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MODUSLINK GLOBAL SOLUTIONS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) 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. 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. Background of Restatement On February 15, 2012, the Division of Enforcement of the Securities and Exchange Commission ("SEC") initiated with the Company an informal inquiry, and later a formal action, regarding the Company's treatment of rebates associated with volume discounts provided by vendors (the "SEC Inquiry"). Concurrent with the SEC Inquiry, the Audit Committee of the Company's Board of Directors commenced an internal investigation of the Company's practices with regard to rebates received from vendors. On March 12, 2012, in its Form 10-Q for the quarterly period ended January 31, 2012, the Company announced the pendency of the SEC Inquiry. In providing its supply chain services, the Company enters into contracts with its clients that employ various arrangements for pricing, including "fixed-price," "cost-plus," or "cost-pass-through" pricing models. Although the specifications and terms of the pricing model can frequently vary from client to client, and among the products or programs for a single client, under a "fixed-price" model, the Company and its client will typically negotiate a fixed unit price for the supply chain services to be provided, where the level of costs incurred by the Company does not affect the contractual, negotiated price. Under a "cost-plus" model, the client agrees to pay the costs incurred by the Company to purchase materials, together with an agreed-to percentage mark-up on those costs. Finally, with regard to a "cost-pass-through" model, materials and other costs incurred by the Company are passed through directly to the client, and the client agrees to pay a separate negotiated fee for specified services provided by the Company. Arrangements with clients can include the use of any one or more of these pricing models, depending on the client program involved and the location from which the Company services the client. In addition, continued price and cost discussions with clients through the course of the relationship can sometimes result in an accepted change in the pricing model applied. Consequently, the implication and interpretation of the cost and price terms applicable to any particular client relationship can vary across client programs and products, at different periods in time, and based on the locations from which a client may be serviced. In the course of the Company's contractual relationships, clients often demand lower costs over time, typically attributable to efficiency gains in service offerings. The Company accomplishes this in various ways, including for example, by shifting production to lower cost regions, redesigning clients' packaging and supply chains, and strategically sourcing materials. As part of these services and in the normal course of its business, the Company purchases certain commodity types of materials, including, but not limited to, print, packaging, media and labels, to meet client requirements, often in quantities well in excess of those required by any one client. As a result, the Company receives improved pricing on materials. Frequently, the Company also received and retained rebates based on aggregate volumes of purchases or other criteria established by the vendor. The retention of rebates produced a positive impact on the Company's revenue, and, therefore, also positively affected the Company's profitability and operating income. Restatement Adjustments As a result of this investigation, the Audit Committee concluded that the Company would need to restate its financial statements from fiscal years 2009 through 2011 and the first two quarters of fiscal year 2012, and selected unaudited financial data for fiscal years 2007 and 2008, and that those previously issued financial statements should no longer be relied upon. The Company is correcting the underlying errors for those periods within its Annual Report on Form 10-K for the year ended July 31, 2012, which will be filed with the SEC immediately after the filing of this Form 10-Q. Within this Form 10-Q for the fiscal quarter ended April 30, 29-------------------------------------------------------------------------------- Table of Contents 2012, the Company has restated its unaudited condensed consolidated balance sheet as of July 31, 2011, the unaudited condensed consolidated statements of operations for the three and nine months ended April 30, 2011, and the unaudited condensed consolidated statement of cash flows for the nine months ended April 30, 2011. Any adjustments from periods prior to the condensed consolidated balance sheet as of July 31, 2011 contained within this Form 10-Q are reflected in a $28.6 million increase to accumulated deficit from $7,170.0 million to $7,198.6 million, as compared to the previously reported amount as of July 31, 2011. For any references to the Company's Annual Report on Form 10-K for the year ended July 31, 2011 and Quarterly Reports on Form 10-Q for the quarters ended October 31, 2011 and January 31, 2012 contained within this document, please refer to the Company's Annual Report on Form 10-K for the year ended July 31, 2012, which contains restated financial statements and other information for these periods. The cumulative adjustments required to correct the errors for these previously reported periods are reflected in the restated financial information presented in this report. Several principal adjustments were made to historic financial statements as a result of the restatement as shown in the tables below. Where the retention of a rebate or a mark-up was determined to have been inconsistent with a client contract (collectively referred to as "pricing adjustments"), the Company concluded that these amounts were not properly recorded as revenue. Accordingly, revenue was reduced by an equivalent amount for the period that the rebate was estimated to have affected. A corresponding liability for the same amount was recorded in that period (referred to as "accrued pricing liabilities"), which decreased working capital in the period. The Company believes that it may not ultimately be required to pay the accrued pricing liabilities, due in part to the nature of the interactions with its clients. Those interactions may provide either legal or factual grounds for mitigation of such liabilities. In addition, during such interactions, clients appear to be focused principally on service levels and the cost savings delivered to them by the Company, measured by the total price charged by the Company for its services. Even where there are "cost-plus" or "cost-pass-through" contracts in effect, clients regularly request periodic price reductions, without reference to the actual costs incurred by the Company. The Company expects that its dealings with clients, which include periodic business and pricing reviews, as well as its ability to demonstrate the delivery of savings over time, may result in mitigation of the accrued pricing liabilities. When, and to the extent that, the Company is able to conclude that the liabilities have been extinguished for less than the amounts accrued, the Company will record the difference as other income. In the course of its business with certain clients, the Company has received releases