PFSweb Inc (PFSW) 2011 Q2 法說會逐字稿

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to PFSweb's second-quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. I would now like to turn the call over to Garth Russell with KCSA Strategic Communications. Please go ahead.

Thank you, Brandy. 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, confident, 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 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 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, merchandise sales, and certain ratios that use these measures. In our press release with financial tables issued today, which is located on our website at PFSweb.com, you will 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 why we think these non-GAAP measures are relevant. These financial measures are included for the benefit of our investors, and should be considered in addition to and not instead of GAAP measures.

At this time, it's now my pleasure to turn the call over to Mark Layton, Chairman and CEO of PFSweb. Mark, the floor is yours.

Thanks, Garth. Good morning, everybody. With me this morning, Tom Madden, our CFO; Mike Willoughby, President, PFS. This morning, we'll be providing an overview of financial results for our second quarter -- end of June 30, 2011. After our prepared comments, we will be available for a few questions.

As you can see in our press release issued this morning, the second quarter of 2011 was marked by the continuation of several major growth drivers that we discussed in our last call. At the center of our continued strong growth is our service fee business, which reported a great increase in revenue this quarter of 27% compared to the same period last year.

The increase is attributable to existing client growth as well as the [ongoing] ramp-up of several new client programs implemented in the last several months. This includes several new End2End solutions launched within the last year that are supporting the transition of some of the world's most well-known brands into today's eCommerce marketplace, including the likes of kate spade NEW YORK and the recently announced relationship with Starbucks.

As I mentioned last quarter, we are experiencing what we believe to be a significant tailwind of industry factors, and a growing list of outstanding PFSweb and client success stories that are driving exciting growth opportunities for us by reputation and reference ability. We are keenly focused on capturing these growth opportunities for clients and ourselves through expanding our sales efforts, deploying a rapidly-growing professional staff in our technology and operational areas, and by investing in our infrastructure with an eye towards being prepared in advance for the growth forecast of our clients.

The collective result of these factors is that our service fee revenue continues to experience strong growth, and we believe that will continue. Along with that, we continue to make strategic investments to ensure we continue to capture the opportunities, and that is resulting in higher SG&A costs. We are keenly focused on striking a careful balance between the need to grow and the need to continue to improve our financial performance. As such, while we are investing for the future, we are continuing to target and we'll reiterate our guidance of adjusted EBITDA between $6 million and $7 million for calendar year -- or fiscal year 2011.

While, as I just described, the service fee business continues to grow, this revenue is being partially offset by lower product revenue from the Business and Retail Connect business segment. Recently, our largest client relationship in this segment proactively communicated to a certain realignment and restructuring activities that they expect to take over the next 12 to 18 months.

We understand that these changes are designed to streamline our client's business processes, reduce costs of operations, and set the business up to be a stronger market presence in the future. Collectively, we believe that these changes may result in some gradual and modest declines of product revenue and resulting gross margins dollars for our Business and Retail Connect segment over the next several quarters, while our client's restructuring activities are implemented and before their targeted benefits take a foothold. That being said, the Business and Retail Connect segment did experience a benefit in margins during the second quarter due to certain client pricing adjustments.

As Mike will address further, we currently expect our service fee business segment to maintain its positive momentum and drive our growth as we look to the future. We currently have about 15 separate contracted by eCommerce client programs set to launch over the next six months, including 10 End2End solutions with some new client programs, some of those which include new product programs that we announced during last quarter's conference call.

As we continue to close and implement new client agreements, we've also been able to attract a healthy flow of potential new business, allowing our business pipeline to remain strong and healthy. As a result of the hard work of our team over the past quarter, our pipeline sits today at about $45 million in size, based on client annual projections. While this pipeline amount is down somewhat for the past few quarters, much of the change is attributable to yet-to-be-announced client wins coming out of the pipeline, combined with the normal summer season new business softness that we generally experience each year.

We believe the continuing strong pipeline speaks for itself in terms of both the rapidly growing number of End2End opportunities we are pursuing, and in the growing reputation that PFSweb has earned for successfully implementing high-quality and customizable solutions for our clients. In line with this positive momentum, we've spent the last couple of quarters -- and expect to continue -- making strategic investments in our staff, facilities, and technology, both domestically and abroad. It is through these investments that we've been able to support our existing client programs, and will be able to support the growth we expect from clients currently in the new business pipeline.

During the first half of 2011, we made significant additions to our technology development team as well as other investments at our facilities and technology and operational infrastructure. This includes the new food grade distribution facility we opened in Memphis earlier this year that will be used to support Starbucks, as well as other new CPG client programs we are targeting to launch in the future.

Also, we're in the process of aggressively expanding our call center operations within the next few months that will include the opening of a new larger facility in the Dallas area. A byproduct of this exciting expansion is that we do expect to record various one-time facility relocation costs during the next several quarters.

We are targeting strong service fee revenue growth to continue in Q3 and Q4, but as I have discussed, the impact of this growth will be somewhat tempered in our financial results by the higher costs necessary to be prepared to embrace our current and future clients' growth forecast. Just to be clear, while we're definitely making investments that will result in higher SG&A costs in the near-term, we believe those investments bode very well for us in terms of our financial future of our business. Again, we're continuing to provide guidance that our adjusted EBITDA for fiscal year 2011 is targeted to be between $6 million and $7 million.

With this information as a backdrop, I'd like Mike to take the call for a few minutes and give you some details in terms of our client programs. Mike?

Thank you, Mark, and good morning, everyone. As Mark just mentioned, we're really excited about the growth we are experiencing in our service fee business for this quarter and the first half of 2011. This growth is being driven by a number of factors, including the ramp-up of a number of new clients launched over the past year, as well as from the organic growth of several of our established clients.

For me, one of the highlights of this conference call is the announcement of the launch of the new Starbucksstore.com website, which is powered by PFSweb's End2End eCommerce solutions. We have referred to this client on previous conference calls as a well-known company in the prepackaged food and beverage category. So for those of you who that follow us conference call to conference call, that answers that question for you.

