InnerWorkings, An Interesting Turn-Around Play

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About: InnerWorkings, Inc. (INWK)
by: Shareholders Unite
Summary

The company's shares slumped on financial restatements, organizational dysfunction and other mishap.

The company hired experienced turnaround artists and is embarking on a wholesale revamping of their organizational processes.

Given that cash flow is still positive and their underlying business seemingly sound, they have time to execute.

There is a lot of upside if the organizational dysfunction was large but even a return to historical margins will provide a considerable boost to the shares.

InnerWorkings (INWK) is a company whose shares have been in the doldrums for at least a year due to financial restatements, a seemingly chaotic organization and other mishap.

However, the bigger that organizational chaos was, the bigger the upside the shares have when that is put right. There could be a leaner, meaner more profitable company at the end of the revamping process.

By all accounts, InnerWorkings had a rough 2018, summed up by the stock price performance:

Of course, this doesn't happen in a vacuum. The company's 2017 financial statements turned out to be incorrect and when the company refiled these the results were much less rosy and the company came with way too much cost in 2018.

There was actually more mishap in that a large client changed its marketing strategy causing a decrease in the company's retail environment (Q4CC):

We also saw declines in our transactional and small accounts and margin compression across some enterprise clients and we were simply too slow to adjust our cost structure in response.

In that light, the company could have fared worse. Revenue growth tapered off only lightly although the company experienced a pretty dramatic worsening in its operational performance:

Chart Data by YCharts

The revenue decline is fairly mild (and new contracts won and 2019 guidance suggest it's reversible) but the operational performance is pretty disastrous (Q4CC):

Many of the issues we faced in 2018 are the result of a lack of standardization in our systems, processes, and controls.

In short, there was organizational chaos at the company. Luckily, this looks like a problem that can be amended by people with experience in these sort of things.

Which is why the company hired Aden Pope as CTO, who is (Q4CC):

I think we've brought in a really seasoned pro who's been through enterprise transformations... So we are very bullish that as Adan gets on board and literally it is his second day that that partnership with finance and operations will help drive incremental value to our shareholders.

So it's early days for Mr. Pope, but his CV is pretty impressive with considerable roles in companies like Ciena, Ericsson, Telcordia and Shopper Trak.

And of course the company also has a new EVP and CFO in the form of Don Pearson since January 10, and he too seems to be hired to reign in the chaos (Q4CC):

Don has a lot of experience in business transformation and exactly the right skill set to help lead the change we need.

His CV seems to back that up and indeed, here is the good man himself (Q4CC):

I've been through several enterprise transformations that resulted in significant improvement in financial performance and shareholder value.

However, there is one complication which will become clear from a part of the description what the company does, from FinViz:

InnerWorkings, Inc. provides marketing execution solutions. The company's software applications and databases create an integrated solution that stores, analyzes, and tracks the production capabilities of its supplier network, as well as detailed pricing data. It offers outsourced print management solutions that encompass the design, sourcing, and delivery of printed marketing materials, including direct mail, in-store signage, and marketing collateral; and outsourced solutions for the design, sourcing, and delivery of branded merchandise and product packaging. The company also assists clients with the management of events, promotions spending, and related procurement needs; and designs, sources, and installs point of sale displays, permanent retail fixtures, and overall store design, as well as offers on-site outsourced creative studio, digital marketing, and on-demand creative services. In addition, it provides fulfillment and logistics services, such as kitting and assembly, inventory management, and pre-sorting postage. Further, the company offers creative services comprising copywriting, graphics and Website design, identity work and marketing collateral development, and image and print-ready page processing and proofing capability services.

That is, the company has many of its employees embedded with customers and restructuring, cost cutting and efficiency improvements have to be balanced against maintaining customer service.

It also becomes a little clearer how the organization could become unwieldy and chaotic if a substantial amount of its employees are based at customers. However, they're not going to give that up, as management argues it's a source of differentiation and stickiness (Q4CC):

So it's really looking at roles responsibilities what components of work can be – could be centralized, but we intend to continue to have and leverage our fantastic and we think world-class on-site staff. And we think that's a critical part of the model go forward. We think that drives stickiness, it drives retention and it frankly drives new growth from existing clients.

