Joseph Lawler - Executive Chairman, Chief Executive Officer, President, Chairman of Business Development Committee and Member of Technology Committee
Steven Crane - Chief Financial Officer and Principal Accounting Officer
ModusLink Global Solutions (MLNK) Q2 2011 Earnings Call March 7, 2011 5:00 PM ET
Hello, and welcome to the ModusLink Global Solutions Second Quarter Fiscal 2011 Conference Call. [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. Crane.
Thank you, Dawn. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions Fiscal 2011 Second 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 discuss our announcement of a special cash dividend to ModusLink stockholders, as well as 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 initial comments, I will review in more detail our fiscal 2011 second 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 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 and a discussion of our use of these measures 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. Before I turn to our second quarter earnings results, I want to start by saying that I'm pleased to announce that our board of directors has approved a one-time special cash dividend in order to directly return value to ModusLink stockholders. This is a special cash dividend of $40 million in aggregate or approximately $0.91 per share. We carefully evaluated our balance sheet, and given ModusLink's liquidity and long-term outlook, the board unanimously determined that it was appropriate to return a portion of the cash on hand to stockholders. This distribution reflects the confidence we have in ModusLink and its ability to generate cash flow on a long-term basis. ModusLink has a strong history of returning excess cash to our stockholders. Including today's special dividend, the company has returned nearly $100 million since fiscal 2008. The full details of this special dividend are available in a separate press release, which we issued earlier this afternoon.
We've also announced our financial results for the second quarter and I'll talk about the period's main drivers, then later in the call, I'll discuss ModusLink's go-forward plans. Revenue in the second quarter was slightly higher than our expectations. We saw improved volumes from certain client programs with our base business and we continue to grow revenue from new programs as a result of our sales and marketing initiatives. However, we continue to experience the headwinds we've described in recent quarters and our revenue mix in the second quarter was less profitable than we expected. Our results this quarter also include impairments charges, which we'll discuss in a moment.
We have a lot of work in progress to put ModusLink on a trajectory of sustained growth in revenue and profits, and today, I'll talk about many of the actions we're taking to get that done. Regarding revenue for the quarter, I'll start by discussing the revenue from new programs, which consists of client programs we've been executing for less than 12 months and then I'll go on to revenue from our base business, which consists of programs we've been executing for 12 months or more.
Revenue from new programs was up 71% and was at its highest level since the July 2009 quarter. This was primarily due to programs secured in prior quarters that were the direct result of our sales and marketing initiatives. We are winning new programs, and clients are recognizing the value of our outsourced supply chain solutions. We're encouraged by our progress as we work to build back to the record revenue from new programs that we achieved in fiscal 2009. We believe that level is needed to achieve sustainable growth and consolidated revenue. Our pipeline of opportunities continues to be robust and we expect revenue from new programs in fiscal 2011 to be significantly higher than the $80 million we achieved in fiscal 2010.
While we're pleased with our sales accomplishments to date, looking forward, we need more progress and at a faster rate for us to continue to achieve growth in fiscal 2012 and beyond. Later in the call, I'll come back to talk about some of the plans we've made and are currently implementing to further improve our pipeline and our ability to close and onboard new business at a faster rate.
Regarding revenue from base business, in recent quarters, we talked about headwinds related to pricing pressure and clients using fewer materials in their packaging and those factors have continued to impact our revenue and margins this quarter. Volumes for consumer technology and electronics products were mixed in the second quarter. Revenue from certain client programs grew both year-over-year and sequentially, while other programs continued to show softness. This was especially the case with certain clients in Asia. Revenue in Asia was lower by 9% year-over-year, primarily driven by work related to notebooks for several computer OEMs. ModusLink remains cautious about our near-term expectations for notebook volumes and is mindful of the significant influx of tablet computers that are attracting mind share in the marketplace. As the replacement cycle of notebook computers becomes extended, we expect that it will have a near-term effect on the notebook unit volumes we handle.
The lower than expected volumes in Asia impacted our revenue mix and gross margin for the second quarter. Gross margin was 10% of revenue and while this was an improvement from gross margin the first quarter, we'd expected greater improvement as we talked about at our last call. At the end of the first quarter, we were tracking toward the 12% to 14% gross margin rate for fiscal 2011, but based on second quarter results and forecasts from clients, we no longer believe that fiscal 2011 gross margin will reach the lower end of that range. However, we expect gross margin percentage for the second half of the year to be greater than what we reported in the first half of this fiscal year. Steve will talk about one-time events that reflected in the first half gross margin that we do not expect to be repeated.
