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Executives

Leslie Green

Jeffrey G. Ross - Chief Financial Officer

Alexandros Moukas - Co-Founder, Chief Executive Officer, Executive Director and Chairman of Executive Committee

Analysts

Peter Misek - Jefferies & Company, Inc., Research Division

Ross Sandler - Deutsche Bank AG

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Brandon Pickett

Andre Sequin - RBC Capital Markets, LLC, Research Division

Peter Stabler - Wells Fargo Securities, LLC, Research Division

Scott Zeller - Needham & Company, LLC, Research Division

Velti Plc (VELT) Q4 2012 Earnings Call March 12, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Velti 2012 Fourth Quarter Financial Earnings Results Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Leslie Green, Investor Relations. Ma'am, you may begin.

Leslie Green

Thank you, Mary. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions, the company will provide projections and make other forward-looking statements regarding, among other things, its future financial performance and longer-term operating model, its ability to manage cash and generate free cash flow, its ability to control costs, its expected growth in key markets, its sales pipeline and additional market opportunities, as well as other market trends and conditions.

Management wishes to caution you that such statements deal with future events, and are based upon management's current expectations, and are subject to risks and uncertainties that could cause actual results to differ materially.

These uncertainties and risks include, but are not limited to, Velti's ability to manage cash and operating expenses, obtain a waiver of its covenant violation on its credit facility, reduce DSOs, add new and expand existing customer relationships, and expand into new markets and verticals, the timing of contingent payment to acquired companies and achieve the benefits of the acquisition, as well as overall conditions in the markets in which Velti competes, global financial conditions and uncertainties and market acceptance and demand for Velti's product.

In addition to the factors that may be discussed in this call, management refers you to its annual report on Form 20-F for periodic reports filed with the SEC, available online by link from the company's website, for additional information on the factors that could cause actual results to differ materially from current expectation. A replay of this conference call will be available at velti.com for 3 months from today.

And with that, I'd like to turn the call over to Velti's Chief Financial Officer, Jeff Ross.

Jeffrey G. Ross

Thank you, Leslie, and again, welcome, everyone, to our Q4 and fiscal year 2012 earnings call. As most of you know, I started with Velti in early January. I accepted the position with a clear mandate to lead the company towards improvements on a number of areas, including financial discipline, accountability and operational predictability. While there's clearly more work to be done, I believe we're making significant progress in addressing these issues and building a platform to profitably capture the significant growth opportunities provided by the mobile marketing and advertising market. I am confident that we will be able to demonstrate our progress in the quarters to come.

Now turning to Velti's results for the quarter ended December 31, 2012. Total revenue for the fourth quarter was $97.5 million, an increase of $10.4 million or 12% from the previous year. Part of the reasons that revenue came in at the lower end of the guidance range was the decision to forego certain revenue opportunities as a result of Velti's change in strategies direction -- strategic direction. Although this business has historically generated meaningful revenue and EBITDA, it is characterized by significant upfront cash investment and long collection cycles. Velti will instead focus on improving free cash flow and long-term growth opportunities, as it focuses on customers and solutions in key markets, such as the Americas, Western Europe, Brazil, India and China.

In terms of the breakdown between advertising and the marketing business for the fourth quarter, advertising revenues comprised approximately 16% of total revenue, while the marketing revenues comprised the remaining 84%, with gross margins of 29% and 76%, respectively.

For the year, a geographic breakdown of revenues is as follows: The Americas generated $63.6 million or 24% of revenue, compared with $41.1 million or 22% of revenue in the prior year. The U.K. generated $74.7 million or 28% of revenue, and that compares to $37.8 million or 20% of revenue in the prior year. Europe, exclusive of the U.K., generated $97.8 million or 36% of revenue, as compared with $86.3 million or 46% of revenue in the prior year. And finally, Africa and Asia generated $34.2 million or 12% of revenue, compared with $24 million or 12% of revenue in 2011.

With respect to expenses and profitability, I'll provide the following: Third-party cost came in at $30.9 million for an overall gross margin of 68%. The overall gross margins were negatively impacted as a result of lower-than-expected yields from certain campaigns late in the quarter that translated directly into lower gross profits and margins.

Pro forma operating expenses, including share-based compensation and acquisition -- excluding share-based compensation and acquisition-related charges, came in at $41.5 million, which included a charge of $6.4 million to increase Velti's allowance for doubtful accounts. The reserve is somewhat judgmental, and we believe that we've made a prudent and more conservative reserve against the receivables of the company.

Adjusted EBITDA was $25.1 million for the quarter and $42.6 million for the year. The sizable shortfall was the result of the overall gross margin being significantly lower than expected, primarily for the reasons we discussed above, along with the impact of high-margin business that was foregone in the quarter as a result of our change in strategic direction, and the reserve for certain doubtful accounts, without which pro forma operating expenses would have been $35 million and EBITDA would have been $6.4 million higher.

