PFSweb, Inc.
Q3 2013 Earnings Call Transcript

Published: 14 Nov 2013

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the PFSweb Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. I'll now turn the call over to Garth Russell of KCSA Strategic Communications. Please go ahead, sir.

[Garth Russell:]

Thank you. Before turning the call over to management, I would like to make the following remarks concerning 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 and may involve and are subject to risks, 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 may also present certain non-GAAP financial measures, such as EBITDA, adjusted EBITDA, non-GAAP net income, Service 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 website at pfsweb.com, you can find our definition of these non-GAAP financial measures, our 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 for the benefit of investors and should be considered in addition to and not instead of GAAP measures. At this time, it is now my pleasure to turn the floor over to Mike Willoughby, CEO of PFSweb. Mike, the floor is yours.

[Michael C. Willoughby:]

Thank you, Garth, and thank you, everyone, for joining us on today's call. Let me quickly outline the agenda. I will begin with an update on the key highlights from our third quarter. And following my remarks, Tom Madden, our CFO, will take you through an overview of our financial performance. We will then open the call for questions. As we have previously stated, 2013 is a transition year as we restructure our operation and feel the impact from the loss of certain client programs. We've also said the third quarter of this year would be the revenue trough of this transition period before we saw sequential improvements in the fourth quarter, as we realize increased benefits from new and expanded client relationships and seasonal client volumes. Taking these factors into consideration, our performance for the September 2013 quarter was generally in line with expectations. As a result, we're reiterating our previous guidance of 2013 Service Fee Equivalent Revenue of $110 million to $115 million, adjusted EBITDA of $9 million to $10.5 million, and we currently expect to be toward the higher end of the range for both targets. Now turning to a new business update. The highlight of the quarter has to be the signing of the contract with the United States Mint. This contract is for the design, development, deployment and operation of an end-to-end omni-channel commerce solution for their numismatics business. We've already begun the discovery and design portion of the deployment phase of the project, with an expected launch in the third quarter of 2014. Our 10-year contract with the United States Mint consists of

[Thomas J. Madden:]

Thank you, Mike, and good morning, everyone. I want to spend a little time providing some additional color on the September quarter results reported earlier today, as well as the preliminary view into 2014. Before doing so, I want to remind everyone, especially newcomers, to our PFSweb story, that when we provide our discussions about our financial results, we often discuss our Service Fee Equivalent Revenue activity. This metric is calculated by taking our service fee revenues, which is the primary business activity we perform, and adding the gross margin on our product revenue business, so that both businesses can be measured on a similar service fee basis. For our service fee business, while we experienced a decrease in revenue on a sequential and year-over-year comparison basis due to the client transitions, we generated solid growth from new and expanded client arrangements. Our overall gross margin for our service fee activity was approximately 32% for the quarter as compared to approximately 26% last year and as compared to our targeted range of 25% to 30%. This strong September 2013 quarter gross margin result was driven by increased level of higher-margin professional and technology services, including project work, as well as operating efficiencies. In addition, the service fee gross margin in the September 2013 quarter included an incremental benefit of approximately $0.2 million due to certain client transition-related agreements. We continue to target an overall gross margin of 25% to 30% on existing and new service fee clients, and we expect to perform within this range for the remainder of this year. We do remain focused, however, on increasing the level of higher-margin service fee activity, including our professional services model and technology-related services to help offset what can often be lower gross margin activity in certain more commodity like service areas of the business. For our product revenue business, as expected, we also saw a decrease as compared to the prior year, due to the impact of the restructuring activity by our largest client in this segment. Gross margins in this business also declined somewhat due to a higher percentage of our product revenue being generated from lower gross margin product categories. Our SG&A increased somewhat as compared to the prior year, primarily due to an increase in personnel-related costs, including health care costs, and also increased facility-related costs and an increase in noncash stock compensation expense. Looking forward, we are continuing to work on optimizing our cost structure to increase efficiencies and operating leverage as we go forward. As we turn to the balance sheet, our total cash and cash equivalents as of September 30, 2013, was approximately $21 million, and our total debt was approximately $12 million. As a result, our net cash-to-debt position as of September 30 stood at approximately $9 million positive, which is relatively consistent with where we were at the end of June. As you may recall, our overall net cash position was strengthened in May of this year by the cash infusion from our $14 million equity raise put forth to our strategic alliance with transcosmos. Mike already covered our outlook for quarter 4 of 2013, as well as our full calendar year of 2013, so I won't go through those again, but instead, we'll provide some initial guidance for next year. As we look towards 2014, we expect to complete our recovery from the impact of the previously announced client transitions as we begin to benefit more from the 2013 restructuring activities and the onset of new client contracts, including the United States Mint. At this time, while we continue to work with our clients on their 2014 projections, our preliminary outlook is that we are targeting 2014 Service Fee Equivalent Revenue to be in the range of $127 million to $133 million and adjusted EBITDA to be in the range of $12 million to $14 million. Here are some additional insights on our guidance for 2014. First, the 2014 service fee revenue target reflects an estimated increase in fees generated from our current and projected new clients of more than 20% as compared to 2013. Our gross margin for the service fee business is expected to be within our targeted range of 25% to 30%. Our product revenue segment is expected to continue decline approximately 20% in revenues on a year-over-year basis and operate at a gross margin level of approximately 6%. We are driving toward maintaining our SG&A level relatively constant with the current year performance, excluding the restructuring expenses in 2013, even with the targeted higher Service Fee Equivalent Revenue expected. Depreciation expense is expected to increase moderately as compared to 2013. From a quarterly perspective, with the anticipated launch of the United States Mint contract in the last half of 2014, we also expect the new contract revenue to be substantially backloaded during the year. While this is expected to result in a strong run rate in revenue and adjusted EBITDA profitability as we exit 2014, our year-over-year quarterly performance comparisons in the first half of 2014 versus the similar periods in 2013 will be down until we fully anniversary the impact of the client transitions from earlier this year. Now I'd like to turn the call back over to Mike for some closing remarks. Mike?