The new website went live during the last week in July, and Starbucks announced the new site with a press release last Thursday. As indicated in that press release, the new site is a complete redesign of the prior site that makes shopping for coffee, tea, and merchandise easier and more convenient for the Starbucks customer. This site is part of Starbucks' growing digital presence, and it offers an elevated Starbucks experience that's consistent with the well-known and respected brand experience that Starbucks creates in its stores throughout the world.

While the launch of the new eCommerce site is exciting in itself, there's some really great eCommerce innovations within the new site that I think are worth mentioning, including a new subscription service. With the subscription service in the site, registered customers can set up time-based shipments for not only coffee and tea products, but be eligible to place pre-orders for special items from time to time -- items that are only available online. The subscription service utilizes a customized version of our continuity module to deliver a very easy-to-use online tool for the customers to maintain their service, using a familiar Queue Interface.

The new site also contains new coffee and tea tour packages that combine relevant products into a exciting new experience for the customer. Using this feature of the Starbucks store, customers can educate themselves to the different dimensions and tastes of coffee and tea by participating in these tours, which are multi-month product packages that ship to them automatically.

For example, in a coffee tour, you can receive two contrasting styles of coffee per month, to compare and contrast the idiosyncrasies of each blend, and increase your knowledge of coffee. Standard ground shipping is free for all products included in the tour.

In addition to the coffee and tour packages, the site will feature a rotating selection of Starbucks reserve coffees. Now customers across the US have access to limited release coffees that otherwise are only available in select company-owned stores in certain areas of the country.

And speaking of Starbucks stores, in order to integrate the digital channel seamlessly, and to the iconic Starbucks in-store experience, we've included the My Starbucks Reward and the Starbucks Card in the new site. You can purchase Starbucks cards from the site for yourself or as gifts. And when you shop online at the Starbucks store, you can use the registered Starbucks Card to earn Stars, which is the Starbucks reward currency, for each purchase that you make online. These stars can be redeemed for free drinks in the store and other unique prices from Starbucks, including personalized product offers and coupons.

In addition to the great features we've built into this site, it's also simply just a wonderful eCommerce experience, with beautiful content that's consistent with the world-class Starbucks brand. And I encourage you to shop the Starbucksstore.com site frequently over the next year, and just experience not only what it looks like today, but experience the End2End commerce solution, and participate in the process of innovation that we're going to be partnering with Starbucks as we evolve this site over the next year and the years to come.

I'm also pleased to be able to name another new client that we've referred to generically in previous conference calls. In the last conference call, I mentioned that three of the new client programs we were working on for eCommerce sites -- were eCommerce sites for Western Europe and/or Canada. Two of those programs are branded eCommerce programs for the Columbia Sportswear brand, supporting both the Columbia brand and the Sorel Footwear brand in Western Europe and Canada.

These sites are expected to launch over the next 60 days, and they'll utilize Columbia's existing technology agreement with Demandware in combination with the remainder of our End2End components, including high test customer care, order management, fulfillment, payment processing, and marketing services. Customer care and fulfillment services for European and Canadian consumers will be provided out of our Liege, Belgian location and our Toronto, Canada area location, respectively. We're really excited to add these two excellent fashion brands to our rapidly growing portfolio of fashion and apparel clients.

As we've said in prior conference calls, success in global markets is really important for our business's long-term success. While our global End2End eCommerce footprint solution is already well-established, expanding this footprint is a key element to our growth strategy. It will help us service our customers even more effectively, and make us an even greater force in the market. I believe the addition of Columbia to our global brand portfolio demonstrates the success we're having in winning global deals. There are more global engagement announcements to be coming in future conference calls.

Also, we've now launched one of four planned new fragrance, beauty, and skin care eCommerce sites under our existing master agreement with Procter and Gamble. These four sites leverage the End2End solution we previously deployed for P&G with the eStore. These launches will serve to illustrate our ability to rapidly launch successive brands on a common platform and a common infrastructure, while still delivering a completely customized consumer experience at every touchpoint.

You may have noticed that we continue to roll out separate customized programs under these master agreements, such as our P&G enterprise agreement, our Liz Claiborne master agreement, and the master agreement we have with a still-unnamed fragrance and beauty company. We believe this success validates our approach to target luxury, prestige, and CPG brand holding companies or portfolio companies, where a single contact relationship may lead to multiple valuable brand engagements.

We believe our End2End solution is uniquely positioned in the industry to meet the needs of these brand holding companies, where we can provide a single solid infrastructure and provide tremendous leverage to our client, giving them economies of scale, while still providing a completely custom branded experience for each brand. Now I think this is critical to the luxury and prestige brands that they're targeting, since they have really zero tolerance for anything that's less than a completely customized, brand-centric message.

In total, including this new fragrance and beauty site and the Starbucksstore.com site, we now have over 17 End2End programs in operation since the first End2End solution was initially launched in 2008. This track record, along with our reputation as a leading solution provider in our industry, is quickly helping us gain entry to potential new clients and helping us compete for new business, both in the US as well as abroad.

Looking forward, as Mark mentioned earlier, we have approximately 15 new client programs set to launch over the next six months. These programs are for companies which span multiple industries, as we continue to benefit from the emergence of several large product categories accelerating growth in the web commerce space. These categories include fashion, health and beauty, and consumer packaged goods, or CPG.

In fact, last quarter, we signed a master agreement with a major CPG company in the prepackaged food and beverage space, to launch End2End eCommerce solutions for two of their major beverage brands before Christmas this year. This engagement represents a significant revenue opportunity for us in 2012, with some contribution currently anticipated in Q4 of this year.

This opportunity also represented one of our larger individual proposal amounts in the pipeline that we reported last quarter. And with our new business sales pipeline still at over 45 million in size, based on client projections, we're encouraged that we are continuing to win major new deals while our business development activities backfill the pipeline with new opportunities. I believe this is a very good indicator that we can sustain our targeted growth rates moving into the future.

Finally, as I indicated at the beginning of my comments, we continue to benefit from impressive organic growth, with several of our established clients, including recently-announced programs with Carter's and kate spade NEW YORK. Helping our clients grow their businesses with our End2End eCommerce solutions, particularly with our digital marketing services, is a core part of our value proposition to our clients.

