Innodata - Earnings Call - Q3 2020

Transcript

Speaker 3

Good morning and welcome to the Innodata First 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.

Speaker 1

Thank you, Sandy. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, CEO of Innodata, and Mark Spelker, our CFO, who joined Innodata last month. Mark retired recently from CohnReznick LLP, a leading accounting, tax, and business advisory firm where he served as an audit and technical consulting partner for 20 years. We hear from Jack first, who will provide perspective about the business, and then Mark will follow with a review of our results for the third 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 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 government, the general global population, our clients, and the company thereto that contracts may be terminated by clients, projected or committed, volumes of work may not materialize, continuing digital data solution 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 solution 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 impairment of the carrying value of goodwill and other acquired intangible assets of companies and businesses that we may acquire, changes in our business or growth strategy, the emergence of new or growth in existing 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 Form 10-K, Form 10-Q, and Form 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

Thank you, Amy. Good morning, and thank you for joining our call. Today, we're reporting third quarter revenue growth of 5% sequentially as well as 5% year over year. What's exciting is that based on trends across all lines of our businesses and market opportunities, and in order to position us for 20% growth in coming years, a level of growth that we have not seen for almost 10 years, our 2021 plan contemplates nearly tripling the size of our sales team and adding resources and budget to our marketing lead gen teams. As a result of operating leverage in the business, we would anticipate cash flow growth to outpace revenue growth and cover increased investment. Our confidence is grounded in the accomplishments this year.

We have successfully expanded our addressable market through new product and service offerings, and we have established product-market fit with these new offerings and demonstrated the ability to win against incumbents. Let me give you some color on what we are seeing and executing on the ground. In our core digital solutions business, we are now primarily focused on the AI data preparation market that was estimated at $1.9 billion this year and is expected to grow to $3.2 billion by 2023. We believe that this is a made-to-order market for us in which customers prize data quality above anything else, which means we're able to bring to the task our 25 years of finely honed skills and technology that we developed to create near-perfect data for leading information companies. As a result, we're winning deals in the AI data preparation market against several incumbent providers.

We launched our AI data preparation offering late in Q4 last year, and to date, we have closed 18 new customers, and we have another 20 or so in our late-stage pipeline. By the time the year is done, we expect our DBS segment to have signed approximately 40% more new business than it did last year. As an example of our execution in this segment, one of the world's largest social media companies became our client in Q2 when we beat out 17 other companies in a highly competitive five-month-long RFP. In just five months, we've become one of this company's preferred vendors, and we're now running multiple projects across seven languages.

Our scope includes AI-based search classification to improve the search experience, sentiment analysis to automate content filtering, product classification engines to improve product placement for advertising, trend representation to identify trending topics on the platform, toxicity identification algorithms to identify content that violates terms of service, and misinformation identification to auto-identify fake and misleading information. We'll now turn to our platform businesses. Our Agility platform for PR and communications professionals is now ranked among the best-in-class platforms in the market today. To capitalize on this traction, we are focusing on two initiatives to significantly accelerate the growth in this business. First, over the course of next year, we plan to increase our direct sales headcount from this year's average of 10 to 43 by the end of 2021, and to expand marketing and lead gen to support the scaled-up sales effort.

Second, we plan to expand and grow our channel partners. We grew channel revenue 23% this year, and we're expecting a higher growth next year. We are similarly excited about the prospects of our Synodex platform. Our Synodex platform is used to extract complex medical data from traditional medical records and electronic healthcare records. This year, we are integrating our document intelligence AI engines into the product, allowing us to offer our target markets a much superior solution at a competitive price point. The 26% revenue growth we achieved in the first nine months of this year is indicative of the traction that we are seeing. Lastly, I'll confirm that we continue to be on track with the cost savings initiatives that we outlined in our last call.

These cost reductions, combined with the considerable operating leverage in our business, make us comfortable that our cash flow growth should exceed our revenue growth, even with the investments in sales and marketing we are making across the board. I'll now turn the call over to Mark Spelker, our new CFO. Mark joined us just last month, so this will be his first earnings call. Mark, welcome.

