Innodata Inc (INOD) 2009 Q2 法說會逐字稿

Good morning, and welcome to the Innodata Isogen Second Quarter 2009 Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Vice President of Marketing and Communications, Mr. Al Girardi. Mr. Girardi, please go ahead.

Thanks, Shawna. Good morning, and thanks for joining us on our second quarter 2009 earnings conference call. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata Isogen, and Jurgen Tanpho, our Interim CFO.

Statements made during this call and answers to your questions are intended to provide an abbreviated, unofficial background to assist you in your review of the Company's Press Release and SEC filings. In addition, there may be some forward-looking comments regarding the Company's operations, economic performance, and conditions. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities and Litigation Reform Act. The words believe, expect, participate -- anticipate, indicate, point to, and other similar expressions generally identify forward-looking statements, which speak only as of their dates.

These forward-looking statements are based on the Company's current expectations and are subject to a number of risks and uncertainties including without limitation continuing revenue concentration and unlimited number of clients, continuing reliance on project-based work, worsening of market conditions, changes in external market factors, the ability and willingness of the Company's current clients and prospective clients to execute their business plans which give rise to requirements for our services, difficulty in integrating and driving synergies from acquisitions, potential undiscovered liabilities of companies that Innodata Isogen acquires, changes in the Company's business or growth strategy, the emergence of new or growing competitors, and various other competitive and technological factors, and other risks or uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission.

Actual results could differ materially from the results referred to in these forward-looking statements. Along with these risks and uncertainties, there can be no assurance that the results referred to in these forward-looking statements will occur. We encourage you to read the risk factors described in Innodata Isogen's various SEC filings for an understanding of the factors that may affect the Company's businesses and results. And now, Jack Abuhoff.

Thank you, Al. Good morning, everyone. Thanks for joining us. During today's call I'll review our second quarter results, discuss the significant developments in our business, note some opportunities that we see for accelerating growth, and provide some insight into how we see the second half shaping up. When I wrap up, Jurgen will break out the numbers in greater detail. And then when Jurgen concludes, we'll open up the call for your questions.

In line with expectations, in Q2 this year we generated revenue of $21.6 million, which is up 21% from revenue of $17.9 million in Q2 last year. And it's essentially in line with the $21.8 million in revenue we generated last quarter. For the six-month period ending June 30, we generated $43.4 million in revenue, which is a 20% increase over the same period a year earlier. We earned $3.2 million in the second quarter or $0.13 per share, up from $36,000.00 or less than $0.01 a share that we earned second quarter a year ago. In the first half of this year, we have earned about $6.8 million or $0.27 per diluted share, again, in contrast to $869,000 or $0.03 per diluted share that we earned in the first half of last year.

We achieved gross margins of 34% in Q2 and 37% in the first half overall, well in excess of the 30% or more that we target when we model our business. We generated about $6.8 million in cash from operations in Q2 this year, up 105% from $3.3 million in Q1 this year and more than two and a half times $1.8 million we generated in Q2 of last year.

In the first six months of this year, we generated $10 million in cash from operations, about $6.1 million more than we generated in the same period last year. It's worth pointing out that the $6.8 million in cash from operations in this single quarter exceeded total cash from operations generated in the four quarters last year put together. We achieved free cash flow of $6.1 million in Q2, more than double the $3 million of free cash flow achieved in Q1 this year, and six times the $1 million of free cash flow achieved in Q2 last year. In the first half of the year, we have achieved $9 million of free cash flow, roughly three times the free cash flow in the same period last year.

As a result of strong financial performance, our balance sheet continues to strengthen. Cash and equivalents rose 51% from about $15 million at the end of Q2 last year to about $23 million at the close of Q2 this year. At the same time, receivables increased from about $8.8 million to about $14 million. In Q2, we continue to grow our client base with some important new logos. We added ten new clients in Q2, including W.W. Norton, Bloomsbury Publishing, and Profile Books. Recurring revenue increased 3% to $12.8 million in the second quarter of 2009, up from $12.4 million in the first quarter of 2009.

