Steven Crane – CFO
Joe Lawler – Chairman, President and CEO
Jeff Graf – Springhouse Capital
ModusLink Global Solutions, Inc. (MLNK) F4Q2010 Earnings Call Transcript September 28, 2010 5:00 PM ET
Good afternoon. My name is Dawn and I will be your conference operator today. At this time, I would like to welcome everyone to the ModusLink Global Solutions fourth quarter results conference call. (Operator instructions) Thank you. Mr. Steven Crane, Chief Financial Officer, you may begin your conference sir.
Thank you, Dawn. Good afternoon, everyone. And thank you for joining us for ModusLink Global Solutions fiscal 2010 fourth quarter and fiscal year 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 fourth quarter and year-end results, which we released earlier today. Before we start, I want to remind you this call is being broadcast as a live web cast 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 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 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?
Thank you, Steve, and good afternoon. I will begin with a few brief comments regarding our fourth quarter and fiscal year before we provide a more detailed overview.
First, in the fourth quarter ModusLink continued to feel the effects of a difficult economic environment. We saw lower unit volumes in certain client programs, and clients were focused on reducing costs and closely managing their inventories during this period. However, revenue for the fourth quarter was in line with our expectations, and we saw some positive signs in our business. In particular, we have seen a modest up tick in base business revenue compared to the fourth quarter of last year even before revenue contributions from our most recent acquisition, and we also made good progress securing new client engagements.
The fourth quarter also concluded a fiscal year in which continuing aggressive management of both expenses and working capital resulted in our achieving record free cash flow from operations. Before handing the call over to Steve for a detailed financial review, I will make a few additional observations regarding our operating results, starting with revenues. I will comment first on our base business, which consists of programs we have been executing for 12 months or more, and then I will go on to our new business, which consists of new programs we have been executing for less than 12 months.
Revenues from base business in the fourth quarter of fiscal 2010 were 9% higher year-over-year overall and 3% higher year-over-year when excluding revenues from our most recent acquisition. This up tick was primarily driven by modestly higher volumes. While we continue to see areas of improvement, it is not yet broad-based across our business. As we spoke about in detail last quarter, we see clients working to reduce costs in the supply chain and reluctant to build inventories.
We see many clients preferring to be out of stock on products versus having excess inventory in the supply chain, and we expect that trend to continue in the near term and reverse as the economy improves. We are also seeing continuing pressure on pricing, especially surrounding the program renewal process, and clients working with us to reduce form factor, which includes the number of inserts, accessory parts and packaging materials used with consumer products as part of their cost reduction programs.
As we talked about last quarter, 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. As we expected, revenues from new engagements were lower compared to the fourth quarter of 2009, which was a record year for revenues from new engagements.
You have heard us talk about our focus on building back to the record levels achieved in that fiscal 2009. We are seeing incremental improvement in the sales environment, although the sales cycle remains longer than before the economy rapidly declined. As expected, revenue from new engagements in the fourth quarter was significantly higher than we reported in the third quarter.
Gross margin for the fourth quarter was lower than what the reported during the same period last year. Primary drivers were revenue mix, pricing, the cost necessary for on-boarding new client programs, and an accrual adjustment that Steve will describe in a moment. Notably in the fourth quarter, revenues were lower in Asia, which is our most profitable region, primarily due to volume softness and pricing in certain clients’ programs.
For the full fiscal 2010 gross margin was higher than in fiscal 2009 and within our target range of 12% to 14% on an annual basis. We continue to closely manage expenses to maximize margin performance and generate free cash flow from operations. These efforts contributed to ModusLink reporting record free cash flow from operations for the full fiscal year.
We have a good cash generating business and have positioned ourselves to perform well in the future. Just before I turn the call over to Steve, I would like to briefly comment on the non-cash goodwill impairment charges in our fourth quarter results, which was required by accounting rules. Many of the economic challenges that we have been describing in recent quarters directly affect PTS, OCS and Tech for Less. The impact of current market conditions was a significant part of our assessment of goodwill for those businesses during the company’s normal annual review.
Notwithstanding these non-cash charges, these businesses are key components of our integrated solutions and long-term strategy. They provide the company with an appropriate mix of services and scale needed to position the company for improved profitability over the long term, as well as enhance our availability to take advantage of our sizeable NOLs.
I would like to make the point that these non-cash charges should not mask the fact that we are enthusiastic and committed to these businesses, and that the fundamentals of our company remain solid. I will 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.