Speaker 0

Thank you, Jack. Good morning, everyone. Thank you for joining us today to review our financial performance for the third quarter of 2020. Total revenue was $14.6 million in the third quarter of 2020, a 5% increase from $13.9 million in the second quarter of 2020. Total revenue was $13.9 million in the third quarter of 2019. Net income was $0.2 million in the third quarter of 2020, or $0.01 per basic and diluted share, compared to a net loss of $0.4 million, or $0.02 per basic and diluted share in the second quarter of 2020, and a net loss of $0.6 million, or $0.02 a share, basic and diluted, in the third quarter of 2019. For the first nine months of 2020, total revenue was $42.9 million, an increase of 4% from $41.2 million for the first nine months of 2019.

Net loss was $0.6 million, or $0.02 per basic and diluted share in the first nine months of 2020. Net loss was $1.7 million, or $0.07 per basic and diluted share in the first nine months of 2019. Our cash and cash equivalents were $15.3 million at September 30, 2020, compared to $10.9 million at December 31, 2019. Thank you.

Speaker 3

If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. The first question comes from Tim Clausman at Van Clemens Capital.

Speaker 2

Hi, guys. Hi, Jack. Just a couple of questions here. First of all, just I have a banker client, and he always looks at the bottom line, and he noticed that Agility is still losing money, I guess, through the six months they lost about $600,000 or something. Anyhow, he was just wondering, when do we expect that division to finally start making money?

Speaker 0

Hi, Tim. Great question. Thank you for that. So the Agility business, especially if you look late this year, and you'll see it, we believe, next quarter also, we've gotten it in a position where we're lean and mean relative to operating costs and free cash flow generation. I think we've seen that come up, and we're going to see that next quarter as well. The important thing in the Agility business is, of course, that the operating leverage is huge. It's a SaaS business. You see 90% or so of revenue hit the bottom line. So the real key there is growth. We've achieved a tremendous amount with the product. The product is ranked as a leader in its addressable market, and it's our intention to start to significantly expand the sales force and expand lead generation next year.

Even in this environment, we're seeing that the return that we're getting on sales makes economic sense, and we think it's time to dial up revenue growth.

Speaker 2

Sure. Can you comment on the potential value of Agility, if it was sold based on comparables?

Speaker 0

Sure, so there have been a few deals that we've seen in the market over the last 12 or 18 months. I think one of the high comps that we saw was 5X revenue, and the median comp is about 3X revenue.

Speaker 2

Do you think realistically that you can put a 3X value on Agility, I mean, theoretically, or is that unrealistic?

Speaker 0

I think when we look at our plans, we're looking at forward-looking a 30% or more forward-looking compounded annual growth rate. We think that with revenue growth, we're going to be hitting our target margin, so we're going to be moving into Rule of 40 territory very, very quickly. I think that the kinds of valuations we're seeing in the market for this kind of business are what we're seeing, and there's no reason that those shouldn't apply to us as well.

Speaker 2

Sure. Okay. On the bigger picture here, I guess it's all about accurate data. Can you just give some color on the logic between radically expanding your sales force? Was it from 15 to 58, I guess it was, you said in the press release?

Speaker 0

Correct. So we did a deep dive just this summer into strategy in each of our businesses, and the numbers look really good, and they justify expanding sales force in all of our businesses. In the core of the business, the key for our strategy is that we're taking exactly what we know how to do, the creation of high-quality, near-perfect data that used to be a requirement only of a couple of handfuls of information companies, and now it's a requirement of almost any company that is embracing AI. So it's a huge opportunity for us. We're winning customers from people who have been focused on that market exclusively for some time now. We just entered that market in Q4, and we're winning. So it's clearly time to dial that up.

And our confidence that the market there is expanding is confirmed by analysts who were saying that market's going to be going from $1.5 billion now to $3.5 billion in just a couple of years. And it's also you were talking about recent market comps. It's also confirmed by market comps that we're seeing right now in that market. One of our competitors, Lionbridge, sold its $200 million AI data prep business, I believe it was just last week, for 5X revenue. So clearly, there are a lot of sophisticated people looking at this market opportunity and understanding it for what it is.

Speaker 2

Sure. I know you mentioned to me offline that you've had a 70% close ratio when you're able to demonstrate the accuracy of your data. Is that still happening?

