Innodata Inc.
Q3 2014 Earnings Call Transcript

Published: 30 Oct 2014

Operator:

Good morning, and welcome to the Innodata Third Quarter 2014 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Amy Agress. Please go ahead.
Amy R. Agress:

Thank you, Cassandra. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata; and O'Neil Nalavadi, our CFO. We'll hear from O'Neil first, who will provide a detailed review of our third quarter results, 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 may be terminated by clients; projected or committed volumes of work may not materialize; our Innodata Advanced Data Solutions segment, IADS, is a venture with minimal revenues that has incurred losses since inception and has recorded impairment charges for all of its fixed assets; we currently intend to continue to invest in IADS; the primary -- primarily at-will nature of contracts with our Content Services clients and the ability of these clients to reduce, delay or cancel projects; continuing Content Services segment revenue concentration in a limited number of clients; continuing Content Services segment reliance on project-based work; inability to replace projects that are completed, canceled or reduced; 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 MediaMiser and any other acquisitions, joint ventures and strategic investments; potential undiscovered liabilities of MediaMiser and other companies 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 O'Neil.
O'Neil Nalavadi:

Thank you, Amy. Good morning, everyone. Thank you, once again, for joining us today to review our third quarter results. As you may be aware, this quarter, we completed the acquisition of MediaMiser, a media intelligence company based in Ottawa, Canada, so today's results include MediaMiser's financials for 2 months after the acquisition. In our earnings call going forward, we will discuss our performance in 3 reportable segments
Jack S. Abuhoff:

Thank you, O'Neil. Good morning, everyone. Thank you for joining us today. O'Neil has provided a detailed financial review of the third quarter and our revenue outlook for Q4. I'll devote my portion of the discussion this morning to additional insight into our business segments, with an emphasis on new client wins, product releases and strategy. So I'll start with our Content Services segment. We reported to you last quarter that we were pursuing several interesting opportunities of significant potential value. And as O'Neil mentioned, in the third quarter, we moved several of them into the win category. In terms of new clients, we signed a contract worth nearly $350,000 in revenue with a large e-commerce retailer of college textbooks and learning solutions that's the key supplier to Amazon. We will be creating a repository of online study briefs and solution sets to assist college students in critical subject areas, including sciences and mathematics. Also, a prominent Europe-based publisher of technical information selected us to help them completely reengineer their content delivery capabilities. Based on the multiphase contracts we put in place and the client's expected requirements, we think it's likely that we'll see billings approaching $1 million within the first 12 months of work. In the third quarter, we also had a few notable wins from existing customers. We closed on a new project with a leading U.S. information provider to build an information product that enables users to obtain detailed insight into international treaties. This new engagement should be worth over $250,000 to us this year and may result in follow-on recurring support opportunity beginning next year. Another client, a large European information company, chose us to help them create content for a major new release of their platform. The project is valued at over $1 million over the next several quarters. Lastly, an existing client selected us to help them with their digital e-book conversion requirements. We expect that a contract for this work will be signed within the next couple of weeks, and that it will yield about $500,000 in annual ongoing revenue. We are also experimenting with new ways of working with our customers to combine their strengths with ours in order to bring new capabilities to the market. For example, we've recently partnered with a large and very innovative learning company to offer trade associations, new moneymaking strategies and technologies. We reported to you last quarter that we'd executed 2 letters of intent with a large European-based information company, for whom we will be taking responsibility over a 5-year period for end-to-end information processing. The letters of intent provide for us to enter into a series of statements of work, which once signed, could potentially yield approximately $10 million of revenue per year once we're fully ramped up in years 3 to 5. In the third quarter, we kicked off providing services under one of the letters of intent. As part of this effort, we rebadged certain of the clients' staff, and we opened a new office in Germany, where our new team will be responsible for servicing this client as well as growing our franchise. In our Synodex business, there have been 2 important developments
Operator:

[Operator Instructions] And we'll take our first question from Stan Berenshteyn of Sidoti & Company.
Stan Berenshteyn:

I apologize in advance if there's any noise on my line. We're having some fire drill tests in my building. So just to start off, I wanted to go back to the guidance that you guys gave in the previous quarter for the third quarter. You said you were expecting $15 million to $16 million. You came shy of that. Is that due to the client that went bankrupt? Was that the catalyst?
O'Neil Nalavadi:

