Executives:
Michael R. Conn - Senior Vice President, Finance and Chief Financial Officer (CFO)
Michael G. Rubin - Chairman and Chief Executive Officer (CEO)
Analysts:
Anthony Noto - Goldman Sachs
Brian J. Pitz - Bank of America Securities
Robert Peck - Bear Stearns
Shawn Milne - Oppenheimer & Co.
David Joseph - Morgan Stanley
Mark May - Needham & Co.
Jim Friedland - Cowen and Company
Colin Sebastian – Lazard Capital Markets
Christa Sober Quarles - Thomas Weisel Partners
TRANSCRIPT SPONSOR |
GSI Commerce (GSIC) Q4 2006 Earnings Call February 13, 2007 4:45 PM ET
Operator
Welcome to the Fiscal 2006 Fourth Quarter and Fiscal year operating results of GSI Commerce. My name is James and I will be your coordinator for today. At this time all participants are in listen only mode. We will be conducting a question and answer session toward the end of today's conference. If at any time during the call you require assistance please press "star" followed by "zero" and the coordinator will be happy to assist you.
As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Michael Conn, GSI Commerce, Chief Financial Officer. Please proceed sir.
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Michael R. Conn
Thanks James and good afternoon everyone. Welcome to GSI's conference call for its fourth quarter and full year results, ended December 30, 2006. This is Michael Conn, I'm GSI's Chief Financial Officer. And I'm here with Michael Rubin, our CEO.
I'd like to comment first on 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", and similar expressions typically are used to identify forward looking statements. These forward looking statements are based on current expectations, beliefs, assumptions, estimates, and forecasts, about our business and the industries and markets in which we and our partners operate.
These statements are not guarantees of future performance and involve risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward looking statements. Factors that may affect our business, financial conditions, and operating results are discussed in our filings with the SEC. We expressly disclaim any intent or obligation to update these forward looking statements.
During this call we will also present certain non-GAAP financial measures, including merchandise sales, adjusted EBITDA, non-GAAP net income, and free cash flow and certain ratios that use these measures. On our form 8K which is located on our website at www.GSICommerce.com in the investors section, you will find our definition of these non-GAAP financial measures, reconciliation of these non-GAAP financial measures with the closest GAAP measures and a discussion about why we think these non-GAAP measures are relevant. These financial measures are included for the benefit of investors and should be considered an addition to, and not instead of GAAP measures.
We delivered above planned results in fiscal 2006, tapped by a solid seasonally strong fourth quarter. Financial highlights for the year included accelerated revenue growth, increased margins, and our first year of positive free cash flow. For the sake of time I will focus my comments on our full year results and our listeners will refer to the press release for details on the quarter.
For fiscal 2006, net revenue growth accelerated to 38% compared to growth of 31% in fiscal 2005, and merchandise sales growth accelerated to 74% compared to growth of 44% in fiscal 2005. Net revenue for fiscal 2006 was $610 million, a $170 million increase from $440 million last year. Product sales increased 30% for the year to $461 million from $355 million driven primarily by strong growth of sporting goods. Service fees increased 75% to $148 million from $85 million last year.
Merchandise sales for fiscal 2006 were $1.2 billion. The first time this measure exceeded the $1 billion mark and more than $500 million greater than fiscal 2005's total of $682 million. In addition to accelerated revenue growth, fiscal 2006 was a strong year of margin improvement. With increases in gross margin, operating margin, adjusted EBITDA margin, net margin, and non-GAAP net margin.
Our gross margin increased 560 basis points for the year to 45.7% from 40.1% driven by strong service fee growth and a 240 basis point improvement in product margins. The product margin improvement primarily reflected a favorable mix between sporting goods and other products.
Our operating margin increased 90 basis points to 1.6% from 0.7% as the increase in gross margin more than offset growth in operating expenses. Income from operations for the year was $9.6 million, more than three times greater than the $2.9 million earned last year.
Adjusted EBITDA increased 81% to $38.5 million from $21.3 million last year and compared to our guidance of $34-35 million. Adjusted EBITDA margin increased 150 basis points to 6.3% from 4.8%.
Fiscal 2006 marked our seventh consecutive year of increased operating margins and increased adjusted EBITDA margins. Our net income for the year of $54 million was substantially influenced by a $44 million non-cash income tax benefit. This benefit related to releasing a portion of the reserve on our deferred tax assets through our assessment of the probability that we will realize a portion of the value of these assets based on our recent profitability trends.
Looking at non-GAAP net-income which excludes the tax related benefit as well as certain other non-cash items including stock based compensation, benefits from cumulative change in accounting principal and amortization of acquisitions related intangibles, we reported a profit of $17 million or $0.34 per diluted share compared to $6.5 million or $0.14 per diluted share last year.
