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Edited Transcript of INWK earnings conference call or presentation 8-Nov-18 10:00pm GMT

Q3 2018 InnerWorkings Inc Earnings Call

Chicago Nov 12, 2018 (Thomson StreetEvents) -- Edited Transcript of InnerWorkings Inc earnings conference call or presentation Thursday, November 8, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bridget Freas

InnerWorkings, Inc. - VP of Finance & IR

* Charles D. Hodgkins

InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives

* Richard S. Stoddart

InnerWorkings, Inc. - President, CEO & Director

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Conference Call Participants

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* Adam David Kelsey

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

* Christopher Paul McGinnis

Sidoti & Company, LLC - Special Situations Equity Analyst

* Kevin Mark Steinke

Barrington Research Associates, Inc., Research Division - MD

* Timothy Michael Mulrooney

William Blair & Company L.L.C., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the InnerWorkings, Inc. quarterly earnings conference call. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to turn the conference over to Ms. Bridget Freas. Ma'am, you may begin.

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Bridget Freas, InnerWorkings, Inc. - VP of Finance & IR [2]

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Good afternoon, and welcome to our third quarter 2018 earnings call. Joining me on the call today are Rich Stoddart, our Chief Executive Officer; and Chip Hodgkins, our interim Chief Financial Officer.

We issued a press release with additional information earlier today, which is available on our website, www.inwk.com.

Please note, this call will include forward-looking statements relating to future results that are made pursuant to the safe harbor provisions of the federal securities laws. These statements are subject to a variety of risks, uncertainties and assumptions that may cause actual results to differ materially from those stated or implied by the forward-looking statements. Additional information concerning these risks, uncertainties and assumptions is contained in our SEC filings, including the Risk Factors section contained in our most recent Form 10-K. Any forward-looking statements represent our views only as of today and should not be relied upon as of any subsequent dates.

This call will discuss, among other financial performance measures, non-GAAP adjusted EBITDA and non-GAAP earnings per diluted share. Please refer to the company's earnings release issued today for reconciliation of these non-GAAP measures to the most comparable GAAP measures.

This call is intended for investors and analysts and may not be reproduced in the media in whole or in part without our prior consent.

I'll now turn it over to Rich.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [3]

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Thank you, Bridget. Good afternoon, and thank you all for joining us. As we approach the end of this year, it's clear that 2018 has been a transitional year for InnerWorkings as we launch several initiatives that will drive greater value for us and for our shareholders over the long term. As we head into 2019, our belief in the strength of this business is unwavering due to the actions we've completed and plan to take as well as the momentum we have in signing new accounts. I'd like to first discuss what we're seeing on the revenue side and then give you an update on what we're doing to lower our costs.

Our lack of revenue growth this year is disappointing and is not representative of what you should expect from InnerWorkings. The decline in marketing spend with one of our largest clients that we serve in the retail environment is a major contributor as we previously discussed with you during our first quarter call. However, more recently, we've experienced softening across a number of our transactional and small accounts. This has prompted us to lower our revenue expectations for 2018 today. With respect to the softness in transactional and small accounts, let me take a step back and share some context.

In my first few months with InnerWorkings, it became abundantly clear that the value of this business is in our core enterprise offering, driving consistency, efficiency and visibility into the marketing supply chains of the world's largest and most well-known brands. That said, we do have numerous small accounts, many of which operate on an order-by-order basis rather than a long-term contract. This work is less sticky, less predictable and doesn't have the potential to achieve the same margin profile as our large enterprise relationships.

We made the strategic decision to reduce certain costs and resources allocated to transactional and small accounts. In doing so, we sharpened our focus on growing our large enterprise relationships, which will make InnerWorkings a stronger, more predictable and more profitable business going forward. We recognized this narrowed focus had the potential to create a revenue headwind, which is materialized quicker than we expected, and you're seeing that play out to some degree in the third quarter, but it's the right thing to do for this business over the long term. It aligns with our strategic plans and facilitates improvement in our cost structure.

