e8vk
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): August 11, 2010
PFSweb, Inc.
(Exact name of registrant as specified in its charter)
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Delaware
(STATE OR OTHER JURISDICTION
OF INCORPORATION)
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000-28275
(COMMISSION FILE NUMBER)
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75-2837058
(IRS EMPLOYER
IDENTIFICATION NO.) |
500 NORTH CENTRAL EXPRESSWAY
PLANO, TX 75074
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(972) 881-2900
(REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE )
N/A
(FORMER NAME OR ADDRESS, IF CHANGED SINCE LAST REPORT)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the
filing obligation of the registrant under any of the following provisions:
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Written communication pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
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Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
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Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
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Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
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INFORMATION TO BE INCLUDED IN THE REPORT
ITEM 8.01. Other Events
On August 11, 2010, PFSweb, Inc. hosted a conference call announcing its financial results for
the quarter ended June 30, 2010. Attached to this current report on Form 8-K is a copy of the
related conference call transcript dated August 11, 2010. The information in this Report on Form
8-K, and the exhibit hereto, shall not be deemed filed for purposes of Section 18 of the Exchange
Act or otherwise subject to the liability of that Section.
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Exhibit No. |
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Description |
99.1
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Conference Call Transcript Issued August 11, 2010 |
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned hereunto duly authorized.
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PFSweb, Inc.
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Dated: August 13, 2010 |
By: |
/s/ Thomas J. Madden
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Thomas J. Madden |
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Executive Vice President,
Chief Financial and
Accounting Officer |
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exv99w1
Exhibit 99.1
Company: PFSweb, Inc. (Nasdaq: PFSW)
Subject: Q2 2010 Earnings Call
Date: August 11, 2010
Operator: Good morning. My name is Wes and I will be your conference operator today. At this time,
I would like to welcome everyone to the PFSweb Second Quarter 2010 Earnings Conference Call.
[Operator Instructions]. Thank you. I would now like to turn the conference over to Mr. Garth
Russell, with KCSA Strategic Communications. Please, go ahead, sir.
Garth Russell, Managing Partner, KCSA Strategic Communications
Thank you, Wes. 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 involve and are
subject to risks, uncertainties and other factors that may affect PFSwebs business, financial
condition and operating results, which include but are not limited to the risk factors and other
qualifications contained in PFSwebs annual report on Form 10-K, quarterly reports on Form 10-Q and
other reports filed by PFSweb with the SEC, 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 this call, we may also present certain non-GAAP financial measures such as EBITDA, adjusted
EBITDA, non-GAAP net income, free cash flow, merchandise sales and certain ratios that use these
measures. In our press release, the financial tables issued today which is located on our website
at pfsweb.com youll find our definitions of these non-GAAP financial measures, a reconciliation of
these non-GAAP financial measures with the closest GAAP measures, and a discussion about, about why
we think these non-GAAP measures are relevant. These financial measures are included for the
benefit of the investors and should be considered in addition to, and not instead of GAAP measures.
At this time, its now my pleasure to turn the call over to Mark Layton, Chairman and CEO of
PFSweb. Mark, the floor is yours.
Mark C. Layton, Chairman and Chief Executive Officer
Great. Thanks, Garth. Good morning, everyone. I would like to welcome you as well to our
Second Quarter 2010 Conference Call. Today, as usual with me Tom Madden, our Chief Financial
Officer and Mike Willoughby, President of our Service business.
This mornings call subject is related to financial results and background information related to
the quarter ended June 30, 2010. As noted, Tom, Mike and I will be available for questions after
the call.
As you turn to the results we issued this morning, the second quarter of 2010 was a very solid
period for us in terms of our Services business. During the quarter, we continued to build momentum
at all three points of our client cycle, including the enhancing of existing client relationships,
the launching of new clients and the signing of new client arrangement that will now move into our
implementation cycle.
As a result, as youll see from the results we put out this morning, Service Fee revenue was up
34%, as we compare to the previous year. This increase in Service Fee revenue helped to offset a
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decline in product revenue from our other business segments in the eCOST and Supplies Distributors
during the quarter.
This resulted in a slight overall increase in total consolidated revenue. However I would be quick
to point out, as I think most of you understand our Service Fee business generates a much higher
gross margin than our product revenue units and thus the impact of the strong growth and revenue in
our Services business, along with a reduction in overall SG&A costs resulted in a significant
improvement in our adjusted EBITDA to $1.7 million this quarter as compared to, or a $1.7 million
improvement, as compared to the prior year.
The success of the Service business as Michael covered a little bit, is mostly driven by our
End2End solution. This continues to be well-received by existing and potential clients. As a result
of this solution, weve been able to address the needs of a bigger slice of the eCommerce market
just as the entire industry is seeing an influx of activity and growth.
This industry growth is driven by a greater number of companies, including manufacturers, retailers
and service providers, looking to start or expand their direct to consumer eCommerce presence, in
order to grow their own businesses and effectively and to effectively interact with their
customers. Industry segments where we continue to see a lot of interest include fashion, apparel,
beauty and fragrance and of course the consumer packaged goods segment. Were not only seeing these
trends in North America, but since launching our End2End solution, weve also seen increased
activity through our presence in the European market as well.
One of the most exciting program launches weve had for the End2End eCommerce solution was the
Procter & Gamble eStore or the P&G eStore. This solution is based on a unique relationship we
developed with Procter & Gamble. While the eStore will exclusively sell P&G products, we have the
ultimate responsibility for pricing, promotion and merchandising of the products on the site. And
as such, we have significant influence over the sites operational and financial success. In short,
were a real partner with skin in the game, with Procter & Gamble.
Product revenue in the resulting gross profit dollars will show in our eCOST segment as activity
begins to ramp upward from this activity. The reason eStore has received so much attention among
the eCommerce industry and the media in general, is because it represents a major CPG or consumer
products packaging company, moving forward with an eCommerce site of this scale, leading the way
for other CPG companies to follow. Were all really excited about the progress that weve made in
this trend setting initiative and now that the site is live, consumers around the country can enjoy
the P&G eStore experience and make the eStore their new destination for everyday products across
the many well-known Procter & Gamble brands.
Now, before I turn the call over to Mike, just let me touch on the eCOST business of a minute and
Ill give you some more detail a little farther in the call. During the quarter, we did begin to
experience e-mail deliverability issues in terms of our some difficulty in delivering e-mail to
our customers desktops, through many of the e-mail service providers like Yahoo, Google, Hotmail.
The ISPs over this last quarter implemented changes as they always do, but there were a number of
different changes this quarter, to their e-mailing filtering algorithms.
While we continuously work closely with these major firms to understand and address the ever
evolving e-mail filtering techniques, these more recent changes have the impact of placing a larger
number of our marketing and promotional e-mails into our customers bulk or spam folders. Because
we rely primarily and majoritively on e-mail marketing for eCOST, and the resulting viral impact of
those e-mails to generate a large portion of our daily visitor traffic, the lack of the
effectiveness of the e-mails resulted in a decline in revenue this quarter. Weve already
implemented various changes to our e-mail marketing approach and frequency and are also
implementing additional online and offline marketing tools, that Ill talk about a little bit more
in a few minutes, that we believe collectively can be both efficient and cost-effective to increase
visitor traffic to the eCOST.com storefront.
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So, with this information as a background, Services business going strong, a little bit of a
downturn on the eCOST side, Ill let Mike now take the call here a little bit and give you some
details in terms of the exciting progress were having in our Services business. Mike?