Turning to operating expenses, we continue to effectively manage expenses in the second quarter. Total SG&A for the second quarter was 15% lower year-over-year due to cost reduction activities and lower costs related to the company's incentive plans. When executing cost reduction actions that affect our cost of goods and SG&A expense, we've been focused primarily on areas that will not impact the initial startup and ongoing execution of client programs. We're onboarding a significant number of new programs and, therefore, we decided to temporarily curtail certain cost reduction actions in order to maintain the momentum we're achieving at bringing new programs to the point of revenue generation. As these new programs are solidified, we'll re-evaluate cost reduction in these areas.
Also I want to comment on the non-cash impairment charges in our second quarter results, which relate to our ModusLink PTS and Tech for Less businesses. We have been disappointed with the performance of Tech for Less in recent months. The business has been experiencing intense competition for buying quality product, which has put significant pressure on our cost structure. Tech for Less has made changes in response to current market conditions by downsizing the operations including a reduction in staff of more than 25%, and we're taking action to evolve the way we buy, process and sell product in order to be more competitive and profitable. We've also made leadership changes at Tech for Less. We recently appointed David Riley, our Executive Vice President, Corporate Development, to the position of President of Tech for Less on an interim basis. David is a highly experienced financial and business professional having led successful restructuring initiatives and he knows Tech for Less intimately. An internal search is well underway for an experienced leader for Tech for Less.
ModusLink PTS, our repair business, is behind schedule for the first two quarters of the year due to slow start-up of new business and lower than projected margins on current business. In response to that, we've reduced cost in PTS including a 14% staff reduction in the first quarter of this fiscal year. Aftermarket Services is an attractive market in the Americas and we see significant opportunity by adding repair capabilities in Europe in the future. In the meantime, we are seeing a strong pickup in the second half of the year for new business within PTS and have added new clients. For example, we have a new client relationship with Flipswap, a leader in consumer electronics buyback programs. AT&T recently announced its partnership with Flipswap to bring a new wireless handset trade-in service to AT&T stores nationwide and we're pleased to be managing all returns, repair, e-waste disposal, promotional card fulfillment and contact center support for phones traded in through this program. Value recovery and e-waste management are fast growing trends within Aftermarket Services and we are well positioned as a turnkey partner for innovative companies like Flipswap.
Our e-Business operation is performing well, and we're adding clients from our current markets, as well as in new markets, such as retail and leisure products categories. The strength of ModusLink's financial transaction management engine, contact center support and fulfillment capabilities are enabling us to grow this business and we expect continued contributions to ModusLink's revenue and profitability in the future. Together, Aftermarket Services, which is comprised of Tech for Less and PTS and e-Business constitute less than 15% of ModusLink's total revenue, but are strategically important to us and are keys to our strategy of bringing the market an integrated value chain solution.
As we've noted in the past, approximately 1/3 of our clients are using multiple ModusLink solutions with several utilizing each of our supply-chain aftermarket and e-Business solutions. For example, the program with Flipswap that I just described will utilize ModusLink's Aftermarket Services and e-Business solution. Client engagements like these demonstrate our ability to effectively sell integrated solutions, support our ongoing strategy and provide us with confidence that we have a unique and powerful value proposition for clients. I'll make some additional comments about our plans to further improve our performance in a few minutes. But before I do, Steve will give you a more complete financial overview.
Thank you, Joe. For the second quarter of fiscal 2011, ModusLink Global Solutions reported net revenue of $234.2 million, a decrease of $1.3 million or 0.6% compared to net revenue of $235.5 million for the same period one year ago. Base business revenue was $205.2 million, a decrease of $13.3 million or 6.1% compared with the second quarter of last year. Within base business revenue, Tech for Less contributed $7.8 million compared with $4.8 million in the second quarter of 2010. Tech for Less was acquired on December 4, 2009, during the second quarter of fiscal 2010.
Revenue from new programs was $29 million, an increase of $12 million or 71% when compared to the second quarter of last year. As Joe noted, this expected increase was a result of new programs secured in previous quarters that are now generating revenue.
