Innodata Inc (INOD) 2009 Q3 法說會逐字稿

Good morning and welcome to the Innodata Isogen Third Quarter 2009 Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Corey Luskin. Mr. Luskin, please go ahead, sir.

Thanks, Berlice. Good morning everyone, and thanks for joining us on our third quarter 2009 earnings conference call. I am pleased to welcome you to the first quarterly conference call since I joined the Company two months ago. I will be handling both corporate development and investor relations here at Innodata Isogen, and I am looking forward to meeting many of you in the coming months.

Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata Isogen and Jurgen Tanpho, our Interim CFO. We will hear from them and then take your questions. First, let me read our Safe Harbor statement.

Statements made during this call and answers to your questions are intended to provide abbreviated, unofficial background to assist you in your review of the Company's news release and SEC filings. In addition, there may be some forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities and Litigation Reform Act of 1995. The words project, head start, believe, expect, should, anticipate, indicate, point to, forecast, likely and other similar expressions generally identify forward-looking statements which speak only as of their dates.

These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including without limitation, the primarily at will nature of the Company's contracts with its customers, and the ability of customers to reduce delay or cancel projects, including projects that the Company regards as recurring, continuing revenue concentration in a limited number of clients, continuing reliance on project-based work, inability to replace projects that are completed, canceled or reduced, depressed market conditions, changes in external market factors, the ability and willingness of our customers and prospective customers to execute business plans which give rise to requirements for digital content and professional services in knowledge processing, difficulty in integrating and deriving synergies from acquisitions, potential undiscovered liabilities of companies that we 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.

Actual results could differ materially from the results referred to in the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the results referred to in these forward-looking statements contained in this release will occur. Thank you, and with that, let me turn the floor over to Jack Abuhoff.

Thank you, Corey. During today's call I am going to quickly recap the third quarter and then I will discuss the developments that are informing our results and our outlook. Following that, Jurgen Tanpho will review the numbers in more detail, and when he wraps up, we will both take your questions.

Let me first provide a quick recap of third quarter results and then move on to our discussion. In the third quarter, we realized revenue of $19.1 million, up from $18.3 million in the corresponding period last year, but it was down 12% from the second quarter of 2009. In the first nine months, revenue was $62.6 million, which was up 15% compared to the first nine months of 2008.

We achieved gross profit of $5.7 million in the third quarter, which represents a 30% gross margin. This is down from 34% in the second quarter. And as we discussed in the last quarterly call, we expected this measure to decline in the third quarter, due to a few factors, but to stay at or above the 30% target threshold.

Net earnings were $1.3 million or $0.05 per share. For the first nine months of 2009, we earned $8.1 million or $0.32 per share. Thus far in 2009 we have added 29 new clients, nine of which were added in the third quarter.

Cash from operations for the first nine months of 2009 was a record $12.9 million, an increase of $9.2 million from $3.7 million for the first nine months of 2008. During the first nine months of the fiscal year, the Company's cash and cash equivalents doubled, increasing from nearly $14 at December 31, 2008 to almost $28 million at September 30, 2009

So I would like to take you through the following items in our discussion today. First, our business momentum is enabling us to absorb some of what we believe is a temporary decline in revenue from one our top customers.

Second, the important investments that we are making in the business by having hired in just the past few months a team of onshore-based, leading content consultants and content related technologists and how this investment is costing us margin in the second half of the year, but what we see it bringing us as we go forward.

And third, how the current revolution in the way people consumer information, which we see most emblematically in the proliferation of eBook reading devices plays very well into our overall strategy.

As we said in our last call, one of our large clients is in the process of resetting its annual operating budgets for certain significant ongoing efforts that we have been supporting them on over the past couple years. So even though they are probably only 5% or 10% of the way through what could ultimately be their requirement, we are having to endure a bit of a lull in the second half as budgets ran down and we await new budget approvals and new requirements.

Importantly, we have seen our business with this client increase every year over the last four years. And it is with the promise of this continuing that we absorb these kinds of interruptions. But timing, in terms of how revenue falls quarter-to-quarter, is largely outside our control. In any event, we are hopeful that we will soon see an acceleration of this work.

But what I want to truly shed the spotlight on here is what we have got going on in the rest of the business because it is representative of secular trends that I believe will continue to accrue to our benefit going forward and will likely lay out better, although imperfectly, quarter-to-quarter. Let me illustrate.

Our total revenue from our business, less our top two clients, was around $10 million in the first quarter this year, but we expect to finish this year doing $16 a quarter from these other clients, plus a new major division of one of our top clients that we are just really breaking into this year. So that is a 60% growth that we are forecasting in less than a year.

So our most important goal, really, is to continue this acceleration. We are driving this by our continued emphasis on sales and marketing, our approach to which centers around a combination of close performance measurements and clarity of focus on clients' needs.

Thus far in 2009, we have seen our efforts paying off. In each quarter this year, we have achieved an increase in bookings with a particularly large jump in the most recent period. And we are finding that we are able to convert a progressively higher portion of our pipeline into signed bookings than ever before.

So far in 2009 we have added 29 new clients, representing a 17% increase over the number of clients we had at the end of 2008. This progressively higher new client acquisition rate will contribute importantly to our growth, especially when you consider it in combination with our client retention rate.

