Innodata Inc.
Q1 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good morning, and welcome to the Innodata First Quarter 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Amy Agress. Please go ahead.

[Amy R. Agress:]

Thanks, Lexi. Good morning, everyone. Thanks 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 Jack and O'Neil and then take your question. 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 could be terminated by customers; projected or committed buy-in support may not materialize; that our Innodata Advanced Data Solutions segment has not reported any substantial revenues to date and is subject to the risks and uncertainties of an early-stage company; the primarily at-will nature of our contracts with our customers and the ability of the customers to reduce, delay or cancel projects; continuing Content Services segment revenue concentration in a limited number of customers; 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 customers and prospective customers to execute business plans, which give rise to requirements for digital content and professional services and knowledge processing; difficulty in integrating and deriving synergies from acquisitions, joint ventures and strategic investments; potential undiscovered liabilities of companies that we 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 over the call over to Jack.

[Jack S. Abuhoff:]

Thank you, Amy. Good morning, everyone. Thank you for joining us. I will review our first quarter 2013 results and update you on our strategic progress and what we will be working on in 2013. Revenue in the first quarter was $16.9 million, an 11% decline from our fourth quarter, consistent with our guidance that we provided in our last earnings call. This decline was a result of lower revenues in the quarter from 3 of our 5 largest clients and a few of our smaller clients, as we completed certain projects for them. As a result of this decline, our pretax earnings in our Content Services segment fell from 10% of segment revenue to 5% of segment revenue. This kind of quarter-to-quarter revenue volatility is characteristic of our Content Services business, which is project-driven. In late 2011, we began investing and building new business lines that would give rise to recurring revenue as opposed to project revenue. We formed our IADS divisions specifically to incubate these new business lines. Notwithstanding this quarter's revenue decline, we maintained investment momentum in our IADS segment, investing $1.1 million net of revenues in the quarter. The Synodex division of IADS reported its first major contract win in the quarter. The 2-year contract valued at $1.4 million, with a highly regarded Fortune 1000 company. Though somewhat modest in size compared to other opportunities we're chasing in Synodex, the contract is important, because it provides us with solid market validation for our innovative approach to health records analysis. While we've been getting encouraging feedback from the market ever since we began showing our capabilities in Q4, there's nothing like the market endorsement that comes with the first signed contract. We continue to make good progress building and cultivating our pipeline of client prospects at Synodex. In Q2, we're expecting to pilot with another 10 companies for our core products and 7 companies for our Synodex connect platform. Our active prospect list includes several of the largest insurance and reinsurance companies in the world. The sell cycle is proving to be more protracted than we anticipated when we first started marketing our capabilities. Notwithstanding our prospective clients' enthusiasm, we see that they're evaluating the impact our capabilities can have within their businesses with great deliberation and analytical results. Therefore, they're measuring our progress on a client-by-client basis. Namely, are we still in the game? Are we continuing to advance the ball down the field? And is the client prospect increasing its own investment in exploring our services? Based on these measures, our optimism is continuing to run high, and we're continuing to invest. As a reminder, we now have 2 services that we're marketing to life insurance companies through our Synodex division. The first enables life insurance carriers to more effectively use medical records and their underwriting processes. The second enables life insurance producers, by which I mean, brokers and agents, to connect and communicate more effectively with life insurance carriers to place applications. At the heart of both of these technology-enabled services are core competencies in digital content management and information extraction. Our value propositions include underwriting efficiency, accuracy and speed and providing data mining opportunities for actuaries seeking to drive better risk allocation and create more profitable products. It is our intention to become an integral part of life application and underwriting process. Beyond insurance, we see applicability for our core technology in several other sectors, which we also intend to explore this year. We believe that the addressable market for our service is likely well in excess of $1 billion of potential services. I'll return now to our core business represented by our Content Services segment. As I said a few minutes ago, the segment continues to be characterized by lumpiness of revenue, principally due to it being largely a project-based business, and we saw the downside of this in the first quarter. Until IADS becomes a significant contributor of recurring revenue, I expect that this lumpiness will continue. Ebbs, will likely be followed by flows, and flows will likely be followed by ebbs. It's the nature of the underlying business. Despite the segment's revenue downswing, we made some progress on a couple of strategic fronts. We helped a major customer successfully launch its Japanese e-book store, successfully delivering many thousands of Japanese language titles towards launch inventory. On the heels of this success, also in the first quarter, we launched our new service offerings direct to publishers in Japan. To date, this has resulted in 2 signed SOWs, 12 late-stage to proposals and another 20-or-so new customer prospects in our pipeline. We think the trend of major digital retailers launching localized e-book distribution stores will gain momentum in 2013. We will benefit by being well positioned to help our major clients create local language inventory and by further leveraging this into providing services directly to publishers in these new markets. In the first quarter, we also continued to progress our enhanced and interactive e-book capabilities, producing iPad e-books, which provide whole new reader experiences. E-books filled with lots of multimedia, as well as guided tours, 3D exhibits, high-definition video and interactive experiences. In the first quarter, we completed another 46 titles, bringing our total portfolio to approximately 170 enhanced and interactive e-books. We expect that our work with Apple, as well as Inkling, a San Francisco start-up founded by an executive from Apple's Education division, will continue to enable us to expand our capabilities and portfolio in this area. We've begun 2013 with 6 key strategic priorities, which I will briefly outline for you