In the same period, recurring revenue as a percentage of sales increased from 57% to 59%. We do expect recurring revenue as a percentage of sales to fluctuate as we continue to see large lucrative project opportunities hitting our radar and our pipeline. As we continue to say, there will be quarter-to-quarter performance swings, at least until we hit our long-term goal of 80% or more recurring revenue on a sufficiently large base of business.

With our revenue growth, we also saw client concentration decline slightly. During the second quarter, 50% of our revenue came from two clients down from 56% in the first quarter. No other client accounted for 10% or more of our total revenues for these periods.

I'd like to share with you now our thoughts on how we see 2009 progressing. First, our sales activities are at record highs. We have grown our business with our two largest customers successively in each of the past three years, and this year looks to be no exception. Secondly, outside of our two largest customers, our other Company bookings have increased every year for the past three years. And this, too, continues to trend positively. And thirdly, in each of the past three years, we have brought in a successively greater number of new clients. Again, I expect to set a new record this year for buy into acquisition.

In terms of Q3, we expect revenue to range between $19.5 million and $21 million. There are two factors, both outside our immediate control, that will influence where we end up within that range. The first is timing of project starts, especially given that things tend to move more slowly in August. And the second is a large client that resets its annual operating budget in August. But even if we swing to the low side of this range, we would nevertheless anticipate sequential revenue growth in Q4.

On the gross margin side, we should expect lower gross margins in the third quarter than we've shown in the first two quarters, but still within our model guidance of 30% or better. The reasons are first, that we are incurring the cost of staff in anticipation of significant new projects; two, that new projects have an initial learning curve, during which they run at less than targeted efficiency; and third, the expansion of our IT and Consulting Services staff, which we announced in April, which will cost us about 175 basis points to 200 basis points per quarter in the near-term. We will expect gross margin improvements as we start some significant new projects, and as our investment in our expanding Consulting and IT staff begins to positively impact revenue.

In terms of our expansion of our Consulting and IT, I believe we will look back on this as a game-changing move, one that will enable us to both expand our service opportunity and drive still more aggressive growth. We'll look to keep SG&A costs relatively flat so that we continue to obtain the benefits of leveraged incremental profit from revenue expansion. So to sum it up, we anticipate that 2009 will be a growth year, as we set out for it be, and that the new wins we're anticipating and our new client additions will give us a good head of steam with which to exceed 2009 financial performance in 2010.

I'll talk for a few minutes about our market opportunities. One interesting area is, of course, eBooks and, more broadly, epublishing. An increasing number of device manufacturers, publishers, retailers, and institutions are both creating and responding to the momentum in the marketplace, creating an accelerating cycle of expectation and demand. We are, perhaps, the leading eBooks services provider in the publishing services industry. Our client roster includes the most significant players in this space.

eBook revenues continue to accelerate. In fact, according to the International Digital Publishing Forum, trade and consumer eBook sales are up 150% year-to-date over last year. But despite the media attention and impressive revenue gains, eBook revenues represent just a fraction of the overall $20 billion publishing industry. Credit Suisse is projecting that eBook revenues will jump from nearly 2% of the wholesale book market in 2009 to more than 16% in 2014.

But what I think is more exciting to us, and certainly to many of our clients, is that the eBook revolution is likely just a small part of the new and perhaps larger wave of development in the publishing industry at large, one that will leverage new and existing technologies, formats, devices, and business models to create and distribute new types of digital information and entertainment products. Clearly, change brings challenges, as well as opportunities. But it is helping our clients respond to these challenges and helping them seize opportunity that is the engine of our business.

Demand for solutions to chronic business issues, rising costs, shrinking margins, burgeoning customer expectations, talent shortages, has helped fuel our growth over the past three years. In particular, we anticipate increasing demand for our KPO services from clients seeking to cut ongoing operating expenses associated with information processing and content creation. Here we take on complex analytical and editorial process that our clients have been performing for themselves. We essentially reinvent how this work is done. We apply new technologies and a global assembly line process. This provides substantial cost savings for our clients.

