Steven G. Crane - Chief Financial Officer and Principal Accounting Officer
Joseph C. Lawler - Chief Executive Officer, President, Executive Director, Chairman of Business Development Committee and Member of Technology Committee
ModusLink Global Solutions (MLNK) Q1 2012 Earnings Call December 5, 2011 5:00 PM ET
Ladies and gentlemen, thank you for standing by, and welcome to the ModusLink First Quarter Fiscal 2012 Investor Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Monday, December 5, 2011. Your speakers for today are Joseph Lawler, President and Chief Executive Officer; Steven Crane, Chief Financial Officer.
Mr. Crane, you may begin.
Steven G. Crane
Thank you, France. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions Fiscal 2012 First Quarter Conference Call. I'm Steve Crane, CFO, and I'm joined today by Joe Lawler, President and CEO.
In just a few moments, Joe will share his thoughts on the company's financial performance. After Joe's comments, I will review, in more detail, our fiscal 2012 first quarter results, which we released earlier today. Joe will then conclude our prepared remarks with an update on our strategic initiatives.
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 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's section of our website.
I'd now like to this call over to Joe Lawler. After our formal remarks, we'll be happy to take your questions. Joe?
Joseph C. Lawler
Thanks, Steve. Good afternoon, and thank you for joining us today. Before discussing our first quarter financial result and business strategy, I'd like to briefly discuss the announcement we made a few weeks ago that ModusLink's Board of Directors is undertaking a review of the strategic alternatives available to the company. We've taken concrete steps to put ModusLink on a trajectory of sustained growth in revenue and profits, including the ongoing execution of our investment and cost-reduction plan. As you'll hear today, we're pleased with the progress we're making executing our plan, and we have a positive view for our performance as a stand-alone entity.
That said, our board regularly evaluates our options to enhance stockholder value and the review its part of that commitment. The Board of Directors has retained Goldman Sachs as its financial adviser. And to facilitate this process, the board has formed a committee comprised solely of independent directors and led by Jeff Fenton to oversee the review and make associated recommendations to the full board. We will provide an update of this process after the board has completed its review and approved a definitive course of action.
In addition, we announced the separation of the Chairman and Chief Executive Officer roles at ModusLink as an enhancement to its governance structure. Frank Jules, who has been the company's presiding director, has been named nonexecutive Chairman of the Board. Frank has been a valuable member of our board, and I look forward to continuing to work with him and the rest of the board.
Turning now to our first quarter financial results and business strategy. There are 3 primary takeaways for our call today. First, we've seen a significant improvement of profitability. Gross profit margin increased to 12.6% of revenue, a significant increase from the same quarter last year reaching the highest level we've seen in nearly 2 years. The improvement compared to the same period last year was supported by a more favorable revenue mix that was driven by higher revenue in our Asia operations, as well as the effects of cost-reduction actions. These factors also contributed to reporting our first operating profit in 6 quarters.
Second, revenue in the first quarter was lower year-over-year as expected and seasonally higher compared to the fourth quarter of fiscal 2011. Our planned investments that we discussed in detail last quarter are specifically aimed at overcoming the pressures in the market and putting ModusLink on a path for sustainable revenue growth and improved profitability.
Third, we're making significant progress executing our cost-reduction plan, which we are phasing in as quickly as possible during fiscal 2012. We're pleased with the progress our management team and all employees are making executing our plan.
I will be talking in greater detail about this progress in all areas, including the appointment of a new leader of our sales and marketing team and several new client wins later in the call. But first, Steve will give you a more complete financial overview of our first quarter fiscal 2012 results.
Steven G. Crane
Thank you, Joe. For the first quarter of fiscal 2012, ModusLink Global Solutions reported net revenue of $206.2 million, a decrease of $30.2 million or 12.8% compared to net revenue of $236.4 million for the same period one year ago. Revenue from new programs was $14.5 million, a decrease of $14.2 million when compared to $28.7 million in the first quarter of last year. Our investments in sales and marketing are directly aimed at achieving much higher levels of revenue from new programs. As we have previously noted, we are aiming to get our annual new business revenues in the range of $150 million to $200 million per annum, a level we believe is required to achieve consolidated net revenue growth for ModusLink.