[Michael C. Willoughby:]

Thank you, Tom. I wanted to briefly comment on our investor relations activity. Over the past several months, Tom and I had racked up some serious frequent flyer miles, traveling the country to present at investor conferences and non-deal road shows. We met with a cross-section of investors, retail and institutional, generalist and sector specific, value and growth, large asset base and small, and we come away from those meetings encouraged by the support we've received as we work to unlock shareholder value. We're also appreciative of the feedback we've received on ways we can better articulate our value proposition to the investment community. And as we head into the final stretch of 2013, we plan on continuing to be aggressive in our investor relations effort. This management team is committed to increasing transparency and visibility into our business, and we look forward to continuing our dialogue with the investment community. I'd like to thank everyone that attended the call today, as well as thank our employees for their hard work in delivering the highest levels of service and value for our world-class customers. We're incredibly excited with the positive developments in our business, and we're fully committed to delivering the best possible returns for our shareholders. This concludes our prepared remarks, and I'd like to open up the call for questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of George Sutton of Craig-Hallum.

[Jason Kreyer:]

It's Jason on for George, actually. Mike, you talked on the call about the one customer in project Atlantic, you gave an update on the progress towards last quarter. I'm just wondering if you could talk a little bit more about where you're at in signing that customer up and bringing them on to the U.S. platform and kind of what more needs to be done with that customer?

[Michael C. Willoughby:]

Sure. Well, we did update, last conference call, that we were moving them through the pipeline. Today, we updated that we were in contracting with that client, which means that the nature of the engagement has been defined and the proposal work is done and now, we're really just talking about some contract details. As you might imagine with the first client in this category, there were some additional details to work out compared to what we might have seen with a typical small client coming from the U.S. But I think we're making good progress on that deal and -- this particular quarter, we had a little bit of color around how they're positioned and that they are a luxury products category manufacturer. They have a nice business in Japan, fairly recognized brand there. And we look forward to helping them launch this brand here at the U.S. That means the initial expectations for the contribution of this client will be modest. But there is a nice potential with the brand. So we're basically at the finish line with that small Asian brand deal.

[Jason Kreyer:]

And I think, last quarter, you had said that the customers wanting to be up and running ahead of the holiday season. Is that still the case?

