Innodata Inc.

Amy R. Agress - Vice President, General Counsel and Secretary O'Neil Nalavadi - Chief Financial Officer, Principal Accounting Officer and Senior Vice President Jack S.

Abuhoff - Chairman, Chief Executive Officer and President

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division Joe Furst Timothy Clarkson Jay Richard Harris - Goldsmith & Harris Incorporated, Research Division

Thank you, Celia. Good morning, everyone.

Thank you for joining us today. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata; and O'Neil Nalavadi, our CFO.

We'll hear from O'Neil first, who will provide a detailed review of our third quarter results, and then Jack will follow with additional perspective about the business. We'll then take your questions.

First, let me qualify the forward-looking statements that are made during the call. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including, without limitation, the matters relating to our Innodata Advanced Data Solutions segment that are discussed during the call and the risks and uncertainties of early-stage companies generally; The risk that contracts could be terminated by customers; projected or committed volumes of work may not materialize; the primarily at-will nature of our contracts with our customers and the ability of our customers to reduce, delay or cancel projects; continuing Content Services segment revenue concentration in a limited number of customers; continuing Content Services segment reliance on project-based work; inability to replace projects that are completed, canceled or reduced; 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 and knowledge processing; difficulty in integrating and deriving synergies from acquisitions, joint ventures and strategic investments; 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.

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

I will now turn the call over to O'Neil.

Thank you, Amy. Good morning, everyone.

Thank you once again for joining us today to review our financial results for the third quarter of 2013. I will begin with a detailed review of our third quarter results, comparing performance with the second quarter of 2013 on a sequential basis and, along with the review, I'll share my insights.

After the financial discussions, Jack will provide the strategic and operational perspective about our business. Our total revenues in the third quarter of 2013 were $15.8 million, compared to $16.2 million in the second quarter.

The decrease of $400,000 was attributable primarily to a $700,000 decrease in revenues from a key e-books client, which was offset by a $300,000 increase in revenues from other clients in our Content Services business. On a segment basis, total revenues in Content Services were $15.6 million this quarter, compared to $16 million in Q2; and total revenues in our Advanced Data Solutions business were $150,000, both in this quarter and last quarter.

Revenues from our top 3 clients were consistent, around 42% of total revenues in both sequential quarters. Looking ahead, our revenue guidance for Q4 is between $14 million and $16 million.

And for calendar year 2013, it's between $63 million and $65 million. As Jack has mentioned on past calls, on account of marketplace challenges in our Content business, we have been investing significant resources in the Synodex subsidiary of our IADS business to achieve our growth aspirations.

We had built a good customer pipeline for Synodex services. However, we are experiencing continuing and frustrating delays in converting this customer pipeline into revenue-generating customers.

This has resulted in we missing our growth objectives for 2013, and we are very disappointed about missing our growth milestone for this year. Now as a result of our missed revenue and cash flow projections, combined with the lack of historical metrics, which would have enabled us to predict customer acquisitions and financial projections for some measure of certainty, we decided to take an impairment charge to write off the Synodex assets in our books.

The total amount of this onetime, noncash write-off is $5.5 million. Jack will cover in more detail his strategic perspective of this business and how we intend to manage the business in light of what is no doubt a very long sales cycle business.

Let me now review our gross margins. On a consolidated basis, gross margins were $3.8 million or 24% of revenues in Q3 compared to $2.8 million or 17% of revenues in Q2, an increase of $1 million.

This increase in gross margin was primarily as a result of efficiencies that we achieved on cost reductions made in Q2 of 2013. On a segment basis, gross margin in our Content Services business was $5 million or 32% of revenues, compared to $4.2 million or 26% of revenues in the second quarter.

And in IADS, cost of production not covered by revenues amounted to $1.2 million this quarter compared to $1.5 million last quarter. Our selling, general and administrative expenses were approximately $4 million in Q3 compared to $4.4 million in the previous quarter, a decline of approximately $400,000.

These expenses were lower, primarily as a result of cost-reduction initiatives we had implemented in the first half of the year. As a result of cost reductions, SG&A expenses as a percentage of revenues was 25% in this quarter compared to 27% of revenues in Q2.

Moving down to pretax earnings. For apple-to-apple comparison, I'm going to provide the figures before the Synodex impairment expense of $5.5 million; and later, I will provide pretax earnings after including the impairment expense.

Before taking account of the Synodex impairment expense, our pretax loss in Q3 was $160,000 compared to a loss of $1.5 million in Q2. This substantial decrease of $1.3 million in pretax loss was primarily due to efficiencies from cost reductions, which was $1 million at production level and $300,000 was in SG&A expenses.

This pretax loss for Q3 is after absorbing costs of $1.6 million net of revenues for building the Advanced Data Solutions business. If we were to exclude IADS costs, pretax earnings in our Content Services business would be $1.5 million or 9% of revenues compared to $600,000 or 4% of revenues in the prior quarter.

Our pretax loss after including the Synodex impairment expense was $5.7 million this quarter. In the current quarter, we had a net tax charge of $7.3 million compared to a net tax benefit of $1 million in Q2.

There are 2 components to this unusually large tax charge in the current quarter. The first is that routine tax expense on profits earned by our foreign operating subsidiaries, which amounted to $200,000 in the current and the previous quarter.

