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MLNK > SEC Filings for MLNK > Form 10-Q on 10-Dec-2013All Recent SEC Filings

Show all filings for MODUSLINK GLOBAL SOLUTIONS INC

Form 10-Q for MODUSLINK GLOBAL SOLUTIONS INC


10-Dec-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The matters discussed in this report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended that involve risks and uncertainties. All statements other than statements of historical information provided herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects" and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, those discussed in Part II-Item 1A below and elsewhere in this report and the risks discussed in the Company's Annual Report on Form 10-K filed with the SEC on October 15, 2013. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.

Overview

ModusLink Global Solutions executes comprehensive supply chain and logistics services (the "Supply Chain Business") that are designed to improve clients' revenue, cost, sustainability and customer experience objectives. ModusLink Global Solutions provides services to leading companies in consumer electronics, communications, computing, medical devices, software, and retail. The Company's operations are supported by a global footprint that includes more than 25 sites across North America, Europe, and the Asia Pacific region.

We operate integrated supply chain solutions that extend from front-end order management through distribution and returns management. Our solutions enable clients to link supply and demand in real time, improve visibility and performance throughout the supply chain, and provide real-time access to information for greater collaboration and making informed business decisions. We believe that our clients can benefit from our global integrated solutions.

Historically, a significant portion of our revenue from our Supply Chain Business has been generated from clients in the computer and software markets. These markets are mature and, as a result, gross margins in these markets tend to be low. To address this, in addition to the computer and software markets, we have expanded our sales focus to include additional markets within technology, such as communications and consumer electronics, and outside of technology, such as medical devices. We believe these markets may experience faster growth than our historical markets, and represent opportunities to realize higher gross margins on our services. Companies in these markets often have significant need for a supply chain partner who will be an extension to their business models. We believe the scope of our service offerings, including e-Business and repair services will increase the overall value of the supply chain solutions we deliver to our existing clients and to new clients. We expect that e-Business and repair services present the opportunity for greater gross margins and profitability. We also strive to reduce our operating costs while implementing operational efficiencies throughout the Company.

Management evaluates operating performance based on net revenue, operating income (loss) and net income (loss). Among the key factors that will influence our performance are successful execution and implementation of our strategic initiatives, global economic conditions, especially in the technology sector, which comprises a predominant proportion of our business, demand for our clients' products, the effect of product form factor changes, technology changes, revenue mix and demand for outsourcing services.

As a large portion of our revenue comes from outsourcing services provided to clients such as computer hardware manufacturers, software publishers and consumer electronics companies, our operating performance has been and may continue to be adversely affected by declines in the overall performance of the technology sector and the sustained economic uncertainty affecting the world economy. In addition, the drop in consumer demand for products of certain clients has had and may continue to have the effect of reducing our volumes and adversely affecting our revenue performance. The markets for our services are generally very competitive. We also face pressure from our clients to continually realize efficiency gains in order to help our clients maintain their profitability objectives. Increased competition and client demands for efficiency improvements may result in price reductions, reduced gross margins and, in some cases, loss of market share. In addition, our profitability varies based on the types of services we provide and the regions in which we perform them. Therefore, the mix of revenue derived from our various services and locations can impact our gross margin results. Also, form factor changes, which we describe as the reduction in the amount of materials and product components used in our clients' completed packaged product, can also have the effect of reducing our revenue and gross margin opportunities. As a result of these competitive and client pressures the gross margins in our business are low. During the three months ended October 31, 2013 and 2012, our gross margin percentage was 11.5% and 9.5%, respectively. Increased competition arising from industry consolidation and/or low demand for our clients' products and services may hinder our ability to maintain or improve our gross margins, profitability and cash flows. We must continue to focus on margin improvement, through implementation of our strategic initiatives, cost reductions and asset and employee productivity gains in order to improve the profitability of our business and maintain our competitive position. We generally manage margin and pricing pressures in several ways, including efforts to target new


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markets, expand our service offerings, improve the efficiency of our processes and to lower our infrastructure costs. We seek to lower our cost to service clients by moving work to lower-cost venues, establishing facilities closer to areas where our clients' products are manufactured or to our clients' end markets to gain efficiencies, and other actions designed to improve the productivity of our operations.

Historically, a limited number of key clients have accounted for a significant percentage of our revenue. For the three months ended October 31, 2013, sales to Hewlett-Packard accounted for approximately 30% of our consolidated net revenue while ten clients accounted for approximately 78% of our consolidated net revenue. We expect to continue to derive the vast majority of our operating revenue from sales to a small number of key clients. In general, we do not have any agreements which obligate any client to buy a minimum amount of services from us or designate us as an exclusive service provider. Consequently, our sales are subject to demand variability by our clients. The level and timing of orders placed by our clients vary for a variety of reasons, including seasonal buying by end-users, the introduction of new technologies and general economic conditions.