[Michael C. Willoughby:]

Clearly, that would be a very difficult thing to do. They reset their expectations for a launch in early Q1 and, I think, as they set their marketing plans appropriately. I'm not sure that the holiday would have necessarily been a big benefit for them as they're launching this brand in the U.S., but we're certainly supporting their current plans for a launch in early Q1.

[Jason Kreyer:]

Okay, perfect. And then kind of to take the other side of that. So you talked about the other customer that you are in talks with in the project Pacific, and just wondering what more needs to be done to the platform there to integrate some existing transcosmos customers? Are there more investments you need to make in the platform? Are you kind of ready to go to accept their customers at this point in time?

[Michael C. Willoughby:]

Right. So just to be clear, the opportunity to onboard clients into the solution beginning in China really has more to do with our current clients or prospects in our pipeline and less to do with clients that are currently clients of transcosmos. So the process that we've been going through is two-fold. One is making the appropriate changes to our technology platform to operate in China, which has to do with integrating with the appropriate gaming gateways, performing some localization work such that the important screens or pages in a website that customer service agents would use or personnel that are interacting with the system in China are presented in the appropriate language, with the appropriate character set. That's all kind of technical work that needs to be done for deployment. We had indicated before that, that effort, we thought, would sort of take through the end of this year and into the first part of next year to do the technical work, and that's going according to schedule, according to expectation for us. The second component is to work with our client base to find a client that was willing to be the first to launch into China. Our pattern has always been when we're doing major initiatives to partner with a client that's willing to go into a new geography or into a new program like we just did with Roots of Canada on our omni-channel solution. And partner with us in, to an extent, experimenting or piloting the launch. And we believe that we have a client who's very interested in being the first, that is willing to travel that journey with us, including probably a few bucks along the way. But we've been very successful in taking that approach in the past and once launching a client, moving to expand with other clients, once you kind of worked out the wrinkles. So hopefully, next conference call, we would have an update where we're able to actually talk about the client and a more tangible roadmap. But I would say, generally, we're on track with what we indicated earlier around our expectations to launch clients in China next year.

[Jason Kreyer:]

Okay, great. And then just the last one for me. I know you guys have opened up some capacity in your data centers, and maybe this one is better for Tom. But just wondering if you could talk about what kind of incremental margins do you expect to recognize as you sell into that available capacity in the DCs?

[Thomas J. Madden:]

Sorry, can you repeat the question? Did you say the technology centers or the data centers -- or the distribution centers?

[Jason Kreyer:]

Sorry, the distribution centers. I know you have some capacity there and I would assume that as you fill that capacity, you can have higher incremental margins than you're currently recognizing, correct?

[Thomas J. Madden:]

That's correct. But sometimes, from a financial reporting standpoint, we put some of that underutilized costs in SG&A as opposed to in cost of fees. And as it gets utilized to support clients, it gets reclassified up into cost of fees. So it may not necessarily have an impact on gross margins, but it will have an impact on our adjusted EBITDA and profitability as we're able to bring more clients on, utilize that existing space to support those clients and generate the incremental fees applicable to it. So from an operating income standpoint, those new client activities will clearly help us as we are able to fill up those -- that space capacity.

[Operator:]

Your next question comes from the line of Mark Argento of Lake Street Capital.

[Mark Nicholas Argento:]

I wanted to spend a little time better understanding the potential pipeline or pipeline of new business, and in particular, your relationship with Demandware. Clearly, Demandware is growing rapidly given some of the reported numbers, and it looks like they've been a great partner for you guys. Can you talk a little bit about your sales group and how you guys interrelate with Demandware? Does Demandware bring opportunities to you? Do you bring opportunities to them? Maybe talk a little bit about kind of the RFP process and how you guys actually win business.