Over 94% of our revenue this year has come from long-term clients or recurring clients. So again, this combination of high client acquisition achieved through a focus on sales and marketing, and high customer retention, achieved through a focus on execution, will be the real enabler of our growth.

Next, I would like to talk a bit more about the investment we are making now in two areas of our business, namely our consulting practice and our IT outsourcing areas. And I am breaking this out for two reasons, first because it is an expensive investment that hits our margins directly, and second, because that I believe that it will bring us significant medium and long-term returns.

To put this investment in perspective in this calendar year, we will have brought on five US and UK-based staff to our consulting team, and another seven US and UK-based staff to our technology team. So that is a total of 12 new unsure heads representing an annual cost to Company of approximately $2.1 million.

Several of these folks have come from high profile positions among our client base. And others have been high profile senior staff from some of the leading IT outsourcing companies. And again, so you understand the importance of this investment, two of these individuals have been brought on as Senior Vice Presidents, increasing the senior executive staff from what had been four, to six.

The rationale for the consulting investment is really simple. Our clients, information publishing companies for the most part, are undergoing an unprecedented level of change. They require better internal information, handling processes, improved technologies and they wish to embrace outsourcing in increasingly significant ways, but sometimes they lack a clear path for doing so.

Our consulting team, in essence, will provide thought leadership in these areas, while also providing the glue between our clients' needs, on the one hand, and our capabilities, on the other. Thus, it is my plan to see that our Company is uniquely positioned to help publishers navigate the change they are facing by positioning us with what we can think about as three highly complementary competencies, first the consulting team, a group of industry veteran consultants located both in North America and Europe who can work with clients who know that change is necessary, but need help figuring out exactly what that looks like and how to implement it.

This is a group that can help clients face the challenges of transforming print products to online products and legacy online products to the kinds of products that will be viable and relevant in the future. At the same time, it is a group that can help clients rationalize their content operations, infusing new kinds or workflows and technologies and outsourcing and offshoring wherever feasible. I see this group getting to a run rate of $10 million or so in annual billings within the next couple years, but their real contribution will the KPO and IT outsourcing work that they will be able to help us accelerate, work that comes about specifically as a result consulting agents.

The second of three competencies is an IT outsourcing group that is second to none when it comes to content-related technologies. Clients will come to see this group is the ideal partner for outsourcing the development of new content, products, platforms and underlying content in workflow systems. In addition, clients will come to see us as a single source for related IT and KPO services, coupling high automation with vast offshore operations.

Our combined capabilities in content services and KPO, together with content technologies, will be a significant point of differentiation between us and other IT outsourcers. It has already contributed to some of our early business wins in IT outsourcing, and we expect that it will continue to do so, within the next several years with some jumpstart from an acquisition, perhaps, but largely based on organic growth. My senior team on the technology side wants to see us approaching $30 million or so just on the technology outsourcing side alone.

And the last of these three unique competencies, after consulting and IT, that is, is KPO, or knowledge process outsource. As a KPO provider, we have distinguished ourselves based on our ability to handle hard to outsource analytics and content creation.

We have done this by putting in place a nine facility multinational content processing infrastructure, spanning four countries and accommodating over 6,000 staff. Using these facilities, we complex analytical and editorial processes that our clients would otherwise have to perform for themselves, and in doing so we essentially reinvent how the work gets done, applying sophisticated technologies and a global assembly line process.

Our infrastructure and our multinational span enable us to multi-shore talent in ways that our clients and our competitors cannot. We believe that in those cases where we bring all three of these competencies together, consulting, technology and multi-shore KPO, we will be bringing the best value to clients and we are seeing opportunities to do that with increasing frequency.

The proof points that this is working are already stacking up all around us. Just in the third quarter, a client selected us to take over development of their content management system. Another client, one of the three largest professional information companies in the world, selected our consulting team to help figure out ways to run their operations better, cheaper and faster.

Clearly, the opportunity to become increasingly intimate with the client by helping them augment their operation spending is well over $100 million, is invaluable for an outsourcing company. And still another client, a major division of another of the three largest professional information companies, selected us to help them migrate to a new product platform, a challenge we proved ourselves equal to by bringing together our new technology experts and our professional processing staff, and this represented a $6 million booking.

So, to reiterate, we are investing in what you might want to think about as a three pillared operating model, business process and technology consulting plus technology outsourcing, plus knowledge process outsourcing. And we think that this is the right combination of services to respond to our clients' requirements now and for the next several years as we help them migrate the change before them.

I would like to take a step back now and provide our view on this change. Along with many others, we fundamentally believe that the world is now beginning a period of profound evolution in terms of how people create, distribute, consume various forms of information. This simple observation, we think, will drive our traditional business and also provide new opportunities that leverage the capabilities we have developed over the years, the continuing emergence of new technologies, competitors and business models, including the most prominent are compelling companies in the information industry to invest in new and upgraded products and reduce costs associated with legacy products.

We help these companies by first sending in our consulting staff. We help the roadmap improvements to legacy processes or new product operations that are bolstered by new technologies and multi-shore outsourcing. And then we help implement change through our outsourcing services offerings, provide Q related and K pier related.

As new ways of distributing information take hold, we intend to be right there, anticipating market need. As a result of our investments in eBook technologies, we are perhaps the leading eBook services provider in the publishing services industry and our client roster includes the most significant players in this space. This area, while still a relatively small portion of our total revenue stream is experiencing strong revenue and bookings growth, and we expect it to be an important source of new business in 2010.