Included in the GAAP results is a $17 million noncash charge for the impairment of capitalized software development. These charges are the result of a write-down of certain software utilized by the business, which is no longer being pursued by Velti in accordance with the strategic decisions previously discussed.

DSOs. In terms of the comprehensive DSOs, as outlined in the earnings deck, DSOs ended the year at 311 days. The increase was largely attributable to normal seasonality. While we will not be giving out our specific DSO guidance for the following year, we expect DSOs on revenues generated in 2013 to be under 100 days and overall DSOs to improve gradually, as older receivables are collected.

One last item before I turn to the balance sheet. While the company neither controls the operations of, nor maintains an ownership interest in, the Greek, Balkan and other assets shown as held for sale in its Q3 financial statements, under this applicable accounting guidance, the company is currently required to continue consolidating these assets and operations. Under these rules, the assets and liabilities of the divested business will be consolidated but separately identified in the financial statements, and the net impact of the operating results from the divested business will be fully eliminated. The sale of these assets was completed in December, and the company has received the first scheduled payment.

In terms of free cash flow generation. In the fourth quarter, the company had positive operating cash flow of $7 million and free cash flow of negative $5 million. The negative free cash flow is primarily attributable to higher expenses.

With respect to our current cash position, cash needs and cash flow projections for 2013, I'll provide the following. First, we ended the fourth quarter with total liquidity of approximately $56 million, which was comprised of $37 million in cash and $19 million available under our credit facility with HSBC.

As many of you know, a number of acquisition-related obligations become payable in Q1 and in early Q2. Our total payments due under these obligations include a $30.5 million payment to MIG, with $15.7 million of this amount payable in cash and the remaining $14.8 million payable in shares or cash at our election. We anticipate paying the $14.8 million in stock and are discussing the exact timing of payment for the cash payment due.

In January, we paid $6 million in retention bonuses related to the 2010 Mobclix acquisition. And finally, while we are still discussing any remaining acquisition-related payments due to CASEE, we anticipate making payments of between $4 million and $5 million in cash or shares some time in 2014.

As of the current date, we have essentially fully drawn down our HSBC facility. The company's fourth quarter results did not meet the EBITDA covenant contained in this loan agreement. We are currently working with HSBC to obtain a waiver of this covenant, and we anticipate receiving this waiver before the filing of our 2012 20-F.

In terms of free cash flow for 2013, we -- as we mentioned at our Analyst Day in January, the first half of the year is a rough patch, in particular given the acquisition-related obligations payable in cash. While we're not going to guide specifically to free cash flow and cash floors on a quarterly basis, we will say the following: One, for the year, we anticipate generating between $5 million and $15 million of free cash flow before acquisitions, and this is heavily back-end weighted to Q4. With respect to free cash flow on a quarterly basis, I'll provide the following: Directionally, we will be substantially negative in Q1, with both -- both with and without the impact of the acquisition-related obligations. Much of this relates to catch-up payments for certain publisher liabilities, which are being paid in Q1 but relate to business in 2012.

Our cash flow should improve significantly in Q2, which we anticipate being modestly negative. In Q3, we will believe we will start generating modest cash flow and then significant cash flow will be generated in Q4.

We have attempted to be realistic in these assumptions and set forth a plan we believe we can achieve. We're monitoring cash very closely and aggressively pursuing opportunities to pursue cash wherever possible.

With regards to financing, management and board members own a significant amount of stock, directly aligning our interests with those of our shareholders. Although at this time we are focusing on running the company without raising money, there are a number of factors which will affect our cash needs. There are a lot of options out there, but, for the time being, our goal is to run this business on a tight cash flow model.

Now I'll turn to 2013 guidance, which you'll note that it's included in the earnings release and deck. To summarize, however, our expectations for the year are as follows: We believe revenue will be between $255 million to $280 million, EBITDA will be between $5 million and $15 million, and free cash flow, exclusive of acquisition-related payments, will range from $5 million to $15 million.

As you're aware, we divested certain assets in the fourth quarter of 2012, which, for the year, generated an estimated $32 million of revenue and an estimated $18 million of adjusted EBITDA. After adjustment, this brings our 2012 revenue base to approximately $238 million, and our adjusted EBITDA base to approximately $25 million. Additionally, as discussed above, a strategic decision was made not to pursue certain business with similar characteristics, i.e., significant revenue and margins but immediate cash outlays and much longer-term cash collections.

Revenue for 2013, off of the divestiture adjusted base, is expected to be approximately 12% at the midpoint. While we believe that the revenue growth off the base adjusted for both the rationalized business along with the divestiture would have been in excess of 40%.

Our focus for 2013 is on revenue growth in key markets with good collection cycles, i.e., the U.S., Western Europe, China, India, Brazil, along with improving cash flows, albeit at the expense of lower gross margins and adjusted EBITDA margins. In terms of the assumptions underlying our 2013 guidance, we plan to grow our business in the U.S. in the high double digits. We anticipate that our business mix will result in gross margins, that's revenue less third-party cost, in the mid to low 50s. We intend to modulate operating expenses in order to generate approximately $5 million to $15 million of adjusted EBITDA for the year. And on the front of capital expenditures, we anticipate cutting CapEx by more than 50% relative to 2012.

