 18 months.

We continue to view ModusLink shares as a strong investment for our company. Looking forward, based on current forecasts from our clients and expected contributions from new client engagements, we continue to expect a sequential improvement in revenue for the fourth quarter of fiscal 2010 compared to the third quarter of fiscal 2010.

In addition, we continue to expect to generate positive free cash flow from operations for the full fiscal year 2010 at a level similar to fiscal year 2009. Thank you and I’ll now turn it back to Joe.

Joseph Lawler

Thanks, Steve. Looking forward, we remain confident that we have the right strategy in place to achieve long-term growth and increased shareholder value. As we talked about during previous calls, our priorities are centered on generating revenue growth from base business and driving new client engagements. I’ll make a few more comments on how we’re executing each of these priorities.

We have been very successful building and maintaining a strong customer base comprised of the leaders in technology in consumer electronics and mainly Fortune 1000 companies. We see significant opportunity to increase revenue and market share by winning new engagements from our client base and in particular by managing elements of our client’s supply chain that are currently insourced.

Providing the highest level of client services has been a key part of developing our client base. Client retention has been very strong and client satisfaction has never been higher. Lowering our client’s costs, shortening the time to market and reliably executing highly innovative solutions continues to set us apart from competitors.

We are very proud of the information just released last week that 11 of the Top 25 companies featured in industry analyst firm AMR’s 2010 report of the top performing supply chains are ModusLink clients which is improvement compared to the strong result in last year’s report.

Regarding new business, both the level of new business actually sold and the pipeline of opportunities remains strong. Many of our new engagements are in e-business and aftermarket services which are compelling opportunities for higher growth and improved margin and we expect to grow our business in those areas faster than the growth of our traditional supply chain services.

We are also adding new engagements for our optimized configuration solutions. For example, we are now working with Logitech, a worldwide leader in personal peripherals, to manage their supply chain in the AMEA region for a new product launch.

ModusLink will execute a postponement strategy and other process improvements for Logitech and will package a new mouse and webcam products later in the supply chain to help them reduce costs, keep inventories under control and react quickly to changing demand.

Our proven methodologies and global footprint were essential for being awarded this business from a strong competitor. Also, we were recently awarded a significant three-year engagement with one of our largest clients and a leader in the computing industry.

ModusLink will work with them in supporting their operations in Chungching, one of the fastest growing cities in China. Our client required a partner that could provide continuity in supply, proven reliability and experience in a highly dynamic region.

For ModusLink, this is an excellent example of our strong customer service and value proposition positions us to grow as our clients expand their business. Acquisitions are an important component of our growth strategy and they open up opportunities to develop our business in higher growth and higher margin areas.

In fact, the acquisitions of PTS, OCS and Tech for Less expanded our capabilities and we’re generating good cross-sell and up-sell opportunities as a result. We will continue to consider acquisition opportunities that fit our business model and contribute to growth in revenue profitability.

Before we open the call to any questions, I’ll summarize why we remain enthusiastic about the future of ModusLink. First, we continue to have a compelling value proposition for outsource supply chain solutions and global execution translated into high client satisfaction and it’s positioning ModusLink as a leading source for forward and reverse logistic solutions.

Second, our pipeline of new opportunities is strong and new business recently closed will enable improving revenue trends for the future. Third, our previous cost reductions and ongoing cost management has resulted in strong cash flow over the past year and provides operating leverage for improved profitability in the future. And, fourth, we have a strong balance sheet that is not only a strategic differentiator but also a solid platform for future acquisitions and long-term growth.

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

Question-and-Answer Session

Operator

(Operator Instructions) Gentlemen, you have no questions. Are there any closing remarks?

Joseph Lawler

No. We appreciate those of you that listened in and I know there’s a number of folks on the webcast and thanks very much. We’re pleased to have this opportunity to update you and look forward to the next update on our Q4 call. Thanks very much, Tracy.

Operator

Thank you. And thank you for participating in today’s conference call. You may now disconnect.

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