Speaker 0

Yeah, that's still holding up, and not only is that holding up, but I think we may even see some expansion in that. The only things that we seem to not close are things that just aren't moving forward for one reason or another, but when you look at just how critical high-accuracy data is to successfully operationalizing AI and creating sound analytical models, people want that high-quality data. It means everything. It's the difference between success and failure, or success and extraordinary success, so that's what we've been doing for the last two decades, is figuring out how do you create near-perfect data, and AI is a broad now requirement. It's moving past experimentation stage at many, many businesses. It's moving beyond voice or, excuse me, moving beyond images to voice and text, and we're just really excited to be part of that right now.

Speaker 2

All right. How about on the Synodex division? Can you give us additional color on how your relationships with these life insurance companies are going?

Speaker 0

Relationships are going very, very well. We're renewing clients as they come up for renewal. As I mentioned in the call, we've seen, looking at the past nine months, 26% year-over-year growth. Looking out to next year, we see that growth accelerating. A couple of drivers there. We're finding some new markets for what we do, number one. Number two, we are successfully integrating our Document Intelligence AI into that platform, which makes it even more powerful. So a lot of excitement there as well. And like the other markets, we're also expanding our sales force for Synodex as well.

Speaker 2

Sure. Sure. Well, I'll do one last analogy and get off the call. I mean, the way I look at Innodata, it's almost like you guys have the only gasoline in town that is clean and makes the engines purr. And the other competition has gasoline with sugar in it, and when they put it in the cars, it sputters. So who wants to do business with people like that?

Speaker 0

Thank you, Tim. I'll be sure to quote you in some of our new proposals. I like the analogy.

Speaker 2

All right. Great. Great. Thanks. Okay. I'm done. Thanks.

Speaker 0

Thank you.

Speaker 3

If you find that your question has been answered, you may remove yourself from the queue by pressing star two. The next question comes from Dana Buska at Feltl.

Hi, Jack.

Speaker 0

Hi, Dan. Good morning.

Congratulations on a nice quarter.

Thank you so much.

You're very welcome. My question is around recurring revenue and your annual contract value on your new AI contract. Can you talk a little bit about how you see that business developing in terms of recurring revenue and what you're targeting the annual contract values to be with the new business you're getting?

Sure. So it's still early days for us. We are seeing that there's a pretty big spread in terms of the ACV value of or the TCV value of engagements that we're signing. And they're ranging from several million dollars to $50,000. One of the things that we are seeing is that by virtue of the way AI is operationalized, it always requires a continuous feed of refined and improved data. So we believe that these projects will have a recurring revenue component to them. That seems to be playing out well. Most likely, there will be an upfront kind of heavy lift and then an ongoing maintenance component to that.

Okay. Great. And then one question around Agility. What do you estimate the total addressable market is for Agility?

If you take the total addressable market for PR communications and communications intelligence, it's about $3.5 billion. If you back out of that newswire, then it comes down to about $2-$2.5 billion. That's what I would consider our addressable market. We are reselling other newswires that are integrated into our platform now, but I think the core market is the targeting and the monitoring piece, and that's about $2-$2.5 billion.

Okay. And then with your annual contract value on that, do you have an average or something that you target for those subscriptions that you are selling there?

Yeah. So it's probably about $5,000-$7,000 for the SaaS platform. The retention rate there is about 80% on a gross basis, but we get about a 10% uplift in terms of increasing seats and increased content and things like that on renewals, typically. On the managed services side, average revenue per customer is probably closer to about $35,000.

Okay. All right. Great. Well, that answers my questions. Thank you, and congratulations on your progress.

Thank you so much.

Speaker 3

Again, if you would like to ask a question, please press star one. It appears there are no further questions at this time. Mr. Abuhoff, I'd like to turn the call back to you for any additional or closing remarks.

Speaker 0

Thank you, Operator. So I'll quickly provide some key closing thoughts. First, we're very pleased to be able to share with you this level of confidence in our business, especially in such trying times. We're expecting to deliver growth in 2020, both on a consolidated basis and across our business segments. Looking out to next year, while there's clearly macroeconomic risk and it's a tough environment in which to predict how companies will budget, we're making investments to position our organization for 20% growth in coming years on a consolidated basis. And we believe that growth will be supported by growth in each of the underlying businesses in which we're confident across the board. We continue to have a strong balance sheet. We're $15.3 million in cash at the end of Q3, which was an increase of $1.8 million over Q2.

And I'll just close by thanking everybody for having joined us today. We'll look forward to reporting our continuing progress.