Total capital expenditures, which include PP&E, capitalization of internal software development cost and third-party purchased software, are expected to be approximately $20 million during 2013.

In addition to our annual guidance, we are transitioning -- as we are transitioning our business during 2013, we also want to provide some guidance as with respect to our longer-term operating model, to give us an indication where we believe mid to long-term growth prospects would be and margins should look like. In this model, we would forecast that over the course of the years 2014 to 2016, that we would see top line growth of between 25% and 35% per year. Our model also shows that roughly 1/3 of this revenue should come from the advertising business, with the remaining 2/3 from mobile marketing. Advertising gross margins would be approximately 30%, while marketing gross margins would be in excess of 60%.

We would expect EBITDA margin expansion during these years to be approximately 400 to 600 basis points per year, as we see -- as we begin to see improvements in operating leverage. And in terms of free cash flow generation, we believe that we should be able to generate approximately $40 million in 2014, and then grow this amount at a rate of 40% per out year.

And with that, I will turn the call back over to Alex. Alex?

Alexandros Moukas

Thanks, Jeff. As we look ahead to the coming year, we view 2013 as a very important transition year for Velti, as we're focusing on balancing growth at the rate of 25% to 35% over the next 3 to 5 years, while generating significant cash flows.

Starting in Q3 and accelerating in Q4, we have been evaluating customer and geographies based on returns of dollars invested, regardless if it is CapEx, OpEx or working capital, to ensure that they meet the minimum cash flow standard.

Consequently, we're exiting customers and geographies where it's too expensive to grow from a free cash flow perspective and to continue to do business. Many of these opportunities we're exiting had high gross profit margins, however, were less strategic in terms of geographies and had high cash flow requirements.

By transitioning away from that business, our CapEx is expected, as I've mentioned, to decrease by more than 50%. As importantly, our working capital cycle will be greatly reduced. Hard constraint for us, revenue we generate in 2013, will have DSOs under 100 days.

The result of these changes will be a $59 million shrink in our free cash flow between 2012 and 2013, from minus $49 million to a positive of $10 million at the midpoint of guidance. And again, as Jeff mentioned, in 2014, we expect cash flow generation to accelerate to approximately $40 million and continue to grow at 40% a year.

Further, the areas we're focusing on, primarily the U.S., U.K., and Western Europe, Brazil, India and China are the most strategic for Velti. Following these changes, the U.S. and Western Europe will become approximately 75% of revenues in 2013. In these areas, we have seen a dramatic increase in interest from brands in leveraging the mobile talents to establish, develop and maintain customer relationships. Over the past few years, we have made a significant investment that are required to be successful in these geographies, and now have well-established operations, key talent in place and a growing referenceable customer base.

We'll continue to build our sales teams and fill our pipeline with additional opportunities, including multiple multi-million dollar deals. Our customers are typically the global 1,000 brands that prefer to work with larger tech providers like Velti rather than startups. Currently, we're seeing that decisions regarding which vendor that brands work with are not globally enforced, therefore, it is necessary in a competitive advantage to have strong business presence in the advanced large markets rather than just in the brands' global headquarters. This plays to Velti's advantage, as we're a global player with strong presence in the U.S., the U.K. Western Europe, Brazil, India, China and Russia, and also some key countries in high-growth areas like the Middle East and parts of Asia.

In terms of geographies, in the U.S., a lot of revenue today is driven by our mobile advertising business, both Mobclix and our growing advertising platform sales. Our mobile marketing business is growing very rapidly, and we expect that it's going to double this year. Western Europe and the large emerging markets are driven primarily by mobile marketing and new performance marketing engagement directly with brands. Demand for mobile advertising is increasing rapidly, and new operational capabilities have been established in the U.K. to support this.

We're also seeing strong growth of our business in India in mobile marketing, exceeding our expectations. In other emerging fast-growing markets like Russia, the emphasis is only on mature verticals, and major outcome-based mobile marketing solutions.

In terms of verticals within key regions, Velti's growth is driven by solutions targeted to vertical markets for which marketing via the mobile channel is particularly well suited. The most active verticals are media, telco, technology, auto, packaged goods, financial services and retail. Mobile carriers are a particularly active category in the mobile channel, given their core competency and their marketing costs for mobile are much lower than other verticals. Velti has more than 10 years of experience in this category and significant penetration worldwide.

In carriers, we work primarily with the CMO side, driving key KPIs through performance products. We don't do any work with carriers around their own deck storefronts. The other verticals, though, have also produced multi-million dollar accounts, and we see them as early adopters that will scale their investment in mobile heavily.

In our conversation with these customers, the emphasis is truly on investing versus spending in mobile. Other solution-based approach is focused on providing a return on this investment by selling outcomes instead of product features. This is a message that resonates strongly with customers, as they're able to measure and justify the effectiveness of their marketing spend.