of claims from such clients which have resulted in the Company concluding that the accrued pricing liabilities for those clients have been extinguished. The amounts derecognized and recorded in other income were $7.5 million during the three and nine months ended April 30, 2012 and $7.2 million and $13.5 million, respectively, during the three and nine months ended April 30, 2011. The remaining accrued pricing liabilities at April 30, 2012 will be derecognized when there is sufficient information for the Company to conclude that such liabilities have been extinguished, which may occur through payment, legal release, or other legal or factual determination. In addition to the errors described above, the restated financial statements include a $3.7 million adjustment in the quarter ended July 31, 2011 to correct a reserve for an uncertain tax position. Based on the date of effective settlement of the uncertain tax position, the reserve should have been reversed in the quarter ended July 31, 2011. The restated financial statements also include other adjustments to correct certain immaterial errors for previously unrecorded adjustments identified in audits of prior years' financial statements. The previously unrecorded audit adjustments are being recorded as part of the restatement process although none of these adjustments is individually material. Throughout the remainder of Management's Discussion and Analysis of Financial Condition and Results of Operations, all referenced amounts give effect to the restatement. Overview ModusLink Global Solutions, Inc. executes comprehensive supply chain and logistics services that 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, luxury goods and retail. The Company's operations are supported by a global footprint that includes more than 30 sites in 15 countries across North America, Europe, and the Asia regions. Management evaluates operating performance based on net revenue, operating income (loss), and net income (loss), and, across its segments, on the basis of "adjusted operating income (loss)," which is defined as operating income (loss) excluding net charges related to depreciation, amortization of intangible assets, impairment of goodwill and long-lived assets, share-based compensation, restructuring and other charges not related to our baseline operating results. See Note 10 of the accompanying notes to the condensed consolidated financial statements included in Item 1 above for segment information, including a reconciliation of adjusted operating income (loss) to net income (loss). We have developed a long-term set of strategic initiatives and an operating plan focused on increasing both revenue and profitability. We view the continued development of our global operational infrastructure and footprint as a primary source of differentiation in the market place. We believe that by leveraging our global footprint, we will be able to optimize our clients' supply chains using multi-facility, multi-geographic solutions. 30-------------------------------------------------------------------------------- Table of Contents Our focus during fiscal year 2012 remained consistent with the continued execution against our long-term strategic plan, and the implementation of the following initiatives which are designed to achieve our long-term goals: Drive sales growth through a combination of existing client penetration and targeting new markets. Historically, a significant portion of our revenue from our supply chain business has been generated from clients in the computing 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 computing 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 are experiencing 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. Increase the value delivered to clients through service expansion. During fiscal year 2012, we have continued to focus on further developing our e-Business, repair services and certain other offerings, which we believe will increase the overall value of the supply chain solutions we deliver to our existing clients and to new clients. We expect that these services will enhance our gross margins and drive profitability. Furthermore, we believe that the addition of new services to existing clients will strengthen our relationship with clients, and further integrate us with their businesses. Drive operational efficiencies throughout our organization. Our strategy is to 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 benefit from our global integrated business solution. We also reduce our operating costs while implementing operational efficiencies throughout the Company. We expect that our lean sigma continuous improvement program will drive further operational efficiencies in the future. The lean sigma continuous improvement program is aimed at reducing our overall costs, increasing efficiencies and improving capacity utilization. The program consists of standardized training for the Company's employees in the lean sigma fundamentals (which include six sigma and "lean" methodology approaches) including standard tools to support the identification and elimination of waste and variability and applying these methods to operational and administrative tasks. As noted, the training enables employees to identify and implement projects to improve efficiency, productivity and eliminate waste through ongoing improvement efforts. We believe this initiative will yield improved process standardization and operating efficiency gains, as well as lower our long-term operating costs. 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, demand for our clients' products, the effect of product form factor changes, technology changes, revenue mix and demand for outsourcing services. For the three months ended April 30, 2012, the Company reported net revenue of $178.6 million, operating loss of $11.0 million, loss from continuing operations before income taxes of $7.2 million, net loss of $6.1 million and a gross margin percentage of 8.6%. For the nine months ended April 30, 2012, the Company reported net revenue of $562.8 million, an operating loss of $22.5 million, a loss from continuing operations before income taxes of $17.4 million, a net loss of $17.9 million and a gross margin percentage of 10.1%. During the nine months ended April 30, 2012, the Company received approximately $3.4 million from the release by TFL Enterprises LLC, the former owner of TFL, of funds held in escrow since the date of the TFL acquisition in settlement of potential claims. The amount of $3.4 million had a favorable impact on selling, general and administrative expenses during the nine months ended April 30, 2012. We currently conduct business in many countries including the Netherlands, Hungary, France, Ireland, Czech Republic, Singapore, Taiwan, China, Malaysia, Japan, Australia, India, and Mexico, in addition to our United States operations. At April 30, 2012, we had cash and cash equivalents and available-for-sale securities of $78.6 million, and working capital of $134.5 million. As a large portion of our revenue comes from outsourcing services provided to clients such as hardware manufacturers, software publishers, telecommunications carriers, broadband and wireless service providers 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 market for our services is 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 31 -------------------------------------------------------------------------------- Table of Contents are low. During the three and nine months ended April 30, 2012, our gross margin percentage was 8.6% and 10.1%, 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 react to 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, establishing facilities closer to our clients 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 nine months ended April 30, 2012, sales to Hewlett-Packard and Advanced Micro Devices accounted for approximately 31% and 10%, respectively, of our consolidated net revenue. For the nine months ended April 30, 2011, sales to Hewlett-Packard and Advanced Micro Devices accounted for approximately 27% and 9%, respectively, 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. Basis of Presentation The Company has six operating segments: Americas; Asia; Europe; e-Business; ModusLink PTS and TFL. The Company has four reportable segments: Americas; Asia; Europe and TFL. 