The second is a nonroutine, noncash tax expense as a result of creating a $7.1 million valuation allowance against all of our U.S. deferred tax assets.

This charge is primarily a result of continuing losses in Synodex, combined with a lack of historical metrics, which will enable us to predict with some measure of certainty whether our future financial projections will be achieved. Our Synodex losses are incurred primarily in our U.S.

books, and these result in U.S. tax losses.

In the normal course, these tax losses are available for setoff against future taxable profits and therefore, result in corresponding deferred tax assets. However, in accordance with current accounting guidelines, if future taxable profits cannot be predicted with certainty, then we have to create a valuation allowance against such deferred tax assets.

Our entire valuation allowance of $7.1 million is primarily due to this accounting guideline, again, in nonroutine and noncash expense. That said, if and when we return to profitability and are able to predict future U.S.

taxable profits, this valuation allowance will be reversed in the books. Finally, I would like to point out that our U.S.

tax losses of $15 million, irrespective of the accounting treatment I just discussed, will still be available for setoff against future taxable profits of the company in accordance with IRS guidelines. Net loss after minority interest was $11.7 million this quarter compared to a net loss of $120,000 in the second quarter.

Turning now to our cash flow statement. Our cash consumption was $200,000 this quarter compared to $2.1 million in Q2 2013.

The cash utilization is primarily attributable to our losses in the IADS business, as well as capital expenses. We incurred capital expenditures of approximately $500,000 in the third quarter compared to $1.4 million in the second quarter.

And of the $500,000 in capital expenditures this quarter, $300,000 was in our IADS business and the balance $200,000 was in our Content Services business. We expect our CapEx to be in the range of $500,000 to $800,000 in the fourth quarter, of which approximately $300,000 will be for IADS.

Until we achieve a state where both revenues and earnings in Synodex can be predicted, all continuing CapEx will be expensed through the income statement. Our balance sheet remains healthy with cash, cash equivalents and investments in term deposit with banks at $26 million at the end of Q3, compared to $27 million at the end of Q2 2013.

In addition, our liquidity sources include a $15 million line of credit, which remains unutilized. Looking at working capital, our accounts receivable was approximately $10.8 million at the end of the third quarter compared to $10.9 million at the end of the second quarter.

In terms of DSO, or days sales outstanding, our AR balance was averaging at 62 days this quarter compared to 60 days during the first half of 2013. Let me now review our inventory of foreign exchange hedging contracts.

As of the end of the third quarter, we had $26 million in outstanding foreign currency forward contracts as a hedge against our foreign currency risk for our future operating expenses in Asia. The U.S.

dollar continued to appreciate this quarter versus Asian currencies, increasing 10% against the Indian rupee and 5% against the peso. As a result of the appreciation, we have notional unrealized losses of $1.7 million on these forward contracts as of September 30, 2013.

These forward contracts will be maturing over next 12 months, and any losses or gains on these contracts will be recognized upon maturity. I will now conclude with a brief summary of the Advanced Data Solutions business.

Net investment inclusive of losses during the third quarter was approximately $2 million, of which $1.7 million was through the income statement and $300,000 represented capital expenditures. Our total cumulative investment, net of revenues and IADS, is $20 million from inception through to the end of the current quarter.

Of this amount, Synodex accounted for approximately $15 million or 75% and docGenix for the balance, 25% or $5 million. In the third quarter, our IADS revenues were $150,000 and our year-to-date revenues were $950,000.

In docGenix business, we signed up a new project in Q3 with an existing client, which is a leading U.S. bank with a revenue potential of up to $1.5 million.

And in Synodex, we have 3 clients in the contract at the end of Q3. This quarter, for reasons that we discussed earlier on the call, we decided to take an impairment charge of $5.5 million to write off the value of all Synodex assets.

Although this charge was required under the accounting guidelines, we intend to continue our efforts to convert our Synodex customer pipeline into revenue-generating customers. And we will review progress quarter to quarter and stay adaptable to make changes to our business plans.

As for our efforts, we're also developing a new release of a proprietary workflow, which we call Workflow 3 [ph], to substantially improve productivity and to achieve our targeted production contribution margins. Our current run rate of investment for all of these efforts is approximately $1.5 million to $2 million per quarter, all of which will flow through our income statement.

I will now turn the call over to Jack, who will provide additional insight into the business and our progress on strategic fronts. After that, we will take your questions.

Jack?

Thank you, O'Neil. Good morning, everyone.

Thank you for joining us. As O'Neil just covered, by virtue of the fact that we are not yet able to accurately predict revenue from our Synodex business, we have had to write off the $5.5 million of capitalized costs that we've incurred to build our Synodex service.

GAAP accounting rules required us to apply an asset impairment test, which, in essence, calls for a write-down if a company can't predict revenues and positive operating cash flows with a measure of certainty. While we have a lot going on in our list of active prospects, to date, Synodex hasn't had a significant revenues or contracts, and we simply don't have the experience under our belts to predict with a measure of certainty if and when significant revenues and contracts will be achieved.

Most recently, we forecasted that 3 new clients would start to do business with us in the third quarter, but our prediction was wrong. One of these 3, we lost unexpectedly; and the other 2 remain in our active prospects lists.

We also decided that the $7.1 million deferred tax asset of our U.S. entity was impaired under the accounting rules for similar reason.