Michael Willoughby, Senior Partner President, PFSweb Services
Thanks, Mark and good morning, everyone. Before I begin with my prepared comments, Id like to
remind you again that when I refer to our Services business segment, Im including both Supplies
Distributors and our PFS Service Fees business. Both of these businesses have essentially the same
operating model, although they have a different financial model.
As Mark just discussed, there has continued to be a lot of excitement surrounding the Services
business, particularly with our End2End eCommerce solution. At this point, we have more than 10
active End2End solutions in place for our clients. This includes the
P&G eStore, Carters and OshKosh, Roots of Canada, Luxotticas Sunglass Hut and Havaianas in
Europe. During the past several months, we have ramped up two of the higher profile End2End
solutions to-date. This includes the Carters and OshKosh co-branded site and the P&G eStore that
Mark just mentioned. These two programs offer a lot of potential for growth as they mature and gain
greater awareness among their respective customers that they have.
First, Id like to spend a few minutes commenting on the Carters and OshKosh co-branded site. As
indicated on Carters first quarter conference call, the new sites exceeded their management teams
sales expectations in the first month of operation. The sites continue to perform very well, and we
anticipate continued sales growth with the program through the upcoming holiday season as we work
with Carters to extend the brands reach through various interactive marking programs that we
operate for Carters, through our interactive Marketing Services business division.
In their most recent quarterly conference call, Carters management revealed that the co-branding
strategy behind these two sites is yielding excellent results. These two distinct websites for
Carters and OshKosh leverage a common shopping cart and an underlying eCommerce technology that
allows us to create a unique eCommerce experience for each brand, while at the same time, we can
provide for cross-merchandising and cross-promotion activities between the two sites.
We found it very interesting that according to Carters management, the synergy between the two
brand sites and the functionality of this common shopping cart has resulted in 25% of the orders
that are taken through the shopping cart containing both Carters and OshKosh products. That
indicates that the consumer had successfully shopped both sites with one resulting transaction and
one consolidated shipment. This is a very encouraging statistic.
Furthermore, Carters indicated on their call that the value of these co-branded orders is 50%
higher than single branded orders flowing through the same site. So a lot of value being gained
through this co-branding strategy. This strategy is unique among our current End2End clients as
well as among all of Demandwares clients. And we believe that this clearly illustrates the
creative solutions that our talented staff is able to deploy using this End2End eCommerce platform
that weve developed. We join the Carters team in being very excited about the opportunities for
growth with this initiative, and were also very excited about the opportunities to leverage this
co-branding strategy with other current and future PFSweb End2End eCommerce clients.
Now with regard to the P&G partnership, as Mark just mentioned, the P&G eStore is a very exciting
new initiative for us. And now that the site is up and running, we are looking at some very
interesting and exciting results. And though the P&G eStore is looking to gather market and
consumer data to help improve their marketing and their products, packaging design and to
ultimately share with their other channel partners to help them improve their approach to customers
online, the site is live for anyone to shop. And were still testing several new features to
improve the
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shopping experience for consumers. We will be instituting these new features over the next several months, and Mark will
get into some details on the operational status of the P&G eStore in his comments.
But let me say from an eCommerce services perspective that we continue to be very excited about the
potential growth and the technical innovation and the CPG market segment pioneering that is
associated with our deployment and operation of the P&G eStore. We also anticipate additional
opportunities may be created for this partnership with geographic expansion of the P&G eStore as
well as program expansion to include additional P&G brands that are not currently included in the
P&G eStore.
We also believe that the announcement of this partnership and the successful launch of the eStore,
is directly responsible for some of the most exciting activity in our U.S. new business pipeline in
that it has helped us promote our End2End eCommerce services, particularly to this CPG market. We
are looking forward to increased potential for additional growth in our Services business as we
take advantage of our eCommerce services leadership position in this huge CPG market segment. This
is a market segment that largely remains unserved by manufacturer direct eCommerce sites today. So
we feel like this leadership position that we have will give us great opportunity as we look
forward to grow up in our new business pipeline.
Now, moving to some of our most recent announcements that you may have noticed. We recently
announced a new End2End eCommerce solution for Havaianas, which is an iconic Brazilian brand of
flip-flop. Were supporting their efforts in Europe. Were supporting this new solution, which was
just launched in June from our operation in Belgium. The eCommerce solution includes site hosting,
platform integration, logistics, fulfillment, returns management, as well as high-touch customer
contact services in seven different languages. We also announced another European agreement with
Baby Boum, through which we will operate the logistics and distribution solutions supporting their
business-to-business channel. The solution which was launched in January 2010 includes fully
integrated warehousing, order fulfillment, distribution and transportation management throughout
Europe to the retail channel.
We are very happy to announce these two European agreements, as this is a market where we see a lot
of potential for new client agreements from both companies that are based in Europe and those that
are also based outside Europe. These international brands will benefit not only from our experience
in eCommerce, but also from our knowledge and experience working through the real world
complexities of doing eCommerce in the distinct national markets within the European Union.
Now, regarding some of the programs where we havent disclosed yet the client name or those clients
where weve agreed not to disclose their name. We are continuing to successfully operate and
innovate a highly customized business-to-business eCommerce solution, along with customer care, and
B2B financial services for a single division of a large Fortune 100 company, which sells consumer
products to small businesses. Were also in the process of launching a new End2End eCommerce
solution for a leading board sports brand. Weve talked about this over the past few conference calls and were very excited to
be taking this Apparel and Accessories business online for the first time. We plan on announcing
the agreement formally once the site is officially launched, which is expected to occur in the next
few weeks.
Next, were preparing to launch End2End eCommerce solutions for multiple brands under a master
agreement with a leading fragrance and beauty company. Each custom-branded eCommerce site will
feature the Demandware eCommerce platform, our logistics and fulfillment capabilities, high-touch
customer care, financial services, as well as various interactive marketing services. We expect to
announce the launch of each brand solution as they occur and as permitted by our partner. The first
couple of solutions are on track to launch this fall. The impact of these agreements will start to
be seen in the fourth quarter of this year, yet will still be in the early stage of ramping up.
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As Ive indicated in the past, we will formally announce specific new agreements by name, as
permitted by our new clients. However, you should remember that our clients are often hesitant to
disclose their decision to outsource major portions of their operations and were sensitive to
their wishes, as we backed up our commitment to be the brand behind the worlds leading brands.
Also weve spent a lot of time talking about our excitement about the End2End eCommerce solution
and its momentum in the marketplace. However its important to remember that while this solution
represents an exciting, growing part of our business, its just one component of our overall
Services business which in total supports more than 35 brands. Our Complete Services business when
combined with our eCOST.com business generates the large volumes and creates the economies of
scale. That is a major selling point to our many potential clients. Now, looking towards the
future, the current value of our new business pipeline is estimated to be more than 40 million in
potential new client projected annual contract value, which is after we successfully closed on
several new business agreements, over the last quarter.
So, to summarize this is an exciting time for the Services business. We have a number of new client
agreements in the process of being launched and ramped up, over the next few months. In addition,
we have a very healthy new business pipeline of companies in the fashion, apparel and accessories
and beauty and fragrance and CPG goods segment. And while, we still have a lot of work to do in
order to get many of these new client programs fully up and running, we believe were
well-positioned to effectively move forward and continue to grow this Services business.
Now, for some highlights from eCOST.com, Im going to turn the floor back over to Mark.