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 four 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 April 30, 2012 compared to the three months ended April 30, 2011 Net Revenue: Three Months Three Months As a % of Ended As a % of Ended Total April 30, Total April 30, Net 2011 Net 2012 Revenue (As Restated) Revenue $ Change % Change (In thousands) Americas $ 58,825 33.0 % $ 70,652 34.2 % $ (11,827 ) (16.7 )% Asia 56,642 31.7 % 56,934 27.6 % (292 ) (0.5 )% Europe 50,706 28.4 % 63,444 30.7 % (12,738 ) (20.1 )% TFL 5,012 2.8 % 6,415 3.1 % (1,403 ) (21.9 )% All other 7,380 4.1 % 9,134 4.4 % (1,754 ) (19.2 )% Total $ 178,565 100.0 % $ 206,579 100.0 % $ (28,014 ) (13.6 )% Net revenue decreased by approximately $28.0 million during the three months ended April 30, 2012, as compared to the same period in the prior year. This decrease was primarily a result of lower volumes from certain existing client programs as compared to the year-ago period. Approximately $105.2 million of the net revenue for the three months ended April 30, 2012 related to the procurement and re-sale of materials as compared to $123.1 million for the three months ended April 30, 2011. 32 -------------------------------------------------------------------------------- Table of Contents During the three months ended April 30, 2012, net revenue in the Americas region decreased by approximately $11.8 million. This decrease primarily resulted from the cancellation of a certain client program due to discontinuance of one of the client's products and decreases in order volumes for certain other client programs. Within the Europe region, the net revenue decrease of approximately $12.7 million was driven by decreases in order volumes for certain client programs, as a result of challenging economic and client-specific conditions within this region. Net revenue for TFL and e-Business decreased by approximately $1.4 million and $1.8 million, respectively, due to lower order volumes as compared to the same period in the prior year. A significant portion of our client base operates in the technology sector, which is intensely competitive and very volatile. Our clients' order volumes vary from quarter to quarter for a variety of reasons, including market acceptance of their new product introductions and overall demand for their products including seasonality factors. This business environment, and our mode of transacting business with our clients, does not lend itself to precise measurement of the amount and timing of future order volumes, and as a result, future consolidated and segment sales volumes and revenues could vary significantly from period to period. We sell primarily on a purchase order basis, rather than pursuant to contracts with minimum purchase requirements. These purchase orders are generally for quantities necessary to support near-term demand for our clients' products. Cost of Revenue: Three Months Three Months As a % of Ended As a % of Ended Segment April 30, Segment April 30, Net 2011 Net 2012 Revenue (As Restated) Revenue $ Change % Change (In thousands) Americas $ 57,834 98.3 % $ 69,672 98.6 % $ (11,838 ) (17.0 )% Asia 45,147 79.7 % 44,009 77.3 % 1,138 2.6 % Europe 48,038 94.7 % 60,145 94.8 % (12,107 ) (20.1 )% TFL 5,521 110.2 % 5,691 88.7 % (170 ) (3.0 )% All other 6,606 89.5 % 7,395 81.0 % (789 ) (10.7 )% Total $ 163,146 91.4 % $ 186,912 90.5 % $ (23,766 ) (12.7 )% 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 $23.8 million for the three months ended April 30, 2012, as compared to the three months ended April 30, 2011, primarily due to lower order volumes. On a consolidated basis, gross margin for the third quarter of fiscal year 2012 was 8.6% as compared to 9.5% in the prior year quarter. For the three months ended April 30, 2012, the Company's gross margin percentages within the Americas, Asia and Europe regions were 1.7%, 20.3% and 5.3%, as compared to 1.4%, 22.7% and 5.2%, respectively, for the same period of the prior year. The increase in gross margin within the Americas region is attributed to the favorable impact of cost reduction programs at certain facilities. The decrease in Asia and Europe is attributed to the effect of the fixed portions of indirect labor and infrastructure costs on lower volumes during the quarter, which were partially offset by a favorable impact from client mix. As a result of the lower overall cost of delivering the Company's services in the Asia region, particularly China, we expect gross margin levels in Asia to continue to exceed those earned in the Americas and Europe regions. However, we expect that there will continue to be pressure on gross margin levels in Asia as the market, particularly in China, matures. Selling, General and Administrative Expenses: Three Months As a % of Three Months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 4,111 7.0 % $ 3,898 5.5 % $ 213 5.5 % Asia 6,870 12.1 % 5,814 10.2 % 1,056 18.2 % Europe 5,754 11.3 % 5,727 9.0 % 27 0.5 % TFL 1,108 22.1 % 953 14.9 % 155 16.3 % All other 962 13.0 % 1,007 11.0 % (45 ) (4.5 )% Sub-total 18,805 10.5 % 17,399 8.4 % 1,406 8.1 % Corporate-level activity 4,710 - 3,389 - 1,321 39.0 % Total $ 23,515 13.2 % $ 20,788 10.1 % $ 2,727 13.1 % 33 -------------------------------------------------------------------------------- Table of Contents 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 April 30, 2012 increased by approximately $2.7 million compared to the three-month period ended April 30, 2011, primarily as a result of a $1.9 million increase in professional fees for consultants to assist with the Company's evaluation of strategic alternatives, the SEC Inquiry, and other consulting projects, a $0.9 million increase in salary costs within the Company's sales organization, and a $0.6 million increase in insurance costs. These increases were partially offset by a $0.7 million decrease in costs within the Company's IT organization resulting from cost reduction activities. Amortization of Intangible Assets: Three Months As a % of Three Months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 38 0.1 % $ 399 0.6 % $ (361 ) (90.5 )% Asia - - 369 0.6 % (369 ) (100.0 )% Europe - - - - - - TFL 46 0.9 % 47 0.7 % (1 ) (2.1 )% All other 247 3.3 % 247 2.7 % - - Total $ 331 0.2 % $ 1,062 0.5 % $ (731 ) (68.8 )% The intangible asset amortization relates to certain amortizable intangible assets acquired by the Company in connection with its acquisition of Modus Media, Inc., ModusLink