We can't predict with a measure of certainty if and when the Synodex business will stop generating losses that offset Innodata's other taxable income. As O'Neil mentioned, these losses remain available for Innodata to set off against any taxable income that Innodata may earn in the future.

But entrepreneurs and investors know that investment decisions are often appropriately made to seek growth despite uncertainty. The tests we think are the right ones for validating a new venture investment include the following: is the venture's product being well received by its early adopter customers?

Is the business progressively attracting the interest of key decision-makers in its targeted client base? Is there an attractive addressable market for the venture's product?

Are there compelling drivers for the market to adopt the venture's product? Is the business learning what it needs to learn, progressively becoming smarter and better aligned to the market's requirements?

And finally, will the business be able to execute well and make money? I'm going to take you through each of these tests.

I hope that by doing so, you will get a glimpse of that world that we're seeing. Let's start with the first test.

Is our product being well reviewed by current customers? We have 3 small early adopter customers at present.

I spoke to 2 of them, most recently this week. The first client I spoke with was the Director of Underwriting at the client we announced having won back in April.

We give each of our clients internal designations, which helps us communicate information about them while safeguarding confidentiality. And internally, we call this client Neolight [ph].

Neolight [ph] is a medium-sized insurance company, but nevertheless, ranks from the Fortune 1,000, with revenue close to $2 billion. And here's some good news.

I am pleased to report that after months of delays on Neolight's [ph] end, as we waited for them to complete their specifications and communications protocol and other internal matters, we started Neolight [ph] production on Tuesday of this very week. Now I asked the Director of Underwriting what he thought of our product and our prospects.

He shared a few interesting perspectives. First, he said that he believed we had a "far better product", and that's a quote, than our competitors.

He also said that Neolight [ph] had big plans for using our data feed in their new decision support system, which would be coming online in the next several months. And he was confident that this would have real transformational value for his company in processing life insurance applications that required an analysis of medical information.

Lastly, he said that our products have the potential to increase the efficiency of the informals business significantly. Informals refers to insurance sourced by independent brokers and represents approximately 30% of the overall market.

The second customer I spoke with this week is a small life insurer that specializes in life insurance sales through banks. Our internal designation for this client is Galena [ph].

That conversation was with a Senior Manager of Individual Life Products at Galena, who first started using us in August of this year. I asked her about our data quality and about whether she was seeing the productivity improvements she was hoping for as a result of using our data.

She said that the quality of our data had now earned a high level of trust among her underwriters. And as a result, she was now seeing it drives the levels of productivity she was hoping to achieve.

The second test is whether the business is progressively attracting the interest of key decision-makers in its targeted client base. Let's begin with the look at the scoreboard.

To date, we have conducted a total of 39 distinct pilots with 33 different insurance companies. Our first pilot was conducted in May of 2012, and our most recent pilot was conducted last week, so this activity has spanned about 1.5 years.

In that time, we've won business with 2 of these companies and we failed to win business with 5, although we believe it's reasonably possible that 2 of the 5 will reengage us. That leaves 26 companies with whom we've conducted pilots in our list of active prospects, 10 of which are especially active.

In addition, there are 4 other companies with whom we are planning pilots near term that are also especially active, so a total of 14. One of our wings was a Q1 2013 pilot and the other was a Q3 2013 pilot.

Our 5 non-wins were pilots from 2012 and first quarter 2013. One of these was a company that was not yet using medical records in underwriting, so we were a little early there.

Two were piloting our Workflow 1 [ph] version of our product, which was in some respects an alpha release. The fourth had an unusual regulatory requirement that may preclude them from using our product.

And the fifth had decided to use our product at an executive management level, but was unable to get its Board of Directors to go along for policy reasons. The 26 piloted companies that are on our active prospects list are all working with the Workflow 2 [ph] version of our product now, which has evolved considerably based on our early experiences and customer feedback.

The other thing that has changed is that we're now spending a lot more time with customers, custom-configuring the product to work within their workflow and tailoring the product to support their specific underwriting manuals. While this takes time and expense on our part, it also represents a considerable investment in time and resources on the part of our prospective clients.

I want to take you through a couple of examples of this, and I'm going to go deep into the weeds here because I want you to have a real feel for what's going on. So I talked about the 14 companies that are especially active prospects.

One of them is one of the 3 largest reinsurers in the world, with net income of over $4 billion. Our internal designation for this company is Cherry [ph].

We were first introduced to executives from Cherry [ph] in January of this year in an underwriter's conference in New York City. After a series of phone calls and sorting out NDAs, we presented to a wide group of their executives at their headquarters.

The executives liked what they saw and decided to move forward with an infrastructure review and signing of a pilot agreement. Infrastructure reviews are often prerequisites for engaging with us on a pilot.

Our client has responsibility under applicable law to ensure that we handle personnel health information in accordance with best industry practices and in compliance with law. We have seen infrastructure reviews take as long as 2 months to get scheduled and completed.

But with Cherry [ph], this went much quicker. Our pilot services agreement required a bit more time, as we prepared both the standard services agreement for performing the pilot, as well as the licensing agreement for Cherry [ph] to use our XML data specification to complete programming on their end.

By mid-June, we were having detailed discussions with them on the specific rule sets that we would need to build our applications in order to process their files. Jim Davis, our Head of Insurance Services, who used to be a Chief Underwriter himself, fronted these discussions with Cherry's [ph] team.

