Steel Connect, Inc. - Quarter Report: 2007 October (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended October 31, 2007

OR

For the transition period from                      to                     

Commission File Number 000-23262

CMGI, INC.

(Exact name of registrant as specified in its charter)

(781) 663-5001

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨            Accelerated filer  x            Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of December 4, 2007, there were 48,996,327 shares outstanding of the registrant’s Common Stock, $.01 par value per share.

Table of Contents

CMGI, INC.

FORM 10-Q

TABLE OF CONTENTS

2

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

3

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

4

Table of Contents

CMGI, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

5

Table of Contents

CMGI, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

CMGI, Inc. (together with its consolidated subsidiaries, “CMGI” or the “Company”), through its subsidiary, ModusLink Corporation (“ModusLink”), provides end-to-end global supply chain management solutions that help businesses market, sell and distribute their products and services. ModusLink services technology-based clients in the computing, software, consumer electronics, storage and communications markets. ModusLink had fiscal 2007 revenue of approximately $1.1 billion and 34 facilities in 12 countries with a significant presence in Asia and Europe. In addition, CMGI’s venture capital business, @Ventures, invests in a variety of technology ventures. The Company previously operated under the name CMG Information Services, Inc. and was incorporated in Delaware in 1986. CMGI’s address is 1100 Winter Street, Suite 4600, Waltham, Massachusetts 02451.

CMGI’s business strategy in recent years has led to the development, acquisition and operation of majority-owned subsidiaries focused on supply chain management services, as well as the investment in emerging, innovative and promising technology companies.

The accompanying condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of a normal recurring nature) considered necessary for fair presentation have been included. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and related notes for the year ended July 31, 2007, which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on October 15, 2007. The results for the three months ended October 31, 2007 are not necessarily indicative of the results to be expected for the full fiscal year.

The Company reports three operating segments, Americas, Asia and Europe. In addition to its three operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of costs associated with certain corporate administrative functions such as legal and finance which are not fully allocated to the Company’s subsidiary companies, administration costs related to the Company’s venture capital business and any residual results of operations from previously divested operations.

In accordance with U.S. GAAP, all significant intercompany transactions and balances have been eliminated in consolidation. Accordingly, segment results reported by the Company exclude the effect of transactions between the Company and its subsidiaries and between the Company’s subsidiaries.

In September 2007, the Company’s Board of Directors authorized the Company to proceed with a 1-for-10 reverse stock split, effective at 11:59 p.m. on October 31, 2007, which had been approved by the Company’s stockholders at the Annual Meeting of Stockholders on December 6, 2006. CMGI’s common stock began trading at the split-adjusted level on November 1, 2007. For 20 days following the split, CMGI’s common stock traded under the trading symbol “CMGID”. After the 20-day period, CMGI’s common stock resumed trading under the symbol “CMGI”.

6

Table of Contents

As the stock split proportionally reduced the shares of Common Stock of the Company, without any change to the authorized number of shares or the par value, the “Common stock” balance on the condensed consolidated balance sheet at July 31, 2007, and all share and per share data contained in this Quarterly Report on Form 10-Q has been adjusted to reflect the 1-for-10 reverse stock split assuming the reverse stock split had occurred on August 1, 2006.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) requires acquiring entities in a business combination to recognize the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141(R) is effective for the Company beginning in fiscal 2009. The Company will evaluate SFAS No. 141(R) and the impact that it may have, if any, on its results of operations or financial position.

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), including an amendment of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company beginning in fiscal 2009. The Company is currently evaluating SFAS No. 159 and the impact, if any, that it may have on its results of operations or financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”) which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands the disclosure requirements related to fair value measurements. SFAS No. 157 is effective for the Company beginning in fiscal 2009. The Company is currently evaluating the impact, if any, that SFAS No. 157 may have on its results of operations or financial position.

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. Accordingly, the Company adopted FIN 48, as required, as of August 1, 2007 (see Note 17).

The Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents. Investments, which generally have maturities between three and twelve months at the time of acquisition, are considered short-term and classified as available-for-sale.