Benefiting from our clients' organic growth is also an important part of our financial model. In order to take advantage of these client organic growth benefits, we must continue to offer leading-edge, comprehensive, End2End solutions. And we must operate those solutions with a very high level of quality. We believe our success in winning, and now expanding these new client business opportunities, validates our model and provides an inherently positive reference to the high levels of quality that we provide to our clients and our customers.

And with that exciting news, I'll turn the call over to Tom for a review of the financial results for this quarter. Tom?

Thank you, Mike. Well, as Mark and Mike have both alluded to, I'm also pleased with the progress PFSweb has made this quarter, in terms of both our business and financial results.

Just a recap on the quarter -- total consolidated revenue for PFSweb in the quarter ended June 30, 2011 was $68.0 million compared to $66.4 million reported in the second quarter of 2010. This included an increase of 27% in our service fee revenue, up to a level of $21.0 million compared with $16.6 million for the 2010 second quarter. This increase is attributable to increased service fees generated from both new and existing service contract relationships.

To break that increase down for you a little bit further, new service fee contract relationships generated approximately $4 million of this year-over-year increase, while existing client activity generated approximately $3 million of growth. These two increases were partially offset by a year-over-year reduction of $2.7 million from the impact of terminated clients. Most of this related to the non-renewal in mid-2010 of the large technology manufacturing client, which we discussed last year. If you exclude that non-renewal, our year-over-year service fee revenue growth would have been approximately 43%.

The increase in our service fee revenue helped to offset a decrease in our Business and Retail Connect business segment, which includes our supplies distributors operations. Our revenue for this segment was $38.8 million for the second quarter of 2011 as compared to $43.7 million for the 2010 second-quarter.

Our consolidated gross profit for the second quarter of 2011 increased to $8.6 million or 14.3% of net revenue, excluding passthrough revenue, as compared to $7.6 million or 12.6% of net revenue, excluding passthrough revenue again, in the second quarter of 2010. This improved percentage is in part due to increased percentage of our overall revenue mix coming from the higher gross margin service fee business. In addition, our gross profit received a boost during the quarter from incremental gross margins earned from certain product price increases, enacted by our large client in the Business and Retail Connect segment, as well as the impact of certain incremental inventory cost adjustments. We expect our margins for the Retail and Business Connect business to settle back to historical levels again in the third quarter.

Our second-quarter results reflect ongoing SG&A investments we are making in our business to support increased client activity, both domestically and abroad, as well as for future anticipated growth. These activities have primarily included strategic investments in personnel, facilities, sales and marketing, and technology. SG&A for the quarter increased approximately $1 million to $9.4 million as compared to $8.4 million for the same period a year ago. In the second quarter of 2011, our consolidated adjusted EBITDA was $1.1 million, which was the same as the prior-year period.

We anticipate our SG&A investments to continue to have an impact on our adjusted EBITDA in the third quarter of 2011. However, we are now expecting a stronger fourth quarter. Overall, we continued to target an adjusted EBITDA range for fiscal 2011 of $6 million to $7 million. This target excludes certain facility relocation-related costs, which we expect to incur during the next few quarters.

For the second quarter, our net loss totaled $1.2 million, or $0.10 per basic and diluted share, compared to a net loss of approximately $1.5 million, or $0.14 per basic and diluted share for the same period last year. Net loss for the second quarter of 2011 included an income of about $14,000 from discontinued operations related to eCost.com compared to a loss of $0.4 million from discontinued operations for the same period last year.

We continue to maintain a solid financial position, with total cash and restricted cash as of June 2011 of approximately $20.2 million. During the quarter, we also completed a renewal of a credit facility for our Business and Retail Connect business segment to support its financing needs.

Our capital expenditures so far in 2011 have reached approximately $4.7 million. This includes new start-up -- or new client start-up integration activity that is generally funded by clients. In addition, we continue to make investments in technology and infrastructure to support our growth and enhanced productivity.

Now I'd like to turn the call back to Mark for some closing comments.

Great, thanks, Tom. I hope that our prepared remarks today that you heard from myself and Mike and Tom give you a little insight to the feel that I and our entire team here at PFSweb are currently experiencing.

Seeing the finished product of great client names like Procter & Gamble, Starbucks, kate spade NEW YORK, Carter's, and so many others, and watching many of these clients' businesses experience strong growth as a result of the new technology platform, marketing programs and site features that have been implemented, it's incredibly rewarding not only for our clients, but for our PFSweb team as well.

I can feel within our business and our staff an awesome buzz of excitement and expectation that feels a lot to me like dot-com boom years in the late '90s, but with what I believe is a whole different universe of tangible and financially sustainable growth opportunities. It is exciting times -- lots going on. And we look forward to continue to update you on our progress in the coming quarters.

With that, that concludes our prepared comments for today. Operator, we'll be available for a few questions.

Mark Argento, Craig-Hallum Capital.

Nice quarter. And it looks like you guys are continuing some nice incremental progress with the services business. Specifically around that, I know you'd mentioned you guys got 15 new -- I think it's new -- is it new programs that you're launching? Maybe you could just kind of clarify that number for me a little bit.

Sure. So when we refer to a client program, it's a specific, usually geographic program deployed. So, for instance, if we have a global client, we sign a master agreement with them, and we launch a US and a Canadian and a Western European site, we would count those as three separate client programs under one master agreement.

And we do it that way, Mark, simply because each one of them is -- while the technology backbone is common, the look and feel in the interface is different in order to deal with the localization requirements in each of the countries. So -- and that's true across brands as well. So we may have -- you look at the Procter & Gamble relationship that Mike discussed in there. I mean, there are a number of client programs within that, that are distinct, either geographies or brands within that.

And generally, we're going to be deploying a separate project team for the launch of each program. So, from our perspective, the bandwidth that we have in order to launch new client programs, one of those teams would be taken up by new client programs. So if we say we have 15 client programs in progress, generally, it means that we have 15 project teams deployed to launch those.