We achieved revenue from new programs within that range in fiscal 2009, and we are working back toward those levels. Base business revenue was $191.7 million, a decrease of $15.9 million or 7.6% compared to the first quarter of last year. The decline in revenue from Base business primarily reflects lower volumes from certain client programs, which had a particular effect in our operations in Europe and the Americas.
Geographically speaking, revenue in Europe decreased 26.1% to $57.5 million compared to $77.7 million in the same quarter last year. The decline in revenue was primarily due to a weak economic environment and, in particular, client experiencing significant volume declines for its products in Europe.
This client program in Europe contributed approximately $13.5 million to our first quarter fiscal 2011 revenue, and we expect our revenues in Europe to be negatively impacted during fiscal 2012.
Revenue in the Americas decreased 13.8% to $69.7 million compared to $80.8 million in the same quarter of fiscal 2011, primarily due to lower new business revenue and the elimination of a client program that no longer met our profitability criteria.
Revenue in Asia increased 5.9% to $60.9 million from $57.5 million in the first quarter of fiscal 2011. The revenue benefited from a modest increase in revenue from new programs and the fact that revenue in Asia for the first quarter of last year reflected a previously disclosed one-time $4 million price concession for a client, which is not present in the first quarter of this fiscal year.
Compared sequentially to the fourth quarter of fiscal 2011, revenues for the first quarter of fiscal 2012 increased 3.7%. The revenue increase was driven by seasonal factors and was within our historical range for seasonal revenue increase when comparing our fourth quarter to our first quarter, although at the low end of that range due to the revenue drivers I just discussed.
ModusLink's gross margin increased $26 million or 12.6% of revenue in the first quarter of fiscal 2012 from $22.4 million or 9.5% of revenue in the first quarter of fiscal 2011, a 310 basis point improvement. Gross margin percentage in the quarter was the highest that ModusLink has reported in nearly 2 years. The increase was driven by a favorable revenue mix with a higher percentage of revenue being derived from our operations in Asia and benefits of our cost-reduction actions, including a reduction in labor cost and the benefits of our continuous improvement initiatives. In addition, results for the first quarter of last year included the one-time price concession for a client that I just mentioned.
Compared sequentially, gross margin percentage for the first quarter of fiscal 2012 increased 370 basis points from 8.9% in the fourth quarter of fiscal 2011. The increase is driven by revenue mix, cost savings and lower charges related to inventory and severance cost.
Overall, we're pleased of the effects of the stabilization of our revenues in Asia and the impact our cost reductions had on our profitability.
Total SG&A for the first quarter of fiscal 2012 was $22.3 million, a 1.2% improvement compared to $22.6 million in the first quarter of the previous year. The improvement was due to a net reduction in labor cost, resulting from the company's cost reduction initiatives, as well as the receipt of $3.4 million escrowed funds related to the company's acquisition of Tech for Less in December of 2009.
Selling, general and administrative expenses for the first quarter of fiscal 2012 also included cost of $3.4 million for professional fees associated with the company's investment and cost reduction plan, which were not present in the year-ago period.
Restructuring expenses for the first quarter of fiscal 2012 were $0.8 million, which compared to the same number of $0.8 million in the first quarter of fiscal 2011.Restructuring expenses in the first quarter of fiscal 2012 related costs associated with the restructuring of facilities in the Americas and Asia.
For the first quarter of fiscal 2012, the company recorded operating income of $2.6 million compared to an operating loss of $2.7 million in the first quarter of fiscal 2011. The improvement was due to higher gross margin, lower amortization expense and lower selling, general and administrative cost compared to the year-ago period.
Excluding net charges related to depreciation, amortization of intangible assets, share-based compensation and restructuring, the company reported non-GAAP operating income of $8.3 million for the first quarter of fiscal 2012 compared to $4.7 million for the same period in fiscal 2011.