As of October 31, 2007, the Company had short-term investments in Auction Rate Securities (“ARS”) of approximately $57.8 million. ARS generally have long-term stated maturities of 20 to 30 years. However, these securities have certain economic characteristics of short-term investments due to a rate-setting mechanism and the ability to liquidate them through a Dutch auction process that occurs on pre-determined intervals of less than

7

Table of Contents

90 days. These ARS are classified as short-term investments on the accompanying condensed consolidated balance sheets due to management’s intent regarding these securities and are accounted for as available-for-sale, in accordance with SFAS No. 115.

The purchase price of the assets acquired and the liabilities assumed in a business combination are subject to an allocation period in accordance with SFAS No. 141, “Business Combinations.” In connection with the Modus acquisition, the allocation period for all adjustments other than those related to tax carryforwards and contingencies expired during the quarter ended October 31, 2005, while the allocation period for certain tax adjustments and contingencies will remain open in accordance with SFAS No. 109 “Accounting for Income Taxes.” The total of the purchase accounting adjustments recorded during the quarter was a reduction of $0.2 million related to the utilization of pre-acquisition net operating losses in the Americas and Asia regions of approximately $(0.1) million and $(0.1) million, respectively.

The changes in the carrying amount of goodwill for the quarter ended October 31, 2007 are as follows:

Approximately 0.2 million stock options were awarded to executives during the quarter ended October 31, 2007 at a weighted average exercise price of $13.20 per share. The weighted average option fair value was $5.90 per share. The weighted average option fair value was calculated using the binomial-lattice model with the following weighted average assumptions. The expected volatility was 51.74%, the risk-free rate was 4.14% and the expected life was 4.12 years.

Additionally, approximately 0.1 million nonvested shares were awarded to executives during the quarter ended October 31, 2007 at a weighted average fair value of $14.60 per share. The fair value of nonvested shares is determined based on the market price of the Company’s common stock on the grant date.

The following table summarizes the allocation of stock-based compensation expense related to employee stock options, employee stock purchases and nonvested shares under SFAS No. 123(R), “Share-Based Payment (revised 2004),” for the three months ended October 31, 2007 and 2006, respectively:

8

Table of Contents

The following table reflects the components of “Other (losses) gains, net”:

During the three months ended October 31, 2007, the Company recorded foreign exchange losses of approximately $2.1 million. These losses related primarily to realized and unrealized gains and losses as related to foreign currency exposures and settled transactions of approximately $1.8 million and $0.6 million in Asia and Europe, respectively, partially offset by $0.3 million of foreign exchange gains in the Americas. Also, during the three months ended October 31, 2007, the Company recorded a gain on the sale of investments of $1.7 million. Approximately $0.2 million of the $1.7 million gain was a result of the acquisition by a third party of Virtual Ink, an @Ventures portfolio company. Additionally, during the three months ended October 31, 2007, gains of approximately $1.3 million and $0.1 million, respectively, were recorded to adjust previously recorded gains on the acquisitions by third parties of Molecular, Inc. and Alibris, Inc., due to the satisfaction of conditions leading to the release of funds held in escrow. Molecular, Inc. and Alibris, Inc. were also @Ventures portfolio companies that were acquired by third parties in previous reporting periods.

During the three months ended October 31, 2006, the Company recorded foreign currency exchange losses of approximately $0.5 million. Also, during the three months ended October 31, 2006, the Company recorded a gain of approximately $1.2 million to adjust a previously recorded gain on the sale of Molecular, Inc. and a gain of approximately $0.3 million to adjust a previously recorded gain on the sale of Alibris, Inc., due to the satisfaction of conditions leading to the release of funds held in escrow.

The following table summarizes the activity in the restructuring accrual for the three months ended October 31, 2007:

It is expected that the payments of employee-related charges will be substantially completed by November 30, 2009. The remaining contractual obligations primarily relate to facility lease obligations for vacant space resulting from the current and previous restructuring activities of the Company. The Company anticipates that contractual obligations will be substantially fulfilled by May 2012.