Cash flow from operations for the year increased to $66 million from $24 million and as I mentioned earlier, fiscal 2006 was our first year in which we generated positive free cash flow, with free cash flow for the year at $23 million compared to negative free cash flow of $5 million last year. Capital expenditures for the year at $43 million were in line with our most recent guidance of $40-45 million.
Looking forward to our guidance for fiscal 2007, we're looking for continued strong trends. With net revenue expected to grow 13–20% to $685-735 million and merchandise sales predict to increase 26-35% to $1.51.6 billion. Income from operations is expected to be at a range of $8-13 million or a 17% decline to a 34% increase.
Adjusted EBITDA is expected to increase 30–43% to a range at $50-55 million from $38.5 million in 2006, which implies adjusted EBITDA margins should increase at least 100 basis points for the year to 7.3-7.5% which is consistent with our expectations that adjusted EBITDA margins will trend toward low double digits over time.
Net income for the year is expected to again be influenced by a large non-cash income tax benefit of $25 million and we project it to be in the range of $34-39 million or $0.71-0.81 per diluted share. Non-GAAP net-income is expected to be in the range of $19.5–24.5 million or $0.41-0.51 per diluted share. Capital expenditures for the year are expected to be approximately $50 million.
Due to the seasonality of our business and the typical timing of our investment spending, we would expect a decline in year-over-year income from operations, adjusted EBITDA, and non-GAAP net-income and each of the first three quarters of fiscal '07 with the largest declines in the fiscal second quarter, followed by strong year-over-year growth in the fourth quarter.
However, due to large income tax benefit in the fourth quarter of '06 we would expect year-over-year decline in net-income in all four quarters of fiscal '07. I think our strong fourth quarter of '06 and prior history of strong fourth quarters demonstrates that the seasonal upswing in 4Q is predictable, and it is only logical that our investment spending occurs earlier in the year.
With that let me turn it over to our Chairman and CEO, Michael Rubin.
Michael G. Rubin
Thanks Mike. I am very pleased with our fiscal 2006 results. As I look back at the year, three things stand out.
First, we maintained our disciplined long term vision by making meaningful strategic investments in our business.
Number two, we executed well on all fronts including outstanding performance in technology, operations, marketing services, and business development.
And third, we delivered breakthrough financial performance including surpassing $1 billion in merchandise sales, significantly expanding our margins, and achieving positive free cash flow for the first time.
Since we started the business in 1999, we have consistently delivered strong revenue growth, yet many have questioned the margin and cash generating potential of this business.
I believe the 2006 results clearly demonstrate that this is a business that can deliver strong financial metrics. At the same time, what was most exciting for me is that we did not achieve this break through in financial results by throttling back our investments in the business. Instead, these results were in large part driven by the key investments that we made.
Consider that we generated positive free cash flow for the first time, while still spending a record $42.6 million on capital expenditures. We also post record earnings for fiscal 2006 while increasing our operating expenses by 55% for the year. The fundamentals of our industry continue to be strong and we are clearly executing well.
E-commerce grew 24% in 2006. This projected to more than double over the next five years. With that as a back drop, our plan for 2007 will be to continue what has been working for us. Continued strategic investments, continued focus of operational excellence, and continued discipline to deliver strong financial results.
To add to perspective to our momentum let me cover some highlights of 2006. First, consider the following statistics.
According to comScore, online demand on Black Friday was up 46% compared to 2005. Demand on GSI’s platform was up 157% for the same day. Online demand for Cyber Monday was up 25% compared to 2005. Demand on the GSI platform increased 85% for the same day. On the industry’s 2006 seasonal peak day, comScore reported a demand increase of 29% over the corresponding day in 2005. For the same comparable period days in our platform, demand was up 89%.
In each case, our increases were a multiple of the increases reported by comScore. These comparisons add perspective to how well we are executing on our growth strategy of adding new partners and expanding the businesses of existing partners.
This also highlights the great year we’ve had for merchandise sales growth, as we benefited from the strong industry trends, excellent execution and addition of new partners.
The $1.2 billion we generated merchandise sales in 2006 is particularly impressive in comparison to the only $5.5 million we generated in 1999.
2006 was also a great year for business development as we signed agreements with nine new partners, seven of which we’ve launched to date. Launched in 2006 were Baby Center, Dockers, Iomega, the NFL, and Toys “R” Us. This year we’ve already launched International Speed Race, Racing One, and Elizabeth Arden. The remaining new partners, BCBG Max Azria, and an unnamed apparel partner are expected to go live in 2007.
So in 2006 we added two new partners in our most mature categories of sporting goods, our first partner for which we provided fulfillment and customer service only, and our biggest partner to date, Toys “R” Us.