The solutions that drive Velti's growth are therefore focused on very specific outcomes, key performance indicators or KPIs, that directly define success for the CMO of the brand. These KPIs can be in the areas of brand awareness, customer acquisition, monetization measured by revenue increase per customer, churn reduction or long-term loyalty.

The enabling technologies to deliver such KPIs are similar across all of the vertical markets I mentioned. What varies is the know-how of what activities are likely to produce the desired results, and what processes are more effective to do so.

Velti has not only the experience, but also data optimization and predictive analytics to deliver highly effective outcomes, and these areas will continue to be a strong focus for our technology efforts.

Buildings of sites, rich ads, serving ads and messaging are all commoditized activities, and Velti has evolved towards combining all these with data and marketing science into complete industry solutions that are sold as outcomes.

Velti is currently delivering long-term multichannel customer life cycle programs, such as loyalty campaigns in Europe, Asia, and expanding in Brazil and the U.S. In almost all running programs, Velti is delivering double-digit growth on revenue per customer versus control groups -- compared to control groups, and thus, significant ROI to our customers. Measurable churn reduction and enriched data for consumers are also deliverable benefits. The same is true for the packaged goods market, where programs piloted have shown double-digit growth in the brand sales, and are currently expanding in other verticals.

We have also experienced some setbacks, primarily major contract in the U.S., as we announced in September, where changes in customer management led to a decision to change the scope of the project. We're negotiating with the customer to winding down of this existing engagement as the customer redefines their needs.

Overall, the strength of the performance of our existing contracts, in conjunction with our new customer wins, will drive this mobile customer life cycle management business to an increase of an approximately 100% in 2013.

Recent successes in this area include Nestea packaged goods loyalty campaign; user-enhanced loyalty campaigns in Dubai; and campaigns across Europe with Vodafone, T-Mobile and Orange, all multi-million dollar deals.

Customer acquisition campaigns are another area of growth. Over the past several months, we have launched programs in the U.S., India and Brazil, with customers from the financial services, insurance and education industry. Another example, in our vertical Nautilus in the U.S. expanding their relationship with us and use our mGage platform and technology to launch their new flagship product, Uppercut, and drive new customer acquisition.

Additionally, we are launching outcome based programs focused on the monetization of audiences for broadcast media, including traditional television, internet media and telco providers. This area has become a key emphasis for our product development and R&D in the last quarters, for the development of second screen applications that complement entertainment programs, gamification for customer -- and gamification for customer life cycle management.

Further, we're also investing in programs to leverage multichannel and multivariate testing to deliver better results. Customer engagements here include U.K.'s ITV and Channel 5 in 7-figure deals that are using mGage to power all second screen mobile interaction services, and buy a radio that it's launching mobile engagement to all of its 27 radio properties.

In terms of mobile marketing engagements, primarily in the U.S., U.K. Germany and India, we're providing software and services to handle multichannel mobile presence and communications. These programs are aimed at handling mobile marketing needs and, in the mobile customer life cycle management side, also significantly reducing the cost of customer care.

For instance, American Express expanding their engagement with Velti to continue integrating with their customer care and expanding into mobile. Vodafone Germany is the latest customer of mGage mobile CRM offering, leveraging our recent established -- recently established Germany office in the 7-figure engagement. SUBWAY in the U.S., extending their mobile presence and mobile engagement use of our platform, while Bath & Body Works used mGage to mobilize its holiday marketing programs.

In the marketing automation field, Velti is powering 6 of the top 10 e-mail service providers with our aggregation and mGage messaging technology. We help many of these ESPs transform into marketing technology solution, and leverage their brand relationships and data to enter this play. Given Velti city capabilities, we're able to offer these channel partners the ability to unify their massive consumer database, literally thousands of brands, with deep mobile behavioral data. Once this data is unified, we then leverage Velti's large mobile media supply to retarget these consumers with the most relevant ads based on the aggregate knowledge of Velti mobile advertising data and our partners' ESP databases, making the media exponentially more effective and valuable. This is a potential large media buying segment that is just emerging.

On the mobile advertising side of our business, we focus our solutions on enabling publishers and media buyers to drive results from the complex ecosystem. We leverage our own Mobclix inventory to help advertisers scale their campaigns for targeted media base. Our focus during the last year has been on margins that improved from around 10% in Q4 of 2011 to 29% in Q4 of 2012. Our Mobclix Exchange is the platform of choice for more than 44,000 application developers and publishers. For instance, global gaming developer Sega picked Mobclix to monetize and mediate all of their mobile applications across iOS and Android. Programmatic buying continues to allow our platform and revenue to scale efficiently. We have over 75 demand bidders leveraging real-time bidding, or RTB, that buy across over 30 billion impressions per month.

Mobclix allows online ad networks, DSPs, video networks and mobile networks to participate in an auction across every ad impression, allowing the highest bidder to serve the ad impression to a particular request.