9

Table of Contents

The net restructuring charges for the three months ended October 31, 2007 and 2006 would have been allocated as follows had the Company recorded the expense and adjustments within the functional department of the restructured activities:

During the three months ended October 31, 2007, the Company recorded a net restructuring charge of approximately $1.6 million. This charge resulted primarily from the costs incurred to shutdown a facility in Newark, California and the corresponding reduction in workforce, which approximated $0.9 million and $0.7 million, respectively.

During the three months ended October 31, 2006, the Company recorded a net restructuring adjustment of approximately $(0.2) million. The adjustments consisted of $(0.4) million in reductions to estimates for previously recorded facilities lease obligations primarily based on changes to the underlying assumptions regarding the estimated length of time required to sublease vacant space and the expected rent recovery rates. These adjustments were partially offset by restructuring charges of approximately $0.2 million as a result of workforce reductions of 7 employees primarily related to the reorganization of the global sales team in Europe and the elimination of redundant positions related to the Company’s Hub & Spoke initiative.

The following table summarizes the regional activity in the restructuring accrual for the three months ended October 31, 2007:

The Company enters into forward currency exchange contracts to manage exposures to certain foreign currencies. The fair value of the Company’s foreign currency exchange contracts is estimated based on the foreign exchange rates as of October 31, 2007. The Company’s policy is not to allow the use of derivatives for trading or speculative purposes. At October 31, 2007, the notional value of the Company’s foreign currency exchange contracts was to sell $17.4 million U.S. Dollars and 0.9 million Euro and to buy 12.0 million Euro and $1.3 million U.S. Dollars, respectively.

The Company believes that its forward currency exchange contracts economically function as effective hedges of the underlying exposures; however the foreign currency contracts do not meet the specific criteria for hedge accounting defined in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”

10

Table of Contents

thus requiring the Company to record all changes in the fair value of these contracts in earnings in the period of the change. During the period ended October 31, 2007, the Company recorded a loss of approximately $31,100 as a result of fair value changes on its outstanding forward currency exchange contracts. This loss has been included in “Other (losses) gains, net” in the Company’s consolidated statement of operations.

Based on the information provided to the Company’s chief operating decision-maker (“CODM”) for purposes of making decisions about allocating resources and assessing performance, the Company reports three operating segments, Americas, Asia, and Europe. In addition to its three operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of costs associated with certain corporate administrative functions such as legal and finance which are not fully allocated to the Company’s subsidiary companies, administration costs related to the Company’s venture capital business and any residual results of operations from previously divested operations. The Other category’s balance sheet information includes cash and cash equivalents, available-for-sale securities, investments and other assets, which are not identifiable to the operations of the Company’s operating business segments.

Management evaluates segment performance based on segment net revenue, operating income (loss) and “Non-GAAP operating income/(loss)”, which is defined as the operating income/ (loss) excluding net charges related to depreciation, long-lived asset impairment, restructuring, and amortization of intangible assets and stock-based compensation. The Company believes that its Non-GAAP measure of operating income/(loss) provides investors with a useful supplemental measure of the Company’s operating performance by excluding the impact of non-cash charges and restructuring activities. Each of the excluded items (depreciation, long-lived asset impairment, amortization of intangible assets and stock-based compensation and restructuring) were excluded because they may be considered to be of a non-operational or non-cash nature. Historically, the Company has recorded significant impairment and restructuring charges and therefore management uses Non-GAAP operating income/ (loss) to assist in evaluating the performance of the Company’s core operations. Non-GAAP operating income/ (loss) does not have any standardized definition and therefore is unlikely to be comparable to similar measures presented by other reporting companies. These Non-GAAP results should not be evaluated in isolation of, or as a substitute for the Company’s financial results prepared in accordance with US GAAP.

Two clients, Hewlett-Packard and Advanced Micro Devices, accounted for approximately 27% and 14%, respectively, of CMGI’s consolidated net revenue for the three months ended October 31, 2007 and approximately 31% and 11%, respectively, of CMGI’s consolidated net revenue for the three months ended October 31, 2006.

