PFSweb, Inc.
Q4 2016 Earnings Call Transcript

Published: 16 Mar 2017

[Operator:]

Good morning, everyone, and thank you for participating in today's conference call to discuss PFSweb's financial results for the Fourth Quarter and Full Year Ended December 31, 2016. Joining us are PFSweb's CEO, Mr. Mike Willoughby, and the Company's CFO, Mr. Tom Madden. Following their remarks, we'll open the call for questions. Before we go further, I would like to make the following remarks concerning your forward-looking statements. All statements in this conference call other than historical facts are forward-looking statements. The words, anticipate, believe, estimate, expect, intend, will, guidance, confidence, target, project, and other similar expressions typically are used to identify forward-looking statements. These forward-looking statements are not guarantees of future performance or may involve or are subject to risks and uncertainties and other factors that may affect PFSweb's business financial condition and operating results, which include, but are not limited to, the risk factors and other qualifications contained in PFSweb's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and other reports filed by PFSweb with the Securities and Exchange Commission, to which your attention is directed. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward-looking statements. PFSweb expressly disclaims any intent or obligation to update these forward-looking statements. During the call, we will also present certain non-GAAP financial measures such as EBITDA, adjusted EBITDA, non-GAAP net income, service fee equivalent revenue, merchandise sales, and certain ratios that use these measures. In our press release with the financial tables issued earlier today, to which your attention is directed on our Web-site at pfsweb.com, you can find our definition of these non-GAAP financial measures, other reconciliation of these non-GAAP financial measures with the closest GAAP measures and a discussion about why we think these non-GAAP measures are relevant. These financial measures are included in the benefit of investors and should be considered in addition to and not instead of GAAP measures. I would like to remind everyone that this call will be available for replay through March 31, 2017, starting at 2

[Mike Willoughby:]

Thank you, Lisa, and good morning everyone. Before I begin my comments, I'd like to let you know that Tom and I are actually dialed into this conference from separate locations and if you happen to hear some New York street noise behind me that would be the reason. As you may have seen earlier this morning we issued a press release announcing our results for the fourth quarter and the full year ended December 31, 2016. 2016 marked the largest year of recurring revenue and project bookings in the history of our company, these strong bookings were enabled by our investment in sales, marketing and infrastructure, as well as multiple acquisitions over the last three years that have expanded our service offering and our addressable market. More details about how we define project bookings, recurring revenue engagement, lifetime contract value and service fee equivalent revenue can all be found in prior earnings call transcript which can be found in the Investor Relations section of our website pfsweb.com. During the fourth quarter we continue to execute our sales pipeline with $15 million of new bookings. We also once again successfully completed the holiday season with a high level of client satisfaction during this very important period. In fact, once again many of our clients exceeded their holiday forecast creating a record volumes through our global distribution centers with a nearly 60% increase in shipped order lines during the peak holiday season period. As announced in October, we experienced operational and financial challenges with one of our newly launched fulfillment clients in Q3 and in early Q4. While efforts were made to improve the performance of this client engagement during the quarter we and our client have mutually agreed to disengage rather than attempt to reengineer the solution in 2017. As part of this transition we agreed to $600,000 revenue reduction with this client which reduced our revenue and adjusted EBITDA in Q4. We expect to fully transition this client off our platform during the second quarter of 2017 and plan to utilize the freed-up infrastructure capacity for more profitable engagement in the back half of the year. Though these operational challenges were driven by this client's unique industry and seasonal product categories, we have learned from this challenging experience and we're moving into 2017 with a greater emphasis on optimizing financial and operational performance across our business and being more selective in taking on new fulfillment business. Before commenting further I'd like to turn the call over to Tom to discuss our financial results. And then following Toms comments, I'll return to provide some additional highlight and comments, and then we'll open your - the call up for your question. Tom?

[Thomas Madden:]