Mark C. Layton, Chairman and Chief Executive Officer
Okay. thanks, Mike. As I discussed earlier, revenues for eCOST this quarter were down on a
year-over-year basis, as we faced certain unforeseen challenges in our sales and marketing strategy
which mostly were based around the e-mail campaigns that I talked
about previously. A key point to keep in mind with eCOST is that, with the changes that weve made
to the business over the last few years, weve put a lot of flexibility into the business model
itself and its allowed us to flex in and out as volumes have changed in the business and to be
certain that we can kind of manage these fluctuations and sales.
As a result of the flexibility, when you look at the adjusted EBITDA for the second quarter; it was
basically flat year-over-year. Net loss was higher in the second quarter compared to the second
quarter of 2009, but this is primarily attributable to about $300,000 of expenses related to a
large vendor pricing dispute that we settled. And then, certain legal fees related to an ongoing
investigation by the U.S. Attorneys Office into the actions of a single eCOST employee, thats
still ongoing.
Were obviously working to overcome these e-mail deliverability challenges and then resume sales
growth. And were doing this by both modifying our current e-mail practices and by utilizing a
broader mix of marketing tools. The actions that we undertook since these issues arose include,
first, working closely with each of the major ISPs to educate them on our need to frequently
communicate with our customers, given the daily deal nature of our business and to educate them
that the consumers may only make one or two consumer electronics or technology purchases each year.
And what we believe is, is that the characteristics of the way we market combined with the products
that we have, might have led their adjusted automated filtering programs to conclude that the
relevance of our e-mail is low to their e-mail recipients, when in fact its simply the nature of
the products being offered.
We have some confidence in our early discussions with these guys that theyre beginning to
understand the quandary that they put us with, and we hope that well see some changes to some of
the filtering technologies, that will allow our e-mails to flow more freely over the next couple of
months.
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While thats going on, weve also increased our offline marketing activities once again with an eye
towards reaching customers through this channel. So, this would be things like postcards and
catalogs and flyers and things that, frankly we diminished in order to control advertising expense
overall. But given the challenges that we have, we need to increase these activities to insure that
we can reach our customers on a regular basis.
Third, weve also selectively increased our other paid online advertising activity to help offset
the impact that Ive described above. And its pretty clear to me that the result of the service
providers, Internet service providers actions, whether they intended it or not, is to force or
drive more online marketing activity through their paid channels paid search, banner ads and
other cost-per-click programs, because that the filtering technologies theyve put in place have
reduced the effectiveness of much less expensive e-mail marketing, not only for eCOST but for
everybody out there. Now, its an interesting dynamic, but when you have a market dominated by a
very few Internet service providers, were basically a passenger in the ship here and are going to
have to make adjustments for our business model.
Its important, I think for everybody to understand that eCOST, as Mike was talking about earlier,
still offers tremendous value to our Services business, just in addition to its own retail
activities. Specifically over the last year, its helped us to develop a new offering within our
Services business that we now call eStore Retail Services division, now we operate that division
within eCOST.com, but the capabilities of distribution are being offered as a conduit through our
Services business. This new business division provides a wide breadth of interactive marketing
services, including interactive marketing, product procurement, content merchandising, customer
acquisition methodologies and other Web retail services, which augment our Service business
capabilities.
Certain clients have already started to use this offering, that includes the Procter & Gamble
eStore. Weve seen a number of clients potentials who are more familiar and see quicker and less
costly implementation avenues using the buy/sell inventory model that our eStore Retail Services
division offers. The eStore model allows our clients to maintain a direct consumer presence,
control the look and feel of the site, the product offering on the site and all the creative
aspects of the site, but have the site operate with its business like a traditional retailer, who
buys and then resells the products.
The beauty of the model is that it can be quicker and cheaper to implement for our client, because
it generally requires less IT, legal and other systems integration work, when compared to the
traditional Service Fee business warehouse inventory model. As this division continues to grow, you
will see growing product revenue and the resulting gross profit component included in our eCOST.com
segment reporting.
As Mike mentioned a few minutes ago, were clearly very excited to have officially launched the P&G
eStore, you can find that at www.pgestore.com. We launched this officially this past quarter. The
P&G eStore is a partnership between Procter & Gamble and PFSweb to provide a rich eCommerce
offering of the full range of Procter & Gamble products direct to consumers. The site opened to the
public officially on May 27 of this year. To date, volumes have been very modest primarily because
marketing spend has been intentionally limited as we, along with our partner, Procter & Gamble,
take the time to fully ensure the store features and functionalities are operating correctly, and
we work to educate and expose the P&G eStore site and its capabilities to the large group of
Procter & Gamble brand managers throughout a very large company at Procter & Gamble.
P&G is taking a very methodical and calculated approach to the store, given that its primary design
is as an innovation and learning laboratory for P&G. Were carefully looking at ways working with
various P&G brand managers to merge and collaborate marketing efforts with each P&G brand in order
to properly maximize the use of the Procter & Gamble customer information assets, which are
tremendous themselves.
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As an example of the efforts that weve taken over the last couple of weeks, if you would spend any
time on any of the individual brand sites, you would see that theres been some very significant
improvements on the where to buy links and the information on each of those individual brand sites. So thatd be, for example, if you went to Old Spice or Oil of Olays
brand sites, and those sites operate outside the scope of our P&G relationship and were sites that
were already present before, but theres been a lot of work done on those where to buy links that
are now functioning properly.
Many improvements were made to enhance product information and presentation. We ensured that the
presentation of the buy now link was easy to find and functioning correctly and that the length of
the P&G eStore store was highly relevant to the origin product from the brand site itself. As a
result, the where to buy links are now one of our largest visitor volume reference sites to the P&G
eStore.
We believe that the P&G eStore will follow a kind of crawl, walk, run pattern, and as such our
near-term expectations for volume need to be tempered, however, as I look at the potential for the
CPG category as an eCommerce category overall and see that less than 1% of this multi-billion
dollar CPG industry is currently conducted electronically and then, I take in contrast back to the
evolution over the past decade of many other major product categories, and as Mike mentioned, you
can see the huge potential for a new market for eCommerce transactions that really is just at the
birth of its transformation right now.
Weve seen a significant increase in CPG companies interested in exploring a new direct-to-consumer
site. We also see this as further evidence of a significant inflection point in the CP industry
evolution. We see many of the same trends and opportunities also occurring in the fashion and
cosmetics industry. While Im certainly excited and encouraged by all of these activities in the
eCOST.com segment, particularly those that relate to the Enhancement Store Services business, I do
remain disappointed in the financial results of the division overall this quarter.
There is no doubt weve learned and continue to learn a lot from the eCOST business, but the cost
has been high. The low gross margin characteristics of that traditional eCOST.com product range
leave little room to absorb challenges like we experienced this quarter as they arise, and for us
to still continue on a positive financial trend. While I was quite encouraged by the improved
financial results over the past year in the eCOST segment, the flat result year on year this
quarter on an adjusted basis has led us to carefully review again each of the business operations
areas and to make appropriate adjustments in the business model.
I remain hopeful that with the significant changes we made in the eCOST business over the last
month or so, that Q3 will show a return to an improving financial trend as we then approach a
historically strong holiday quarter. And well keep you informed as those activities continue to go
on.
Now, for some details on the actual financials for the quarter, let me turn the call over to Tom.
Thomas J. Madden, Senior Partner Chief Financial Officer and Chief Accounting
Thank you, Mark, and good morning to everyone. If you recall, our earnings conference calls
over the past year, we have noted numerous times that our prior year June 2009 quarterly results
were expected to reflect our trough quarter for the Service Fee business segment. This is because
we had not yet seen the benefit of various new client wins at the time but have the negative impact
of the non-renewal of our previously largest Service Fee client arrangement with a U.S. Government
agency, which ended in April 2009.
