Innodata - Earnings Call - Q2 2020
August 6, 2020
Transcript
Speaker 3
Good morning and welcome to the Innodata second quarter 2020 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Amy Agress. Please go ahead, ma'am.
Speaker 0
Thank you, Anna. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, CEO of Innodata, and Robert O'Connor, our CFO. We'll hear from Jack first, who will provide perspective about the business, and then Robert will follow with a review of our results for the second quarter. We'll then take your questions. First, let me qualify the forward-looking statements that are made during the call. These statements are being made pursuant to the safe harbor provisions of Section 21E of the Securities and Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements.
These statements are based on management's current expectations, assumptions, and estimates, and are subject to a number of risks and uncertainties, including, without limitation, the expected or potential effects of the novel coronavirus, COVID-19 pandemic, and the responses of governments, the general global population, our clients, and the company thereto. The contracts may be terminated by clients, projected or committed volumes of work may not materialize, continuing Digital Data Solutions segment reliance on project-based work, and the primarily at-will nature of such contracts, and the ability of these clients to reduce, delay, or cancel projects.
The likelihood of continued development of the markets, particularly new and emerging markets that our services and solutions support, continuing Digital Data Solutions segment revenue concentration in a limited number of clients, potential inability to replace projects that are completed, canceled, or reduced, our dependency on content providers in our Agility segment, a continued downturn in or depressed market conditions, whether as a result of the COVID-19 pandemic or otherwise, changes in external market factors, the ability and willingness of our clients and prospective clients to execute business plans that give rise to requirements for our services and solutions, difficulty in integrating and deriving synergies from acquisitions, joint ventures, and strategic investments, potential undiscovered liabilities of companies and businesses that we may acquire, potential impairments of the carrying value of goodwill and other acquired intangible assets of companies and businesses that we acquire, changes in our business or growth strategy, the emergence of new or growing competitors, potential effects on our results of operations from interruptions in or breaches of our information technology systems, and 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, including our most recent reports on Forms 10-K, 10-Q, and 8-K, and any amendments thereto.
We undertake no obligation to update forward-looking information or to announce revisions to any forward-looking statements except as required by the federal securities laws, and actual results could differ materially from our current expectations. Thank you. I will now turn the call over to Jack.
Speaker 2
Thanks very much, Amy. Good morning, everybody. Thank you for joining our call today. So Q2 was our first full quarter operating our business during the COVID-19 crisis. Now, with four and a half months of experience operating in this environment, I am increasingly confident that despite the environment, we are positioned to accomplish a great deal this year. Here's what I believe we will succeed at accomplishing. I believe we will succeed at growing both our Synodex and Agility platform businesses this year. I believe we will succeed at landing dozens of new customers in the AI data annotation market, a new market which we are just going after or just started going after in Q4 and which is predicted to grow rapidly. And I believe we will succeed at substantially reducing our operating costs to the tune of $2 million this year and $2.6 million in 2021.
Let me take each of these and offer some context and some proof points. First, let's take Synodex and Agility. I'm expecting that we grow both of these businesses this year. In our Synodex business, we've built the technology and systems to extract complex medical data from unstructured medical records, both electronic health records and traditional health records. This year, we are building additional automations into our routines using AI. We are expanding engagements with several of our existing insurance industry customers, and we are bringing on a select number of new customers. Our Synodex first half revenues increased 28% over the last year, with revenues this quarter increasing 31% year over year. While the business is still small scale, we believe that integrating AI into our data extraction process will enable us to expand our target markets and give us a path to grow and scale the business.
The business is contributing to free cash flow. It enjoys strong 60% plus incremental margins, and nearly all of its revenue is recurring in nature. Now, let's talk about Agility. Agility is a SaaS platform business providing a full PR workflow platform that has been ranked among the top tier, even though right now we're just a small player in the overall $3 billion global PR workflow market. Our subscription revenue is a function of our retention rate and our bookings. We ended the quarter with a year-to-date net retention of 87%, just a few points shy of our internal target of 90%, but a solid performance given the economic environment. We booked about $750,000 of new business for the small direct sales staff, which, in combination with our retention, we believe is enough to continue to grow our business modestly.