Thank you, Mike and good morning everyone. I'll start with an overview of our 2016 results and then share some comments regarding 2017. Total revenues in the fourth quarter of 2016 increased 14% to $102.5 million compared to $90.1 million in the same period of 2015. Our fourth quarter service fee equivalent revenue increased 18% to $72.7 million. The increase was driven by both new and expanded client relationships, as well as approximately $1.1 million of incremental service fees generated by our acquisitions of Conexus in June of 2016. Excluding the year-over-year impact of acquisitions, our service fee equivalent revenue growth for the quarter grew organically by approximately 16% over the prior year. As expected, our product revenue declined to $12 million compared to $13.9 million in the same period of 2015 due to the ongoing restructuring activities by our last remaining client under this business model. Service fee gross margin in the fourth quarter was 27.7% compared to 31.6% in the same period last year. The expected decrease was primarily due to incremental facility, labor and operating cost applicable to serve new large fulfillment client implemented during the year, including the client that Mike referred to earlier. And as Mike indicated, as part of the transition agreement with this particular client, we agreed to $0.6 million revenue reduction which was recognized during the December 2016 quarter. The impact of these items was partially offset by the benefit of higher margin project activity, including our agency and technology services groups. SG&A expenses during the fourth quarter were $22.4 million, compared to $19.2 million in the year ago quarter. If we exclude acquisition related restructuring and other cost from both periods, the comparative SG&A was $18.4 million versus $17.9 million in the year ago quarter. Increased sales and marketing cost and costs related to our professional services business during the quarter were partially offset by reduced incentive based compensation in 2016. Regarding the acquisition related restructuring and other costs, we recorded a $4.0 million expense in the fourth quarter of 2016. This was primarily related to increased accruals for performance based contingency payments applicable to our CrossView acquisitions due to improved results for this business in the latter part of 2016 and forecasted for 2017. For the fourth quarter of 2016, adjusted EBITDA came in at $6.9 million compared to $7.5 million last year. As a percentage of service fee equivalent, adjusted EBITDA was 9.5% compared to 12.1%. The decline in adjusted EBITDA margin was primarily driven by the previously mentioned incremental facility, labor and operating costs associated with servicing new fulfillment clients, as well as the revenue adjustment from the transition and client relationship and an increase in sales and marketing and infrastructure resources, partially offset by higher margin professional services activity and reduced incentive-based compensation. With these results for the fourth quarter, I'll briefly provide an overview of the full year 2016 financial results. Total revenues in 2016 increased 16% to $334.6 million compared to $288.3 million in 2015. Service fee equivalent revenue increased 24% to a record $229 million compared to $185.3 million in 2015. This 2016 service fee equivalent revenue which was slightly above our previous guidance range included approximately $18 million of incremental revenue generated in 2016 versus the prior year applicable to the company's acquisition of CrossView and Moda [ph] in 2015 and Conexus in 2016. Excluding the impact of the acquisitions, the organic growth of our service fee equivalent revenue was approximately 14%. Service fee gross margin decreased a 100 basis point in 2016 to 31.2% compared to 32.2% last year. Adjusted EBITDA was $18.2 million in 2016 compared to $20.7 million in 2015. The 2016 adjusted EBITDA amount was toward the lower end of our previously issued guidance and was impacted by the incremental operating costs related to the new large fulfillment clients implemented in 2016, as well as the $0.6 million revenue adjustment to the client transition. Now turning to the balance sheet; we generated free cash flow of approximately $4 million in 2016. We defined free cash flow as cash flow from operations but cash purchases of property and equipment. At December 31, 2016 cash and cash equivalents totaled $24.6 million including restricted cash compared to $22.1 million at December 31, 2015. Total debt was $59.7 million compared to $35.4 million. As such, our net debt position was approximately $35.1 million compared to $13.3 million as of December 31, 2015. The increase in our debt position was primarily driven by funds used to support the 2000 acquisition of Conexus and payment of calendar year 2015 related earn out liabilities applicable to prior acquisitions, as well as the funding of capital expenditures, primarily for the buildout of facilities. Additionally as stated on prior calls, our cash balance includes the benefit from the timing of certain cash collections received by PFSweb from our clients customers that are then later remitted to our clients. This benefit is generally higher during the December quarter as a result of higher holiday season activity. Now let's review our 2017 outlook. As disclosed in the earnings release this morning, we will evaluate our omni-channel operations in 2017 and focus on driving higher margin engagements. On a year-over-year basis, this will present a slight revenue headwind. However, we plan to utilize the related infrastructure capacity for more profitable engagements in the second half of the year. As a result we are slightly paring back our 2017 service fee equivalent revenue guidance and expected to range from $240 million to $250 million compared to our previously issued guidance of $245 million to $260 million. However, we are maintaining our expectation for adjusted EBITDA to range between $23 million and $26 million reflecting 26% to 43% growth from 2016. We also expect our annual outlook for adjusted EBITDA to be weighted towards the back half of the year. From a margin perspective we will continue to target service fee gross margin of 27% to 32%. Our service fee gross margin will continue to be impacted by the relative proportion of our infrastructure related services versus our higher margin professional services activity, as well as project work. We currently expect that our first three quarters would be towards the higher end of this gross margin range and our fourth quarter would be closer to the middle of this range as a result of the higher percentage of activity in the fourth quarter being driven by lower gross margin omni-channel operations. There are a few additional items as it relates to our target for 2017. We expect our product revenue business to continue to decline slightly in 2017 to a level of $38 million to $45 million and our expected gross margin on this revenue to be approximately 5%. We currently expect our capital expenditures to be in the range of $9 million to $12 million in 2017 some of which is expected to be funded by capital leases or debt. For depreciation and amortization excluding amortization of acquisition related intangible assets, we expect D&A in 2017 to be between approximately $12.5 million and $13 million. And our amortization of acquisition related intangibles is expected to be approximately $3.2 million in 2017. For interest expense we do expect to see an increase related to higher average borrowing levels, as well as slightly higher rates. We currently expect our interest expense to be between $2.5 million and $3 million for 2017 as compared to $2.3 million in 2016. For income taxes, we currently expect our income tax provision to be relatively consistent compared to 2016 ranging from between $2 million and $3 million. Lastly, from a cash flow perspective in 2017 we expect to generate positive free cash flow of approximately $4 million to $8 million. From a quarterly perspective, we would expect our service fee equivalent revenue to reflect growth of approximately 10% in the beginning of the year and then expect that growth rate will taper off in the second half of the year as we migrate away from some of the lower margin engagements. For adjusted EBITDA we would expect our first quarter of 2017 to be down slightly from the prior year levels as we continue to transition the one client engagement and make operational enhancements for the other large new clients. We then expect year-over-year improvement through the rest of the year. This concludes my overview and I will turn it back over to Mike. Mike?