[O'Neil Nalavadi:]

Thank you, Jack. Good morning, everyone. Thank you once again for joining us today to review our financial results for the first quarter 2013. I will be reviewing our first quarter results with you by comparing performance for the fourth quarter of 2012 on a sequential basis. Along the way, I will share my insights. Our total revenues were $16.9 million in the first quarter 2013 compared to $19 million in Q4 2012. The decrease of $2.1 million was attributable to a $350,000 decline in revenues from a key client in our e-book business combined with a $1.9 million decrease from our other customers within our Content Services business. This decline was partially offset by higher revenues of $200,000 in our Advanced Data Solutions business. Total revenues in Content Services were $16.3 million this quarter compared to $18.5 million in Q4 2012. And revenues in our Advanced Data Solutions business increased from $450,000 in Q4 2012 to $650,000 in the first quarter. Revenues from our top 3 clients amounted to 42% of revenues in the first quarter compared to 40% in Q4 2012. Our gross margin was 24% of revenues in the first quarter compared to 31% in Q4 2012. In dollar terms, our total gross margin was $4.1 million this quarter compared to $5.9 million in the last quarter, a decline of $1.8 million or 30%, which essentially reflects the impact of lower revenues without a proportionate reduction on labor costs. This gross margin is after [ph] taking into account $350,000 of expenses, net of revenues incurred for our Advanced Data Solutions business. The gross margin in our Content Services business was 27% of revenues in the first quarter compared to 34% in Q4 2012. Our selling, general and administrative expenses were $4.6 million in Q1 compared to $5.4 million in the previous quarter, a decline of $800,000. Our expenses were lower due to seasonal factors and decisions made in Q4 2012 to reduce our cost structure. SG&A expenses as a percentage of revenues was 27% this quarter compared to 28% in the last quarter. On a segment basis, SG&A expenses were $750,000 in Advanced Data Solutions business for both the sequential quarters. And in Content Services, it was $3.9 million this quarter compared to $4.7 million in the previous quarter. In Q4 2012, we had taken a $500,000 impairment charge for completely writing down the assets and the acquisition cost of docGenix. There were no such charges this quarter. Moving down to pretax earnings. Our pretax loss in Q1 was $400,000 compared to earnings before taxes of $100,000 in Q4 2012. After ignoring the impact of docGenix impairment charge we had in Q4 2012, the decline in earnings before tax was primarily due to $1.8 million decrease in gross margins, which was offset by lower SG&A expenses of $800,000. These pretax results are after absorbing continuing cost of $1.1 million net of revenues for this quarter and $2.1 million in the previous quarter for building the Advanced Data Solutions business. If we exclude these costs, pretax earnings were $700,000 or 5% of revenues for our Content Services business in Q1, down from $1.8 million or 10% in Q4 2012. In the current quarter, we had a net tax benefit of about $500,000 compared to a net tax benefit of $300,000 in Q4 2012. The tax benefit is primarily on account of deferred tax asset created in our books as a result of a pretax loss incurred in our U.S. entity. On the basis of 10% pretax profits, we estimate our effective tax rate to be in the range of 20% to 25% of pretax earnings. Net earnings in Q1 2013 after minority interest were $300,000 or $0.01 per diluted share compared to net income of $700,000 or $0.03 per diluted share in the fourth quarter of 2012. Our printed financial results for Q1 2013, though in line with guidance, are disappointing, essentially reflecting the negative impact of unpredictable volume fluctuations and lumpy project-type revenues in our Content Services business combined with an income statement impact of our continuing investments to build the IADS business. The solution to having predictable financial results is growing our IADS business, which has the potential to produce more predictable revenues on a quarter-over-quarter basis. As Jack mentioned, we are pleased that this quarter we signed our first major contract with