Innodata Inc.
Q3 2018 Earnings Call Transcript

Published: 10 Nov 2018

[Operator:]

Please standby. Good morning, and welcome to today's Innodata Third Quarter 2018 Earnings Call. Just as a reminder, today's conference is being recorded. At this time, I'd like to turn the call over to your host for today, Amy Agress. Please go ahead, ma'am.

[Amy Agress:]

Thank you, Sarah. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata; and A.K. Mishra, our COO. We'll hear from A.K. first, who will provide a detailed review of our results for the third quarter, and then Jack will follow with additional perspective about the business. We'll then take your questions. First, let me qualify the forward-looking statements that are made during the call. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including, without limitation, that contracts that may be terminated by clients; projected or committed volumes of work may not materialize; the primarily at-will nature of contracts with our Digital Data Solutions clients and the ability of these clients to reduce, delay or cancel projects; continuing Digital Data Solutions segment revenue concentration in a limited number of clients; inability to replace projects that are completed, canceled or reduced; our dependency on content providers in our Agility segment; depressed market conditions; changes in external market factors; the ability and willingness of our clients and prospective clients to execute business plans which give rise to requirements for our services; difficulty in integrating and deriving synergies from acquisition, joint ventures and strategic investments; potential undiscovered liabilities of companies and businesses that we may acquire; potential impairment of the carrying value of goodwill and other acquired intangible assets of companies and businesses that we may acquire; changes in our business or growth strategy; the emergence of new or growing competitors; various other competitive and technological factors; and other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission. We undertake no obligation to update forward-looking information, and actual results could differ materially. Thank you. I will now turn the call over to A.K.

[A.K. Mishra:]

Thank you, Amy. Good morning, everyone. Thank you for joining us today to review our financial performance for the third quarter of 2018. Total revenue this quarter was $14 million compared to $14.3 million last quarter. Our adjusted EBITDA for the third quarter of 2018 was $2.27 million compared to $1.64 million in the second quarter of 2018, an increase of $630,000 or 38%. The increase in adjusted EBITDA was mainly due to the impact of lower costs resulting from continuous cost rationalization and the continuing efforts on the productivity improvement. I will now review key line items and segment performance on a sequential quarterly basis, comparing the third quarter of 2018 with second quarter of 2018. At the segment level, Digital Data Solutions, or DDS, revenues were at $10.8 million in this quarter and the prior quarter. Synodex revenues were $1 million this quarter and the prior quarter. Agility revenues decreased slightly by $150,000 from $2.43 million in the prior quarter, a 6% reduction, to $2.28 million in the third quarter. Moving on to gross margins. Gross margins in DDS segment were $3.84 million or 36% of revenues this quarter compared to $3.17 million or 29% of revenues in the second quarter, an increase of $670,000 or 21%. On account of benefits from our cost rationalization initiatives and continuing efforts on productivity improvement. Gross margins in our Synodex segment decreased slightly to $230,000 in the third quarter from $300,000 in the prior quarter. Gross margins in the Agility segment were $730,000 or 32% of revenues this quarter as compared to $870,000 or 36% of revenues in the prior quarter, a decrease of $140,000 or 16% on account of lower revenues in this quarter. We will now look at the selling, general and administrative or SG&A expenses, excluding the onetime noncash impairment charge in the second quarter. SG&A expenses were $3.65 million or 26% of revenue this quarter as compared to $3.76 million or 26% revenues in the prior quarter. SG&A expenses for DDS segment in the third quarter were $2.2 million or 20% of revenues as compared to $2.1 million or 19% of revenues in the prior quarter. The $100,000 increase is primarily due to a noncash charge for stock options granted in this quarter to directors and named executive officers. The stock options issued to the directors were fully vested at the time of the gap. SG&A expenses of Synodex were $102,000 in this quarter and $170,000 in the prior quarter, a decrease of 40%. SG&A expenses for Agility were $1.4 million in both the quarters. Our adjusted EBITDA for the third quarter of 2018 was $2.27 million compared to $1.64 million in the second quarter of 2018, an increase of $630,000 or 38%. This is comprised of $2.4 million adjusted EBITDA from DDS and $130,000 adjusted EBITDA from Synodex, offset by a $250,000 adjusted EBITDA loss in Agility. For taxes, we recorded an income tax provision of $459,000 this quarter compared to $450,000 last quarter. After deducting tax expenses and minority interest, our net income was $688,000 this quarter compared to a net loss of $466,000 in the prior quarter. In the third quarter, we performed the calculation of the GILTI, that is Global Intangible Low-Taxed Income provisions, and concluded that it has no impact on account of the net losses of the company's foreign subsidiaries. As of September 30, 2018, we had approximately $18.9 million in the net operating loss carryforwards. Our cash and cash equivalents balances were $11.9 million this quarter compared to $11.7 million in the second quarter. Approximately 30% of – 34% of the balance is held in the U.S., and the rest is held overseas. Our CapEx was approximately $440,000 in the third quarter, and we expect our CapEx to be in the same range in the fourth quarter. I will now turn to our ForEx hedging program and other items. At the end of this quarter, we had approximately $2.6 million in outstanding forward contracts to hedge a portion of our exposure to foreign currency-denominated revenues and expenses. Based on market-to-market, our forward contracts had a notional loss of $147,000 at the end of the third quarter. In terms of guidance for the fourth quarter of 2018, we expect our fourth quarter revenues to be in the range of $13.9 million to $14.6 million