As global sourcing and process reengineering increasingly become key strategies that companies embrace to reduce expenses and increase competitiveness, we've seen the pace and scope of our engagements in areas like editorial services, offering, and content origination continue to increase. At the same time, we are seeing more and more companies adopt an outsourcing strategy from the outset of their product life cycle, that is, in the new product development stage. By working with us from the outset, they are able to field these new products more quickly and at lower cost.

Competitive pressures have induced many companies to continue making investments in new product development through the course of the recession. And as the economy brightens in coming months, we expect to see a further increase in new product development opportunities. Again, it is our intention to pursue these product development opportunities, other transformational opportunities, and eBook opportunities, largely without regard to quarterly ups and downs that will likely result from large-scale, project-based work.

We will evaluate opportunities in terms of their cash generation potential and their strategic value. At the same time, we will continue to drive operational outsourcing in parallel, which brings recurring revenue, so that over time these quarterly swings will even out. I'm looking forward to taking your question in our Q&A session. But now I'll turn the call over to Jurgen for a closer look at the numbers. Jurgen?

Thanks, Jack. Good morning, everyone. And, again, thank you for joining us. Now, for a closer look at the numbers in the income statement, cash flow, and balance sheet. Revenue in the second quarter of 2009 was $21.635 million, an increase of 21% from the $17.87 million in the second quarter of 2008, and essentially in line with the revenue of $21.815 million in the first quarter this year.

In the first half of 2009, revenue was $43.4 million, a historical high and a 20% increase from the $36.3 million of the same period last year. Recurring revenue for the second quarter reached $12.8 million, up 3% from the $12.4 million of the first quarter, and up 1% from the $12.7 million of the second quarter of 2008. Gross margin for the second quarter of 2009 was 34%, up from 23% in the second quarter of 2008. While lower than the 40% we achieved in Q1 this year, still within our target range of 30% or better.

For the first six months of 2009, our gross margin was 37% as compared to the 25% in the first six months of 2008. The year-over-year increase in gross margin was driven principally by improved revenue mix, lower costs from a more favorable foreign exchange rate, and continuing savings from the cost restructuring activity we did in the fourth quarter of 2008, partially reduced by the increase in labor expenses relating to new hires in our Consulting and IT Services Group. The decrease in gross margin from the first quarter was caused by higher costs from a less favorable foreign exchange rate between the two sequential quarters and an increase in labor expenses relating to new hires made in the IT Services Consulting Group.

Foreign currency fluctuations are one of our biggest challenges. We have had the foreign currency hedging program in place. And we have been continuously monitoring the currency forecasts for the Philippine peso, Indian rupee, and Israeli shekel. In the second quarter, these forecasts signaled us to proceed with hedging activities. And we took out foreign currency forward contracts with the Philippine peso and Indian rupee worth approximately $12 million. We've also undertaken additional foreign currency foreign contracts in July and August pursuant to our hedging program. And, as of today, we have contracts worth $36 million.

SG&A for this quarter was $3.1 million, a decrease of $1 million or 25% from the second quarter of 2008, and a decrease of $550,000 or 15% from the previous quarter. As a percentage of revenue, SG&A was 14% this quarter, an improvement of three percentage points from the 17% of last quarter, and an improvement of nine percentage points from the 23% of the same period last year.

On a year-over-year basis, reduction in SG&A costs were caused by continuing SG&A cost savings from the restructuring activity we did in December 2008, lower compensation costs, and lower costs from a more favorable exchange rate. On a sequential quarter basis, reduction in SG&A costs were caused by lower compensation costs and lower professional fees that reflect the seasonality of these types of costs.