We are now one year removed from this event, and as new clients have come on aboard during 2009 and
into 2010, along with some expansion of our existing contracts through organic growth and product
activity, our financial results for our Service Fee business reflect significant growth from that
2009 second quarter level.
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We continue to take a number of positive steps toward improving our short-term and long-term
financial results. While growth in our Service Fee business is a key component, we have also taken
steps to reduce our overall consolidated SG&A costs, which reflect a decrease on a year-over-year
basis during the quarter. As Mark alluded to earlier, this combination of strong growth in our
higher gross margin Service Fee business, combined with the impact of reduced SG&A costs, resulted
in an improvement in our consolidated adjusted EBITDA for the June 2010 quarter of 1.7 million as
compared to the prior year second quarter.
Let me spend a few minutes taking you through a recap of the results for the quarter as reported in
our press release from this morning. Our consolidated revenue for the quarter ended June 30, 2010
increased slightly to 82.5 million, compared to 82.3 million for the quarter ended June 30, 2009.
Increases in Service Fee revenue and pass-through revenues were almost entirely offset by decreases
in product revenue for both our Supplies Distributors and eCOST business segments during the
quarter.
Gross profit for the second quarter of 2010 was 9.0 million or 11.8% of net revenues excluding
pass-through revenues as compared to 8.2 million or 10.5% of net revenue excluding pass-through
revenue in the second quarter of 2009. As mentioned earlier, the gross margin increase was
primarily due to the higher percentage of revenue generated from our Service Fee business compared
to the second quarter of 2009. We utilized adjusted EBITDA as a key metric in evaluating our
operational performance. In the second quarter, our adjusted consolidated adjusted EBITDA was a
positive 1.0 million, versus a loss of 0.7 million in the prior year. For the second quarter, net
loss was 1.5 million or $0.14 per basic and diluted share compared to a net loss of approximately
2.5 million or $0.25 per basic and diluted share for the same period last year.
Let me share some additional comments on the performance of our select business segments for the
quarter as well. First, Service Fee revenue increased as we talked about, 34% to 16.6 million as
compared to 12.4 million in the prior year. Strong activity here related to new clients, organic
growth at existing clients and incremental project work. Our increased gross profit in this
business combined with relatively stable costs resulted
in a significant improvement of 1.9 million in adjusted EBITDA for the segment as compared to the
prior year.
As we look ahead into the third quarter, we currently expect our third quarter Service Fee revenue
will continue to reflect strong increases on a year-over-year basis. However, the percentage
increase is expected to be somewhat less than June quarter due to the impact of the previously
disclosed non-renewal of one of Service Fee business-to-business client relationships.
For our Supplies Distributors business segment, revenue was 43.5 million in the second quarter of
2010, as compared to 45.3 million for the prior year. This decrease was primarily due to the impact
of the euro currency conversion rate. Our adjusted EBITDA results for this business was
relatively constant as compared to the prior year and we continue to believe that this business
will remain relatively stable in terms of product revenue in the near-term. And for eCOST.com
revenue in the second quarter of 2010 was 16.2 million, compared to 20.3 million last year. As Mark
indicated, most of this decrease related to the reduction in sales to our business-to-consumer
customer segment. Our adjusted EBITDA for this business remains relatively constant as compared to
the prior year, but was down as we compare the results on a sequential basis to the March 2010
quarter.
From a balance sheet perspective during the quarter, we strengthened our balance sheet by raising
approximately $7.3 million of net proceeds through a public offering completed in May of 2.3
million shares of our common stock. This capital provides us increased flexibility to manage our
businesses and plan to grow. This offering as well as the benefit of certain other positive cash
flow items resulted in an increase to our cash and equivalents and restricted cash balance to $20.8
million as of June 30, as compared to 16.4 million as of March 31, 2010, as well as created a
reduction in our debt balance of 18.6 million as compared to 21.8 million as of March 31, 2010.
8
Now, Id like to turn the call back over to Mark for some closing comments.
Mark C. Layton, Chairman and Chief Executive Officer
Okay. Thanks, Tom.
So, anyways in summary folks, as you can see, Services business, great strong momentum in terms of
things that are going on there and our expectation is thats going to continue to move forward.
eCOST business is clearly, some challenges that are there, but weve got some activity in there
particularly with our eStore Retail Services division, where we see opportunities for growth going
forward and weve implemented changes that we think will help that business improve this quarter,
and our Supplies Distributors segment is basically flat, but continues to contribute nicely to us
on an overall basis.
Financially strong, weve got the capital we need to continue to expand and were real excited
about our opportunities given the new business pipeline that Mike described earlier.
So, with that as a backdrop in summary, were done with our prepared comments and well now open
the call for questions. Operator?
9
QUESTION AND ANSWER SECTION
Operator: [Operator Instructions]. And your first question comes from Mark Argento of
Craig-Hallum Capital.
<Q Mark Argento>: Hi. Good morning, guys.
<A Mark Layton>: Good morning, Mark.
<Q Mark Argento>: Nice quarter. Just some thoughts around I know you talked a little
bit about the pipeline value, roughly $40 million on the services side. Can you just talk about how
thats trending? I think that might be up from last time you disclosed the number. And maybe talk a
little bit about the types of companies youre that are looking at potentially signing up for
services and potentially the scope of those customers as well?
<A Michael Willoughby>: Sure. I think that in the last conference call we mentioned a
number of over 30 and so, this is a pretty good increase in the value of our pipeline from the last
conference call, which was very exciting for us. The mix, if you look at clients that are in the
pipeline, I think is fairly consistent, quarter-on-quarter. There are a number of the CPG type
opportunities, which once again were excited about and we also think as directly points to the
announcement of the P&G relationship is generating that interest.
We see continue to see quite a lot of fashion, apparel and accessory opportunities here in the
U.S., brands that are representing those. And then, something that actually has grown a little bit
over the past quarter in value, in the pipeline is fragrance and beauty, seem to be in a cycle
where between re-platforming efforts that are going on out there from first or second-generation
sites to more modern sites as well as brands that have not yet gone online directly seem to be
entering the marketplace and looking for solutions, so thats a bit of a growing segment in the
pipeline.
And then finally, I would say that over the past six months and certainly three months, weve seen
an increase in the interest of companies that have a global perspective on eCommerce and that are
interested in our services, because we have a global offering and we are able to take them online,
not only here in North America, but also in Europe. And I believe that we have the ability to
extend our solution effectively into even the Asia Pacific area. And so, as we deal with customers
that are looking at a global solution, once again were down to just a very few competitors,
primarily us and our direct competitor in the market, able to offer that global solution. So
thats, maybe the couple of drivers behind the pipeline growth.
<Q Mark Argento>: Thats helpful. And can you talk a little bit about the different
economic models that youre utilizing in the on the services side? I know some are pure
services-based, some have a buy/sell component to it. Do you expect to do, its kind of a little
of each or do you see predominately moving in one or the other directions?
<A Mark Layton>: Well, it depends on the channel. I think what were seeing this is
Mark. We have, in terms of clients in the pipeline today, I would say still the larger majority of
the numbers of clients in the pipeline are pure Service Fee relationship deals, where our targeted
gross margins are in the 25 to 30% range with those particular clients, depending on deal size and
scope of activities that were performing. But we have seen certain channels where they just, as I
mentioned in my prepared comments, theyve just got a lot more comfort with the idea of a buy/sell
relationship.
Some of these companies have never developed capabilities to handle things like consignment
inventory. So, as they begin to address business controls and software capabilities, its basically
a void in their capabilities as it is for now. So if they head down a consignment inventory route,
what they end up with is cost and lead time that delays their ability to be able to launch the
site.