Now, so far, we've kept our sales team small because we wanted to first prove that we had cracked the code in terms of sales process, structure, and hiring profiles. As a result of the refinements we've made in these areas, from Q1 2019 to Q4 2019, we practically tripled bookings per sales executive. Now, with this improved sales productivity, the economics now support rapidly scaling the sales force, notwithstanding a tougher selling environment. We are now running the numbers through our models to figure out exactly how fast we can go given our resources. Let me talk about AI data annotation now. Now, if you've been following our story the last few years, you know that we launched Synodex and Agility because our core markets, legal, medical, financial information publishers, and e-book publishers, those core markets were simply too small for us to support growth.
But just late last year, we discovered a whole other market that is practically made to order for us and that is really just in its formative stages, with significant growth expected in the next several years. This market is the AI data preparation and annotation market. It is estimated to grow from $1.9 billion this year to $3.2 billion by 2023. Data scientist teams that want to build AI models need to train those models with large quantities of very high-quality data, but they express continued frustration that creating high-quality data is a task for which they are ill-equipped. In fact, they report that even high-profile AI projects regularly fail because they are not trained on large, high-quality data sets. AI data preparation includes collecting, cleaning, and normalizing data, as well as annotating, classifying, and segmenting data.
Now, these are precisely the things that we believe we're the best in the world at providing, but we've traditionally provided them for a small market. Now, a new, much larger market is emerging. Given our history of being a leading provider of high-quality data to leading legal, financial, and medical information companies, we see a clear path to becoming a leading provider of AI data preparation and annotation to companies that are seeking to build models in these and other areas. We only started marketing and selling AI data prep and annotation services in Q4 of last year. Nevertheless, to date, we have closed 15 new customers, and we have another 16 customers in late-stage pipeline that are expected to close in the second half.
We are forecasting a total of 3.5 billion of bookings, excuse me, 3.5 million of bookings from this market this year, and we're expecting that a majority of these deals will produce recurring managed services revenue at our target margins. We've also identified opportunities to license our data annotation platform, which is a customer-facing version of our internal production platform that we have refined over many years. It is worth mentioning that one of our recent data annotation wins is with a prominent big tech company. To secure this work, we beat out seven incumbents, winning the business based on our quality and our capabilities. Our current pipeline includes banks, hedge funds, online trading platforms, financial research firms, as well as drug companies, drone companies, AI software companies, and two big tech companies. In the quarter, we saw a sequential revenue dip of about $500,000 in DBS.
We expect about half of this will come back as soon as we're able to get the full project team back into our delivery center because it's attributable to a customer project that we can only provide with equipment situated within the facility. The other half is from a combination of smaller customers whose requirements declined due to COVID-19 disruption. Looking out over the year, we're predicting that the durability of our new data annotation market, in combination with a forecasted expansion from one of our largest traditional market clients, will nevertheless enable us to show sequentially improving revenues. We talked about bookings. I'd like to talk just a little bit more about that and overall growth. Our new business signings, which we refer to as bookings, are a leading indicator of growth and an important indicator of sales effectiveness.
Looking across our businesses, in just the first half of 2020, we have already booked 71% of our full-year 2019 bookings, and we're presently forecasting beating 2019 bookings by 32%, and that's notwithstanding the environment that we're now working in. Let's now turn to cost management. In order to enable our business continuity plan and our COVID response plan, we needed to provision our team members with encrypted laptops and desktops, as well as remote internet access and cloud processing and storage. In Q2, this cost us approximately $400,000. We now have plans in place to reduce these costs over the next several quarters, as well as a plan to drive additional significant cost savings across the business. We expect that the result will be a net savings of approximately $2 million in 2020 and $2.6 million in 2021, each as compared to 2019.