Other income for the first quarter of fiscal 2012 was $0.8 million compared to an expense of $2.7 million in the first quarter of fiscal 2011. The improvement was primarily the result of foreign exchange transaction gains recognized in the first quarter of fiscal 2012 compared to foreign exchange transaction losses in the first quarter of 2011.
The company recorded a tax expense of $1.9 million for the first quarter of fiscal 2012 compared to $1.3 million in the first quarter of fiscal 2011. We continue to evolve and drive our tax strategy to both support our business strategy and to maximize the use of our U.S. net operating losses.
With all the above factors impacting the first quarter of fiscal 2012, ModusLink recorded net income of $1.6 million or $0.04 per share compared to a net loss of $6.7 million or $0.15 per share for the same period in fiscal 2011.
We concluded the quarter with a very strong balance sheet. As of October 31, 2011, the company had working capital of $185.8 million compared to $184.2 million at July 31, 2011, and $224 million at October 31, 2010. Within working capital, accounts receivable and inventory increased by $59.9 million, and accounts payable increased by $49.6 million when compared to July 31, 2011, primarily as a result of a start-up of some new Sony business, which Joe will provide more detail on in his remarks.
Included in working capital as of October 31, 2011, were cash, cash equivalents and marketable securities totaling $111.7 million compared to $111.4 million at July 31, 2011, and $146.2 million at October 31, 2010.
In the third quarter of fiscal 2011, ModusLink paid a special cash dividend of $40 million in aggregate, which is funded by cash on the company's balance sheet. The company concluded the quarter with no outstanding bank debt.
Turning to cash flow, for the first quarter of fiscal 2012, free cash flow from operations was $3.5 million compared to a cash use of $17.5 million in the same period in 2011. Historically, our cash flow has been seasonal with the business typically using cash during the first fiscal quarter as ModusLink and its clients prepare for the holiday period. However, our improvement in profitability and client program mix supported our generation of free cash flow in the quarter.
Regarding our outlook for the second quarter of fiscal 2012, ModusLink continues to execute its investment and cost-reduction plan and remains cautious regarding the effects of the global economic environment on its business, especially in Europe. For the second quarter of fiscal 2012, the company expects a sequential decline in revenue compared to the first quarter of fiscal 2012 at a rate that is similar to the seasonal decline the company has experienced in the recent years.
I'll now take a moment to reiterate the expected effects of the investment and cost-reduction plan.
Our cost-reduction plans, including restructuring actions, are expected to result in approximately $30 million to $40 million in annualized cost savings. We expect approximately $15 million to $20 million of benefit for this fiscal year with full year savings expected in fiscal 2013. We expect the majority of the benefit to be in cost of goods sold with the remainder of the benefit in SG&A.
As we have previously said, in total, we're planning to reinvest and add approximately $15 million to fiscal 2012 operating expenses to support our initiatives. These investments will be concentrated in the areas of sales and marketing, with the balance in consulting and some one-time projects associated with the market penetration and cost-reduction activities. We are planning to reduce those expenses by $6 million in fiscal 2013 as those short duration elements of the investments conclude.
In addition, we continue to expect to incur in the range of $10 million to $15 million of restructuring and other one-time expenses associated with the cost-reduction plan in fiscal 2012. With the actions we are taking now, we firmly believe that we can achieve top line revenue growth and expect to see meaningful improvement in the operating profitability starting in fiscal 2013.
Thank you, and I'll now turn it back to Joe.
Joseph C. Lawler
Thanks, Steve. As mentioned earlier, we began fiscal 2012 having made significant progress executing our investment and cost-reduction plan. This plan, which -- as I noted earlier -- is being phased in during fiscal 2012, has 4 primary components.
First is cost reduction and alignment to enable significantly improved profitability as our sales and marketing initiatives gain traction. Second is sales acceleration and increased market penetration. We're making changes to become a more market-driven company, focused on the most attractive client programs. Third is working capital and free cash flow improvements. And fourth is strengthening our leadership team by putting the right leaders in place to drive improved result in all facets of our business.