Thank you, Joe. For the fourth quarter of fiscal 2010, ModusLink Global Solutions reported net revenue of $228.1 million, an increase of 1.3%, compared to net revenue of $225.2 million for the same period one year ago. Base business revenue was $202.1 million, an increase of $15.9 million or 8.5%, compared to the fourth quarter of last year.
Within base business revenue are contributions of $10 million from Tech for Less, which was acquired on December 4, 2009. When excluding revenues from Tech for Less, base business revenues increased 3.2% compared to the fourth quarter of last year.
Revenue from new engagements was $26 million, a decline of $13 million or 33.3% [ph], when compared to the fourth quarter of last year. This was an expected decline and it was a result of our client’s delayed decision-making that began in the spring and summer of 2009. However, revenue from new engagements were sequentially higher at 49.4% compared with the third quarter, which represents good progress as we continue our efforts to build back towards the higher levels of new business engagement we saw in fiscal 2009.
Geographically, revenues in the Americas increased 1% to $83.8 million compared to $83.7 million in the same quarter of 2009. Revenues in Europe were $69.5 million, relatively flat compared to $70 million in the same quarter last year. While we have seen volumes softness and price pressures in Europe, they have been almost fully offset by new business in that region in the quarter. Revenue in Asia decreased 10% from $63 million from $69.9 million in the fourth quarter of fiscal 2010, and was particularly affected by lower volumes from certain programs, pricing and other factors we describe today. We continue to feel optimistic about the opportunities we see in the Asia market, although we remain cautious about the direction of labor costs in that part of the world.
ModusLink’s gross margin decreased 17.7% in dollar terms to $24.4 million or 10.7% of revenues in the fourth quarter of fiscal 2010 from $29.7 million or 13.2% of revenues in the fourth quarter of fiscal 2009. there are many factors that impact the gross margin, and for some time we have been working hard to improve gross margins through cost reduction programs, and continuous improvement initiatives, which have had a very positive effect. However, on balance gross margin for the fourth quarter was lower primarily due to revenue mix, the cost necessary for on-board and new client programs, pricing, and an accrual related adjustment that I will talk about in a moment.
For the first quarter of fiscal 2011, we expect our gross margins to continue to be impacted by drivers such as revenue mix, the cost necessary for on board and new client programs, and pricing. For example, a price concession was made in the fourth quarter with a client that has a significant program with ModusLink. This will have an one-time impact of $4 million to revenue, gross margin and cash flow in the first quarter of fiscal 2011.
We have talked about challenges related to pricing as normal in our business, and this is particularly pronounced in the current economic environment, but we do expect this to improve as market conditions improve. As I just referenced, also affecting gross margin for the fourth quarter was an accrual adjustment related to bonus. Achievement of two of our annual three target metrics caused us to increase accrual in the fourth quarter of fiscal 2010, as compared to reversing what was accrued in the fourth quarter of the prior year, when none of the target metrics were achieved. This swing resulted in 90 basis points difference when comparing gross margin year-over-year. this also resulted in a $5.4 million difference when comparing SG&A expenses year-over-year for the fourth quarter, which is comprised of an expense of $3.3 million in the fourth quarter of fiscal 2010, and a credit of $2.1 in fiscal 2009.
For the full fiscal year 2010 gross margin percentage was 12.6%, an improvement from 12.1% reported in fiscal 2009 and within our target operating range of 12% to 14% on an annual basis.
Total selling, general and administrative costs excluding restructuring for a fourth quarter of fiscal 2010 was $24.6 million compared to $21.4 million in the fourth quarter of the previous year. Please note also that the prior year period did not include operating costs related to Tech for Less, which accounted for $1.9 million of the $24.6 million in SG&A expenses in the current year quarter. Excluding SG&A from Tech for Less and the effects of the bonus accrual in both periods, total SG&A would have been 17% lower year-over-year primarily due to our cost reduction and expense management activities.
Restructuring expense for the fourth quarter of fiscal 2010 was the credit of $1.9 million compared to an expense of $6.1 million in the fourth quarter of fiscal 2009. the credit was driven by the reversal of a restructuring charge accrued several years ago. 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.
Fourth quarter 2010 results also include goodwill impairment charges of $25.8 million, which Joe described earlier in the call. I must emphasize that these are non-cash charges and do not impact the company’s cash balances, liquidity, ability to operate and service our clients. For the fourth quarter of fiscal 2010 and as a result of what I discussed, the company recorded an operating loss of $25.8 million compared to operating income of $902,000 in the fourth quarter of fiscal 2009.