The launch of Toys “R” Us in particular was a notable accomplishment for us last year. Consider that not only are they our largest partner, but we had a very short window to execute the launch. And I am pleased to tell you that the execution was seamless. By successfully taking on such a large partner, we have immediately increased our skills and clearly demonstrated that our platform is capable of serving large e-commerce businesses.
Also of note, we demonstrated in 2006 that we can take on a large partner on good terms, successfully manage the execution, and deliver strong financial results all at the same time. We also executed several extensions of agreements with existing partners, which we believe demonstrates the success we’re having in delivering a strong value proposition to our partners.
In 2006 we executed extensions with five existing partners: Nickolodeon, Palm, PBS, Rockport, and Wilson’s Leather. Since announcing these extensions, we have received some questions regarding the terms of these deals and the reasons behind the string of announcements.
First, with regards to the terms, we view all the recent extensions as good deals for GSI, and the economics between the original and extended deals are not materially different, if at all. With respect to the timing, it’s important to recognize that we are still a relatively young business, and given that our deals are long-term in nature, we have not had many deals come up for renewal.
The recent successes we have had with renewals reflects what I believe is a trend that we will continue to see. Satisfied existing partners sign up for longer terms with good economics for GSI.
As far as the news releases themselves, it is part of an increased investment in corporate marketing, as we have found that these types of communications help to give us a higher profile and increase awareness to our target prospects.
As I mentioned earlier, we make important investments into our platform in 2006 in areas including technology architecture and infrastructure, a logistics-and-customer-care footprint, our marketing services agencies, and a product-management roadmap, which is a new and enhanced features and functions of our platform.
Let me point out a few of the results of our investments, new products, features, functions, that we successfully wrote out to partners in 2006.
To begin with, we invested in our partners, to give them more control over the execution of their e-commerce businesses. Specifically, we introduced a new content-management system, new analytic capabilities, and enhanced our customer-service applications.
We also enhanced the consumer shopping experience with technologies like Express Shop and Mini-Cart, to make online shopping experiences faster and more convenient to consumers. We’ve seen strong adoptions of these features by our partners.
Another example of the roadmap investment is the expansion of our alternative payment and checkout options. We’re an industry-leader in this space and we offer several alternative tender options, and in addition to already handling private label credit cards, gift certificate, and gift cards, we use Google Checkout and PayPal as alternative payments and checkout options to complement our existing options.
Our partners enjoy great success with the significant investment we made in the area in 2005 and 2006, and they have been able to take advantage of options that likely would have been uneconomic for any one partner to do on their own. The result of the complex undertaking was meaningful business for each of our partners in the fourth quarter.
We also focused on operation infrastructure in 2006, opening a 48,000 square-foot customer-care center in Eau Claire, Wisconsin. Together with our Melbourne, Florida facility, we now have more than 100,000 square feet of call-center space with more than 1,000 seats, and room to grow. This addition provides capabilities for our 27 call centers, and is another good example of how we are leveraging our scales to deliver capabilities to our partners that they would not otherwise be able to justify on their own.
We also added to our logistics operation by securing a 540,000 square-foot fulfillment center in Ridgewood, Kentucky.
Another strategic investment was enhancement of our product customization and decoration capabilities to support one of our new partners, the NFL. The operation customized nearly 100,000 NFL jerseys in less than six months. Going forward, we expect to offer this capability to our other partners to help them grow their businesses.
Another area of investment I want to touch on is marketing services. We believe this represents a growing opportunity for us and for our partners. We are seeing a pronounced challenge shift to marketing dollars from traditional media to online channels. This shift is promising for us. It not only includes moving off-line dollars to on-line advertising, but also moving off-line dollars to web-based brand efforts such as the store redesign and branding project that we've produced for Dick's Sporting Goods in 2006.
To address this opportunity, we expanded and enhanced our marketing service capabilities in creative web strategy and design, concentration, search, e-mail, affiliate, and on-line marketing. More than 120 marketing-services employees currently provide service to more than 50 of our partners.
Now, looking to 2007, expect us to maintain the same strategy that delivered positive results in 2006. For new business development, we expect to sign five to ten new partners in 2007. Our pipeline is strong, and we believe we can again hit the high end of the range in 2007.
As I mentioned earlier, we are also increasing our investment in sales and marketing teams, as we look to increase our number of annual deals over time. We also expect to continue the momentum with deal expansion in 2007.
On our product-management front, we will continue rolling out new and advanced features and functions from our product roadmap, nearly doubling our investment beyond 2006 levels. This follows having doubled this investment in 2006 over 2005 levels.
This includes optimizing our return-of-payments processes, enhancing marketing and promotional tools, introducimg new personalization capabilities, further empowering our partners with more control over the web businesses by continued enhancement of site-management tools, and providing shoppers with an additional and more powerful search options, and rolling out web 2.0 features.