This quarter we earned $4.379 million pre-tax, as compared to the $108,000 in the second quarter of 2008, representing an increase of $4.271 million. For the first half of 2009, net income was $9.49 million, compared to the $918,000 for the same period last year, an increase of $8.572 million. The Company's effective tax rate in 2009 is approximately 29%. While the US tax rate is approximately 38%, the Company's foreign subsidiaries have tax rates that range from 5% to 34%. The combination of these different rates and the earnings of each of these entities results in our overall effective tax rate.

In terms of EPS, we earned $0.13 per diluted share in the second quarter of 2009, a $0.13 increase from the second quarter of 2008, and a $0.02 decrease from the $0.15 per diluted share in the first quarter. For the first half of 2009, our EPS is $0.27 per diluted share, a $0.24 increase over the same period in 2008. This increase in EPS is primarily attributable to the increase in gross margin for improved revenue mix, lower costs for more favorable foreign exchange rates, and lower SG&A expenses, partially offset by an increase in the provision for income taxes.

Now, let's turn our attention to cash flow and the balance sheet. Cash from operations in the first six months of 2009 was a record $10.054 million, an increase of $6.1 million from the $3.947 million in the first six months of 2008. Similarly, cash from operations for this quarter was $6.757 million, an increase of $3.46 million over the previous quarter's $3.3 million. The significant improvement in our cash from operations for the first half of 2009 was primarily driven by increases in our net income.

We ended this quarter with a record of $23.118 million in cash, an increase of $6.488 million or 39% from the previous quarter, and an increase of $7.855 million or 51% from the previous year. Free cash flow was $9.079 million for the six months of 2009, an increase of $6.754 million from the $2.325 million in the first six months of 2008. This $9.079 million was from cash from operations of $10.054 million less net capital spending of $975,000.

At the end of Q2, we had spent $1 million of the $5 million we budgeted for CapEx. We anticipate spending the balance within the rest of the year. Beyond this period, we anticipate capital spending in the range of $4 million to $4.5 million per year for ongoing technology, equipment, and infrastructure upgrades.

We ended the quarter with accounts receivable of $14.177 million, lower by $959,000 from the $15.136 million of the previous quarter. Our day sales outstanding, or DSO, improved to 58 days from the previous quarter's 60. And we ended the quarter with working capital of $30.784 million, up by $7.978 million from year-end, December 31, 2008, and up by $3.859 million from last quarter's $26.925 million. We maintain the $7 million line of credit, under which we have no outstanding obligations.

We continue to believe that our existing cash balances with funds generated from operating activities and funds available under our current credit facility will provide sufficient sources of liquidity to satisfy our financial requirements for the next 12 months. Okay. That wraps up my review. Again, thank you, everyone, for your time and looking forward to your questions that you may have. Operator, we are ready to take our questions.

Thank you very much. Your question and answer session today will be conducted electronically.

(Operating Instructions)

We'll take our first question today from Jay Harris with Goldsmith & Harris.

Good morning, Jack.

Good morning, Jay. How are you?

Good. On the P&L statement, there are three lines that I'd like to have you comment on. What is the significance, if any, that your revenues came in on the light side of the first quarter, where on our last conference call you suggested it would come in on the positive side of the first quarter. Number two, the -- were any of the reduction in the gross margin due to a mix issue? And, if so, could we get a little color on that? And number three, selling and administrative expenses, what caused them to drop on a consecutive quarterly basis? And where are they going as the year progresses?

Sure, Jay. Thanks for your questions. Let me try to take each one of those. In terms of revenue guidance, what we said last quarter this time was that revenues would be flat or maybe a little bit sequentially up. And what we delivered was revenues of $21.6 million after having delivered $21.8 million. So that's a very small difference on a percentage basis. It's essentially flat. In terms of the gross margin -- was that your second question?

Yes.

There were a few factors that influenced the gross margin. And I think that there's no doubt some mix issues that are in there. But really that was a minor part of it. I think a lot of what we're seeing is foreign exchange reevaluation losses. That was probably about over 60% of the delta. And then what we're also seeing is investment we're making in the business, as we announced in April, in terms of the new hires we brought in for IT and Professional Services. And that's about -- that's the remaining 40% essentially.