[Mike Willoughby:]

Thank you, Tom. As mentioned earlier, we had a record year of booking in 2016 driven largely by the investments made in sales, marketing, infrastructure and acquisitions over the last couple of years. But before jumping into the usual booking and business development commentary, I'd like to briefly touch on our operations from the fourth quarter and the holiday season. We did notice some interesting trends emerging during the last holiday including an apparent change in promotional activity that had the effect of spreading order volumes out over a somewhat longer period of time compared to prior holiday. For instance, across our global operation 2016 Cyber Monday order lines were down 34% compared to 2015 Cyber Monday. But for the entire 2016 peak week which is the 7-day period beginning with Black Friday order lines were up 48% compared to 2015 peak week. This does illustrate the challenge of forecasting and staffing to client order volumes on a day by day basis during the holiday. However, I believe this is a positive change that should it become a trend would help us more efficiently support client volumes throughout the entire holiday period. Now moving on I'd like to briefly comment on a few of our solutions that recently went live. Last week we were able to announce our extension with L'Oreal USA and if you missed the press release, we signed a three year extension to continue providing services for many of their top brands. These services include customer care, order fulfillment, product merchandising and order and fraud management for ten brands in the US. The continued expansion of our relationship with L'Oreal further reflects the value we can provide to enterprises with multiple brands with different identities. And also validates the success of our land and expand strategy. During the fourth quarter we also had three other solutions go live. These included a European fulfillment solution for a major adult beverage brand and expanded end to end solution for a leading beauty and cosmetics brand and a new e-commerce site for a Canadian based natural wellness company built on the sales force commerce cloud platform. We hope to be able to share a few of these names with you in the coming week as we seek and receive approval from the client. Moving on, to some details about our bookings, during the fourth quarter we booked 40 new agency and technology projects worth an estimated $12 million in total - bringing the total project bookings value for calendar year 2016 to approximately $46 million. We also booked five new recurring revenue service engagements worth an estimated total of $3 million in lifetime contract value bringing the total recurring revenue bookings for 2016 to approximately $132 million. These lifetime contract bookings include the signing of new B2B contract with two new clients to provide a variety of e-commerce development services. First, we signed a two year engagement with a leading provider of electrical industrial and communications equipment. This contract is to provide a wide variety of development services including database support and managed services on the SAP hybrid platform. And this two year contract is estimated to be worth over 1.5 million in lifetime contract value. Next, we signed a two year engagement with a global manufacturer and supplier of safety product. This contract is to provide a variety of development services including e-commerce development, posting and value services once again on the hybrid platform. This contract is estimated at just over $1 million in lifetime contract value. I mentioned on our previous call that B2C opportunities would likely slowdown in the fourth quarter as those companies focused on operating their business during the holiday. On the other hand, we expected to pursue B2B opportunities that didn't experience holiday peak period. These two bookings I just mentioned are perfect examples of that trend to generate additional sales in what has been typically a slower selling quarter. Our new services on the hybrid platform enabled us to compete for this B2B opportunity. And, we continue to see momentum from our hybrid practice as we move into 2017. The remainder of the Q4 recurring revenue bookings are from smaller engagements including agency services retainer contract. Moving on to the forty project bookings, the more of the last quarter these projects were a mix of technology and agency services for new and existing client. To comment on a few, we signed a project agreement with a men's and women's casual apparel brand to provide e-commerce development and AGC services on Hybris. This total project is estimated to be worth about $2 million which includes upgrading them to the latest Hybris platform creating an online employee store and creating a guided selling experience application within the site. In addition, we signed two e-commerce consulting contract which are smaller revenue projects that help us further monetize our thought leadership and serve to help offset our cost of sales. Services included our tools selection, detailed requirements gathering and defining the full scope in order to provide a more accurate quote for the larger project follow. After completing these projects worth about $300,000 combined, we anticipate larger revenue projects to be booked with both of these clients in Q2 to actually build the new e-commerce site. And as a reminder, we launched our strategic consulting practice in late 2015 and project winds like this prove the effectiveness of the model and our improved ability to being included earlier in the commerce evaluation process, which we believe will enable us to continue winning larger engagements while exposing us to a broader target market. Overall I'm very pleased with the performance of our sales team in the quarter ended 2016 altogether. At December 31st, we had over 175 active client engagements. Looking at our current sales pipeline, we're in the middle of one of our busiest sales period of the year as many brands and retailers look to get new contract and begin implementations to go live before the next holiday season. This includes both onetime project as well as potential recurring revenue engagements and our primary B2C market but can also be true for the B2B segment. As Tom noted earlier, we expect our 2017 service be equal in revenue to grow mid to high single digit with adjusted EBITDA growing more than 25%. These anticipated 2017 results reflect our decision to terminate engagements that do not meet our minimum level of profitability freeing up resources for higher margin engagement to come online later in the year. As a result and as Tom indicated earlier, our churn rate and our recurring revenue base is likely to be higher than our targeted rate of 5% to 8% creating some revenue headwinds in the business in 2017 but allowing us to largely mitigate impact to our bottom line. We are targeting to return to an organic service be equivalent revenue growth rate of 10% to 15% thereafter. We have also instituted a process change in our sales and client on-boarding cycles to do our best to avoid engagement that could be deemed to have a poor risk reward profile similar to the recently launched fulfillment client that has led to operational challenges. We plan to utilize those challenges as a learning experience not just to identify high risk engagement but also better manage the timing of those engagement as we look to avoid launching a large fulfillment client around their seasonal peak period. Also in light of this new positioning, we've recently come across some new lower risk and higher margin revenue stream from providing oral management technology on a hosted basis. Technically we've provided our hosted OMS as part of an end to end engagement including our fulfillment Services. But our targets for these new agreements are for customers that don't have an interest in outsourcing their fulfillment operation but are looking for an enterprise caliber hosted order management solution as part of an e-commerce platform installation. Building our OMS into the deployment of any of the platforms we support is relatively straightforward since we've pretty integrated the platforms into our OMS. This type of hosted OMS builds a gap in the market where the platform providers and traditional OMS and the ERP vendors do not have a hosted offering that is quick to launch. Providing the service enables us to help our clients with order execution technology assistance without requiring them to really relocate the physical fulfillment and customer care. To the extent that we're able to increase these type of engagement in the future, we would expect a positive effect on our gross margin in the operations segment of our business and a reduction in the execution risk especially during the holiday. Now, moving on to some recent market development, in January you may have seen our joint announcement with sales force including our connected commerce offering as part of the sales force, full-force solution program. This offering highlights our deep expertise from both sales force marketing cloud and sales force commerce cloud. Combined we have over 15 years of experience working with these technologies and as a result we're able to rapidly and effectively integrate these cloud solutions for clients to create tailored, triggered and relevant messaging to their end customer. This collective platform experience differentiates us from our competitors and enables us to develop a stronger, more value added relationship with sales force. We're thrilled about the product, about the revenue opportunities this formalized program can bring as we're now one of the premier commerce cloud system integrators in the world. Our competitive landscape does continue to evolve with some competitors struggling, new entrants into the market and solidations and acquisitions continuing and partners making substantial changes to their product offerings. In the world of e-commerce change is the only constant. The rapid changes in the competitive landscape don't surprise us but they do validate the attractiveness of the e-commerce industry and the growth opportunities associated with our market. According to e-marketer, the North American e-commerce market is predicted to grow 15% in 2017 and reach $728 billion dollars in sales by 2020. We believe we are well positioned to take advantage of this growing market and will continue to differentiate ourselves by providing our clients with a holistic and global view of their customer to through world class agency, technology services and operation solution. I look forward to engaging with all of our investors to answer questions and to communicate our exciting and admittedly complex story. And we will have many opportunities to meet with you at various conferences over the next quarter and we're always happy to make ourselves available by phone. Now Lisa, we're ready to open up the call for question and answers.