[Michael C. Willoughby:]

Sure. One of the challenges when we're talking about our sales process is trying to generalize because every engagement actually is different and unique, so generality sometimes are challenging. But I think describing our relationship with Demandware, it's a very strategic relationship. I think it's a very synergistic relationship because the services that we can provide in an end-to-end model, I think, are very compelling for certain clients, particularly those that are in our core categories. And so when Demandware is with their substantial sales force, and sales and marketing resources are out in the market talking to clients that are ready to re-platform from a smaller end-to-end provider or a direct competitor of ours, or when as the Demandware sales reps are talking to prospects and are hearing the kind of requirements that would indicate that an end-to-end model -- a full-service model is appropriate. We certainly are the go-to provider here in the U.S. to help them to engage and win those deals rather than seeing those deals go to a competitor with an end-to-end solution and a different platform. So we do see lead generation activities from Demandware. We are certainly taking responsibility for our own lead generation activities in the market and in constant communication with prospects that we believe are appropriate for our model. As indicated with our L'Oreal relationship, we also have opportunities with Demandware where there's a direct relationship with them or the platform, but we still can provide all of the rest of our services wrapped around that direct relationship and provide a lot of the value proposition associated with End2End, even though the client might have a direct relationship with Demandware. I actually wouldn't be surprised to see that kind of engagement increase over time as Demandware continues to expand up market and to offer more and more services that are targeted at supporting large enterprise clients. We're fine with that. We think that our value proposition in that scenario is very high. If you also listen to Demandware and their objectives going forward, they definitely are looking to focus upmarket and enterprise class, which is very consistent with our strategy. They're also looking to increase their efforts in Europe, to take advantage of a very nice opportunity there. That's also aligned with our strategy. One of our direct competitors in Europe is having difficulties, which creates a competitive opportunity for us, and we're looking to capitalize on that opportunity in the marketplace. So I think we're very well aligned. We cooperate in our sales cycle appropriately to jointly engage to win deals. And I certainly see Demandware as being an important part of our strategy going forward as we look at these -- both mature markets and emerging markets together.

[Mark Nicholas Argento:]

Do -- is there -- is the vast majority of your End2End implementations, are you using Demandware? Or will you use other types of eCommerce engine platforms when you do your implementations?

[Michael C. Willoughby:]

Sure. So when we do an End2End engagement, it is always going to be on the Demandware platform. That's the platform that we resell and support as part of our End2End. So that being said, if you look at our current 81 programs, 38 of those programs are on the Demandware platform, either because we're reselling the platform as part of our End2End offering or the client is direct with Demandware and we wrap the rest of our services around that. So 38 of our 81 engagements involve Demandware, either as us a reseller or us participating with that direct relationship. That being said, then we have several other platforms that we have active integrations with, including Magento, IBM Websphere, Hybris and ATG, as well as a couple of other in-house-type platforms that clients have operating. So we have the ability to engage with all of the rest of our services around another platform and frequently do that. In those scenarios, we're not reselling the platform or currently providing any development assistance around that platform.

[Mark Nicholas Argento:]

All right, that's helpful. And then switching gears to some of the new customer wins. Of course, U.S. Mint, nice win, sounds like that will hopefully impact second half of '14. And Tom, I just want to make sure I understood, so in your comments, your prepared remarks, did you say that the front half of 2014 should be down year-over-year relative to the second half of the year as some of these new contracts kind of kick in?

[Thomas J. Madden:]

That's correct. So as we look at -- until we fully anniversary the transition activity from some of the clients from this year, those -- some of those clients still contributed to us in Q1 and Q2 and to a small extent in Q3. So until we fully anniversary those client transitions away, we're still going to see in the early part of next year, from a comparative standpoint with the same quarter of 2013, a downward trend. But on an overall basis, as we then start seeing the full impact of these new client activities, including U.S. Mint started in -- especially in Q3 and Q4, we'll see a nice ramp up there from a top line and bottom line standpoint.

[Mark Nicholas Argento:]

And then could you remind us on the -- on your relationship with TJ Maxx? How many sites do you have up and running right now, and what's the opportunity there?

[Michael C. Willoughby:]

So TJX Companies chose to launch the TJ Maxx brand site first on the program, which makes sense. It is the cornerstone brand. Their approach is to do this the right way and to be excellent in every aspect of it. So I think they are being appropriately conservative in the rollout. As we indicated on the conference call, there is the potential for additional brands to come onto this platform. And if you look at the TJX portfolio, certainly, Marshalls is a great addition to that portfolio, having a very similar product category as TJ Maxx. We're quite excited about the potential of the HomeGoods brand joining that portfolio, being in a different product category and having some different sort of inventory dynamics and financial profile. So that's exciting to us. We would characterize that as a potential at this point because we don't have a committed schedule, but I think it's fair to say that TJX is committed to the online channel and use this as a very strategic opportunity for them to support their brands.