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So, the buy/sell arrangements that we have come up with allow us to be able to structure deals
where we not only gain the kind of inventory risk aversion that were after with that, but also
offer the client the ability to kind of control the site as if it was their own. And its a
flexibility in our technology platform and in the way our contracts are structured and in the
negotiation of the deal in there that allows us to do those.
So, in those situations because we buy and resell the inventory, we have to recognize product
revenue. I would say that gross profit ranges and that will be from 15% to 25%, typically for us to
earn the return that were after in those particular deals that are there. Inventory financing is
always a question with that and typically we force the client to provide some sort of ability to
finance the inventory, whether thats through terms or a floor planning arrangement or something
along that line. But the majority of the inventory has to be financed somehow by the client in
order for us to go through those deals. And weve been successful in negotiating those things.
So, those are the two primary ways that were seeing our Services business grow. There are some
other techniques out there that have been proposed along the way, but we dont have any of those in
house right now. So, as you collect those in the financial statements youll see Services business
growth as we saw this quarter and typically in the 25 to 30 point gross margin range. And then,
under the eCOST segment our plan right now is for the product revenue that we gain through the
buy/sell arrangements that will show up in the eCOST.com segment. Were accounting for that
separately internally, but it rolls into the same subsidiary in there. And again, 15 to 25 point
targeted growth margins in that. Long answer, but its kind of a its a pretty comprehensive
offering in terms of the things were doing there.
<Q Mark Argento>: Sure. Two quick questions, then Ill hop back in the queue. In terms of
the overall competitive environment right now, are customers and potential customers, are they
shopping price, are they shopping flexibility? What are some of the kinds of the key
characteristics that potential customers are looking for? And then, Ill just throw my second one
out here as well. In terms of the RFP activity, do you feel like you have the right people in place
enough the employee base to be able to service what looks to be a pretty fast-growing segment on
the services side?
<A Michael Willoughby>: I think that, responding to the first question. I think what
prospective clients are looking for is a bit, all over the board as it always has been. We still
primarily see from a competitive perspective the internal solution as our most frequent competitor.
So a client whos evaluating either leaving a portion or all of their eCommerce solution in-house
or outsourcing it or whether or not if theyre with another outsource provider whether they want to
bring that in-house or continue to leave it with an outsource provider. And so, in that from
that perspective, the quality versus price, one alternative or the other is something that we feel
is always considered. I would say that our biggest differentiator when price is a consideration is
the flexibility that we can provide along with the economies of scale that the business generates
to provide for either a highly competitive price solution to an internal solution or even rather
maybe a pricing advantage if you really look at from an all-in perspective.
One of the things that we find with clients is when they start to really look at the staffing
requirements around an eCommerce solution, where they would have to put a full-time equivalent
against a certain activity, it really doesnt require a full-time head and were able to have a
partial person assigned to that task, we start to generate pretty significant savings for the
clients just in the staffing levels and there are all sorts of other cost saving opportunities as
well. So, I think that primarily we do well when clients are looking for flexibility, feature set,
and for global capabilities. And then, unless theyre just extremely price conscious and theyre
have their own economies of scale theyre generating internally, rarely do we lose on price.
When you start to look at the business, the pipeline size and the activities that were looking at
obviously, were very excited about all of the opportunity thats embedded in the pipeline, but we
do have to keep in mind what kind of bandwidth we have to service those deals should they close.
11
And so, I think were always looking out three to six months ahead. We have the ability within our
organization to make adjustments by moving people around. Weve done a lot of cross training within
the organization. So, project managers can flow into and out of our implementation area. We have
the ability to augment our IT staff with contract labor when necessary. So, its quite a bit of an
expansion capability even within the organization. And then looking out even further, as we kind of
develop our one to three year plans, well obviously continue to look at our staffing levels and
make those adjustments. But in the near term, Im comfortable that we have the staff and the
organizational capacity to handle the pipeline that we have now.
<A Mark Layton>: And staffing is growing right now, theres no doubt about it. I mean
weve got were doing I dont know how many implementations actively right now, its a pretty
big number of things that are coming on board here the last half of the year. So, staffing is
growing. Were effectively using our Manila operations, which allows us some cost advantages with
things. Weve done a real nice job, our folks here have, of being able to train a group of people
who have experience in the Demandware platform in Manila, which was a unique skill set that weve
developed over there and so weve got some cost advantages that allow us to be able to hire staff
in those market places as well. So, but were expanding and as Mike said, its got to be in a
controlled fashion, you cant just run out and hire 50 people and expect them to be effective. But
we kind of slowly introduced new people into the process while we used the kind of flexibility and
cross-training capabilities that Mike talked about.
<Q Mark Argento>: Okay. Thanks a lot, guys. I appreciate it.
Operator: Your next question comes from Alex Silverman of Special Situations Fund.
<Q Alex Silverman>: Hey, guys. How are you?
<A Thomas Madden>: Good, Alex. How are you?
<Q Alex Silverman>: Good. Mark Argento answered or asked a number of my questions, but
can you give us some sense of how much was taken out of the pipeline in this most recent quarter?
<A Thomas Madden>: Well, let me think.
<A Mark Layton>: While they work that out, you got the next question?
<Q Alex Silverman>: Sure. My next question is, in terms of the e-mail issues within eCOST,
how much of whats being stopped is prospecting and how much of it is to existing customers?
<A Mark Layton>: We only e-mail to our existing clients. So all of it is to an existing
customer base. Weve got an e-mail database thats over a million names, not all of those are opted
in but lets say 70% of those roughly are in an opted in e-mail database for us, thats out there.
And so, we only rely on seeding our people who had bought from us or had specifically signed up for
e-mail. The impact that really happens though is that our biggest visitor traffic deal on a daily
basis, and still about 50% of our revenue on a daily basis at eCOST are from new customers. Those
new customers are typically someone who has referred an eCOST e-mail through them, what we call the
viral impact if you will.
<Q Alex Silverman>: Sure.
<A Mark Layton>: So, we get an exponential disadvantage when our customer doesnt get the
e-mail because he may have passed it on to one or two other people. So like hey, Alex, I heard
youre looking for a flat-screen TV, heres a great price on one and now youre a new customer for
eCOST. So, its really a hindrance for us in terms of prospecting in that way, but we only e-mail
to our existing clients.
12
<Q Alex Silverman>: Do you know whether everything is being stopped or just the
promotions?
<A Mark Layton>: Well, we have not had any reports of transactional e-mail is being
stopped. So, e-mails that confirm orders or shipment confirmations, things like that are flowing.
Those do come from a different IP address, so but those are not being stopped. Its basically
all of our promotional e-mails that are being impacted and its not everyone. I mean, weve still
got a good flow to corporate going on. The big issue really is with Google, Gmail, Yahoo!, Hotmail
are the two major areas right now that we have seen changes in their algorithms that have impacted
our ability to deliver.
<Q Alex Silverman>: Okay. I mean, the reason I asked that question is, Ive received
e-mails in the past from e-tailers who have said, youre not receiving our promotions. Please go
into your spam box and mark our e-mails as Not Spam.
<A Mark Layton>: Thats correct. And were undertaking similar techniques and were not a
spammer. I mean, there is the word spam is used loosely to describe maybe e-mails that people
dont want, but frankly what I see right now is the actions being taken by these major ISPs is
really akin to your mailman standing in front of your mailbox going through your mail and saying,
Well, you dont want this. You dont want this, and you dont want this and throwing it in the
garbage before he puts the rest of it in your box.