There is some evidence to back this up, the company basks in a customer retention rate of 97%. The company has three priorities for the year:

  • Profitable growth
  • Managing and lowering cost
  • Operational excellence

From revenue development (see graph above) we can surmise that revenue generation doesn't seem to be the major problem. Indeed (Q4CC):

We closed out the year with $136 million in new multiyear revenue awarded and came out strong right out of the gate this year signing more than $40 million in new annual business in the first two months of 2019.

So it boils down to improving the organizational structure and processes and eliminating cost.

Organizational change

Here is CFO Don Pearce on what needs to be done (Q4CC):

The path for InnerWorkings to create shareholder value is clear. We need to lower our cost to serve our clients by improving our processes and accountability across the organization. I can see that the company had the right ideas when it embarked on its cost reduction program last summer, but it is now clear that those quick wins weren't enough. InnerWorkings needs standard processes and more automated systems to enable permanent cost reductions and achieve a platform for sustainable profitable growth and operating leverage.

What are the changes they are putting in place to improve organizational performance? Here are the main measures:

  • A much more robust deal review process with a "sharper focus" on cost to serve and profitability for the company.
  • They're mapping standard operating procedures with the help of third-party consultants and have a work stream dedicated to "resolving our disparate inefficient network of internal systems to make our processes less manual and more efficient."
  • The company is "revamping" its sales process and the resource allocation underpinning it.
  • The company is reviewing the way in which it is incentivizing and compensating employees and monitoring their performance of their accounts.
  • The company is revising its supply chain for opportunities to cut cost.

On top of restructuring cost, operational performance was marred by some substantial one-off cost, most of which are non-cash:

  • $5.5M in non-reoccurring inventory and other adjustments.
  • $2.7M of bad debt expense in relation to a terminated client.

Without these expenses the adjusted EBITDA would have been $9.5M, rather than the $1.3M, recorded in Q4.

Guidance

From the earnings PR:

The Company expects gross revenue to be in a range of $1.15 to $1.18 billion, which represents growth of 3% to 5% compared to 2018. Adjusted EBITDA is expected to be in a range of $42 to $46 million dollars, which represents growth of 45% to 58% compared to 2018. Non-GAAP diluted earnings per share guidance for 2019 is expected to be $0.20 to $0.24.

So the company expects growth to come back and strong EBITDA growth and positive earnings.

Margins

Chart Data by YCharts

Either the company has had considerable organizational slack for a long-time or this is generally a fairly low margin business. We think for shareholders to really see considerable upside in the shares margins need to return to historical highs of mid-20s for gross margin and 3%+ for operating margin, and preferably a bit beyond that.

Gross margin suffered from the above mentioned one-time cost and an unfavorable product mix but management projects higher gross margins this year due to a better mix.

Cash

Cash flow is still positive, which should be a considerable reassurance to investors, even if it's rather paltry for a company producing $1B+ in revenues:

Chart Data by YCharts

The company has a net debt of $116.4M and is seeking refinancing.

Valuation

Chart Data by YCharts

Valuation crashed with the share price, no surprise here. On a sales basis, the shares are cheap historically but it all depends whether the company can become more profitable.

However, if company guidance materialize and the company does $0.22 in EPS (midpoint) this year, the shares trade at 17x earnings.

Whether that's cheap or expensive very much depends on whether they can grow earnings beyond that $0.20-$0.24, that is, how much they can clear up the apparent organizational mess.

Historically, this is a 24% gross margin and 3% operating margin at best, that is not great profitability by any means. Analyst expect an EPS of $0.37 next year with the highest estimate at $0.44, which suggest at least some upside.

Conclusion

Organizational turnarounds aren't rocket science. This has been done before many times over by hiring a few people with relevant experience.

Only where turnarounds get tricky is in very large organizations, or ones that are very cash strapped. InnerWorkings falls in neither category.

In fact, the crisis doesn't seem as severe to us, as the underlying business seems sound and the company is still generating positive cash flow.

In short, while their underlying business seems fine to us, one could say that the shares have more upside, the more chaotic and dysfunctional their organizational processes were. In that case there is more low-hanging fruit and more room to increase margins. Even a return to historical margins would already produce a notable boost to the shares.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.