Innodata Inc Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. 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.

Thank you, Paula. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, Chairman and 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 first 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 the 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 statements that may predict, forecast, indicate or imply future results, performance or achievements. These statements are based on our management's current expectations, assumptions and estimates and are subject to a number of risks and uncertainties, including without limitations, the expected or potential effect of the novel coronavirus COVID-19 pandemic and the response of the government; the general global population, our clients and the company; there too that contracts may be terminated by clients, projected or committed volumes of work may not materialize in whole or in part; the primarily at-will nature of contracts with our Digital Data Solutions clients and the ability of these clients to reduce, delay or cancel projects; 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; our inability to replace projects that are completed, canceled or reduced; our dependency on third-party content providers in our Agility segment; depressed market conditions; changes in external market factors; the ability and willingness of our clients and prospective clients to execute business plans 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 businesses or 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 Form 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.

Thank you, Amy. Good morning, and thank you for joining our call. Today, I'm going to talk about our COVID-19 response, the very exciting momentum we were seeing in our business in January and February, and why we believe we can regain this momentum once things normalized. In mid-January, as news about COVID-19 began to circulate, Doug Kemp, our Senior Vice President, suggested we create a comprehensive COVID-19 response plan. We did that and in early March, AK Mishra, our COO and I, agreed to enable our business continuity plan and our COVID response plan. In doing so, our priorities were; first, to safeguard the health and safety of our team members; second, to provide continuity of service to our valued customers; and third, to maintain intact all of our new AI capabilities so that as things normalize, we can capitalize on the momentum we have enjoyed in our business. Thanks to Doug's initial insights, our well testing protocols for business continuity and the around-the-clock tireless efforts of our global operations teams led by AK, we successfully enabled our BCP on March 11th. We provisioned our team members with laptops and encrypted desktops. We increased security protocols to enable people to utilize personal equipment, we increased Internet bandwidth and we increased the cloud-based processing and storage following close coordination with our customers. As a result, we now have 94% of our global workforce of close to 4,000 people successfully working remotely and we have customers who continue to express their gratitude. I expect we will get to 96% by the end of this week. We started the quarter with significant positive business momentum. Last year, as you recall, we pivoted the company from a publishing services provider to a data engineering company, rolling out new products and solutions to help companies in various markets prepare data for AI and put AI to work in their businesses. In Q1, we've started to see the fruits of our labor in the form of significant increases in the dollar value of new business lines, increasing the number of new customers acquired, as well as a growing pipeline of prospective customer engagements. In the quarter, we signed $6.6 million of net new business and expansions. This was close to double the new business and expansions we signed in the first quarter of 2019. And we brought in 88 new customers, which is 14% more new customers than we brought in during the same period last year. What was most exciting about this new positioning was that it leveraged our core competency, the efficient creation of large-scale perfect quality data, which is always relevant to large publishing and information companies, but which was now becoming relevant to virtually any company that had an AI strategy. With our AI focus, our pipeline soon grew to include banks, hedge funds, online trading platforms and financial services firms, as well as drug companies, drone companies, software companies, and even movie studios. It was exciting to watch our pipeline grow in this way and engage with new kinds of companies to see deals start to close and new customer relationships start to form. Our AI data preparation and AI-based data transformation solutions will clearly align to the market's needs and our rebranding as a data engineering company is resonating. Our platform businesses, Synodex and Agility, were firing on all cylinders as well, each with significant year-over-year increases in backlog. From an operations and COGS perspective, we were running lean and mean coming off of Q4 with gross margins of 38%; this is actually a 10-year high. We anticipated that incremental revenue dollars would continue to bolster this with 50% to 80% of incremental revenue depending on the line of business contributing to gross margins. With our strategy clearly gaining traction and momentum, we thought that 2020 had the potential to be the year in which Innodata pivoted to broad-based growth across our business and segments. Now as you can imagine, once the World Health Organization formally declared a global pandemic, new signings quickly started to get delayed or postponed as customers and prospective customers became preoccupied with their own business disruption with business continuity plans. This slowdown clearly presents a significant level of uncertainty for us. We're all guessing about how and when normalcy returns and the effects and duration of the economic slowdown that is projected. But there is little doubt that we will eventually emerge from this health crisis, and business will cycle back as well. In fact, several important prospective customer engagements that had stalled in mid-March have just in the past week come back to life. I actually think this crisis is going to accelerate global demand for AI services and solutions. We're entering a new era in which AI can help people solve complex problems quickly. AI can spot things people can't. I predict that there will be a much greater emphasis on creating high-quality labeled datasets for AI and harnessing AI to help manage enterprise data. We believe data engineering will be seen as an essential discipline and the key to successfully deploying AI, and that is exactly where we’ll be contributing. Before I turn the call over to Robert, I'll just share a couple of other data points with you. We expect to progress from our current 94% deployment to 100% deployment over the next couple of months as cities where we operate ease their lockdowns, and to reiterate I’m expecting to go from 94% to 96% hopefully by the end of this week. As we do so, we believe we will recapture about $260,000 of monthly revenue run rate. Importantly, we are confident that the projects that produce these revenues will continue to be available to us, and we'll resume as soon as we can accommodate them. On the cost side, we will be incurring about $200,000 to $250,000 of monthly BCP costs during the crisis. These are costs for PC rentals, remote Internet access, and cloud storage that are all necessitated by remote working. We are working on plans to begin reducing these additional costs and/or offsetting them with other cost savings so that if the crisis persists for longer than three months, we will be in a position to reduce these expenses. I'll now turn the call over to Robert, who will take you through the numbers in greater detail, and then I'll share some closing thoughts.

