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MLNK > SEC Filings for MLNK > Form 10-Q on 3-Mar-2014All Recent SEC Filings

Show all filings for MODUSLINK GLOBAL SOLUTIONS INC

Form 10-Q for MODUSLINK GLOBAL SOLUTIONS INC


3-Mar-2014

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 an integrated supply chain system infrastructure that extends from front-end order management through distribution and returns management. This end-to-end solution enables 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 business solution.

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 such as communications and consumer electronics. 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 also strive to reduce our operating costs while implementing operational efficiencies throughout the Company.

Our clients' products are subject to seasonal consumer buying patterns. As a result, the services we provide to our clients are also subject to seasonality, with higher revenue and operating income typically being realized from handling our clients' products during the first half of our fiscal year, which includes the holiday selling season.

Management evaluates operating performance based on net revenue, operating income (loss) and net income (loss) and a measure that we refer to as adjusted EBITDA, defined as net income (loss) excluding net charges related to interest income, interest expense, income tax expense, depreciation, amortization of intangible assets, SEC inquiry and restatement costs, strategic alternative s and other professional fees, executive severance and employee retention, restructuring, share-based compensation, impairment of goodwill and long-lived assets, other non-operating gains and losses, equity in losses of affiliates and discontinued operations. 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 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. For both the three and six-month periods ended January 31, 2014, our gross margin percentage was 11.6% as compared to 10.0% and 9.7% for the three and six-month periods ended January 31, 2013. Increased competition as well as 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 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, consolidating facilities, 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 January 31, 2014, sales to Hewlett-Packard accounted for approximately 28% of our net revenue while our top ten clients collectively accounted for approximately 81% of our net revenue. For the six months ended January 31, 2013, sales to Hewlett-Packard accounted for approximately 29% of our net revenue while our top ten clients collectively accounted for approximately 80% of our net revenue. We expect to continue to derive the vast majority of our 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 net revenue is 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 January 31, 2014, the Company reported net revenue of $194.0 million, operating income of $1.2 million, income from continuing operations before income taxes of $1.8 million and net income of $1.1 million. For the six months ended January 31, 2014, the Company reported net revenue of $385.4 million, operating income of $3.9 million, income from continuing operations before income taxes of $3.6 million and net income of $1.7 million. For the three months ended January 31, 2013, the Company reported net revenue of $203.4 million, an operating loss of $8.5 million, loss from continuing operations before income taxes of $11.0 million and a net income of $12.6 million. For the six months ended January 31, 2013, the Company reported net revenue of $400.5 million, an operating loss of $15.8 million, a loss from continuing operations before income taxes of $19.6 million and a net loss of $23.2 million. At January 31, 2014, we had cash and cash equivalents of $75.3 million, and working capital of $122.9 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 primarily 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 January 31, 2014 compared to the three months ended January 31, 2013

Net Revenue:



                                                      As a %                           As a %
                                   Three Months         of          Three Months         of
                                      Ended           Total            Ended           Total
                                   January 31,         Net          January 31,         Net
                                       2014          Revenue            2013          Revenue       $ Change        % Change
                                                                        (In thousands)
Americas                          $       78,787         40.6 %    $       67,731         33.3 %    $  11,056            16.3 %
Asia                                      47,530         24.5 %            60,356         29.7 %      (12,826 )         (21.3 %)
Europe                                    56,751         29.3 %            67,818         33.3 %      (11,067 )         (16.3 %)
All Other                                 10,943          5.6 %             7,531          3.7 %        3,412            45.3 %

Total                             $      194,011        100.0 %    $      203,436        100.0 %    $  (9,425 )          (4.6 %)

Net revenue decreased by approximately $9.4 million during the three months ended January 31, 2014, 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 has reorganized its supply chain, partially offset by increased volumes from other clients. Fluctuations in foreign currency exchange rates had an insignificant impact on net revenues for the quarter ended January 31, 2014. Revenue from new programs, which the Company defines as client programs that have been executed for fewer than 12 months, was $12.6 million during the second quarter of fiscal 2014, as compared to $30.5 million in the second quarter of fiscal 2013. 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, defined as client programs that have been executed for 12 months or more. Revenue from new programs in the second quarter of fiscal 2014 benefited from a particular consumer electronics client, which commenced several new programs in recent quarters.