Most of these people have subscribed to our e-mails in one fashion or another or everybody has. I
mean, theyve had to have opted into our programs in order to receive e-mails. So theyve made a
conscious decision at one point in time to be able to receive our e-mail, and yet an ISP is
stepping in the middle of it and saying, Well, no. They dont really want that.
So, theres a lot more to be learned on this and its an ever-evolving space. I cant say that the
changes that were made recently impacted everybody. Ive got to believe that others are
experiencing issues that are there. The biggest challenge for us is, is that we had evolved to
where probably more than 90% of our marketing activity was e-mail-based and so, the impact on us
was significant in terms of our marketing activity now that we have, because we just got limited to
being able to deliver the message. So, thus weve opened up these other channels again.
<Q Alex Silverman>: Makes sense. In terms sorry, just to switch back to the pipeline.
Can you give us a sense a rough number, how much of whats in the pipeline are folks that are
new to the web and really new to e-tailing and how much of it is going after a competitive win?
<A Mike Willoughby>: Well, I dont have an exact percentage, but my feel is that a good
percentage may be 25% or so of the pipeline is made up folks that do not currently have their own
direct-to-consumer initiative. And I think that, you can safely put most of the CPG opportunity in
that category. And so, while those are some very large companies they may not be large annual
estimated revenue portion of the pipeline because it was starting from zero, the first full year
run rates going to be much less than their total potential. So, Ill throw a 25% number out there
just as a rough estimate of that and answer that...
<Q Alex Silverman>: Okay. I asked the question because, I mean its pretty well known
that one of your well, your largest competitor has some pretty major client renewals coming up
in the next year.
<A Mike Willoughby>: They do, including some of their sort of long-term, tenured core
category sporting goods type clients. We do see them in a lot of deals that were working on
whether its a competitive situation or somebody who is doing eCommerce for the first time. And
were very happy with the win rate that weve got to this point and we think we still are very
positive and optimistic looking forward with the differentiation we have versus them. So, not a
concern. And then I guess
13
that first question they asked, Alex, about the what came out of the pipeline over the past
quarter? Which I assume you mean due to signings?
<Q Alex Silverman>: Correct.
<A Mike Willoughby>: That number is going to be in the 1 million to 2 million range.
<Q Alex Silverman>: Okay.
<A Mike Willoughby>: Just off the top of our heads, we kind of looked at what were
dealing with there. That would not include churn that comes from other areas such as opportunities
that come into and out the pipeline. And theres a fair amount of churn which indicates a lot of
activity. And thats a positive thing for us as we pretty aggressively take a look at
opportunities, qualify them in or out and move on.
<Q Alex Silverman>: Okay.
<A Mike Willoughby>: So, an end result of the 30 to going to 40. I think is extremely
positive given all the activity we have within our pipeline.
<Q Alex Silverman>: And I agree, extremely positive.
<A Thomas Madden>: And weve made some good progress with some of these pipeline contacts
in moving them from kind of a proposal to a next stage of working closely with them being
potentially close the deal.
<Q Alex Silverman>: Okay. Last question from me. Did you guys end up I dont recall
whether you made an investment in Demandware?
<A Mark Layton>: We did not.
<Q Alex Silverman>: You did not? Okay.
<A Mark Layton>: No. Weve got a very close relationship with them, but no financial talk.
<Q Alex Silverman>: Okay. I know theyre looking to go public as well. So, great, guys.
Thanks so much. Good luck.
<A Mark Layton>: Thanks, Alex.
Operator: Your next question comes from Marco Rodriguez of Stonegate Securities.
<Q Marco Rodriguez>: Good morning, guys. Thanks for taking my questions.
<A Mark Layton>: Hi, Marco.
<Q Marco Rodriguez>: Both Mark, you and Mike talked a little bit about Europe and the
expansion there in terms of opportunities. Can you provide a little color there? Did you guys take
any additional steps to create that?
<A Michael Willoughby>: To create the opportunity?
<Q Marco Rodriguez>: Correct.
<A Michael Willoughby>: Well, I think that what were seeing is a natural reaction to the
End2End announcement that we made several years ago here, and since the technology work that
14
weve done is on a global platform that worked really sort of automatically becomes available to
client prospects that are there. The marketing of that, the aggressive marketing of that capability
somewhat lagged the introduction of that here in the U.S. So, you might think of it as being maybe
a year behind and sort of rolling out that capability, and I guess were starting to see the
results of that now, thats part of it. Part of the opportunity delay is due to the global
recession that kind of happened right in the middle of announcing that End2End strategy and
starting to deploy it. So, now were starting to see some interest come back into our pipeline
there, its just natural pent-up demand, its coming out of the global recession.
So, those two things combined probably point to some of the increase activity. One of the I
think clear advantages we have is that the work that were doing and the investments that were
making here to this North American solution are directly leverageable in Europe because its on the
same platform and the same would be true moving into Asia Pacific as well.
<A Mark Layton>: The other thing, we opened in Europe in 1998, I think. At the time, I
think we thought the European market might be 18 to 24 months behind the U.S. in terms of Internet
adoption rates and what weve learned is its been years behind that. I think youre finally
beginning to see some momentum in the European marketplace in terms of the adoption of the
eCommerce activity, its been much, much slower than anybody predicted. So, I think thats also a
groundswell factor in addition to Mikes comments.
<Q Marco Rodriguez>: Okay, thats helpful. And I was wondering if you could address
competition here? Obviously you guys are very comfortable with your position and your
differentiation versus your major competitor. But theyve been talking more about I guess revamping
their offering to make it more modular. So, it might be more akin to your particular offering. Can
you discuss how you look at that and how youre thinking about that?
<A Mark Layton>: Well, its interesting to watch. I think in the direct-to-consumer
industry the first statement I would make is that the last five years have really seen two
companies emerge with an ability to be able to provide the kinds of services that we do to major
brands. And almost every competition that we end up in, its us and our major competitor that are
at the end here in terms of competing on the deal and as you stated, were very comfortable with
our competitive position within the sphere of or the spectrum of what we provide today with our
competitive capabilities that are there.
We have seen a very significant action on behalf of GSI to expand their capabilities. They have
made a number of acquisitions and used the greater financial capabilities that they have to make
these acquisitions over the last three or four years. And as a result, their publicly stated
strategy now is that they I think are focused on an even smaller number of clients in the market
who are mega size if you will and have determined that because there may only be hundreds if you
will of potential clients that they can do business with that their strategy would be to sell more
services broader spectrum to that market place thats there.
From our perspective, I understand how you can draw that conclusion. They certainly are focused on
very large contracts, very long terms and what we see is that, that has moved them into a smaller
segment of the market in terms of the population of people that they can pitch that type of
arrangement too. I think its put us in a stronger competitive position, almost created a big of a
vacuum if you will, for us to be able to move into and stand alone in the sense that were willing
to discuss what we deem to be more reasonable terms in terms of the length of contracts.
Were more focused on size of businesses that and the kind of flexibility that we can offer with
that and the customization that they can gain from us. So, I think has strengthened our competitive
position if you will in all but maybe the very largest potential clients out there. Now, that
doesnt mean that, again Im very comfortable with our competitive position in terms of competing
and what we do with those clients, but we certainly today are not offering e-mail marketing
capabilities ourselves or affiliate capabilities. Now, one other point Ill add to that quickly
Marco is this. Our
15
competitors chosen to go and buy all the players. That presents them with the challenge of
continuing to have to make significant investments in each of those players to remain, if you will
best of class in each of those areas that are there. Thats an expensive capital intensive endeavor
to continue to do that.