a large insurance company. This is our first deal that will involve using the full scope of Synodex platform. This win is an important first endorsement of our Synodex service offering. Our next goal is to exceed client expectations in this contract and convert other pilots into customer relationships. As I said in the previous quarterly call, during this phase of transformation, investors will have to assess our long-term prospects versus our near-term challenges. I will now turn to our cash flows and balance sheet. Cash generated from operations was $3.8 million this quarter compared to $4.1 million in the fourth quarter of 2012. Our liquidity position remains healthy, with cash, cash equivalents and investments and term deposits with banks at $31 million at the end of Q1 compared to $28 million at the end of December 31, 2012. In addition, our liquidity sources included $15 million line of credit, which has so far remained unutilized. Let me now review our capital expenditures, working capital and our foreign exchange hedging program. We incurred capital expenditures of approximately $1.6 million in the first quarter of 2013 compared to $1.2 million in the fourth quarter of 2012. The capital expenditures in Q1 primarily include $300,000 for assets that will be utilized by our Advanced Data Solutions business and $1.3 million for CapEx in our Content Services business. CapEx in our Content Services business was relatively high this quarter, because we spent approximately $800,000 on replacing and upgrading our network servers in Asia, which are typically replaced after 4 to 5 years. We expect our CapEx to be in the range of $1 million to $1.5 million in the second quarter of 2013, of which approximately $500,000 will be for Advanced Data Solutions business. Looking at working capital. Our accounts receivable declined to approximately $10 million at the end of the first quarter from $14 million at the end of the fourth quarter 2012. Our DSO or days sales outstanding was 66 days in the first quarter compared to 78 days in Q4. This change is primarily on account of the timing of payments of past due balances by one of our key customers. Let me now review our inventory of foreign exchange hedging contracts. As of the end of the first quarter, we had outstanding foreign currency forward contracts of $32 million to hedge to foreign currency exposure for our operating expenses in Asia. We have notional unrealized gains of $100,000 on these forward contracts as of March 31, 2013. Any final gains or losses on these qualified hedging contracts will be recognized in our income statement upon the maturity of the contracts. I will now conclude with a brief summary of the Advanced Data Solutions business. During the quarter, we increased our ownership interest in Synodex from 78% to 85%. Total investment inclusive of operating losses during the first quarter 2013 was $2 million, of which $1.7 million was for the income statement and $300,000 represent the capital expenditures. In the first quarter 2013, we earned revenues of $650,000. And more importantly, we signed our first major Synodex contract with a 2-year contract value of $1.4 million. Our current run rate of investments is approximately $1.5 million to $2 million per quarter, of which approximately 75% is through our income statement and the balance, 25%, is in CapEx. I will now open the line for questions.

[Operator:]

[Operator Instructions] And we'll take our first question from Vince Colicchio with Noble Financial.

[Vincent A. Colicchio:]

Yes. Jack, I apologize if I missed this, but what was your e-book revenue in the quarter? And can you break down your e-book revenue in terms of foreign language and interactive revenue versus more traditional revenue?

[Jack S. Abuhoff:]

O'Neil will be able to provide -- to help with the e-book revenue -- or O'Neil, do you have the number that...

[O'Neil Nalavadi:]

Sure. The e-book revenues for the quarter was 22% of total revenues.

[Jack S. Abuhoff:]

I don't know that we've got a foreign language breakdown from that, but a lot of it is starting to become foreign language.

[O'Neil Nalavadi:]

That's right, yes.

[Vincent A. Colicchio:]

And the foreign language and interactive, are those 2 areas on the e-book side higher margin than your other e-book revenue?