11

Table of Contents

Summarized financial information of the Company’s continuing operations by business segment and the Other category was as follows:

12

Table of Contents

The following table reconciles Non-GAAP operating income to GAAP operating income and net income:

The Company calculates earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period. The dilutive effect of common stock equivalents is included in the calculation of diluted earnings per share only when the effect of the inclusion would be dilutive.

Approximately 0.3 million weighted average common stock equivalents were included in the denominator in the calculation of dilutive earnings per share for the three months ended October 31, 2007. Approximately 0.8 million common stock equivalent shares and approximately 0.1 million nonvested shares were excluded from the denominator in the diluted earnings per share calculation as their inclusion would have been antidilutive.

The components of comprehensive income, net of income taxes, were as follows:

13

Table of Contents

The components of accumulated other comprehensive income was as follows:

Inventories are stated at the lower of cost or market. Cost is primarily determined by the first-in, first-out (“FIFO”) method. Inventories at October 31, 2007 and July 31, 2007 consisted of the following:

From time to time, the Company may become involved in litigation relating to claims arising out of operations in the normal course of business, which it considers routine and incidental to its business. The Company currently is not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, would have a material adverse effect on the Company’s business, results of operation, or financial condition.

In September 2007, the Company’s Board of Directors authorized the repurchase of up to $50.0 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions over the following 18 months. The timing and amount of any shares repurchased will be determined by the Company’s management based on its evaluation of market conditions and other factors. The repurchase program may be suspended or discontinued at any time. Any repurchased shares will be available for use in connection with the Company’s stock plans and for other corporate purposes. The repurchase program is funded using the Company’s working capital. During the three months ended October 31, 2007, the Company repurchased an aggregate of 0.6 million shares of common stock at a cost of approximately $8.0 million.

The Company adopted the provisions of FIN 48 on August 1, 2007. The Company did not recognize any change in the liability for unrecognized tax benefits as a result of the implementation.

The liability for unrecognized tax benefits related to various federal, state, and foreign income tax matters was $6.6 million at August 1, 2007. At October 31, 2007, the liability for income taxes associated with uncertain tax positions was $6.3 million. Included in this amount is approximately $3.1 million of unrecognized tax benefits, which if recognized, would impact the effective tax rate. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective rate consists of items that would be offset through goodwill.

14

Table of Contents

Upon adoption of FIN 48, the Company’s policy to include interest and penalties related to gross unrecognized tax benefits as part of the provision for income taxes did not change. As of August 1, 2007, the Company had accrued $6,000 of interest and penalties related to uncertain tax positions. As of October 31, 2007, the total amount of accrued interest and penalties is $17,000.

The Company does not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.

The Company is subject to U.S. federal income tax and various state, local and international income taxes in numerous jurisdictions. The federal and state tax returns are generally subject to tax examinations for the tax years ended July 31, 2004 through July 31, 2007. In addition, a number of tax years remain subject to examination by the appropriate government agencies for certain countries in the European and Asian regions. In Europe, the Company’s 2002 through 2007 tax years remain subject to examination in most locations, while the Company’s 1997 through 2007 tax years remain subject to examination in most Asian locations.

15

Table of Contents

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. 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

CMGI, through its subsidiary, ModusLink, provides industry-leading end-to-end global supply chain management solutions that help businesses market, sell and distribute their products and services. Our core capabilities are categorized as sourcing and supply base management, manufacturing and product configuration, fulfillment and distribution, e-Business, and aftermarket services such as reverse logistics and asset disposition. ModusLink services technology-based clients in such markets as computing, software, consumer electronics, storage and communications.

We also invest in emerging, innovative and promising technologies and industries through our venture capital business, @Ventures. During the three months ended October 31, 2007, approximately $5.5 million was invested by @Ventures and $1.7 million of proceeds were received from the acquisition by third parties of certain @Ventures portfolio companies.