Got you. Okay. That's helpful. And you said within the 15 is one of the -- a major packaged foods guy, and the beverage programs are two of the 15, is that right?

That's correct.

Okay. Maybe you could better help me understand the whole beverage/eCommerce. I mean, what -- are you actually going to be a Direct-to-Consumer model here? Is it a B2B? Or what do you have going on? Or what potentially does this thing look like?

The program is an End2End Direct-to-Consumer program. And the products are prepackaged. So, shelf-stable type products like you'd see on a grocery store shelf, for instance, Direct-to-Consumer.

Got you. And is it actually -- I assume it's a beverage type of liquid product?

It's in that category, so there's a variety of different types of products. Some are liquid, some are other -- powder-type products. And there's also merchandise and consumer electronic type products in there as well.

Got you. Okay. That's helpful. And then you guys -- do you expect to have that up and running by the end of the year?

Before Christmas.

I got you. Okay. And will they let you announce who -- hopefully, let you announce the client at that time or --?

We expect to be able to announce the client at or after the launch.

Got you. Okay. Mark, when you talk about -- I mean, you guys are -- [Cooledge] is a massive pipeline of business here. And you talked about gearing up to be able to handle that business. When you're talking about incremental spend, are you -- is it hiring people to -- call center people, operations people? Maybe you could kind of, at a high-level, bucket out the spend a little better, help us think about that.

Okay. Well, it is a combination of people and then capital investments in the other existing infrastructure to expand it or new capabilities that we have. So specifically, technology developers, for example, that area has grown pretty significantly over the last year. And we have a period of time during their ramp-up period as we train them on the technology backbone that we use, that they're not necessarily assigned to a client. So that results in an increase in SG&A during that period of time, that we would then expect will move into cost of goods, as new client programs are implemented with those people working on them.

That's a similar scenario for account managers that manage our client relationships. We've seen a significant headcount increase in that area as well. Again, there is a training period that's involved with that. We -- particularly our entry-level account manager are primarily new college graduates, so our recruit program and the runway -- run-up time period, if you will, for their training is included in SG&A during that period of time, until they are assigned specifically to a client area. And then they'll show in our cost of goods.

So what you're seeing is a people component running through SG&A that we expect over time will move to cost of goods, and be associated with new revenue that we would make in that area. So that's the people front.

On the infrastructure side of things in here, we have made some pretty significant investments in terms of our mobile [Pick] card technology in our facilities in Memphis. The Pick card technology is a very highly productive picking method for many of our clients. And with the growth that we've experienced with clients like Carter's and a number of the others, the Pick card technology has grown significantly in that area, so we've made significant investments there. We've talked about the food grade facility already that we added earlier this year. So that's some of the infrastructure.

And then we just have facility expansion needs. So, for example, our call center agents will grow substantially. We have a smaller period of time where they are in SG&A, but they've become productive much more quickly in our environment, that we're ramping up infrastructure requirements to support the seat needs for the new clients that Mike described, as well as a pretty significant fourth-quarter peak that we expect at this point. So that is square footage, furniture, telecom equipment, PCs and so on and so forth in that area that, from an infrastructure needs. Then again, a lot of that will end up in cost of goods as the revenue comes from there.

So you see a bit of a ballooning in the SG&A component that will move to cost of goods. But as we continue to see an aggressive new business pipeline, that amount is going to continue to be in there because we've got to get ready for the next bulge as well, so.

Got you. And then, Tom, you had mentioned facilities relocation costs. Is that at a corporate level or is that just additional distribution facilities?

It's a combination. We've talked a little bit about different facilities. We just, within the last couple of weeks, have relocated our Canadian facility from its prior location to a somewhat larger facility to support some of the growth activity there. As Mark alluded to, we're talking about -- or we're in the process of looking at a new call center environment for us. In addition, we are evaluating a -- what to do from a corporate headquarters standpoint as well.

Our lease on our current facility here ends in March of next year. So we're looking at some various options to deal with our growth aspects -- the technology developers and the account managers. What comes with that, obviously, is requirements for desk space and square footage to put that on in there. So you will see some expansion in our square footage, both on the headquarters side as well as the call center side, and some additional facility expenses as we go forward.

Last question and maybe Mike or, I guess, whoever can chime in on this one, but when you really look at -- I mean, we see this really big trend of branded CPG companies really want to develop that direct one-on-one relationship with the customer using the Internet and the Web, and eCommerce to do that.

Are you starting to see them actually put real spending behind on the marketing side to really start to drive the channel -- not only just establish the channel, but really start to drive throughput through that channel yet on the marketing side, opening up their customer account, their databases, all those things -- are we at that point now where they're kind of starting to light that up?

Well, every client has got a different viewpoint on how they want to use the Direct-to-Consumer site -- this is Mark, by the way. And so there are some clients who immediately want to aggressively move activity through specifically the site itself.

I think you'll see us begin to talk more and more about a role we see ourselves evolving into as it relates to being a facilitator of commerce across channels. And the client, in many cases, is using our expertise and our technology that we bring to play, that may facilitate transactions that go across the eCommerce bandwidth, if you will, but that don't necessarily get shipped out of our facilities or result in a call in our call center. They may grow revenue activity in another piece in the channel.

And so, increasingly, I think over the next several years, our role will become more of a eCommerce facilitator, if you will. And as the consumers continue to determine when, where and how they want to buy, more and more, our role will be to facilitate the convenience of that consumer to complete their demand, if you will, in that case. And that's an exciting component, I think, for our clients, is they want to grow overall -- whether it's -- they want to grow market share; they want to grow revenue. And depending -- and they want to do it in a manner that the consumer can choose the most convenient method for them.

So it's a bit out there, a little bit strategic-wise, but it gives you some feel for where we're at. And I think, as you look at a company like Procter and Gamble, for example, they're much more interested in overall eCommerce growth for them as a company, regardless of which retailer or which channel gets it. They want themselves as a company to be at the forefront of servicing clients -- their customers of the future, however that customer wants to be serviced. And they're using our expertise and our technology to allow them to get there. And where that shows up at is somewhat irrelevant to them in terms of that.