Today, I'll provide an update on our progress in these areas and will start with the cost reduction and alignment initiative. We've been analyzing our infrastructure and processes to identify opportunities for further cost reduction. As Steve outlined, our ongoing cost-reduction actions positively affected our profitability in the first quarter and include the following:
First, improving labor costs. We've taken steps to improve labor cost and efficiencies across our facilities. Through actions taken in the first quarter, as well as those executed in the fourth quarter of last year, we've reduced headcount by approximately 6%.
Second is reducing facilities costs. We've taken actions to reduce our capacity in each of our regions including the Americas, Asia and Europe and expect more in the coming months.
Third, we're also expanding our shared services initiatives as part of our strategy to reduce labor cost through outsourcing non-core processes.
Fourth is our strategic sourcing activities. We're leveraging the purchasing power of our collective facilities across our global and regional network for purchases of services and commodity materials. We're taking action in the areas of staffing and labor, materials and freight, insurances, IT contracts, facility leases and travel services.
And fifth and importantly, continuous improvement initiatives that are executed in each of our facilities to improve operating efficiency and reduce cost continues to help drive an improved cost structure.
We expect to benefit from all of these cost alignment initiatives this year and in the years ahead.
In terms of sales acceleration, the macroeconomic environment has shown weakness, especially in Europe, as Steve described. This has been challenging for our clients, which in turn impacts ModusLink. Despite these challenges, we believe the long-term prospects for our market are very good. We believe companies will outsource more key processes within their supply chain to reduce cost and manage the increasing complexity that global companies face to serve their customers.
We are in a favorable competitive position given our global capability, our client base with opportunity for new programs and integrated solutions that include other high-value services such as Aftermarket and e-Business solutions.
As part of our investment plan, we've grown our sales team and are working hard to minimize their ramp-up time and maximize their near-term results. I remain pleased with the quality of our new hires, and we continue to see a good increase in activity as we build our sales pipeline. As we've talked about in prior quarters, this investment in new sales people is necessary to restore new business revenue to annual levels of $150 million to $200 million, a level of annual new business revenue that we believe is required to achieve consolidated net revenue growth for ModusLink.
As I noted last quarter, we're also combining sales and marketing under common leadership and have been working to bring aboard a highly experienced person to lead our sales and marketing organization. To that end, I'm pleased to have announced earlier today the appointment of Tom Nightingale to the ModusLink management team as President, Sales and Marketing. Tom comes to us from Con-way Inc., a $5 billion transportation and logistics company, where he was instrumental in growing the company's market share and profitability in creating an enterprise sales program. Tom has the right mix of industry experience and sales and marketing acumen that we believe will build on our market position, accelerate our plans for new business growth and increase stockholder value. Tom will officially start later this month, and I certainly look forward to working with him.
In the meantime, our team has stepped up its focus on sales force effectiveness and account planning to accelerate our ability to identify and close new programs in growth segments of our target markets. We've closed several new client wins recently with global brands, which exemplify the actions that I just described around improving sales targeting and account planning. For example, ModusLink has won its first ever program with a global consumer-products company. As a part of the new relationship, ModusLink will perform configuration and packaging of consumer products for retail sale in Western Europe. This program’s expected to contribute annualized revenue of approximately $60 million, making it our largest program win since before the recession. We expect to begin receiving revenue in the second half of the fiscal year.
ModusLink also won 2 new programs from Sony. ModusLink is now managing the full supply of all Sony's memory products to all of our regions, including North America, Europe and Asia. Our relationship with Sony and ability to manage their inventory were essential for securing the program. In addition, ModusLink is handling the product packaging for a soon-to-be-launched Sony PlayStation product in Europe and Asia. Sony has historically insourced many of its supply chain processes. And since we described our first Sony program with you about a year ago, we've grown the relationship to 5 programs today.
We also secured our first program with GoPro, one of the world's fastest-growing camera companies. GoPro has brought to market one of the most innovative and versatile cameras I've seen in a long time. ModusLink is GoPro's partner for e-Business, Aftermarket and Supply Chain solutions, utilizing solution centers in each of our 3 regions.