Thank you, Jack. Good morning, everyone. Total revenue was $14.5 million in the first quarter of 2020, which was a 1% decline from $14.7 million in the first quarter of 2019. Total revenue was $13.7 million in the first quarter of 2019. Net loss was $0.4 million in the first quarter of 2020 or $0.01 per basic and diluted share, compared to net income of $0.1 million or zero dollars per basic and diluted share in the fourth quarter of 2019. Also, we had a loss of $0.05 million or $0.02 per basic and diluted share in the first quarter of 2019. Income before income taxes in the first quarter of 2020 was $51,000 and included $200,000 of expenses in connection with the activation of our business continuity plan across our 12 global locations as a result of the COVID-19 pandemic, and also included foreign exchange losses of approximately $100,000 from the revaluation of monetary assets and liabilities. Our cash and cash equivalents remain stable at $10.7 million as of March 31, 2020, compared to $10.9 million at December 31, 2019. Thank you, operator, we’re ready to take questions now.

Thank you. We will take our first question from Tim Clarkson with Van Clemens.

Just some basic questions, just in terms of the first quarter. I know there's a little bit of seasonality within it that isn't typically the fourth quarter seasonally the strongest in the first quarter seasonally one of the weaker quarters?

Tim, that's absolutely right. And that comes about for several reasons. There's usually a push for companies to ease up their budgets in Q4, and there are some underlying conferences and proceedings that generate a lot of content. So our Q4 is typically high, that's correct.

And I know you've been shifting the company with this emphasis in artificial intelligence. How do you actually go out if you're working in these new areas like banks and hedge funds and drugs and so on? How do you actually prove that you're better than the competition? What's that process like?

One of the most critical things we can do now is demonstrate our technology through live demos. We can integrate people into our API and showcase the capabilities we're able to deliver, and these live demonstrations have been very compelling. People can see what is possible, marking a significant transformation in data annotation. We often receive requests to provide samples; either we’re given a dataset and asked to annotate it, or we are compared with some of our new competitors in this space. What we are discovering is that in head-to-head competitions for customers, our prospects find that our data quality is significantly better because we have been in the data quality business for decades. Many of our competitors are well-valued companies, including startups, but they lack our infrastructure. In these direct comparisons, we consistently perform strongly and come out ahead.

You mentioned that you're working with a major brokerage firm and that they were almost astounded at how much better you were than the competition?

A lot of our competitors relied on crowd sourcing companies that provision work out to crowd source labor typically for language translation. They jumped on the bandwagon for data preparation for AI. The problem is that data stopped, and it's taken us a long time to develop the tools and the processes to carefully control the data. Working for the kind of companies that we worked for, like Apple and Bloomberg, there is no tolerance for data error. As a result, we have built over time great processes and technology for delivering near-perfect data. All of that becomes repurposable as we expand into new markets. In AI, data quality is critically important. If you train your AI on bad quality data, you've got a bad quality AI solution. It's garbage in, garbage out; the errors not only persist but they multiply, they become like a cancer. So the critical element here is very, very high-quality data. That's what we're able to do, and we have a competitive advantage because it's what we've been about for so long. The really exciting thing is we get to be who we are and with some modifications, the creation of some demo products and APIs, we’re now able to leverage ourselves into this much broader market.