[Jack S. Abuhoff:]

I think the foreign language right now is about the same, interactive is a little bit higher. From a percentage of revenue perspective, there's very little interactive in there at this point. We do see that as being growth area though.

[Vincent A. Colicchio:]

And can you talk to your relationship with your e-book platform clients in terms of are you maintaining share, are you growing share with them? And what do you expect for the rest of the year?

[Jack S. Abuhoff:]

Sure. In terms of our platform clients and our major publisher clients that were supplying us with the volume of work, we're maintaining -- we're growing our relationship with our major clients. That is certainly the case. We had -- I can think of one platform client, who's kind of -- this is a small win and a small player in the field and is exiting and changing some factors, so that might be one exception. But in terms of the core platform players and the large publishers, across the board, we're doing very, very well with them.

[Vincent A. Colicchio:]

Shifting gears to the IADS side. How many pilots do have in place now? You mentioned that -- I have a bad connection, I didn't hear that. And also if you can comment on -- you had mentioned potential acquisitions related to Synodex. Can you give us a little bit more color in terms of that? Have you identified potential deals, et cetera?

[Jack S. Abuhoff:]

Sure. In terms of the pilot in Q2, we're currently looking at 10 pilots that are scheduled for the core service and 7 on Synodex connect. And then when I say that they're scheduled, they're forecasted. Some of those could slip a little bit, but that's the volume of activity that we're currently looking at the future. On the acquisition side, what we're looking at is the sort of the supply chain of activities that take place on either side of the offering that we've got. So there are things that are, from a supply chain perspective, or vertical integration perspective that take place earlier with information we're looking at opportunities there and then there are also possibilities in terms of how the kind of information that we create gets integrated and utilized within a carrier, and we're looking at opportunities on that side as well. That said, I also remarked that we're looking at acquisitions in the ePublishing space. We're probably a little bit further along in that area. We've got several things at any point in time that we're evaluating. Of course, we're going to take -- be very careful and very deliberate in the choices that we make, and that's it.

[O'Neil Nalavadi:]

And then just to add to what Jack said, our business plan is not predicated on making these acquisitions. So we are going to be very disciplined. And if they fall into the characteristics that we're looking at and help us to accelerate our business plan then we will be looking at them.

[Vincent A. Colicchio:]

And then, Jack, on the IADS side, how large could this one client -- could you give us some color in terms of how large the piece of business could ultimately be? And sort of any thoughts you have on that.

[Jack S. Abuhoff:]

Well, I think when we look at the clients borders, I said earlier, within the clients that we're piloting that includes some of the largest insurance companies in the world. And the opportunity in terms of individually within those clients is potentially very, very significant. Again, potential opportunity of tens of millions of dollars in several of those clients. I don't expect that we'll be signing contracts that large. I think what will happen is we will get a scope of work. And we'll be successful with that, we will roll out from there. But importantly, what I see is great growth potential within that. New market for us is expanded market, and I think we've got something that is being perceived as differentiating and really enabling them to do business more effectively.

[Operator:]

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

[Joe Furst:]

I had a question similar to the previous question about the size of potential orders in this new segment of business. Your -- the customer you've got is $1.4 million over a couple of years, which is a little less than $200,000 a quarter. While over the last year you've been losing revenue at a rate of an average of $2 million a quarter. So it would take 10 of these size customers just to make up what you've been losing. Can -- and you sort of indicated that the potential customers, many of them could be much larger than the first one. I assume that the first one is relatively small, because it's a smaller insurance company, and smaller insurance company can make decisions faster than larger. But could you comment on that and be a little more specific?

[Jack S. Abuhoff:]

Sure. I think one of the benefits -- the clear benefit that we see in the IADS businesses is that we're building differentiated products for larger markets that will result in recurring revenue. And we recognize as clearly as I know you do, Joe, that one of the deficiencies in our existing business is the lack of revenue visibility and the uneven performance. And as much as we know that we could sit here and not do this new development, not make this reinvestment and new projects will come, it will continue to be uneven. So I think what we're going to be accomplishing through this investment is demonstrating that we can change the course that the business is following. We can change that fundamental weakness in the business, which is visibility and unevenness. We see it as being a large market. And we see the adjacent markets that will be able to benefit from the same technology. Moreover, we're successful at proactively developing something that's differentiating there and building upon our ability to help companies with digital enablement and perform more effectively through digital enablement. There are other sectors where we can do the same thing. So I'm very, very focused on that. We believe that it'll be an important growth driver going forward, and most importantly, it will be sustainable, visible forecastable growth.

