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ModusLink Global Solutions (NASDAQ:MLNK)

Q2 2012 Earnings Call

March 07, 2012 5:00 pm ET

Executives

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

Thomas Nightingale - President - Sales and Marketing

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the ModusLink Second Quarter Fiscal 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded, Wednesday, March 7, 2012.

Our speakers for today are Mr. Joseph Lawler, President and Chief Executive Officer; and Steven Crane, Chief Financial Officer.

I would now like to turn conference over to Mr. Crane. Please go ahead, sir.

Steven G. Crane

Thank you, George. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions Fiscal 2012 Second Quarter Conference Call. I'm Steve Crane, CFO. And I'm joined today by Joe Lawler, President and CEO; and Tom Nightingale, President, Sales and Marketing. 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 second quarter results, which we released earlier today. Joe and Tom 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 Investors 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 C. Lawler

Thanks, Steve. Good afternoon, and thank you for joining us. I would also like to welcome Tom Nightingale to the call. Tom is traveling today, meeting with clients, so he is joining us remotely.

Before I discuss our quarterly results, I'd like to briefly comment on our strategic alternatives process. As you know, in November, we announced that our Board of Directors initiated a comprehensive review of the various strategic options available to the company to enhance stockholder value. The review is well underway. It would not be appropriate for us to comment further until our board has completed its review and approved a definitive course of action. So for today's call, we will only be taking questions regarding our quarterly results.

On this call, we'll focus our comments on 3 primary areas. First, revenue reflected expectedly lower volumes from certain client programs compared to the second quarter of last year and was also impacted by client-specific conditions and the continued challenging environment particularly in Europe. For example, 2 clients in the computing market experienced supply chain constraints, which primarily affected our operations in Asia. In addition, and as expected, our planned investments and one-time costs impacted profitability in the second quarter. Steve will provide a more detailed overview of our financial results in just a moment.

Second, we continue to execute on our investment and cost reduction plan that we're implementing throughout fiscal 2012, and we are on track to achieve our stated objectives of annualized savings of $30 million to $40 million. The ongoing execution of our cost reduction actions are aimed at improving our profitability, as the results of our investments in sales and marketing begin to take hold.

And third, the investments we've made in sales and marketing are gaining traction, and we are confident in their ability to improve our revenue trajectory. Today, our pipeline of sales opportunities is at its highest level since before the economic recession took hold in fiscal 2008. And new business sold in the first half but not yet contributing to revenue is ahead of the previous fiscal year.

In addition, we've combined sales and marketing under one leader, and we are excited that Tom Nightingale joined our team as President of Sales and Marketing in December. On today's call, Tom will comment on the pipeline and new business sold to date, as well as provide us perspective on the opportunities we see in the market and the actions we're taking to grow revenue.

Our financial results for the second quarter underscored the importance of these investments that are aimed at putting ModusLink on a path of sustained top line growth. The investments are focused on achieving higher levels of revenue from new programs in areas that present the greatest opportunity for growth and profitability. We're making very good progress, and Tom will update you on our actions later in the call.

Before we get to that, Steve will now give you a financial overview of our second quarter fiscal 2012 results, and I will return to provide further updates on our cost reduction actions. Steve?

Steven G. Crane

Thanks, Joe. For the second quarter of fiscal year 2012, ModusLink Global Solutions reported net revenue of $178.6 million, a decrease of $55.6 million or 23.7% compared to net revenue of $234.2 million for the same period one year ago. The decline in revenue was due to lower revenue from new programs, as well as challenging economic and client-specific conditions. Base business revenue was $164.4 million, a decrease of $40.8 million or 19.9% compared to the second quarter of last fiscal year.

I'll take a moment to talk about the primary revenue drivers by geography. Revenue in Asia decreased 18.2% to $51.4 million from $62.8 million in the second quarter of fiscal 2011. During the quarter, we saw 2 of our clients in the computing market experience supply constraints, such as the impact of the flooding in Thailand on the supply of hard disk drives. This impacted our operations in other regions, but primarily affected Asia and was acute in our results for the month of January. However, in February, we saw an uptick in volumes from those related client programs, which provides us with optimism that those issues are abating.

Revenue in Europe decreased 35.3% to $50.6 million compared to $78.1 million in the comparable period last year. The decline in revenue was primarily due to a particular client experiencing significant volume declines from one of their consumer electronics products we support in Europe, as we described last quarter.