Other income for the fourth quarter of 2010 was $440,000 in the fourth quarter of 2010, compared to a loss of $4.9 million in the fourth quarter of 2009. Improvement of $5.3 million was driven primarily by a favorable impact from foreign exchange transactions and a reduction in losses associated with the @Ventures portfolio. The company recorded a tax expense of $165,000 for the quarter compared to $154,000 in the fourth quarter of fiscal 2009. Tax expense was again very low for the quarter. We continue to evolve and drive our tax strategy to both support our business strategy, and to maximize the use of our US NOLs. The positive effects of our tax strategy are very apparent when looking at our results on a full year basis. Tax expense was reduced by 52% from $10.8 million in fiscal 2009 to $5.2 million for fiscal 2010.
With all the above factors, for the fourth quarter of fiscal 2010 ModusLink reported a net loss of $25.5 million or $0.58 per share, compared to a net loss of $4.1 million or $0.09 per share in the fourth quarter of fiscal 2009. Our balance sheet continues to be very strong. At July 31, 2010, the company had working capital of approximately of $222.6 million compared to $237 million at July 31, 2009. included in working capital as of July 31, 2010 were cash, cash equivalents, short-term investments and marketable securities totaling $161.6 million compared to $179.2 million at July 31, 2009. The company concluded the quarter with no outstanding bank debt.
It is worth noting to our investors how important it is for ModusLink to have a strong balance sheet for business purposes. This is for two primary reasons. First, it is important to our large global clients that they have confidence in their mission-critical, day-to-day suppliers like ModusLink, especially when the markets are down. One key way to give them that confidence is to have a balance sheet that is unlevered and has a strong cash position. Second, ModusLink’s working capital requirements ramp up when the company onboards new projects. In the past, we have had annual working capital needs of up to $40 million for this purpose, and we expect to have similar requirements going forward as we sell more new business.
For these reasons I just outlined, ModusLink has a healthy financial profile that provides a competitive advantage and affords us the opportunity to act in the long-term interests of our company and shareholders. It is also worth noting that ModusLink has a significant presence in China, where it is a challenge to repatriate the funds. We can have up to $40 million of the company’s cash in China at any point in time, which we need to keep in mind as we think about the best ways to deploy our cash.
Free cash flow from operations for the fourth quarter of fiscal 2010 was $4.9 million, compared to $12.6 million in the same period in 2009. For the 2010 fiscal year, free cash flow from operations was $32.1 million, compared to $24.9 million in fiscal 2009, and a cash use of $31.8 million in fiscal 2008. $32.1 million of free cash flow from operations during a fiscal year is a record high for ModusLink. This level exceeded our expectations as a result of continuing aggressive management of expenses and working capital.
As investors that have been following us now, there is a degree of seasonality in our business, and in our fiscal first quarter we typically increase inventories as ModusLink and its clients prepare for the higher demand at the end of the calendar year holidays. As a result of this seasonal increase, we are typically a net cash user during our first fiscal quarter. As you know, putting cash to work through share repurchase has been a significant part of our effort to create value. During the fourth quarter, we repurchased approximately $2 million worth of shares of ModusLink common stock, as part of a previously announced $10 million stock buyback program.
This latest repurchase brings our total stock buyback investment to $55.3 million since we first initiated a stock buyback program in early fiscal 2008. in total, we have purchased $5.6 million shares of stock, which is about 12% of the fully diluted outstanding share count at the time we announced the first program. We remain committed to enhancing shareholder value and we view a balance of a share repurchase program, investing in the business and improving financial performance as the best means of creating long-term and lasting shareholder value.
Regarding our view of fiscal 2011, we expect that our clients will remain cautious about managing their supply chain and we expect to experience similar economic-related factors that influenced our financial performance over the past two quarters. With that as background, we expect revenue for the first quarter of fiscal 2011 to be similar to the fourth quarter of fiscal 2010.
Entering fiscal 2011, ModusLink is leaner and more efficient from a working capital perspective. As a result, we do not expect free cash flow from operations to duplicate the record level achieved in fiscal 2010. That said, we will continue to manage expenses and working capital, which in combination with our continuous improvement initiatives, should yield increased efficiency over time and enable us to compete effectively for years to come.
Thank you and I will now turn it back to Joe.
Thanks, Steve. Looking forward, we are focused on keeping our base business strong, increasing contributions from new engagements and effectively managing expenses. We have successfully built and maintained a strong customer base comprised of the leaders in technology and consumer electronics, and client satisfaction has consistently been high. Our success in this area is based on providing a very compelling value proposition, coupled with consistently strong execution.