[Joe Furst:]

Okay, apparently I didn't ask my question very well. The other potential customers, are they -- could they be significantly larger than the one you already got?

[Jack S. Abuhoff:]

Sure. Yes, we have clients in the pipeline who would be significantly larger.

[O'Neil Nalavadi:]

And, Joe, just to add a little bit more to what Jack said, when you're comparing the revenue decline in the previous quarter and what we are trying to do with the Synodex business, in terms of the business model, you've got to recognize that the e-book revenues are essentially nonrecurring in nature, though the relationship is an enduring, long-term relationship, our revenues are essentially derived from producing the e-book titles for the investments, which are being made by large e-book retailers primarily. So the predictability is essentially project based. If they get x thousand titles in the quarter, we produce them, we turn them around and we recognize revenues. In the case of the Synodex business, though the contract could be a 2-year contract or a 3-year contract, but we're locked into the value network of underwriting insurance policies, so it is essentially recurring in nature. So in a while, I understand the temptation to mathematically look at -- 10 of these contracts or 15 of these contracts, but it is a far more durable business in terms of predictability of revenues.

[Joe Furst:]

Oh, I appreciate that, and I'm really glad you're doing this, because that's what you need to do, because I mean, the other nature of business drive you nuts as much as it does us. So that's great that you're doing it. And one other question to clarify about stock buyback. It was a little confusing. I thought you said you think your stocks might buyback then you said, but we have a lot of cash outside the country, and we can't use that without tax in locations, but do you have -- how much cash do you have inside the country that you can use toward that?

[O'Neil Nalavadi:]

Joe, on average, the U.S. cash balances could swing from a range of 5% to about 25% of our total cash balances. I'm giving a range, because it is all dependent on the timing of payments that we get from our customers and the obligations to pay our Asian subsidiaries within a certain period of time. For example, at the end of the last quarter, which we have disclosed in our 10-K, the cash balance was approximately -- 10% was in the U.S. and 90% was overseas. At the end of this quarter, it is going to be higher, but that is a purely timing issue, because we have to pay the bills to our Asian subsidiaries within the next 30 to 60 days. And I think just to add color to that, so that the investors clearly understand, the -- as and when the IADS business takes off, that will have an incremental positive impact on our U.S. cash balances, because right now the investments we are making are essentially running in the form of operating expenses running through our income statement. That means we pay for those operating expenses to the Asian subsidiaries. So as we start leveraging those operating expenses with new revenues, those new revenues will essentially go to increasing our U.S. cash balances. I hope I'm making myself clear in explaining.

[Operator:]

We'll take our next question from Tim Clarkson with Van Clemens and Company.

[Timothy Clarkson:]

A question I have is you talked about now with the insurance IADS business that you have additional service with brokers. And could you just explain what the utility or value of that service would be to brokers?

[Jack S. Abuhoff:]

Sure, Tim. I'll explain a little bit, and I'd ask for your indulgence in waiting until we get it off the ground a little bit more than it is now, and then we'll feel comfortable from a competitive perspective in terms of going into a lot more detail. Really, what we're looking at is the relative efficiency in cost of applications producers, brokers and agents and BGAs placing policies and getting bids from policies from the companies that write insurance policies. We're looking at ways that we can create greater efficiency within that process. So I spoke about a pilot that we're likely to do in this quarter with a group of people operating on that platform. And those 7 companies will all be part of that platform that will be working together demonstrating and experimenting with the efficiencies that can come from doing their business over this platform. So we're obviously very excited about it. And more importantly, they're obviously very excited about it. And as we get that pilot under our belts, no doubt we'll need to do some further customization around the platform to make it better and better with the way they're looking for it to work. But we think that from there, it can expand. And as it does, and as we get it off the ground, we'll provide more detail exactly on how it's working.

[Timothy Clarkson:]

Right. Getting back to the more traditional IADS offering you have with insurance companies, what's the main benefit that these insurance companies are seeing by potentially the one that took on the service and the ones that are considering taking on the service?