Doug Kemp, our Chief Product Officer, also participated. These were detailed discussions that took place over several months, analyzing Cherry's [ph] underwriting manuals to determine, for example, whether the same multi-variant criteria that apply to the presence of tachycardia or fibrillation should also be applied to ventricular fibrillation.

You get the picture. These discussions and the programming that they spawned continued through August.

At the same time, our IT team coordinated file transfer protocols with Cherry's [ph] IT team so that our systems could talk to each other. By mid-September, our rules and AI engines have been configured with Cherry's [ph] detailed decision criteria.

And by late September, we completed the third testing regimen. We were ready to receive and process pilot files.

After all that pre-work, actually processing the 100 files, required only a couple of days. And that's where we are today.

As next steps, we would likely review our files with Cherry [ph] to identify additional rules that they will need to share with us for us to program into our system. I would expect that it will take us a couple of weeks for this, which will likely be followed by an additional pilot run and additional client evaluation.

Here's another story, with another company that's also one of the top leaders in global life reinsurance, with nearly 3 trillion of life insurance in force. We were introduced to this client, who we internally refer to as Kenisha [ph], in late 2011.

Now in early 2012, we were invited to their headquarters to present to 20 of their key executives. And we took them through PowerPoint presentations that explained our products and our associated value propositions.

We showed them samples of our data. We showed them examples of the reports that we generate.

They were intrigued and wanted to see more. But before they can begin live pilot projects with us, in which they entrusted us with their client's personal health information, their information security and IT teams needed to get comfortable with our information security practices.

We provided them with our compliance pack, the detailed presentation of our infrastructure -- of our information handling practices, information security certifications and IT infrastructure. A couple of months later, they let us know that they had been quite pleased with what they saw.

They said the pilots could proceed. They also said that a more detailed infrastructure review would be required should our relationship progress beyond piloting.

Cleared now, at least for pilot work, we began a pilot this past January. For the first couple of months, Kenisha's [ph] focus was on quality.

Our data had to be extremely accurate to be of use to them. To say that they put our data through the paces is an understatement.

They scrutinized it, using their most experienced underwriters to review our output line by line and code by code. The important thing is that they came away so impressed by our quality that they began introducing us and recommending us to several of their carrier clients.

They invited us to attend and present at their internal global managers meeting at the only outside company in attendance. And they served as a reference for several of our other client prospects.

We also started discussions about specific ways that our XML output, in combination with new applications and workflows on their side, could help them increase underwriting speed and decrease underwriting costs. They began internal development of a prototype decision support system that we use our XML to automate aspects of their operations.

3 months after those discussions began, they let us know that they had been successful. They were able to auto-categorize applicant policies using our data and the results were holding up.

Based on this success, they began sharing with us details of their underwriting manuals so that we could build the required logic codes into our application logic and artificial intelligence rules. Once we developed the first set of rules, we ran some new files through and sent them to output.

Kenisha [ph] tested these files within their system and sent us an additional set of rules for incorporation within our application. Just a couple of weeks ago, I joined our team for a meeting at Kenisha's [ph] U.S.

headquarters. The meeting was attended by Kenisha's [ph] Vice Chairman, which should give you an idea of how high profile the initiative is.

He also offered a personal perspective. He said that companies in his industry were "slow to follow" -- excuse me, "slow to lead but fast to follow."

And that even as a mature and well-regarded company, these best new products often took 3 years to penetrate the market. Since that meeting, Kenisha [ph] has mentioned to us informally that their present intent is to begin using our services within their operations in January or February of next year, if all goes well.

We know that in order for this to happen, additional rule sets will need to be configured within our systems. Kenisha [ph] will need to complete building out its decision-support tool for in-taking our data.

And Kenisha's [ph] more comprehensive information security assessment of us will need to be completed. Meanwhile, the relationship continues to strengthen.

The Vice Chairman has joined us at a subsequent meeting to kick off a multi-company pilot that features our product within the informals for independent broker channel and has committed this company to actively participate in this pilot. In addition, we have other meetings planned at their headquarters to discuss other initiatives we are pursuing with them.

This level and type of activity is representative of the level and type of activity that we are now having with several of the companies that are especially active prospects. So I've now covered the first 2 investment criteria: reviews by early adopters and progressively attracting the interest of key decision-makers.

I'll now turn to the third. The third investment criterion we suggest is sufficiency of addressable market.

There are a number of different markets for medical records processing and data extraction, which we intend to address eventually. But for now, our focus is on life insurance underwriting and claims, disability insurance underwriting and claims and reinsurance.

We've concentrated most of our business and product development efforts to date on the life insurance segment. On the U.S.

side, we estimate the addressable market in this segment to be approximately $145 million of potential annual revenue. Based on data from the National Association of Insurance Commissioners, the American Council of Life Insurers estimates that in 2011, there were approximately 10.3 million new life insurance applications in the United States per year, excluding group coverage.

Our market-sizing assumes that about 20% of these policies involve an application. We believe that there are 2 or 3 current, well-financed and well-connected competitors that have captured somewhere between 10% and 20% of the U.S.

market. A number of insurance companies have also developed internal tools that are competitive with our services.