But the eBook phenomenon should really not be viewed in isolation, but rather in context because I believe that it is just a small part of a 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 and change the rules in terms of how, and really by whom, content gets created. So, for example, this quarter we started creating content that previously would have been created by law firms.

And we started writing a psychology textbook for a client that publishes what they are calling open textbooks, clearly the kind of work that we are accustomed to seeing from large education publishers. What these engagements have in common was that they are being undertaken without the involvement of the traditional players, and they both involve not traditional processes and approaches that we are able to bring to the market.

A second dimension is that we believe we are positioned for growth in new markets that, while outside our historical publishing and information vertical, nevertheless, leverage our expertise in content related services. For example, this quarter we kicked off several initiatives that relate to the complex information needs of new clients in the medical and health area. And indeed, in 2009, we brought in several prominent new clients outside the publishing and information sector, including one of the world's leading providers of computers and peripherals, a leading international developer and distributor of video games and $13 billion network services company.

So in terms of the big picture, and looking out to 2010, we see significant opportunities for growth and we believe that we have positioned ourselves well. We believe that we will be able to grow revenue without having to incur significant SG&A expansion, enabling us to leverage both our fixed operations and our SG&A.

The simple way to think about this dynamic is that approximately 50% of new revenue flows through to the bottom line. Moreover, even as we expand physical capacity, which we will likely have to do in 2010, this flow through number diminishes only by maybe about 5%.

The fourth quarter on the revenue side remains tough to call. Our best guess would be approximately in line with third quarter as our visibility continues to be challenged by a couple of large new eBook engagements that are off to slow starts. We are waiting for new clients to finish tweaking their not as net released eBook readers into complete title rights acquisition deals they are working on. And in terms of the large client that we spoke about just a few minutes ago, we can only really try to approximate when we think new budgets for subsequent project phases are going to kick into gear.

In terms of 2010, we are seeing significant opportunities for growth for increase client diversification. We believe that this will be achieved as a result of first, accelerating requirements from our existing clients, second, the high end bookings we have been experiencing this year, which roll into next year, and third, expansion in our consulting and IT outsourcing revenue, which we believe will create new revenue sources for us while helping to drive core KPO and publishing services revenue.

Finally, we see considerable opportunity for strategic acquisitions and are addressing these in a systematic and consistent way. Toward this end, we are pleased to have Corey on board now, who joined us in September.

Corey is a Wharton graduate with 15 years experience in M&A gained at Wasserstein Perella at Smith Barney, in addition to developing and managing an enhanced investor relations program, Corey is going to be focusing on helping us accelerate growth through strategic partnerships, joint ventures and acquisitions.

And next week, O'Neil Nalavadi will be joining us as our new CFO. O'Neil too brings a great growth orientation with an underlying M&A bent and has been successful at a couple of high profile outsource services companies. We are now well into our 2010 planning process and my team is aggressively looking at how to use our distinguishing capabilities to best drive growth. Now I will turn the call over to Jurgen for a closer look at the numbers. Jurgen?

Thanks, Jack. Good morning everyone, again, thank you all for joining us. I am going to take you through a closer look at the numbers and the income statement cash flow and balance sheet and offer some insight and perspective.

Revenue in the third quarter 2009 was $19.1 million, a decrease of 12% from the $21.6 million of the second quarter, and an increase of 4% from the $18.3 million in the third quarter of 2008. For the first nine months of 2009, revenue was $62.6 million, a historical high and a 15% increase from the $54.6 million in the same period last year.

The sequential decrease was a result of revenue from our top two clients decreasing by $10.9 million in the second quarter to approximately $7.8 million in the third quarter. As Jack emphasized, this decline reflects the clients' expected project facing and budgeting cycle.

Gross margin in the third quarter was 30%, lower than the 34% in the second quarter 2009, but still in line with our target gross margin of 30% or better. In dollar terms, the decline in gross margin totaled $1.7 million. We attribute roughly $1.2 million of this to the revenue decline to the remainder consisting of the costs incurred for the new hires in our consulting and IT sourcing groups and startup expenses we incur at the beginning of new projects, reflecting the increased level of new bookings we have recently achieved.

On the year-over-year basis, the 30% compares against 28% in the third quarter of 2008. And for the first nine months of 2009, our gross margin was 35%, an improvement of the 26% in the same period 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 we did in the fourth quarter of 2008, partially reduced by the increase in the labor expenses relating to the new hires in our consulting and IT services group.

Base earning for this quarter was $3.8 million, an increase of $700,000 or 22% from the $3.1 million of the previous quarter and an increase of $100,000 or 3% from the previous year. As a percentage of revenue, base year was 20% this quarter, an increase of six percentage points from the 14% last quarter, and on the same level as a 20% of the same period last year.

The reduction of $1.6 million in SGA costs, SG&A costs rather, during the first nine months, was attributable to the continuing cost savings from the restructuring activity we did in December 2008, a reduction in non-employee costs expenses, partially offset by the additional SG&A employee costs. On a sequential quarter basis, the increase in SG&A costs come principally as a result of an additional $200,000 of SG&A employee costs from investment in consulting and IT outsourcing capabilities that I referred to just a moment ago and that Jack discussed at length. The remaining increase was caused by the timing of certain SG&A expenses.

