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Edited Transcript of INOD earnings conference call or presentation 14-Mar-19 3:00pm GMT

Q4 2018 Innodata Inc Earnings Call

HACKENSACK Mar 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Innodata Inc earnings conference call or presentation Thursday, March 14, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amy R. Agress

Innodata Inc. - Senior VP, General Counsel & Corporate Secretary

* Ashok Kumar Mishra

Innodata Inc. - Executive VP & COO

* Jack S. Abuhoff

Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer

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Conference Call Participants

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* Joe Furst

* Timothy Clarkson

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Presentation

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Operator [1]

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Good morning, and welcome to the Innodata Fourth Quarter and Fiscal Year 2018 Results. 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.

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Amy R. Agress, Innodata Inc. - Senior VP, General Counsel & Corporate Secretary [2]

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Thank you, Jon. Good morning, everyone. Thank you for joining us today. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata; and A.K. Mishra, our COO.

We'll hear from A.K. first, who will provide a detailed review of our results for both the fourth quarter and the 12 months ended December 31, 2018, and then Jack will follow with additional perspective about the business. We'll then take your questions.

First, let me qualify the forward-looking statements that are made during the call. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including, without limitation, that contracts that may be terminated by clients; projected or committed volumes of work may not materialize; 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; continuing Digital Data Solutions segment revenue concentration in a limited number of clients; inability to replace projects that are completed, canceled or reduced; our dependency on 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 which give rise to requirements for our services; difficulty in integrating and deriving synergies from acquisitions, joint ventures and strategic investments; potential undiscovered liabilities of the 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 growing competitors; various other competitive and technological factors; and other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission.

We undertake no obligation to update forward-looking information, and actual results could differ materially.

I will now turn the call over to A.K.

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Ashok Kumar Mishra, Innodata Inc. - Executive VP & COO [3]

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Thank you, Amy. Good morning, everyone. Thank you for joining us today to review our financial performance for the fourth quarter and fiscal 2018. I will start with the full year 2018 performance, and then review the quarterly performance. Jack will later provide additional perspective on the business.

Our revenues in 2018 were $57.4 million compared to $60.9 million in 2017. In both years, we incurred one-time cost and charges. In 2018, we incurred a noncash goodwill impairment charge of $675,000. In 2017, we incurred one-time cost and charges amounting to $2.4 million, which were allocated $2.2 million to the Digital Data Solutions segment and $150,000 to the Agility segment. After excluding the impact of onetime cost and charges, our adjusted EBITDA in 2018 was $6.7 million compared to adjusted EBITDA in 2017 of $1.7 million. Our 2018 adjusted EBITDA was comprised of $7 million in the Digital Data Solutions segment and $450,000 in the Synodex segment, offset in part by an EBITDA loss of $700,000 in the Agility segment.

I will now review year-over-year performance, excluding the impact of these onetime cost and charges. Revenues in our Digital Data Solutions, or DDS segment, were $43.5 million in 2018 compared to $47.8 million in 2017. DDS gross margins were 32% in 2018 versus 25% in 2017. And DDS adjusted EBITDA was $7 million or 16% in 2018 versus $3.7 million or 8% in 2017. The DDS segment margin improvement was the result of reduction in direct operating cost of $6 million.

In our Synodex segment, revenues increased to $4.1 million in 2018, up from $3.7 million in 2017. The increase was driven by revenue expansion from existing customers. Net income in the Synodex segment was $400,000 in 2018 compared to a loss of $600,000 in 2017. This improvement is largely due to technology-driven efficiency improvements. In our Agility segment, revenues increased to $9.8 million in 2018 from $9.4 million in 2017. In 2018, adjusted EBITDA was a loss of $0.7 million compared to a loss of $1.2 million in 2017.

I will now review key line items and segment performance on a sequential quarterly basis, comparing the fourth quarter with the third quarter.

Total revenues in the fourth quarter were $15 million compared to $14 million in the prior quarter. On a segment basis, DDS revenues were $11.5 million in the fourth quarter compared to $10.7 million in the third quarter. Synodex revenues were $1.1 million in the fourth quarter compared to $1 million in the third quarter. And Agility revenues were $2.4 million in the fourth quarter compared to $2.3 million in the third quarter.