So there remains a fairly large untapped market for Synodex, which we are trying to capture based on the strength of our advanced services for our digital XML data. On the U.K.

side, we're estimating the potential market to be about 40% of the U.S. potential market or 58 million, taking into account a smaller population but possibly offset in part by a greater demand for life coverage.

On the U.S. disability side, extrapolating information we have about the numbers of claims processed by one of our potential clients, we estimate that there are approximately 8 million addressable disability claims per year in the U.S., yielding an annual market opportunity of approximately $560 million.

On the reinsurance side, if we guesstimate that 10% of life policies are reinsured, there is an additional annual market opportunity of roughly $50 million. This is very rough analysis of the business opportunity we see with lots of guesswork.

Our fourth suggested investment measure is whether macro business drivers support acceptance of our product in the market. Slow economic growth has created a challenge for life insurers.

Many consumers have cut back on life insurance, seeing it as a discretionary expense. And the result is declining life sales over the past few years.

At the same time, the protracted low interest rate environment has meant shrinking investment yields for life insurance companies, putting more pressure on making money through careful risk appraisal and management. On the revenue side, life insurance companies are seeking to increase their acquisition market share by improving the time it takes them to review informal applications.

They see this as a potential competitive advantage for their captive agents who are in the field vying for clients, as well as an advantage in competing for business from valued third-party producers. On the cost side of the equation, insurers are interested in business process improvement and automation solutions that can reduce the tedium of data gathering for underwriters, as well as agents and actuaries, and otherwise increase operational efficiencies.

The way the insurers see it, underwriters exercise skilled judgment. Their time and energy is best spent analyzing information, not gathering it or looking for it.

Automating processes that do not necessarily require human decision-making can enhance an insurer's competitive advantage by enabling its most capable people to focus on complex and unstructured decisions that require human intelligence and judgment. For that reason, insurers are interested in a more focused, rules-driven environment.

They're looking to run leaner and assign talent to areas that require relationship-building and decision-making skills, require relationship building and decision-making skills, relying upon information-driven, automated rules-based environments for the remaining processes. If you're interested in gaining further insights into the challenges life insurers are facing and how they're coping with these challenges, I'd recommend reading PricewaterhouseCoopers white paper entitled Top Insurance Industry Issues in 2013, which is available on PwC's website.

Now the fifth important key question that we think helps validate an investment in a new venture is whether the venture is learning what it needs to learn, progressively becoming smarter and better aligned to the market's requirements. In the course of the 2 years that we've been working on Synodex, we've created 5 major versions of our product specifications and 3 major releases of our workflow.

Each of these has been driven by the voice of the market as we put each version of our specs and workflow through the rigors of client testing and feedback. Each time, the data we obtain shapes our further product development.

That said and with the full benefit of hindsight, we've made several mistakes. For example, we spent the first year basically working hand-in-hand with a single customer prospect with whom our Synodex CEO had significant prior business relationships.

We ramped up our staff in order to accommodate what we expected would be their near-term needs. When they changed directions unexpectedly, we had already extended ourselves on the cost side.

We quickly re-prioritized, broadening our market outreach. Once again, we were surprised but this time in a good way.

We had not anticipated the level of interest we were experiencing. And without any past experience, data or detail to draw upon, we made our second mistake.

We underestimated the time that it would take to convert this customer enthusiasm into customer revenue. Our near-term revenue forecasts proved to be significantly off.

We also underestimated the extent to which detailed customization would be required to map to our customer's individual requirements. We tried selling our first few customers a basically off-the-shelf solutions.

By contrast, today, we are significantly more invested and working closely with our potential clients to define application and process environments in which they are able to use our products. Our sixth and last critical question is, will the business be able to execute well and make money?

As Synodex drives to achieve meaningful revenues, we are, at the same time, working to complete development of our Workflow 3 [ph] processing engine, which we will require in order to achieve a processing speed that supports our targeted profitability. We expect that this can be achieved, but we'll only know for sure once we're completed and once we get going.

But I would tell you this, our Synodex delivery organization shares management with our Content Services delivery organization, an organization that has a long track record of delivering projects successfully and within budget. So in summary, we don't yet have significant Synodex revenues or contracts, but we see that our product is being well reviewed by active prospects and early adopter customers.

We believe that there is a large addressable market, and we believe that there are macro business drivers for the market to adopt our products. At the same time, we need to improve our internal processing speed with the development of Workflow 3 [ph] which we expect we can achieve and we need to get going.

Let's turn now to the cost side of Innodata as a whole. In our Content Services segment, we have been continually finding opportunities to make cost adjustments over the past several quarters.

Over the past 4 quarters, we have reduced our U.S.- and U.K.-based annual labor costs by $4.3 million, our Asia-based labor costs by $1 million, and our infrastructure costs by yet another $1 million. This totaled $6.3 million.

We found about $1.7 million of these savings in Q3. On the IADS side, we reduced cost by approximately $650,000 over the past 4 quarters.

Synodex had a cash burn rate of $1.6 million in the third quarter, which approximated our Content Services segment cash income in the quarter. In the fourth quarter, our cash burn rate should be approximately $1.5 million.

This burn rate includes cost of sales, engineering and production operating expenses, and it also includes a large staff that we can immediately deploy to customer engagements as they come in. We will review our Synodex progress at the end of Q4.

At that time, we will evaluate our effectiveness in booking business and our revenue projections, hopefully with an improved level of visibility. Based on this review, we will decide on a 2014 operating budget.