This quarter we earned $2 million pretax, as compared to the $4.4 million the second quarter of 2009, a decrease of $2.4 million. For the first nine months of 2009, pretax income was $11.5 million compared to $2.5 million in the same period last year, an increase of $8.9 million.

The Company's effective tax rate of 2009 is approximately 29%, of the US tax rate is approximately 38%, the Company's foreign subsidiaries of tax rates that range from 5% to 34%. The combination of these different rates and the earnings of these entities result in our overall lower effective tax rate.

In terms of EPS, we earned $0.05 per diluted share in the third quarter of 2009, an $0.08 decrease from the second quarter of 2009 and at the same level as the $0.05 per diluted share earned in the third quarter of last year. For the first nine months of 2009, our EPS is $0.32 per diluted share, a $0.24 increase over EPS in the same period of 2008.

In terms of managing foreign currency exposure, we have a hedging program in place based on currency forecasts for the Philippine peso, Indian rupee and Israeli shekel. Pursuant to this program, we have foreign currency forward contracts worth $35.5 million as of September 30, up from $12 million as of June 30.

Now let's turn our attention to cash flow in the balance sheet. Cash from operations for this quarter was $2.9 million, lower than the $6.8 million of the previous quarter, but higher than the negative $200,000 in the third quarter of 2008.

For the first nine months of 2009, cash from operations was a record $12.9 million, an increase of $9.1 million from the $3.7 million of the first nine months of 2008. The significant improvement in our cash from operations in the first nine months of 2009 was primarily driven by the increase in our net income. We ended this quarter with a record $27.9 million in cash, an increase of $4.7 million, or 21% from the previous quarter and an increase of $13.8 million, or 98% from the previous year.

Pre-cash flow was $11.2 million for the first nine months of 2009, an increase of $9.4 million from $1.8 million in the first nine months of 2008. This $11.2 million represents cash from operations of $12.9 million less net capital spending of $1.7 million.

During the first nine months, we spent $1.7 million of the $4.5 million we budgeted for CapEx this year. We anticipate spending the balance over the next several quarters.

We ended the quarter with accounts receivable of $12.9 million, lower than last quarter's $14.2 million. Our day sales outstanding, or DSO, increased to 65 base from the previous quarter's 58. And we ended the quarter with working capital of $35 million, up by $22.8 million from yearend December 31, 2008, and up by $4.3 million from last quarter's $13.8 million.

We maintain a $7 million line of credit under which we have no outstanding obligations. We believe that our existing cash balances with funds generating 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. Looking forward to any questions you may have. Operator, we are ready to take questions.

Thank you. (Operator Instructions). Our first question comes from the line of Bart Blout with Sawtooth Capital.

Yes, thank you, a few questions. What was the reason for the DSOs to be longer? Second of all, the new sales that you are getting, I take it they will generate far higher gross margin than the previous sales and I wondered if that was correct, or say the older sales that you used to get? And also, what is being expensed and capitalized in terms of last quarter on your expense, if you could just give me some examples of what is being expensed and capitalized?

Sure, Bart, hi, this is Jack. I think I'll take off and I'll ask Jurgen to jump in and support me on some of the answers here.

Okay.

In terms of the DSOs, we have got, primarily, one client that is historically a slow payer and they sometimes become slower than they otherwise are. It is not one of our largest clients, our top, largest clients. They pay very, very well, but sometimes this client needs a little bit more time and over the last 12 or 13 years even that we have been working with them, they always make good on their obligations, so we are not concerned from that perspective.

They aren't in financial problems?

No, they have got collections. They provide services to another group of clients and we provide some services through them. Their clients pay slow and when their clients pay slow, they pay us slow. That's really what goes on there.

In terms of the new sales, a combination of things there, we are selling a diversity of things. I think on certain things we see gross margins as being much higher than they have been in the past and other things we still sell the things that we have been selling all along, and there the gross margins are more similar to what we have seen in the past.

But I think what we are trying to achieve over time is migrating, overall, project margins progressively higher. And that is really what is behind our strategy of adding more value to clients' relationships. The more value drive you can become, the less cost plus you end up having to act.

Well, the reason I remark on it is because a lot of businesses tend to be looked at with sales first, followed by lower line figures. And I just think in this particular case, your newer sales it seems are a lot more profitable and I just wanted to make sure that I was reading that correctly.

Yes, I think you are seeing more profitable, more profitability in newer sales, but we also see, and what we really have to emphasize here are two things, first, and I tried to play this out in some of my prepared remarks, the first is we have got a business that cash flow is very, very well with significant operating leverage in SG&A and fixed costs. So, as we expend, that we see 50% of incremental revenue or 45% as we start to build that new facilities next year, going right to the bottom line, that is very substantial.

Now, we can move that to a higher number, progressively over time, even better still. That is one thing. The second thing that I have tried to bring across, which I think is -- it is really the hidden gem here, it is the thing that is being eclipsed, is when you look beyond the vacillations of a single customer, and when we take a step back, what we will get to see in this calendar year is an underlying 60% growth rate, which is, obviously, very significant.