[Jack S. Abuhoff:]

I think there are several benefits. One of the big benefits is efficiency. They're able to process more information by using our service. And they're also seeing great benefit in quality. The quality of information that they're getting is much better than the information they may get from a competitive product and better information than they're able to produce economically internally. So that's the initial benefit they're seeing, but what they're also seeing is ancillary benefits in terms of the quality of their underwriting and the quality of their data mining that they'll be able to do as a result of that.

[Timothy Clarkson:]

Have you been able to essentially prove just in terms of cost-effectiveness that they can save money by doing this?

[Jack S. Abuhoff:]

We have. We have clients who piloted with us and then shared with us in the benefits that they're experiencing. We've -- recently, were told by one client that they were able to do easily 3 times as much work with their current investment. And importantly, they -- and we see opportunities to increase it even beyond that. So I think the -- in this economy and efficiency and the ability to do more with less is great. You can get attention. You can get traction that way. And then having the ability to demonstrate benefits that go well beyond that in terms of quality, ultimately revenue production, data mining opportunities to become progressively more selective and you can create new products, those are tremendous icing on the cake.

[Timothy Clarkson:]

Going back to the e-book business in terms of -- I know that there's been a lull between the big surge in English books, and now you're doing international books. What's your belief about later on the year is there a potential for that international book business to pick up?

[Jack S. Abuhoff:]

I think there is. It's unpredictable. So when we look at the opportunities we see, there are countries, there are languages. As you know, we've done a lot in terms of expanding our language capabilities. That we were able to become experts in processing and creating Japanese e-books, I think, is a testament to the quality of talent we've got here and has enabled us to further create even stronger relationships with our key client through that success. So I see that continuing to expand. I see more languages, more countries coming. And then I think another opportunity that exists for us, like also mentioned in the call is to take the opportunity to ride in the wake of those launches and those successes and to build relationships directly with content producers and publishers in those countries and to essentially help them by becoming their digital partners. From a strategic perspective I think it's exciting. From a timing perspective, it's much less within our control than we want business to be, generally speaking, again highlighting the importance of the IADS investment.

[Timothy Clarkson:]

Right. In terms of the rich media, it's still, obviously, a small part of your business. But what are the features within rich media that seem to be taking off? Is it video? Is it audio? Is it interactivity? What -- is it chat? What are the things that they're building into the rich media or interactive books? .

[Jack S. Abuhoff:]

I think there's a combination of things, and there's several markets there. I think it's less feature specific, less whether it's read aloud or animation or a particular type of activity than it is markets, so I think there's a lot of experimentation going on now around which market will get the most traction. And you've got several ranging from corporate learning to textbook publishing, to illustrated books. And I think -- we're trying to do is play in each of those markets and to play in a way where, again, we're known for the ability to mass manufacture at very high levels of quality, and then we're also known for our ability to innovate and create innovative opportunities for the kind of interaction that the platform enables.

[Operator:]

We'll take our next question from Charlie Pine with Van Clemens & Co.

[Charlie Pine:]

Pretty much, just 2 questions. Back on the e-book topic, it sounds like if I'm understanding this correctly, sort of parsing a little bit of your language to your so-called major customer, you haven't just proved it out now on the -- on your capabilities on the foreign language side, but you've actually got an order from that customer and are fulfilling on that order. Could you characterize sort of the scoping of that particular Japanese e-book contract versus the prior size of the type -- amount of business that you are getting from that customer when you are doing English language books?

[Jack S. Abuhoff:]

Sure. The -- we continue to do work in English and Japanese with that client. I think the relative amount of work that there was in order to hit a milestone, which was launched in the Japanese market for us was smaller than the U.S. market. There are other markets that I expect that we're going to be participating in as well. In terms of giving more exact numbers, I am precluded by NDA from going into much more detail there. I hope that's helpful.

[Charlie Pine:]

Are they giving you, at this point, what you would define as material amounts of work?

[Jack S. Abuhoff:]

Yes. Absolutely.

[Charlie Pine:]

And do you see that material amount of work expanding with them over the next quarter or 2 in the Japanese side? Or do you think it's just going to be relatively steady-state from where it was in Q1?

