Transcript
Thank you, Paul. Good afternoon, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, CEO of Innodata; and Marissa Espineli, Interim CFO. Also on the call today is Aneesh Pendharkar, Senior Vice President, Finance and Corporate Development. We'll hear from Jack first, who will provide perspective about the business, and then Marissa will follow with a review of our results for the first quarter. We'll then take your questions. Before we get started, I'd like to remind everyone that during this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations, assumptions and estimates, and are subject to risks and uncertainties. Actual results could differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's earnings press release in the Risk Factors section of our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission. We undertake no obligation to update forward-looking information. In addition, during this call, we may discuss certain non-GAAP financial measures. In our SEC filings, which are posted on our website, you will find additional disclosures regarding these non-GAAP financial measures, including reconciliations of these measures with comparable GAAP measures. Thank you. I will now turn the call over to Jack.
Good afternoon. We are very excited to be here with you today. We have lots of updates to share regarding the accelerated momentum we are experiencing across our business. First and foremost, we are pleased to announce record revenues for the quarter of $26.5 million, representing 41% year-over-year growth. Our growth in the quarter was driven by the value we are bringing to help the world's largest tech companies build AI large language models or LLMs. As a result of accelerated business momentum, we are raising our 2024 revenue guidance to an expected organic revenue growth of at least 40% year-over-year. This is double the growth rate we guided to last quarter. We are executing a multi-pronged strategy designed to deliver extraordinary levels of growth over the next several years as we extend what we believe is our early leadership in generative AI solutions. We're focused on providing solutions at three levels of the Gen AI stack. At the bottom layer, helping some of the world's largest tech companies and independent software vendors, or ISVs, develop generative AI foundation models. In the middle layer, helping enterprises that prefer not to build models from scratch, but rather to leverage existing LLMs and other AI customized for them with their own data. And at the top layer, building generative AI enabled platforms that are useful for niche industry requirements. Our primary focus this year is on that first layer of the stack, partnering with some of the world's largest tech companies to develop generative AI foundation models. We are pleased with the success we are having thus far. We entered the year with agreements in place with five of the so-called Magnificent Seven companies, which are a group of well-known high-performing big tech companies we believe will spend billions of dollars on generative AI data engineering over the next several years. We announced today that we were awarded yet another program expansion from one of our big tech customers. We're valuing this expansion at approximately $23.5 million of annualized run rate revenue once implemented. This is on top of the $20 million in new programs with this customer we announced less than two weeks ago on April 24. We expect that these programs will ramp up over the next two months. While our customer agreements typically contain early termination upon notice provisions, we believe this customer is committed to a significant multiyear LLM strategy from which we stand to benefit. In fact, we are in discussions with this customer regarding potential new programs and expansions beyond what we have announced so far. We also signed two additional big tech companies, a large prominent generative AI company and a large prominent consumer-facing ISV investing substantially in generative AI foundation models. As a result of these new wins, we now serve seven big tech customers. We believe we will continue to grow with these customer relationships in 2024 and that we may grow some of them possibly quite substantially. For big tech customers, we provide a broad range of services to support their generative AI programs. This includes creating instruction data sets, which you can think of as the programming behind large language models. It also includes human preference data used in reinforcement learning and reward modeling to align models to human preferences and build guardrails against toxic biases and harmful responses. In the blog post last month that accompanied a major release, one of our large big tech customers stated that the quality of these instruction data sets has an outsized influence on the performance of their models and that some of their biggest improvements in model quality come from carefully crafted instruction data sets and multiple rounds of quality assurance. This statement crystallizes why we have become the partner of choice for such customers. We believe we are well positioned to anticipate big tech's changing needs and to grow with them. It is evident that big tech's aspirations extend beyond today's predominantly text-to-text English language models. We foresee expansion in terms of multimodal models, domain and task-specific models, models natively built in more than 30 different languages, and models capable of complex reasoning. All of these dimensions will require modeling with the kind of data that we create. We believe we are still in the early innings of this journey. I encourage you to read the latest quarterly earnings transcripts from the Mag Seven. Generative AI is a prevailing theme with promises of more Gen AI models, more Gen AI products and commitments to multiyear investment cycles and CapEx increases to support aggressive AI research and product development. We believe the emerging enterprise market, which we call the middle layer, consisting of companies across verticals that seek to adopt generative AI technologies will be another important growth factor for Innodata, one that will ultimately dwarf the big tech market for us. In parallel with executing