The work that we've been doing is now being in-sourced as the client works to fill unused capacity in their factory. We expect fiscal 2012 revenue in Europe to be negatively impacted by this. However, during our last investor call, we talked about a large new client win, which we expect to contribute to revenue in our operations in Europe beginning in the second half of fiscal 2012, and we are onboard-ing that program now.

Revenue in the Americas decreased 21.8% to $59.6 million compared to $76.3 million in the same quarter of fiscal 2011, primarily due to the elimination of a client program that no longer met our profitability criteria, as we described last quarter, and a consumer electronics client that discontinued its product. Revenue from new programs was $14.1 million, a decrease of $14.9 million, compared to $29 million in the second quarter of last year.

Our investments in sales and marketing are directly aimed at achieving higher levels of revenue from new programs to drive increased total revenue. Tom will be providing an update on those actions in a moment.

ModusLink's gross margin was $16.1 million or 9% of revenue in the second quarter of fiscal 2012 compared to $23.4 million or 10% of revenue in the second quarter of fiscal 2011. The decrease in gross margin percentage was driven by lower revenue.

Total SG&A for the second quarter of fiscal 2012 was $24.6 million, an increase of $4.1 million compared to $20.5 million in the second quarter of the previous year. The increase in SG&A was primarily due to one-time cost associated with the contested 2011 annual meeting, as well as the planned one-time cost for consulting related to the company's investment in cost reduction plan. SG&A for the second quarter of fiscal 2012 also included investments in sales and marketing and other components of our stated investment plan.

Restructuring expenses for the second quarter of fiscal 2012 were $4.6 million, which compared to $0.4 million in the second quarter of fiscal 2011. Restructuring expenses in the second quarter of fiscal 2012 related to actions to reduce facility and employee costs associated with facilities in Ireland, France, the Netherlands, China and the U.S.

For the second quarter of fiscal 2012, the company reported an operating loss of $13.5 million compared to an operating loss of $26.3 million in the second quarter of fiscal 2011. Operating results for the second quarter of last fiscal year included non-cash goodwill and intangible asset impairment charges of $27.2 million.

Excluding net charges related to depreciation, amortization of intangible assets, impairment of goodwill and intangible assets, share-based compensation and restructuring, the company reported a non-GAAP operating loss of $4 million for the second quarter of fiscal 2012 compared to non-GAAP operating income of $8.1 million for the same period in fiscal 2011. Other income for the second quarter of fiscal 2012 was $0.6 million compared to an expense of $0.8 million in the second quarter of fiscal 2011. The improvement was primarily the result of foreign exchange transaction gains in the second quarter of fiscal 2012 compared to foreign exchange transaction losses in the second quarter of 2011.

The company recorded a tax expense of $0.4 million for the second quarter of fiscal 2012 compared to an expense of $1.1 million in the second 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. NOLs.

With all of the above factors impacting the second quarter of fiscal 2012, ModusLink recorded a net loss of $12.6 million or $0.29 per share compared to net loss of $28.3 million or $0.65 per share for the same period in fiscal 2011. We concluded the quarter with a strong balance sheet. As of January 31, 2012, the company had working capital of $169.8 million compared to $184.2 million at July 31, 2011, and $226.3 million at January 31, 2011.

Accounts receivable, inventory and accounts payable increased by $9.8 million, $17.6 million and $21.4 million, respectively, when compared to July 31, 2011, primarily as a result of the startup of a new program for our client, Sony, which we described in our investor call last quarter. Included in working capital as of January 31, 2012 were cash, cash equivalents and marketable securities totaling $95.8 million compared to $111.4 million at July 31, 2011, and $154.4 million at January 31, 2011.

As a reminder, in the third quarter of last fiscal year, ModusLink paid a special cash dividend of $40 million in aggregate, which was funded by cash on the company's balance sheet and represents the majority of the change in the year-over-year comparison. The company concluded the quarter with no outstanding bank debt.

Now turning to cash flow. For the second quarter of fiscal 2012, net cash used for operating activities was $10 million compared to cash flow from operating activities of $11.2 million in the same period in 2011. Cash used for operating activities in the second quarter of fiscal 2012 reflected a net loss reported during the period, as well as working capital requirements related to new business, some of which is in the process of being onboard-ed.

Looking forward, ModusLink has a cautious outlook based on the economic and client-specific conditions that its clients experienced in the second quarter of fiscal 2012. However, for the third quarter of fiscal 2012, the company expects revenue to be similar to revenue reported in the second quarter of fiscal 2012, despite the third quarter historically being seasonally lower on a sequential basis. The company's expectations for the third quarter assume the effects of supply constraints recently experienced by certain computing clients will begin to abate and revenue from new programs will improve on a sequential basis as a result of the company's sales and marketing activities.