OCS, ModusLink PTS and TFL. The $0.7 million decrease in amortization expense is due to the intangible assets related to Modus Media, Inc. becoming fully amortized during the quarter ended April 30, 2011. The remaining intangible assets are being amortized over lives ranging from 1 to 4 years. Impairment of Goodwill and Long-lived Assets: Three months As a % of Three months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ - - $ - - $ - - Asia - - - - - - Europe 1,128 2.2 % - - 1,128 - TFL 934 18.6 % - - 934 - All other - - - - - - Total $ 2,062 1.2 % $ - - $ 2,062 - The Company conducts its goodwill impairment test on July 31 of each fiscal year. In addition, if and when events or circumstances change that would reduce the fair value of any of its reporting units below its carrying value, an interim test would be performed. In making this assessment, the Company relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and marketplace data. The Company's reporting units are the same as the operating segments: Americas, Asia, Europe, e-Business, ModusLink PTS and TFL. During the third quarter of fiscal year 2012, indicators of potential impairment caused the Company to conduct an interim impairment test for the long-lived assets of TFL, which includes amortizable intangible assets. These indicators included continued operating losses and increasingly adverse trends that resulted in further deterioration of current operating results and future prospects of the TFL reporting unit. These adverse trends included increased competition for and a decline in the supply of quality products at a reasonable cost and the emergence and growth of new competitors for TFL. 34-------------------------------------------------------------------------------- Table of Contents As a result of the impairment test, in connection with preparation of financial statements for the quarter ended April 30, 2012, the Company concluded that TFL's long-lived assets were impaired and recorded a $0.9 million non-cash impairment charge. The $0.9 million impairment charge consisted of $0.5 million of intangible assets and $0.4 million of fixed assets. The intangible asset impairment charge for TFL is deductible as amortization for tax purposes over time. The impairment charge did not affect the Company's liquidity or cash flows. In addition, during the third quarter of fiscal year 2012, indicators of potential impairment caused the Company to conduct an interim impairment test for the fixed assets of its facility in Kildare, Ireland. These indicators included declining revenues and increasingly adverse trends that resulted in further deterioration of current operating results and future prospects of the Kildare facility. These adverse trends included declines in sales volumes resulting from the loss of certain client programs, pricing pressure from existing clients, and the emergence and growth of new competitors for the services performed in Kildare. As a result of the impairment test, in connection with preparation of financial statements for the quarter ended April 30, 2012, the Company concluded that Kildare's fixed assets were impaired and recorded a $1.1 million non-cash impairment charge. This charge has been recorded as a component of "impairment of goodwill and long-lived assets" in the accompanying condensed consolidated statements of operations. The impairment charge did not affect the Company's liquidity or cash flows. Restructuring, net: Three Months As a % of Three Months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 4 0.0 % $ - - $ 4 - Asia 4 0.0 % - - 4 - Europe (99 ) (0.2 )% - - (99 ) - TFL 517 10.3 % - - 517 - All other 69 0.9 % - - 69 - Sub-total $ 495 0.3 % $ - - $ 495 - Corporate-level activity - - - - - - Total $ 495 0.3 % $ - - $ 495 - During the three months ended April 30, 2012, the Company recorded a net restructuring charge of $0.5 million. Of this amount, approximately $0.5 million related to a workforce reduction of 87 employees within TFL and $0.1 million related to a workforce reduction of 4 employees within e-Business. These costs were partially offset by a $0.1 million reversal of restructuring costs associated with employee termination benefits within the Europe region. Interest Income/Expense: During the three months ended April 30, 2012 and 2011, interest income was approximately $0.1 million for both periods. During the three months ended April 30, 2012 and 2011, interest expense totaled approximately $0.1 million for both periods. Interest expense recorded in both periods related primarily to the Company's stadium obligation. Other Gains, net: Other gains, net, were approximately $6.9 million for the three months ended April 30, 2012. During the three months ended April 30, 2012, the Company extinguished accrued pricing liabilities of approximately $7.5 million, partially offset by foreign exchange losses of approximately $0.4 million. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions in Asia. Other gains, net, as restated, were approximately $5.5 million for the three months ended April 30, 2011. During the three months ended April 30, 2011, the Company extinguished accrued pricing liabilities of approximately $7.2 million, partially offset by foreign exchange losses of approximately $1.5 million. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions in Europe and Asia, partially offset by net gains in the Americas. 35-------------------------------------------------------------------------------- Table of Contents 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 $3.1 million and $0.4 million for the three months ended April 30, 2012 and 2011, respectively. 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 subjective 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 and is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies. As such, the reliability and the accuracy of the data may vary. During the three months ended April 30, 2012, the Company became aware that there may be indicators of impairment for a certain investment in the @Ventures portfolio of companies. The Company completed its evaluation for impairment in connection with the preparation of the financial statements for the quarter ended April 30, 2012 and determined that the investment was impaired. As a result, the Company recorded an impairment charge of approximately $2.8 million during the quarter ended April 30, 2012. There was no impairment charge recorded for the quarter ended April 30, 2011. 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 $10.8 million of investments in affiliates at April 30, 2012 ranging from 10% to 20%, respectively, would decrease our income from continuing operations by $1.1 million to $2.2 million. Income Tax Expense: During the three months ended April 30, 2012, the Company recorded income tax benefit of approximately $1.2 million, as compared to income tax expense of $1.3 million for the same period in the prior fiscal year. For the three months ended April 30, 2012 and 2011, 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 decrease in income tax expense recorded during the three months ended April 30, 2012 was primarily the result of a change in the mix of earnings in various jurisdictions as compared to the year-ago period and certain discrete tax items. These discrete tax items included a tax benefit from the reversal of liability for uncertain tax positions of approximately $1.0 million, primarily due to the favorable resolution of outstanding audits during the third quarter of fiscal 2012. 