[Jack Abuhoff:]

Thank you, A.K. Good morning, everyone. Thank you for joining us today. I'm going to provide some general perspective on the business as a whole and our reporting segments as to the third quarter. So we kicked off 2018 with a turnaround operating plan that calls for rightsizing the business to achieve substantial EBITDA growth and positive cash flow, even on the low revenue we were forecasting. As a result of the work we've done in the first nine months of the year, our adjusted EBITDA is over 5x what it was in the first nine months of 2017, and our adjusted EBITDA for the full 2018 will likely be the highest it has been since 2012. In our core Digital Data Solutions segment, DDS, this quarter's adjusted EBITDA as a percentage of revenue is higher than it's been in the last 26 quarters. We've internally developed AI and cloud technologies as our fulcrum. We reduced our annual fixed and semi-fixed spend by approximately $3.5 million in late 2017, and so far, in 2018, we have taken out another $700,000. As a result, in the quarter, our core DDS business enjoyed a healthy 36% gross margin. And on the SG&A side, in late 2017, we reduced spend by about $1.2 million annually. A moment ago, I said that our performance is better now than it has been since 2012, but in some respects, it is actually better than 2012. Our adjusted EBITDA in 2012 is much more dependent on a select few large onetime projects. Today, by contrast, our margins are derived broadly across our portfolio of projects. In 2012, all our revenue is purely service-based. Today, by contrast, 15% of our revenue is platform-based. In 2012, we had 50% recurring revenue, while this past quarter, we had 88% recurring revenue. In 2012, 30% of the business came from a single project with a single customer, while in Q3, only 17% of the business came from a single customer, with whom we have 23 distinct projects, the largest of which accounted for just 3% of overall revenue. Beyond driving operational performance, our 2018 plan called for reorganizing our sales and marketing function, that in sales, it can meet its objectives for new business signings of both 2016 and 2017. We put in place a plan that we thought it would enable us to do better, shedding a few resources while bringing some fresh talent into the team. This has brought positive results. As of the third quarter, we have signed more new business than we signed in all of 2017. In 2019, we will shift our sites to growth, specifically sustainable growth. Achieving sustainable growth will require that we serve our existing markets at progressively higher points of need and develop repeatable service offerings and new products for broader markets. We expect that our AI development, which was so critical to our operational performance turnaround, will play a front-and-center role in our growth initiatives as well. Sustainable growth will not come just because we wish for it. We will need to reinvest in the business. This reinvestment will be funded, at least in part, through cash we expect to internally generate in 2019 by virtue of the improved operating performance we are establishing this year. To create sustainable growth, we're going to need to invest in some new DNA around product management and strategic marketing, while at the same time, increasing our budget for technology innovation. In our DDS business today, many of the projects we undertake end up being one-offs and were tethered to a market that is experiencing little or no growth. Our core business processes and account management, engineering and project delivery, while great, are insufficient on their own to build the escape velocity needed to change our growth trajectory. Project management and strategic marketing and upping the ante on technology innovation will all be critical. We are in the late stages, we hope, of recruiting a Chief Product Officer, who will be a key player in our sustainable growth strategy. We have several opportunities that we are now incubating which could be building blocks for 2019 growth. One is a potentially new program with a key customer. A couple of others involve partnering with key customers' brand-new products that they would bring to market. In this partnering approach, we would be revenue-sharing and owning IT rather than billing for work-for-hire. It's greater risk, but greater potential return. I'll now turn to our venture businesses, Synodex and Agility. Each of these businesses leverage our digital data technologies and offshore platform. In our Synodex business, we're focused on turning patient medical information into useful digital data. Our primary, but not exclusive, focus is on the needs of life and disability insurance markets. In the quarter, we signed two new clients with relatively small requirements, but in a new end of the market. We were able to offset volume declines from one of our long-time customers with a new volume from two new customers we announced last quarter and increasing volume from a large existing customer that has decided to extend our services into one of their other product groups. In terms of near-term pipeline, we are continuing to focus on two other clients who have recently expressed interest in expanding their programs with us in several prospects for which we have completed prior – programs. I'll now turn to our Agility business, which has two main components

[Operator:]

Thank you. [Operator Instructions] Up first, from Van Clemens, we'll hear from Tim Clarkson.