To be clear, we are not eliminating our transactional and small accounts. We are only refocusing our attention on our core enterprise clients and away from some empty calorie revenue. Many of our small accounts are high value add, and we think there's opportunity to leverage certain transactional work into new enterprise relationships. In fact, a perfect example of this is with a Fortune 500 global adult beverage company that InnerWorkings has been supporting on a transactional basis since 2004. Now that relationship is expanding into advanced contract discussions to deploy a full technology suite for this client, which would drive efficiencies and transparency in the purchasing and selection of its point of sale and branded merchandise in the United States.

This software solution would replace multiple legacy client ordering systems and improve the purchasing process, benefiting both the client users and the distributor network by creating full order visibility, an updated look and mobile ordering capability. There are several other transactional clients in our pipeline that we think could see transformational benefits by adopting our full solution and implementing our technology platform. Those discussions are ongoing.

Meanwhile, we announced today a major expansion with an existing client. This one is with a Fortune 100 food and beverage company we previously served only in Latin America. The new scope significantly expands our relationship into North America, managing point-of-sale displays and other marketing collateral for key brands in their major markets.

With this new win, our year-to-date total of new annualized revenue rises to approximately $134 million, already surpassing the amount awarded for the full year 2017. These new wins span 14 clients, including 9 existing clients ranging from a relationship tenure of less than a year to more than a decade. The 5 new clients add to our depth of expertise across beer, wine and spirits, health care and food verticals and expand into new niches.

I'm also encouraged by our pipeline, which includes significantly higher-quality opportunities than in recent history. It is a more focused pipeline with a greater proportion of large, often global enterprise opportunities. As of today, the pipeline includes approximately $85 million of potential annual revenue in the contracting phase. While no deal is assured, the contracting phase is the final gating stage in the sales process, and we expect a significant portion of this potential new work to sign in the near term. With this momentum, we fully expect to return to our long-term historical pattern of organic growth in 2019.

Now I'd like to share with you an update on the efforts we're making to improve our cost structure. Through the end of the third quarter, we achieved $11 million of the $20 million in planned cost reductions. This is in line with our original time line. Actioning the remaining $9 million has greater complexity as we deal with European labor laws and tread carefully to ensure that we're retaining the necessary resources to support our current business and implement new wins.

In addition, the slowdown in our revenue growth has brought to light the opportunity and the need for additional cost reductions. We've hired a third-party consultant to aid in this exercise, and they recently completed an 8-week assessment of our business. We're very encouraged with their initial findings and are in the early stages of evaluating the recommendations as we scope further profit enhancement initiatives.

Chip will now take us through our financial performance for the third quarter. Chip?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [4]

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Thanks, Rich. Hello, everyone. Our third quarter gross revenue was $270.9 million, a decrease of 6% over the third quarter of 2017. Excluding currency impacts, gross revenue declined 5%. There were some timing factors that drove the larger revenue decline in the third quarter relative to the rest of the year. In particular, we had an unusually strong second quarter from a seasonal perspective, which pulled forward certain revenue that we would typically see in the third quarter.

On a year-to-date basis, gross revenue was $827.4 million, a decrease of 1% compared to $833 million in the same period of 2017. Our gross profit or net revenue was $64 million compared to $71.9 million in the same period of last year.

Our gross margin was 23.6% in the third quarter. Adjusting for a write-off of obsolete inventory in our retail environment service offering, our gross margin was 24%. We currently expect full year unadjusted gross margin to be between 23.6% and 23.8%. This is slightly below our previous expectations due to the inventory write-off I just mentioned as well as lower expected revenue in some small accounts, including transactional work. As a reminder, work that is placed on an order-by-order basis typically carries higher gross margin but with significantly greater commissions expense.

Third quarter non-GAAP earnings per share was $0.04, down from $0.15 a year ago. Note that the tax expense in our third quarter non-GAAP earnings per share was disproportionally burdened by the impact of the impairment charges on our pretax income forecast by legal entity. However, this does not change our expected full year tax rate of approximately 26%. Therefore, we expect a significantly lower fourth quarter tax expense.