So you'll see our revenue models evolve to where we'll be -- whether it's a rev share or people billing hours and things along that, to align with where our clients are taking us in that area.

And you guys have proprietary software? Or are you developing the technology platform to be able to manage across all the different -- if it's the Company's own website, a third party website -- I mean, you guys have the technology to be able to start to do more of that type of business?

It's a combination of those things. So, certainly, our relationship with Demandware is important to begin with. One of the differentiators that we have as an integrator for Demandware I think we're -- I'm certain we're pretty much the largest integrator for Demandware in the world. And in terms of the developers that we have.

So we distinguish ourselves from our competition first of all, by the fact that we have more high-quality developers on the platform that know how to use it, and we have developed a number of proprietary-type capabilities around that. So Mike mentioned the continuity program for Starbucks as an example. We have other, if you will, apps that are plug-ins to the Demandware technology that our competition can't offer nor really can Demandware offer it directly. They can do it in partnership with us, but they couldn't do it on their own. So we're developing our own technology.

Secondly to that is that we've developed hundreds of interfaces to third-party technologies that allow, whether it's a payment processing method or a rating and review service, or on and on and on with that -- we're building a library of technological interfaces that have -- that allow the products to be enabled in the Demandware platform out there and use on the site. That again is a differentiator for us.

We're not setting out to try to be a large software development house. If we can buy it, we'll do that. But in many cases, the technology is not necessarily available or not to the quality standards that we would like. And so we'll develop it in-house in those cases from there. So what you'll see increasingly is a library of either our own proprietary technology or third-party interfaces that we have created reseller agreements with. And they are bundled around the Demandware platform.

And that same concept can work with other software manufacturers' products. Now, there's really not another strong SaaS player in the industry today, so this is where Demandware itself has a significant advantage in terms of the architecture design that they have for their platform. And why we're so keenly aligned with them in terms of where they are and where they're going. It's been a great partnership, continues to be, and both of us are benefiting significantly from it.

Great. And just last question. If you look at the service fee revenue, the $21 million you guys did in the quarter, I know you kind of broke it up in new relationships, existing relationships. Maybe just to step back a little bit, if we're looking at the $21 million, of that $21 million, how much is kind of what we'll call production revenue -- meaning revenue generated from actually doing the fulfillment work versus, say, initial setup or pre-revenue or pre-production service fee revenue?

I don't have those exact numbers in front of me, but I'll estimate for you. I think that the total fulfillment revenue activity for the quarter would probably be approximately 50% of our overall revenue -- 45% to 50% would be my expectation. And call center following second as the second largest component.

And start-up revenue is not going to be a major --

I'm sorry -- yes, start-up revenue is not a significant component. We generally take that activity and defer it over the life of the contract for the start-up activity.

Okay. So you guys aren't really getting paid a couple of million bucks to spool up on the front end (multiple speakers) --?

We may get paid to cover our anticipated costs, but we're generally deferring that revenue and cost over the life of the contract.

Okay. All right. That's helpful. Thanks, guys. Appreciate it.

Marco Rodriguez, Stonegate Securities.

Thanks for taking my questions. I was wondering if I can get a clarification in regards to the Retail Connect. The sequential drop in revenues -- has that particularly been driven by that one customer you referred to that is restructuring? Or is there something else in there?

Yes, as we look out over the next several quarters, I think that my comments related to the modest decline that we may experience in that is related to that large client in that area of the restructuring activities that they're undertaking.

Okay. And then shifting to the gross margins on the service fees in the quarter was a little bit lower than what's going on from a historical perspective. Can you provide any color there?

Sure, a couple of components there. First of all, we did have a high level of new client startup activity. Generally, when you have a new client, you start operating with a gross margins that's a little bit lower than what our long-term targeted gross margin percentage would be. So that's one component. Another component is the fact that we didn't have a lot of project work, incremental project work this quarter that we generally see a higher level of. And oftentimes some of that project work can sometimes occur at a higher than traditional gross margin effort.

And just to add a little color there, Marco, as Tom was talking about startup, he's really talking about the time period of when a client's site goes live, okay, and when we get it operating maturely -- a few months, typically. Not the ramp, not the building period, all right. That goes into startup revenue that he described earlier that's amortized over the life of the contract.

So once a client goes live and we're recognizing revenue, we typically experience lower gross margins in the first several months of the client until things are in a steady-state aspect. And given the number of new clients we're bringing on, it has a mix impact right now that's impacting margin.

The other part about the project work, not necessarily that it isn't available, it's just -- our staff are all busy working on new deals right now, so we haven't been able to take advantage of some of the project opportunities that were out there in that. So that had a little bit of impact on margin, because as Tom mentioned, typically those -- we kind of can sell that at list price in many cases, so.

Yes, and where we have taken on some projects, we've used a staff augmentation model where we're bringing in some outside contractors that would be at higher rates. And so it isn't necessarily that we're not getting the job done for the client, but we're not deploying our internal resource to do some of those things -- we're putting them on new client deals because we have that opportunity right now.

That's helpful. And so with the new 15 client engagements that you're expecting to launch in the next six months, let's just say the second half of the year, are you expecting that same sort of an impact on the gross margins for your service fee? Or are you expecting it to bounce back up?

I think -- that's a pattern that we expect and have seen historically, where the first 90 days or so of the contract as we have the project management folks still on the project, additional work just to make sure that everything is going really well. And setting in the processes and procedures around a deal -- that's a phenomenon that we historically have seen and we expect to continue.

Okay. And then just in regards to the 15 new clients or 15 new engagements that you're launching here, can you provide color in terms of how many -- like or rather kind of by brand how many of those 15 represent? And any sort of additional information in terms of which ones were are doing the full line of services?

So a couple of different questions there. One is -- I assume you're asking what category or vertical market they might fall into. Most of the deals that we're currently working on do fall into one of the three top verticals we have. Most of them are fashion and apparel or accessories. In fact, our current pipeline, 50% of the opportunities we have in our pipelines are fashion, apparel or accessory deals. And so if you extend that into what we're working on, it's pretty close -- about half the deals are in that category.