In 2007 we expect more partners to take advantage of our expertise and capabilities in marketing services, and many of them to invest more of their off-line marketing dollars into on-line channels.
With regards to logistics, we expect to open our new fulfillment center in Ridgewood, Kentucky, in the second half of 2007. We expect that this facility will allow us to scale our logistics operation to $2 billion in merchandise sales. When it opens, this will be GSIC's most automated facility, and will give us a total of more than 1.7 million square feet of fulfillment space.
From a financial perspective, I am confident that we will continue managing our goals of increased profitability and margin expansion, while simultaneously investing in our business. Specifically, we'll invest an estimated additional $12 million in discretionary fixed operating expenses in fiscal 2007.
We're committed to this investment and still providing guidance from an adjusted EBIT of $50-55 million, the high end of which is $5 million greater than we had previously indicated was a reasonable expectation.
To sum it up, I believe our 2006 performance was excellent, and we delivered breakthrough financial results, while significantly enhancing our platform. This type of performance, I would note, is only possible with tremendous execution by our team and tremendous support from our partners.
We are well positioned for 2007, and in my opinion, we are in an enviable position of being able to continue executing a successful strategy with strong momentum from our own performance and the industry at large.
And with that, I’ll open the call for questions.
Question-and-Answer Session
Operator
Ladies and gentlemen, if you wish to ask a question, please press * followed by 1 on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, press * followed by 2. Please press *1 to begin.
Your first question comes from the line of Anthony Noto of Goldman Sachs. Please proceed.
Anthony Noto - Goldman Sachs
Thank you very much. Michael, I was wondering if you would comment on what drove the acceleration in sporting goods gross-product sales, and then, as you look at the margin, you had a very big improvement in the gross margin of product sales. Your comment on that was 31.5% versus 21%
And I had one follow up. Thanks
Michael G. Rubin
Sure I'm going to hit the question regarding sports acceleration and then I'm going to have Mike answer the question as it relates to margin.
As it relates to sporting goods, sports as I think, you know, is our most mature business today. We've continued to be very impressed with the overall constant growth that we have in sporting goods. We also brought on the NFL business which is also a good business in the fourth quarter of last year. But overall, I think we continued to be really impressed and very satisfied with both the growth of existing partners and new partners. And I think sports again just had really terrific comps. in the fourth quarter and again NFL was also a good contributor during the fourth quarter.
Michael R. Conn
On the margin side, I think there's really a couple of factors that play both mix related. The biggest factor is just that the two components of product sales are sporting goods and non-sporting goods and sporting goods carry a higher margin. So, sporting goods increased as a percent to total with its faster growth so that is accretive to margin. Also even within sporting goods, the faster growth from licensed products because of the addition of NFL also was a benefit. The reality is I think we even left a little bit on the table from a margin perspective. The warm weather during December really hurt sales of apparel and outer wear which is a good margin category of course. I think even with a more normal weather we would have even seen stronger margins in the period.
Anthony Noto - Goldman Sachs
Great. Then the one question I had on your outlook for '07.
I think you may have mentioned that the operating income or net-income on a year-over-year basis would be down in the first three quarters and then obviously up in the fourth quarter, making the full year up.
If that's correct, is the reason for that, the fact that you have Toys now and it's much more of a scaled seasonal product in the fourth quarter so you have to carry the infrastructure for the other three quarters or is that due to a higher level investment because you clearly invested a lot in '06, but you were able to grow on a year-over-year investment despite that investment in the non-holiday quarters? Thanks.
Michael R. Conn
Yeah, I wouldn't really attribute it to the addition of Toys “R” Us. I think that really the latter part of what you're suggesting which is the investment spending, and I think that one of the things we have seen is that the earlier we can get investments in play the more benefit that we can get from them. Particularly in the fourth quarter we have so much leverage in the business, so clearly we're working to get as much spending underway for investments that we're planning to make in 2007 upfront. So that clearly creates that drag-effect. It’s really not something new for us. We've had certainly that drag-effect historically in the first three quarters of the year. A little bit more pronounced in 2007 although not much.
And I think another thing to keep in mind is just that if you look at the numbers of the first three quarters of the year versus the fourth quarter, they're so small that a $1 or $2 million of incremental spending in a particular quarter can swing it from positive to negative versus clearly that wouldn't be the case in the fourth quarter.
Anthony Noto - Goldman Sachs
Great. Thank you.
Operator
Your next question comes from a line of Brian Pitz of Bank of America. Please proceed.
Brian J. Pitz - Bank of America Securities
Thank you. Can you talk about the impact of promotional activity on the top-line for your partners of the quarter including such things as Google Checkout, your email marketing, and other discount codes that seem to be virally moving online? And then a second question unrelated, would you update us on your thoughts around partner pipeline? You talked about five to ten new deals in ‘07. Can you give us any sense for the partner's size and the categories that may be involved here? And also, as your business scales from a lot of the implementations you did in 2006, how much incremental scale can you get from new partner ads? Thanks.