Coming back to revenues, were there any revenues that you anticipated in the June quarter that got pushed into July or later?

There's always a little bit of movement. And trying to schedule exactly when something books and what the ramp-up looks like is an art form. And we're not talking about just one project, of course. We're talking about many. There are many moving parts. No, I think that we were pleased with second quarter. And looking out over the rest of the year, we're very excited about what we see there, too.

All right. We'll move on now to Tim Clarkson from Van Clemens Capital.

Hi, guys. Nice quarter. I just wanted to ask again on this eBook thing, when we hear all these things about Amazon -- and now I guess there's a recent news report on Sony with they're going to be coming out with a new digital device that's going to compete with Amazon. Are you seeing on your end real business interest that's reflecting these news reports? Or are these just ghost reports that aren't meaningful in terms of your business?

Thanks for the question. We're absolutely seeing real business opportunities there for us. I think what we've got, and I'm observing this as you are, is there's a bit of a lag time. People talk about things, and there's a lot of buzz in event of the rubber hitting the road.

Okay.

So I think the buzz is an early indicator of opportunity.

Okay. Great. On a technical question, how much -- you mentioned that you're doing a meaningful amount of hedging. How much is that actually costing Innodata to do that?

Figuring out what it costs us is -- you're paying on the spread. I think the important thing there is that we're now covered for 75% of our anticipated rupee and peso requirements for the next 12 months. So I think we're in pretty good shape. And we're doing a good job strategically of monitoring consensus estimates and reacting accordingly there.

Okay. Great. Thanks.

Thank you.

(Operator Instructions)

We'll move on now to [Bards Love] from [Sanchez Capital].

Yes, Jack. Congratulations. In the past, you of course are well-aware that you had to overcome the foreign hedges and the up and down quarters and the concentration of clients, in particular. And I wonder how you should be -- how you think you should be thought of now? And what is the future of strongest area of focus now that you've seemingly taken care of the issues of the past? And then also in tandem, I wanted to know if you have been approached by anybody because I'm trying to understand the reason, and I don't think it was, as some people might say, because of indexing, the enormous short position that was generated in the last few weeks.

Thanks for your question, Bards. I guess when I look at what we've done that's helping us overcome issues of the past, I think the most significant accomplishment is what we've done on the sales side of the business. So if you look at the last couple of years or three years' performance and take the areas of customer concentration, we've grown our two largest customers successively in each of the years.

On top of that, if you look at our other customer bookings, we've steadily improved year-over-year in terms of the magnitude of our bookings. And then thirdly in each of the last three years, we're bringing in successively greater numbers of new clients. So in terms of de-risking the business, in terms of showing the scalability and the growth potential of the business, I think those are absolutely critical. Without that, I think I'd have greater concerns. So that, I think, is essential.

In terms of being approached by people, we're not -- I think there might be some rumors there. We're not going to -- we're not in a position to confirm or deny any of that. I think we do have conversations with people. And we'll always be -- the Board will look carefully at any types of opportunities strategically for the business. The short position I can't explain.

The short position, the magnitude of it, would lend one to think that there was every reason that they didn't -- they would prefer the stock not go up. And there's usually one or two reasons for that, and that's why I asked the question about in case they came in with an all cash tender offer or something, would you be prepared to gather resources that held the stock and holds them at bay? Or how would that work?

I think that we're -- we'll be looking at all opportunities that are appropriate. We have the shareholders' best interest in mind always. And we'll evaluate opportunities as they come our way.

Thank you. We'll move on now to Joe First from First Associates.

Good morning, gentlemen. And congratulations on a very good quarter. I've got several questions. Just one quick question; how do you invest your excess cash? Money market funds or something like that?

Yes, Joe. Money market funds, conservatively invested.

That's what I thought. Good. And then you talked about this Consulting and IT staff. What are your goals in this new segment of the business? What would you like to see happen from that area?