GoPro saw ModusLink as a partner that could provide them with the ability to scale their business globally, and we believe GoPro has exciting products capable of generating strong volumes in the future.
We're pleased with these recent successes and their ability to contribute revenue in the second half of the fiscal year and beyond.
So in summary, we look forward to continue progress executing our investment and cost-reduction plan. We saw a significant improvement in profitability in the quarter and remain on track to achieve $15 million to $20 million in benefits in fiscal 2012.
While reducing costs, we are also making investments in sales and marketing. The investments are specifically aimed at overcoming the pressures in the market and are focused on achieving higher levels of revenue from new programs to put ModusLink on a trajectory of growth.
We have a lot of work ahead of us, and we look forward to providing you with updates on our progress. And now Steve and I are happy to answer any questions you may have. So, France, if you would open it up for questions.
[Operator Instructions] Our first question is from the line of Sam Rebotsky from SER Asset Management.
I looked over the numbers as you were talking and -- what you filed in your 8-K, and it appears the $3.4 million that you benefited was the -- 100% profit. Could you sort of indicate what your expenses for that -- the cost of that program in the first quarter last year, what that was in total?
Steven G. Crane
Yes. If I could just expand on that a little bit.
Yes, go ahead.
Steven G. Crane
Yes, there were two 3.4 -- coincidentally two 3.4 numbers, one going in one direction, and one going in the other direction. The first $3.4 million was a receipt of some funds that we received from the release of an escrow account, which was associated with the acquisition of Tech for Less in December of 2009. So that had the effect of reducing sales SG&A cost. On the other side, we had $3.4 million of professional fees associated with the cost-reduction activities that we're doing because we've hired an outside firm to help us in that effort. So those 2 things did impact the P&L. One was positive one was negative.
But I assume the $3.4 million reduction expenses relative to the contract will not be repeated, while you will be expending more money, et cetera, going forward until you finished your costs. Or were there any other cost of that nature?
Steven G. Crane
Yes. Well, what we've said in terms of our guidance when we looked at FY '12 as we move into FY '13 is there's about a total of $6 million of kind of short-term duration cost associated with that cost-reduction activity, and that will occur in FY '12 that will not be repeated in FY '13.
Okay. And what was the amount of the increased expenses in the same quarter last year for the 150% that you were given to that one customer? What was that cost that increased your expenses?
Steven G. Crane
I'm sorry, I'm not sure...
In other words, your restructured [ph] the reduction of 150% to that one customer in the same quarter for the previous year, could you sort of relate that in dollars?
Joseph C. Lawler
It was a cost of goods. It was in gross margin not in the SG&A numbers of $4 million.
Steven G. Crane
Yes. This was the $4 million price concession, I think, is what you're referring to there. So we had $4 million. It hit both revenue and cost of goods, as well as our gross margin for the quarter last year and then was not repeated in this quarter.
Okay. So it was net additional expenses of $4 million, which it's not in this current quarter?
Steven G. Crane
That's correct. That's correct.
What is the cost of Goldman Sachs? What are you going to pay Goldman Sachs to do what they're doing for you?
Steven G. Crane
Yes. We actually haven't disclosed that at this point. But it's a traditional type of investment banking type deal and consulting with strategic advice attached to it. But we haven't gone public with that. So I can't...
When do you expect to make that? I mean with what's going on, it would be appropriate to state what it's going to cost, don't you think?
Joseph C. Lawler
Goldman Sachs has worked with us for quite a while, well over a year. They’ve been an adviser to us. The cost that you're asking about are not, in terms of the review of strategic alternatives at this time, are not material to our financial statements. When they complete and the board decides to report, as we said in here, when they decide to report on any definitive actions to the extent that there are any costs that are material to those definitive actions, once they decided on that, we would, of course, report at this point. But at this time, they're not significant.