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. Discontinued Operations: During the three months ended April 30, 2012 and 2011, the Company recorded a loss from discontinued operations of $0.1 million for both periods. The loss from discontinued operations in both periods relates to the accretion of the liability related to a facility lease obligation. Results of Operations Nine months ended April 30, 2012 compared to the nine months ended April 30, 2011 Net Revenue: Nine months Nine months As a % of Ended As a % of Ended Total April 30, Total April 30, Net 2011 Net 2012 Revenue (As Restated) Revenue $ Change % Change (In thousands) Americas $ 187,835 33.4 % $ 227,438 33.7 % $ (39,603 ) (17.4 )% Asia 168,506 29.9 % 176,722 26.2 % (8,216 ) (4.6 )% Europe 159,020 28.3 % 218,008 32.3 % (58,988 ) (27.1 )% TFL 21,979 3.9 % 23,943 3.5 % (1,964 ) (8.2 )% All other 25,457 4.5 % 28,950 4.3 % (3,493 ) (12.1 )% Total $ 562,797 100.0 % $ 675,061 100.0 % $ (112,264 ) (16.6 )% 36 -------------------------------------------------------------------------------- Table of Contents Net revenue decreased by approximately $112.3 million during the nine months ended April 30, 2012, as compared to the same period in the prior year. This decrease was primarily a result of lower volumes from certain existing client programs as well as a decline in new business as compared to the year-ago period. Approximately $329.6 million of the net revenue for the nine months ended April 30, 2012 related to the procurement and re-sale of materials as compared to $409.6 million for the nine months ended April 30, 2011. During the nine months ended April 30, 2012, net revenue in the Americas region decreased by approximately $39.6 million. This decrease primarily resulted from the cancellation of a certain client program that was no longer profitable to the Company and decreases in order volumes for certain other client programs. Within the Asia region, the net revenue decrease of approximately $8.2 million primarily resulted from short-term supply constraints for certain client programs, as a result of the impact of the flooding in Thailand. This decrease was partially offset by a non-recurring $4.0 million price concession for a certain client program which was recorded as a reduction of revenue in the first quarter of the prior fiscal year. Within the Europe region, the net revenue decrease of approximately $59.0 million was driven by decreases in client order volumes, as a result of challenging economic and client-specific conditions within this region. At TFL, net revenue decreased by $2.0 million during the nine months ended April 30, 2012 compared to the prior year period due to increased competition in the market. Within e-Business, the net revenue decrease of approximately $3.5 million was driven by decreases in client order volumes. A significant portion of our client base operates in the technology sector, which is intensely competitive and very volatile. Our clients' order volumes vary from quarter to quarter for a variety of reasons, including market acceptance of their new product introductions and overall demand for their products including seasonality factors. This business environment, and our mode of transacting business with our clients, does not lend itself to precise measurement of the amount and timing of future order volumes, and as a result, future consolidated and segment sales volumes and revenues could vary significantly from period to period. We sell primarily on a purchase order basis, rather than pursuant to contracts with minimum purchase requirements. These purchase orders are generally for quantities necessary to support near-term demand for our clients' products. Cost of Revenue: Nine months Nine months As a % of Ended As a % of Ended Segment April 30, Segment April 30, Net 2011 Net 2012 Revenue (As Restated) Revenue $ Change % Change (In thousands) Americas $ 181,616 96.7 % $ 222,358 97.8 % $ (40,742 ) (18.3 )% Asia 130,146 77.2 % 138,467 78.4 % (8,321 ) (6.0 )% Europe 150,528 94.7 % 203,688 93.4 % (53,160 ) (26.1 )% TFL 22,392 101.9 % 23,231 97.0 % (839 ) (3.6 )% All other 21,419 84.1 % 23,962 82.8 % (2,543 ) (10.6 )% Total $ 506,101 89.9 % $ 611,706 90.6 % $ (105,605 ) (17.3 )% 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 $105.6 million for the nine months ended April 30, 2012, as compared to the nine months ended April 30, 2011, primarily due to lower order volume. Gross margins for the first nine months of fiscal year 2012 were 10.1% as compared to 9.4% in the first nine months of fiscal year 2011. This increase is attributed to a non-recurring $4.0 million price concession for a certain client program which was recorded as a reduction of revenue in the prior year period which had a negative impact on gross margin. For the nine months ended April 30, 2012, the Company's gross margin percentages within the Americas, Asia and Europe regions were 3.3%, 22.8% and 5.3%, as compared to 2.2%, 21.6% and 6.6%, respectively, for the same period of the prior year. The increase in gross margin within the Americas region is attributed to the favorable impact of cost reduction programs at certain facilities. Within the Asia region, the increase in gross margin is primarily attributed to the non-recurring $4.0 million price concession recorded in the prior year period, which was partially offset by unfavorable client and product mix. Within the Europe 37 -------------------------------------------------------------------------------- Table of Contents region, the decrease in gross margin is attributed to the effect of the fixed portions of indirect labor and infrastructure costs on lower volumes and an unfavorable change in client mix. Gross margin for TFL for the nine months ended April 30, 2012 was (1.9)% compared with 3.0% in the prior year period. The decrease in gross margin is primarily attributed to higher inventory related charges during the nine months ended April 30, 2012 compared to the prior year period. As a result of the lower overall cost of delivering the Company's services in the Asia region, particularly China, we expect gross margin levels in Asia to continue to exceed those earned in the Americas and Europe regions. However, we expect that there will continue to be pressure on gross margin levels in Asia as the market, particularly in China, matures. Selling, General and Administrative Expenses: Nine months As a % of Nine months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 11,664 6.2 % $ 11,699 5.1 % $ (35 ) (0.3 )% Asia 19,508 11.6 % 17,290 9.8 % 2,218 12.8 % Europe 16,567 10.4 % 16,880 7.7 % (313 ) (1.9 )% TFL 3,583 16.3 % 3,621 15.1 % (38 ) (1.0 )% All other 2,839 11.2 % 2,769 9.6 % 70 2.5 % Sub-total 54,161 9.6 % 52,259 7.7 % 1,902 3.6 % Corporate-level activity 16,159 - 11,538 - 4,621 40.1 % Total $ 70,320 12.5 % $ 63,797 9.5 % $ 6,523 10.2 % 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 and marketing expenses. Selling, general and administrative expenses during the nine months ended April 30, 2012 increased by approximately $6.5 million compared to the nine month period ended April 30, 2011, primarily as a result of a $10.5 million increase in professional fees for consultants to assist with the Company's proxy contest, investments in sales and marketing and