Our savings include reducing lease space and data center costs and other costs associated with operating large-scale facilities. We are continuing to undertake a strategic evaluation of how best to allocate our capital and resources in view of the divergent but compelling market opportunities we are presently pursuing for growth. COVID clearly presents a significant level of uncertainty, and we're all guessing about how and when normalcy returns and the effect and duration of the economic slowdown that is projected. That said, we have so far prevailed, and for all the reasons I've just discussed, we are forecasting meaningful progress, notwithstanding the macro environment. We are weighing whether to continue to proceed along all the paths we're now on or to concentrate investment on fewer areas. We will provide updates as we progress through this evaluation.
I'll now turn the call over to Robert, who will take you through the numbers, after which we will come back and take your questions. Thank you very much, Robert. I'll turn it over to you.
Speaker 1
Total revenue was $13.9 million in the second quarter of 2020, a 5% decline from $14.5 million in the first quarter of 2020. Total revenue was $13.6 million in the second quarter of 2019. Net loss was $0.6 million in the second quarter of 2020, or $0.02 per basic and diluted share, compared to a net loss of $0.4 million, or $0.01 per basic and diluted share in the first quarter of 2020, and a net loss of $0.7 million, or $0.03 per basic and diluted share in the second quarter of 2019. For the first six months of 2020, total revenue was $28.4 million, an increase of 4% from $27.3 million in the first six months of 2019. Net loss was $0.9 million, or $0.04 per basic and diluted share in the first six months of 2020.
Net loss was $1.1 million, or $0.04 per basic and diluted share in the first six months of 2019. Cash and cash equivalents were $13.5 million at June 30, 2020, compared to $10.9 million at December 31, 2019. One other data point: 99% of Innodata's global team members are presently deployed, with approximately 95% working remotely. Thank you, Robert. We're ready to take questions now.
Speaker 3
Thank you, ladies and gentlemen. If you wish to ask a question at this point, please signal by pressing Star 1 on your telephone keypad. Please make sure your mute function is switched off to allow your signal to reach our equipment. And that's again Star 1 to ask a question. We will pause for just a brief moment to allow everyone an opportunity to signal for a question. Once again, ladies and gentlemen, that's Star 1 to ask a question. And we take our first question from Tim Clarkson from Van Clemens & Co. Please go ahead.
Speaker 2
Hi, Jack.
Speaker 4
Hey, Tim.
Speaker 2
Hey.
Speaker 4
Hey. On this cost reduction announcement, now, is it a $2 million this year, an additional $2.4 million, or would it be the total $2.4 million when you factor in the combination of the expense reductions?
Speaker 2
Yeah. So it would be $2 million this year and $2.6 million next year cumulative. In other words, we're measuring that savings in terms of structural costs and operating costs over 2019 as a baseline.
Speaker 4
Right. So it's not $2 million plus $2.6 million. It's a total of $2.6 million.
Speaker 2
That's correct.
Speaker 4
Right. Okay. Now, in terms of the Agility, why don't you give us a little bit more color why you think we're suddenly doing better there, growing in this difficult environment?
Speaker 2
Yeah. I think when you look at the SaaS business like Agility, there are a couple of things that have to be in place. The first thing is you need a product in place, a product that people want. And we've done a tremendous amount of work on the product over the last couple of years. We did a very important release just in the fourth quarter. And the result of the work that we've done, the release that we've done, is enabling us to compete with the two largest companies that dominate this market. In addition to that, the product has been validated by analysts and ranked highly in, I think, seven out of nine areas. It's ranked as the top product. We've got a lot going on there.
With that as a foundation, then you need to work on your bookings, and you need to work on your retention numbers. Our retention numbers are way up over where they've been in the past. As I said in the call today, we're just a couple of points shy of the 90% net retention that we aim for. And we think that in this market, given what's going on, that's a tremendous result. On the booking side, we had a lot of things we had to figure out there. How do we train a team? How do we measure a team? How do we appropriately manage and monitor the team? Who do we recruit for the team? How do we compensate the team?
There was a tremendous amount of experimentation and things that we wanted to get right at subscale before we scaled it because if you scale a process that's broken or if it just magnifies a bad result. So we've worked on that, and we're very happy with what we accomplished. We tripled our bookings per account executive over the course of last year, which is a tremendous result. Now, when you take that capability now, that's a result of all that work we've done on process and training and sales oversight and management and measurement. When you take that in combination with, of course, a great product, a very large market, and very demonstrated high and improving retention rates, that is, in a SaaS business, a recipe to grow, and we're very excited about being where we are right now.