Yes, 2 things. The bankruptcy had a little impact on the top line because it was a bad debt expense. The main reason were lower-than-expected volumes on 3 of 4 projects in Content Services. And that's part of the challenge in the business that when we do recurring projects, the volumes cannot be anticipated under the existing contracts, and there's some fluctuation that happens from quarter-to-quarter. This particular quarter, one of our clients also migrated to a new system for a recurring revenue engagement that we've been doing for the last several years. And as they migrated to a new system, they built a backlog that got created, and that impacted the revenues as well.
Stan Berenshteyn:

I see. Okay. Can you give us a flavor for the amount of revenue that Content Services has slated to bring in as a result of all these contracts? As Jack mentioned, you have several contracts going online. Do you kind of see an equilibrium level of revenue going into 2015 that we can expect?
O'Neil Nalavadi:

Stan, right. There are several contracts starting, and they will be ramping at different points of time. I don't have a number to right away give you what it means in terms of revenue recognition for a particular -- for a calendar year. But we can work on that, and get back to you separately.
Stan Berenshteyn:

Okay. And can you give us an update on the other contracts under Synodex? So you had 2 contracts, right? One was $2.5 million; one was $1.3 million. Can you give us an update on the other contract?
Jack S. Abuhoff:

Sure. So the update that -- this is Jack, Stan. The contract that I updated you on was the one we've been talking about as $1.6 million. And on that contract, as we had said, there was this internal dependency on the client's side, which now seems to have been worked through. So we're excited about kicking that off on November 10. The other contract we talked about there being a couple of issues there with third-party consents that were required. The client had obtained the first of them. We were waiting for the second of them to come in. The second now has come in, and we're starting to include that client's -- or that party's -- that company's files within the flow. Don't have a clear perspective on where it goes from there, but that -- clearly, that second client has -- that has -- or the second company has provided its consent, which is really good news.
Stan Berenshteyn:

Okay. And can you give us an idea of what kind of improvements does a Synodex 3.0 have over the previous iterations of the product?
Jack S. Abuhoff:

At this point, we're not publicizing everything specifically that it does. I think the important thing that I do want to emphasize is that we got a whole lot of feedback from, I think, from 16 different companies who essentially said very similar things to us. And they told us exactly what they would need, and we were able to take that feedback and bake it all into the new release. A lot of it is very technical and would only be appreciated by insurance underwriters, writers and medical directors and actuaries and people like that. But it makes it much more useful to them. And I had shown it to -- just a couple of weeks ago, I showed it to the medical director of a very large, prestigious life insurance company who initially was not a big fan of what we had in 2.0. And when we showed him 3.0, he said, "That's it. You guys got it now. That is perfect." And we said, "Come on, tell us what more do we need? How do we need to fine-tune it?" And he said, "No, no. Don't do anything. Right there, that's what we need." So I'm very excited about it.
Stan Berenshteyn:

That's great to hear. What would you say would be an adequate time for one of these companies in the pipeline to test the Synodex product? Would it be on a quarterly basis? Do they need to spend 6, 12 months testing Synodex before they say, "Okay, you know what? We'll go ahead and sign a contract."?
Jack S. Abuhoff:

Yes. The way we're doing testing now is very different from the way it was done months ago. It's very carefully kind of choreographed around what the client needs to assess and what their objectives are. And the objectives are stated very explicitly, and the design of the pilot is designed around those objectives. The designs of -- that we're putting in place are ones that can be accomplished within a month or, at the most, 2. They're not extended periods of time.
Stan Berenshteyn:

Okay. Let's look of the balance sheet real quick. Do you have any plans for your uses of -- for the cash that you have on the balance sheet right now?
O'Neil Nalavadi:

The -- it's -- kind of go to look at the balance sheet strength from -- in a 2-key -- 2 dimensions for this. If you look at our business and the customers that we serve, these are all generally big brands with -- and we are not really integrated into their operations in one form or the other because of the recurring revenues they provide. So the strength of the balance sheet is critical in terms of giving them assurance about the sustainability and building and growing the business. So clearly, it's required for that and any ongoing capital expenditures and ramping up as the business scales up in both Content Services and in IADS. The second part is we continue to have a pretty decent pipeline for acquisitions. That said, our criteria for acquisitions are very high. We look -- we have very clear understanding of strategic fit and what it should mean in terms of the business model and what predictability and margin characteristics it should bring. And if we want to retain that balance sheet strength for preceding the right opportunities and organically to grow our core businesses that we're focusing on.
Stan Berenshteyn:

Okay. And just to be sure, the -- under Synodex, the $1.6 million, that was the preexisting client. It's not a new client, right? It's a preexisting client that used to be $1.3 million, and now you're estimating $1.6 million in revenue?
Jack S. Abuhoff:

That's correct.
O'Neil Nalavadi:

Yes.
Stan Berenshteyn:

Okay. What's the status of your revolving loans? Has there been any developments on that front?
O'Neil Nalavadi:

Stan, no. We have not. We are working with them. We are engaged with bankers to keep talking. I think the start of the IADS operations is critical. And as it scales up, I think we'll be in a better position to talk from a collinear perspective with the bankers.
Stan Berenshteyn:

Okay. And lastly, just to clarify, for MediaMiser, O'Neil, you were going through the stats on it. You said 100% retention. Average, I think you said $35,000 per client in revenue. How many clients are currently with MediaMiser? And what's the growth rate and the client base?
O'Neil Nalavadi:

This quarter, they added 7 new customers, and the client -- total number of customers was 113. At the beginning of the quarter, it was 106, so that's a healthy growth during the quarter. And historically, they have -- they've added about probably 20% growth for the last 3 years in terms of compound annual growth rate. And MediaMiser team is focusing from an aspiration perspective to achieve that level of growth.
Operator:

And we'll take our next question from Vincent Colicchio of Noble Financial.
Vincent A. Colicchio:

Yes. O'Neil, I missed what you said on the banker client. What was the revenue -- annual revenue contribution for that client?
O'Neil Nalavadi:

The revenue contribution from that business was -- from that client, was $1 million.
Vincent A. Colicchio:

Okay. And are there any other clients that we should be worried about from the share financial standpoint?
O'Neil Nalavadi:

Right, good question. I think, historically, if you see our business, the bankruptcies or -- are very rare. I think the -- our general experience of bad debt has been few and far between. And the -- in this particular case, it's a strange case because they were providing extremely valuable services to publishers, managing their subscription management. So this is for the key journals, but it was one of those companies that was bought by a private equity and highly leveraged. And I think the kind of business that it was in and really high leveraged, it could not sustain itself, and that's what resulted in the collapse. Now in the -- normally, these recurring revenue kinds of situations when businesses get into trouble, they get acquired. But in this case, unfortunately, there was a mass migration of customers to other platforms. And that kind of created the restructuring -- became -- the restructuring became more complex. And that's the reason I -- we have been thinking that it will probably not emerge out of bankruptcy as a going concern. That's a long story, but our experiences at bad debts is very pretty rare.
Vincent A. Colicchio:

And your gross margin came in a bit higher than I expected. Is that level sustainable for this level of revenue?
O'Neil Nalavadi:

With -- that's the kind of margins that we are targeting because we said that our range is somewhere in that 32% to 35%. A couple of things will impact that margin, as always. One is the foreign exchange could impact it in a particular quarter. And sometimes, we have to make some decisions, and that could impact the nonrecurring expense fees in that. And the third piece is the volume fluctuations. But that is where we are aspiring from -- for margins in the Content Services to be in the 32% to 35% and achieve a 10% operating margin.
Vincent A. Colicchio:

And Jack, could you give -- update us on -- give us some color on the eBook market, and how prospects look there?
Jack S. Abuhoff:

Yes. I think the eBook market remains a good market for us. We just came back from the Frankfurt Book Fair this month. We came back with lots of interest in new orders and opportunity. Today, I talked about how we've got some new work with a major digital retailer who we -- haven't been doing so much with over the last several years, so that's very, very good news. It's a good market, and there is innovation taking place in there. We're very much involved in the things that are innovative as well, and we're going to try to sustain and maintain our leadership perspective there. At the same time, the innovation that we're doing, and that we're talking about in Synodex and now in Media Solutions and to docGenix, is really designed to enable us to drive the kind of revenue that'll have a lot better visibility in terms of characteristics that would be less project-based and things like that. The most part, the eBook will continue to be project-based, so it's a good work for us. We make money at it. Clients love us for it, but we do need to go in other directions at the same time.
Vincent A. Colicchio:

And O'Neil, what was the eBook revenue in the quarter? And also, what was the contribution from the largest client?
O'Neil Nalavadi:

The eBook revenues was 15% this quarter, and the top client was approximately 17%.
Vincent A. Colicchio:

17%?
O'Neil Nalavadi:

1-7, yes, that's right.
Operator:

And we'll take our next question from Joe Furst of Furst Associates.
Joe Furst:

I have a couple of questions. And you're discussing the MediaMiser earlier, and you said their goals were at 20% growth. And I'm not sure whether you're talking about growth in the number of customers or growth in revenue. Which were you referring to?
O'Neil Nalavadi:

Joe, the -- both, actually. The idea that it does a 20% growth in customer, there should be 20% growth in the top line. That said, we will continue to share with you more details. MediaMiser is introducing a couple of new products in the marketplace, and one of them already have been introduced, a new product called MediaMiser SNAP, which comes in at -- for the small and medium businesses. The average revenue on that will be $6,000 compared to enterprise clients, where the average revenue could go as high as $200,000 to in a -- to $20,000, $25,000 per annum basis. So the SNAP will reduce the average when you think in terms of weighted average. But as the SNAP product starts gaining momentum, we will break up the customer acquisition and the revenue for the benefits of investors into the 2 categories
Joe Furst:

Okay. And then the other question, as I asked this question last quarter, was in Synodex. You had a lot of trials with a lot of people, and you've been successful into getting a couple of new clients. But of all these people who've tried it, how many have said, "No, I have no interest in this," as opposed to saying, "Well, it's okay, but I need this and I need this and I need this." And how many have just said, "Forget it. I have no interest"?
Jack S. Abuhoff:

Joe, I think there may have been one that said, "Forget it. No interest," over a year ago. Maybe then there was one more who said, "We're so small. We have like one underwriter." There was something like that. But everybody else that we've been talking to has stayed very much engaged. And they've said -- they've been working with us. And they've been saying, "Here's what we need, and here's our challenge, and here's the way we can tweak this in order to make it work for us." And that's what's giving us the enthusiasm and optimization that we've got right now. We feel we're really building our clients' product here, and listening very carefully to what they need, and we've kept them engaged in the process.
Joe Furst:

I think it's fair to say over the next couple of quarters, you might get several more of these insurance companies that go along with it, and that would be a substantial step in reaching your goal of getting more recurring type of revenue. Is that a reasonable thing over the next 6 months?
Jack S. Abuhoff:

Absolutely. That's exactly what we're working towards.
Operator:

And we'll take our next question from Tim Clarkson of Van Clemens Capital (sic) [Van Clemens & Co.].
Timothy Clarkson:

Just a couple of questions. In the previous quarter, you were indicating that you thought that your run rate next year would be $16 million, $17 million, based on some of the wins you had. Have you changed your thinking on that? Or what's up in terms of what your run rate with your European wins and so on?
Jack S. Abuhoff:

Yes. I think that as we said last quarter, the good thing is that when we kind of look at the business, we've got visibility on almost $70 million of potential revenue for next year. And we're looking at a probably closer to a $50 million, $53 million recurring revenue base, so some uplift there given the things that we've got going on. Now the difficult thing, and I know O'Neil responded to this just a few minutes ago, is to take the client wins that we're describing, and lay them out over a forecast. We know that in the content business, some things ramp up faster than other things, and there can be delays, and there can be offsets. There are projects -- some of these are projects, and they're replacing projects that end. So in that business, what we're going to try to do is, as we have been, is give you visibility quarter out. If we start to feel that we can do more than that, we'd certainly like to. I think the great benefit to the MediaMiser business and the businesses that we're incubating in IADS is we're going to have that visibility, and that will enable us to share longer that we now do. So I don't know that we've got a number right now, or we'll have a number soon. But maybe in our next call, when we're talking about how we see 2015 shaping up, we'll at that point have a little bit more of our ramp-up forecast done for the new wins that we're describing, and we'll do our best to share with you what we know.
O'Neil Nalavadi:

And Tim, just to add to what Jack said, the only thing that has really changed from what we discussed last quarter was the loss of the recurring revenue as a result of that bankruptcy situation. Otherwise, some of these were baked in when we looked at what state of the pipeline they were in.
Timothy Clarkson:

Yes. But that's a relatively small contract in the big [indiscernible] $0.25 million a quarter.
O'Neil Nalavadi:

Right. Nothing has materially changed from what we had shared last quarter.
Timothy Clarkson:

Right. Now on the IADS, how much revenue do you need to do to break even on that division?
Jack S. Abuhoff:

It depends. We're kind of testing out our productivities right now with Synodex 3.0. It looks very, very promising, so the number could actually come down a bit from what we've been thinking about, but we'll range it. It's probably somewhere between, I'd say, $5 million and $8 million, maybe a little lower than that.
Timothy Clarkson:

Generally or quarterly or annually or...
Jack S. Abuhoff:

No, that -- annually.
Timothy Clarkson:

Annually. Okay. And is there any way to kind of rationalize the spend a little bit to spend $600,000 to $800,000 rather than a $1.4 million, and keep this thing ongoing? I mean, how much of that $1.4 million that you're spending is absolutely critical to keep this thing going?
Jack S. Abuhoff:

Yes. We're looking at -- a lot of the expenses in some operational aspects, and we do have a plan in place to reduce probably by another $400,000 or so, on an annual basis, that spend. I think what we're going to be looking to do on -- again, it will be a function of productivities and ramp-up on some of the new clients in late-stage pipeline. But we're -- based on our forecast, we think that there's clearly a light at the end of this tunnel. We don't want to get out ahead of ourselves and kind of make commitments that we can't maintain. But between some additional operational kind of efficiency to the tune of the $400,000 that we've got about to be implemented, and then the forecast that we've got, we think that it's going to be manageable.
O'Neil Nalavadi:

And Tim, just to add to what Jack said, I think there are 2 ways to look at it. I think the way we look at it internally, we want to share that with you as well. The key thing always to look at it is there's always this urge to look at what the breakeven point is. But the truth of the matter, what happens when we report results is as we continue to -- if we continue to win clients, there will be always some expenses incurred in anticipation of that particular contract coming in. It could be preparing for the ramp-up or whatever, so that impacts our income statement. So the breakeven from a static perspective is completely different from a breakeven that will emerge as a healthy business that is growing. So one of the metrics that we would like to share as live production starts is what does it mean in terms of revenues for clients, revenues for file [ph], entity mergers revenue and gross margins that we make because that will get -- those are validation metrics to measure the business model.
Timothy Clarkson:

Okay. Could you just update us on what the status is of the derivatives business, where we're at with that?
Jack S. Abuhoff:

Sure. We're finalizing our pilot launch on what we call docGenix analytics, which is a completely rebuilt platform. It's looking real good. We brought it to our current large client, who has been a charter customer, really, who's going to help shape that products. They like it a lot, and they have included in their budget costs for -- their 2015 budget costs for migrating to the new platform. We also brought it to a very large European bank, and they're interested in piloting it, and we'll be doing that this quarter.
Timothy Clarkson:

What kind of potential revenue is there in that division? I mean, is this a division that can be doing $5 million, $10 million annually? Or what kind of potential is there?
Jack S. Abuhoff:

Well, I think it certainly has at least that potential. I don't want to get ahead of ourselves. I'm very -- we did the development over the course of the past year. We did it very efficiently. The product really looks very sharp. It answers a lot of the concerns that we had heard from clients that the previous product wasn't flexible enough. It didn't go wide enough, it didn't enable them to expand it enough. It was -- from the visual interface perspective, it was hard to use. We've nailed that now. And now we need to get back out into the market in more of a -- in a commercial way and look to expand horizons and talk to more people and see what utility they have for it. So we'll keep you updated as we do that.
Timothy Clarkson:

What percentage of the spend on the, let's say, on $1.4 million on the IADS is on that part of the business versus the insurance part?
O'Neil Nalavadi:

About $150,000 per quarter, approximately.
Jack S. Abuhoff:

It could be short of that number.
Timothy Clarkson:

Okay. So it's the smaller part of the 2 divisions.
O'Neil Nalavadi:

That's right.
Operator:

[Operator Instructions] And we'll take our next question from George Melas of MKH Management.
George Melas-Kyriazi:

2 questions. First one is on Synodex. Now that you have the -- that you have 3.0, and it seems like it's really hitting a sweet spot with customers. I just want to put it here, if somehow it doesn't ramp, somehow if we cannot sell it, what would be Plan B in terms of you spend a lot of time, you spend a lot of money to build it. You sort of had huge interest. There's huge number of -- very large number of customers on the space gotten their feedback. Now it seems like it's ready for a big ramp, but what if it doesn't?
Jack S. Abuhoff:

I think that right now, we're very confident that it will, and our energies are devoted to making it successful. There are a lot of components to making it successful, and I think we're doing a pretty good job covering all of those. Now for some reason that we're not successful, I think we'd try to understand why it isn't, and whether there's something that we can do about that, whether it's a systemic issue, whether it's a market issue, whether it's a technical issue. And depending upon our analysis, we would try to do the right thing.
George Melas-Kyriazi:

Okay. And in a way, can you try to capture what are the hurdles right now to getting more customers with 3.0? It seems like it's not the product anymore. What -- where are you spending most of your resources and -- or where are most of your concerns going?
Jack S. Abuhoff:

Yes, I think that the resources up until now, really, were being spent on building 3.0. It's thousands of lines of code. It's new report generators and digital analyzers. It's a new database structures and all of that. So there was a lot of technical work that needs to be done. On some of the -- on the customer-facing side, it was bringing back mock-ups and samples and things and getting their feedback and helping iterate it along, so that we knew that we weren't missing it by even a degree or 2. Now a lot of the work on the customers' side is working with them to make sure that we understand their business realities, that we understand and help them to sort of visualize and to analyze what the opportunity is and reduce that down to business cases. And then it will be to pilot the workflow within their environments, and make -- and help them see that it's doing all the things that they needed to do in order to accomplish the business objective.
George Melas-Kyriazi:

Okay. And you have -- do you feel like you have the right resources to accomplish that?
Jack S. Abuhoff:

I believe we do.
George Melas-Kyriazi:

Okay, great. And then just my final question is on the large new German customer on the Content Services. I didn't quite understand what the progress was, and maybe you can tell us who [indiscernible] the progress has been and what you expect in '15.
Jack S. Abuhoff:

Sure. So it's -- and I can understand why you may not have understood it. It's a lot to try to understand. So basically, what we've got there is a customer that we've worked for, for numbers of years. We've done very, very good work for them. And on the strength of that good work, we have been awarded by them 2 new opportunities to basically perform end-to-end operations for them, for 2 of their companies. Those letters of intent then, in essence, as we peel that work off, form statements of work and we operationalize our end of statements of work. To win the process of doing exactly that, we sign the first statement of work and operationalize the first component of work for one these divisions this quarter. That involves setting up the German office and beginning operations. That will be a continuing process. So next year, we do not believe that we will be at that $10 million run rate. We will be continuing to ramp up. I don't have a dollar number for you right now to put on that for next year. We think we will be safely ramped up by year 3 of operations to that $10 million target, and we'll be going from where we are now to commencement to that in some fashion, probably linearly.
George Melas-Kyriazi:

Okay. But the second statement of work have been signed, right? Just -- you signed the first statement of work, I mean, the statement of work with 1 of the 2 companies.
Jack S. Abuhoff:

No. Actually, there were 2 letters of intent. And letters of intent are like umbrella agreements that describe all the different work that we're going to do. And then we signed statements of work under those letters of intent for each portion of the work. So we have 2 letters of intent signed. We are now operationalizing around both of those efforts. And we've got the first statement of work that we've begun work on for one of them.
O'Neil Nalavadi:

And George, just to add to what Jack said, I think in our business, as you know, the start is very critical as to what happens in the first 2 or 3 months. So we have a great team, first of all, in place for that particular engagement that has started. And I think the team has done -- performed absolutely brilliantly in terms of 2 key criteria that we look for
George Melas-Kyriazi:

Okay, great. And those 2 letters of intent would translate into how many statements of work? I just want to see how far you are in operationalizing the work.
Jack S. Abuhoff:

I don't know the number of statements of work. Probably, amid all the -- of equal booking value, I guess in very rough terms, the first is probably about 25% of...
O'Neil Nalavadi:

So that's $1 million and $1.5 million?
Jack S. Abuhoff:

Yes, a little bit more than that.
Operator:

And we'll take our next question from Jay Harris of Goldsmith & Harris.
Jay Richard Harris:

I'm a little confused, some housekeeping items. What percentage of your cash is in the United States?
O'Neil Nalavadi:

I think it's -- we shared that with you, with the investors, $4.3 million is in the U.S.; and the rest is overseas, and the total balance is $26 million.
Jay Richard Harris:

And I presume the debt of a little less than $8 million is due to the acquisition?
O'Neil Nalavadi:

The metric we looked at in terms of 2 components. One is the debt that we have, in terms of lease financing obligation, that's just over -- about $1 million. The rest of the long-term obligation has to do with pension, then -- and other things that we accrue for employees and should not be looked at as debt. And then the third thing is for the MediaMiser acquisition, there is a stock -- there's a compensation that has to be paid, deferred compensation. We estimate that and incorporate that in terms of long-term obligations. So there are 3 different components in that long-term obligation that you see on the balance sheet.
Jay Richard Harris:

Well, you have $1.6 million short term, and you have $6.3 million long term. What -- if we took the -- what is the actual debt, the cash that you borrowed? What is that number?
O'Neil Nalavadi:

It's a little over $1 million, which is the debt from -- for lease finance that we have. And -- let me see if there is -- in addition to that, there is the deferred compensation that is payable to the MediaMiser acquisition.
Jay Richard Harris:

Yes, but I -- that's -- when is that due? When is the payment due?
O'Neil Nalavadi:

It is due in 2 different -- one is due next -- on the first anniversary, which is approximately about $700,000; and another $700,000 is due on the second anniversary. So that's about $1.5 million.
Jay Richard Harris:

But that's really not debt. That's deferred compensation. But that -- I mean, that -- my preference would be to use the term debt solely for borrowed funds, all right?
O'Neil Nalavadi:

Right. Let me help you with that. I was trying to reconcile if you were looking at the balance sheet and asking the question. But if you are looking at it from that perspective, the debt is only $1 million.
Jay Richard Harris:

All right. You said that. Now when you guys turn profitable...
Jack S. Abuhoff:

And I'll just put my own two cents in there, Jay, to help a little bit further. That's not bank debt. It's not -- we didn't get cash and sign a note. It was equipment financing.
Jay Richard Harris:

Understood, understood.
Jack S. Abuhoff:

So a manufacturer gives us a computer, and we pay that over time.
Jay Richard Harris:

All right. Understood. When you turn profitable, what will your taxes look like? I'm confused. I presume you're paying taxes because you're generating profits in the Philippines, et cetera. But when the company starts to report earnings, what will the taxes look like?
O'Neil Nalavadi:

From a business model perspective, add a 10% operating margin, you should look at 20% in taxes, the effective tax rate.
Jay Richard Harris:

Do you have any significant NOLs that will shelter that?
O'Neil Nalavadi:

We have significant, yes, NOLs. The U.S. NOLs are approximately $18 million. And the effective tax rate that you'd see would be an accrual in the books. From our cash perspective, the outgo of tax would be much less than that.
Jay Richard Harris:

All right. So you're doing some business in Germany, and I presume that'll function at a loss?
O'Neil Nalavadi:

May not be, but it will have a pretty marginal impact on the effective tax rate.
Jay Richard Harris:

Understood. Okay, you've solved some of my problems. When -- how will you communicate to investors when you think that you'll start to generate some earnings? Are you just going to wait until the quarter in which it happens and report it on a quarterly basis? Or will there be a signal before that?
Jack S. Abuhoff:

I think it will depend, Jay. So certainly, we know where the earnings come from, right? They come from revenue. And as we ramp up a lot of the projects that we talked about, and that, in combination with moving the Synodex toward breakeven, we're going to then begin to show earnings. I think you'll see it. You'll see it when you see it. You'll also -- where we think that it's pragmatic and we have customer consent, we will do announcements of things. We can't guarantee that those will come because there will be customers who don't want to see that take place. We're very results oriented right now. We are not going to -- we're more fixated on getting products out there that the customers want in closing business than thinking about being promotional. But if you have any ideas for how we can better communicate, we'd love to hear those as well.
Jay Richard Harris:

All right. How will a $4.3 million selling and administrative expense -- what are you looking at for the fourth quarter?
O'Neil Nalavadi:

The fourth quarter administrative expenses typically go up by about $300,000 to $400,000. This is mainly an account of timing issues. And the timing issues have to do with the audit expenses, which is the -- a significant part of that increase. And then there are holiday expenses that we incur for our Asian employees, particularly in Philippines. That accounts for the bulk of that increase. And the third component of that onetime increase that typically takes place on the fourth quarter is the Frankfurt Book Fair that we participate in and is a source -- is an important event for us because that's the forum where we meet a number of customers, and we bring in a lot of leads. And that typically has an expense tag of about $100,000.
Jay Richard Harris:

Can you run the business next year with a selling and administrative expenses at the $16 million level?
O'Neil Nalavadi:

It will be $4.3 million per quarter, approximately, is what we're looking at per quarter.
Operator:

And we'll take our next question from Stan Berenshteyn of Sidoti & Company.
Stan Berenshteyn:

Just 1 question. I was curious if you can give some color on revenue generated by Content Services by putting it into 2 buckets. What percent comes from projects? And what percent would you qualify as recurring?
O'Neil Nalavadi:

The recurring revenues, Stan, in the third quarter were $11 million, and that number in third -- in second quarter was $10.5 million. So as a percentage of sales, it has gone up from 74% to 79%.
Operator:

And we'll take our next question from Joe Furst of Furst Associates.
Joe Furst:

I just wanted to make the suggestion with all the cash you have. Even though there's not a whole lot in the United States that would add to investor credibility or to year-end credibility, if you would buy back a little bit of stock, it would show that you actually believe what you're saying. I think it would go a long way to make investors a little happy. That's all.
O'Neil Nalavadi:

I think that's a point very, very well made. And I think it's -- it is getting a lot of attention. And I think -- and I want to share a couple of perspectives, so that all investors are -- obviously, we seek great value in our stock. I think the businesses that we are in with our Content business has continuously now been shaped and engineered to deliver. We feel confident that we can continue to grow that and deliver a 10% margin. There will be some shifts from quarter-to-quarter, but that's what we are aiming for. Jack discussed in detail our aspiration in IADS and the characteristics of that business. The Media Intelligence business is also pretty strong, powerful business model. So taken together, truly stating the stock doesn't reflect the value that we see. Now that said, you got to remember that we are in an investment world, and those investment model requires capital. And the way we look at it internally is in where does that cash balances hold and how does the income statement look even to read additional sources of capital from borrowings. And I think it's important that we have cash sufficient to the U.S. We negotiate from a position of strength with providers of capital, particularly the borrowed capital, and one of those things requires us to preserve our cash. And I think -- I strongly believe that, that is in the best interest of the shareholders rather than the emotional part of buying $200,000 or $300,000 of stock. It is -- it truly is in the best interest of the shareholders is the way I see it, but that's my perspective.
Joe Furst:

Okay. I understand what you're saying. But to spend $1 million out of your $26 million, I don't think would be a significant difference[ph] than would really help, so...
O'Neil Nalavadi:

Sure. Okay. I think we will give it due -- enough consideration. Thank you.
Operator:

[Operator Instructions] And with no further questions in the queue, I would like to turn the conference back to today's speakers for any additional or closing remarks.
Jack S. Abuhoff:

Sure. Thank you, operator. So I guess I'll close with a real quick summary. We had good wins in our Content Services segment this quarter. We began providing services under our recently signed letters of intent with a large European publisher. And in connection with the first statement of work that flowed from these letters of intent, we've rebadged certain of its staff. We opened a new office in Germany that we're very excited about. In our Synodex business, we will be kicking up services on November 10 with a multiyear contract valued approximately $1.6 million per year. Also, in our Synodex business, we've launched our new Synodex 3.0 solution, which we're very excited about. And lastly, integration of our MediaMiser acquisitions proceeded on schedule, and it's going very smoothly. On a whole, a very productive quarter. So thank you, everyone, for joining us on today's call, for your continued support and your continued interest. Thank you.
Operator:

Today's conference is available for replay by dialing (719) 457-0820 or (888) 203-1112 and referencing passcode 5861075. This concludes today's conference. You may now disconnect.

Innodata Inc. Q3 2014 Earnings Call Transcript

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Innodata Inc.
Q3 2014 Earnings Call Transcript