Our mobile advertising technology is also providing agencies with the right audience and the right insight into their media buys. Audience management and audience extension, thus, the ability to convert traditional long-tail inventory into premium inventory, are key areas of product development for Velti's mobile advertising business this year, as well as retargeting.

For instance, global agency Saatchi & Saatchi is using Velti's technology for mobile ad serving and multichannel tracking, while Academy Sports leverage their mobile media to drive awareness followed by mobile engagement. In addition, this year we're rolling out our visualized product for the mGage platform that provides highly accurate multichannel tracking on investment returns for brands in real times as they run their campaigns.

The beta program for this product was developed and tested at a major U.S. brand, and its success was so impactful that the brand has migrated all of its campaigns to the mGage platform. We view this product as a significant differentiator and are very pleased by the perception it's receiving from customers. I will continue to grow our business across our key regions, and new vertical markets would benefit from a business model that is very scalable and transactional.

Outcome solutions, such as customer acquisition, coupon and code redemption, purchase, optimum database enrollment, registration completion or click-throughs, are charged per consumer, per transaction or as a combination of both. Each transaction has a perceived outcome value, and is charged accordingly. This approach mitigates much of the investment risk for brands and also provides a profitable and scalable model for Velti.

Overall, there's strong industry research suggesting that the worldwide market for mobile advertising and marketing will continue to grow at a health rate -- at a very healthy rate. Brands will spend more on mobile, and mobile will become the primary medium that encompasses many others.

As this occurs, Velti's outcomes-oriented approach provides a low-risk high-reward means for brands to lever the mobile channels to drive positive, profitable and effective relationships with our customers.

In closing, we recognize that we're undergoing a significant transition in our business, and this has been very difficult on our shareholders. As a major Velti shareholder myself, I absolutely share the disappointment in our stock performance. The team believes strongly that we're doing the right things for the business. We're in a tremendous market with great opportunity. We have a first mover advantage in our space, and I believe that we enable mobile advertising and marketing better than anyone else. By making this transition, we are not only positioning ourselves strongly in the most important and fruitful geographical markets for products and services, we're also building a business model that will deliver solid growth and returns to our shareholders for the next year and for the long run. We look forward to reporting to our progress.

And with that, we're going to open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Peter Misek from Jefferies.

Peter Misek - Jefferies & Company, Inc., Research Division

Can we walk through cash flow quarterly for the remainder of the year and walk us through why we don't need a capital raise to ensure that you're going concerned? Because as it stands now, it doesn't look like you're going concerned. It looks like you're violating your debt covenants, and it looks like you need a capital infusion in order to keep the business going.

Jeffrey G. Ross

So where we stand right now, it will be tight. I mean, I think that we would -- we acknowledge that it's going to be tight based upon the timing of certain payments. However, we believe that now we have the potential of getting through this without a capital raise. And at this point, we have no definitive plans, one way or the other, to do anything with respect to raising capital. We are trying to be responsible with respect to the interest of our shareholders, and we understand options that are out there, but at this point, we think we can manage the business from a very tight cash flow basis. So walking you through the numbers. At the end of Q1, we are close to working capital needs for the business. In Q2 -- and we are working with the timing of certain acquisition payments that perhaps provides us with a little bit more flexibility in that regard. Once we move into Q2, it's pretty much a flat year -- or a flat month -- quarter for us with respect to cash flow. And then once we get into Q3, we believe that we start generating cash flow under our model.

Peter Misek - Jefferies & Company, Inc., Research Division

So Q1 and Q3 are basically on a knife edge, and if things go wrong, one way or another, there's a Plan B. And so what's the Plan B? If the knife edge, you fall on the wrong side of it, can you walk us through what Plan B is?

Jeffrey G. Ross

We're not prepared to talk about Plan B on this call today. But suffice it to say, that we've been exploring various Plan Bs.

Operator

Our next question comes from Ross Sandler from Deutsche Bank.

Ross Sandler - Deutsche Bank AG

So, Jeff, obviously, a tough call for you to be on, on your first one, but you've only been in the seat now for a few months. How confident are you that the model that you've just articulated in the prepared remarks and on that last question is set up appropriately? And I guess you're not going to go into Plan B, but how confident are you that you are on the right trajectory? And then the second question is, given the high DSOs and the fact that you guys are walking away from some of those higher DSO regions, how much cash collection could come in from those higher DSO areas that did generate revenue last year? And then, lastly, would you consider selling certain assets? And if so, what could some of these acquired businesses potentially fetch in an asset sale type situation?

Jeffrey G. Ross

Okay. Let me address the first 2, and then I'll turn the last question to Alex. So with respect to your question regarding DSOs. I mean, there's a meaningful amount in current year cash flow expected to come in from some of these older receivables. We are working down some of those older balances, and the new receivables that we're adding to that -- to the population have a much better characteristic of, say, under 100 days. So there's a meaningful -- there will be a meaningful increase. Because of the magnitude of some of that -- those old balances, you're not going to see a 300 to 200 type drop on DSO, but we would expect it to go down modestly throughout the year. And then, sorry, I didn't write down your first question. Can you remind me again what your first question was? Oh, I have my confidence in the model.