Michael G. Rubin
Sure. As it relates to the promotional activity in the fourth quarter, certainly many of our partners have brick-or-mortar stores and are by their nature very promotional in the fourth quarter. I don't think that this fourth quarter was any different than a normal fourth quarter. I think there's always a lot of promotional activity that goes on. I think our partners are generally very consistent between their offline businesses and their direct businesses and I think that's really what happened in the fourth quarter. Certainly, alternative...you asked about Google, I think alternative payments as a whole was something that was a driver in the business. Certainly, we think that's something that will continue to get bigger over time. But overall, I'd describe the promotion activity as consistent this fourth quarter versus historical fourth quarters. I certainly don't think it was any more than it had been.
As it relates to pipeline, we definitely feel really good about where we are. I think that as we continue to build up our leadership position and separate ourselves from many of the smaller companies of space, I think GSI is clearly seen as a leader today. And I think that's going to really pay dividends from how we turned pipeline into actual partners. I think from the category perspective with the message that we've historically said is, I think consistent with what we're going to say going forward, which is we'll continue to probably add one or two new categories per year with very similar trends to the categories that we're in; good average order, good gross margins, great brand names, that's what really makes a new category interesting to us. And I think that the majority of the new partners that we bring on will be within existing partners or I think we will add one to two new categories per year. And again, I think we feel very strongly about the pipeline going forward.
Brian J. Pitz - Bank of America Securities
Now just a quick follow up on Google CheckOut can you give us any color on specific usage of that product on your site?
Michael G. Rubin
I think what I'll do is kind of, I think I made some comments historically. I'll kind of just repeat those because they may not have been widely disseminated. I think we had made an announcement that all alternative payments together were a little bit less than 20% during a pretty big period in the fourth quarter. I think Google CheckOut was definitely the biggest of those payment methods. And we looked between PayPal, Google CheckOut, and Bill-Me-Later. Google was definitely the biggest. So I'd say, for the partners that had multiple payment methods, I think it was around 20%, and Google was definitely the biggest of the three.
Brian J. Pitz - Bank of America Securities
Great, thanks.
Michael G. Rubin
Thank you.
Operator
Your next question comes from a line of Robert Peck of Bear Stearns. Please proceed
Robert Peck - Bear Stearns
Hey guys, congratulations. I just wanted to talk a little bit about longer term, where margins are going and what have you. If we look at your guidance for '07, I guess we're talking somewhere around 7.5% EBITDA margins and what we're wondering is with the $12 million sort of one time spending or increased spending, if you stripped that out you'd be more on 9.1%. How should we sort of look at the leverage and the incremental margin you can get out of that line item looking passed '07 and further out?
Michael R. Conn
Sure. I mean I think if going through the same exercise I think that you know you get incremental EBITDA margins looking at our guidance of you know the 10% or so that we hit this year to low teens, and I think that that's reflective of directionally where they can go. I think we've commented in the past that EBITDA margins should trend towards low double digit. Certainly, we continue to feel comfortable with that.
I think as far as looking at out multiple years, it's a little bit hard for us to have perfect precision just based on if we look at the last several years of our business, we've seen this trend of continuing to get bigger faster than we would have expected but also then that bringing with it requisite investment spending. So I think that certainly we're positive that the trend of upward trajectory to the margins is something that should continue. And continue at a nice pace as it has been. Certainly, we see low double digits in the future.
As far as how much higher than that it can go, I think, you know, we'll see over time but we're certainly very bullish that this could be a good margin business.
Robert Peck - Bear Stearns
And a quick follow up. When you think about traffic from your partners, are you able to give us any sort of demographics as far as where the traffic is coming from? Is it coming more from, you know, direct site going to, or is it more of search engines? How are you sort of seeing traffic coming from there? And ultimately how have you seen the price per click trends for them?
Michael G. Rubin
Direct is definitely the biggest part of our business and the reason that direct is the biggest part of our business is just because of the big brand names that we work with. I think for some of the smaller online players certainly they have most of the traffic come from online marketing. So first and foremost, direct is definitely the biggest, continues to be the biggest, and we believe it will up for the perceivable future be the biggest. And that's just because, I think our partners spent something like $3 or $4 billion collectively in advertising and if they leveraged those brands, that's going to drive traffic directly to this site.
Saying that, at the same time, our partners do spend meaningful dollars in online advertising. It's very effective for them. And what we're really seeing, and we think that this is a great trend that's really going to benefit GSI in the future, is our partners today probably spend less than 2% of their online marketing budget from the total marketing budget online. So we certainly believe that our partners are going to continue to meaningfully increase their total marketing budget spent online going forward and we think that's going to be a great benefit to both GSI and their direct strategies and it's going to be great for the overall business. We think we're just starting to scratch the surface on that and certainly really big potential in the future.