If, at that time, we are not forecasting a significant near-term improvement in our revenue outlook, we will likely take steps to lower our spend further, preferably in ways that don't impact our ability to meet the markets' demands as they emerge. Here are some other recent developments.

Our IADS segment closed a new 3-year contract with major financial services client that we are estimating will generate annual revenues of approximately $1.5 million per year. This is for new service that we will be providing to this institution, which is a current client of our IADS docGenix product.

We expect to begin providing this service sometime in the first quarter of 2014. We've built a solid relationship with this client, and we see additional opportunity to expand the services we are providing to them.

We are now in the process of creating a second-generation docGenix product, which we hope to be marketing in the first quarter of 2014, and we expect that this institution will be a valuable reference for us. They've already offered us several referrals and quite proudly claim that in our product, they have the best contract risk management system on Wall Street.

In our Content Services segment, we also closed 2 new deals with one of our large customers, a leading provider of scientific content. For the first deal, we'll be adding a significant number of new titles to one of their leading databases as part of a large multiyear expansion plan.

The expected revenue from the first phase of this work, the part that we're now under contract to provide, is approximately $900,000. The second deal should yield approximately $500,000 of revenue.

Our task here will be to help produce and improve quality of certain aspects of our client's production of health sciences content. On the Content Services sales front, we're starting to see some modest improvements in potential new customers.

Sales VP, Kevin Perry, took over for Jim Lewis, who left in late June. In addition, we hired 2 new VPs, who are working closely with our technology team to bring some new service capabilities to the market.

We're seeing a wide range of new Content Services opportunities. For example, we're working on several arrangements that would have us assume responsibility for large portions of our existing clients' production workflow.

There are several potential new e-book backlog conversions and interactive e-book requirements. There is also a variety of opportunities to help our clients produce content products using advanced technologies.

In the quarter, we continued to sign up Japanese publishers, leveraging the capabilities we developed for a major customer who required Japanese e-book conversion. We're in the process of testing additional foreign language capabilities with our major clients.

Finally, we invested significant time exploring several acquisitions where there was the possibility of driving value through operating synergies. We are committed to a disciplined approach, however, when it comes to acquisitions, and we will try not to overpay for an asset.

I will now open the line for questions, after which I'll wrap up with final comments. Operator, we're ready for questions at this point.

E-book -- what was e-book revenue in the quarter? And what was the contribution from your largest client?

Sure. Vince, thank you for the question and, well, we thank you also for enduring our longer than usual prepared remarks, but we thought it was important for you and our other shareholders to have an opportunity to really see what we're seeing in order to form a view about our trajectory.

In terms of e-book numbers, O'Neil, can you share that?

Vince, the e-book revenues this quarter were 14% of total revenues, and the key client that we referred to was approximately 10% of revenues this quarter.

And is there -- on the e-book side with that client, is there a pipeline of opportunity ahead of you? Or is it just a -- are you still optimistic that there will be more business ahead with these guys?

Can you give us an update there?

Sure, Vince. The business continues and we're involved in lots of projects and various initiatives.

So the relationship is strong, and we're doing everything that they need us to do. In terms of going-forward volume projections, we don't have as much visibility there as we might wish, but, again, the relationship is a strong one and we're doing new things and testing new things with them.

Okay. Several quarters ago, you had an initiative to try to ramp up -- you had a workshop, I think, with one of your larger clients in Content Services.

And I thought you had some traction, but are you still working on those types of activities to improve your core business? Or is that something that you've stopped doing?

No. It's something that we're very much going to continue doing and we find the clients appreciating.

In fact, the -- I talked about a couple of the deals that were awarded to us in Q4. Those deals very much trace their roots back to the kinds of marketing that you're referring to.

And just to add to that -- so we have our intelligence in terms of how we're performing against some of our competitors in our core business. And we don't believe that we are missing any significant deals.

We compete hard for the ones which are out there. At the same time, we have a disciplined approach.

There are some deals which are really low-margin deals that we try to walk away from those unless we strongly believe that we have technologies and abilities to meet our targeted margin. So bottom line of what I'm sharing is we are not missing any significant deals out there.

That applies to your core business, as well as your e-book side. Is that right?

That's right.

My question has to do with acquisitions. You mentioned that you're always considering M&A.

I know you've been considering for years and you've been -- you haven't made any. Are any of them at a more than just over beginning, cursory stage or any serious ones that are getting along in negotiations?

Joe, thank you for -- let me take that and maybe Jack can step in to add some color. Rather than starting off with the philosophy, let me tell you what we did this quarter.

We worked very hard on a transaction that met all our criteria. And just to revisit our criteria for acquisitions, we look at what kind of customer franchise do they have, we look at the predictability of revenues, we look at what kind of operating synergies we can draw from the transaction.

So this particular transaction clearly met all our expectations, and we spent a significant amount of time doing business diligence, if not due diligence. It was undergoing the sell-side process.

We competed hard. We were short-listed, which is an important milestone in any sell-side process.

The final outcome was that we were competitively well placed in terms of pricing, but our nearest competitor for this particular transaction had the ability to write a check for the whole deal, while our ability to close the deal was based on using our cash balances and raising some debt to do the deal. We had done sheets [ph] to fill the deal, but we didn't have a clear response to close the deal.