A couple are in health and beauty, so on average, about 15% of our opportunities show up in that vertical market -- health and beauty, skin care. And then CPG is 10% of our pipeline. And so a couple of deals, as we mentioned, two for that prepackaged food and beverage category are CPG. Does that help?

Yes. And then I guess you mentioned that if you have a client and you're going to launch that client a particular brand in three separate geographic locations, if I were to look at it from, I guess, counting those three -- the example that you have where you have three different locations -- Europe, the US and Canada -- if you were to consolidate it and count that as one, how should we think about those 15 engagements?

So just to give you a flavor of where we're at year-to-date, we have signed six new clients. So that would be either an individual deployment or a master agreement with a client. And for those six, that would include 22 client programs. So on average, you can see that we're doing a little less than three -- or a little bit more than three client engagements per master agreement, on average.

That's helpful. And then lastly, I was wondering if you could maybe provide us with a little bit of an update in regard to your competitive environment, now that your largest competitor has been acquired and the spinoff has been complete. Any kind of color you can provide there?

I don't think there's been a lot of change in terms of where we see the competitive marketplace. I mean, we typically come down to the two large global providers being the final two selections in that. eBay is certainly trying to tout its PayPal capabilities and the marketplace around the PayPal area as an advantage. However, it's an open environment and we have relationships with PayPal as well. So I don't see that in there.

I think there are certainly some clients that are still trying to understand it all. And with that creates uncertainty. So maybe there's at times a little bit of advantage for us in terms of being a known, stable entity in that. So maybe we get a little bit of an advantage and a checkmark on that. But I would say as of today, the competitive landscape has not really changed.

Now for all the reasons that we described out there, particularly the technology deployment of our End2End solution out there, we've been in a very strong competitive position for some time, even before the acquisition, from our perspective. And I think that that -- we expect that to continue, particularly with some of the investments that we're making. And also we're, as I described a couple of minutes ago to Mark Argento, how we see ourselves in the years to come as a facilitator of a lot of these eCommerce transactions.

Great. Well, thank you, guys. I appreciate it.

Alex Silverman, Special Situations Fund.

The End2End beverage brand that you mentioned, the CPG client, that ramps by Christmas, is this the client that you initially won that resulted in the leasing of the 50,000 square foot food-grade facility?

No. As I covered in the prepared comments on that, we originally built that facility for the Starbucks deal.

So that was for Starbucks and this one will then be incremental to that?

No. At this point, the fulfillment activity is not included in that particular deal. This is a large relationship. But at this point in time, the activities that we are performing are technology and customer interaction-related, customer response and a lot of marketing services.

This is for the beverage?

That's correct, yes, the -- yes.

Okay. That's very helpful, thank you. And then in terms of the Retail Connect margin benefit this quarter, which will fall back in Q3, can you give us a little -- can you help us there with that, explain a little further what happened there?

Sure, this is Tom. Our primary client in that business put in place a price increase back toward the beginning of the quarter. When that price increase occurs, we generally get some benefits of the sellthrough of some existing products as we carry that price increase on to the channel. So it's a kind of a temporary benefit that we (multiple speakers) --

So in other words, your inventory was priced at the lower price?

That's correct.

Got it. And so it will just be a catch-up?

That's correct.

And what -- I don't how much you can share, but I think your comment was that this same client was planning to restructure -- can you give us some sense of what's going on there?

Yes, I mean, it's pretty much public information that's available out there but -- so I don't want to get too much into that aspect of things in there, but you've got what's being operated as a totally separate subsidiary worldwide. Basically, they are making some rationalization, if you will, by combining a lot of the operations, particularly in the international markets into the mother ship, if you will.

It allows them to align some product lines together; eliminate a little bit of duplication in some of those product areas that they had; and also make some significant benefits for them in terms of their sales force and the engineering aspects of things in there, so they'll be able to reduce -- kind of streamline costs of operations going forward.

So our relationship with them -- they have reiterated, is solid. There will be some changes in the product categories out there that we think could result in some modest declines of revenue over the next several quarters, but we'll keep our finger to the pulse. And frankly, I think that there is some opportunity for us to potentially begin to expand with this client into other business lines that were at the mothership, that we had previously not had a lot of access to.

Is there a chance that that arrangement moves from basically a buy/sell to a consignment service contract?

Well, I've been answering that question for 15 years. (laughter) I think there's always a chance as that. And as I've mentioned before, we are relatively agnostic as to how our clients choose to deploy with us. We can make similar -- from a modeling standpoint, we can make similar gross margin dollars if it were operating income in either model, in terms of how clients deploy with us.

So while product revenue might go away if the model was changed, hopefully, we're in a situation, at least in terms of how we model these things in here, that we can earn a similar operating income regardless of which way it happens. So there's nothing at this point that indicates that they want to make any change in that relationship. But it has been discussed over the years and it's something that at least pops up on the radar screen in terms of should we consider this. And at this point, they continue to feel that the way they want to deploy the relationship with us has been through a buy/sell model.

Okay. And then just to change gears, can you give us a sense of how much was taken out of the pipeline in the quarter? And then of that that was taken out, how much of that was won versus either passed on or lost?

Sure. So and just to remind you that we -- if you look at our sales funnel, our objectives are to propose on about 50% of the leads we sort of qualify in. So you'd expect to see some pretty significant churn in the pipeline.

And this quarter, we actually have seen much more activity than we even traditionally see; we actually completely turned over our pipeline. So we added in the neighborhood of $65 million in potential as client projection value to the pipeline. And we actually took out $61 million. And if you look at the pipeline for the quarter, 22% of the pipeline was actually deals that we won, that we contracted. And that would equate to about $15 million or so in value.

So, historically, 50% you actually end up bidding on. So assume that half of it was taken out because you didn't bid on it; 22% you won; and the rest you didn't win?

That's right.

Okay, very helpful. And then any update in terms of an umbrella lender?

Still kind of looking at that. Now that the eCOST business has been sold and we're in the process of having discussions with our banking partners about a potential US-consolidated facility, but not a lot has been done further on that. We'll probably be looking at that a little bit more in the early part of 2012.