Sure. Well, there are a couple of things. First, what we're seeing is that our customers are hungry for strategies. They are hungry for help in having to navigate an increasingly complex competitive environment. And we're in a position to help with that. And we're in a position to accelerate our growth by virtue of enabling them to embrace outsourcing and new technologies as part of their strategies. So we need more hands to feed the demand. And we think that that will help accelerate our growth.

In terms of the IT side, increasingly IT services and content services are intertwined. And there's a whole other set of opportunities for us as we continue to build the IT side of our business. As you know, we've done some very impressive things on the IT side; clients like Lockheed and things that we're doing in government and some things we've done on the professional publishing side. Increasingly, professional publishers are looking at IT as a strategic advantage. And we need to increase our scope in order to be able to feed that demand.

And do you have a goal of what percent of your total business you would like these two things to be or not?

We do. We've got three-year goals that we're not putting out there, per say, right now. But they're very aggressive. One of the exciting things as a result of having built our team and find our team over the last years, I think we're in a position now where we can start to say, we want to be, name the number, a $200 million Company within so many years. How do we get there? And then working backwards as opposed to more of an incremental, here's where we are, and here's where we can get to, approach. And we see the IT side and Consulting and the level of opportunity that can be fed by Consulting as meaningfully contributing to that growth over the next couple of years. We're very excited about it.

Good. And I'll ask one other question and go back in queue. You talked earlier about gearing up for some potentially very large contracts. Can you expand a little bit on what sector of the business? Are you talking about eBook business or are you talking about Knowledge Management business? What area are you talking about there?

Sure. I guess in terms of opportunities, we're seeing opportunities across the business. So we're seeing opportunities in eBooks most certainly. We're also seeing significant opportunities in KPO and in more transformative types of projects for clients. So we're seeing opportunities across the board. We are looking at some significant opportunities, which I don't want to get ahead of myself here, but that we're late stages on. And I'm going to target having a couple of fairly impactful new deal announcements that we can be making in the next few weeks.

Thank you.

(Operator Instructions)

We'll go now to Bill Sutherland from Boenning & Scattergood.

Good morning, Jack. And thanks for taking the questions. So the sales pipeline, can you -- is there a way to characterize it at all in terms of size or relative to maybe the prior quarter, or just to give us a sense of the potential out there?

Yes. The potential is definitely increasing. The sales pipeline on an order of magnitude year-over-year has increased significantly. And, more importantly or equally importantly, our bookings are increasing very significantly. We think that we're going to have a very strong booking quarter this quarter. We think there will be some very impactful opportunities hitting the table. And there's a great market opportunity there for us, which we're very excited about.

Is the -- I'm sorry to interrupt. Is the mix -- how would you characterize the mix for all your revenue mix in terms of project and recurring?

I think that we're going to -- if I look out at the business, I think that we're going to see a steady increase in recurring business. We've got some very good opportunities with clients who are essentially looking at us to take over their complete back-end publishing editorial capability. That's ongoing.

And those wins are tremendous because they create a good, solid recurring base of business. At the same time, we're seeing transformative opportunities and eBook opportunities and other things, which will be just great cash generators. And we're going to seize those opportunities as we come by them. So in terms of pipeline and bookings, a lot of companies are talking about the slower decision-making as a result of the financial crisis and the global recession, we've grown because our larger pipeline and our sales execution has enabled us to. And from what I see firming up, that's going to increase.

I was going to ask you about decision cycles, but they sound pretty firm. On eBooks, have you ever discussed where it stands now as a percent of your revenue? I had a sense, even though you're a meaningful player, that it hadn't been more than a few points of revenue. But I wonder if we can get clarity on that.

If I look at the year, I would project that eBooks would probably be about 10% of our revenues this year. When I look out at the next half, I see several millions of dollars of new bookings that are likely to occur. So I think that will increase, perhaps significantly, as we go out into 2010.