[Jack S. Abuhoff:]

That's hard to say. I think that our job, where we define it is we want to become progressively more relevant. We're going to do that through doing things like we did last year and doing things like we did in the first quarter, helping people launch products. And in this case, launch bookstores and doing it at large scale and doing it at very high levels of quality that earn us very positive kudos at the end of those activities. We believe that forming strategic relationships with important brands is going to be an important part of our success. Moreover, by virtue of those successes, we get to talk about new things and new conversations whether those are new territories or new languages or new capabilities and books. And we think that, that -- we have -- a lot of success can come from that.

[Charlie Pine:]

What is the -- what are the next foreign language bookstores that you anticipate that you would be providing your services for?

[Jack S. Abuhoff:]

Yes. I'm not at liberty to share that, unfortunately.

[Charlie Pine:]

Okay. My last question has to do with your statement on the IADS segment, and, I guess, Synodex in particular, where you described the addressable market now as being $1 billion a year. I imagine that, that's what you're referring to as a $1 billion year opportunity. I seem to recall in the not too -- in the fairly recent past, you had been characterizing this as around about $500 million, your addressable market. Can you tell me how this -- all of a sudden gone from $500 million to $1 billion a year?

[Jack S. Abuhoff:]

Sure. We took the information about the U.S. market, and with some successes now in terms of piloting U.K. companies, we added that market share to the U.S. And we also looked at outside of life and included disability where we're also piloting.

[Charlie Pine:]

And just to dig a little deeper, how did you -- what did you scope? And what is that number really based on?

[Jack S. Abuhoff:]

It was based on published information that we were able to find about the numbers of life policies and then disability of policies that are read manually in the U.S. and then an approximation of life policies that we were able to -- through some anecdotal conversations put together for the U.K.

[Charlie Pine:]

Is there some number out there that you're working with that is sort of an average cost per policy in underwriting costs that you're using in cranking into an equation?

[Jack S. Abuhoff:]

No, there's not. Because the -- our billings are not dependent upon or driven by the amount of cover, it's more the complexity of the case. So even if we had numbers, which I'm sure we could find on the amount of cover, I don't think that would be indicative of our particular economic opportunity. So instead what we're looking at is the number of policies and an approximation of difference of our products that would be applicable to different kinds of policies. And then we're taking our approximate price point per policy and doing math around that.

[Operator:]

And we'll take our next question from George Melas with MKH Management.

[George Melas:]

I'd like to sort of focus a little bit on the traditional Content Services. It seems like we've had a meaningful drop in revenue, gross margin dropped as well. The incremental EBIT margin, I think, was north of 50%, of course, on the negative side. And I think about a year ago, you decided to increase your sales and marketing investment in that business. And, clearly, now you've pulled them back. So could you talk a little bit about what's going on in that business? I know it's lumpy, but it seems that it's not just lumpy, it seems like it's declining. And it seems like your guidance for the next quarter would suggest a further decline.

[Jack S. Abuhoff:]

Sure. Well, if you take the Content Services business and you strip out the e-book, which we know will be especially lumpy, I think what we see is that we've been sort of locked into the $14 million to $15 million range per quarter for quite some time, and that's frustrating us. Within that $14 million to $15 million, about $10 million is arguably recurring business. So we are succeeding at replacing $4 million or $5 million per quarter of project-related business. What we want to do, of course, is more than that. We want to grow. The challenge, I think, in terms of growing is, obviously, one that we haven't solved yet. And in part, that's inspiring us to make investments in other sectors. The core segment of the market that we're addressing in terms of Content Services, again, apart from e-books and e-book distribution is the information industry. Information industry has, over the past couple of years, not been growing as quickly as it was 7 years ago. But what we're looking to do is to find ways that we can grow into some of the needs that they've got. So yes, where we do see early success is through things that we're doing with some of our core customers especially on the technology side. So we see that as we replace projects, because again the $14 million or $15 million, there's about a $5 million per quarter replacement in there. A lot of the complexion of that work has changed. It's become a little more sophisticated. It's become more technology enabled. That's enabled us to significantly increase over the past couple of years the margin that we're obtaining on that $14 million, $15 million business. That's good. But the frustration is not being able to grow past that glass ceiling, something that we worry a lot about and think a lot about. The emphasis is going to be to manage our costs relative to that opportunity and be very selective and take the things that appear to be working, that appear to be enabling us to transform the nature of some of that business and do more of that. We see that we've done a good job of broadening the relationship with certain of our key customers and becoming more integral to certain of their technology-enabled products and visions. We think that's an opportunity, and we're going to continue to experiment. We're going to continue to be very vigorous in terms of how do we choose, how much investment to make, what's the nature of the investment, what's working, what's not working. We'll make changes quickly as we calibrate that. But it's an important part of our business. We have very good relationships there. We have a good reputation there. And we're intent on figuring out how to become not just better margin producing but more growth enabled within that.