Basically, it's positive that you're trying to improve everything. I'm going to make a general comment, I mean, the fact is it would be nice when you look at the 2010 and 2009 proxy statement, we see that management and Board of Directors has about 900,000 shares after the options compared to about 833,000 last year. And, Joe, I mean, your shares were a little lower. And I would make a suggestion, based on all the different events that are going on and with the staggered directors, I think in order to create greater shareholder value, I think management and everybody else should be more aggressive in purchasing shares in the open market. And the staggered directors also would give more positive ability for other people to get involved and be constructive because everybody, shareholders, et cetera, would like to see greater value. And in essence, even though you gave a cash dividend, my judgment is that it's better used by the corporation to maximize the tax loss carryforward. And with everybody having -- being in the same space with more shares, they would be in -- look forward to have the shares increase in value. But hopefully, the profits will improve so everybody will be happy.
Joseph C. Lawler
I appreciate those comments. I appreciate those comments.
[Operator Instructions] We have a follow-up question from the line of Sam Rebotsky.
I really, personally -- no, everybody should be on the same page because I think if your tax loss carryforward is close to $2 billion, I'm sure it's over $1 billion, that is the significance and utilization of cash to make this profitable. Everybody should be on the same page. And frankly, the -- it is appropriate that when you look of the proxy statement that the salaries and the incentive compensation came down, that's a positive thing. And hopefully, that you could do something. The real key is -- it's not necessarily Goldman Sachs. You've got to look at acquisitions. Are you looking at acquisitions to be able -- are you seeing acquisitions? Or what are you seeing?
Joseph C. Lawler
I appreciate those comments. We -- as I said in my opening remarks and we'll continue to say publicly, our board has looked at all -- I think virtually all strategic options over every year that I've been here. Virtually every board meeting, we look at a variety of options. We've executed acquisitions. We bought back stock. We paid special dividends. We've done a major merger of equals a bunch of years ago when we combined SalesLink and Modus Media. The board has been very active looking at a variety of things, and we've had outside advisers, as well as internal committees that have driven that process, and we'll continue to do it. We felt that in the face of a lack of the external pressures right now that we're just better off publicly announcing that we will very actively look at other strategic alternative process again, and that we'll have Jeff Fenton, an independent board member, oversee that, although the full board is involved. So I appreciate your comment. Yes, we're looking at every option that we can conceive of, both as a board and with our outside advisers.
Could you address why the board and the management, they presently own, after the options, 900,000 shares with 43,318,000 shares outstanding? It would seem appropriate, based on the value of what everybody thinks this company is, that a 10b5 plan to buy stock from everybody, considering the salaries, et cetera, that that's an appropriate way to show the outside shareholders that they believe in the company. What about that?
Joseph C. Lawler
We absolutely understand. The number that you're quoting, I don't have that number at my fingertips here, but management has bought stock. Management does get stock options in the business, and management has ownership of stocks through its own programs and...
I'm addressing for the proxy. I'm looking at the proxy that was just filed. And I'm looking where the current year 1,784,631 less 886,945 gives me 897,786, where the previous year the number was 1,849,574 and after the options was 833,480, where yourself, Joe, you had 438,368 after the options last year, and currently, it's 713 less 287,565 or 425,886. And basically, what I'm really suggesting to, sort of, set everything in motion properly because we're going to spend money on a proxy fight, which is not -- which shouldn't have to be done, and it seems better that everybody with the 10b5 plan, everybody could add to their stock positions and show that their pocketbook and everything is in the right direction.
Joseph C. Lawler
Sam, I understand. I understand. I don't have a copy of the proxy in front of me. We're really focused on the quarter's earnings results right now. But I understand your comment, and we absolutely -- not only am I encouraged to participate in our stock plans, we encourage the board and others to do so as well. Is there room for improvement, heck, yes. I appreciate your comments.
Management, there are no further questions at this time. I will turn the call back to you. You may continue with your presentation or closing remarks.
Joseph C. Lawler
Yes. Sam, I appreciate your -- both your comments and your questions there. And we thank all of you that had been on the call for your participation today. We look forward to talking to you again on our next earnings call. So thanks, France. You can complete the call.
You're welcome, sir. Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation and kindly ask that you, please, disconnect your lines. Have a great evening, everyone.