A little bit on this size of the transaction, that was about $65 million in revenue and EBITDA exceeding about 15% and we saw significant synergies from the combination. But at the end of the day, it didn't work out for the reasons that I just said.

And we are going to be looking around, keeping our eyes and ears open to look for similar deals that meet our aspirations. We are working closely with a set of bankers to look for deals that would meet our expectations.

Jack, anything that you'd like to...

No. I think that's -- I think that's good, and I -- it's a little self-serving, but it's not credit that goes to me.

It really goes to O'Neil and his team. They took a very disciplined approach to looking at it.

And as much as we wanted it, as much as it would have helped us be able to declare victory on where we want to get to by the end of this year, especially given the delay in Synodex revenue, we took a disciplined approach, I think we came in second. But to come in first would have pushed the envelope a little bit too far and would have, I think, stressed the valuation.

So we didn't do that. And again, I credit O'Neil and his team for having the discipline to do that.

I just wanted to explore. Now you're looking at potentially reducing your expenditures if, in the fourth quarter, you don't see a big revenue increase come in on a predictable basis.

How easy is that going to be? Is that -- I mean, can you legitimately cut your expenses by $1 million there or $0.5 million?

Or would that impact your ability to go along with these new projects?

We've got a few different ideas on how to approach it, and whatever we do, we're going to try our best to do it if, indeed, we need to in ways that don't impact our ability to respond to market demands. It's not easy, but I think we demonstrated this year on other aspects of our business that we know how to do it.

We know how to achieve efficiencies and find opportunities, and that's how we got the $6.3 million of savings out of the business that O'Neil is referring to. So I think we'll take a real creative approach to do whatever we can if, indeed, our fourth quarter tests suggest that we should be and hopefully make sure that we're able to respond to all the market opportunities that we're now seeing.

Yes. And just to go back on this, I remember talking with you privately, Jack, about how excited you were about this new stuff.

And I said it's exciting, but it always takes not twice as long, about 5 to 10x longer than you expect. And that system I experienced was new stuff, not just at Innodata, anywhere.

And I think ultimately, this new technology ends up being very significant, very positive, but the -- there's just a patience factor. And I think that controlling that spend so that at the worst, we're not losing money and we're maintaining the balance sheet is an important consideration.

It ends up becoming a marathon rather than a sprint.

Yes. I think that's exactly right.

I mean, the experience is certainly proving to us that incubating a new venture isn't for the faint of heart, and it's almost like walking across the desert. You see an oasis in the distance, but you're really not sure if it's a mirage.

And once you get pretty sure that it's not a mirage, then you have to ration water in your canteen to make sure that you get there. So I think we've got a good canteen of water, but we're going to conserve it and we're going to do everything we can to get there with water -- plenty of water left in the canteen.

Now do you have any good idea of what the gross margins on this new business is once you're -- once you get it? I mean, are you looking at 40% gross margins on a new business with the insurance companies?

Yes. I think what we're looking at is targeting 35% to 40% gross margins, and that would be in a steady-state scenario.

So assuming we don't have lots of labor, I mean, training sitting in the wings to drive the growth curve and assuming that we're successful as we think we will be with our Workflow 3 [ph] product, that would be target. And then it's pretty good leverage on the SG&A side, so we would expect pretty healthy operating margins to flow off that.

Right, right. Now in terms of a competitive advantage, I guess the bad news is if you can't go in there with a standard product with all these insurance companies, the good news is, as you develop a relationship with different ones and you do the special types of adjustments, that it gives you proprietary advantage with maintaining relationships with these guys.

Yes, I think that's absolutely right. So what we're seeing is that we're clearly differentiated.

We try to protect the IP around the differentiation. And what we're seeing is there is some standard product set, but there is some detailed integration required there and, certainly, a lot of painstaking evaluation.

So we think the differentiation plus that pain that we're now enduring on the other side will result, if we're successful, in high-quality, sticky revenues, and that's exactly what we've been looking for from this business.

I infer from all the remarks that one should expect higher revenues in 2014 than 2013, and I know your budgets aren't put together. Can you talk in a qualitative term what will happen to your costs, operating expenses, in particular?

Well, first, Jay, thank you for enduring the length of the prepared remarks. I hope you had a cup of coffee sitting next to you.

Maybe you can just help me focus your question a little bit better. Are you asking what would happen to costs if our revenues increase?

Yes. In other words, there are -- I guess, Synodex revenues could increase.

What would happen to costs if Synodex revenues don't increase? And what would happen to costs if they do increase?

Jay, let me help in answering that question along with Jack. The way to look at our business is twofold.

One is the Content Services business and the IADS business. In terms of Content Services, that's our primary revenue driver.

We are hitting, currently, gross margins of about 32% and net operating margins of about 9%. We have enough capacity there to increase the revenues flatly, another $5 million quarter -- $5 million per quarter without significantly increasing the facility cost and the SG&A cost.

So the way to look back is during -- about a year ago, when we were operating at full steam to produce e-books, that kind of revenue should rate at about roughly closer to 40% in gross margins and about 15% odd in terms of operating margins. So that would be the way to look at it in terms of scalability with regard to our existing content business.

On the IADS business, obviously, we are incurring somewhere close to between $1.5 million to about $1.8 million in operating costs, which are essentially going down to the bottom line and not covered by revenues. We have capability to produce up to somewhere between $4 million of revenues without increasing anything at the production level.