And how do you compete in terms of costs? Are you cost competitive with the competition too?

We are, and that’s also really good. We always used to say we can be fast, good, or cheap. You can pick two out of three. We’re finding in these markets we can be three out of three. Our quality can be better, we can move and deploy to get things done faster, and we can be either cheaper or easily cost-effective from a pricing perspective.

And are these good gross margins for Innodata once you do get the business?

They seem to be. The gross margins that we’re targeting and showing today, we think we're going to be in a position to sustain those margins as we move into these new areas. As we continue to grow some of our stickier solutions and long-term partnerships emerge, our platform businesses continue to grow; we think there's a good opportunity to continue to push those margins higher. I'm really proud of the fact that the business in Q4, so we have the COVID cost and kind of up and down, we've gotten to an operational efficiency level, producing the highest gross margins in 10 years. You take that and now you start to put revenue growth with substantial operating levers on top of that, and it gets really exciting.

And you're using artificial intelligence in the legacy businesses already, right?

Yes, and in other words that's getting started. You may recall that two years ago what we like to call our act one was let’s see if we can figure out how to use AI with large data sets internally to drive margins. For a few years, when we experimented, we succeeded, we failed, we pivoted, we grouped but we figured out how to deploy machine learning and AI in the service of creating very high-quality annotated data sets. What we did last year was we figured out how we can take that capability and pivot it so that we can use it not as an internal tool, but as an external product to address larger markets.

Can you explain just on a couple of these new areas that we're getting involved in. For example, movie studios. How would artificial intelligence help them?

So, if you take a movie studio, for example, they need to manage vast amounts of contracts and agreements regarding rights and royalties, what images and videos they have the right to use in what kind of channel; it's a very complex area. As movie studios and television studios start to look out and expand their channels and think about streaming services and new means of distribution, they need to go back and say do we have the right permissions lined up to be able to use this content in this new way. It's not a trivial problem. It was really slowing them down because to figure that out, they’d have to hire teams of lawyers to take weeks or months to do the research. What we're able to do is to take all of that data, put an AI on top of it, extract the key data terms out of that, and return back in a platform that can do that research almost in real time.

How about drones, how are they using AI?

There's a lot of interest in tracking supply chains and the physical movement of items and predicting supply chain disruption. One way of creating that data is to use drones to capture images of your ships delivering cargo, and trucks being packed and moving products across the nation. The drones can capture those images. But to turn that into data requires AI that can actually look at those images, recognize them, identify the contents, and assign data values to them. It's very similar to the AI technology that's being used in autonomous driving systems. Creating these systems will give companies the ability to foresee supply chain disruptions and to address that quickly. Drone technology captures the images, but what the AI does is it turns those images into actionable data.

How about banks, how does it help banks?

In so many different ways. We're working on several really interesting use cases. One use case is banks have, especially over the last several years, faced some huge regulatory fines and penalties they’d like to avoid. The key to avoiding fines and penalties is to know what the laws are that need to be complied with. When there’s a change in the law, it triggers operational changes within groups inside the bank who are responsible for maintaining those obligations. When regulators come in for audits, everything needs to be in good shape. There's a huge amount of global regulation, and it's changing over time, being published, and revised continuously. Our abilities to manage and monitor all that change and help banks understand it as it occurs, place them in a much better position to comply and thereby avoid billions of dollars of fines. Another great use case is banks handle loan documentation, bond debentures, and tons of documents that are very dense and lengthy legal contracts. Historically, they depended on teams of lawyers to interpret these things, which takes time. With our systems, they're able to extract key data points from all those documents, push these data points into a platform we call product analytics, and react very quickly to market changes. One of the largest hedge funds in the world, I can't use their name unfortunately, just in February of this quarter, started using our system, and they loved it. We see a lot of opportunity to grow in this area as well.

One last question. Can you comment, I know you hired new salesmen? How many new salesmen did you hire? What kind of competencies do they bring in? Are they bringing in new business?