strategies to penetrate big tech, we're taking steps to prepare for what we foresee as a likely explosion in the enterprise space. We believe we are very well positioned due to our intimate knowledge of the Gen AI roadmap of the large tech companies, which has enabled us to gain exceptional domain expertise in the future product needs of the enterprise market. We believe that enterprise adoption is about to enter a Cambrian period of explosive growth as a result primarily of three technology developments now underway. I'll explain and illustrate each with examples. Today, enterprise users of generative AI are mostly using ChatGPT as a stand-alone application. We'll call this Level 0 use case. For example, if I'm an HR Director at Innodata, tasked with revising Innodata's employee handbook, I can prompt ChatGPT to write a first draft of the vacation policy. Companies are now shifting from this Level 0 to what we think of as Level 1. We think of Level 1 systems as those based on retrieval-augmented generation, or RAG, which we believe are likely to become better performing for reasons I will explain shortly. RAG systems couple search technology and prompt engineering. With such a Level 1 system, an Innodata employee might prompt an Innodata HR chatbot with a request like, please summarize for me Innodata's vacation policy. A search engine working behind the scenes would then retrieve Innodata's vacation policy from a large document repository and insert it into the prompt as context with an instruction to the LLM to answer the question primarily based on the inserted policy. RAG-based systems are about to become more useful as the latest crop of soon-to-be released LLMs offer significantly expanded context windows. The context window refers to the amount of retrieved information that can be included with the prompt. By including more context, the chatbot can become more consistent, relevant and useful. One of the big tech companies is about to release a new model with a context window that is eight times larger than that of OpenAI's GPT-4 Turbo, enabling you to include, for example, 3,000 pages of documents in a single prompt. Today's expert or advanced expert augmentation systems are, for the most part, RAG-based systems that combine generative AI with humans in the loop to deliver improved productivity. In a few minutes, I'll give you an example of such a system we started working on for a customer in the quarter. We believe the second technology development called agentic workflows will enable what we'll call Level 2 systems. With an agentic system, rather than asking a question to a chatbot, you present a goal to a virtual agent. Your virtual agent then accesses multiple back-end systems and LLMs talk to each other to accomplish your goal. Agentic workflows really open up the kinds of things you can ask computers to do with LLMs. With an agentic system, an Innodata employee might ask a virtual Innodata agent, please look up how many days off Innodata employees get, check how many days off I have left and request a week off around my son's graduation, so long as there are still available hotels in Boston. Imagine that. Now while the full realization of agentic workflows may be years away, we believe incremental progress is being achieved and will likely accelerate. The third development that we believe will accelerate enterprise adoption is that the cost of training and serving models is likely to go down dramatically, making it possible for enterprises to train and serve models at scale. Once this happens, we believe that companies are likely to want to fine-tune their own models rather than relying on RAG-based architectures. We'll call these Level 3 systems. Level 3 systems will support more complex use cases and enable sensitive information to be processed in private clouds or on-premises rather than being served up as context to third-party foundation models. We intend Innodata to offer enterprises all of the services they require to navigate the journey from Level 0 to Level 3 and beyond. This will include custom development, integration and fine-tuning services, as well as managed services, services around data readiness and data governance, and industry-specific workflow platforms. We are not alone in our thinking that the enterprise market for generative AI is about to explode. In a report last year, Bloomberg estimated that the market for generative AI-focused IT services will grow to nearly $22 billion by 2027 and to nearly $86 billion by 2032, representing a 100% compounded annual growth rate for the 10-year period from 2022 to 2032. To position ourselves to drive enterprise growth, we are expanding our talent base, creating new accelerators and winning new reference engagements. This quarter, one of the largest legal information companies in the world engaged us to develop a new LLM-based workflow system for their complex operational processes, spanning legal and regulatory law in multiple European countries and multiple languages. This is an example of what I referred to a few minutes ago as an advanced Level 1 system. Our implementation uses GPT and a combination of several techniques, including chain of density, prompt engineering, and a vector database with similarity matching. Our generative AI-enabled workflow system is expected to enable the customer to drive significant operational savings across high-cost processes that previously relied entirely on humans with language and legal expertise. This quarter, we also delivered a generative AI-powered tool that gathers on-the-fly insights from large-scale textual data, contextually analyzes the data for specific areas of interest and performs language translations. Its technology aims to increase an organization's efficiency by ensuring knowledge workers are equipped with the intelligence needed to make informed decisions. We built it into our Agility Public Relations platform, where we call it Intelligent Insights. We made Intelligent Insights generally available to Agility customers in the quarter, and it has been well received. To build the solution, we utilize RAG-based prompt engineering. We recently demonstrated it as an accelerator to one of our large banking customers, and it inspired a POC that we are now executing. Agility