[Operator:]

Yes, thank you, Sir. [Operator Instructions] And our first question will come from George Sutton with Craig-Hallum.

[George Sutton:]

Thank you. Guys I have three questions and first question really relates to the macro thesis coming out of this past holiday season so it's certainly our understanding that a lot of brands that were built in-house for all of this work we're unable to scale during the quarter. And that may have created some incremental opportunities for you looking out into 2017. Could you - is that made its way into your funnel.

[Mike Willoughby:]

Well, George you know, it is an observation I think that was made and we would tend to agree the complexity of providing an enterprise class e-commerce solution actually continues to increase rather than decrease which is a really interesting phenomenon in e-commerce typically. With a technology oriented trend you see things simplified over time versus you know, being more complex over time. As a result you know, I think there are brands and retailers that have continued to struggle. Providing an enterprise class type solution scalability issues can come up in the technology side, they can come up in the infrastructure and operations side. And I think a lot of retailers and brands are struggling with how to implement OMI channel as a strategy at the same time and so I do think it's a favorable trend, I do think that it will contain to reinforce the value of outsourcing element if not all of the program. You know, if you look at the pipeline today I would say that as we've seen over the past couple of years we have you know, retailers and brands that are approaching us that did not have a great holiday and they're looking for us to help them in various ways to deal with that. But we certainly are seeing that as a trend. I would expect that especially with some of the aggressive moves that Amazon continues to make in the industry that OMI channel will continue to be at the top priority. And although I did mention in my comments, one of the things we are seeing is an increase in our strategic commerce consulting practice of clients coming to us to do on the channel enablement assessment and to help them with their strategy so I would definitely agree with your observation about the macro trend and I do think that it benefits us in the near term and the long term.

[George Sutton:]

Thank you for that and relative to the challenge you had with the defined customer that's moving off the platform. So it's certainly our understanding that retailers have been more challenging for you overtime than have been branded products; is that - is this just another statement to that effect or was this really related to the uniqueness of this one retailer?

[Mike Willoughby:]

This was related to the uniqueness of this one retailer and their business model as we discussed over the last conference call. The way that this particular product category has to be managed was unique and different and we simply missed some important details about that as we scoped this solution and implemented it. And while I do believe that we could have reengineered the solution in 2017 it really became apparent in Q4 that for both us and our client the best solution was to disengage. Your point about retail versus brand I think is an important point, it really has more to do with the fact that we typically see large retailers as they scale the business, look to in-store certain functions more often than we see brands and brand manufacturers doing that. I wonder - but you know, kind of based on your previous macro comment; whether or not that will hold true and whether we will see some of our larger retailers think twice about and sourcing some things that are complicated and difficult to scale fail and whether or not those things really are core competency for retailers. So it's interesting just to try to see the trends but I think in the case of this one client it really is more about the solution, not about the category.