For the three months ended October 31, 2013, the Company reported net revenue of $191.4 million, operating income of $2.6 million, income from continuing operations before income taxes of $1.7 million and net income of $0.6 million. At October 31, 2013, we had cash and cash equivalents and available-for-sale securities of $67.6 million, and working capital of $120.7 million.

Basis of Presentation

The Company has five operating segments: Americas; Asia; Europe; e-Business and ModusLink PTS. The Company has three reportable segments: Americas; Asia; and Europe. The Company reports the ModusLink PTS operating segment in aggregation with the Americas operating segment as part of the Americas reportable segment. In addition to its three reportable segments, the Company reports an All Other category. The All Other category represents the e-Business operating segment. The Company also has Corporate-level activity, which consists primarily of costs associated with certain corporate administrative functions such as legal and finance which are not allocated to the Company's reportable segments and administration costs related to the Company's venture capital activities.

All significant intercompany transactions and balances have been eliminated in consolidation.

Results of Operations

Three months ended October 31, 2013 compared to the three months ended October 31, 2012

Net Revenue:



                                                      As a %                           As a %
                                   Three Months         of          Three Months         of
                                      Ended           Total            Ended           Total
                                   October 31,         Net          October 31,         Net
                                       2013          Revenue            2012          Revenue       $ Change        % Change
                                                                        (In thousands)
Americas                          $       76,575         40.0 %    $       63,909         32.4 %    $  12,666            19.8 %
Asia                                      45,390         23.7 %            56,375         28.6 %      (10,985 )         (19.5 %)
Europe                                    60,616         31.7 %            68,930         35.0 %       (8,314 )         (12.1 %)
All Other                                  8,834          4.6 %             7,837          4.0 %          997            12.7 %

Total                             $      191,415        100.0 %    $      197,051        100.0 %    $  (5,636 )          (2.9 %)

Net revenue decreased by approximately $5.6 million during the three months ended October 31, 2013, as compared to the same period in the prior year. This decrease was primarily a result of lower volumes from a significant software client that is reorganizing its supply chain partially offset by increased volumes from certain client programs. Revenue from new programs was $13.9 million during the first quarter of fiscal 2014, as compared to $39.0 million in the year-ago period. The decline in revenue from new programs was primarily due to a large consumer products program that has been generating revenue for more than 12 months and is now being categorized as base business. Revenue from new programs in the first quarter of fiscal 2014 benefited from an engagement with a consumer electronics client, which commenced several new programs in recent quarters. The Company defines new programs as client programs that have been executed for fewer than 12 months. Base business is defined as client programs that have been


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executed for 12 months or more. Approximately $113.6 million of the net revenue for the three months ended October 31, 2013 related to the procurement and re-sale of materials on behalf of our clients as compared to $120.1 million for the three months ended October 31, 2012.

During the three months ended October 31, 2013, net revenue in the Americas region increased by approximately $12.7 million, as compared to the same period in the prior year. This increase resulted primarily from higher order volumes from a program for a consumer electronics client and higher revenue from an aftermarket services program related to the repair and refurbishment of mobile devices. Within the Asia region, the net revenue decrease of approximately $11.0 million primarily resulted from lower order volumes from certain clients related to the software and personal computer markets. Within the Europe region, net revenue decreased by approximately $8.3 million primarily due to lower volumes from a significant software client that is reorganizing its supply chain. Net revenue for All Other increased by approximately $1.0 million primarily due to higher revenue from a consumer electronics client.

Cost of Revenue:



                                                     As a %                            As a %
                                  Three Months         of           Three Months         of
                                     Ended           Segment           Ended           Segment
                                  October 31,          Net          October 31,          Net
                                      2013           Revenue            2012           Revenue       $ Change        % Change
                                                                        (In thousands)
Americas                         $       69,696          91.0 %    $       61,841          96.8 %    $   7,855            12.7 %
Asia                                     34,435          75.9 %            42,929          76.1 %       (8,494 )         (19.8 %)
Europe                                   57,840          95.4 %            67,257          97.6 %       (9,417 )         (14.0 %)
All Other                                 7,449          84.3 %             6,400          81.7 %        1,049            16.4 %

Total                            $      169,420          88.5 %    $      178,427          90.5 %    $  (9,007 )          (5.0 %)

Cost of revenue consists primarily of expenses related to the cost of materials purchased in connection with the provision of supply chain management services as well as costs for salaries and benefits, contract labor, consulting, fulfillment and shipping, and applicable facilities costs. Cost of revenue decreased by approximately $9.0 million for the three months ended October 31, 2013, as compared to the three months ended October 31, 2012. Gross margin for the first quarter of fiscal 2013 was 11.5% as compared to 9.5% in the prior year quarter. For the three months ended October 31, 2013, the Company's gross margin percentages within the Americas, Asia and Europe regions were 9.0%, 24.1% and 4.6%, as compared to 3.2%, 23.9% and 2.4%, respectively, for the same period of the prior year. These increases are attributable to a favorable geographic and client mix and the impact of cost reduction actions at certain facilities.