And you can see that by the amount of money that theyve invested in their technology
infrastructure over the last 10 years. We in the mid 90s made a strategic decision to diverge to a
path of aligning ourselves with the best of industry or best of class players with that. And the
Demandware a perfect example of that. And, but we are nonexclusive. So, we will continue to if a
client has a choice to work with a different front end software provider, for example, WebSphere,
then we are qualified and capable to integrate with that particular platform as well. So, not only
does it allow our client to make choices in terms of what platform that they use, but also allows
us to reduce the capital expenditure that we need to make to stay best of class in terms of our
offering and if a new guy comes along, which will always happen, we can go and create that
relationship with the new guy. And were immediately on board with those types of capabilities.
So, we think it provides us an ability to remain more fleet of foot as we look for the next five or
10 years down the road. And frankly, just provides us a greater EBIT contribution in terms of the
things that we do, going forward. So its two different models, two different ways of going about
it out there, but again, we feel very comfortable with the competitive offering that we have in
each of those particular areas.
<Q Marco Rodriguez>: Okay. And then I was wondering if you could talk a little bit about
the gross margins in the Service Fee business. Looking at it quarter-over-quarter rather a
year-over-year, is a pretty significant uptick in the margin. Can you talk a little bit about the
drivers behind that and how you see that kind of moving in the second half of the year?
<A Thomas Madden>: Okay. This is Tom. Weve continued to communicate that our gross margin
range for our Services business is in that 25% to 30% range, which this last quarter it was right
around 27%, if you round the numbers, as compared to 24% or so last years second quarter. One of
the things that impacted us negatively last quarter or last years second quarter was the fact
that we did have this decline in Service Fee business activity. And as we try to allocate as much
of our cost as possible to our Service Fee clients, as opposed to those costs ending up in SG&A, we
ended up having certain fixed costs that we werent able to adjust, when the revenue went down that
were now getting the benefit of the economies to scale with a larger revenue base to be able to
cover those costs with the growth that weve had over this past year. So, as we look forward, I
believe that the 25 to 30% range is an appropriate mix. Things will change as we are able to take
on the project activity or other things that come in, but our stated goal there is to stay
relatively unchanged over the last several years.
<Q Marco Rodriguez>: And then lastly, you guys talked a little bit about eCOST and how
theres very little wiggle room there for unforeseen events and obviously you guys have no control
over. And you made some changes here in the quarter that are hopefully going to see improved
results here in Q3, Q4. Im wondering if we assume that these changes dont realize the returns
youre looking for, has there been any discussion or is there anything that we can look for to
where perhaps that division is either spun out or sold or anything of that nature?
<A Mark Layton>: Well, I dont want to get in to details in terms of exactly what we do. I
would say that, we have had some discussions around planning of what would be next if things didnt
work. All I can say is that were committed to an improving financial trend from that business. As
I said in my prepared comments, were learning a lot from it. Its out in the frontier land of
eCommerce in terms of pioneering things that are going on out there and everyday we learn something
from the activities in that business that become applicable to all of our clients from the services
side.
16
The question is how much is that worth and the answer I would provide is, we have to show a
continuing improvement in the financial trend of that business, like we have been for a number of
quarters in a row right up through the first quarter of this year. If we cant get that on track
and Id say this for any business we run and anything we do, if we cant show an improving
financial trend and promise, then you got to consider all the alternatives that are out there. So,
nothing specific but at this point weve got guarded optimism that the changes that weve made are
going to result with some improvements for us.
<Q Marco Rodriguez>: Okay. So, like how many quarters or what sort of a timeframe would
you if you dont see the improved results you may take action?
<A Mark Layton>: Well, we will continue to take actions. Were not going to stand still
with the things in there. So I think, thats a daily evaluation process and that you have to go
through with that. So theres no stagnation, theres no set date or something that weve laid out
on that, other than we want to see an improving financial trend. And Im not Im less concerned
about the slope of the trend then just knowing that the things are headed in the right
direction. And, so again, if we dont see those kind of improvements in the trend and as we would
in any of our business units well evaluate all the alternatives that we have to either improve the
trend or do something different with the business.
<Q Marco Rodriguez>: Okay. Great. Thanks a lot, guys.
<A Thomas Madden>: Thank you.
Operator: And our final question comes from George Walsh of Gilford Securities.
<Q George Walsh>: Good morning.
<A Thomas Madden>: Hi, George.
<Q George Walsh>: Just a question regarding in the breakdown of the business different
business segments with the SG&A for the PFSweb, the SG&A is running at about that $7 million level.
As you ramp up with more revenues there and the new clients, do you see that changing much? Or is
that something that is that year-over-year that stays fairly constant?
<A Thomas Madden>: Right. This is Tom. Our objective here in the Services business is to
add our new clients with a 25 to 30% incremental gross margin contribution from them and maintain
our SG&A costs as much as possible at current levels. But we will need to have some investments.
There are certain variable components to our SG&A cost infrastructure, as well as well need to
make some investments in resources in order to support that growth. But the objective here would be
to have that SG&A growth be significantly less than the top-line growth in that business.
<Q George Walsh>: Okay. And is it a matter of is there a because of the loss of the
government contract and theres certain excess capacity, so to speak in the SG&A that you can use
up to a point? Is there a revenue point that the SG&A kicks in, is there any kind of quantification
you can give us?
<A Thomas Madden>: We cant. Theres nothing specific out there. Obviously, we do have
some capacity in some of our facilities today...
<A Mark Layton>: Although weve absorbed most of the loss from last year has been
utilized, weve shed some space in terms of leases have expired and those kinds of things. So,
were not operating, carrying a large burden of excess capacity right now where we would have had
more of that last year. And more of our contracts are designed today to where our clients are tied
to the space and so, we dont have too much of that in that aspect of things from there.
17
<Q George Walsh>: Okay. So as you ramp up, so there will be some added cost if you need
the space and that kind of thing?
<A Mark Layton>: Yeah. And these are, Im just going to throw this out to give you as an
illustrative example, not quantitatively correct. But if revenue on the Services business grew 20%,
then I might expect SG&A to grow 3 to 5% in that area. And again, thats just an illustrative
example and not necessarily of what it was going to be, but you ask for something on that basis in
there. And I think thats kind of where were at that you have some general HR and other
overhead-type stuff that you have to add, training Tom mentioned and expenses that, theyre not
necessarily allocated to a client that come along with some of the revenue growth that you have.
<Q George Walsh>: Okay. And, Mark, you talked about the ramp up with P&G, kind of a crawl,
walk, run. Is there a just to review the income stream for you, is there a fee basis that
carries you along a bit besides just being running the site and carrying the inventory?
<A Mark Layton>: Yes. There is and again, most of these eStore retail type arrangements
have both components to them. They have a services component, where we are providing specific
services that are outside the scope of being a retailer if you will. And then we cover traditional
retail costs by way of the gross margin of that buy/sell arrangement. So, in the Procter and Gamble
example, if we have a nice significant Service Fee arrangement for building the sites and other
marketing activities that were providing for them and frankly, its a large company thats full of
opportunities and we have a number of other things within the Procter & Gamble Company that were
doing for them in addition to the P&G eStore. So, they are a significant Service Fee client for us.
And we would expect that the P&G eStore product revenue will become significant over the next few
years as that ramps up.
<Q George Walsh>: Okay. But even through this process its cash flow positive for you and
its not a negative?
<A Mark Layton>: That is correct.
<Q George Walsh>: Also just on the capital side, Tom, has the addition of capital had any
impact I guess this is a marketing site also in terms of as youre speaking to clients in the
pipeline and any other maybe negotiations youre doing it with them, in terms of monies you have to
invest versus things that they have to do?