Now, when you marry that 60% underlying growth rate to the financial dynamics from the business, the way it cash flows, the operating leverage, I think we are on the right track. As you astutely pointed out, we need to keep moving those project margins progressively higher and one of our techniques for doing that is being much more customer centric, much more value based. And that is where the IT and the consulting investment comes in. You had a third question.

Yes, let's see.

Oh, expenditures, cap, thank you. Yes, I think the important thing to bear in mind is we, partly through our maybe conservatism, but partly through just the way the GAAP works, much of what we call investment, real investment in the business is expense. We do not get to capitalize it.

So when we brought in, in the second half of the year, essentially an annualized $2.1 million of additional costs that we view as important investment in our future, we think it is going to compel our growth, all of that hits the P&L immediately, and it has the effect of wiping a good 3% off gross margins and another 3% off operating margins for an accumulating 6% off operating margin, so --

I don't think if we had, if somebody chose to cover us, that would be pointed out to people because the Company is far richer than it shows on paper.

I think that's right. In other words, we don't have product that gets R&D'd and capitalized in the way that other companies might. What we have is, I think, a very well now developed sales and marketing competency. Our bookings are higher than they have been across the board in any time. We have been progressively increasing our bookings quarter-to-quarter.

And I think we are very well positioned, well regarded by our clients. And that needs to be invested in, in terms of new services, new capabilities that are progressively more value based. And it requires investment. So, do I wish, in accord where we are off a little bit in terms of our largest customer that we weren't making investment? Well, no, I don't.

From a perception perspective, it might be nice to not have that hitting the margins right now, but from a -- we are looking at this business with a two, three year perspective. I assure you we are going to look back three years from now and say, wow, that was a good decision that was made right there.

No, I agree. The last thing is that customer that you speak of is not -- they didn't go somewhere else or some of their business somewhere else, or do you want to even say?

What I guess really what I want to say there is that they are only scratching the surface so far. And we have been growing that customer and our top two customers over the past four years. Year after year, it gets bigger and bigger.

And that comes from, I think, having done good work. And we try not to rest on our laurels. We are thinking about what we can be doing in the future. In terms of what they are doing, they are only scratching the surface so far, and what, ultimately, can be their requirements. So we feel very good about it. The relationship is a very good one.

And the problem is that one of the things they count on us for is variability. When they are rethinking their exact direction, refocusing, planning and all of these things, then it means an interruption in our revenue stream for a couple of months. Well, that type of variability is one of the things that they pay us for.

Unfortunately, it is one of the things that investors do not like very much, but that is kind of where we have to just have a steady hand and keep driving and focusing on the things that we are in control of. And those things are going pretty good.

So in the digitalization more steps up, that you won't be affected? In other words, I just wait for somebody to say there is going to be a pricing war in digitalization because, because, because, and I just hope that we have made people understand that, why you have gone the direction you have gone so that it will be understood that that is not necessarily the case and what is going to happen to us.

Sure, and I think if you look back three years, four years ago, the vast majority of what we were doing was digitized. You come into one of our factories and you see paper and books, all sorts of things stacked all over the place and the stacks starting to fall over on themselves.

Come into one of our factories today, and I wish we were closer so I could invite investors there and have an investor day conference at one of our facilities because what you would see would be a grade A office, no paper, no books, everything is -- people sitting behind high end workstations doing analytical processing and taking over backend workflows that customers recognize we can do more effectively and efficiently. It is not the digitization that we remember from a few years ago.

So today I was looking at some emails and seeing one of our clients who is, that we had taken over maybe 20% of their backend operations and they are now saying we are ready, you guys have done such a good job, we are ready to see you take over the rest of it. And our people and our Sri Lanka facility who are responsible for that success, they are thrilled, the client is thrilled. And that is the type of work that we see more of going forward. It is not the old I have got a big stack of paper and we need you to feed that through a scanner. That you are quite right, that is commoditized a long time ago.

We will go ahead and take our next question from Tim Clarkson with Van Clemens Capital.

Hey, Jack. Hi guys, how are you doing?

Hi, Tim, good, thanks.

Yes, what I was just looking at the numbers, trying to pull back from what the street was expecting, I think the street was expecting $20 million and you did $19 million. I think the street probably is expecting $0.10. You made $0.05. And the way I look at is do a $19 million versus $20 million, that's $0.02 and the balance is investments you are making either with the new people you are adding and also the projects, the front end expenses of projects. Is that kind of a quick and dirty explanation of maybe the difference between what people are thinking and what actually happened?

Yes, I think that is pretty much it. If you compare the Q2 gross margin to the Q3 gross margin there is about a $1.7 million spread there.

Right.

$1.2 million, like we have said all along, we have got this 50% flow through that cuts both ways, so when there is a revenue decline, 50% hits the gross margin. That would be, on a revenue decline of 2.4%, that would be $1.2 million. And then, on top of that you have got the portion of the investment, that $250,000 that hits cogs. And then you have got another $250,000 of costs which are sunk into new project startups.

So like we said, we have got this underlying, really big growth that is welling up inside the Company. You are just not seeing it because of the facilitations in the big customer. We have got this big growth. We have got to feed that with project startup --

Right.

-- incur costs, but you do not incur revenue. So that is exactly what you are seeing on the gross margin side. On the SG&A side, again, another $250,000 of this investment in IT and consulting, and then so if you look at SG&A delta there, $3.1 million of the second quarter, $3.8 million in the third quarter for a $700,000 delta, $250,000 there too is the investment. And then, $450,000 is timing issues like some sales related activity.