Selling, General and Administrative Expenses:



                                                         As a %                            As a %
                                      Three Months         of           Three Months         of
                                         Ended           Segment           Ended           Segment
                                      October 31,          Net          October 31,          Net
                                          2013           Revenue            2012           Revenue       $ Change        % Change
                                                                            (In thousands)
Americas                             $        3,186           4.2 %    $        3,742           5.9 %    $    (556 )         (14.9 %)
Asia                                          4,982          11.0 %             5,610          10.0 %         (628 )         (11.2 %)
Europe                                        4,435           7.3 %             5,046           7.3 %         (611 )         (12.1 %)
All Other                                       555           6.3 %               759           9.7 %         (204 )         (26.9 %)

Sub-total                                    13,158           6.9 %            15,157           7.7 %       (1,999 )         (13.2 %)
Corporate-level activity                      4,957            -                8,984            -          (4,027 )         (44.8 %)

Total                                $       18,115           9.5 %    $       24,141          12.3 %    $  (6,026 )         (25.0 %)

Selling, general and administrative expenses consist primarily of compensation and employee-related costs, sales commissions and incentive plans, information technology expenses, travel expenses, facilities costs, consulting fees, fees for professional services, depreciation expense and marketing expenses. Selling, general and administrative expenses during the three months ended October 31, 2013 decreased by approximately $6.0 million compared to the three-month period ended October 31, 2012, primarily as a result of reduced employee-related costs ($1.1 million), professional fees including fees related to the financial restatement ($3.2 million).


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Amortization of Intangible Assets:



                                                   As a %                             As a %
                               Three Months          of           Three Months          of
                                   Ended           Segment            Ended           Segment
                                October 31,          Net           October 31,          Net
                                   2013            Revenue            2012            Revenue         $ Change         % Change
                                                                        (In thousands)
Americas                       $          38            0.0 %     $          38            0.1 %     $       -               0.0 %
Asia                                      -              -                   -              -                -               0.0 %
Europe                                    -              -                   -              -                -               0.0 %
All Other                                242            2.7 %               247            3.2 %             (5 )           (2.0 %)

Total                          $         280            0.1 %     $         285            0.1 %     $       (5 )           (1.8 %)

The intangible asset amortization relates to certain amortizable intangible assets acquired by the Company in connection with its acquisition of ModusLink OCS and ModusLink PTS. The remaining intangible assets are being amortized over lives ranging from 1 to 4 years.

Restructuring, net:

                                                     As a %                             As a %
                                 Three Months          of           Three Months          of
                                     Ended           Segment            Ended           Segment
                                  October 31,          Net           October 31,          Net
                                     2013            Revenue            2012            Revenue         $ Change         % Change
                                                                          (In thousands)
Americas                         $         167            0.2 %     $         326            0.5 %     $     (159 )          (48.8 %)
Asia                                       122            0.3 %               664            1.2 %           (542 )          (81.6 %)
Europe                                     687            1.1 %               454            0.7 %            233             51.3 %
All Other                                    3            0.0 %                26            0.3 %            (23 )          (88.5 %)

Total                            $         979            0.5 %     $       1,470            0.7 %     $     (491 )          (33.4 %)

The $1.0 million restructuring charge recorded during the three months ended October 31, 2013 primarily consisted of approximately $0.2 million, $0.1 million, and $0.7 million of employee-related costs in the Americas, Asia, and Europe, respectively, related to the workforce reduction of 49 employees in our global supply chain operations.

The $1.5 million restructuring charge recorded during the three months ended October 31, 2012 primarily consisted of approximately $0.3 million, $0.7 million, and $0.5 million of employee-related costs in the Americas, Asia, and Europe, respectively, related to the workforce reduction of 62 employees in our global supply chain operations.

Interest Income/Expense:

During the three months ended October 31, 2013 and 2012, interest income was $0.1 million in each period.

During the three months ended October 31, 2013 and 2012, interest expense totaled approximately $0.2 and $0.1 million, respectively. In August 2000, the Company announced it had acquired the exclusive naming and sponsorship rights to the New England Patriots' new stadium, for a period of fifteen years. In August 2002, the Company finalized an agreement with the owner of the stadium to amend the sponsorship agreement. Under the terms of the amended agreement, the Company relinquished the stadium naming rights and remains obligated for a series of annual payments of $1.6 million per year through 2015. In both periods, interest expense related primarily to the Company's stadium obligation.