[George Sutton:]

Good point on retail. So one last question relative to CrossView and very encouraging here that that has picked back up. Obviously you had one strong platform, you were supporting one weaker platform; you - I believe were moving people to the stronger platform, is that why you've seen the pickup there?

[Mike Willoughby:]

Predominantly the strengthening in the one platform as we've mentioned during my prepared comments has resulted in a number of new engagements. The first part of the year we kind of indicated to you guys that even that platform was kind of getting off to a bit of a slow start. Our platform partner indicated they felt like their sales were going to be back loaded in the year and that's exactly what happened and so we're really very excited about the traction in that platform. However, we did see a strengthening in the other platform as we - I think did a really good job maximizing the engagement that we have with our current client and being able to show them additional value and have additional work coming from current clients. And because that platform is not currently selling a lot of new software technology into the market, we have a renewed effort to target the overall installed base for that platform. And I'm hopeful that based on our current pipeline we actually may see some net new clients to us that are current clients of the platform where we're actively taking away some business from the competitors. So my hope is that that platform practice remains stable maybe we'll see some slight growth but we're most excited about the other platform or where we have the B2B opportunities then we see a lot of traction.

[George Sutton:]

Okay, perfect. Thanks for the answers.

[Mike Willoughby:]

Thanks, George.

[Operator:]

We'll go next to Mark Argento with Lake Street Capital Markets.

[Mark Argento:]

Good morning. Just a follow-up on George's questions, in terms of the pricing environment - obviously, it doesn't seem like you guys have a hard time winning customers, it boils down to obviously bandwidth and the ability to integrate but when it comes to the pricing - are you - as you alluded to these systems and solutions are becoming much more complex, do you see the ability to take some pricing to be able to kind of increase wallet share a little bit, just seems that this is not an easy thing to do; like you said earlier, it's getting more complex but - you know, maybe talk through - you guys are thinking thought process as you start bidding some of these businesses and it sounds like you guys are focusing more on a more profitable customer. You can walk us through that a little bit, it would be helpful.

[Mike Willoughby:]

Well, that's exactly right. We are really trying to focus on opportunities where we feel like we can see margin expansion versus opportunities that may end up being in the more commoditized areas of our solution. So you probably will see us focused less on some of these large fulfillment opportunities that can be at the lower end of our margin range, as well as bringing some significant execution risks; it's not that we're - we're not still looking at those opportunities but I think the focus is more on end-to-end opportunities and professional services where we see the higher margins. One of the interesting trends I think and I mentioned in my prepared comments is the earlier we're able to engage with the client and the more strategic that we're able to be with the client, more opportunity there is to provide the higher margin services and so those strategic consulting services where we are engaging with the client to do retail strategy, to do omni-channel readiness assessment, to engage in what we would call define and designed activity, either prior to a platform selection or at the same time that the platform selection process is going - generate service revenue opportunities for us at that or at the highest end of our margin range. And so we will target to do more and more of that, we will expect to be building that part of our business up. We're looking to embed that kind of strategy support into our client relationships where even an existing client relationship we can bring services to them that are more transformational for them and also at the higher margin range. And generally, if you were just to look at the client lifecycle and you were to look at the components that we're providing all the way from strategic consulting through digital agency and to technology services and then to operations, the margin expectations follow that lifecycle; they are at the very highest in the range with the strategic support - somewhat lower although still very high in the digital agency but we see some commodity pressure in the tech services around just deploying an e-commerce platform that we tend to make up for with services such as contact management and the advanced user experience, development things like that. And then it obviously - as it has been the case, we see the most margin pressure in the operations side and our strategy there is to focus on clients that really have the most complex needs in the highest sort of value and service requirement. So that's our strategy. You know, I think that the approach to really play to the complexity part of it and to look for clients that have the need to really drive innovation and deploy the most complex solutions is the way for us to experience margin expansion.

[Mark Argento:]

When you look at the number of customers or clients that you have that are the end-to-end solution relative to the broader number and the operations side of the house, what - is that a quarter of your customers right now you're fully end-to-end with or is there any way to…

[Mike Willoughby:]

It's a little over 25% and now a little less than half of the clients consume services from our operations and so more than half - a little more than half of our clients are really just professional services. I would expect with the growth and the attention that we're placing on the services side of the business, that percentage of clients that are consuming services just in the professional services segment will grow; my hope is that land and expand and it's successful as that has been will help us to continue to increase the number of end-to-end clients as well. But I don't - this year anyway expect to see much of an increase in client opportunities that start out in the end; I do believe land and expand is the way that we'll continue to increase that number of end-to-end client.

[Mark Argento:]

Tom, one quick one for you. So in the quarter you guys - it looks like you took a $4 million expense that ran through those [indiscernible] and EBITDA; is that basically - it looks like most of it was up in the gross margin, was that all related to the customer loss and writing down some of the expense in relationship to widen that relationship amount [ph]?

[Thomas Madden:]

No, the $4 million was - did not include anything related to that particular client engagement and client transition. The $4 million was completely related to kind of acquisition and restructuring related cost. Just about all of that was related to changes in the performance based liabilities, applicable to their earn-out agreements that we have a place with that, especially the CrossView business. If you would have recalled earlier this year, we - earlier in 2016 we had reduced the earn-out liability based on lower expectations from that business in terms of their profitability contribution. As we've talked about we saw improved performance during the latter half of 2016 and our forecasting good performance in 2017 as well which resulted in an increase in that liability requirement. So just about all of that $4 million was applicable to that performance-based incentive liability component. We didn't…

[Mark Argento:]

And what's the total liability?