Ross Sandler - Deutsche Bank AG

Yes, that's it.

Jeffrey G. Ross

Yes, we've spent a lot of time pressure testing the model here. And I think we -- internally, the initial model was, shall I say, more robust. I've tried to take -- I've tried to pressure test it in ways that would be more conservative and more aware of kind of worse-case scenarios. So on a scale from 1 to 10, how comfortable I am with the model? 7, 8. As you said, I haven't been here all that long, so my institutional knowledge of just how good we are at predicting is maybe not as good as if I would have been year for 5 or 6 years. But again, I'm trying to triangulate from a variety of different sources, be a voice of skepticism on some of these assumptions. And based on that, I'm pretty comfortable with where we came out from an operating model and do feel good about if we get through this transition, or once we get through this transition year, that we are operating on a much better model moving forward with better characteristics and better expectations and better ability to meet those expectations. And then with respect to your question regarding selling assets, I'm not the right person to chat about that.

Alexandros Moukas

Again, as Jeff said in his original remark, this is not something -- I mean, we're looking at all the options, but this is not something we're actively pursuing right now.

Operator

Our next question comes from Richard Ingrassia from Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Alex, you touched on this briefly in your prepared comments, and I think it's fairly clear from your description of some of the most recent campaign work. But there was a fairly persistent aspect of the Barrett thesis on your story, and I just wanted to give you a crack at responding to it directly, and that's the claim that Velti is really still only a super low tech SMS marketing platform with little to no smartphone capabilities, that all your business is in carrier stores and so-called lottery offers, and other comments along those lines. How would you counter that directly?

Alexandros Moukas

I mean, first of all, we don't do carrier stores. I mean, we don't do on the carrier offering. That's 0% of our revenue. We work with carriers as a brand. We work with their CMOs and their marketing organizations to essentially drive customer lifecycle management campaigns and increase customer acquisition, increase retention, reduce churn. In terms of the multichannel and all the -- our approach, it really depends on the market, right? So our platform is flexible enough to operate with whatever is on the ground. What I mean by that, if I look at the U.S. market, I would say that 85% of our revenue is smartphone focused, and 15% is, let's call it, feature-phone focused. If you go to now to a country like India, it's a completely different picture because there are a lot of more feature phones on the ground. So as we have mentioned before, more than 80% of the typical campaigns that we're using requires an -- at the request of our customers, to use multiple mobile channels. And that includes mobile web. You might have an app, you might have mobile video, you might have text messaging, you might have couponing. But again, to answer question, we don't do anything on the carrier's, sort of, storefronts in terms of monetized offerings. In advance slot markets, like the U.S. for instance, the vast majority, 85% of our revenue, is smartphone focused.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Okay. And on the telcos in Europe, a lot of talk recently on consolidation. Does that dynamic impact your growth outlook in that territory in any way?

Alexandros Moukas

No, actually, we have actually seen acceleration in that business. So again, if you look at our customer lifecycle management business for carriers, we expect that to double this year.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Okay. Two quick questions for Jeff. And on the gross margin, it came in a good 10 points lower than we would normally expect for a fourth quarter. You mentioned lower yields on some late quarter campaigns. Can you say a little bit more exactly what happened there?

Jeffrey G. Ross

Yes, I mean, if campaigns -- at the end of a quarter, the revenue is largely gravy. You're recovering your cost earlier in the campaign, and the -- generally, the accelerator of volume -- the acceleration of volume on which we're paid generates very, very, very high margin business at the end of the quarter. So to the extent that, that was not achieved, and there was some disappointments on some of the campaigns there along with some global factors, the revenue miss is both -- well, it's both a revenue miss, but then also it has an extremely significant impact on the overall margins.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

I guess, what I'm asking is, why were they disappointing? What caused the issue on the failure to monetize a late quarter return?

Jeffrey G. Ross

So again, I wasn't here during that period of time, so perhaps it's better to ask Alex to address that a little bit.

Alexandros Moukas

So essentially, in some of these campaigns, the costs are taken essentially sort of upfront. And the performance that they've said that comes sort of later on covers this cost and then you have sort of the incremental sort of revenue being the gravy. So in some case was delays in the launches of these campaigns. In a couple of case, there were campaigns at a completely new market that we're testing.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

And finally, if you don't mind, just an OpEx question for Jeff. How much did you say in G&A was due to bad debt? And can you comment on any other one-time expenses in sales or marketing and R&D that we can back out to get to some reliable steady state per quarter?

Jeffrey G. Ross

Sure. I mean, clearly, the most -- the large component there was the bad debt expense, so it was $6.4 million in the quarter. We -- new guy coming in, took a fresh look at some stuff, tried to take a little bit more conservative view, decided to book a larger reserve. As far as other kind of one-time expenses, I would expect those to be around $1 million for a variety of cats and dogs that occurred during the quarter.

Operator

Our next question comes from Shyam Patil from Raymond James.