[Mark Nicholas Argento:]

Okay. And then shifting gears to kind of the OpEx or expenses. You guys have done a better job. It looks like of controlling the expense in terms of the SG&A. Although I still -- I'm on the understanding that a decent chunk of that $44 million, $45 million a year that you're spending in that SG&A line is related to -- it isn't just corporate overhead, but it's related to the supporting the business and in terms of more -- almost like a cost of goods. Is there any way we can get a better idea of what kind of your corporate overhead expenses are relative to the cost to support the business? Because just on its face, $40 million, $45 million relative to $130 million or $120 million, $130 million Service Fee Equivalent Revenue line and kind of a blended 20% gross margin business. Just trying to see how there's more leverage or how the leverage kind of develops in the model a little bit more. Could you talk a little bit about what's in that $45 million? Are you pre-spending? Are you -- do you have excess capacity in that number in terms of additional warehouse space? Maybe you could kind of crack that number open a little bit if you could.

[Michael C. Willoughby:]

Okay. So the -- you are correct, the $45 million for this year does -- first of all, that number does include some restructuring charges earlier this year, so the real run rate is somewhere in the low $40 million range. As we look at that, while it includes our corporate overhead fees in sales and marketing and IT, there are other costs that are included in that business that are associated with readying the business and supporting our clients. And as I indicated earlier, there is also some, to the extent that a facility is somewhat underutilized because it's not full yet from a client standpoint, some of those costs that are not being utilized, we allocate to SG&A as opposed to cost of fees. If you talk to different companies, they're going to allocate things a little bit differently. We feel like ours is an appropriate way of measuring our client profitability and keeping track of SG&A. As we look to the future, it's really our objective to minimize any future SG&A increases from the level that we've got today and grow the top line of the business -- incremental service fees and the gross margin contributions from those with just minimal increases from an SG&A standpoint. And as my guidance for 2014 indicated, our objective next year is to kind of hold the SG&A line relatively in check as compared to 2013, even on a revenue number that, depending on the range, is somewhere 10% to 12% higher on a year-over-year basis. So our -- it's a focus of ours to ensure that we continue to monitor that closely and control those costs. We also, as we explore the business, we have to keep in mind that appropriate investments are being made in order to support the long-term growth of the business. So we've got investments in sales and marketing and other areas, in implementation and costing that we believe are the appropriate investments in order to support the long-term growth opportunities that are out there for us. So to continue the balancing act that we play, to ensure that in the short term, we're creating the right financial results for us but also in the long term, making sure that we're taking -- in a position to take advantage of the opportunities that are out there in the -- both U.S., Europe and now, China marketplace.

[Operator:]

Your next question comes from the line of Wilson Jaeggli of Southwell.

[Wilson S. Jaeggli:]

Help me here a little bit with your pipeline and how you define that. You're talking about $45 million in annual -- average annual contract value. Is this -- is that just applicable to your current customers?

[Michael C. Willoughby:]

No. So the pipeline consists of opportunities that we have where we have delivered a proposal to a prospective client, and that could be a brand-new client to us that we're not currently engaged with or it could be a client relationship that we have where there's a new opportunity in a different geography or with a new brand, supporting a new brand with a new program. So it's a mix of current clients and new clients...

[Wilson S. Jaeggli:]

And so it's not organic growth in your current relationships?

[Michael C. Willoughby:]

No. It's incremental growth. Even if you're talking about a current client, it's for a new brand or a new geography.

[Wilson S. Jaeggli:]

Understand. And this is kind of what, is this a projection over the next 12 months?

[Michael C. Willoughby:]

So the average annual contract value is based on client projections for a full year. It depends on whether you're looking at a contract of 3 to 5 years, sometimes it's kind of the midpoint. We have to look at whether this is a mature business that we're on-boarding or a startup-type opportunity and try to have a reasonable estimate of what the average annual contract value would be over the life of the contract. So there's a little bit of work to do in arriving at the estimate, but we start with client projections that are delivered to us.