revenue in the quarter increased 16.5% year-over-year. We have over 1,400 direct customers and we're generating cash. We've been leaders in the industry, rolling out cutting-edge generative AI functionality that is bending the productivity curve for PR and communications professionals. We started early last year with the release of PR CoPilot, a generative AI implementation that helps people write press releases and media pitches. In Q1, we announced the general availability of Intelligent Insights. We are planning another five significant generative AI feature releases over the course of the second half of this year and into the first quarter next year. As a result of what we believe is our generative AI leadership in the PR space, in the first quarter, we converted over 35% of demos to wins, up from less than 20% prior to the implementation of our generative AI roadmap. Our customers told us that one of their biggest challenges was that they needed more hours in the day. With our generative AI innovations, we're making tactical PR a less labor-intensive process, giving our customers the time back they need for strategic thinking. For both the big tech market as well as the enterprise market, we see additional opportunities in model safety evaluation and responsible and ethical AI. We began working on trust and safety for one of our big tech customers in Q4 2023, providing model assessment and benchmarking services, which help ensure that models meet performance, risk and emerging regulatory requirements. We learned a lot from the work and development we've been doing on this engagement. So we decided to share our learnings, tools and innovations with the market more broadly. Just a couple of weeks ago, we announced our release of an open source LLM evaluation toolkit together with a repository of 14 semi-synthetic and human-crafted evaluation data sets that enterprises can utilize for evaluating the safety of their large language models in the context of enterprise tasks. Using the toolkit and the data sets, data scientists can automatically test the safety of underlying LLMs across multiple harm categories simultaneously. Developers can understand how their AI systems respond to a variety of prompts and can identify remedial fine-tuning required to align the systems to the desired outcomes. We expect to release the commercial version of the toolkit and more extensive, continually updated benchmarking data sets later this year. In Q1, we won two additional engagements for LLM safety and evaluation, one for a hyperscaler's own foundation models and one for an enterprise customer of the hyperscaler through the white label program we have in place with the hyperscaler. In addition, in Q1 2024, we started pilots for a new customer and an existing customer around LLM trust and safety. I'll conclude with this. We believe we have an incredible opportunity in front of us. We have the talent, capabilities and scalability to support the world's leading companies' efforts to build AI models and services and to help enterprises advance AI and generative AI technologies. We can drive best-in-class growth over the next several years and maintain our early leadership position in generative AI services. Moreover, we believe we can accomplish this without the need to raise equity, incur debt or burn cash. This year, based on our current growth forecast, we intend to invest approximately $3.5 million in recruiting costs to scale our business and approximately another $3 million in new sales, marketing and product development talent. The recruiting costs relate to the significant increase in revenues we expect this year and will not be incurred next year to support that revenue going forward. The investment in sales, marketing and product development are incurred to continue our growth momentum, and we anticipate that they will yield revenue and profitability benefits primarily next year and beyond. We anticipate approximately 70% of the recurring recruiting costs to be incurred in Q2 and most of the OpEx investment to be incurred in the second half of the year. We are making these investments while simultaneously driving year-over-year growth in adjusted EBITDA and building cash on our balance sheet. At the end of Q1, our cash balances were $19 million, up from $13.8 million at the end of Q4 2023, driven by positive cash flow from operations and tight working capital management. I'll now turn the call over to Marissa to go over the numbers, and then we'll open the line for some questions.
Thank you, Jack, and good afternoon, everyone. Let me briefly share with you our 2024 first quarter financial results. Revenue was $26.5 million, up 41% from $18.8 million in the same period last year. Net income was $1 million or $0.03 per basic and diluted share compared to a net loss of $2.1 million or $0.08 per basic and diluted share in the same period last year. The adjusted EBITDA was $3.8 million compared to adjusted EBITDA of $0.8 million in the same period last year. Our cash and cash equivalents and short-term investments were $19 million at March 31, 2024, and $13.8 million at December 31, 2023. We currently have an unused line of credit of $10 million with $9.2 million as borrowing base. So thank you, everyone. Paul, we're ready for questions.
Congratulations on the strong sales results and the positive feedback from customers who are providing additional business. Jack, I have a quick question. It's evident that companies can expand organically, but they can also grow through acquisitions. I would like to know your thoughts on the significance of acquisitions for your future growth.
Aria, thank you for the question. So the business plan that we're currently executing successfully is an organic-only plan. We've got a strategy in place that we think we can successfully deliver through organic growth and through the resources that are available to us and that we're able to augment our team with. From time to time, we will kick the tires on potential inorganic opportunities. But I think the important thing is that we're not dependent upon that for growth. We recognize that those come with risks that are not necessarily risks that one incurs with an organic strategy, and that's the way we're executing right now.