Geographically, revenue in the Americas increased 0.5% to $76.3 million, compared to $75.9 million in the same quarter of 2010. The startup of new programs has had a positive impact on our revenue in the Americas. Revenue in the Americas included revenue from ModusLink PTS, which was $7.2 million in the second quarter of fiscal 2011 and $9.2 million in the same quarter of fiscal 2010. This 22% decline reflects a decline in volumes partially offset by revenue from new programs. Revenue in Europe increased 2.6% to $78.1 million compared to $76.2 million in the same quarter last year, primarily due to the start-up of new programs.
Revenue in Asia decreased 8.8% to $62.8 million from $68.8 million in the second quarter of fiscal 2010. As Joe described, revenue in Asia was primarily affected by lower volumes from certain programs especially those that support notebook computers.
ModusLink's gross margin decreased to $23.4 million or 10% of revenue in the second quarter of fiscal 2011, from $31.5 million or 13.4% of revenue in the second quarter of fiscal 2010. Gross margin for the second quarter was lower primarily due to unfavorable revenue mix and pricing, as well as $1.9 million of inventory charges taken in the company's ModusLink PTS and Tech for Less operations. We believe those inventory charges are one-time events and will not be repeated.
Total SG&A for the second quarter of fiscal 2011 was $20.5 million, a 14 ½% decline compared to $23.9 million in the second quarter of the previous year. Approximately half of the improvement in SG&A expenses was due to cost reduction initiatives with the remainder due to lower cost related to the company's incentive plan. Regarding the impairment charges, as Joe described, ModusLink PTS and Tech for Less are currently performing below our expectations and below our projections used in the annual impairment analysis for those businesses. We've been making changes within these businesses to improve the performance, and during the second quarter, we determined that the fair value of these businesses is below the carrying value. As a result, we're recording impairment charges of $27.2 million, comprised of a $13.2 million goodwill impairment expense and a $14 million impairment of intangible assets. I must emphasize that these are non-cash charges and do not impact the company's cash balances, liquidity or ability to operate and service our clients.
Restructuring expense for the second quarter of fiscal 2011 was $411,000, primarily related to our cost reduction initiatives compared to a nominal amount in the second quarter of fiscal 2010. For the second quarter of fiscal 2011, as a result of the factors I just discussed, the company recorded an operating loss of $26.3 million compared to operating income of $6 million in the second quarter of fiscal 2010. Excluding net charges related to depreciation, amortization of intangible assets, share-based compensation restructuring and long-lived asset impairment, the company reported non-GAAP operating income of $8.1 million dollars for the second quarter of fiscal 2011 compared to $13.2 million for the same period in fiscal 2010.
Other expense for the second quarter of 2011 was $774,000 compared to an expense of $1.2 million in the second quarter of 2010. This decrease in expenses primarily due to lower losses associated with the company's @Ventures portfolio in this comp quarter compared to the prior year quarter. The company recorded a tax expense of $1.1 million for the quarter, an improvement of $1 million compared to the second quarter of fiscal 2010. We continue to evolve and drive our Tech strategy to both support our business strategy and to maximize the use of our U.S. net operating losses.
With all of the above factors impacting the second quarter of fiscal 2011, ModusLink recorded a net loss of $28.3 million or $0.65 per share compared to net income of $2.6 million or $0.06 per share in the second quarter of fiscal 2010.
Our balance sheet continues to be very strong. As of January 31, 2011, the company had working capital of approximately $226.3 million compared to $222.6 million at July 31, 2010, and $222.8 million at January 31, 2010. Included in working capital as of January 31, 2011, were cash, cash equivalents and marketable securities totaling $154.4 million compared to $161.6 million at July 31, 2010, and $164.3 million at January 31, 2010. The company concluded the quarter with no outstanding bank debt.
Turning to cash flow for the second quarter of fiscal 2011. Free cash flow from operations was $9.2 million compared to $29.5 million in the same period in 2010. As Joe mentioned, ModusLink also announced today that its board of directors has approved a one-time payment to stockholders through a special cash dividend. A special dividend of approximately $0.91 per share or $40 million in aggregate will be funded by cash on the company's balance sheet. This special dividend is payable on March 31, 2011 to stockholders of record as of March 17, 2011.
The $40 million distribution is inclusive of the amounts remaining under ModusLink's current authorized repurchase plan. As I said before, ModusLink maintains a strong balance sheet and after the dividend is paid, we still have sufficient cash to support ongoing business operations and execute our strategy for long-term growth.