Great. And then --

I do think, and I'll reiterate from what I said in the other question, I think there's a lag time in things like this. There's the buzz, and then there's the reality. Certainly we look at market projections, we talked a little bit about the Credit Suisse report, that just seeing the install base of eBook readers going from today's 1 million to 32 million in just the next few years. And then there are other things; new devices, new content that can be read, convergence of readers and other devices that will further drive that. So I think there's a lot of good things going on there that will help drive our business.

Great. And let me see if I can get one or two more in. On the gross margin and the FX impact obviously significant year-to-date, now with the hedging given where rates are today, would it be moving gross margin meaningfully in the current quarter or fourth quarter?

I think the hedging is going to help even that out certainly. In terms of gross margin going into the third quarter, like I said in our prepared remarks we're doing several things that will temper gross margins in the third quarter, most likely. We're preparing for some significant new products or projects, rather. So we're holding staff. That's cost that's not offset by revenue. We will have projects in the learning curve stage where you take a margin hit that's overcome as the project matures.

We've brought on the IT Consulting -- we've expanded the IT Consulting services, which is going to cost us a couple of points of gross margin in the short-term. But I'm very confident that we'll look back on that as a wonderful, impactful investment. So I think that's basically what we're going to see in the third quarter, a little bit of margin compression in order to obtain the benefits of margin expansion as we go out from there.

Thank you. We'll move now to George Melas from MKH Management.

Good morning, gentlemen.

Good morning, George.

It seems like you had a great quarter. I'd like to ask a few questions on the recurring revenue. It seems like it has been relatively flat over the last 12 months. So I'm trying to understand maybe the mix there. Maybe you can help us understand what are the different components of the recurring revenue, and if there has been some significant change, if some has increased, some has decreased, if some customers in response to the economy have reduced their spend there? And maybe also related to that, try to understand most of your capabilities there with the work that you do. Is to augment client capabilities? Or do you really take over the entire function of the client there, which makes it very difficult for the client to in-source the work back?

Sure. Those are big questions. Let me start with the last one. Typically, when we're working with a client we'll start as augmenting their capabilities. And as confidence is developed and we prove the ability to meet or exceed our service levels, more and more the work shifts to us. So we've got quite a number of plans for whom we are doing -- we are their content origination editorial processing capability. We have lots of other clients for whom we're bringing them on. They're part of the mix. But it's small because we're still in that confidence-building stage.

In terms of your first question, within our recurring revenue base there are always some trade-offs; a client increases, a client decreases. There are a lot of different reasons for that. But, importantly, we're brining on increasing numbers of recurring revenue relationships where we've got the ability to prove ourselves to grow that business. We're in discussions with several people about increasing that somewhat significantly. And I think that's going to be an important generation of -- source of opportunity for us as we go forward in the next year.

Okay. Great. Is there some pricing pressure on the recurring revenue work?

I'm not seeing pricing pressure any more now than I've seen always in the business. Clients want value. And our opportunity is to create the value. And I think we're good at that, so pricing pressure is just -- that's just a reality we're used to. We're not seeing any more of it or any less of it than we ever have. And we're prepared to grow that business.

Great. Okay. Thank you very much.

Thank you. We'll move on now to a follow-up question from Bards Love.

Yes. Jack, would the eBook business be characterized as a lower gross margin but not so with the textbook business, which might in the form of eBook might have higher margins because of more editing would be needed or some such thing like that? And compared to the other businesses that you have; in other words, straight digitization. Is that a -- does that tend to be commoditized?

Sure. I think that the -- first of all, I'll compare the eBook business to our KPO business, if you will. I think the KPO business where we're performing analytical functions on content and we're creating content does have higher gross margins associated with it than eBook business is likely to have, although we've got some good technologies in place that we can use to enhance those margins beyond what they would be for most companies. So I think that's one thing. In terms of you were comparing it to textbooks, we don't do a lot with textbooks unlike several of our competitors. And I think that's fortunate. I think that's the result of some good strategic thinking in my team who doesn't believe textbooks necessarily has a great future.

All right. We'll move on now to a follow-up question from Joe First with First Associates.