Our GAAP net loss was $44.9 million or $0.87 per share. During the quarter, we incurred some primarily non-cash charges that [I'd] like to walk you through. The largest components of the differences between our GAAP and non-GAAP earnings per share relate to a non-cash goodwill impairment and asset impairment charge totaling $41.9 million. These charges were the result of our conclusion that the carrying value of our assets outside North America was higher than their fair value. The largest portion of these charges was related to our retail environments business we acquired in 2013.

In connection with our previously announced cost reduction plan, we also incurred an after-tax restructuring charge and other severance and employee-related charges totaling $3.4 million. By taking these actions, we head into 2019 financially stronger and better equipped to improve profitability and returns on invested capital going forward.

Continuing with our financial results. Adjusted EBITDA was $12.2 million in the third quarter, down from $18.1 million in the third quarter of last year. Adjusted EBITDA was 19.1% of net revenue in the third quarter compared to 25.2% a year ago. Due to progress made improving our cost structure, our SG&A expense in the third quarter declined by 5% versus the second quarter.

Now to the cash flow statement and balance sheet. Cash provided by operating activities was a use of $12.5 million in the third quarter and a cash inflow of $38.5 million for the trailing 12-month period. Cost reductions and profit enhancement initiatives in flight will drive continued improvement in our cash flow going forward.

Our net debt position was $124.3 million as of September 30, which was approximately 3.2x our adjusted EBITDA for the trailing 12-month period. Our total debt leverage was in compliance with the covenant requirements in our credit agreement, which was amended and extended in September.

Now turning to the outlook for 2018. Due to the revenue headwinds discussed earlier, we are lowering our gross revenue guidance to a range of $1.12 billion to $1.135 billion. Based on the flow-through of this lower revenue expectation, we are reducing our guidance for non-GAAP adjusted EBITDA to a range of $43 million to $46 million and non-GAAP diluted earnings per share to a range of $0.17 to $0.20. This guidance implies at least 40% growth in non-GAAP adjusted EBITDA for the fourth quarter compared to the same period of 2017 due to the expected impact of continued cost reduction measures. As we continue to grow our enterprise business and make further progress improving our cost structure, we expect higher results on all of these metrics in 2019.

And now we would be glad to answer your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question is from George Sutton of Craig-Hallum.

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Adam David Kelsey, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [2]

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This is Adam on for George. I was hoping you provide a little more color around what you see with the small accounts that migrate and grow into the larger enterprise accounts. How often do you see that happen? And what is the typical average growth you see there?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [3]

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Yes, I would -- thanks, Adam, for the question. I would characterize that as, as the relationship develops and as the transactional account potentially gets stickier, and we expand our relationship, we have an opportunity to go in and sell a more comprehensive enterprise solution. So the example that I gave you of the global adult beverage company is a perfect scenario for that. I can tell you that is not a -- I wouldn't call that a common occurrence. In many cases, that's order-by-order basis. But we're being targeted and strategic with those accounts that we think can significantly scale to an enterprise-level relationship and not putting the kind of focus on the accounts that would appear to remain smaller on an order-by-order basis. So we're being much -- we're very targeted about that migration. I would say, on the growth side, moving from transactional to enterprise can drive exponential growth as we implement our software solution and dive deeper into their marketing supply chain.

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Adam David Kelsey, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [4]

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And then just looking at that, how much potential revenue do you have available to transition towards enterprise with the small account base?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [5]

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Yes, I'm not sure I can put a specific number against that. Again, it's -- we're being strategic about where we're focusing our efforts in that regard, but it's not -- how that develops over what period of time and how much revenue that yields is extraordinarily hard to predict. And that's, frankly, a long cycle time as well to move from transactional to enterprise.

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [6]

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There's still a lot of upside across all of our accounts in terms of expanding the size and scope geographically and in the types of services we're doing now. That hasn't changed.