Robert Peck – Beat Stearns
Thanks so much, guys.
Operator
Your next question come from a line of Shawn Milne of Oppenheimer Funds. Please proceed.
Shawn Milne - Oppenheimer & Co..
Thank you, for clarification, Oppenheimer & Co. Good quarter guys.
Michael G. Rubin
Thank you.
Shawn Milne - Oppenheimer & Co.
A couple of quick questions. We've heard a lot about Amazon recently, more on the web services side in dealing with small businesses, any sense from potentially exiting your business of going after larger partners? I have a follow-up.
Michael G. Rubin
Sure, I don’t want to comment on Amazon specifically and what the strategy is and certainly it’s always better to ask them but I think there’s been a reasonable amount of noise in the market place about that.
Shawn Milne - Oppenheimer & Co.
I noticed you’re now live with Baby Center, is there a chance you can extend that business with Johnson and Johnson.
Michael G. Rubin
Certainly Baby Center’s a partner that we’re real excited to work with. We think the Baby Center business itself is a great business with a lot of potential and certainly that it is a J&J company and I think definitely presents a good opportunity for a great company certainly with lots of opportunities.
Shawn Milne - Oppenheimer & Co.
Micheal Conn, can you break out Toys “R” Us in the fourth quarter in terms of percent of NMS?
Michael R. Conn
It is not something that we would break out specifically. Overall as we’ve commented in the past we’ve been pleased with the results in the business, but in terms of breaking out partner’s specific results that’s not something that we would do just out of respect for the partner.
Shawn Milne - Oppenheimer & Co.
Okay, Great.
Operator
Your next question comes from the line of David Joseph of Morgan Stanley, please proceed.
David Joseph - Morgan Stanley
Hi guys, we’ve got two questions here. One is that your outlook for revenue growth in ’07, it actually implies a significant deceleration at the mid-point and even at the high end of the range from the 38% that you saw in ’06 even the near 50% you saw in Q4 exiting the year. I’m just wondering where that deceleration is coming from or why. It could be I’m missing something. It seems like Toys “R” Us would be a little bit of a good guy being that it wasn’t part of the full year of ’06. So, I’m trying to get my arms around that.
Also on the $12 million of ‘07, you mentioned quite a few buckets, from infrastructure to product to sales and marketing. I’m wondering if there’s any of those items that might be taking up more of that $12 million than others?
Michael R. Conn
Sure. So, I keep things on the revenue growth. Things to keep in mind with respect to 2006 results, there was a significant new partner that was owned inventory and that was the NFL. And that’s become somewhat abnormal for us in that most new partners that we’re bringing on, including our expectations for 2007 are non-inventory owned.
So, you have equivalent economics from a bottom line perspective from those deals the non-inventory owned or serviced fee deals verses the inventory owned product sales. So they have more of a gross impact on your net revenue guidance.
So that’s certainly a piece of it. You know, also I would say we certainly view our guidance’s as what we would characterize as reasonable expectation. But I also think, If you look back at our track record, we consistently surprise ourselves in terms of the upside.
So, current guidance is appropriate but I would say it certainly feels good about tone of sales as we sit here currently and think that there’s good opportunity there as we look out over the year.
Michael G. Rubin
And David’s questions, as it relates to what are the biggest spends within the $12 million. I think there’s a couple and I don’t wan to get into all of them.
First would be the sales and marketing area which is really focused on partner acquisition and one of the things that we like to do over time is be able to handle more than five to ten partners, and that starts with sales and goes all the way through the business.
How do we execute that? We’re going to almost double our investment in the sales and marketing area in 2007 from 2006. And that’s a payoff that we think we will begin to see payoffs in 2007 but will begin to see bigger payoffs in 2008.
And again, that’s a meaningful expansion there, it’s something that’s going to have marginal benefits in ’07 but is certainly going to be great for us in the long term.
The next is in product management which is the features and functions of the websites and the tools that our partners had. And as I mentioned, we’re going to double that spend in 2007 against 2006 and we doubled it in 2006 against 2005.
I think the most important thing is to put it in the context again, the thing that I’m most happy about is when I look back to ’06 is that we went from $21 or $22 million dollars in EBIDA at $38 million dollars, where we invested a lot more in the business. And the same story is really true as we go into 2007 we’re materially increasing our financial performance.
And I think today the high end is even $5 million dollars better than what we recently said, while continuing to invest in the business. I think that’s the right mix as CEO that I really look to get so we’re not betting better financial performance, but not making investments, but making the investments without getting the better financial performance. I think we have a really good mix of both and that’s probably what I’m most excited about.