Thank you. You mentioned about some of your competitors in the eBook business. What type of competition do you face in that business? Is it from a few large companies or a lot of small ones? Or just what is the nature of the competition?

Joe, it's fairly fragmented. I think what we're able to bring to the table is first, we've got relationships with all the major players. We are their primary, if not singular service provider. Beyond that, what we've been able to bring to the table as value propositions is the ability to create eBooks with very high-density linking, complex design, foreign language, complex scientific content, even looking at some music content and all sorts of different things.

And we're able to do that because we've got a good technology base that we're working on. So I think it's a fairly fragmented competitive set. But (inaudible - background noise) and report back to us on their experiences with the competitors are somewhat encouraging in terms of our prospects there. And, as I've said, we're in a very central position in terms of the clients that are looking at us for services.

Good. Thank you. And along the line of potential acquisitions, have you seen -- are the things that are being shown to you any more reasonable than they have been in the past? Because before they've just been too expensive and too much risk. Have you seen anything lately that's a little more reasonable?

Yes. We're looking at a lot of things. And we're certainly seeing more reasonable valuations. So far nothing that we've looked at has passed our screen, our filter. We're taking a very hard look. We've set a very high threshold for merger synergies. And we're not willing to compromise that. So what we will be looking to do is increase the throughput of our deal flow and the numbers of things we are looking at. We are looking to bring in some particular expertise onto the team for that hopefully within the next several weeks or month or two. So the values are there. But I think the threshold of criticality, the critical view that we look, has to be maintained.

Thank you. We'll move on now to Perry Highland from Van Clemens.

Hi, you guys. Congratulations on a great quarter and great guidance. What do you see on potential big projects that you've hired these IT guys, which I think you said a couple of quarters ago, were out there, available? You were able to get some very good hires. But the projects, would they be in publishing, like with BBC or Airline industry or whatever 14 fire planes? Or what might those be? Or would it be enough publishing with doing visual media?

Yes, Perry. Hi. Thanks for the question. I think that the large projects that we're seeing for the most part -- we're seeing large projects across the board, actually. But the ones that are most critically being followed on our radar right now are within the information sector.

(Operator Instructions)

And we have a follow-up question from Joe First.

Thank you. This will be my last one. Your market cap at $5 a share is about $125 million, and you're making roughly $12 million or so and, of course, there's a 10% return on that equity. Given you're getting, I would guess, somewhere around 2% on the money market fund, is there -- would it be a reasonable alternative to spend some of that money to buy back some of your stock here?

I think it's a fair point, and something that we're going to always be looking at. It's a subject of discussions in most of our Board Meetings. There's a lot that we want to do. We want to grow the Company aggressively in the next few years. So we're looking at diversifying our vertical and our client coverage. We're looking at new services. We're seeing interesting opportunities to provide new services in several sectors that are enabled by the types of work we do in the information sector. So I think it will be more competition for investment. Where is the best value for shareholders in terms of how we deploy those -- that cash?

Thank you. We have no further time for questions. I'll turn the call back over to Jack Abuhoff for any additional or closing remarks.

Okay. Thank you. And thanks, everybody, for your questions. Thanks for taking the time to join us today. Before signing off, I'll just recap a few key takeaways from our remarks. First, we generated $6.8 million in cash from operations in Q2. We achieved free cash flow of $6.1 million. Our cash rose 51% to about $23 million at the close of Q2. At the same time, our receivables increased to about $14 million. And we continue to carry no debt.

We anticipate a strong second half to the year. Q3 revenue will likely range somewhere between $19.5 million and $21 million, which would be an increase of 10% to 15% year-over-year. It's a bit of a sequential slide, but I'll think we'll be back to the sequential up in Q4. So for the year overall we expect a third straight year of record revenue. And I think we are going to be well-positioned for continued successes in 2010. So thanks, everyone, again for joining us today. We all look forward to being with you next time.

Thank you, everyone. We appreciate your participation.