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Adam David Kelsey, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [7]

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Great. And then just one final question. In terms of the asset impairment charges, is there anymore that we should expect for the remainder of the year? Or was this all taken at once?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [8]

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We do not expect more impairment charges. This was all taken at once.

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Operator [9]

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Next question is coming from Tim Mulrooney of William Blair.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [10]

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So you guys lowered your revenue guide by $45 million at the midpoint. Does that account for the majority of the $7 million decrease in your EBITDA guide at the end point -- at the midpoint? I guess that's a decremental of about 16%. Or are there other things to consider here?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [11]

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That's correct. That accounts for the shift in the EBITDA guidance.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [12]

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All right, Chip. And you guys have implemented, I guess, $11 million of the $20 million in your cost realignment. How long will that take to realize that $11 million annual run rate? And do you plan to have the additional $9 million completed by year-end?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [13]

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We don't expect to have the full remaining $9 million completed by year-end, but we expect to get after most of it in the beginning part of next year. We do see more opportunities, as we dig under the hood in some of these offices and accounts, to drive additional cost reduction moving forward, beyond the $20 million now.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [14]

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Okay. So to that end, Chip, I mean, you guys previously said you expect operating expenses in 2019 to be in line with what you saw in 2017. Is that still a good guidepost for us?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [15]

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Where we are today, yes. And I will note also that if you just look at the 2017 SG&A full year run rate, we're below that for this quarter on a quarterly basis. So -- but there's more to go.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [16]

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Yes, you're already starting to see some to that point, Tim, and Chip made this comment in his remarks. But we're starting to see the impact of those cost reductions begin to show up on a sort of quarter-to-quarter comparison. So it's starting to flow through.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [17]

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Got you, okay. And Rich, you mentioned this pipeline of $85 million in the contracting phase. How does that compare to the historical pipeline in the contracting phase? Just so we have an idea for how that looks relative to prior periods.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [18]

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Yes, so we called that out for you because, obviously, we -- while we'd love to control the timing of when a contract converts, we don't, right? It's a conversation and a negotiation with the client. It's often contingent on a lot of commercial diligence on our part and of course, on their part. And so we called that out for you because that amount of revenue in the final stage. It's not in assessment. It's not in qualifying. It is an advance conversation with the client with an intention to move into a formal relationship, assuming we can land all the contractual details, which, as I said in my comments, is never guaranteed. But that is a historically large amount in the final contracting phase all at the same time, which is why we highlighted it for you.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [19]

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Okay. That's good info. Maybe I'll just ask a couple more about -- it's just important to get an idea of how you guys are thinking about this. Moving forward, I mean, you lowered your 2018 guidance from a midpoint of $52 million down to $45 million. But given the assumption you laid out this quarter and what you mentioned last quarter, do you still expect EBITDA in that $65 million to $70 million range next year? Or should I think about it more like still expecting EBITDA growth in the 30% range next year?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [20]

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So we're not -- we'll be providing formal 2019 guidance on our Q4 call. I'd say, we don't have -- and we're in the midst of our planning process right now for 2019. We really outlined what we did for you on that prior call, just to illustrate the impact of the cost reductions as they flowed through to profitability. So consider that an illustration for '19, but you'll be getting formal 2019 guidance on our Q4 call.

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Operator [21]

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Next question is coming from Chris McGinnis of Sidoti & Company.

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [22]

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Maybe just keeping on the revenue side of the questioning, can you -- you talked about organic growth in 2019, just given the decline in Q3, the impact of the transactional business in the -- in one retail customer. Can you just maybe walk us through how you bridge to get to, again, growth next year, if you're running into this impact? And would you expect the revenue decline to go until maybe Q2 of next year? Is -- Can you just walk us through your thoughts around the transactional business, the impact on the business along with the retail and then these new contract wins?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [23]

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So I would maybe take the second part first and say that we don't expect the transactional business to continue an acceleration of decline, right? We think we've seen what we've seen. We've been strategic in how we're thinking about that business. There are -- as we said, we're not exiting the small and transactional business, and we have no intention to. There's some good business there, so we're just being more focused. I think our view to revenue growth in 2019 is really based on the run rate of signing in last year and then the acceleration of new signing this year, much of which will have an impact on 2019.