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Other Gains (Losses), net:

Other gains (losses), net consists primarily of net realized and unrealized foreign exchange gains and losses and also include other items such as amortization of deferred costs associated with our credit facility and other gain and losses. The Company recorded foreign exchange losses of approximately $1.2 million during the three months ended October 31, 2013. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions of approximately $0.7 million and $0.5 million in Europe and Asia, respectively.

The Company recorded foreign exchange losses of approximately $1.0 million during the three months ended October 31, 2012. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions of approximately $0.5 million and $0.5 million in Europe and Asia, respectively.

Equity in Losses of Affiliates and Impairments:

Equity in losses of affiliates and impairments, results from the Company's minority ownership in certain investments that are accounted for under the equity method. Under the equity method of accounting, the Company's proportionate share of each affiliate's operating income or losses is included in equity in losses of affiliates. Equity in losses of affiliates was $0.1 million and $0.3 million for the three months ended October 31, 2013 and 2012, respectively. During the three months ended October 31, 2013 and October 31, 2012, @Ventures did not receive any distributions from its investments.

The Company assesses the need to record impairment losses on its investments and records such losses when the impairment of an investment is determined to be other than temporary in nature. The process of assessing whether a particular investment's net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, the Company carefully considers the investee's cash position, projected cash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data, the current investing environment, management/ownership changes and competition. The valuation process is based primarily on information that the Company requests from these privately held companies which are not subject to the same disclosure and audit requirements as those required of U.S. public companies. As such, the reliability and the accuracy of the data may vary.

Estimating the net realizable value of investments in privately held early-stage technology companies is inherently subjective and has contributed to volatility in our reported results of operations in the past and may negatively impact our results of operations in the future. We may incur impairment charges to our investments in privately held companies, which could have an adverse impact on our future results of operations. A decline in the carrying value of our $7.8 million of investments in affiliates at October 31, 2013 ranging from 10% to 20%, respectively, would decrease our income from continuing operations by $0.8 million to $1.6 million.

Income Tax Expense:

During the three months ended October 31, 2013, the Company recorded income tax expense of approximately $1.1 million, as compared to income tax expense of $0.9 million for same period in the prior fiscal year. For the three months ended October 31, 2013 and 2012, the Company was profitable in certain jurisdictions where the Company operates, resulting in an income tax expense using the enacted tax rates in those jurisdictions.

The Company provides for income tax expense related to federal, state, and foreign income taxes. The Company continues to maintain a full valuation allowance against its deferred tax assets in the U.S. and certain of its foreign subsidiaries due to the uncertainty of realizing such benefits.

Liquidity and Capital Resources

Historically, the Company has financed its operations and met its capital requirements primarily through funds generated from operations, the sale of our securities, returns generated by our venture capital investments and borrowings from lending institutions. As of October 31, 2013, the Company's primary sources of liquidity consisted of cash and cash equivalents of $67.6 million.

On October 31, 2012, the Company and certain of its domestic subsidiaries entered into a Credit Agreement (the "Credit Facility") with Wells Fargo Bank, National Association as lender and agent for the lenders party thereto. The Credit Facility provides a senior secured revolving credit facility up to an initial aggregate principal amount of $50.0 million or the calculated borrowing base and is secured by substantially all of the domestic assets of the Company. As of October 31, 2013, the calculated borrowing base was $41.6 million. The Credit Facility terminates on October 31, 2015. Interest on the Credit Facility is based on the Company's options of LIBOR plus 2.5% or the base rate plus 1.5%. The Credit Facility includes one restrictive financial covenant, which is minimum EBITDA, and restrictions that limit the ability of the Company, to among other things, create liens, incur additional indebtedness, make investments, or dispose of assets or property without prior approval from the lenders. The Company did not have any outstanding indebtedness related to the Credit Facility as of October 31, 2013. The Company's working capital at October 31, 2013 was approximately $120.7 million.


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Cash provided by operating activities of continuing operations represents income
(loss) from continuing operations as adjusted for non-cash items and changes in operating assets and liabilities. Net cash (used in) provided by operating activities of continuing operations was $(9.5) million and $8.8 million for the three months ended October 31, 2013 and 2012, respectively. The $18.4 million decrease in cash provided by operating activities of continuing operations for the three months ended October 31, 2013 compared with the same period in the prior year was due to increased usage of cash for inventory purchases and accounts receivable.

During the three months ended October 31, 2013, non-cash items included depreciation expense of $3.5 million, share-based compensation of $0.5 million, amortization of intangible assets of $0.3 million, non-operating losses, net, of . . .

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