Brandon Pickett

This is actually Brandon Pickett filling in for Shyam tonight. I just want to hop back to the cash flow issue that's been brought up a couple of times. I was just wondering, Jeff, if you could just kind of walk us through the, by quarter, what your expectations are for cash flow from operations and CapEx?

Jeffrey G. Ross

By quarter. You know what, we're not going to provide that level of detail. I think suffice it to say -- I mean, what I said was Q1 was substantially negative. From a free cash flow perspective, that's probably in the 25-ish range. Capital expenditures, our CapEx throughout the year is pretty normal as far as what quarter is going to be incurred in, maybe a little bit more towards the beginning with the Q1 number that I gave you than it is towards the end of the year. And then I provided comments as to where we think that the free cash flow is going to come or how that's going to change around. So basically, near flat in Q2, up single digits in Q3, and then more substantial in Q4 to get to the overall number.

Brandon Pickett

Okay, that's helpful. And then, I was just wondering how we should be thinking about the cash and debt balances by each quarter going through 2013 as well?

Jeffrey G. Ross

Well, I mean, so I wouldn't expect debt to increase. I would expect cash to, based on what I said, to be down in Q1. Looks like it'd still be down in Q2 since that's flat or negative, and then up in Q3 and up in Q4.

Operator

Our next question comes from Andre Sequin from RBC Capital Markets.

Andre Sequin - RBC Capital Markets, LLC, Research Division

There's one thing I just want to make sure I heard right. I think you said that the EBITDA from your ongoing business in 2012 would have been about $25 million. And then now we're looking at about $5 million to $15 million in 2013. Could you walk us through how we get to a lower number despite the revenue growth, is that expensing the software cost for it, where they were capitalized last year? Was there something else going on? And then, secondly, how did you decide or how did you select the additional clients to walk away from? And was this entirely a DSO decision? And will any of them be going with the divestiture? Or is that a done deal, and this is now an entirely separate thought transaction?

Jeffrey G. Ross

Sure. So let me address the first question, and then Alex can hit the second one. So the number of $25 million, that was normalized after we took out roughly $80 million associated with the Spend Co.[ph]. We also provided -- we've talked about the rationalization or the repositioning of the business and other business that we're walking away from. And one of the comments I made was that, if you reset the base, taking that out to -- your growth rate is roughly 40%. So the biggest difference from your delta between, say, $10 million, mid-point of the current year guidance to $25 million that you were adjusted at on that other base is this other business. That business, we've said a number of times, has high margin characteristics, probably similar to that of Spend Co.[ph]. If you adjust for EBITDA on that business that we're walking away from there, you get something below our EBITDA. You probably get actually something below 0, slightly negative as the base. So really, the business that we're building up from is new business that we will build the business on going forward.

Andre Sequin - RBC Capital Markets, LLC, Research Division

Okay. So that $25 million, sorry, was for sort of a base for 2013 rather than 2012? I think I might have misheard that then.

Jeffrey G. Ross

Sorry, say that one more time, please?

Andre Sequin - RBC Capital Markets, LLC, Research Division

So the $25 million was a base or an -- a base expectation for 2013 rather than 2012?

Jeffrey G. Ross

No, it was a 20 -- sorry, the $25 million was a 2012 number if you took out what we've given you for the EBITDA associated with Spend Co.[ph]. And then what I was commenting on is further -- again, we're not going to pro forma that number. We don't expect to get credit for that. But the impact of the EBITDA on the business that we're walking away from is substantial. And if you took that out, you're -- you'd be high-single digits negative from an EBITDA perspective.

Andre Sequin - RBC Capital Markets, LLC, Research Division

Understood, okay. And so then on the clients you walked away from, what the decision was there?

Alexandros Moukas

So again, we evaluate every single one of them based on the total cost profile. So what would be our investment in terms of customers or geographies, in terms of CapEx, in terms of operating expenses, and then in terms of working capital and collection cycles. So we focused a lot on that. And we also looked in -- essentially want to make sure that we could invest on working capital in the areas where we get the most return. And these areas are places like the U.S., like Western Europe, like Brazil or India, where we have an established base. They're much larger countries. And with a single dollar of investment can drive a lot of more -- much more significant sort of revenue growth. These are much more strategic customers in much more strategic geographies.

Operator

Our next question comes from Peter Stabler from Wells Fargo Securities.

Peter Stabler - Wells Fargo Securities, LLC, Research Division

A couple. So, Alex, did I hear you correctly in your prepared comments, you said that the large deal that you announced in the U.S., the contract was now under review by a new marketing team?

Alexandros Moukas

There's a new management team, and we're helping the customer in their transition and in their evaluation of how they should proceed, yes.

Peter Stabler - Wells Fargo Securities, LLC, Research Division

So could that yield an outcome where that contract is reduced to a meaningful level? Or is this just restructuring, let's say, the phasing of the contracts?

Alexandros Moukas

Yes, again, we don't really want to make a statement on that before we actually have the final answer there. But the answer is yes.