[Thomas Madden:]

The total liability at the end of December was a little over $4 million, so it's about $4.1 million.

[Mark Argento:]

So best you can get them to zero and [indiscernible]?

[Thomas Madden:]

It was, yes. It was previously about $400,000 and we wrote it up to $4.1 million to $4.2 million.

[Mark Argento:]

Got it. Last question for me. So in terms of customer loss, it's basically you've taken the $600,000 charge or basically walk away from revenue, goes all the way through. Are there any incremental cost now that you would need to bare to wind that down or is that all been factored in?

[Thomas Madden:]

So as per my comments, we did talk a little bit about how the first quarter - we do expect there this to continue to be some impact on our bottom line in regards to that transition client and the cost structure that we have in place to support them during this meeting couple of months of time. So we've got that considered in our forecast amounts included in the projections that we've provided.

[Mark Argento:]

Got it. Alright, thanks guys.

[Thomas Madden:]

Alright, thank you, Mark.

[Operator:]

And we'll go next to with Michael [ph] with Canaccord.

[Austin Moldow:]

Hi, it's Austin on for Mike, two questions please. On the revenue side, so the headwinds that are coming in the second half of the year, is that all from the - just revenue loss from the discontinuation or are there more clients you anticipate - I don't know, de-emphasizing in the fulfillment engagement area? And then the second question is - if I'm just looking at bookings or lifetime value of bookings per engagement on the recurring revenue engagements, it looks like it's - you know, those values are about half of what they were in 2015; so I don't know if that means that the bookings per customer but these contracts are becoming smaller and smaller. I'm wondering if you could talk to that trend there, if there is any sort of major changes in your sales strategy and pipeline over 2016 that would suggest that should continue? Thanks.

[Mike Willoughby:]

Okay, thanks Austin. So with regard to the turn in 2017 and the revenue headwinds comment; so clearly the loss of the fulfillment client is a major portion of that. Every year we would target around 5% to 8% churn in the recurring revenue part of the business, this year that term is going to be higher because of the loss of this one client. But also because we are taking I think an aggressive look at our client relationships particularly in the operations area and really wanting to make sure that we're using our existing infrastructure and resources to the most profitable use. So there will be some cleaning of our portfolio - that isn't all that atypical, you know, each year as we have specific client that churn out of the solution, we tend to focus on the ones that are underperforming, not meeting our profitability expectations; this is a year I think where we're really quite focused on that and wanting to set the business up and that part of the business - part of our model to be much more profitable than we would have seen certainly last year. So that's the reason why we're indicating that the churn rate is higher than we might have expected in prior years. There is - there are - will be as every year, some additional client that churn out in addition to the one that we've mentioned. With regard to the bookings information on the project side, this year was an interesting year for us because we did see across all four quarters a relatively consistent performance with project booking. I mean we had a very strong Q4 when we expected that we might even see a decline in large part, that's because of the B2B opportunities that we had but we did continue to see some really interesting activity on the B2C side as well. Your observation about the average size of the project is correct. As we've increased the attention and focus on selling professional services, we've seen a significant increase in the number of projects and in many cases the starting point with the client may be a relatively small - define and design engagement or it could be - you know, what we call lift and shift re-platforming effort which may be less than $0.5 million in project revenue. And so I do believe that there's a mix of a few large projects every quarter and a number of smaller ones. My guess is that 2017 will have a similar pattern to it. I would like to see an increase in the overall number of projects, but I think the ratio of large to small would be similar and that means the average project size probably is similar as well. There may be a quarterly variation as we go through the year where we see a single large project come in and skew the results, but I think overall across the year the pattern you saw in 2016, we expect to be more or less repeated of 2017.

[Austin Moldow:]

Thank you.

[Mike Willoughby:]

You're welcome.

[Thomas Madden:]

Thank you

[Operator:]

And we'll go next to Kara Anderson with B Riley and Company.

[Kara Anderson:]

Hi, good morning.

[Mike Willoughby:]

Hi Kara.

[Kara Anderson:]

So prior to the disengagement with the client, I'm just wondering if you began to fix the operational issues or if you sort of parted ways before actually tackling that?

[Mike Willoughby:]

So we had this indicated in our conference call done some remediation already. Both before and during their September and October peak period and our thesis behind this, one of the thesis points behind onboarding this client was an expectation that as their late Q3 and early Q4 peak started to wind down that we would be able to reallocate particularly labor resources away from that client and two other clients that had a traditional holiday peak. That part of the thesis actually turned out to be pretty accurate. We did have the opportunity to move labor in the D.C. from that client over to other clients. Interestingly that client continued to have a very strong performance during Q4 particularly in the party supplies side of that business which presented challenges for us given the lack of profitability in the account, but it also made it more difficult for us to continue to do remediation while at the same time we're supporting all of our clients during the holiday and that part of their business. So the reality is that while we had done some work to put on paper the reengineering solution and presented to the client what we believe would effectively rightsizing reengineer the solution to get us and them where we wanted them to be. That work was not going to be able to happen until Q1 and early Q2 of this year and as we just looked at that effort and the execution risk associated, we both came to the conclusion that rather than making that investment it was better to disengage. So really not a lot of investment in Q4 more just the ideation aspect had occurred in Q4.