<A Thomas Madden>: So, Ill answer the question from a marketing and sales perspective,
George. In that the capital infusion that we had this quarter has had a benefit in our sales and
marketing activities, such that I think prospective clients are comfortable that we have cash
reserves and the wherewithal to be in this for the long term, which is very beneficial to not
having otherwise negative kind of conversations that you didnt have to step into a much of detail
to give them that same comfort level. So, I appreciate that. We are not having any uncomfortable
conversations at this point about wherewithal, thats a big benefit.
<Q George Walsh>: Okay. And a question regarding the e-mails. Its an interesting point
you brought up, Mark, regarding that all the recipients have opted in. And I would think that would
be a very, as you mentioned, extremely large issue where theres almost a I dont know if its a
first amendment issue, whatever you want to call it, but theres an interference here of
communicating with opt-in clients.
<A Mark Layton>: I completely agree with you. Thats unfortunate that youve got two guys,
there are two companies that basically control the industry and these, their activities related to
e-mail, and search, and paid search algorithms, and the order at which things appear on search
lists are there, they view as their intellectual property and thats a big black box, and they
dont give you very much information about it, and its a trial and error method not only for us
that are legitimate senders, but also for spammers, and so its a tough, its a tough route,
theyre not particularly
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responsive when you call them, and so I think this is early days of what will become a big issue
over the next few years.
<Q George Walsh>: And is this affecting as you talk about eCOST and as it affects the
services side of the business, is this an issue that is affecting your service clients and
operations there? Or what youre doing for them?
<A Mike Willoughby>: So, I think this is illustrative of one of the benefits that eCOST
brings to the Service side is we are able to get out ahead of this a little bit and actually go
proactively to our clients and talk about this phenomenon. One thing that most of our clients do
have as an advantage is that they are well-known brands and theyve got other marketing avenues
that theyre currently very active in such as offline advertising, things like that. So they may
not see the initial hit that eCOST took being primarily an e-mail marketing, but it still has an
impact. And so weve been able to go to our clients and say what things could we do to help you
mitigate this while were working through the issue with these ISPs? And I think that puts us in a
great position to be proactively helpful to our clients and not have them see a quarter hit before
they respond to the issue.
<A Mark Layton>: The challenge for the eCOST business is that we have a true daily message
much like a newspaper has. We acquire deals and theyre available today, theyre in limited
quantity, limited time deals and we want to make that announcement to our customer base because I
dont know if youre looking for a toaster or a TV, an mp3 player, an iPod, an iPhone, a computer,
and so, we make the announcements of the deals that weve had on a daily basis.
Many of our brand clients as Mike was talking about, because they have other off line activity that
theyre doing out there dont have the same frequency schedule in terms of sending e-mail. One of
the things that weve, thats been recently introduced has to do with this relevancy scores of
e-mails. And the denominator obviously, is the number of e-mails sent and the numerator in that
equation of e-mails opened.
Well, you can immediately affect your relevancy score by sending less e-mail and which could be
fine for someone thats got other active marketing channels or an inventory message that isnt
moving as rapidly as the eCOST inventory messages and thats allowed their relevancy score to stay
above the gateway if you will thats determining whether you should be delivered or not delivered.
Thats really the message that were trying to carry to these guys is wait a minute the nature of
our business is a daily e-mail that says heres whats available.
And the fact that the guy doesnt look at it today because hes not in the market for a technology
product isnt relevant, because I dont know whether a week from Tuesday youre going to be looking
for a toaster and when my e-mail arrives its there. And so if it gets filtered away, the message
doesnt happen, the impulse doesnt happen and its basically destroyed the market place. The
response you get from the ISPs after that is really well there are other paid search avenues
available to use to get that message across, which was my comment about the fact that what you see
is the major ISPs are controlling the majority of the e-mail addresses that are out there,
probably particularly consumer e-mail addresses.
And whether they intended it or not, the result of this action is to force more activity down the
paid channel versus the free or low cost e-mail marketing channel which does poorly from a
financial standpoint.
<Q George Walsh>: Okay. And speaking of which, I see the cost to acquire a new customer
did go up year over year. I think thats the first time in a little while that thats happened. Is
that directly the result of what happened this quarter?
<A Mark Layton>: Yes, and then the fact that were having to use other channels that were
paying. Its got to go up because Ive got in invest more money in off line advertising than what I
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was doing before. Its more expensive, and I dont have the viral impact thats helping me acquire
new customers that I have so my new customer number was down this quarter as well in that
particular segment of our business. So if you take all of those things into factor and it drives a
higher cost to acquire and thats whats going to happen here, is weve been, weve reduced to
acquire the eCOST businesses, we bought the business in 2006 from probably the high 20s, $30.00 to
acquire a customer now but where we were running around five bucks youre probably going to see
that number move back up again as we look for other channels out there to be able to acquire
clients. And it comes back to the pressure that it puts on the business in terms of the gross
margin characteristics, that this has added. We just dont have a lot of margin for error. If you
have a 40 point gross margin, it makes different financial characteristics in terms of what you can
afford to pay to acquire a customer.
<Q George Walsh>: Well, do you think they could come up is there a possibility thered
be like an e-mail marketing fee or something thats some kind of scheme theyd come up with regard
to that?
<A Mark Layton>: Well, I think right now theyll stand behind the thing that says well
this is junk mail and our people didnt want it because they werent reading it.
<Q George Walsh>: Right, okay. And just on the other side with the impact of that. How is
this affecting your acquisition of inventory or things that youre looking for since you have a
theres an impediment fear to kind of slow you of getting going there?
<A Mark Layton>: Right. And weve had to slow down inventory purchases. Theres no doubt
about that aspect. Weve had to be more selective on the deals that we buy and some of those that
may have been second-tier hot, if you will, deals. Were not acquiring or were not buying there as
many units in deal that we would have before.
<Q George Walsh>: Okay. And you obviously I guess try to also look for some higher-margin
type things?
<A Mark Layton>: Yeah. And again, this is where the eStore segment comes into play in
here, because as we look at Services clients that want to utilize this model, as I was talking
earlier, the gross margin range would typically are targeting and that are in the 15 to 25% range.
So, if we can add $50 million worth of 20 point business to the eCOST area, thats over there what
allow us to create economies of scale and gross profit dollars that uses the overhead of the eCOST
business model that we have. Because its been basically were using the eCOST business model
and the people that work within it, to do the eStore function thats there.
So, if we add $50 million hypothetically of 20 point business thats in there, that obviously
completely changes the whole eCOST dynamic and I think it moves it away from its core business, but
its still a profitable business operation for us from there. So, thats part of the complication
in terms of evaluating where we go with the business with this thing, this is it, we kind of
ingrained it into our service offering from here, so the question becomes whether its a trough in
terms of the financial results and Im back to that financial trend that Ive got to see improving
here or do we have to find a different way to continue to do what were doing on the services side
with this piece thats there and unravel the eCOST products out of the thing because the margin
characteristics dont work. So its kind of a its a complicated analysis and something that we
just have to continue to look at.
<Q George Walsh>: Okay. All right. Thanks a lot.
<A Mark Layton>: Sure, George.
Operator: And at this time, I am showing no further questions.
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Mark C. Layton, Chairman, Senior Partner and Chief Executive Officer
Okay. Thanks, everybody. Have a great day.
Operator: And ladies and gentlemen, that concludes the PFSweb Second Quarter 2010 Earnings
Conference Call. We appreciate your time. You may now disconnect.
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