That will straightaway go down to reducing the losses. Beyond that, we'll have to add people at the production level, not necessarily increase our facility costs and SG&A costs.

So does that help in understanding the way to look at our impairment?

That was an excellent answer. I have another question, unrelated.

What were the nature of the assets that you wrote off? What were the categories?

Jay, the bulk of the costs in Synodex are -- clearly, there is some element of cost which has to do with hardware. The second category of cost is the proprietary workflow that we are developing, which is -- and Jack reported that as Workflow 1 and Workflow 2.

That was approximately about $3-odd million. Out of the $5.5 million that was written off, about $2 million was to do with the facility cost, which is fittings and furnitures, et cetera, in our offshore delivery center.

The remaining $3.5 million is to do with the hardware and software costs.

Would you comment on your foreign language content and the direction the market is moving there? And what would you see that as a percentage of your content business going forward?

Also, where do you see your cash position at the end of the fourth quarter?

I'll start with the first and then I'll turn the second question over to O'Neil. Most of the work that we do for our customers, putting e-books aside, is English language content even though many of our customers are European -- Europe-based.

That said, we're -- in terms of e-books, we're exploring opportunities and finding opportunities outside of English language, and we clearly see that the major e-retailers of e-books are pushing the boundaries globally and expanding their presence significantly, and interested in additional inventories, and local content inventories. We're able to help with that.

At the same time, within Europe, we're finding opportunities to begin to work with some of our large global customers at addressing some specific European language requirements that we haven't done a lot of in the past. So in part, we're seeing that we're prepared for that by virtue of some of the e-book work we've done and also by virtue of some of the presence that we've got in locations that we do production in, where we're able to find foreign language expertise.

So definitely, there is growth there and opportunity there. I think we're pretty well poised to tackle it, and what we've done to date has been successful.

O'Neil?

Okay. At the -- I'll go a little bit to the points I discussed in my prepared remarks.

If you recall, in Q3, we consumed about $200,000 of cash at the operating level and we had capital expenditures of somewhere about $0.5 million. And I also shared that CapEx for Q4 will be between $0.5 million to $800,000.

So if you use the same numbers with the revenue guidance that we've given of $14 million to $16 million for Q4, the cash balance would work out to somewhere about $25 million compared to $26 million. So the breakdown of that would be about $200,000 of cash at the operating level and another $800,000-odd in capital expenditures.

Now having said that, keep in mind, timing differences could impact that cash balance. If one of our customer delays in paying and doesn't pay by December, then to that extent, the cash balance may change.

But right now we're projecting about $25 million compared to $26 million.

That's good. You're holding onto it, then.

That's a good sign. Looking back at my notes, I -- you made some comments, I think, in the -- in April or May that you had 12 late-stage proposals in Japan.

Where are you on that? That was in the enhanced content.

I don't have a number for you. The Japanese, we're finding, move very methodically as well.

We've closed business there. I don't know what and how many contracts that represents, but one thing that I would caution you on is those are relatively small numbers.

I think they will be good relationships and enduring, but they are not big numbers per contract.

So where are you spending your time with regard to enhanced content? What countries or what languages?

Most -- well the work that we're doing in Japan for the most part is not interactive content work. The interactive work is more English-language-based.

And we're working with several types of customers, trade publishers, as well as education publishers who have a real interest in exploring how interactivity helps the learning process and truly enhances their content, converts it to a different level.

Jack, you mentioned something going on with this new deal with the docGen (sic) [docGenix]. Can you put more clarity onto that?

Is this tied to your product that you were working with the bank a year or 2 ago but didn't come through? Are they coming back to you?

Well we -- what this is tied to is the one large customer that we had for docGenix. So the history there is we acquired one very prestigious bank as the customer.

We fully integrated with their systems. We built some additional integration layers to be able to help them use our content to manage the feeds and risk systems and collateral management systems.

We decided strategically because, again, we wanted to not extend ourselves too far in too many directions, we decided strategically to not be actively marketing and selling the docGenix service for a period of time while we were actively marketing and selling Synodex. We realized that for it to have a wide market appeal, there were some things that we needed to do differently.

Now we've actually started this quarter addressing some of those things because with our experiences at this customer and the feedback we've gotten, we clearly do believe that there is an opportunity there. In terms of what we're now going to be additionally doing for this customer, it's much the same thing.

It's creating extracted normalized data from risk instruments and legal documents that can then be then downstream-ed and fed into other systems. One of the drivers there is compliance and the regulatory issues and deadlines that are coming up, so interesting opportunities, some good business -- macro business drivers, working on addressing some of the deficiencies that we found in our product in order to be able to market it more broadly.

And we're very proud of the fact that they're saying very good things about us and they're voting with their dollars and awarding us this type of new work.

Thank you, operator. So I guess, just to recap a bit, quarterly revenue was down a bit sequentially.

That we anticipated. We wrote off our IADS investments and took an impairment on our deferred tax asset because we are and were unable to predict substantial revenue with certainty.

That said, we have 30 companies in our list of active prospects. With 26 of these, we've conducted pilots.

And of the 30, there are 14 which are especially active at this time, companies that are investing significant time and significant resources, working with us to explore how we can be helpful to them. So thanks, everybody, for joining us today and thank you for your continued support.

I look forward to talk with you next time.