We had a big trade show which was very successful, by the way, just recently, a lot of interesting new opportunities and leads. And in the quarter we are paying some pretty big bonuses to sales people who have driven what has been an outstanding booking year this year. So those are kind of onetime things that end up hitting the quarter that really you need to spread out and not think about that as SG&A approaching a new level. It is really just a timing thing.

Right, so that means from my vantage point, being with the Company a long time here and having a big investment, I, the way I figure which way things are going, if revenues go up, earnings will go up disproportionately and so you have to make a judgment whether you think revenues are going to ultimately go up or not, and there is no reason why you guys can't being doing 15% and 20% after tax in the $25 million to $30 million range per quarter.

Yes, I think that is right. It is really, when you look at the effect that growth, that driving revenue has on our earnings, it is huge. And that's, I think, what really makes the business interesting. Now, can we drive revenue? I think clearly the answer is yes.

When we look at this, what I think will end up being 50% underlying growth from the business, progressively quarter-to-quarter stronger bookings, big customers who over the last four years have shown increase appetites to drive business for us, the things that we are doing now, expanding IT and consulting to further accelerate that growth, demonstrating that we kind of see where the world of information publishing is going and being in the right place at the right time with things like eBooks. And we have got more like that coming.

Striving to play more effectively and be more prominent in other industries, bringing on the kinds of new clients we did this year, I think it is a pretty good bet that we are going to be driving revenue going forward. Now, the issue, though, is it doesn't work out particularly, predicatively quarter-to-quarter. That is what we have got to live with for now. And ultimately, that too will start to take care of itself.

Right. Thanks, I'm done.

We will go ahead and take our next question from Jay Harris of Goldsmith and Harris.

Good morning, Jack.

Hi, good morning, Jay.

I need a little clarification. The customer that gave us less business than we thought, and I guess that is going to continue at least until its budgeting for next year is completed, was that one of your two large customers or is that a different customer?

Yes, Jay, that is one of the two large customers.

All right. Has this happened before with this customer?

Well, I think the pattern that we see with this customer is that they accelerate very hard, very fast. They decelerate hard and fast. And that is just something that we live with because we have over the past few years done a lot of business with them and they have -- they are going directions where we can be very helpful to them.

Could you go back to the guidance numbers that you gave 90 days ago in the June quarter and reconcile what changed since then and what we are looking at right now?

Sure. I guess what we focused on and tried to emphasize last quarter was the range of possibilities and I wish we had a much better crystal ball. Certainly I think we should be able to, we would like to be able to look out a quarter ahead and nail what revenue is going to be.

But what we said in the last call is that we were having difficulty doing that because first, the big client doesn't give us a good crystal ball and secondly, because we are starting up so many new things, it is very hard to predict how a new thing kicks in exactly, how it works. We announced, and one of the things we said that we were going to do in the last call is that we were going to be announcing several very new large projects, which we did, so the $4 million eBook contract, new customer, new requirement, both for us and for them, how exactly does that ramp up?

What is the schedule? Do they have everything in place in terms of rights acquisition? Those are unknown. So there revenue became harder to clarify.

So what we tried to communicate was that the range, if we go down in the range, it would be driven by these things. But what we also communicated in terms of guidance was that we would be winning several new, large, important opportunities.

And on that score, we delivered the $4 million eBook contract. We delivered an over $6 million contract for applications development to XML services. And then we delivered two contracts that were about $1 million each in terms of outsourced content processes. So I think that, again, given like we just said that growth is so important to the business in terms of how the fundamentals of the business work, we did a pretty good job nailing what we said we would deliver in terms of new client acquisition, the crystal ball stuff, how it lays out in a quarter, as I said, that is just something that we are going to have progressively hope gets better, but live with for now.

Just for clarification purposes, if I recall correctly, I think you said that you thought that the third quarter revenues would come in between $19 million and $21 million, something like that?

That's right.

And so, the revenues came in, in that range. What were the reasons that you gave a range at that point? Did you have any indication from this large customer that things might slow down or was it just the rate of startup and billing on new programs?

Well, I think it was a combination. Really what we try to do it take a whole ton of moving parts and synthesize that, coalesce that into a vision of what's to come. So we were looking at, well, when do we expect these winds to occur?

Once they occur, what do we think the ramp up is going to be? When do we believe the big client will be rebudgeting and starting the new initiatives that we are aware of, and making lots of guesses at those things, so we ranged it knowing that if those things go particularly well, if the winds come in fast, if the new clients are really ready to get out of the gate strong, if the big client rebudgets quickly, we are going to be on the, closer to the $21 million side. If those things happen a little bit more slowly, we are going to be closer to the $19 million side and I am glad that we ranged it that way and communicated it that way.

Well, you also said, I think, that because you had added to staff, that the gross profits which were, if I remember correctly, 34% in the June quarter, could be off a couple of percentage points, and of course, they are off four percentage points. What happened between to cause that difference?

Yes, I guess two things. One, is I wish I had communicated a little bit more clearly there. I said it would be 200 basis points off of the margins in that quarter, so --

Right.