cost alignment initiatives, evaluation of strategic alternatives, the SEC Inquiry and other consulting projects within the Company's finance and marketing organizations, and a $1.2 million increase in salary costs within the Company's sales organization. These increases were partially offset by a non-recurring receipt of approximately $3.4 million from the release of TFL Enterprises LLC, the former owner of TFL, of funds held in escrow since the date of the TFL acquisition in settlement of potential claims, and a $1.8 million decrease in costs within the Company's IT organization resulting from cost reduction activities. Amortization of Intangible Assets: Nine months As a % of Nine months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 113 0.1 % $ 1,911 0.8 % $ (1,798 ) (94.1 )% Asia - - 1,107 0.6 % (1,107 ) (100.0 )% Europe - - - - - - TFL 140 0.6 % 660 2.8 % (520 ) (78.8 )% All other 742 2.9 % 742 2.6 % - - Total $ 995 0.2 % $ 4,420 0.7 % $ (3,425 ) (77.5 )% The intangible asset amortization relates to certain amortizable intangible assets acquired by the Company in connection with its acquisition of Modus Media, Inc., ModusLink OCS, ModusLink PTS and TFL. The $3.4 million decrease in amortization expense is due to the write-off of certain intangible assets during the quarter ended January 31, 2011 and that the intangible assets related to the Modus Media Inc. acquisition have been fully amortized. The remaining intangible assets are being amortized over lives ranging from 1 to 4 years. 38-------------------------------------------------------------------------------- Table of Contents Impairment of Goodwill and Long-lived Assets: Nine months As a % of Nine months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ - - $ 15,889 7.0 % $ (15,889 ) (100.0 )% Asia - - - - - - Europe 1,128 0.7 % - - 1,128 - TFL 934 4.2 % 11,277 47.1 % (10,343 ) (91.7 )% All other - - - - - - Total $ 2,062 0.4 % $ 27,166 4.0 % $ (25,104 ) (92.4 )% The Company conducts its goodwill impairment test on July 31 of each fiscal year. In addition, if and when events or circumstances change that would reduce the fair value of any of its reporting units below its carrying value, an interim test would be performed. In making this assessment, the Company relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and marketplace data. The Company's reporting units are the same as the operating segments: Americas, Asia, Europe, e-Business, ModusLink PTS and TFL. During the third quarter of fiscal year 2012, indicators of potential impairment caused the Company to conduct an interim impairment test for the long-lived assets of TFL, which includes amortizable intangible assets. These indicators included continued operating losses and increasingly adverse trends that resulted in further deterioration of current operating results and future prospects of the TFL reporting unit. These adverse trends included increased competition for and a decline in the supply of quality products at a reasonable cost and the emergence and growth of new competitors for TFL. As a result of the impairment test, in connection with preparation of financial statements for the quarter ended April 30, 2012, the Company concluded that TFL's long-lived assets were impaired and recorded a $0.9 million non-cash impairment charge. The $0.9 million impairment charge consisted of $0.5 million of intangible assets and $0.4 million of fixed assets. The intangible asset impairment charge for TFL is deductible as amortization for tax purposes over time. The impairment charge did not affect the Company's liquidity or cash flows. In addition, during the third quarter of fiscal year 2012, indicators of potential impairment caused the Company to conduct an interim impairment test for the fixed assets of its facility in Kildare, Ireland. These indicators included declining revenues and increasingly adverse trends that resulted in further deterioration of current operating results and future prospects of the Kildare facility. These adverse trends included declines in sales volumes resulting from the loss of certain client programs, pricing pressure from existing clients, and the emergence and growth of new competitors for the services performed in Kildare. As a result of the impairment test, in connection with preparation of financial statements for the quarter ended April 30, 2012, the Company concluded that Kildare's fixed assets were impaired and recorded a $1.1 million non-cash impairment charge. This charge has been recorded as a component of "impairment of goodwill and long-lived assets" in the accompanying condensed consolidated statements of operations. The impairment charge did not affect the Company's liquidity or cash flows. During the second quarter of fiscal year 2011, indicators of potential impairment caused the Company to conduct an interim impairment test for goodwill and other long-lived assets, which includes amortizable intangible assets for its ModusLink PTS and TFL reporting units. These indicators included continued operating losses, the departure of key personnel, and increasingly adverse trends that resulted in further deterioration of operating results and future prospects for both the ModusLink PTS and TFL reporting units. As a result of the impairment tests, in connection with preparation of financial statements for the quarter ended January 31, 2011, the Company concluded that its goodwill was impaired and recorded a $13.2 million non-cash goodwill impairment charge, consisting of $7.1 million for ModusLink PTS and $6.1 million for TFL during the three months ended January 31, 2011. The Company also determined that its intangible assets were impaired and recorded a $14.0 million non-cash intangible asset impairment charge, consisting of $8.8 million for ModusLink PTS and $5.2 million for TFL during the three months ended January 31, 2011. The goodwill and intangible asset impairment charges for ModusLink PTS are not deductible for tax purposes. The goodwill and intangible asset impairment charges for TFL are deductible as amortization for tax purposes over time. The impairment charge did not affect the Company's liquidity or cash flows. 39-------------------------------------------------------------------------------- Table of Contents Restructuring and Other, net: Nine months As a % of Nine months As a % of Ended Segment Ended Segment April 30, Net April 30, Net 2012 Revenue 2011 Revenue $ Change % Change (In thousands) Americas $ 752 0.4 % $ 608 0.3 % $ 144 23.7 % Asia 680 0.4 % 586 0.3 % 94 16.0 % Europe 3,677 2.3 % 6 - 3,671 61183.3 % TFL 650 3.0 % - - 650 - All other 88 0.3 % 1 - 87 8700.0 % Sub-total $ 5,847 1.0 % $ 1,201 0.2 % $ 4,646 386.8 % Corporate-level activity - - - - - - Total $ 5,847 1.0 % $ 1,201 0.2 % $ 4,646 386.8 % During the nine months ended April 30, 2012, the Company recorded a net restructuring charge of approximately $5.8 million. Of this amount, $3.7 million related to a workforce reduction of 48 employees in Europe, $0.5 million related to a workforce reduction of 87 employees within TFL, $0.5 million related to a workforce reduction of 144 employees in China, $0.4 million related to a workforce reduction of 5 employees within the Company's IT organization, $0.1 million related to a workforce reduction of 4 employees within e-Business, and $0.4 million related to certain contractual obligations in connection with the restructuring of a