David Joseph - Morgan Stanley
Great, thanks, guys.
Operator
Your next question comes from the line of Mark May of Needham & Company. Please proceed.
Mark May - Needham & Co.
First few questions have to do with drilling down on Organic versus new client growth. On the sporting goods products sales, obviously NFL drove that growth rate up quite a bit. As the anniversary of that deal, which I think launched in April, what is the underlying kind of organic growth in your sporting goods business? It think it’s 15 to high teens percent. Wonder what your view is there.
The other product sales not surprisingly down significantly in the quarter, would you expect that that segment of your business will grow in ’07 and I had a couple follow ups?
Michael G. Rubin
Sure. I mean the sports, as everyone knows, is our most mature business, we’ve been in the business since 1999 and we’ve continued to every year be really impressed with the growth and I think that coming forward, the story is not going to be anything different.
I think that we’re going to see comps that are consistent to above average within the sporting goods business on a comp-store basis. We’re certainly very bullish on all the opportunities that exist going forward in the sports business and again I feel really good about the underlying comp story.
As it relates to other product sales, there’s one partner that makes up the majority of that. We’ve taken a very conservative approach to that in our guidance and I think there’s opportunity from the guidance that we have, but we’re going to take a conservative approach and again as I think Mike mentioned, there’s nothing but opportunity going forward.
Mark May - Needham & Co.
And on the service fee site, can you give us a sense of what, if you do have these numbers, what organically your current client base grew out of Q4 and all of those sects?
Michael R. Conn
Not a number that we’ve specifically broken out. The biggest driver of service fees for us is transactions. We consistently commented on a comparable basis we’ve generally trended in line with e-commerce growth. So clearly, that’s a good proxy for what’s going on.
Beyond that and also a factor from a comparable service fee standpoint, things like marketing services that are starting to grow, technology professional services that are starting to grow, all from existing partners that are helping drive incremental service fees from partners that have been on the platform longer. So that’s helping also add a few points on to the organic.
Mark May - Needham & Co.
OK, and that’s a good segway to my last question. A simplistic way of modeling your service fee business is then a percent of the GMS for those customers, and in ’06 that went down primarily as some of your new customers bought fewer modules particularly fulfillment.
As we look into ’07, kind of using Q4 as a base with Toys “R” Us, and a lot of the other customers now into Q4. How should we consider that ratio to be stable or do we still have some mixed shifts going on where that ratio will continue to edge down a little bit?
Michael R. Conn
Yeah, I think the big shift, certainly in 2006, was the mix of services, particularly with Toys “R” Us not having fulfillment. That was the biggest single driver of what caused that. We still have a half a year, although now it’s big seasonal peak with Toys “R” Us’ anniversary, so it might trend down a little bit in 2007 but clearly a big drop in 2006 is not something that I would expect to continue and I would look for that number to stabilize, although maybe a little lower than where it was in 2006.
Mark May - Needham & Co.
OK, thanks a lot, nice quarter.
Operator
The next question comes from the line of Jim Frieland of Cohen & Company.
Jim Friedland - Cowen and Company
Thanks, a question relating to international. Any update there in terms of stuff you’re doing beyond Iomega. Where I’m getting with this, the incremental investments, seems to be in the U.S., is there any point in the near future where you might starting building out fulfilling or a customer service feature to service that market? Thanks.
Michael G. Rubin
Sure, we think international represents a really good opportunity for the company and we’re definitely getting more serious about it. Within the $12 million dollar investment number that I went through, there’s definitely some dollars earmarked for international. What I would say to you is that I would not expect us to do anything other than continue to look to improve our financial performance.
Saying that, I think we could invest more in different areas of the business, at the same time looking to improve our financial performance. I think international is definitely the area we’re excited about. We think it represents big opportunity, we think it’s going to do more with additional partners in 2007.
And 2007 should be a significant step forward with international business, but I don’t want you to think that that’s going to come at the cost of doing anything other than going forward with our financial performance and the bottom line.
Jim Friedland - Cowen and Company
So it means for ’07, basically your guidance has baked in whatever your spending on international?
Michael G. Rubin
That’s right and if we were to spend more…because we had incremental profits above what our guidance takes into consideration today.
Jim Friedland - Cowen and Company
OK, great. And just a quick follow up on accounts payable. Looks like on the working capital side you had a boost there, good quarter in general…but I was just curious, is there anything one time in nature, or a timing issue that might have pushed the working capital benefit up in Q4?
Michael G. Rubin
Nothing one time in nature. Certainly if you look at the last couple of years, we’ve seen relatively stable inventory as we brought up the NFL as a partner, the inventory aside, we brought on some inventory so that’s going to lead to higher AP. We tend to run AP with good average terms and in general as you saw in 2006 which historically has been the trend for us, working capital as a source of cash for us.