[Tim Clarkson:]

Hi, Jack. Hi, Mishra. This is good to see profitability. I just wanted to do a shout-out to Chris Beach for bringing in an adviser and for the management and the board listening to him. And for lowering costs, and obviously, you've done some other things beyond that with innovative technology. So it's good to see Innodata profitable again. It's, obviously, a much better and more solid base in which you guys can start to grow.

[Jack Abuhoff:]

Good morning, Tim. Thank you.

[Tim Clarkson:]

Yes. Anyhow, so in terms of growth potential, I mean what kind size of markets, what kinds of potentials do we have? You talked a little bit about the new stuff you're doing in the DDS. Give us some additional color on what the size of these markets are and why you think Innodata can grow in these markets?

[Jack Abuhoff:]

Sure. I think there – it's a great question, Tim. It's a complex one. There are several markets that were planning to be interesting and very attractive. As I mentioned in my remarks, there are a couple of things that we're working with. First, we're using fundamentally the AI and machine learning technologies that we developed, that we primarily use internally in order to generate the improved operating results. We're now fashioning those into service offerings and products that we can bring to markets. There are several different markets that we're in the process of choosing from, and I'll look forward to updating you more on that as we proceed into next year. In terms of the Synodex market, we're primarily focused on life and disability insurance, but we've also opened up a couple of loosely connected markets that are showing promise. We're not prepared to go into a lot of detail about that right now for competitive reasons, but we are seeing some good opportunity there. And in Agility, Agility is the David and Goliath story. I estimate the market at $1.5 billion. Other estimates go a little bit broader than that and call it a $3 billion market. But in any sense, the fact remains, that we're a small player with a great product, with great customer success. We've done a tremendous amount of work on the product side. We've done a tremendous amount of work on the technology side that's been well received by our markets and by analysts. We're showing improved retention. There were some issues when we made one of the acquisitions last year. Marketing is performing strongly, and now we're working on sales. I think that those would need to be done in order to start to make hay in that market.

[Tim Clarkson:]

Now you mentioned kind of, just seriously, last time about how you thought you could have, say, 3x the amount of business by the end of the year. What do you mean by that?

[Jack Abuhoff:]

I'm sorry. Could you...

[Tim Clarkson:]

Yes, you mentioned, I think in the – I guess, it was in the second quarter, that you thought that you'd be going into next year with a lot more bookings for the – I guess it would be 2019 than you did at the end of 2017, behind 2018, yes.

[Jack Abuhoff:]

I got it. Yes. Certainly, so what we – our primary focus in terms of the year was rightsizing. We're using the technologies that we developed in order to simplify the business, in order to reduce our unit costs at a production level and to drive profits and cash flow in that regard. At the same time we were doing that, we made some changes in terms of our – how we were organizing our sales and marketing position. We streamlined a little bit there. We brought in some new people, internal people, who we thought could help drive that performance. And that has succeeded. So we will go into next year with a higher level of backlog than we had going into this year. As of the end of the third quarter, we had exceeded our bookings significantly from all of 2017. And the changes that we made were very much provisional. They were nipping and tucking, but the focus has been on rightsizing. As we move into next year, the focus will be on sustainable growth. How do we take our competencies in managing digital data and applying AI and applying machine learning and turning that on in new markets and working with our existing markets at a higher point of need. And we think that we have every reason to believe we're going to be as successful in that as we've been this year in terms of executing turnaround.

[Tim Clarkson:]

One last question, and I'll open it up. On this AI thing, I know that you've done a nice venture capital deal about 1.5 years ago using some unique skills from some of the people inside the company. Without getting too complex, what just essentially differentiates Innodata's AI capability from some of the other people out there?