Understood. The follow-up question is about organic growth. Specifically, what kind of sales per employee can you expect when primarily providing services to large technology companies? Additionally, what gross margin range do you anticipate achieving with optimal utilization of employee time?
We aim for approximately 40% adjusted gross margin when excluding one-time recruiting expenses associated with our revenue growth and the sales and marketing investments that we plan to see returns on in the following year. We don't specifically track revenue per employee, but it's significant and noteworthy. Our revenue per employee, especially due to the large language model projects we're working on, is likely four to five times higher than what we've historically experienced with our business process management services.
Got it. And just finally, in terms of employee retention, you're going to be in a more competitive marketplace for employees in the future. And I'm just wondering what you're putting in place to try and make Innodata a place that people really enjoy working at where your churn, hopefully, our turnover employees will be kept to a minimal level.
Over the years, churn has generally not been an issue for us that we couldn't handle. We have managed to keep it significantly lower than that of most of our competitors. In the last quarter, we were recognized as one of the best places to work in two of our locations. We are confident in our ability to manage it and are very enthusiastic about the growth opportunities ahead of us.
Jack, it’s clear that you had a strong quarter. I want to go over some basics for those of us who may not be as familiar. When I first learned that Innodata was getting into artificial intelligence, a key insight into your success was the high level of accuracy you achieve. A top executive from IBM mentioned that they face a 75% failure rate primarily due to inaccuracies. In contrast, I understand that you only make about three mistakes in 20,000 annotations. Can you elaborate on how this fundamental skill sets you apart from the competition, even as you clearly do much more?
Thank you for the question, Tim. I completely agree that data quality is essential for achieving excellent model performance. We've had customers recently attribute their recent improvements to enhanced data quality, and we're proud to support them in this effort. It's rewarding to see these positive outcomes translating into growth and further opportunities. Regarding large language models, there are three key components: compute resources, data science expertise, and data engineering efforts. Given the substantial investments and strategic focus these companies are making in their developments, it's crucial for them to have high-quality data to create accurate models. We believe we are well-positioned in this landscape, doing excellent work, and are optimistic about the future.
Right. Now just as kind of an extension to that idea, I mean one of the challenges, obviously, with Innodata historically was you do a project and then it ended and there wasn't a durability of revenues. Can you comment on how durable you think this new business model is going to be into the future?
So I think it's extremely early days still. We see lots of developments that are taking place. I mentioned several of those. We believe that we're still in the early innings of executing all of these opportunities. We're starting to now talk to our customers about multimodal models, about multiple languages, more complex reasoning tasks if they want the models to be able to take on domain and task specificity. All of these things are early for them, and we think we're early in our partnerships with them such that we're going to be able to drive multiyear growth as a result of their multiyear investments. And at the same time, we're landing more companies, and we're getting into the enterprise opportunity. So we think there's a tremendous amount of growth opportunity in front of us.
Historically, in the past when your projects were at their peak, you were generating $20 million and managing to net 15% to 20% after tax. It seems like you are currently facing some one-time expenses related to sales investments, but aside from that, there appears to be a significant potential to achieve 15% to 20% pretax margins once you establish a consistent performance.
So yes, I think that that's certainly what we're pursuing. We think the opportunity is there. We also think it's important. As I mentioned, to be investing in our growth, we believe that we have an opportunity in front of us to create a truly great company, and we're very excited about that.
Now these investments would be directly tied into AI then, right, on that part of the business?
Exactly right.
Right. Great. Well, good luck. It's an exciting future.
Congratulations on a wonderful quarter. I have just a couple of questions for you. You talked a little bit about the demand for training on enterprise data. Can you talk a little bit more about that? And are you seeing more enterprises look to train their own models?
I believe we will see more enterprises training their own models as the costs decrease, which we think is inevitable. Currently, enterprises are mainly focused on using their own data as context within Retrieval-Augmented Generation implementations. Even with this focus, there are many opportunities being piloted and in proof of concept stages, and we are still in the early days of moving from development to implementation. We are prepared to assist in this process. The quality of data feeding these models and the improved integrations, particularly with larger context windows, will enhance the outcomes of these models and their capabilities. We are well positioned to support enterprises in transitioning from proof of concepts to development, and we are actively doing that now.
Okay. Great. In a lot of those lines, I seem to read or come across articles about how companies are coming up with tools and software to speed up, fine-tuning and doing trust and safety. Could you talk a little bit about how that may affect your business? And do you consider that to be a threat?