So regarding three or four new people, I'm nearly looking to extend that further. We're going to take a little slow until we see how things are shaking out. But they are gaining good traction and starting lots of fascinating new conversations. One of the things they bring to the table is their network; they're not from publishing but from banks and Silicon Valley, and they've got different kinds of experiences in different networks. That's been really helpful to us. I talked in the call a little bit about how a few things installed in mid-March are starting to unfold a bit, and just last week, two examples of that occurred: one very large technology company is exploring embedding our solution into their go-to-market solutions, and another very large insurance company has a completely different use case. These are leads that are being generated and worked on by our new sales force.

Well, good. I've been hogging up the call. So I'll see if anybody else wants to get in. Otherwise, obviously it’s an improved quarter, and as this COVID situation gets resolved, hopefully we'll see significant better sales and earnings. So thanks.

Thank you. We have a question from Joe First with First Associates.

Could you explain a little bit on your other businesses and tell us a little bit about how they're going?

The real good news in both Synodex and Agility is that as we were approaching the year, we had in both cases sold booked work that exceeded the revenue we did the year prior. So very good traction. We had branched out to new use cases and new segments of the market that we’re very positive about. There is a lot of very strong momentum in both of those businesses. Our Agility business is ranked by an independent analyst firm who surveys customers to draw their conclusions. We were ranked as the number one product in its industry, which is just mind-blowing when you think about the fact that the two largest competitors in that industry are $800 million companies and $250 million company, and we're there at $10 million with the best product out there. We have made additional improvements to the product that made it very strong in an area we felt we were a little weak in, and sales were going very, very well. Synodex was more impacted from a revenue perspective on the supply side than Agility was by virtue of the nature of the business. Agility is a little bit more impacted in terms of the need to sell new business, and sales have been a little tough since mid-March. But on the Synodex side, we're solving the supply-side problems, closing that gap from 94% to 96% hopefully by the end of this week. We're confident and cautiously optimistic that as the world starts to gain its footing in the new normal, we will see progress in both of those areas as well. On the Synodex side, it was interesting: we had a couple of customers that we weren't able to take care of due to not having access to our equipment, but we've scrambled and come up with workarounds for them. They told us that as soon as we're back, they absolutely need us engaged. They are critical to their smooth operations, their ability to process life insurance applications, which you know has been on the rise recently. So, real good momentum and our efforts now are to conserve that momentum and to put ourselves back in a position to drive those businesses forward as the crisis settles in or alleviates.

And at this time, I would like to turn the conference back to Mr. Abuhoff for any additional or closing comments.

Thank you, operator. I'll quickly provide some key thoughts to close. Because we’re well positioned to address the crisis and because we triggered our BCP early, we truly came through for our customers. Our teams are now 94% fully functional. We expect this to get to 96% hopefully by the end of this week and then progress to 100% over the next couple of months as lockdowns are softened. This delta now represents about $260,000 of monthly revenue run rate. I'm confident that as soon as we're able to accommodate it on the supply side, the demand side is going to be intact. We entered 2020 seeing strong positive market validation for our new positioning as a high-value AI-based solutions provider. As a result of COVID-19, we’re in a tough business environment, but I think we can make meaningful progress in 2020. We are continuing to book new business at a lower level than we were in January and February, but we're seeing some signs that that's going to improve as well. We'll be continuing to optimize our cost structure to align with revenue curves. But against this, we’re going to protect our key new skills and capabilities so that as the world returns to normalcy and people settle into the new normal, we're in the best possible position to resume stronger momentum. We’re bolstered by the fact that 83% of our revenue is recurring in nature or subscription-based, and our customers serve diverse markets. We presently have $11.1 million cash. In the current quarter, we generated $700,000 in cash from operations. So again, thank you for joining. One other observation: I actually think that the COVID-19 crisis is going to end up shedding light on how powerful the tool AI is to solve complex problems. As a result, we’re probably going to end up with the best case study for AI imaginable. I think AI is going to accelerate and I think we're going to be in a great position to respond to that increased demand. Thank you all for joining today. Please do stay safe and continue to be optimistic and persevere. Let’s look forward to continuing to build momentum through 2020.

Thank you. Today's conference is available for replay from 2 p.m. Eastern Time today to June 13, 2020, at 2 p.m. Eastern Time. You may access a recording by dialing 719-457-0820 or 1-888-203-1112 using passcode 9231591. Again, those numbers are 719-457-0820 or 1-888-203-1112, passcode 9231591. This concludes today's conference. You may now disconnect.