I'll now take a moment to reiterate the expected effects of the investment and cost reduction plan. We continue to expect our cost reduction plans, including the restructuring actions, to result in approximately $30 million to $40 million in annualized cost savings. We expect approximately $15 million to $20 million of benefit for fiscal 2012, 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 growth 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're planning to reduce those expenses by $6 million at fiscal 2013, as the short duration of those elements of those 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. We estimate that cost reduction actions done in the first half, which are driven by headcount reductions, strategic sourcing activities and efficiency improvements, will have a total annualized benefit of approximately $15 million. However, the initial favorable impact so far have been offset by the recent revenue softness.

In addition, the expected annualized savings of the specific actions that were taken in the second quarter in France, Ireland, the Netherlands, China and the Americas are approximately $6 million. With that, we remain on track with our plans to reduce cost by $30 million to $40 million on an annualized basis relative to fiscal year 2011.

Thank you, and I'll now turn it back to Joe.

Joseph C. Lawler

Thanks, Steve. As mentioned earlier, we began fiscal 2012 focused on executing on our investment and cost reduction plan. We'll now provide you with an update on several key elements of the plan, including cost alignment, strengthening our leadership team and sales acceleration and increased market penetration.

On cost alignment, as we've talked about in recent quarters, our cost reduction actions are being implemented throughout fiscal 2012, and I'll cover several of these actions. The first is reducing facilities cost by better matching capacity with demand. We've reduced capacity in the U.S., France, Ireland and the Netherlands, and we've closed the facility in China, all to better align with current volumes.

We're making these reductions as quickly as we can without affecting the high level of service we provide to clients. We've also focused on ensuring that ModusLink has the right talent in the right locations, while making reductions to improve our cost structure. Through actions taken to reduce facilities and employee cost, we've reduced net headcount by approximately 6% since the beginning of the fiscal year.

More specifically, in our supply chain operations, we removed headcount in the Americas by 11% and in Europe by 10%, while headcount in Asia was relatively unchanged. We also reduced headcount in integrated services, which includes our aftermarket services and e-Business operations by 9%.

We're continuing to execute lean manufacturing continuous improvement actions. We ship approximately 470 million units from our facilities annually and implement continuous improvement programs focused on the design and implementation of processes to increase productivity. In the first half of fiscal 2012 alone, we've completed more than 150 continuous improvement programs that will result in cost savings this fiscal year.

And we're seeing benefit from strategic sourcing activities. We're better leveraging our purchasing power for areas such as staffing and labor, freight and employee benefits. As Steve noted, we're on track with our plans to reduce cost of between $30 million and $40 million on an annualized basis.

You also heard us talk about strengthening our leadership team. We now have new leaders in functional areas that will play a key role in achieving our growth objectives, including the senior additions we've made to lead integrated services, human resources and sales and marketing.

The investments we're making in sales and marketing, which were begun -- which we began in the second half of fiscal 2011, are essential for generating revenue from new programs. As we've talked about in prior quarters, we're working to build new business revenue to annual levels of $150 million to $200 million per year. That level, we believe, is required to achieve consolidated net revenue growth for ModusLink.

I've asked Tom Nightingale to provide his perspective in the opportunities we see in the market and give you an update on the actions we're now taking to grow sales. So Tom, over to you.

Thomas Nightingale

Thanks, Joe. My decision to join ModusLink at this critical point in its development was primarily based on what I believe to be an outstanding market opportunity.

Having led sales and marketing at some of the top companies in the supply chain and logistics industry for more than 20 years, I saw several key factors that make this market opportunity possible. Today, I'm even more convinced that we will differentiate ModusLink in the marketplace and achieve long-term revenue growth.

ModusLink has a great global footprint, excellent physical infrastructure, differentiated solutions and a strong team to manage some of the most challenging supply chains for our clients. I've also been pleased with the long-standing relationships that we hold with an enviable base of clients across the world's leading brands, all underpinned by a strong track record of execution with those clients.

This is illustrated by the fact that 9 of the top 10 high tech companies recognized in the 2011 Gartner Supply Chain Top 25 are ModusLink clients and that more than 75% of ModusLink's -- 75% of ModusLink's top 30 clients in fiscal 2011 have been clients for more than 5 years.

Lastly, we bring a unique portfolio of services to the market. From our factory feed to our postponement, to aftermarket services and our full e-commerce solutions, we're in a great market position to support the challenges of the modern supply chain.