So, really just normal seasonal trends. Nothing that I would characterize as out of the ordinary from the timing perspective.
Jim Friedland - Cowen and Company
OK, great, thanks.
Operator
Your next question comes from the line of Colin Sebastian of Lazard Capital Markets.
Colin Sebastian – Lazard Capital Markets
Thanks for taking my question and congratulations on the quarter.
Two questions, the first going back to Dick’s Sporting Goods, just curious given the site redesign if you can be specific in terms of any changing conversion rates or other observations that have come as a result of that redesign?
And then secondly, going back to the incremental or discretionary investments for the year, should we consider these overall platform investments or can you break those down between investments in new partners or growing existing partners organically? Thank you.
Michael G. Rubin
Sure, as it relates to Dick’s and any change of conversion, certainly they’ve been very pleased with the conversion with the new site. I think the biggest thing is that if you take a retailer like Dick’s and you take the completely redesigned site, I think what they’ll tell you today is that it’s completely consistent with the stores and now they’re looking to integrate it into everything they do from a marketing perspective.
So, I think the biggest benefit is because of the consistency of the site and the store because they really look at that as one of the best marketing assets for their company, you’re going to look at better integration now than you’ve ever seen historically.
On the conversion rate specifically, I think certainly everyone has been pleased with it.
As it relates to the investment in the platform versus specific partners, I’d say most of these investments were platform wide investments. Certainly they allow us to scale up, they allow us to take more partners on. They allow us to be that much more important to our existing partners but I think that these are overall platform investments, not tied specifically to a partner.
Colin Sebastian – Lazard Capital Markets
OK, and then lastly. I was wondering if you noticed any material change in gift card sales in the quarter, if that business is contributing materially to your sales in the quarter?
Michael G. Rubin
Sure, gift cards certainly continue to be a meaningful part of many of our partners’ businesses. I think every year we continue to see it inch up a little bit. I think it continues to inch up slightly each year. We’re certainly very excited about the potential that gift cards could be more meaningful to us in the future. But certainly it wasn’t so materially different this year versus last year.
Colin Sebastian – Lazard Capital Markets
OK, thanks a lot.
Operator
Your next question comes from the line of Christa Quarles of Thomas Weisel Partners. Please proceed.
Christa Sober Quarles - Thomas Weisel Partners
Hi, a couple of questions.
First, as it relates to some of the renegotiations that you have, I was wondering if you could comment broadly again how marketing services is becoming a bigger component or discrete item if you will in the contract.
Second question, as you look back on the original 2006 guidance, it looks like 28% upside on G&V. Just wondering is that primarily due to Toys, additional partners, the breadth of partners, if you could extrapolate on where the upside was as per your original
guidance.
The third question, if you could give us free cash flow guidance for the year or anytime soon?
Michael G. Rubin
Sure, as it relates to renegotiations and what role marketing service plays in that, it’s really a discrete bucket, and that’s really the way you asked the question, that is correct. I don’t think we’re generally bundling marketing services into a base agreement, I think we’re looking that to really be an incremental opportunity and further revenue for us to do with each of the partners we provide the services to.
And I think the exciting thing is that I mentioned before it was kind of a start-up business in 2006 and had roughly fees in the $10 million range. We’re just getting starting in penetrating many of our partners, so we think there’s a big opportunity to grow that business and we think that will be really incremental to the base business.
As it relates to the second question, where did the MNS upside come from. Certainly Toys was a big factor for us and certainly the biggest factor from our original guidance. Certainly NFL was an additional factor, and then I think if we look at the original guidance and just overall sales, we’ve been very pleased of just overall sales of the base business. So, I think it’s really a nice place to be, everything contributed to the upside.
Michael R. Conn
On the free cash flow side, I think without having the make-up of new partners until they’re on, some of the working capital dynamics are a little bit harder for us to get as precise on. Though certainly if you look at the main components we’d have EBITDA at or above CapEx and certainly would expect to see working capital benefit. But to give you a precise forecast at this time is tough for us to do.
Christa Sober Quarles - Thomas Weisel Partners
OK, thanks and then a quick follow up on the marketing services piece. Could that then ultimately lead to an increase in take-rates? I guess as how we define them?
Michael G. Rubin
Definitely.
Christa Sober Quarles - Thomas Weisel Partners
Great, thank you.
Michael G. Rubin
Thank you.
Operator
Ladies and gentleman, this concludes the question and answer portion of today’s call. I will now turn the presentation back to Michael Conn for closing remarks. Michael?
Michael R. Conn
Just want to thank everybody for listening and we’ll talk to you in a couple of months when we report first quarter.
Operator
Thank you, this concludes today’s presentation and conference call for the 2006 fourth quarter and 2006 fiscal year operations results of GSI commerce.
Thank you for your participation and interest. Have a good evening.
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