And most of your credit facilities come up for renewal in the March/April/May of '12 range?

Actually, we -- the facilities have just gone through a significant amount of renewals. The primary ones are with Comerica. Those now come up for renewal in September of 2012, so it was an 18-month renewal, which is longer than what we had normally got from a renewable period with them.

The Wells Fargo renewal is for a three-year period, so that actually -- for the Supplies Distributors business, so that goes through March of 2014. The Retail Connect piece that we just renewed in May was extended for a year. And then the IBM Global Financing relationship is extended for a year. So it's a little bit of a mixed year. As we look out into next year, we won't have as many coming up for renewal at that March timeframe as we've had this year. Many of them extending their terms with us this year.

Great. Thank you very much.

(Operator Instructions) Glenn Primack, PEAK6 Investments.

I was wondering how much extra cost did you take on with Starbucks this quarter without the matching revenue that would potentially, I guess, move from SG&A up to gross margin expense?

I'm not going to go into specific details on individual clients. There would have been some this quarter. It wasn't a significant amount, but there would have been some.

Okay. And then, Mark, on your vision on, I guess, being an eCommerce consultant to major CPG companies, does that come about just because you've had so much potential project demand that you can't get to, because you're taking care of your clients?

No, that's coming about because the world is changing in terms of the way -- I mean, the simple thing you can look at today, 99% of these eCommerce transactions originate from a PC today. As we sit back and look at this over the next several years, that number is, we believe, will decline significantly. And as mobile transactions come to play and other electronic widgets, if you will, come about, whether that might be a seat back device at a stadium, or something in a cab, an electronic billboard, a shelf talker -- various ways that consumers can interact with brands and potentially purchase products.

What we see is that an ability to facilitate electronic commerce transactions, if you will, across channel partners, some of which will continue to result in shipments from our own facilities and interactions with our own call center; others of which might facilitate transactions between various retail locations out there, in order to be certain that the brand still captures the sale and doesn't lose it to a competitor.

So this is several years out, but with that, then you sit back and say, well, how does our revenue model evolve around that? And there will be things more oriented around potential rev share agreements and things along that basis in there that we'd go. So this is a perfectly -- a hypothetical example I'll give you here, but let's assume for a minute that we moved a couple of billion dollars of overall commerce this year -- facilitated a couple of billion dollars in overall commerce this year. Today, almost all of that moves through -- would move through one of our facilities. And the customer interactions would be with one of our call center agents.

Fast forward five years -- let's just say that we may facilitate $10 billion of commerce and $3 billion of that moves through our facilities and $7 billion of that is facilitated across various channels, where we may not actually hold the inventory for the client at all or handle the interaction, or there may not be an interaction required. But we might be able to gain a rev share of that other $7 billion, because we facilitated through our technologies and our -- both proprietary and our technology interface relationships that I described earlier in there -- those particular transactions. So it's a new revenue source for us, if you will, almost a new product area that we can offer that we see the opportunity for going forward.

So your return on invested capital looking out, I don't know, for the three to five years, goes up dramatically if that takes place?

If that hypothetical example takes place, you would assume that would happen, yes.

Okay. Last one with Behrens writing a piece a couple of weeks ago on Amazon, I don't know if you saw it or not, but the whole -- they're growing revenue but they're having to put that much more into infrastructure. Can you just compare and contrast what you're going through? I mean, you guys started as big distributors. They kind of started as not. And so is there some things of similarity or you wouldn't even view that as a comparable-type company?

So I'm not familiar with the piece that you're referring to. When we look at Amazon, we look at them in two different ways -- one is as a potential competitor because they have a fulfillment by Amazon type of a product. They aren't really a competitor to us because their infrastructure and their go-to-market strategy is really targeted to small and medium businesses with a pretty generic fulfillment and e-Commerce offering; whereas our vertical markets demand a highly customized, very robust offering across the touchpoints.

So if you look at their outsourced business, we don't see them as a competitor, and the infrastructure that they've built is really built for this large volume of products across a large number of small to medium businesses. And I think the problem with that model is you've got this huge diversity of clients and products that you're trying to warehouse and pick, pack and ship -- we may have, say, 35 clients across our facilities doing very large volumes per client. And we can get a lot of leverage and economies of scale across those 35 clients. If you had 3,500 clients doing a similar volume, you could just see the complexities and the inability to get the economies of scale, if there's any customization required or diversity with the product.

The other side of Amazon, obviously, is their core business, which I think is the emphasis for them. And as they try to broaden their product categories with other people's products, third-party products that they're bringing into their facility, the complexity just gets exponential as far as the technology you have to deploy, and processes and procedures you have to put into the facility just to make that work.

We've often been asked why don't you have a box solution, if you will, that could deal with small and medium-sized websites out there? And this conundrum that Mike just described has been something that we have circled around for many years, and have never really been able to identify a financial model that we think it works.

We do take some calculated risks with startup sites each year that don't have any revenue -- it may not have a customer base with them in there, but maybe a great brand name. And we'll take some risk with that. Generally, we've got to be able to see -- both for our client's financial justification and our own -- we've got to be able to see a site that can generate more than $20 million a year in commerce in the first couple of years, or it just doesn't really make a lot of financial sense for either party to be able to deploy the solution necessary to make that happen.

The technology is expensive; the people around it are expensive; and it's really the whole justification as to why do people outsource their Web commerce platforms. They're fast-moving. The features and functionalities change constantly. They're expensive to deploy. And today, most Web commerce sites don't have the economies of scale, in terms of revenue, to be able to overcome the investment necessary to deliver the consumer the type of experience that they're after, and that the brand wants to deliver in that.

So the fact that we share several billion dollars worth of economies of scale across the 40 or so clients and 80 or so programs that we have in place in there -- we share that with all these clients that are out there. But doing that across several thousand clients is a whole different ballgame when they're a lot smaller. So and that's where I think the big diversion between the Amazon model and ours sits.

Okay. Great. That really clears things up for me.

Lastly, in terms of measuring how you're leveraging your model internally, what do you look at operationally? Like line items coming out of a given facility? Or what types of things that we wouldn't necessarily see on a press release that your -- daily sales? Lines shipped?