facility in the ModusLink PTS business. During the nine months ended April 30, 2011, the Company recorded a net restructuring charge of approximately $1.2 million. Of this amount, approximately $1.1 million related to the workforce reduction of 55 employees in the Americas and Asia. For the nine months ended April 30, 2011 approximately $0.1 million of the recorded net restructuring charge related to changes in estimates for previously recorded facilities lease obligations primarily based on changes to the underlying assumptions. Interest Income/Expense: During the nine months ended April 30, 2012, interest income increased to $0.3 million from $0.2 million in the year-ago period. The increase in interest income was the result of higher average interest rates during the current period compared to the same period in the prior fiscal year. Interest expense totaled approximately $0.3 million and $0.4 million for the nine months ended April 30, 2012 and 2011, respectively. In both periods, interest expense related primarily to the Company's stadium obligation. Other Gains, net: Other gains, net, were approximately $8.9 million for the nine months ended April 30, 2012. During the nine months ended April 30, 2012, the Company extinguished accrued pricing liabilities of approximately $7.5 million and foreign exchange gains of approximately $1.6 million. These net gains primarily related to realized and unrealized losses from foreign currency exposures and settled transactions in Europe and Asia, partially offset by net losses in the Americas. Other gains, net, as restated, were approximately $9.6 million for the nine months ended April 30, 2011. During the nine months ended April 30, 2011, the Company extinguished accrued pricing liabilities of approximately $13.5 million, partially offset by foreign exchange losses of approximately $3.5 million. These net losses primarily related to realized and unrealized losses from foreign currency exposures and settled transactions in Europe and Asia, partially offset by net losses in the Americas. 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 $3.8 million and $2.2 million for the nine months ended April 30, 2012 and 2011, respectively. 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 subjective 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. 40 -------------------------------------------------------------------------------- Table of Contents The valuation process is based primarily on information that the Company requests from these privately held companies and is not subject to the same disclosure and audit requirements as the reports required of U.S. public companies. As such, the reliability and the accuracy of the data may vary. Based on the Company's evaluation, it recorded impairment charges of $2.9 million and $1.2 million during the nine months ended April 30, 2012 and 2011, respectively, related to its investment in a privately held company. This impairment charge is included in "Equity in losses of affiliates and impairments" in the Company's Consolidated Statements of Operations. During the three months ended April 30, 2012, the Company became aware that there may be indicators of impairment for a certain investment in the @Ventures portfolio of companies. The Company completed its evaluation for impairment in connection with the preparation of the financial statements for the quarter ended April 30, 2012 and determined that the investment was impaired. As a result, the Company recorded an impairment charge of approximately $2.8 million during the quarter ended April 30, 2012. There was no impairment charge recorded for the quarter ended April 30, 2011. 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 additional 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 $10.8 million of investments in affiliates at April 30, 2012 ranging from 10% to 20%, respectively, would decrease our income from continuing operations by $1.1 million to $2.2 million. Income Tax Expense: During the nine months ended April 30, 2012, the Company recorded income tax expense of approximately $1.1 million, as compared to income tax expense of $3.8 million for same period in the prior fiscal year. For the nine months ended April 30, 2012 and 2011, 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 decrease in income tax expense recorded during the nine months ended April 30, 2012 was primarily the result of a change in the mix of earnings in various jurisdictions as compared to the year-ago period and certain discrete tax items. These discrete tax items included a tax benefit from the reversal of liability for uncertain tax positions of approximately $1.0 million, primarily due to the favorable resolution of outstanding audits during the third quarter of fiscal 2012. 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. Discontinued Operations: During the nine months ended April 30, 2012, the Company recorded income from discontinued operations of approximately $0.6 million, as compared to a loss of $0.2 million for same period in the prior fiscal year. The increase of $0.8 million is attributable to the execution of a sublease of the Company's previously abandoned facility, which resulted in an adjustment to the Company's estimate of future minimum lease payments recoverable through sublease receipts. 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 April 30, 2012, the Company's primary sources of liquidity consisted of cash and cash equivalents of $78.5 million. The Company's working capital at April 30, 2012 was approximately $134.5 million. In addition, on February 1, 2010 the Company and certain of its domestic subsidiaries entered into an Amended and Restated Credit Agreement and a Security Agreement (the "Credit Facility") with a bank syndicate. The Credit Facility provided a senior secured revolving credit facility up to an initial aggregate principal amount of $40.0 million, which was reduced to $15.0 million on August 16, 2012, and was secured by substantially all of the domestic assets of the Company. The Credit Facility expired by its terms on October 31, 2012. Interest on the Credit Facility was based on the type of borrowing, at the base rate or the Eurodollar rate plus an applicable rate that varied from 1.50% to 2.00% for the base rate and 2.50% to 3.00% for the Eurodollar rate depending on the Company's consolidated leverage ratio. On October 31, 2012, the Company and certain of its domestic subsidiaries entered into a Credit Agreement (the "New Credit Facility") with Wells Fargo Bank, National Association as lender and agent for the lenders party thereto. The New 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, 2012, the calculated borrowing base was $36.0 million. The New Credit Facility terminates on October 31, 2015. Interest on the New Credit Facility is based at the Company's options of LIBOR plus 2.5% or at a base rate plus 1.5%. The New 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. On April 30, 2012, the Company did not have any debt outstanding and had letters of credit for $0.2 million outstanding under the credit facility. 