This substantial cash dividend reflects the company's commitment to creating value for its shareholders. Following distribution of the special dividend, the company will have returned more than $96 million since the beginning of fiscal 2008, which includes both the special dividend and stock buyback programs. Since initiating its buyback programs in early fiscal 2008, the company has repurchased $56.7 million worth of ModusLink shares, reducing its total share outstanding by approximately 12%.
Looking forward, as we discussed last quarter to our fiscal 2011, the company expects that its clients will remain cautious about managing their supply chains given the general uncertainty surrounding consumer spending and the company expects to experience similar headwinds that have influenced its financial performance in recent quarters.
For the third quarter of fiscal 2011, the company expects a sequential decline in revenue compared with the second quarter of fiscal 2011, at a rate that is similar to the seasonal decline the company has experienced in recent years. The company is encouraged by the progress that it's making to increase revenue from new programs and expects that it will continue to show year-over-year improvement in revenue from new programs in the third quarter. Before I get into a brief discussion on our outlook for second half gross margin, let me re-emphasize our commitment to having this business generate a 12% to 14% gross margin on an annual basis. For several years, we have said that is our goal and we remain focused on achieving that goal. With that said, we expect our gross margin to continue to be impacted by the drivers that influenced our second quarter results. However, as Joe mentioned, we expect that gross margin percentage in the second half of this fiscal year will be higher than the first half with the improvement weighted towards the latter part of the fiscal year. Our expectation on gross margin for the second half is premised on three assumptions: First, we expect ModusLink PTS and Tech for Less to perform better in the second half versus the first half due to the management changes at Tech for Less and improved volumes at ModusLink PTS. Second, the inventory charges taken at those two companies of $1.9 million and the previously disclosed $4 million price concession taken in the first quarter are one-time events and will not be repeated in the second half. Third, based on our client forecast, we expect our Asia business to perform in a similar fashion to its first-half results. While our customer forecasts have historically been fairly accurate, there is risk that the volumes there will not materialize at levels projected, which could then impact the second half gross margin. Thank you, and I'll now turn it back to Joe.
Thanks, Steve. I'll spend a few minutes talking about the actions we are taking to put ModusLink on a trajectory of long-term growth. The first is improving the performance of our Aftermarket Services capability. We're taking decisive action to improve the performance of TFL and PTS, as I described earlier in the call. With strong leadership, improved processes surrounding buying, processing and selling product and improving cost structure, we expect these businesses to contribute to our profitability in the second half of the year. Second, we are effectively managing cost. As Steve noted, we achieved meaningful SG&A cost reduction in the second quarter and we're continuing to reduce expenses in many areas of our business through cost reduction programs and continuous improvement initiatives. Third, we are investing in sales and marketing and refining our go-to-market approach. We're making these investments in areas that will help increase our already strong new business pipeline. By the end of the fiscal year, we plan to increase our sales team in each region and for each of our supply chain aftermarket and e-Business solutions.
Earlier, I mentioned the level of volume we need to get to sustainable growth, and we expect these investments will enable us to grow our pipeline, get to the proposal stage faster and then close and onboard business more quickly and efficiently in line with our new business growth targets. Continuing to build a strong pipeline comprised of quality opportunities is important for both future revenue growth and margin improvement, and we're pleased with the progress we've made over the past several quarters. We're now applying the same continuous improvement methodologies that have successfully enhanced our operating efficiency to our sales teams to increase productivity and drive results. We will also continue to execute on the recent realignment of our sales organization. We're moving forward with a streamlined reporting structure for our sales force with dedicated teams for each of our primary solutions to enable a more targeted selling approach. In addition, we're re-doubling our efforts to add new programs from current clients. We work with some of the largest global brands in technology and consumer electronics, including eight of the top 10 PC manufacturers, four of the top five flash memory manufacturers and more generally, 10 of the top 50 global brands as recognized by Interbrand. We support only a small portion of their value chain processes and have excellent client satisfaction and a stable client base.
Based on our track record of execution and end solutions and a strong global footprint necessary to support large global brands, we have an excellent opportunity to increase share within our current client base. For example, you recently heard us talk about a program for Sony, where from our solution center in Brno in the Czech Republic, we’re executing a forward-supply chain program for Sony memory products in EMEA. We're pleased that we have expanded this program and will now be executing the supply chain program for Sony memory products in Asia as well. So in summary, we continue to make progress growing revenue from new programs. ModusLink has a unique and powerful value proposition for clients, and we are winning new programs. In addition, we're focused on implementing the necessary steps to improve the trajectory of the business and achieve sustainable revenue growth and profitability. Importantly, we've announced a special dividend as a means of directly returning value to stockholders, and we are committed to creating value for the long-term. 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 you may have. So Dawn, if you would open it up for questions.