During the second quarter of fiscal year 2014, a major client in the computing market notified us of an intended change in their sourcing strategy effective during our third fiscal quarter for one of their supply chain programs in Asia for which we are currently the primary service provider. While we have been notified that the client intends to add an additional service provider to this program, we expect to continue to be the primary service provider. We expect this change in sourcing strategy to result in reduced annualized net revenue of approximately $15 million to $20 million, and to have a greater proportionate impact on operating income consistent with the historical margins realized from this type of service program. Although there can be no assurances, we are and will continue to seek to offset this loss of net revenue and associated operating income through increased revenues from other clients, new business opportunities, increases in productivity and ongoing cost reduction initiatives.

During the three months ended January 31, 2014, net revenue in the Americas region increased by approximately $11.1 million. 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 $12.8 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 $11.1 million primarily due to lower volumes from a significant software client that has reorganized its supply chain. Net revenue for All Other increased by approximately $3.4 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
                                 January 31,         Net          January 31,         Net
                                     2014          Revenue            2013          Revenue       $ Change        % Change
                                                                      (In thousands)
Americas                        $       72,947         92.6 %    $       63,545         93.8 %    $   9,402            14.8 %
Asia                                    35,271         74.2 %            47,784         79.2 %      (12,513 )         (26.2 %)
Europe                                  53,162         93.7 %            65,052         95.9 %      (11,890 )         (18.3 %)
All Other                               10,051         91.8 %             6,777         90.0 %        3,274            48.3 %

Total                           $      171,431         88.4 %    $      183,158         90.0 %    $ (11,727 )          (6.4 %)

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 for the three months ended January 31, 2014 included materials procured on behalf of our clients of $115.3 million, or 59.4% of consolidated net revenue, as compared to $123.7 million or 60.8% of consolidated net revenue for the same period in the prior year, a decrease of $8.4 million. Total cost of revenue decreased by $11.7 million for the three months


ended January 31, 2014, as compared to the three months ended January 31, 2013, due to the decline in revenue as well as to cost reduction programs implemented by the Company. Gross margin for the second quarter of fiscal 2014 increased to 11.6% from 10.0% in the prior year quarter, primarily as a result of cost reduction actions taken by the Company. For the three months ended January 31, 2014, the Company's gross margin percentages within the Americas, Asia and Europe regions were 7.4%, 25.8% and 6.3%, as compared to 6.2%, 20.8% and 4.1%, respectively, for the same period of the prior year. Fluctuations in foreign currency exchange rates had an insignificant impact on gross margin for the quarter ended January 31, 2014.

In the Americas, the 1.2 percentage point increase in gross margin, from 6.2% to 7.4%, resulted from the favorable impact of cost reductions at certain facilities, partly offset by an unfavorable shift in client mix. In Asia, the 5.0 percentage point increase in gross margin, from 20.8% to 25.8%, was primarily the result of a favorable client mix. This was offset by cost reductions in Asia that were not enough to offset the impact on gross margin of lower net revenues. In Europe, the 2.1 percentage point improvement in gross margin, from 4.1% to 6.3%, was attributable to a favorable client mix as well as the impact of cost reductions at certain facilities. The gross margin for All other, which is comprised primarily of e-Business, was 8.2% for the three months ended January 31, 2014 as compared to 10.0% for the same period of the prior year. This decrease of 1.8 percentage points represents a higher proportion of materials costs due to the addition of a consumer electronics fulfillment program with higher relative materials cost, that was partly offset by labor and overhead costs that did not increase in proportion to net revenues.