[George Melas:]

Right. But it seems that I think the margin in that business did improve, and now has actually gone back to sort of, I think, it was 27% this quarter. And 2 years ago when you had roughly similar revenue levels, the margins were actually higher, so...

[Jack S. Abuhoff:]

We -- no, I'm sorry, go ahead.

[George Melas:]

And the second question there is if your investment in that business has gone down. And I'm just wondering if that reflects -- I think maybe it reflects what you're saying about being more selective, but it doesn't give much confidence that, that business can actually grow. Maybe you can address the gross margin first.

[Jack S. Abuhoff:]

Yes. Well, there are a lot of factors that come into play in terms of margins. When I'm thinking about opportunity, I'm very much focused not on the portfolio level, but I'm focused on the kinds of business we're winning and the incremental margins we're getting on new projects. So I'm looking for that to increase. In terms of the general sense of how we're allocating investment dollars. Right now, we do see more opportunities as evidenced by our very rapidly developing pipeline of more opportunity on the IADS side. So it's not that we don't see the opportunity on the Content Services, we see opportunity. But we're putting a lot of our dollars in terms of the IADS work.

[George Melas:]

Okay. Great, and then a quick final question on the non -- your non-major customer e-book business. It seemed that it declined this quarter. It had been increasing sort of fairly steadily and that declined. Is there a particular -- did something happened? Was there a project that was not renewed or...

[Jack S. Abuhoff:]

I don't think that, that was within our e-book business. I think that, that's in general Content Services business. And like I said before, there are projects that start and there are projects that end. There was no business that walked away from us. We didn't lose market share or anything like that. It was just a natural cycle of projects.

[Operator:]

We'll go next to Perry Highland with Rubicon Wealth Advisors.

[Perry Highland:]

Just one quick question. What are your kind of general idea for the second half, rest of the year and maybe going into 2014?

[Jack S. Abuhoff:]

Perry, it's such a good question, and I'm confident that the Synodex business comes off the ground. A year and 2 years from now, when you ask that question, we're going to be able to give you 2- and 3-year guidance. That's my dream. Right now, we struggle with the fact that we don't have the visibility we want to. That's why, again, not to reiterate, we're making investments, we are in the business and taking direction that we want to. So right now, we're going to go out the quarter. There's we do not have the visibility from our pipeline or from our major customers in order to give you better guidance from that at this point.

[Perry Highland:]

Okay. And then the customers you're working with. Those I would guess you could probably pick up and did an order, additional orders or at any almost any time from the where you are with the various companies you're working with.

[Jack S. Abuhoff:]

Absolutely, and, I guess, to the extent there's a double-edged sword to lack of visibility that is the other side of it that it can come at any time. That remains to be the case. Relationships are good. The discussions are taking place all the time, and there are things that are on the horizon, but timing is a challenge.

[Operator:]

[Operator Instructions] And it appears there are no further questions in the queue.

[Jack S. Abuhoff:]

Well, thank you, operator. Just to recap, slightly, quarterly revenue was down sequentially, but we anticipated due to projects that completed in Q4. We signed and announced our first major Synodex contract. And though it's modest in amount compared to other things we're chasing in the Synodex business, we're very enthusiastic about the market validation that this early win provides. We're working to make Synodex an important sustainable growth driver going forward. We believe that it will enable us to drive high-quality revenue, which over time will even out the kind of revenue ups and downs that we're seeing this quarter and help to transform our business to grow more predictably and steadily. We're working hard at other areas of the business too, including Content Services notwithstanding our frustration of $14 million to $15 million issue that we talked about. Continue to be very excited about international expansion and enhanced e-books on the e-book side. And with that said, again thank you, everybody, for joining us today. And thank you for the continued support.

[Operator:]

Today’s conference is available for replay by dialing [phone] or [phone] and entering passcode 7761757. That concludes today's conference. You may now disconnect.