[Jack Abuhoff:]

Sure. So I think there are two things. First, we're focused on a very specific domain, and that domain is the enhancement and transformation of content, number one. Number two, we're applying a best-of-breed technologies asset, and we're building on those technologies. We've got an extremely talented group of people in our Innodata Labs organization who understands the meaning very well, and they understand the technology very well and they're great at both developing on top of and applying leading-edge technologies to our domain. I think the other thing that is a great advantage is that we have the technologies that improve over time through feedback under self-learning and we process it, a tremendous amount of technology. So if you have great engineering, you're building on great technologies and you're validating that and processing the best management technology through those algorithms and platforms, using subject matter experts in law, in finance, in science, in health care. The tools that you end up with improve dramatically over time, exponentially even, and then they become progressively higher-value.

[Tim Clarkson:]

Sure. Okay, I will open up the queue to other people. Thanks.

[Jack Abuhoff:]

Thank you.

[Operator:]

[Operator Instructions] And with no additional questions, I would like to turn the conference back over to our presenters – excuse me, I apologize. We do have a question now from Joe Furst of Furst Associates. Please go ahead.

[Joe Furst:]

Good morning, gentlemen. Again, I also want to commend you on cutting costs and making yourself profitable at even at these lower levels of revenue. And that's certainly progress. Could you talk a little bit more about the Agility business and what kind of growth you could see in that area? The company, I know, it's a small part, but that seems to me that you might be able to get some substantial growth there. Could you expand on that a little bit?

[Jack Abuhoff:]

Sure, Joe. Our aim is clearly sustainable double-digit growth. I'd like to see that business growing at 20% a year. Now we've had to approach it kind of step-by-step in order to have a view on achieving that. The first step was the product side. There was a lot of technology, a lot of integration we had to do, a lot of fixing we had to do. One of the assets we've got is arguably the best database of journalists and bloggers in the world internationally and globally. And there was – as good as that was when we acquired it, there was a lot of work that we had to do to improve it. That's been done. There was work that we had to do on our interface, there was work that we had to do on our big data engine and integration. So all of that had to be put under our belts. On top of that, we never had a great marketing function. We had to build that. I think we've succeeded at that. Beyond that, we ended up inheriting a piece of that business that claimed to have some customers that it really didn't, and that kind of tanked our retention numbers for some time. Once that was out of the system, we then had to work on our core account management skills and our customer success skills and build some new processes and new ways of working. So when I look at the year, I'm seeing solid success at building that up in the third quarter. On the Agility side, we had 75% retention. We're aiming for more like 85%, but given that we started the year with much, much lower numbers, directionally, it's moving well. On the enterprise side of the business and the managed service side, we hover around 90%. That's kind of where we're comfortable being. And then the last frontier, the icing on the cake, is the sales side. And I don't want to diminish the difficulty and the challenges that are there. They're pretty substantial. But I think we're making the right moves, and we're doing the right things. So if we can get that working, and I'm hoping that in Q4 and Q1, we're going to see some good progress there, then I think that kind of growth is squarely within reach.

[Joe Furst:]

That's helpful. And how about on the insurance side of the business. I see you finally got a couple of new customers. But you had a tough time getting new customers, but at least, you've turned out profitable. Can you say a little bit more on the outlook for the insurance area?

[Jack Abuhoff:]

Sure. Right now we're working on a couple of markets that are a bit ancillary to the core life insurance and disability insurance market. And we're seeing some good success there. So I'm hoping, over the next couple of quarters, there's some real solid bookings that we're able to bring in from this new market. From there, I think, strategically, there are some decisions we have to make. We've got a very good view of where our product fits in, how it's being utilized. Our two largest customers continue to expand with us. In terms of other markets and other things, we've recently put a new account manager on task and replaced our former account manager. She's making good progress, so I think there's definitely growth there. As we achieve that growth, there is very solid incremental contribution margins that flow out of that business, so we're continuing to be bullish about the possibilities there.

[Joe Furst:]

Okay, thank you. Good luck.

[Operator:]

And with no further questions, I would like to turn the conference back over to our presenters for any additional or closing remarks.

[Jack Abuhoff:]

Thank you, operator. So I'll just reiterate a few key takeaways from the quarter. As we mentioned, our adjusted EBITDA for the nine months of 2018 was over 5x the first nine months of 2017. In DDS, our new business bookings have exceeded the business we booked in all of 2017, so we're moving in the right direction. We're forecasting top line growth this year in both Synodex and Agility venture businesses. And in 2019, our focus is going to be on sustainable growth. We intend to leverage the improved operating performance that we're showing this year by redirecting a portion of the cost savings back into the business in the form of product management and strategic marketing and also technology talent. So thank you all for joining us today. We look forward to reporting continued progress next quarter.

[Operator:]

And ladies and gentlemen, today's conference is available for replay from 2