No. We consider that to be an opportunity. The more success we have and the world has at moving things from POC into development, the more acceleration we will see in the technology and the opportunities that we have. We are among the companies who is developing capabilities around trust and safety. We're very excited about that. Again, it's a data-driven initiative and a data-driven approach that we're taking that we believe will help companies along in that path.
Okay. Excellent. That sounds exciting. And when you're looking at hiring these new recruiting costs, could you talk a little bit about hiring the new people? Could you talk a little bit about what type of positions you're looking to hire?
So we're hiring very broadly. We're hiring people who have the ability to help us build the kinds of data sets that we require to train these models. A lot of the people that we're hiring are language experts, they're domain experts, they're linguists, they're people with backgrounds that enable them to appreciate nuance and language. As we think about these models, it's language that is used to program them. And the more fine-tuning we can do around the nuances of those languages, the better performing the models are.
Okay. Great. And then one question about Agility. It looked like it grew about 20% last quarter. Is that a growth rate that you are targeting for this year? Or is that a growth rate that you think is sustainable?
So I think it was about 15%, if I'm not mistaken.
Yes. Dana it was 17%.
17%. Yes. So I think 15% to 20% is certainly what we would aspire to. We could do a lot more with more reinvestment in it, and that's something that we would probably be considering at some point. But right now, we're very focused on capital allocation relative to the service opportunities we have with the large tech companies.
Jack, congratulations. It seems like you're getting a lot of traction. Just to quantify the size of these contracts and some of the new additions. You mentioned the $23.5 million add-on to the $20 million hyperscaler that you announced in April. I guess that was the one that was doing $23 million a year that extended it for three years. So that alone is a $43.5 million add-on from the $23 million, which on a base of $86 million last year, that's over 50% growth rate just from one customer. Can you give us some quantification on some of these other contracts, how big they could be and how much they can scale to?
Sure. As I mentioned, we are currently collaborating with seven major tech companies. We believe that across this portfolio, all of them are investing significantly in these technologies, much like the company you referenced. We see an opportunity to scale our efforts with each of them. While it would be great if all of them grew to the size of that company, I cannot guarantee that will happen. However, we are certainly well positioned for growth. This quarter, we acquired two additional customers who are significant players and seem very enthusiastic about partnering with us. When we evaluate the potential, we are confident that our 40% growth target, which is double what we shared last quarter, remains a reasonably conservative estimate. We have many opportunities in progress, and we are adopting a cautious perspective on our pipeline to bolster our growth guidance. It is an exciting time for our business.
So looking at your current infrastructure, your personnel and your installed base, I mean, do you have the capability? I mean adding $3 million in personnel and $3 million in CapEx seems a very modest amount for the scalability and the upside that you have with all these huge contracts coming through.
So the investments that I spoke about were investments in the recruiting costs associated with adding the headcount that is required for the near-term contracts to get to that 40% growth, and other investments that we're making in sales, marketing and product development. I'm not including in those numbers, the costs that we would be incurring as cost of goods. But again, from a cost of goods perspective, I think you should look at it as an opportunity to drive in the services area, probably about 37% adjusted gross margin. And that would assume the costs of producing the revenue.
Okay. And also, as far as the cash generation, you generated like $5.2 million in cash. Is that mostly from receivables? Or is it pure cash from operations? Or a combination thereof?
Yes. I mean, it's cash from operations that include receivables. So as we build, we then collect.
Thank you. And that does conclude today's Q&A session. I will now hand the call back to Jack Abuhoff for closing remarks.
Thank you. So yes, we're off to an exciting start for 2024. And my team and I are tremendously energized by what we believe we will accomplish in 2024. We grew revenue by 41% year-over-year in Q1. We anticipate a substantial sequential revenue increase next quarter. And for 2024 overall, we have raised our guidance from 20% to at least 40% year-over-year expected organic-only revenue growth. Today, we announced yet another substantial customer win, this one worth approximately $23.5 million of annualized revenue. This is on top of the win with the same customer we announced a couple of weeks ago, valued at approximately $20 million of annualized revenue. We also announced the signing of two additional big tech customers, both of which we believe will contribute to 2024 revenue growth. Longer term, in addition to expected continued growth from our big tech customer base, we expect increased market demand from enterprise customers that we hope will continue to accelerate our growth trajectory. We're super excited about the work that's underway. We are laser focused on creating long-term shareholder value. And thank you all for attending today's call. We'll be looking forward to our next call.
Thank you. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.