On consolidated basis, gross margins, excluding onetime cost and charges, were $5 million or 33% of revenues in the fourth quarter compared to $4.8 million or 34% of revenues in the third quarter, an increase of $0.2 million. The increase in gross margins primarily reflects the increase in revenues, offset by foreign exchange losses sustained in the fourth quarter.

At the segment level, gross margins in DDS were $3.8 million or 33% of revenues in the fourth quarter compared to $3.8 million or 36% of revenues in the third quarter. Gross margins in our Synodex segment increased to $350,000 in the fourth quarter from $200,000 in the third quarter. In our Agility segment, gross margins were $800,000 in the fourth quarter or 35% of revenues, up from $700,000 or 32% of revenues in the third quarter. The increase in gross margins in all segments is due to the increase in revenues and increased cost efficiencies.

I will now drill down to SG&A expenses, selling, general and administrative or SG&A cost for the company were $4.6 million in the fourth quarter compared to $3.6 million in the third quarter. The increase in SG&A cost is mainly due to year-end-related expenses and onetime costs. At the segment level, SG&A costs were $2.8 million in DDS; $200,000 in Synodex; and $1.6 million in Agility for the fourth quarter. In the third quarter, SG&A costs were $2.2 million in DDS, $100,000 in Synodex and $1.4 million in Agility.

Our adjusted EBITDA was $1.4 million in the fourth quarter compared to $2.3 million in the third quarter. Fourth quarter adjusted EBITDA is comprised of $1.6 million in DDS, $200,000 in Synodex and a loss of $400,000 in Agility.

Moving to net earnings. We recorded an income tax expense of $300,000 in the fourth quarter compared to a tax expense of $470,000 in the third quarter. After deducting tax expenses and minority interest, our net earnings in the fourth quarter were $50,000 compared to $700,000 in the third quarter.

Our cash balances were $10.9 million for the fourth -- in the fourth quarter compared to $11.9 million in the third quarter. Our DSO in Q4 was 66 days compared to 62 days in the prior quarter.

Our CapEx in the fourth quarter was $0.3 million compared to $0.4 million in the third quarter. In the first quarter of 2019, we expect CapEx to be in the range of $300,000 to $400,000. At the end of the year, we had fully settled all of our outstanding forward contracts. Realized losses from the settlement of these contracts in the fourth quarter were $108,000 compared to $153,000 in the third quarter.

In the fourth quarter, we performed the calculation of the GILTI, Global Intangible Low-Taxed Income providence, and concluded that it has no impact on account of the net losses of the company's foreign subsidiaries. As of December 31, 2018, we had approximately $14.8 million in net operating loss carry forwards.

In terms of the guidance for the first quarter of 2019, we expect our first quarter revenue to be in the range of $13 million to $13.6 million, consisting of DDS revenues in the range of $9.6 million to $10 million, Synodex revenue in the range of $1 million to $1.1 million and Agility revenue in the range of $2.4 million to $2.5 million.

Thank you. And now I will pass the call over to Jack.

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [4]

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Thanks, A.K., and good morning, everybody. I will begin with some brief remarks regarding our 2018 performance. After which, I will lay out our key priorities for 2019 for both our venture businesses and our core businesses. In 2018, we succeeded in executing the turnaround plan that we laid out for you this time last year.

As you saw in our earnings release this morning, we delivered 12% adjusted EBITDA or $6.7 million, up from an adjusted EBITDA loss in 2017. In fact, our adjusted EBITDA was the highest it has been as a percentage of revenue since 2014. We accomplish this through technology innovation using deep learning, a branch of AI, through cost reductions from consolidating physical plant and by shifting data storage and data processing increasingly to the cloud.

In many respects, we now have a stronger business than we had in 2014. In 2014, we had 11% of our revenues from our single largest project. But in 2018, only 6% of our revenues came from our largest project. In 2014, we had no SaaS platform revenue, but in 2018, 17% of our revenue was from SaaS subscription business. In 2014, we classified just 75% of our revenue as recurring versus 88% in 2018. While our focus in 2018 was on cost rationalization, our focus in 2019 will be on growth. In 2019, we are anticipating accelerating top line growth in both our Agility and Synodex venture businesses, and we will be making investments in our core business in order to reposition in a way that supports sustainable growth.