[Thomas J. Madden:]

And again, as Mike indicated, it represents a 1 year of revenue for those clients if we were to win those debt client arrangements.

[Wilson S. Jaeggli:]

I got you. And so it dropped down from $55 million in the previous quarter here because of the signing up of U.S. Mint?

[Michael C. Willoughby:]

Correct. So once we sign a contract with a client, we move it out of this pipeline number. So now, we're implementing the deal. The deal is not actually going to go live until Q3 of next year, so it's going to take us the next 10 months to implement the deal. But it's contracted and so it will move out of this pipeline. And if you look at the range, we kind of indicated for the average annual contract value, you would see that we've replaced -- partially replaced that deal in the pipeline with other incremental deals.

[Wilson S. Jaeggli:]

Right. I guess you're talking about the U.S. Mint not kicking in until the third quarter, having a potential revenue of $17 million to $20 million. So I guess you would have some revenue in the third quarter and then you would have it ramped up fully in the fourth quarter with the U.S. Mint?

[Michael C. Willoughby:]

That's our expectation.

[Wilson S. Jaeggli:]

Okay. And so that is a negative that gets subtracted here from your pipeline. Help us here, a little question, a little more info on the TJ Maxx contract which is, obviously, it seems very exciting. When would that go live?

[Michael C. Willoughby:]

Well, the TJ Maxx site launched in October, I think.

[Wilson S. Jaeggli:]

October of next year?

[Michael C. Willoughby:]

No, this year.

[Wilson S. Jaeggli:]

Okay. You've gone live here on October?

[Michael C. Willoughby:]

Right. The site is live. It's launched. TJX, their ambitions were to have the somewhat soft launch without doing a lot of publicity. So it was a fairly quiet launch. Although, the day after their launch, I think the Boston Globe picked up on the fact that they were online again and wrote a big article. And so there was a little more buzz around the launch than maybe what TJ Maxx was expecting. But from that point, they have, as I said, had a fairly conservative rollout as they looked to really make sure that they're doing everything with excellence. And so the site is live, and we would expect it to ramp up gradually over the next year to 18 months.

[Wilson S. Jaeggli:]

Year to 18 months. So you don't have all their current product on your site yet?

[Michael C. Willoughby:]

No. If you were to go shop the site, you would see limited categories, mainly women's fashion. So there's lots of opportunity for them to expand categories in that product as they ramp up the program.

[Wilson S. Jaeggli:]

Okay. Can you give us a range of what service revenue potential might come from this relationship?

[Michael C. Willoughby:]

No, I can't. We typically don't break out on a client-by-client basis. Even the communication we've done with the U.S. Mint is a little unusual. But because the Mint is a government agency, there had been some indication of the contract value that was already out there, so we needed to make sure that we provided a realistic estimate. It's also challenging on a startup-type deal on what TJX did to pinpoint that, so we haven't broken that out.

[Wilson S. Jaeggli:]

I see. That's too bad. I hope you were starting a new trend here. Tell me, if you would, the history of the TJ Maxx, had it gone silent for a while, gone dark? Or did you win it from a third-party or was this an in-house service that TJ Maxx offered?

[Michael C. Willoughby:]

No. So the TJ Maxx site, they were not online prior to the launch of the site. They had been online for a brief time, I think, back in the 2007, 2008 timeframe. The program did not meet their expectations. They also had some issues, you may remember, around the same time around data privacy concerns in their store Point-of-Sale systems. Yes, so TJX took that opportunity to kind of reset and look at how they could be online with excellence and have a commanding presence in their sector online. And their relaunch was very well done, making sure that there were no opportunities for stumbles or not doing it 100%. So...

[Wilson S. Jaeggli:]

Okay. And previously, when they had their site up, it was done internally?

[Michael C. Willoughby:]

I'm not sure of all of the...

[Mark Nicholas Argento:]

Not sure of the history?

[Michael C. Willoughby:]

The history of that.

[Operator:]

Your next question comes from the line of Scott Tilghman of B. Riley.