Now, obviously, this is not the economic environment and the business environment that any of us were hoping for, but we think with the numbers where they are, we've got what it takes to power through those choppy waters.
Speaker 4
I know at one time you thought that companies in this industry are worth about three times revenues. Do you still think that's true?
Speaker 2
We saw a couple of important acquisitions take place last year in this space, one of which was, I want to say, it was five times revenue, their valuation. I'll have to check that and come back to you. But yeah, I mean, when you look at SaaS businesses, they're typically valued based on their ability to grow, their ability to penetrate a market, and the cash flows that are forecasted as a result of that. I think we're extraordinarily well-positioned right now, given the work that we've done and the results that we're seeing.
Speaker 4
Okay. Let's move to Synodex. So it seemed like it was forever trying to get these life insurance companies to move. What's changed that they're finally starting to sign some contracts?
Speaker 2
Yeah. I think a few things have changed. First, one of the big things is we are becoming more and more efficient at what we do. We're cutting out cycle time that it takes for us to produce data. We're automating where we haven't automated before. And we have companies that are our clients who are conservative by nature, but they've become progressively more operationally reliant upon us. We've got great partnerships in place with many of the leading insurance companies, and we're succeeding at expanding those relationships. Now, one of the things that we're working on is integrating AI more essentially into our technology and our products in this area. And I think as we do that, we're going to see additional use cases open up for both within insurance but then also outside of insurance. And we're very excited by that. That'll bring additional market availability to us.
It will make us more efficient in terms of the work that we do. It will reduce cycle time, and those are all things that the industry is looking for, so very excited about that as well.
Speaker 4
Right. Right. I was listening to one of the seminars you gave that was on the Innodata website, and you talked a lot about the advantage Innodata has in terms of quality of data. I know you mentioned at one point you did some work for a major brokerage firm, and they were really astounded at the difference in the quality of the information. Can you explain exactly why Innodata is competing in coming up with better data than the competition?
Speaker 2
Sure. Happy to. So if you think about our legacy, our legacy was in taking companies like Apple and Bloomberg and Amazon and Thomson Reuters and satisfying their extraordinarily demanding requirements for high-quality data, so we built our company around producing extraordinarily high-quality data at very cost-effective means. Now, our problem and our constraining factor was that there are a couple of handfuls of companies who were customers for highly refined data for financial, medical, and legal data sets, a few handfuls or a couple of handfuls of publishers, but that didn't give us enough market space to grow into, and as a result, every now and then, we'd see a big project, but then that project would come to an end, and we were back with our small market.
Fast forward to today, and fast forward to what's going on in AI. You're seeing companies in all sorts of verticals who are launching AI projects. And the common denominator is that what you need to make an AI project successful is exactly what we're good at doing. It's high-quality data and lots of it. So all of a sudden, we went from a market of a couple of handfuls of companies to a market that is virtually any company that's looking to embrace artificial intelligence. And as we all know from just reading the newspapers, that pretty much includes every company out there. So high-quality data is absolutely the fuel that's going to feed the explosive growth in AI that we're all expecting to see take place. And we think we're just ideally positioned in order to provision that fuel.
Speaker 4
Right. Right. Now, you talked about doing maybe a total of about $3.5 million in AI this year. I mean, how close are we to seeing some of these $200,000-$400,000 deals turning into $2-$5 million deals? Is that five years away, or is that pretty close?
Speaker 2
Yeah. So when I think about that, I look at some of the companies that have been in this space longer than we have, who incidentally, in competitive contests, we're now beating. But I look at them, and I see how are they successful. And one of the things that the most successful companies among them have done is they've broken into big tech. You can think of the big five tech companies, and then there's another 10 outside of that that are almost or equally important. And these are companies that are spending tens of millions of dollars per year on high-quality data engineering for AI, high-quality data annotation. So we know that one of the key things that we need to accomplish is we need to break into these companies as a market.