Selling, General and Administrative Expenses:



                                                         As a %                           As a %
                                      Three Months         of          Three Months         of
                                         Ended          Segment           Ended          Segment
                                      January 31,         Net          January 31,         Net
                                          2014          Revenue            2013          Revenue       $ Change        % Change
                                                                           (In thousands)
Americas                             $        3,292          4.2 %    $        3,554          5.2 %    $    (262 )          (7.4 %)
Asia                                          6,148         12.9 %             5,733          9.5 %          415             7.2 %
Europe                                        5,005          8.8 %             4,989          7.4 %           16             0.3 %
All Other                                       699          6.4 %               635          8.4 %           64            10.1 %

Sub-total                                    15,144          7.8 %            14,911          7.3 %          233             1.6 %
Corporate-level activity                      4,428           -                8,810           -          (4,382 )         (49.7 %)

Total                                $       19,572         10.1 %    $       23,721         11.7 %    $  (4,149 )         (17.5 %)

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 January 31, 2014 decreased by approximately $4.2 million compared to the three-month period ended January 31, 2013, primarily as a result of reduced employee-related costs ($0.4 million) and professional fees ($3.8 million), including audit fees and various costs related to the financial restatement. Fluctuations in foreign currency exchange rates had an insignificant impact on selling, general and administrative expenses for the quarter ended January 31, 2014.

Amortization of Intangible Assets:



                                                   As a %                             As a %
                               Three Months          of           Three Months          of
                                   Ended           Segment            Ended           Segment
                                January 31,          Net           January 31,          Net
                                   2014            Revenue            2013            Revenue         $ Change         % Change
                                                                        (In thousands)
Americas                       $          38            0.0 %     $          38            0.1 %     $       -               0.0 %
All Other                                242            2.2 %               247            3.3 %             (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.


Impairment of Long-lived Assets:

During the three month period ended January 31, 2014 the Company determined that the carrying value of an owned facility was not fully recoverable from future cash flows. The Company recorded an impairment charge of $0.5 million to adjust the carrying value to its estimated fair value.

Restructuring, net:

                                                    As a %                              As a %
                                Three Months          of           Three Months           of
                                    Ended           Segment            Ended           Segment
                                 January 31,          Net           January 31,          Net
                                    2014            Revenue            2013            Revenue         $ Change         % Change
                                                                         (In thousands)
Americas                        $         430            0.5 %     $       1,040             1.5 %     $    (610 )          (58.7 %)
Asia                                      303            0.6 %             1,254             2.1 %          (951 )          (75.8 %)
Europe                                    233            0.4 %             1,677             2.5 %        (1,444 )          (86.1 %)
All Other                                  27            0.2 %               827            11.0 %          (800 )          (96.7 %)

Total                           $         993            0.5 %     $       4,798             2.4 %     $  (3,805 )          (79.3 %)

The $1.0 million restructuring charge recorded during the three months ended January 31, 2014 primarily consisted of approximately $0.4 million, $0.3 million and $0.3 million of employee-related costs in the Americas, Asia and Europe, respectively, related to the workforce reduction of 35 employees in our global supply chain operations. The estimated savings on an annualized basis expected to result from these actions is approximately $0.6 million.

The $4.8 million restructuring charge recorded during the three months ended January 31, 2013 primarily consisted of approximately $1.0 million, $1.3 million and $1.7 million of employee-related costs in Americas, Asia and Europe, respectively, related to the workforce reduction of 140 employees in our global supply chain operations. In addition, the Company recorded $0.8 million of employee-related costs related to the workforce reduction of 15 employees in e-Business.

Interest Income/Expense:

During the three months ended January 31, 2014 and 2013, interest income was $0.1 million in each period.

During the three months ended January 31, 2014 and 2013, interest expense totaled approximately $0.2 million and $0.1 million, respectively. In both periods, interest expense related primarily to the Company's stadium obligation. 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.


Other Gains (Losses), net:

Other gains (losses), net consists primarily of net realized and unrealized foreign exchange gains and losses and also includes other items such as amortization of deferred costs associated with our credit facility and other gain and losses. The Company recorded foreign exchange gains of approximately $1.0 million during the three months ended January 31, 2014. These net gains primarily related to realized and unrealized gains from foreign currency exposures and settled transactions of approximately $0.2 million and $1.0 million in the Americas and Europe, respectively.

The Company recorded foreign exchange losses of approximately $1.0 million during the three months ended January 31, 2013. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions of approximately $0.6 million and $1.0 million in Asia and Europe, respectively, offset by realized and unrealized gains of approximately $0.6 million in the Americas.

Impairment of Investments in Affiliates:

During the three months ended January 31, 2014 and 2013, the Company recorded $0.2 million and $1.5 million, respectively, of impairment charges related to certain investments in the @Ventures portfolio of companies. 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 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 . . .

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