Let's first drill down a bit on the Agility business. In 2018, Agility's annual recurring revenue, or ARR, which in SaaS businesses is an important point in time measure of backlog, grew year-over-year from $9.8 million to $11 million or 12%. In 2019, we anticipate accelerating this growth. Our confidence results from several factors. First, we have a large addressable total market dominated by 2 large companies against which we complete -- compete successfully.

Second, our customer revenue retention has largely recovered and continues to improve. The main challenge we had on the retention side was that we had acquired customers from our acquisition that, as it turned out, had rarely and sometimes never use the product. They had really been customers of PR Newswire's distribution service. And once they started getting separate invoices from us, they canceled effective the next renewal date.

Third, we are poised to continue to drive increases in our average revenue per customer. This is a result of having expanded the breadth of services that we're able to deliver to our customers have had -- and having shifted to technologies that enable us to manage better, both customer credentials and content usage. This year, our #1 strategic priority will be to further accelerate growth by driving performance in both direct sales and channel sales.

In the quarter, we reorganized our sales efforts replacing sales management and rolled out improved sales training programs. We're also starting to get the benefit of sales headcount we added in Q3. In the fourth quarter, despite these sales interventions, or perhaps because of them, we have the best quarter of the year in direct sales, posting $900,000 in new direct booked ACV.

Direct sales is arguably the last nut to crack for us on Agility. By necessity, after the acquisition, we had to first focus on remediating shortfalls in the product from a product needs and performance perspective. On the heels of that, our next-in-line area of primary focus was building our new brand and building a lead gen engine from the ground up. The product engineering set efforts were successful. In G2 Crowd Winter 2019 report, we were ranked as an industry leader in media and influence of targeting software and ranked #1 in terms of ease of use and #1 easiest to do business with.

We also launched several well-received product innovations, including being the first in our competitive set to incorporate image-based news monitoring using AI. Similarly, we've succeeded at building a well-performing sales lead gen engine. In November, we had a record 80,000 visitors to our website, which serves as our inbound lead engine. This was double the visitors we had last January. Overall, in 2018, combining both inbound and outbound, we drove the 60% year-over-year increase and generated qualified leads.

I'm confident that addressing the product first, the brand second, lead generation third, and now direct sales fourth has been the right order of operations. And just like we got the first 3 right, I'm confident that we're now going to get the direct sales portion right as well. It is worth mentioning that the benefits of scale in the Agility platform model are significant and in line with investor expectations of SaaS businesses with incremental margins north of 80%.

Turning now to our Synodex business. We grew revenue by 11% in 2018, and we think we can accelerate this as well in 2019 based on a combination of new business that we have already won in high-quality late-stage prospects. In addition to serving the life insurance industry, we are expecting to open at least 1 new addressable market early this year.

In our core Digital Data Solutions business, revenue has declined in each of the past 6 years. There have been several factors that have contributed to this, most notably and historically narrow addressable market and a historic dependency on large onetime projects. In DDS, our goal for 2019 is to booking up new business to hold our revenue levels steady while investing in the apparatus we need to drive sustainable growth. Improved economics of our business provide us with the confidence and the investment resources with which to pursue this ambition. And I'll take each of these in turn.

Our first goal is to book about $7 million of new or expansion business in the course of the year, which if achieved, should enable us to hold revenue steady. This is the same level of new bookings we achieved in 2018, which was twice the new business we booked in 2017. We would expect about 40% of 2019's new bookings to turn into revenue in the year, filling the gap likely to be created by completing projects and other factors.

In terms of the investment I just referred to and had mentioned in our last quarter's call as well, this year, we're planning to invest approximately $3 million in a combination of new products management, new product marketing and increased technology engineering as well as certain salary adjustments.

To put this $3 million investment in context, our second half 2018 adjusted EBITDA in DDS was about $4 million, which reflects a period when most of our cost rationalization initiatives had been effectuated. On a forward-looking basis, all things being equal, this half year $4 million annualizes to $8 million of adjusted EBITDA. From a budgetary basis, this is -- it is from this $8 million that we'll be funding our $3 million investment.

The investment will enable us to accelerate our AI technology development that helps us achieve our 2018 turnaround plan. But this time, we'll be focusing our technology investment outwardly to the market rather than inwardly on our own operations. We will be identifying new markets to serve and new ways to serve existing markets, privatizing our technology and services and executing a development road map.