My understanding is you've got to break into one, and once you do that, then that's kind of your ticket to another one, and then you develop a reputation, and you can get a tremendous amount of traction from there. The truly good news in Q2 is that we've closed a deal, our first deal in this market. We're going to start off slow. We've got to prove ourselves. As I said in my prepared remarks, we were competing against seven incumbent providers. When you're not an incumbent, I'm telling you, it's so hard to break in. When you get selected in lieu of seven incumbents who are fighting for the business, you're doing something right. We were told that what we were doing right was our quality was off the charts.
Our intention is to progressively grow that relationship, which we think that one relationship can, as I said, these are companies spending tens of millions of dollars a year on data for AI, expand that, cultivate that with the utmost of care, and use that to pivot into other relationships in this market where there's a lot of incestuous activity and a lot of people talk to people and share what they're doing, and we get referrals.
Speaker 4
Right. One last question. Let me ask you this. If I was trying to break into this annotation business of AI, how difficult would it be for somebody, a startup that doesn't have the kind of experience Innodata has to be able to do what needs to be done?
Speaker 2
It's a funny thing. It's a market that looks like it should be simple until you try to go do it. We think we bring a couple of things to the table that are absolutely critical. One is our technology stack. We've been building technologies to refine data for many, many, many years, and when you're talking about high-quality data, you're not talking about being able to do 80% of it. You're talking about being able to do it to the point where you're making perhaps one error out of 20,000 possibilities. So that quality standard is critical, and we've built the technologies to be able to handle that. That's right up there.
The second thing that we've got is we've got very deep domain expertise in the areas that are implicated by a lot of what's going on now in the world: financial data, legal data, medical data, deep domain expertise that we can bring to the table there. And the third thing that we've got is we know how to integrate AI into the problem of training data for AI or building training data sets for AI. So we're able to bring a level of efficiency to the problem that a lot of companies would not be able to.
Speaker 4
Sure. Sure. Well, it's very exciting. And one last question. What would be the incremental margins on some of this AI business?
Speaker 2
It's not dissimilar to other business that we do. In DBS, I think it's safe to think about it as 50%-60% incremental.
Speaker 4
Right. Right. So you start making a lot more money at slightly higher revenues.
Speaker 2
Correct.
Speaker 4
Right. Okay. I'm done. I appreciate it. Thanks. A good quarter, especially in the context. And one last thing. I know nobody pays attention to valuation anymore, but Innodata trades for about 60% of sales. I mean, Microsoft trades at 11 times sales. So there's a big differential between the valuation of an Innodata and some of these high-tech stocks that have already gone way, way up. So with that, I'll pass.
Speaker 2
Thanks, Tim.
Speaker 3
Thank you. As a reminder, ladies and gentlemen, that's star one to ask a question. And once again, star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal. Ladies and gentlemen, I will turn the call back to our host for any additional remarks.
Speaker 2
Thank you, Operator. I'll just recap a couple of things that we've talked about. Notwithstanding COVID-19 and the environment that we're in, we're forecasting very meaningful progress in 2020. We're predicting growth in both our Synodex and Agility platform businesses. We've validated Agility's readiness to scale with additional investment in sales. In the core DBS business, we validated our ability to serve the new rapidly growing market for AI data prep and labeling services with 15 new customer wins just in the initial six months of marketing these services, and that includes one of the best-known global big tech companies. We have another 16 companies in our late-stage pipeline that we're looking to close in the second half. We had $400,000 of BCP-related expenses in the quarter, which we anticipate will be reducing as we optimize our tech stack for working remotely.
We've identified additional cost savings that we are continuing to roll into the way we work and into the second half and early next year. When we net the new BCP-related expenses against our identified cost savings, we're actually expecting a net cost reduction as compared to 2019 of approximately $2 million in 2020 and $2.6 million in 2021. We continue to have a very strong balance sheet with $13.5 million in cash at the end of Q2, which was an increase of $2.8 million over Q1. Again, thank you all for joining us today. I wish you continued success and health and be well. Thank you.