[Kara Anderson:]

Great. And then you said you plan to use the related infrastructure capacity for engagement in the second half of this year. Do you already have clients sort of plated for that capacity or is that people who might be in the pipeline?

[Mike Willoughby:]

So we do have clients plated for that capacity. And it's nice that we actually have some current clients where we have some expansion opportunities that are going to enable us to utilize at least a portion of that space, I think we will have some capacity beyond what the current client needs in order to sell, it's always good to have selling capacity. And our preferences this year to move current clients that are expanding and new clients into existing infrastructure where it's much easier for us to manage that versus opening a brand new facility particularly in the Memphis area. We still are evaluating along with our clients where there is opportunity to expand our fulfillment footprint in a very targeted way on both the West Coast in the US and also in the UK. Our current expectation is that UK has precedence which is consistent with what we said last year but even in that scenario, we are really looking to support our clients and their expansion versus opening a large new facility that creates capacity that then has to be sold. So this is really tracking with our current clients versus looking to aggressively expand fulfillment capacity without the clients being there to support it.

[Kara Anderson:]

Great. Thank you.

[Mike Willoughby:]

You're welcome.

[Operator:]

And we'll go next to Ryan MacDonald with Wunderlich Securities.

[Ryan MacDonald:]

Hi guys. Can you go into a little more deeply about from the process changes that you - client onboarding you talked about. And particularly in relation to as you're looking at the first half of this year where you tend to see a little bit more aggressive recurring revenue engagement activity and how that could potentially be impacting your sale cycles or client onboarding cycles?

[Mike Willoughby:]

Sure, I can comment on that. So as we were doing the obvious lessons learned process with the client that we on boarded in the end. In retrospection with hindsight, we probably have chosen not to engage with because of the unique aspect of the business model and the challenges we had operating them profitably, we made some business process changes but I would categorize those process changes largely as risk management or risk evaluation changes where we have the opportunity to look at deals that are flowing through our sales pipeline and score them for what we believe the risk and reward and effort will be to engage with a certain client and what we're looking for and we're able to score for our clients that are relatively low effort and low risk and hopefully have the potential for high reward that clearly defines the sweet spot for us, if we see clients that are in that quadrant from a scoring perspective we want to move them quickly through the sales cycle put a focus on winning those deals because clearly that that's a sweet spot. But we also want to recognize where we see clients that are high risk and high reward because they still might be very interesting to us but require additional focus and additional governance and additional executive oversight in order to make sure that we minimize the risk and we actually realize the reward and so we've already seen some really interesting results by implementing those process changes by being more rigorous in that evaluation. And I think that is actually going to help us reduce our overall cost of sales because we will spend less time with opportunities that ultimately we're not interested in and be able to qualify them out of our sales pipeline earlier in the process and then just focus on the ones that really have the potential to generate reward at a lower risk profile. So it's a formal process that we're doing every two weeks where we're looking at the pipeline, making that evaluation and I don't expect that that will impact the conversion rate through our sales funnel. The back half of the sales funnel what we call state four and five, I do expect it will help us to qualify out deals that we wouldn't have wanted to engage earlier in the process which is helpful.

[Ryan MacDonald:]

Thank you. And then just, I guess one for Tom. As you look into 2017 and look at sort of the strength of the balance sheet and the capital structure, I mean how do you balance out sort of investing for growth within the company with also then paying down debt and if there's an ideal leverage ratio that you're shooting for I guess on the balance sheet, if you could give any commentary around that as well it would be helpful.

[Thomas Madden:]

Okay. So as we take a look at our capital expenditure requirements for this coming year, I provided guidance earlier that it's expected to be somewhere between $9 million to $12 million, we would expect a portion of that to be funded by cash and then also would expect some of that to be funded by either debt or capital leases as we go forward. As we look at each of those expenditures, we always try to evaluate the types of things that it's needed for usually what we have is a certain amount of let's call it kind of $2 million to $3 million a year of what I would categorize as maintenance type CapEx just to keep the world class capabilities up and running properly throughout our infrastructure whether it's IT call center or DC. We would expect some kind of internal development activity for certain of the capabilities that we have and then we would expect others to be related to new client opportunities as they go forward. So we do look at a kind of IRR analysis to ensure that the investments that we're making are appropriate. From a calendar year 17 standpoint, you know, my expectation is that we will be generating free cash flow in the business of somewhere around $4 million to $8 million. The expectation would be that that would be utilized to reduce our debt structure through the year.

[Ryan MacDonald:]

Excellent, thank you very much.

[Operator:]

[Operator Instructions] We'll now go to Kevin Kopelman with Cowen and Company.

[Kevin Kopelman:]

Hi, thanks a lot. Just a couple of quick ones. First, just to help us with the Molly [ph], could you - could you let us know how much contribution you got in 2016 from the contract that you're exiting in terms of revenue and EBITDA and even bookings if you could? And then I have a follow-up.

[Mike Willoughby:]

Okay. Unfortunately we don't give specific guidance input on specific clients like that so I can't share with you the revenue makeup of that particular client. So I apologize for that.

[Kevin Kopelman:]

Sure. Let me ask it a different way which is - I think you lowered the revenue guidance by $5 million to $10 million, was that - is that all from - is the change entirely from the expectation of exiting engagements, not just sort of particular client but in the broader sense that you're discussing?

[Mike Willoughby:]

Yes, that would be the primary reason for the change is - we'll put not only this particular one client but also kind of a change in some of the other lower margin engagements that we expect this year.