[Operator Instructions] Your first question comes from the line of Vadim Perelman with Baker Street Capital.
Actually I have a couple of questions. First, with respect to the special dividend, what drove the decision to do it in the form of a dividend instead of a tender or buyback just given the tax consequences that are unfavorable?
The board really did evaluate all of those options available to it, and I think the company weighed the benefits of each one of those. It determined the special dividend was in the best interest of all of our stockholders including our 40-plus percent that is retail shareholders. We thought it was one of the most direct ways to return the value to shareholders and still maintain that financial and operational flexibility for us going forward. So it was all of those things that, I think, got us and the board to that conclusion.
But I guess given the valuation and tax consequences of doing a special dividend, it doesn't make much sense why you would do a taxable dividend relative to doing a tender looking at where the stock is trading relative to its intrinsic value. What else drove the decision?
Those were the factors affecting the decision. There's an analysis that needs to be done that's included in the release that will determine how much of the special dividend is 1099 div versus a return of capital. I mean that's not an analysis that can be done until the end of the fiscal year. So that also is a factor. But the board, with outside advisers and a special committee of the board, have evaluated this over the past several months and it was their conclusion and unanimously that’s supported by the board.
And in terms of cost opportunities, I guess, I heard you say that you're sort of suspending those cost reduction initiatives. Was that right?
Not quite. My point there was in the normal course of business, we drive continuous improvement initiatives across the entire company. It's in our D&A. We've talked a lot in past calls about what we do in terms of Kaizen events in individual facilities and then move those across all of our facilities. That continues to be a very important part of how we drive productivity improvements for us and for our clients. There are some cost initiatives, however, that it was our feeling that, while we had targeted some of them for the second quarter, it was our feeling that it would directly impact our ability to onboard new business and support some of the volumes of that new business in our facilities. Those are the ones that we've suspended because of good activity on the new business side.
Let's assume that you weren't thinking about new business. Can you sort of quantify what the cost opportunity would be if you just sort of serviced your existing revenue base? Is it sort of a $10 million run rate, $30 million run rate, how much more profitable could you be if you just thought about the existing customer and revenue base?
Our view is that existing customers’ programs atrophy over time, right? Programs come and then they go as product life cycles go away. So the idea of not augmenting existing business with new business, it does not result in a sustainable business model. The point in my comments today have been that two years ago, we had a strong level of new business which we reported at that time. Our feeling is that, that's the level of new business that's needed to achieve the kind of growth targets that we've talked about many times. Last year, we did half that level or about $80 million and that put a lot of downward pressure. We're seeing good momentum, good improvement in new business this year, but the focus is really on leveraging the existing and differentiated global platform and global capabilities that we've got. So the idea of just stopping to support our new business activity is not an option.
How do you feel about sort of the industry capacity issues, sort of widely believed that there's still significant overcapacity in the Logistics business. Are you still encountering that in your business? How do you see that relative to the cost structure of the business?
Yes, as we've talked about for several quarters now as we came out of the recession, there was a lot of additional capacity both with direct competitors and broadly in the logistics category as you talk about. And certainly that incremental capacity puts a certain amount of pricing pressure which we've talked about. It's always been a normal part of our business. We saw it spike up a little bit, a little bit more than we had seen in fiscal '10, seems to have returned to a normal level during fiscal '11. But it's always a part of our business. Something we've got to deal with and that's where we really focus our continuous improvement and productivity initiatives that has offset that direct impact. I think it's going to continue to be a factor and a troubling factor and so it's the other executional capabilities that we've got, where we really differentiate ourselves in a bidding process on a piece of work.
Okay, and I noticed on Friday there was a change to the bylaws. Can you just kind of highlight what that was and what drove it and why you're doing that?
I'd just refer you back to that specific release.
There were no details really in that release other than what actually happened. What was the rationale?
Why don't you just follow up and if you'll just forward an e-mail to us at Investor Relations, we'll get you the details to it.
I'm sure we'll be in touch. Thanks.
[Operator Instructions] And there are no further questions at this time.
Okay. Thanks very much, Dawn. Thank you, all. We appreciate the opportunity to review the business with you and look forward to speaking with you on the next quarter. Thank you, Dawn. You can conclude the call.
This concludes today's conference call. You may now disconnect.
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