On previous calls, the company has provided insights into recent investments made in sales and marketing, and I'd like to provide you with an update on those investments and outline our key initiatives around sales force effectiveness and how we go to market.

The investments in ModusLink -- that ModusLink has made are beginning to gain traction. Compared to a year ago, our quarter bearing sales force has increased approximately 50%. It typically takes 2 or 3 quarters for new salespeople to close new business and begin making a significant contribution.

The ramp-up of our recent hires is going very well. We're encouraged by the opportunities that we are actively pursuing. Currently, the annualized value of opportunities in our sales pipeline is more than $800 million, which is an increase of more than 30% compared to the end of the second quarter of last year. This is also the highest level since before the global economic recession.

In recent quarters, we've seen an increase in both early-stage and late-stage opportunity in the sales pipeline, which suggests that not only are our marketing and lead generation initiatives are working, but also that our value proposition is resonating with our target clients. We are encouraged by the progress that we're making, and we're working hard to bring those opportunities to successful closure, which should position us well for fiscal 2013 and beyond.

We see good opportunities in our sales pipeline across each of our regions, including Europe despite the economic challenges there. For example, last quarter, Joe referenced a large new client win in the consumer products market that is expected to contribute significant revenue to our operations in Europe. For that program, we'll be performing configuration and packaging of products for retail sale in Western Europe.

We're working on several initiatives to improve sales force effectiveness. Among those are changes to our alignment and our sales compensation structure designed to increase productivity and incentives within our sales organization which will drive collaboration, cross-selling and deep selling activities. We're also streamlining many of our sales processes, expanding marketing programs and improving our pricing efforts.

While we implement these initiatives, we've seen improvement with the value of new business closed, which we expect to benefit revenue in future quarters. Specifically, new programs closed in the first half of fiscal 2012 have an estimated annualized revenue of more than $100 million, which is an increase of more than 50% compared to the same period last fiscal year.

For clarity, annualized revenue from new programs is the total estimated revenue for the program that would produce -- that it would produce in its first year of activity. Included in this new business closed in the second quarter were 3 exciting wins from TomTom, Logitech and Samsung. TomTom is one of the leading -- world's leading suppliers of in-car navigation products.

Our long-standing relationship with TomTom started by providing them with content loading, product packaging and distribution services for its navigation products in Europe. Since then, our relationship has grown, and we are now -- and also include services such as packaging redesign and returns management. With this new program win, we are now providing product configuration and distribution services for TomTom in India, a new region for ModusLink, entering that region through a strategic relationship, opening opportunity for ModusLink to enter a high growth, emerging market with low cost and at low risk.

We also won a program with Logitech, a worldwide leader in personal peripherals. We will be working with Logitech providing product configuration services in Europe. And in addition, we won an incremental new program with Samsung. We'll be expanding our existing relationship by managing supply chain processes for Samsung memory products in additional regions within Asia.

From a go-to-market perspective, our actions are focused on 2 core areas. First, we're taking a research-based approach to identifying high-growth subcategories within our target markets and in adjacent markets. This growth is reflected in our pipeline. Second, we're effectively targeting new programs with existing clients. We work with some of the world's largest technology companies, and there are many opportunities to support them with more services and in additional regions and related products.

So in summary, my efforts are laser-focused on accelerating ModusLink's sales through 3 critical initiatives: first, improving sales force effectiveness through structure, collaboration and incentives. We're integrating these improvements across our newly-expanded sales team; second is clarifying, simplifying and communicating our value proposition to the marketplace; and third is finding and winning opportunities within our blue-chip list of customers while expanding into related verticals.

We have a lot of work ahead of us, but we are committed to profitable growth, and I'm fully confident that we're headed that way. With that, I'll turn it back over to you, Joe.

Joseph C. Lawler

Thanks, Tom. In recent quarters, you have heard us talk a lot about the challenges in our markets and the many changes that we are making to address those challenges. Our entire team is focused on executing those challenges or those changes as rapidly as possible, and we are mindful of the constructive feedback we receive from our stockholders in the many conversations we had with them over the last couple of months. We are moving forward with a singular focus of putting ModusLink on a path to sustained growth and profitability as rapidly and effectively as possible.

Now we're happy to answer any questions you may have. So George, we'll ask you to open up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Joseph C. Lawler

Okay, very good. George, then, I'll -- if there are no specific questions right now, I'm sure we'll be following up with our -- some of our larger shareholders and others who have questions, as they often do after these calls are completed. And we know many of you are participating via webcast and don't have access to the phone right now.

We thank you for your participation today and look forward to talking with you again on the next earnings call. Thanks, George. You can complete the call.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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