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [24]

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Right. I wouldn't dwell too much or draw too many conclusions based on one quarter. When you look at our business, also on a year-to-date basis, we're down 1% and a lot -- the decline is largely explained by one large retail environment's client that we've explained in the past. And so I think that -- when that will be flushed out through this year. So that coupled with all the good wins we've had this year and going into next, that's what gives us confidence in the growth looking forward.

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [25]

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Great. And can you just -- I don't know if you want to mention this. But how much of a percentage of sales is the transactional or smaller side business off hand, just in the portfolio?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [26]

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The transactional business on a stand-alone is about 15%, but we don't actually break out the small business. So it's across the enterprise. So...

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [27]

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Okay. And then just one last one, just on the -- whether it's the current $135 million that you talked about or the $85 million in contract, can you just maybe give a mix of new, existing -- new versus existing?

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [28]

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Yes, so I would say, it's about 50-50 but -- which is a healthy mix for us, right? I think when an existing client expands and -- geographically or into new service areas with us, that is a great testament to our success, but it's also our life blood to bring in new. So it tends to historically be around 50-50, and it looks like that this year. And I would say that is also true of the $85 million that's in the final contracting phase as well.

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Operator [29]

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Next question is coming from Kevin Steinke of Barrington Research.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [30]

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So when you made the cost reductions that impacted the smaller transactional business, I guess, were you strategic about where you made the cuts such that you protected those transactional relationships that you felt had potential to expand into larger ones? And it sounds like that's the case, but I just wanted to make sure that you've been able to protect and maintain the ones that you find to be of value.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [31]

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Yes. That's correct, Kevin, and that's why we highlighted that one transactional business that we're in final discussions -- contracting discussions on moving to an enterprise-level relationship, to try to illustrate that for you. So the answer is yes.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [32]

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Okay. And the $20 million of cost reductions, that's just what InnerWorkings has identified on its own, is that correct?

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Charles D. Hodgkins, InnerWorkings, Inc. - Interim CFO and Senior VP of Corporate Development & Strategic Initiatives [33]

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Correct.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [34]

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And so do you feel that you, yourself can identify more, and then the third-party experts you're working with could identify more beyond what you have? I'm just trying to get a sense of what might potential size of the savings could be if they -- as they potentially expand beyond the $20 million.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [35]

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I would say that we -- beyond the $20 million, we are working with that third-party consultant collaboratively at this point, right? They've provided us some initial observations and finding, and now we're scoping and sizing and building out our plans to go beyond that $20 million.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [36]

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Okay, good. And can you talk about the pipeline you mentioned, more large global opportunities in the pipeline than ever before? I mean, is it still a good mix of geographies in terms of where you feel you can still execute work? You have Europe, Latin America, North America. I mean, is Asia cropping up? Is it more of an opportunity? I mean, anything more you could do to characterize the pipeline and the global nature of that.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [37]

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Yes, I would say, the pipeline has a number of true global opportunities. We're obviously being focused on those opportunities and geographies where we're best suited to serve the business and can run the business profitably. A number of those opportunities have very strong North America components and LatAm components. We are seeing some nice opportunities to begin to drive some more scale in APAC. So I think it's broadly diverse but representative of the concentration of our business, which is 2/3 North America and 1/3 international.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [38]

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Okay. Are you still looking at the market in Japan as a potential opportunity? I know there have been some smaller efforts made there in the past. I'm just wondering what the status of that might be.

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Richard S. Stoddart, InnerWorkings, Inc. - President, CEO & Director [39]

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Yes, I think -- look, we still see opportunity in Japan, but we have a very small presence there. It hasn't been a priority area of focus for us. And I don't think it will be in the near term.

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Operator [40]

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Ladies and gentlemen, this concludes the Q&A session. Thank you for participating in today's conference. You may all disconnect. Everyone, have a great day.