Peter Stabler - Wells Fargo Securities, LLC, Research Division

Okay.

Alexandros Moukas

However, if you look at our numbers and the forecast that we're giving, obviously, all of that is blended in, and that part of our business is going to double from the previous year to this year.

Peter Stabler - Wells Fargo Securities, LLC, Research Division

Okay. And secondly, when you talk about a change of strategy, I think those are words you used several times, is that exclusive to walking away from these type of poorly performing, from a cash flow perspective, performance campaigns? Or are there other elements to this change of strategy in terms of what you're bringing to market? Who you're working with? Are you going through agencies? Are you still selling the mGage platform and the developer tools, et cetera? Just wondering if there's some significant shifts to the product strategy as well.

Alexandros Moukas

No, there's no significant shift on the product strategy. Again, on the product strategy, we're focusing a lot on data, on optimization, on predictive analytics, on multichannel tracking, on things like real-time bidding and attribution modeling. So if you look at our product strategy, 100% of our focus has been on, let's call it, the how do we combine all the elements of the mobile channel together in an effective way for our customers, and how do we leverage the performance, utilizing their data and our data? So our high level strategy there has not changed.

Peter Stabler - Wells Fargo Securities, LLC, Research Division

No loss of confidence in the pay-for-performance model? That's going to continue to be a focus going forward?

Alexandros Moukas

Correct. Absolutely. We'll continue to move forward. What we were able to do is also provide more alternative for our customers, more alternatives for our customers in terms of paying for transactions, paying for performance, as we get deeper and deeper into specific verticals.

Operator

Our next question comes from Scott Zeller from Needham & Company.

Scott Zeller - Needham & Company, LLC, Research Division

I'd like to revisit the question about gross margin from earlier. I wanted to ask it a different way. Were there any changes at all to the gross margin and the success of the campaigns due to an interpretation of meeting goals of the campaign?

Alexandros Moukas

If you're asking whether there was any discrepancies between our numbers and our customer numbers, the answer is no.

Scott Zeller - Needham & Company, LLC, Research Division

Okay. And was there guidance given for third-party costs as a percentage of revenue? Or could you give some color on that, please, for calendar '13?

Jeffrey G. Ross

Well, I mean, let's see -- let's see what we specifically said. So yes, I mean, we said gross margins would be in the low to mid-50s.

Scott Zeller - Needham & Company, LLC, Research Division

Okay.

Alexandros Moukas

With advertising being around 30%, marketing being in excess of 6.50%.

Scott Zeller - Needham & Company, LLC, Research Division

Okay. And then the reserves. Could you give us some more color about what led you, Jeff, to change your view on the receivables?

Jeffrey G. Ross

Sure. The company has had very, very limited experience with bad debts. We've had very few instances where customers have ultimately been unable to pay, or either bankruptcy or something else. It, oftentimes it takes a heck of a long time, but very little experience. So if you sort of come up with a reserve based on your past experience, it's a rather -- it's pretty dang close to nothing. I -- just looking at it, the -- you look at the DSOs of the company and sort of say they're a little bit older. I just pressure tested some of the assumptions, took mathematical percentages of balances over certain ages and came up with an amount that I felt more comfortable with that provided us some cushion when and if something happens. There wasn't much in the specific area that led me to say, "Oh, my gosh. We have a huge problem. I want a big additional reserve." But with the magnitude of the reserve -- with the AR on the company's books, I just thought it was more prudent to have a little more cushion with respect to those numbers.

Scott Zeller - Needham & Company, LLC, Research Division

Okay. And could you tell us the exact -- there was mention of it in the prepared remarks, and I apologize, but what exactly is the cash situation right now? I thought I'd heard that the line was drawn down entirely. But then I thought I also heard there was $90 million of capacity.

Jeffrey G. Ross

$90 million capacity is in the Q4. At the current date, it's drawn down completely.

Operator

I'd like to turn the conference back to Mr. Alex Moukas for closing remarks.

Alexandros Moukas

So let me quickly summarize what we'd like you to take away from today's call. 2013 is a transition year, and we're focused on driving balanced growth in our key geographies like the U.S., U.K., Western Europe, Brazil and India. We're expecting continued rationalizing operation and expect to reduce CapEx from $56 million to around $20 million. Target DSOs that are hard constrained for new revenue generated in 2013 is going to be below 100 days. That's going to lead us to a free cash flow stream of $9 million, from $49 million negative to a positive of $10 million at the mid-point for 2013. Following our key senior management addition in 2012, including Jeff Ross, our CFO, we continue to strengthen our team, especially on the operating side, as we consolidate our global operation and leverage our existing infrastructure. We're also going to continue to leverage our technology and data, rolling out the next innovation of mGage, starting with Visualize, data science and audience management, optimization, multichannel tracking and predictive analytics. And again, I want to reiterate that we recognize that we're undergoing a transition, a significant transition in our business, and that has been difficult for everybody. And we're looking forward to reporting on our progress. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may all disconnect at this time.

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