[R. Scott Tilghman:]

Wanted to touch on 3 things, and I'll throw those all out up front. First, just on the design and implementation process with the new customer wins. Wondering what, if anything, you're getting in terms of upfront monies during that process or if everything is deferred until you actually go live. Related to that, with some of these new programs, are you getting guaranteed minimums beyond just the cost of implementation or not? And then just third, thinking about the new customers that are coming to you versus some of the other solutions out there, essentially going direct to their customer base rather than choosing to partner with one of these more virtual-mall-type operators, your big competitors, what rationale are they given -- giving for making that choice?

[Michael C. Willoughby:]

I'll let Tom take the first 2 and I'll take the third, okay?

[Thomas J. Madden:]

So from a startup standpoint, our objective is to be paid by our clients for the effort that's involved with the startup activity, applicable to launching the new site, and the integration effort that go along with integrating our systems and theirs and setting everything up. So that's generally our target. Sometimes, we'll do things a little bit differently there, but generally, our cash flow is somewhat neutral with the cost and the startup activities that are involved. We are -- once that happens, we generally recognize the bulk of that startup-related activity on a amortized basis over the life of the contract. So to the extent that it's a $500,000 startup and it's a 3-year contract, we'll recognize both the revenue and cost over that 3-year period.

[R. Scott Tilghman:]

So you're not seeing any difference in the contracts today versus what you've seen over the last couple of years?

[Thomas J. Madden:]

I guess the thing that would have changed over the last several years is that the start-up amount and activity level has increased as we've deployed more of an enterprise full End2End solution and taking to account our full scale of offering. So the upfront activity and cost and revenue that we experienced, applicable to the startup is higher than where it would have been previously. And so that means there's a little bit more ending up on the balance sheet getting deferred. On your second question in regards to the guaranteed minimums. We generally do have is some type of minimums in place in order to ensure that on an ongoing basis, that we're getting paid at least for the infrastructure requirements that are out there to support the client, regardless of whether they -- if volume expectations are met or not. So we usually have minimum storage footprint fees, account management support and other components that are tied into the contract. So even if the volume is significantly lower than the original expectations, we're still, at least, feels like we're in position to cover most of the cost activity in the business.

[Michael C. Willoughby:]

So with regard to the third question, kind of talking about competitive landscape and when a prospective client is evaluating operating their own eCommerce initiative by leveraging our solution versus the option that they may have to sell through a site like Amazon.com or eBay. First, the first criteria, I think, that we see our client is making a decision based on his brand support. So most of our clients, if we look at the product and categories, are very interested in making sure that their brand is handled in an appropriate way. The website is a very customed -- customer touch points are highly branded, and you simply can't get that same brand experience through a large retail site like Amazon offers. Whether that's the website look and feel, the interaction with the customer, whether it's calls that may come in the call center that need to be handled or whether it's even the package and the way it's delivered, giftwrapped and that sort of thing. So brand support is kind of the #1 criteria that helps a client determine whether they want to go with large retailer versus a custom branded solution. Second, I think, criteria is the customer relationship itself. So when you're selling through a retail site like Amazon, the customer is an Amazon customer. And when you're selling through your own site that we operate, it's your customer, and so you have all the data, you own the transaction, you're able to opt them in to your e-mail list and market to them. And none of those things are possible if you're selling through an online site like Amazon where they own the customer, they're opted in to their e-mail list and et cetera. That said, many of our clients do view Amazon or eBay as an alternate channel and an opportunity to partner with them, particularly on end-of-life product or products that they want to clear out, and they want to do that using them as an alternate channel. And so we have active connections with both eBay and Amazon as we're assisting our clients to move primarily end-of-life product out using them as an alternate channel. And right now, the biggest opportunity, I think, that we have with our clients, as you maybe aware, particularly, Amazon has announced that they're building warehouses all over the country in order to promise enhanced service levels for delivery. So you can get your product the next morning or have a courier deliver even the same day because they're building these warehouses all over the country. We have an opportunity to help our clients that are multichannel clients, and most of them are, to leverage their in-store inventories to deliver a similar service level without having to have the increased working capital to position inventory in warehouses all over the country. So we think we have a real opportunity to help our clients compete with that, provide a similar service level at a lower cost and still preserve their branding of the experience.