[Kevin Kopelman:]

Okay. And then my second question is just - just as we are here today, it's a couple weeks from the end of the quarter; can you give us an update and - you know, it's part - I think you're into kind of the peak booking season, can you give us a sense of what we should expect for bookings or what you've seen quarter-to-date in terms of bookings? In Q4 the number was kind of flattish on a year-over-year basis; what are you seeing so far for Q1?

[Mike Willoughby:]

In the preparatory comments I indicated we feel like we have a really strong platform or strong pipeline, the Q1 and Q2 were actually technically that sort of height of the selling season. So it will be really interesting to see what closes out over the next two or three weeks versus kind of what closes out in the first part Q2. And we're not in the business of sort of preannouncing a quarter but I would say that if I look at how I felt about Q1, particularly the professional services pipeline in Q1 last year versus this year; you know, we're feeling very optimistic and we're feeling like we have a strong pipeline; so it's looking good. You probably will expect less recurring revenue bookings this year, kind of with the emphasis on professional services and just tighter focus on looking for high margin opportunities, even in our BPO and based on what I'm seeing right now; I think there will be more contribution from current clients versus net new that we might have seen last year. But we still have a long way to go in our selling season.

[Kevin Kopelman:]

Okay, thanks Mike.

[Mike Willoughby:]

Thank you.

[Operator:]

And we'll go next to Tim Klasell with Northland Securities.

[Tim Klasell:]

Good afternoon guys, just a few quick questions and I'm sorry I had some technical difficulty, so I missed a couple of these. First, you talked about the land and expand, maybe you could remind us what the - sort of the timeframe is when you sort of land a smaller and more point type project and expanded to the end-to-end, how long does that normally take? Are you foreseeing any shift in that as you begin to sort of focus a little bit different type of projects if you will with that cycle?

[Mike Willoughby:]

It's an interesting question and - you know, there is no stereotypical profile that I could give you; I can talk about some trends. It really depends on what the entry point is with a client and where they are in their kind of overall journey with regard to putting a commerce program together. The earlier that we're able to engage with the client in decision-making. So if we're able to engage with the client in a strategic way with a consulting engagement; what generally happens is that you end up with a steady stream of additional work that serves to increase the intimacy of the relationship and the stickiness that we have and has the most potential to create in a linear fashion an end-to-end type relationship. Whereas if the engagement begins with say an operational opportunity like they are switching fulfillment partners, then - to an extent your so swimming upstream and you're having to present a value proposition to a client who's probably already got a lot of pieces in place. And so maybe it's a little bit harder work but you're starting out with a much chunkier revenue base. And of course the operations services that we offer have their own type of stickiness, usually in the form of a long-term contract. So what we would really want to see is an increasing number of professional services engagements where we are helping to evaluate approaches and platforms, and to be involved in towards the innovation aspect of a program and then from that point just continue to present the rest of the service offering; and I would expect where we can grow from the services, ad agency services, help them with the technology re-platforming, that's the best path and the most predictable path to ultimately being end-to-end. And in that scenario it could be anywhere from six months to 18 to 24 months of time where you're stitching together the project opportunities and ultimately kind of be at the right place at the right time when the other changes might happen to allow you to pick up the entire scope of service.

[Tim Klasell:]

Good, helpful. And then the next question, you owe - your revenue expectations for '17 are obviously a bit lower but the EBITDA is holding, so the revenues loss for our - we're probably, roughly zero margins let's say. Did that all come from the one client where you disengaged or was that your - you mentioned earlier about going through and maybe trimming their portfolio from lower margin type businesses or disengaging from some of the lower margin businesses. So the question is was [indiscernible] that impact or that lack of impact come from that one client or are there some other clients in that that you're deemphasizing?

[Thomas Madden:]

This is Tom. It's a combination. As I said earlier, the - obviously, the one client transition does impact us from a top line standpoint and some of these other migrations away from some of the lower margin omni-channel client engagements that we have today is also impacting us from a top line standpoint but is having minimal impact to us from a bottom line standpoint.

[Tim Klasell:]

Okay. And then one of the one - I'm sure you probably hit this; obviously the client you - the one client you're disengaging with, what will they be doing going forward? Are they bringing it all and how are they doing something else?

[Thomas Madden:]

So we are not completely certain of the detailed plans but I think from a fulfillment perspective, we expect they are going to transition to a different third-party provider. Hopefully, one who has more experience and a portfolio of clients that have it similar kind of product categories what they have versus the verticals that we are supporting today. But I believe it's to a different third-party provider.

[Tim Klasell:]

Okay, good. Thank you.

[Operator:]

And at this time this concludes our question-and-answer session. I would now like to turn the conference back to Mr. Willoughby for closing remarks.

[Mike Willoughby:]

Thank you, Lisa. And I would like to thank everyone that attended the call today. We remain incredibly excited with the many development in our business. We look forward to moving past this one client engagement and leveraging our resources in a better way; and we also look forward to speaking with our investors and analysts - really just around the corner when we report our first quarter results in May. In the meantime, as I said earlier, we will have opportunity at various conferences to meet with you and we are always willing to jump on the phone and answer questions. So reach out to Tom and I if you would like to take advantage of that opportunity. Thank you and I hope everyone has a great day.

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. You may disconnect your lines at this time. Thank you for your participation.