Our existing client base is an important source of new programs and a driver for future growth. We plan to continue to deliver strong customer service and highly differentiated solutions to our clients. For example, earlier today I chaired a webinar on developing sustainable supply chain strategies with our client AMD, and the research firm Gartner Inc. AMD recognizes the value of innovative sustainable solutions, and referred to ModusLink’s sustainable packaged modeling tool and the benefit it gives them. Providing innovative solutions to clients such as AMD is a key part of our market strategy.
We expect new business to be a primary driver for future growth. Our sales efforts are focused on developing new programs from existing clients, as well as new logos. We expect that sales cycles will continue to be relatively long; especially as we target perspective clients that have historically insourced supply chain activities. However, our level of activity of developing the new business remains good, and we are pleased with the size and quality of opportunities in our pipeline.
For example, this month we started a new program for Sony, where from our solution centre in Brno, we will be executing a forward supply chain program for Sony memory products in EMEA. Sony previously managed these processes in-house, and ModusLink is achieving Sony Green Partner certification and meeting their high quality standards was essential for securing the business, and onboarding it efficiently.
As Steve mentioned, closely managing expenses continues to be a priority for us and we will continue to aggressively manage expenses in all areas of our organization. Our cost reduction actions and continuous improvement initiatives are focused on our objective to maximize profitability and cash flow. Taking a long-term view, we believe the prospects are very strong for ModusLink for several reasons.
First, we believe that more companies will outsource key components of their supply chain, reducing costs and effectively managing the increasing complexity that global companies face to reach customers around the world are primary drivers. We expect those drivers to increase in importance in the future. Second, we believe that the technology and consumer electronics markets will continue to be characterized by rapid product cycles and the necessity for faster and faster time to market.
As a global leader in outsourced supply chain services, we are competitively positioned to be the partner of choice for global technology brands, and we have the potential for entering additional growth markets in the future. Third, as evidenced through reporting record free cash flow from operations, we have a business model that can create value even during a difficult economic environment. And fourth, we are building aftermarket services and e-business solutions around our core supply chain business. They represent good opportunities for ModusLink, and have the potential to grow faster than our supply chain services.
Our aftermarket solutions manage the complete range of post sales activity for technology companies, including returns management, product repair and asset recovery, and our clients are seeing the value of an integrated solution. Through our e-business solutions, we provide clients with a comprehensive set of integrated solutions from web store development and hosting to customer support, financial transaction management, fulfillment and post sales services. This is a high-value solution that places us close to our clients’ customers, which is an important part of our strategy to increase revenue and margins.
Together, e-business and aftermarket services currently constitute less than 20% of ModusLink’s total revenue. We have developed these solutions both organically, as well as through acquisitions such as PTS, OCS and Tech for Less, which I discussed earlier. When we look at our client base, approximately one third of our clients are using multiple ModusLink solutions, with several using each of our supply chain aftermarket services in e-business solutions, which shows that clients value our integrated solutions and that we’re growing deeper into our clients’ business.
In summary, we are encouraged with the progress we made during the year. We expect to face challenges as we enter fiscal 2011, but we are well prepared to manage them and are supported by a strong balance sheet and strategic plan. With that said, I look forward to speaking with you again on our next earnings call, but now Steve and I are happy to answer any questions you may have.
So, Dawn, if you would open it up to questions for us.
(Operator instructions) Your first question comes from the line of Jeff Graf with Springhouse Capital.
Jeff Graf – Springhouse Capital
Hi, guys. I just had a follow-up question on the gross margin that you mentioned for the first quarter, next fiscal year you said that there was a one-time $4 million impact due to price concessions. Did I get that right, and can you describe why that is a one-time impact?
Hi, Jeff. That is a one-time impact, I will describe why it is. For that one we are pointing that out as, it was a one-time with a very significant client. It's $4 million as I said it will impact the revenue, the gross margin and then the cash flow during the quarter, but it's not going to be repeated that we see going forward. I don't know if that answers your question, I mean it was a one-time price concession.
Jeff Graf – Springhouse Capital
Right. Was there a new contract that was being signed and it was just an upfront concession?
It was Jeff. That's exactly right.
Jeff Graf – Springhouse Capital
What was the length of that contract?
Jeff Graf – Springhouse Capital
Okay. Okay, great. I think that is all I had. Thank you.
(Operator instructions) There are no further questions at this time. I would like to now turn the call over to management.
Okay. Thanks, Dawn. Thank you all. We appreciate your listening in and those on the web cast, I appreciate them listening in as well. We thank you for dialing in today. We look forward to talking to you on our next earnings call. You can close the call out now, Dawn. Thank you.
This concludes today's conference call. You may now disconnect.