If we are successful, we'll emerge from 2019 with a fresh product service architecture that broadens our addressable market and aligns with macro trends in digital data and technology. We will also emerge with a fresh set of brand messaging and a new website as well as new campaign execution capabilities to drive awareness and lead flow.

Towards this end, in the fourth quarter, we successfully completed our search for a new Chief Product Officer. Rahul Singhal joined us in January and is now about 9 weeks into his role. Rahul was Chief Product Officer at an AI marketing start-up, which won several accolades, including Gartner Cool Vendor and CES Top 5 and won IBM Watson Independent Software Vendor Award. Prior to the startup, Rahul led product portfolio for IBM's Watson platform, where he grew usage of the Watson platform by 100-fold and launched 15 new services. Before Watson, Rahul was a member of IBM strategy and transformation practice. Rahul was also an Adjunct Professor at NYU, where he teaches competitive strategy and advanced experimental design and machine learning.

Thank you. Operator, we're ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Tim Clarkson of Van Clemens Capital.

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Timothy Clarkson, [2]

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Wanted to ask, first of all, just a couple of book keeping questions. I noticed there was a goodwill write-off. Where was that from?

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Ashok Kumar Mishra, Innodata Inc. - Executive VP & COO [3]

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Well, we had a goodwill -- this is A.K. Mishra. We had a goodwill write-off of $675,000 in DDS segment, and we did that in second quarter, I believe.

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Timothy Clarkson, [4]

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Okay, okay. And then in terms of the -- I saw there's $1 million increase in G&A. What was that mainly?

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Ashok Kumar Mishra, Innodata Inc. - Executive VP & COO [5]

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This is primarily onetime costs and the year-end costs comprised of multiple items, which includes things like audit fee, fee for recruitment of product management team personnel, which we are going through, onetime year-end commissions and so on. So it's a year-end onetime activity.

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Timothy Clarkson, [6]

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Okay. And then just, Jack, in terms of the -- I know this emphasis now on artificial intelligence. Are you to a point now where you figured out the niches that -- or niche that Innodata can focus on, where there's, hopefully, some relatively low-hanging fruit that where you have some differential skills and you can get some businesses relatively quickly?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [7]

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Yes. Tim, I think in the -- that's certainly what we've been working on. So in 2018, we were taking what we had developed in 2017 and 2018, and we were deploying it primarily internally. And the benefits to that was really twofold for us. There were the operational benefits that we got from it in terms of rightsizing the business and lowering costs. But beyond that, we were testing our technology, we were improving our technology and kind of positioning it that we would be ready to deploy it in different ways into the market, both in terms of existing markets that we play in and as well as new potential markets. We do have ideas there. The idea is continue to be vetted and explored. The good news, of course, is that we're attracting some top talent to work that problem for us, people who very much understand the market for AI-enabled business services, and we have well-formed ideas on where we can fit into -- in the world in terms of having a bigger market presence.

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Timothy Clarkson, [8]

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Now what would be -- one of the areas you'd look at will be customers you're already doing business with and you have relationships with that you could, on a relatively small scale, test out some of these different schemes using artificial intelligence to reduce cost?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [9]

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Absolutely. And I think one of the benefits to a lot of the things we're working on now strategically is they provide us the dual possibility of adding a lot of new value to our existing customer relationships, and at the same time, expanding our markets. So if we think back to other venture businesses we've had, those have leveraged our core competencies and some of our core technology, but they took us into areas that were separate from our core business. They didn't add value to our core relationships. The things we're doing now align very well in that regard, so we've got existing customers are excited about it. And we've got new opportunities to explore in terms of other verticals and other markets that we can serve.

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Timothy Clarkson, [10]

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Okay, one last question. When you employ these new technologies internally, how painful and difficult was it to -- at Innodata to make those changes? I mean, was it relatively simple? Or what was the internal emotional cost and difficulty in making those changes?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [11]

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Great question. It was difficult. And in the course of making the changes, we learned a tremendous amount about the technology and about what it would mean to successfully instantiate these technologies in project workflows. And the net of that is that the operational design around implementing and augmenting with AI is completely different. It's not just a new layer. It's a new way of looking at how business is done. And what we're now able to do is take a lot of that learning and bake that fundamentally into our tools and our platforms and share that with customers.