Yes, all of those things. I mean, there's different metrics in every key area of the business. There's a lot of Web analytics related to visitor traffic conversion rates, abandoned rates, minutes spent on the site, which pages are used that we get from our Web analytics programs that are used to analyze the activities. There's a lot of email metrics from a marketing standpoint that we're looking at related to emails sent; open percentage; monitoring the potential for spam, labeling on the activity that's there.

And the new customer site, it's very important in terms of new customer adds. That is an important statistic as it relates to the vibrancy and the ability for the site to survive long-term in that.

And then you move into the distribution area, you speak into average order sizes, average weight per order, freight cost per order, lines per order -- we look at a lot of the cubic size of products that are involved in the facility, movements per individual unit that allows us to maximize pick rates and how we store the product for the clients, and different types of technology that we can deploy on the floor to be able to do that.

In our call center, we're looking at length of call; call per order; email per order; how long it takes us to respond to emails, so on and so forth. And we can go on and on with that. There's a lot in the technology area as it relates to response time and the monitoring of our equipment in those areas in there.

Demandware has a whole other set of statistics that they are monitoring related to their whole worldwide deployment of technology stacks that allow things from there. So there's a lot of gauges and a lot of daily metrics that are looked at in order to manage the business.

At our level, the leverage comes from the transactions that are flowing through the infrastructure, whether it's just electronic transactions or physical transactions, that is where we get the leverage.

Okay, super. And would you share some of that data with your customer base in terms of, I guess, how the master agreement and the partnership -- as if, I don't know -- back in the analog days, when you had sales runs that you'd share as a distributor back to the manufacturer. Is that --?

There's two areas where we would work with our clients. One is, obviously, complete transparency into how their program is operating across all service levels and across all of the statistics that Mark was mentioning.

The other thing we can do with our clients is to give them an idea of how they are stacking up against their peer. So we would divide up our clients into what we call cohorts, by vertical market, aggregate our statistics and also industry statistics we're seeing. And then we can, during our quarterly business review process with our clients, give them an idea of how their program is performing compared to comparable programs out there, which we think is a huge value. And when you start to see the kind of client -- number of clients that we have within these top three verticals, even just the things that we're doing for our clients, you end up giving our clients sizable information.

Great. Thank you for your time.

Your final question comes from the line of George Walsh with Gilford Securities.

Just wondered if you could review the landscape relative to the GSI-eBay deal earlier this year? Has there been any follow-up in the industry in terms of strategic partnerships and potentially how that might affect you?

And really, I'm speaking on a business level here -- just the idea of -- you mentioned that you are looking at smaller entities that are startups that you might partner with, but are there larger entities that you guys can work with that are looking for your capabilities in terms of the services business?

I think in this conversation, when we were talking about smaller entities, it was talking about clients that we might take on, who are starting from zero that have a great brand presence. And that we would decide -- even though they don't have the kind of year-one volumes that would meet our minimum threshold, they have the potential to get there quickly. So we're going to take a little bit of risk in taking on a client, using up an implementation slot.

We do that once or twice, maybe three times a year, where we just really love the brand and think they've got great potential. You're saying all the right things, wanting to spend the money on marketing programs, and we'll place a bet, along with them, on their program. I don't think we were talking about potential acquisition targets (multiple speakers) -- at least in that conversation.

Okay. But the broader question is, just industry-wide, is there any need for strategic services or consolidations or larger entities that are looking for to expand their services?

Well, I think if you look at our strategy over the long-term, George, we've partnered very aggressively with what we call best-of-breed partners. In many scenarios where the partnership allows us to make money on the services being provided, so we get to be a reseller of that technology -- which I think gives us the ability to access the technology without locking us into an R&D spend, if we were to do it ourselves or if we were to buy that provider, like GSI has traditionally done, and then sort of being locked into only having that technology and having to make the investments to keep it up.

And so I think our strategy going forward is to continue to do that -- to partner aggressively with best-of-breed providers. And then as Mark says, as we look toward the future, where the strategic direction is in some of these multi-channel initiatives and supporting these touchpoints that are diversifying, if it makes sense to buy either the technology or the provider, I think we'd be open to that. But that remains to be seen as the strategy evolves.

I do think overall we do continue to see consolidation in our industry. We were seeing activities with providers like Demandware looking to go public and filing S-2 type documentation -- or S-1, sorry. Obviously, the crazy market may affect their decision of what they're going to do. I don't see any reason why that wouldn't change -- that we continue to see some level of consolidation in companies going public, taking advantage of the opportunity they have.

Okay, thanks.

Your next question comes from the line of [Chris Aneglio] with Stifel Nicolaus.

My question was actually in line with the caller just before me, which was are you seeing other opportunities due to GSI commerce being taken over and them being part of a bigger entity, that other institutions may not want to do business with GSI any longer?

Well, as I mentioned earlier, I don't think the competitive landscape has changed all that much at this point. As I said earlier, I think the one thing we are seeing is at least a ponderance from some potential clients to say how is this -- it's new, so how is this going to short out and what's going to happen?

I don't think that the competitive advantages that we feel that we have, I think they're still there. They're strong and -- I'll go back again to the technology platform -- what we've done with Demandware and the SaaS offering, we believe, is a very significant competitive advantage versus what GSI could offer with its proprietary technology platform and the challenges that they've had in terms of updating it. And eBay has been public about the fact that they've got some technology things they want to do as well.

So you've got some rationalization that's got to happen on that side. So I think that's created a little bit of concern and confusion potentially in the market. I'm certain that eBay and GSI can answer it from their standpoint, because they're still very formidable competitors. And as I said earlier, almost always it's the two of us that stand at the batter's box at the end, just seeing who can win the deal. So I don't think a lot has changed at this point.

Thanks.

At this time, there are no further questions. I will now turn the call back to Mark Layton for closing remarks.

I just appreciate everybody's time this morning. We'll talk to you next quarter. Have a great day.

This concludes today's PFSweb's second quarter 2011 earnings conference call. You may now disconnect.