-- because the revenues were higher, that really does translate into about a $400,000 delta. So I think that is part of it. Another part of it was we have had a few more sales people be hitting the ball out of the park and getting some big bonuses.

But don't you put reserves in your quarters for bonuses?

We do, and I think we ending up being a bit more successful on the sales side than what we reserved for and that's an elegant problem.

But bonuses -- all right, it is. There is no question about that. I gather the bonuses are paid in the month in which the contracts are signed?

It depends. We have got a -- we have certain bonuses we pay them. We have sales commissions which are different. The commissions end up getting paid based on billings so it is a program with several different layers of compensation that is built in.

Is there a way to spread the cost of these bonuses out over four quarters by anticipating a higher level of success than we have in the past?

Yes, there might be. I think, certainly, if we are underestimating our success, we will have to start to rethink that.

Because you don't want to run into a situation where the greater the future revenue generation success is, the lower your earnings are.

Certainly, that is correct. And, again, I think that the variability that we saw in that one large client affects us substantially given the 50% flow through characteristic. The other thing that we have got though is that customer, new large project wins, we book that business and in some cases do have some amount of compensation around that.

And that occurs in advance of revenue recognition. So, I think you point, though, is well taken that we want to do everything we can to even that out as much as possible so that a substantial, a sudden increase in SG&A isn't seen by people as being permanent and a new level that is going to be instantiated into the P&L.

(Operator Instructions). We will go next to [Joe First] with First Associates.

Good morning, gentlemen. Before I ask a question, I just want to make a comment. I am trying to look at your Company over the long-term and I just noticed that in looking at the data, you have to remember over the last three years you have grown your revenue from $40 to basically $80 million and you have gone from losing $8 million to probably making around $9 million this year and that is your sales, that is over a 25% annualized rate of growth.

And you are talking about a rate of growth over the next three years that could be at least equal to that I would think. So looking at the long view, you have done a very good job over the last three year increasing your business, and although this quarter is certainly disappointing, we certainly understand why that is, so, just one comment, trying to take a long view of it.

And secondly, you have gotten some rather large contracts in the last quarter in your backlog. Do you see an outlook there of bidding for or possibly getting any more of these large type contracts?

Hi, Joe, thanks for the question and I think to your point, taking a long view is important. The quarters in this business do not necessarily dovetail or particularly in a way that really shows what is going on in the business. What we are trying to do though is shine a light on what is going on in the business and what is getting us excited about the business, what keeps us excited about the business.

In terms of, I'm sorry, your fault, there was large contracts, thank you. We are working on several things that we are very excited about and I know one thing that Corey is very intent on is making sure that we get more information out there, that the information that we are communicating both shows kind of the progress that we are making strategically and shows some stakes we are putting in the ground, but also make sure that we get out there word of large contracts.

So, I think as we see a couple of things that we are working on, hopefully come in, we will get those announcements out to you.

And one other quick question, the KPO business is the business that is the recurring type of business and you are trying to have emphasis on that business so you get a much higher of your revenue being recurring revenue. And earlier this year you were saying that was going very well, that a lot of people were inquiring to you about doing that kind of work. How is that marketplace now?

I think it is moving pretty well along in terms of -- and I know we don't put these numbers out there for various reasons. They need to be shaped a bit before they are ready to be committed to be shared publicly, but in terms of our internal bookings targets, we are dead on for where we want to be in terms of driving recurring growth.

We are, actually, quite ahead of ourselves in terms of the project side of the business. But we continue to see good opportunities on the recurring side. I talked just a minute ago about, anecdotally, about an example just from the last day or two where the client who is real happy with the way we have taken over operational responsibility for and wants to increase that fairly significantly.

So, we are going to keep a real focus on that and continue to drive that. At the same time, when we look at the fact that 94% of our revenue is coming from clients that have been doing recurring business with us, so even if it is a project, if there is another project after that or two projects after that, that is pretty compelling also.

And you have these 29 new clients who, obviously, up to now have been a very small part of the business, but if history is a guide, I think those new clients can increase their business. I would assume you expect that from those clients.

That's exactly right. And if you look at us, as you were saying, if you look at over a very long period of time, what we have shown is that we can grow these saplings into big redwoods. What the issue is we have got so many more saplings that we are now germinating, we need more people to really grow them that way. And again, that is where the consulting investment comes in.

It is our intention to do exactly like you say, and the clients that we are bringing in, these new clients, are not, we are not fishing, we are not scraping the bottom of the barrel. We are talking about a $13 billion client. Now if a $13 billion client doesn't have a few tens of millions of dollars it can spend with us, then I don't think we're doing a good job of fishing.

Just roughly, how many clients do you have roughly?

I think that number is about 170 right now.

170, okay. Good. Thank you, and it is nice to see also you have you are over $1 a share in net cash, which is good.

Yes.

Thank you. Keep up the good work.

We'll go next to Bart Blout with Sawtooth Capital.

Yes, Jack, first of all, I wanted to say that the web page which you have done just an incredible job on, it -- there is so much information on it, I don't know -- like I was looking through the other day and I saw that you had all these clients. And one of them was Conde Nast.