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Timothy Clarkson, [12]

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Right. And when you approach customers with opportunities to do this, what's their initial reaction? Are they -- is there a lot of resistance, or what is the process from going to them being excited about saving money, obviously, to actually trying this stuff out?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [13]

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I think that -- I think it varies. I think there are customers who are very much aligned to this mission and they see us as being able to help accelerate the path that they're already on. They're -- at the far -- other extreme, there's a customer I can think of who just doesn't think AI works and doesn't even want to talk about it. So there's a wide spectrum. That said, I'm finding that most of the customer base is moving in this direction. There's some early adopters, there's some people who are late adopters, but they're moving in these directions. And our ability to add thought leadership in terms of what works and potentially technology that they can be utilizing is being very well received.

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Timothy Clarkson, [14]

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All right. One last question, do you have any idea what a conservative estimate of the size of the opportunity is?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [15]

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I think they're going to be several different opportunities. I don't think it's a single opportunity, so I think there is an opportunity to serve our existing market perhaps at a higher order in a slightly different way. And then I think there are new vertical market opportunities, and there are potentially kind of horizontal opportunities in data science. So we're working all of those. It would be premature to start putting numbers around those or get ahead of our skis. I think, for now, my -- the key message I want to be sure to communicate today is that we worked hard on operational efficiencies, cost rationalization, business transformation last year. This year, it's all about growth. Agility and Synodex, we think are well positioned to accelerate growth this year. And in the core business, we're making investments in order to fundamentally reposition the business.

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Operator [16]

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We will now take our next question from Joe Furst of Furst Associates.

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Joe Furst, [17]

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I wanted to clarify something that I must have misunderstood about 2 things you said in your presentation that were inconsistent. I must have misunderstood one of them. Didn't you say that your recurring business was up to about 88% now of -- by -- well, much increased from back several years ago. Is that correct?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [18]

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That is, yes.

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Joe Furst, [19]

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But then -- and I thought I heard you say something about you needed -- wanted to try to get $7 million in new orders to keep revenue consistent. And obviously, those 2 things don't match. So what did I misunderstand there?

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [20]

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Sure. So without doing the math, I'll just talk conceptually for a moment. First, the way we -- what we call recurring revenue is a service that customers require as part of their operations. It's not a onetime build. It's not a onetime project. That said, recurring revenue isn't a perpetual motion machine. It's not something that goes on forever necessarily. So we do have, within the recurring revenue, layer movements. There are customers who end up moving out of a particular product and into other things or reducing their requirements for one reason or another or from whom we're driving less revenue than we might have otherwise. So within that necessary $7 million of bookings, about -- as we said, about 40% of that would end up being revenue in a year. So if you start with our revenue, take 40% of it, that would be the revenue that, on a pro forma basis, we look to replace. A portion of that would be project revenue and a smaller portion of that would be compression within the recurring revenue layer.

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Joe Furst, [21]

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Okay. So okay, I -- it's my interpretation where recurring revenue was. It's not the same as yours.

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [22]

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Okay. And again, Joe, if you want me to do the math with you, we can take that offline. I'd be happy to. But what we've been doing all along, and I think we've been pretty consistent in this regard is we've been defining recurring revenue conservatively. So we -- our recurring customer revenue, which is what a lot of people talk about is larger than that. But what we look at is really, what are we doing for a particular client. If we're doing something that they should require on an ongoing basis, then we call that recurring revenue. When we become part of their operations, part of their cost of goods sold basically. If we're building for them a new system, if we're building for them a new content set and it's a onetime effort, we refer to that as nonrecurring revenue.

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Operator [23]

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(Operator Instructions) It appears there are no further questions via telephone at this time.

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Jack S. Abuhoff, Innodata Inc. - Chairman, President, CEO & Interim Principal Financial Officer [24]

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Well, thank you, operator. So I'll just quickly underscore a couple of key takeaways from the morning's call. Our 2018 turnaround met its objectives, delivering 12% EBITDA, the highest it's been since 2014. In 2019, we're making an investment into DDS that we think will reposition it for growth, and we're anticipating accelerated growth in 2019 in both Agility and in Synodex. Thank you all for joining today, and we look forward to reporting on our progress through the year.

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Operator [25]

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Today's conference is available for replay from 2 p.m. Eastern Time today to April 6, 2019, at 2 p.m. Eastern Time. You may access the recording by dialing (719) 457-0820 or 1 (888) 203-1112, using passcode 5693923. This concludes today's conference. You may now disconnect.