41-------------------------------------------------------------------------------- Table of Contents In addition, the Company maintains a credit facility of approximately $1.0 million in Taiwan. As of April 30, 2012, $34 thousand was outstanding under this facility. Cash used in 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 operating activities of continuing operations was $16.3 million during the nine months ended April 30, 2012, as compared to net cash provided by operating activities of continuing operations of $0.3 million during the prior year period. The $16.6 million increase in cash used in operating activities of continuing operations for the nine months ended April 30, 2012 compared with the same period in the prior year was due to a $16.7 million increase in loss from continuing operations as adjusted for non-cash items offset by a $0.1 million increase in cash resulting from changes in operating assets and liabilities. During the nine months ended April 30, 2012, non-cash items included depreciation expense of $10.7 million, impairment of goodwill and long-lived assets of $2.1 million, share-based compensation of $2.4 million, amortization of intangible assets of $1.0 million, non-operating gains, net, of $8.9 million, and equity in losses of affiliates and impairments of $3.8 million. The increases in accounts receivable and inventory are due to seasonal demands of clients and due to the high dollar value of inventory for a new client program. The increase in accounts payable is due to the high dollar value of inventory for a new client program and increases in costs related to the Company's proxy contest. During the nine months ended April 30, 2011, non-cash items included depreciation expense of $12.4 million, impairment of goodwill and intangibles assets of $27.2 million, share-based compensation of $2.6 million, amortization of intangible assets of $4.4 million, non-operating gains, net, of $9.6 million, and equity in losses of affiliates and impairments of $2.2 million. The Company believes that its cash flows related to operating activities of continuing operations are dependent on several factors, including increased profitability, effective inventory management practices, and optimization of the credit terms of certain vendors of the Company. Our cash flows from operations are also dependent on several factors including the overall performance of the technology sector and the market for outsourcing services, as discussed above in the "Overview" section. Investing activities of continuing operations used cash of $11.7 million and $8.8 million during the nine months ended April 30, 2012 and 2011, respectively. The $11.7 million of cash used in investing activities during the nine months ended April 30, 2012 resulted primarily from $9.1 million in capital expenditures and $2.6 million of investments in affiliates. The $8.8 million of cash used by investing activities during the nine months ended April 30, 2011 resulted primarily from $6.5 million in capital expenditures and $2.5 million of investments in affiliates. As of April 30, 2012, the Company had a carrying value of $10.8 million of investments in affiliates, which may be a potential source of future liquidity. However, the Company does not anticipate being dependent on liquidity from these investments to fund either its short-term or long-term operating activities. Financing activities of continuing operations used cash of $0.2 million and $41.5 million during the nine months ended April 30, 2012 and 2011, respectively. The $0.2 million of cash used for financing activities of continuing operations during the nine months ended April 30, 2012 primarily related to $92 thousand of capital lease repayments and $176 thousand used to repurchase the Company's common stock which were partially offset by $91 thousand of proceeds from the issuance of common stock. The $41.5 million of cash used for financing activities of continuing operations during the nine months ended April 30, 2011 primarily related to a $40.0 million payment of a special dividend, $1.6 million of cash used to repurchase the Company's common stock and $78 thousand of capital lease repayments, which were partially offset by $0.2 million of proceeds from the issuance of common stock. The Company is not dependent on liquidity from its financing activities to fund either its short-term or long-term operating activities; however, we have utilized our revolving line of credit to meet operating requirements in the past. Cash used in discontinued operations totaled $1.2 million and $1.3 million for the nine months ended April 30, 2012 and 2011, respectively, primarily for ongoing lease obligations. Given the Company's cash resources as of April 30, 2012, the Company believes that it has sufficient working capital and liquidity to support its operations for at least the next 12 months. There are no material capital expenditure requirements as of April 30, 2012. However, should additional capital be needed to fund any future cash needs, investments or acquisition activities, the Company may seek to raise additional capital through offerings of the Company's stock, or through debt financing. There can be no assurance, however, that the Company will be able to raise additional capital on terms that are favorable to the Company, or at all. Off-Balance Sheet Arrangements The Company does not have any significant off-balance sheet arrangements. Contractual Obligations A summary of the Company's contractual obligations is included in the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 2012, which will be filed with the SEC immediately after the filing of this Form 10-Q. The Company's gross liability for unrecognized tax benefits was approximately $1.3 million and approximately $70 thousand of accrued interest and penalties as of April 30, 2012. The Company is unable to reasonably estimate the amount or timing of payments for the liability. 42-------------------------------------------------------------------------------- Table of Contents From time to time, the Company agrees to indemnify its clients in the ordinary course of business. Typically, the Company agrees to indemnify its clients for losses caused by the Company. As of April 30, 2012, the Company had no recorded liabilities with respect to these arrangements. Critical Accounting Policies The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, inventory, restructuring, share-based compensation expense, goodwill and long-lived assets, investments, and income taxes. Of the accounting estimates we routinely make relating to our critical accounting policies, those estimates made in the process of: determining the valuation of inventory and related reserves; determining future lease assumptions related to restructured facility lease obligations; measuring share-based compensation expense; determining projected and discounted cash flows for purposes of evaluating goodwill and intangible assets for impairment; preparing investment valuations; and establishing income tax valuation allowances and liabilities are the estimates most likely to have a material impact on our financial position and results of operations. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. However, because these estimates inherently involve judgments and uncertainties, there can be no assurance that actual results will not differ materially from those estimates. During the three and nine months ended April 30, 2012, we believe that there have been no significant changes to the items that we disclosed as our critical accounting policies and estimates in the "Critical Accounting Policies" section of Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011. |