And so the first thing I thought was when they closed their magazines, wouldn't that be a perfect place for you to get some business from. And when I looked at these different -- I don't know how long it has been on there, but every time I go back to your website, there is so much information on there that is a -- you are really a big deal and I don't know what you can do to get people to do to go to the website, but then, at the same time, because you are big deal,

I think you noted that people expect for you to be better at predicting to Wall Street and that's why the stock goes from the other day $7 to $4.97 this morning up to $6.03 now. That is just, percentage wise is a mind boggling thing to have to deal with and you are a far better company than that. So I don't know if you want to answer the one about Conde Nast, but I wish you take in consideration the fact that they -- you are such a big deal company they expect you guys to come out with predictability because, otherwise, when the market goes down and it is -- if IBM goes down it's IBM goes down, but if it goes down with me, it is one of Sawtooth Capital's piece of junk.

Yes I understand what you are saying, Bart, and I guess in terms of talking about the magazine and history in a general sense, I think clearly there is a whole lot of challenge there. Advertising revenues are way, way down and there are a lot of players who are having to think about new business models and a lot of them are very much thinking about what do these new eBook devices suggest for us? How do we maybe advertise, get some more online advertising dollars by being more of an e-publishing play and relying more upon electronic distribution?

So there are lots of interesting conversations to be had there. And it is an area that I would like to see us investing much more in because I think there is just tremendous opportunity.

In terms of the frustration watching the stock price go up and down, I really do feel for investors and being one myself and I wish I could prevent that from happening. And I think the best way that I can is to try to have a real steady hand here and to do the things that are necessary, to grow the business, to bring in the types of deals that we can, to strategically position ourselves for the right kinds of services that we are progressively, increasingly relevant to customers so that a magazine publisher will come to us at a high level and say we are struggling with our business model. How can we work together?

And I think we are doing largely the right things in that respect. So we are very focused on kind of the mountains we are prepared to climb. We are not going to obsess on the foothills and the little bumps that are directly in front of us. And I think with that appropriate focus and cultivating the right investor base and people that understand where we are and where we are trying to get to, we will do well by investors.

We will go next to a follow up question from Jay Harris with Goldsmith and Harris.

Jack, as one of the guys from Wall Street, can we assume that the SG&A in the fourth quarter will be down by $300,000 or $400,000 since you had special charges in the third quarter?

Jay, I don't want to try to speculate on what it will be in the fourth quarter because some of those special charges I didn't see coming, as you perfectly pointed out, in this quarter. So I think what I want to stick with there is that there was $400,000 that were not recurring. They are not permanently in that cost base.

Yes, but there are -- I guess an offset to any reduction would be the full quarter burden of people that you had hired during the third quarter, right?

Maybe you could restate that for me?

You hired people during the third quarter whose costs show up in SG&A and they weren't in the third quarter for the full 90 days. And they will be in the fourth quarter for the full 90 days.

I see what you are saying. No, for the most part, the people that affected SG&A were in the third quarter for the full third quarter.

Okay.

We are not going to see a dramatic increase there.

All right, so I guess that is a challenge in terms of how people like myself on Wall Street can basically react to a -- to form a perception on what, how the quarters are going to lay out in a way that doesn't create the kind of surprise that this last quarter, obviously, created.

Sure. And I think what we will continue to endeavor to do is to take all of the moving bits and pieces, all the moving parts and to synthesize them and communicate to Wall Street what we think that looks like near term when we, when there is some uncertainty, we will put that out there too. But then also, equally, with a view to, as I said, the mountain that we are climbing, I think we want to make sure that we are maintaining sufficient attention on the promise of that.

I thank you. It's obvious, even to me, that you are building a company. I think it is difficult to, in this investment environment to, basically, get comfortable with these irregular quarters, that's all.

Understood.

Thank you. That concludes the question and answer session today. At this time, I would like to turn the conference back over to Mr. Abuhoff for any additional or closing remarks.

Thank you, and more broadly, thanks to everybody who joined us today, appreciate your questions and your time. I guess I will just take minute or two to just recap some of the key takeaways. Our revenue for the quarter was $19.1 million. We are saying that fourth quarter could be, essentially, flat with that.

Visibility remains a little bit tough for the reasons that we gave. Our volume of business with one of the large clients is down as a result of budget cycles, but we expect that they will be rebudgeting. We hope to see new requirements from the soon. What this isolated event is really hiding is what is going on in the rest of the business, which we are forecasting is 60% growth within the year.

And this is the kind of trend that is more predictive than the quarter-to-quarter requirements and vacillations of a single client. Our investment in building out onshore staff in our consulting and technology areas is one that we are confident. It is one that we are excited about. And even though it is costing us 3% or so in the gross margin side and still another 3% on the operating margin side, we are already winning deals as a result of this.

It will be an important additional growth drive for going forward and I think it will be an investment that we will look back on and say it had big pay back. As we are now going full steam into our 2010 planning, we are excited by the prospects that we see from the coming year for the market, that we believe that 2010 taken as a whole is going to be propelled by the combined forces of a strong market opportunity, certainly solid execution both on the delivery side of the business and on the sales side, and an expanding talented team of managers that we are bringing to bear.

So, again, I thank everybody who joined us today, looking forward to being with you next time and thank you.

Ladies and gentlemen, a replay of today's call can be accessed by dialing 1-888-203-1112 using replay pass code 4966935 and will be available from November 5, 2009 at 1 p.m. central time through December 5, 2009 at 1 p.m. central time. This concludes today's conference and we thank you for your participation.