Management evaluates operating performance based on net revenue, operating income (loss), and net income (loss), and, across its segments, on the basis of “Non-GAAP operating income (loss),” which is defined as the operating income (loss) excluding net charges related to depreciation, long-lived asset impairment, restructuring, and amortization of intangible assets and stock-based compensation. See Note 11 of the notes to the condensed consolidated financial statements for segment information, including a reconciliation of Non-GAAP operating income (loss) to net income (loss).

Our focus during fiscal 2008 remains consistent with fiscal 2007 with regard to continued execution against our strategic plan, and implementation of the following initiatives designed to achieve our goals:

Drive sales growth through a combination of existing client penetration, and targeting new vertical markets. A significant portion of our revenues are currently generated from clients in the computing and software verticals. These verticals are mature and, as a result, gross margins in these verticals tend to be low. To address this, we have expanded our sales focus to include three new markets, in addition to the computing and software verticals, that we believe can benefit from our supply chain expertise. We believe these verticals, communications, including broadband, storage devices, and consumer electronics, are experiencing faster growth than our historical markets, and represent opportunities to realize higher gross margins on our services. Companies in these markets often are early in their product life cycles and 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. We will continue to focus on and invest in expanding our e-commerce and logistics management services 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 these solutions will continue to enhance our gross margins and drive greater profitability. Further, we believe that the addition of new services to existing clients will strengthen our relationship with these clients, and further integrate us with their business.

16

Table of Contents

Drive operational efficiencies throughout our organization. As a result of the acquisition of Modus Media, Inc. in August 2004, the Company has been running multiple information technology systems at a significant cost. Our strategy is to offer an integrated supply chain system infrastructure that extends from front-end order management through distribution and returns management. This end-to-end solution will enable clients to link supply and demand in real time, improve visibility and performance throughout the supply chain, and provide real-time access to information for greater collaboration and making informed business decisions. We believe our clients will benefit greatly from a global integrated business solution while we too reduce our operating costs. We currently expect to invest a total of approximately $31.5 million in this initiative. Another program that we expect will drive further operational efficiencies in the future is the implementation of a global shared services model utilizing centralized “hub” locations to service multiple “spoke” locations across the Americas, Asia and Europe regions. We believe this initiative will yield improved process standardization and operating efficiency gains, as well as lower our operating costs.

We believe that successful execution of these initiatives will enable us to improve our financial performance. We have developed financial operating metric goals which are dependent on the successful implementation of these initiatives and annual revenue growth on a percentage basis of high single to low double digits. These goals are to (i) increase our gross margin percentage to approximately 12% to 14%, compared to approximately 11.5% in fiscal 2007 and approximately 10.3% in fiscal 2006, (ii) reduce our overall selling, general and administrative, restructuring and amortization costs to approximately 7% of revenue compared to approximately 10.2% in both fiscal 2007 and 2006, and (iii) therefore, result in an operating margin between 5% and 7%. From time to time we publicly state our progress against these goals and current expectation of when we believe we will attain these goals and begin operating at these levels. Among the key factors that will influence our performance against these goals are successful execution and implementation of our strategic initiatives, global economic conditions, especially in the technology sector, demand for our clients’ products, and demand for outsourcing services.

For the three months ended October 31, 2007, the Company reported net revenue of $274.7 million, operating income of $9.1 million, income from continuing operations before income taxes of $9.2 million, net income of $8.6 million and a gross margin percentage of 14.2%. We currently conduct business in The Netherlands, Hungary, France, Ireland, the Czech Republic, Singapore, Taiwan, China, Malaysia, Mexico, Japan and other foreign locations, in addition to the Company’s United States operations. At October 31, 2007, we had cash and cash equivalents, available for sale securities and short-term investments of $261.2 million, and working capital of $294.9 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 could be adversely affected by declines in the overall performance of the technology sector. The market for our supply chain management products and services is very competitive. We also face pressure from our clients to continually realize efficiency gains in order to help our clients maintain their gross margins and profitability. Increased competition and client demands for efficiency improvements may result in price reductions, reduced gross margins and in some cases loss of market share. As a result of these competitive and client pressures, the gross margins in our business are low. During the three months ended October 31, 2007, our gross margin percentage was 14.2%. However, 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. Therefore, 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 are reacting to margin and pricing pressures in several ways, including efforts to target new vertical markets, expand our service offerings and to lower our infrastructure costs. Our ERP and hub and spoke initiatives are key enablers to drive efficiencies and lower our operating costs. We also seek to lower our cost to service clients by moving work to lower-cost venues, establishing facilities closer to our clients to gain efficiencies, and other actions designed to improve the productivity of our operations.