[Operator:]

And your next question comes from the line of Glenn Primack of PEAK6.

[Glenn Warren Primack:]

First question, within your 2014 guidance, is there an implied revenue stream at all from that first client win in China, or potential client win in China?

[Michael C. Willoughby:]

Right. There's really not, at this point, any benefit projected in that guidance. We haven't gotten to the point where we would be in a position of estimating the revenue. As you might imagine, it's a startup, we knew that these opportunities would be for startups, and so I'm not sure how much we would expect to have contributed in the first year. But there's nothing in the guidance from that at this point.

[Glenn Warren Primack:]

Sure, that's great. And then on the gross margin front, as you continue to roll out your suite of professional and technology work, do you expect that mix to improve so that your gross margins potentially improve as you go through, let's say, I don't know, '15 or '16?

[Michael C. Willoughby:]

Yes. If we -- even as we take a look back over the last couple of years, you'll see that our gross margin percentage has improved somewhat in our service fee business, as we've experienced a higher percentage of our activity coming from technology and/or the professional services. So our current target continues to be kind of 25% to 30% range. We would like to see an opportunity for us to continue to trend upward there. There's always going to be some pressures on the other side of the business with some of the lower margin, more commodity-like characteristics. But if it can continue to drive a higher level of professional fees and technology services, it should end up resulting in an improved overall gross margin for our service fee business.

[Thomas J. Madden:]

That would be -- that would certainly be true of the way that we project the sort of organic growth of the business. We've also said in the past and we'll say here that we have an opportunity to accelerate that lift that we would get through M&A activities. So to the extent that we execute on a plan to acquire a digital agency or a technology services company, and that already has a revenue stream coming in at a much higher margin, then we have the opportunity to integrate that into our business model and affect our gross margins that way as well. And it certainly is a part of our strategy as we look at our 4-year plan that we're in the middle of executing.

[Glenn Warren Primack:]

That's super. I'm not really concerned with '14. As I look forward into '15 and beyond, I mean, if you just continue to kind of execute on your plan, the stock should probably take care of itself. I don't think you really need to spend a lot of time on the road meeting with investors because the tough period, it seems like it's behind you, and it seems like the combination of your strong paddling and decent current at your back is taking your canoe down the river pretty quickly.

[Michael C. Willoughby:]

Well, I appreciate that.

[Glenn Warren Primack:]

Yes. So specifically, I mean, like the EBITDA guidance that you're given for '14 shows some pretty nice operating leverage. And so if that continues a little bit more into '15, the EBITDA gets closer to $20 million, just on my back of the envelope stuff versus in '10, then I put 10x on that, and that's like almost a double on your stock.

[Thomas J. Madden:]

Right. And as I indicated...

[Glenn Warren Primack:]

That's a pretty easy story. Given all the hard work that I know goes into it. I know it's not simple but...

[Thomas J. Madden:]

Yes. We wish it was that easy. But as I indicated in my comments, especially with the new contract activities that is going to benefit us later part of next year, we feel like we're going to exit 2014 with a strong run rate, from both the top line and bottom line standpoint, that would hopefully fuel continued strong improvement in our EBITDA performance as we look into 2015.

[Glenn Warren Primack:]

Yes. Sure, Tom. I mean, you know how this works. As you go through '14, people will start looking out in '15. So stock kind of work more off of what that following year looks like, versus what this one does when you get past all the noise and stuff. So if you just kind of keep your heads down and the productivity and the morale over there continues to kind of ramp, you're in pretty good shape.

[Thomas J. Madden:]

That's the plan.

[Operator:]

At this time, there are no further questions. I'll now return the call to management for any additional or closing remarks.

[Michael C. Willoughby:]

Okay. Thank you once again for participating on the call. As we've indicated, we have a very optimistic outlook. These new client wins are great for both morale and for our financial outlook. We will continue to engage with our investment community actively. We'll be out on the road talking about our plans and sites we have in our future. We appreciate your support. And if there are any questions that you have and you want to reach out to us directly, we would love to hear from you. Thank you, and have a great day.

[Operator:]

Thank you for participating in today's conference call. You may now disconnect.