17

Table of Contents

Historically, a limited number of key clients have accounted for a significant percentage of our revenue. For the three months ended October 31, 2007, sales to Hewlett-Packard and Advanced Micro Devices, accounted for approximately 27% and 14%, respectively, of our consolidated net revenue. During the three months ended October 31, 2006, sales to Hewlett-Packard and Advanced Micro Devices, accounted for approximately 31% and 11%, respectively, of our net revenue. As previously announced, in February 2007, we were informed that a business unit of Hewlett-Packard intended to migrate away from ModusLink a program which has historically accounted for approximately $100.0 million of annual revenue. The migration of this program away from ModusLink was completed during the last quarter of fiscal 2007. We expect to continue to derive the vast majority of our operating revenue from sales to a small number of key clients. We currently do not have any agreements which obligate any client to buy a minimum amount of products or 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 reports three operating segments, Americas, Asia and Europe. In addition to its three operating segments, the Company reports an Other category. The Other category represents corporate expenses consisting primarily of costs associated with certain corporate administrative functions such as legal and finance which are not fully allocated to the Company’s subsidiary companies, administration costs related to the Company’s venture capital business and any residual results of operations from previously divested operations.

In accordance with accounting principles generally accepted in the United States of America, all significant intercompany transactions and balances have been eliminated in consolidation. Accordingly, segment results reported by the Company exclude the effect of transactions between the Company and its subsidiaries and between the Company’s subsidiaries.

Results of Operations

Three months ended October 31, 2007 compared to the three months ended October 31, 2006

Net Revenue:

Net revenue decreased by approximately $8.9 million during the three months ended October 31, 2007, as compared to the same period in the prior year. This $8.9 million decrease was primarily a result of lower revenue of approximately $45.0 million related to two previously announced discontinued Kodak and Hewlett-Packard programs, offset by increased volume associated with other client programs of approximately $36.1 million.

During the three months ended October 31, 2007, the net revenue in the Americas and Europe regions were also negatively impacted by lower revenue of approximately $22.0 million and $7.2 million, respectively. This decrease resulted primarily from approximately $45.0 million of lower revenue associated with the two previously announced discontinued client programs and $6.9 million associated with the cessation of other client

18

Table of Contents

business, partially offset by an increase in order volumes and new business. Within the Asia region, the net revenue growth of $20.3 million resulted primarily from $9.4 million of higher revenues due to increased order volumes for certain clients’ programs and from the contribution of revenue of approximately $7.7 million from our subsidiary in Japan which was previously operated as a joint venture in which we had a 40% interest. ModusLink acquired full ownership of the entity in April 2007.

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. 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 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:

Cost of revenue consists primarily of expenses related to the cost of products purchased for sale or distribution as well as salaries and benefit expenses, consulting and contract labor costs, fulfillment and shipping costs, and applicable facilities costs. Cost of revenue decreased by approximately $17.9 million for the three months ended October 31, 2007, as compared to the three months ended October 31, 2006. Gross margins for the first quarter of fiscal 2008 were 14.2% as compared to 10.6% in the prior year quarter. This increase is primarily attributable to improved client and work mix and incremental efficiencies realized as a result of the implementation of the initiatives described in the “Overview” section. However, we expect that there will continue to be pressure on gross margin levels resulting from a number of factors, including competition, order volumes, pricing, client and work mix and configuration, and overall demand for our clients’ products. A significant portion of the costs required to deliver our products and services is fixed in nature.

For the three months ended October 31, 2007, the Company’s gross margin percentages within the Americas, Asia and Europe regions were 12.1%, 25.6% and 6.4%, as compared to 11.1%, 21.3% and 3.7%, respectively, for the same period of the prior year. Within the Americas region, the decline in the cost of revenue of approximately $20.4 million was in proportion to the decrease in revenues. Despite this decline, the gross margin increased by approximately 1%. This increase is primarily attributable to improvements in the client and work mix and cost efficiencies as compared to the same quarter of the prior year. Within the Asia region, the gross margin increased by approximately 4.3%, which can be primarily attributed to an increase in volume for certain client programs and achieved efficiencies, resulting in higher margins as compared to the quarter ended October 31, 2006. Within the Europe region, the gross margin increased by 2.7% as compared to the same quarter in the prior fiscal year due to improvements in the client and work mix and achieved efficiencies realized as a result of continuous improvement initiatives.

19

Table of Contents

As a result of the lower overall cost of delivering the Company’s products and services in the Asia region, particularly China, and the increasing demand for supply chain management services in that region, 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 China, matures.

Selling Expenses:

Selling expenses consist primarily of compensation and employee-related expenses, sales commissions, facilities costs, consulting fees, marketing expenses and travel costs. Selling expenses during the three months ended October 31, 2007 increased by approximately $0.1 million compared to the three month period ended October 31, 2006, primarily as a result of higher employee-related costs. The increase in employee related costs is primarily attributable to higher sales commissions and salaries in Europe of approximately $0.3 million, offset by lower travel costs in Asia of approximately $0.1 million and lower employee-related costs in the Americas of approximately $0.1 million, resulting from lower sales commissions. For the three months ended October 31, 2007 and 2006, employee related costs represented approximately 63% and 62% of the total selling expense, respectively.

General and Administrative Expenses:

General and administrative expenses within the Americas, Asia, and Europe operating segments consist primarily of compensation and other employee-related costs, facilities costs, depreciation expense and fees for professional services. The general and administrative expenses for these operating segments increased during the three months ended October 31, 2007, as compared to the same period in the prior year, primarily as a result of $1.7 million of additional costs associated with the Company’s migration to a new ERP platform, higher employee related costs of $0.7 million, higher depreciation expense of $0.5 million resulting from the change to the new ERP platform, and approximately $0.4 million of additional consulting costs. These costs were partially offset by approximately $0.5 million of lower information technology infrastructure charges, consisting primarily of global telecommunications expenses, and $0.4 million of lower administrative fees which consisted mainly of accounting fees. Within the Americas region, the $1.1 million decrease in general and administrative expenses was primarily the result of lower employee-related costs of approximately $0.4 million resulting from a decrease in the headcount year-over-year, lower administrative fees of approximately $0.5 million and lower information

20

Table of Contents

technology infrastructure charges of approximately $0.2 million. Within the Asia region, the $2.3 million increase in general and administrative expenses was primarily the result of higher costs associated with migration to the new ERP platform of approximately $1.1 million, higher employee related costs of $0.6 million resulting primarily from the acquisition of our subsidiary in Japan, higher depreciation expense of $0.3 million resulting from the change to the new ERP platform, and an increase of approximately $0.2 million in consulting costs. Within the Europe region, the $1.2 million increase in general and administrative expenses was primarily the result of higher costs associated with migration to the new ERP platform of approximately $0.5 million, higher employee related costs of approximately $0.4 million, and higher depreciation of approximately $0.3 million.

Amortization of Intangible Assets:

The intangible asset amortization relates to certain amortizable intangible assets acquired by the Company in connection with its acquisition of Modus. These intangible assets are being amortized over lives ranging from 3 to 7 years. As of October 31, 2007, those intangibles with 3 year lives have been fully amortized, which resulted in a $0.4 million decrease in amortization expense from the three months ended October 31, 2006 to the three months ended October 31, 2007.

Restructuring: