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Innodata Isogen Inc. (NASDAQ:INOD)

Q4 2007 Earnings Call

March 13, 2008 11:00 am ET

Executives

Al Girardi - VP of Marketing

Jack Abuhoff - Chairman and CEO

Steve Ford - CFO

Analysts

Shane Kim - Camden Partners

Glenn Mattson - GTK Capital

Tim Clarkson - Van Clemens

Walter Ramsley - Walrus Partners

Joe First - First Associates

Operator

Good morning and welcome to the Innodata Isogen Fourth Quarter and Yearend 2007 Earnings Release Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to the Vice President of Marketing, Mr. Al Girardi. Please go ahead, sir.

Al Girardi

Thanks Rob. Good morning, thank you all for joining us on our fourth quarter 2007 Earnings Call. Our speakers today are Jack Abuhoff, Chairman and CEO of Innodata Isogen; and Steve Ford, our company's Chief Financial Officer.

Statements made during this conference call and answers to your questions are intended to provide abbreviated, unofficial background to assist you in your review of the company's press release and SEC filings. In addition, there may be some forward-looking comments regarding the company's operations, economic performance and conditions. These forward-looking statements are made pursuant to the Safe Harbor Provisions of the Private Securities and Litigation Reform Act. The words believe, expect, anticipate, indicate, point to, and other similar expressions generally identify forward-looking statements, which speak only as of their dates. These forward-looking statements are based on the company's current expectations and are subject to a number of risks and uncertainties, including without limitation, continuing revenue concentration in a limited number of clients; continuing reliance on project-based work; worsening of market conditions; changes in external market factors; the ability and willingness of the company's current clients and prospective clients to execute their business plans, which give rise to requirements for our services; difficulty in integrating and deriving synergies from acquisitions; potential undiscovered liabilities of companies that Innodata Isogen acquires; changes in the company's business or growth strategy; the emergence of the new or growing competitors; and various other competitive and technological factors and other risks and uncertainties indicated from time to time in the company's filings with the SEC.

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

Now, I will turn the call over to Jack Abuhoff. Jack?

Jack Abuhoff

Thanks Al. Good morning everyone and thanks for joining us today. My team and I are pleased to put the operating results that we are reporting today. First, we exceeded our guidance for the quarter and achieved financial records for the quarter and for the year. Equally important, we are reporting a strong outlook for 2008 and our expectation that 2008 will also be a growth year for us. Our results reflect execution of key strategic initiatives that we laid out for you at the beginning of the year, including building a more energized and effective new business development team and focusing on the emerging knowledge process outsourcing market.

We'll start with a brief overview of fourth quarter and yearend results. Then we'll discuss the business, its dynamics and direction and what we see as our opportunities and challenges and we will address also what we see for the year ahead. Then Steve Ford will breakout the numbers in more detail. When Steve concludes, we'll take your questions and comments in our Q&A period.

Fourth quarter 2007 revenue rose to $20.5 million, which was almost double the revenue of $10.5 million from the same period last year. More importantly, looking at performance for the year overall, revenues increased 65% from 2006 to 2007, climbing from approximately $41 million to approximately $68 million.

At the same time, we continue to demonstrate significant operating leverage. We grew revenue by 65%, but with only a 7% increase in SG&A spend, and so a 44% of incremental revenue goes straight to the bottom line.

Now comparing fiscal year 2007 net income to fiscal year 2006 net income, the swing there was nearly $12 million. We earned approximately $2.2 million or $0.09 in Q4 and approximately $4.5 million or $0.18 in 2007 overall.

We generated about $6 million in cash from operations last year. At the same time, we saw balances in cash and equivalents rise again, up to almost $15 million by December 31, with another $11 million in solid accounts receivable.

Looking ahead to 2008, we anticipate continuing improvement in recurring revenues driven by new KPO engagements and expansion of existing programs. We expect first quarter revenues to be approximately $18 million or up more than 40% year-over-year, as we complete several 2007 projects and begin ramp up on several new 2008 programs. And we believe that we're seeing a sufficiently broad and robust set of opportunities that we can anticipate double digit growth in annual revenues in 2008. By the end of this year, I would like to see us having moved progressively toward our stated goal of $100 million in revenue.

Looking forward we have an aggressive strategy for growth, the central thrust of our strategy will be to further leverage our industry and professional expertise, our experience to relationships and reputation we have and the infrastructure we've put in place in the area of outsourced content services. These assets that we've got in place surpass nearly all competitors in the media, publishing and information services sector, and these are our platform for future growth.

First, we have an opportunity to continue to grow within existing clients and to add new logos to our roster of success through ongoing improvements in sales and marketing execution.

Second, we can expand the service offerings we provide to our core media and information services clients, emphasizing our KPO services.

Third, we will continue to plant seeds in select KPO segments that are outside the media and information sector. We have already begun this and have had early successes in areas, such as Technical Writing. We will select areas for investment that we think have the highest probability of reaching critical mass in a relatively short period of time. There are a multitude of knowledge based offerings that leverage our capabilities and our competitive assets. This strategy will allow us to grow the business efficiently, to invest and reinvest capital in our productive capacity and by doing so, enhance and accelerate our growth.

Now our confidence in the businesses is driven by a number of factors, some external and macroeconomic in nature, others linked to the strategic and operational improvements we have worked so hard to accomplish internally.

For example; we've made steady gains in the development and management of our sales fore. We've adopted a team based business development approach that is driving results and reinforcing results based culture. We have put in place repeatable sales processes that maintain our focus sharply on client satisfaction, and helping businesses accomplish their goals. We have improved our focus on attracting skilled talent, supporting them in the field, measuring and managing the fundamentals of their activities, rewarding success, and also of course transitioning individuals that might be more successful elsewhere.

The results so far are encouraging. This is important, in 2007; we added 33 new organizations to our client roster. Some of these new companies, you are, no doubt, familiar with Random House, [Kent Media], The British Library, A&C Black, Alcatel-Lucent and Microsoft for example. This kind of continuing expansion in our client base is indeed significant, and it's significant for several reasons. The first is that our client relationships frequently attain greater scope in scale, as new clients experience success with us. What's more, because our services extend across a chain of inter-related business processes, we often have ample opportunities to cross-sell, to up sell and other wise consolidate business. So once we engage with a new client, we're typically able to expand our services with them in scope and scale, and to provide additional adjacent surfaces.

An example, last December, we announced that we had expanded our outsourcing relationship with Swets, the world's leading subscription services company. At first, Swets had hired us to provide very basic conversion service to them. But, they have recently now engaged us to help them on a much broader level, fulfill their subscription requests where we locate copies of journals and How to Find articles using librarians and such. This is a fairly complex process that requires our people to have expertise in a range of topics and domains and to follow-up and respond directly to customer queries.

So when you take this ability to expand our customer relationships this way, and then factor that by our high customer retention rate, what you realize is that our client relationships often represent considerable and sustainable lifetime value.

Over the past three years, we've maintained retention rates above 90%, specifically 94% in 2005, 93% in 2006, and 95% in 2007. So in other words, in the last three years, an average of 94% of our new clients that we bring in, become recurring clients. So the upshot of this is that the lifetime value of new clients is considerable and the opportunity to monetize our new found ability to bringing clients at this level. Remember, we brought in a record 33 new clients this year. This opportunity is considerable. Also, to this point, over the past three years our revenue from what were in 2007, our top four client relationships has just about doubled, from $22 million to $42 million.

We have accomplished this by expanding relationships within the companies by launching new projects with new divisions, and essentially earning the status of a trusted partner and a key player in these companies' product development and maintenance strategies.

Now in order to continue to foster close client relationships, which again is the key here, we seek to work with our clients as consultatively as possible. This quarter, I'm pleased to say, that we further expanded the number of strategic consulting engagements where our consultants are retained by our clients for strategic consulting, helping them develop technology roadmaps, drive process or business process rationalization, consolidate activities and of course identify outsourcing opportunities.

While we've traditionally done a good job with technology consulting, where we help companies chose a tool or a technology that drives operational efficiency for example. Frankly, we historically struggled with strategic consulting. But in 2007, we are very happy to say, we turned this around, and have created the beginnings of a track record of successes in this area. Our strategic consulting team is working with several large enterprises now at a strategic level, and we have some significant opportunities at late stages that represent important expansions of this work and we are seeing KPO implementation work come from these efforts.

It's also important to recognize, that from a historical perspective, we are in no doubt in the right place at the right time. Increasing numbers of companies here in North America, as well as in Europe and elsewhere are embracing outsourcing. And not only are large numbers of companies looking to source skills globally, but the type and the extent of the work is growing, and it’s growing in scope, it’s growing in complexity and also in value.

This is very much evident in our business, as we have expanded beyond production oriented services such as data conversion and composition, into much more challenging knowledge process outsourcing activities. Our offshore staff several years ago was comprised almost entirely by entry level hires, is increasingly represented by people with post-graduate degrees and professional certifications like lawyers and medical doctors and engineers. We use this globally distributed workforce consisting MDs, MBAs, PhDs and others to help author, edit and organize content into the specialized information products that are sold by the world's leading publishers and media companies.

For example this quarter we're helping a leading STM publisher, offer a new product, an online subscription based reference service to physicians and medical colleges, and at the core of the offering are medical diagnostics for more than 50,000 medical images. The physicians and radiologists on our staff examine the images, and they create summary diagnostic aids and cross references that help doctors, who subscribe to this service, fine tune their patient diagnosis.

So KPO. KPO remains our most significant growth area, and our most significant growth opportunity. To maintain our momentum here, we'll continue to promote our KPO capabilities and drive the changes necessary to make our company an even more aggressive competitor and even a more valuable partner to our clients. In part, that means developing new services such as the technical writing and research and analysis services we've launched this year.

Service to research and analysis, this past quarter we began two new research and analysis engagements, which together should add about $500,000 of recurring revenue to our recurring revenue base. In the first engagement, our researchers search for and analyze corporate websites, SEC filings, journal articles and other sources to create analysis reports. In the second, our teams of allied healthcare professionals provide literature service and retrieve on content creation services.

That first engagement is on the heels of three others, with the same new client. The second engagements, with the new division of existing client, and its ripe with expansion opportunity.

Now as we discussed in our last call, the weakening of the US dollar against the Philippine Peso and the Indian Rupee is a headwind to our margins in general, and of course erodes the labor costs arbitrage play, which is a component of our value proposition. We have however, taken active steps of tactically and strategically to deal with this. For example, on the tactical side, we are able to put in place hedging strategies that help mitigate for a period of time, the effective dollar depreciation, and Steve will talk more about this in a few minutes.

But perhaps, even more importantly, we are focusing our considerable engineering talent, the same talent that is helping the world's leading software company engineer new content systems. To focus on greater automation, to achieve productivity offsets.

Let (inaudible), we typically bill our clients, based on units of content produced. We can drive improved margins by engineering better technology and better processes. And this is an advantage that many BPO companies, such as call center companies lack, because they bill clients based on headcount deployed.

The combined greater margins and asset utilization from higher revenue per head work, combined with our operating leverage, means that we have tools at our disposal to mitigate the perceived impact of the currency issue.

We're also better positioned than a lot of BPO companies to perform well during periods of economics slowdown. Again, for call center companies, as consumer spending declines, people buy fewer goods and services and call volumes to call centers decline. However, we expect the slowing economy to lead to an increased demand for our services, as our clients and prospective clients have a greater need and urgency to reduce both operational costs, as well new product development costs.

As our clients and prospects realize that they can reduce operating costs by reassessing the need to have (inaudible) build to maintain information products and perform analytical services, we are positioned to grow.

Similarly, as our clients and prospects realize that they can more effectively drive their top line growth, by lowering their costs of new product development, we are again positioned to grow. So in these ways, we believe our business enjoys some strong counter cyclical elements and that our business is strategically well positioned to perform positively, regardless of the market environment.

And our increased ability to win new client programs, we anticipate will overtime, result in a broader, more diversified revenue base, enhancing our ability to weather customer or product downturns and smooth quarter-to-quarter volume volatility. When we look at all these factors together, given our growth prospects we believe this the right time to invest additional resources in our business.

We will be looking at opportunities to do just that. For example, we will be looking to increasingly align sales, engineering and delivery around products and services, which in turn, will enable to us to invest in people and infrastructure ahead of demand. We will also be looking to invest more significantly in developing technologies and approaches that constitute value add and set us apart from our competitors. Technologies that improve consistency and improve quality while reducing cost.

We will look to increase the level of touch points that we have with our clients. This will involve expanding our onsite presence with clients, a program that we started in 2007, and from which we've seen significant successes. And of course, we will be looking at ways of increasing further sales and marketing effectiveness and driving toward big win in client engagements.

I want to thank you for your time. I will be joining you again during the Q&A portion of our call. But first, Steve Ford will walk you through the numbers in greater detail. Steve?

Steve Ford

Thanks Jack. Good morning and thank you for joining us. Now let's take a closer look at the numbers. I will go through the changes in revenue, give you my insight on the cost structure, including discussing the impact on operations of the falling US dollar, explain the changes in SG&A, comment on our cash generated from operations, review the balance sheet and then conclude with some general remarks.

Revenues of $20.5 million in the fourth quarter of 2007, were up by $10.5 million or 95% from the fourth quarter of last year, and were up 13% from the $18.1 million in revenue last quarter. On a year-over-year basis, revenues in 2007 improved 65% to $67.7 million from $41 million in 2006.

In examining this year-over-year increase of $26.8 million, the majority is from an increase in revenues from recurring projects. As you know we customarily separate our revenue into recurring and non-recurring categories.

Recurring revenue consists of services that we anticipate a client will require for an indefinite period. Non-recurring revenue refers to projects that have a more specific timeframe for completion. The main driver of our revenue increase, both for the fourth quarter and for the full year of 2007, was our knowledge process outsourcing or KPO services. Majority of which are recurring.

KPO services target processes that demand advanced analysis, interpretation and judgment. KPO activities drove the majority of the year-over-year revenue growth of $26.8 million and the majority of the quarterly year-over-year and quarterly sequential growth in 2007.

Next I'll turn my attention to the area of direct cost and SG&A expenses. As a result, of the $26.8 million increase in revenue, direct operating cost rose from $34.1 million to $48.6 million. While, at the same time decreasing as a percentage of revenues to 72% in 2007 from $83% in 2006.

In comparing Q4 of 2007 to Q4 of 2006, direct operating costs have increased by $5.7 million or 68%. But as a percentage of revenue, have declined to 69% in Q4 of 2007 as compared to 80% in Q4 of 2006.

In comparing the sequential quarters of 2007, you will notice that direct operating costs in Q4 increased by $1.5 million compared to Q3, while sustaining 69% of revenue in each quarter.

The improvement in direct operating costs as a percent of revenue to 72% in 2007, as compared to 83% in 2006, was achieved in spite of the impact from a weaker US dollar versus the currencies of the Philippines and India. As you know, we perform most of our production in the Philippines and in India with a large majority of our employee based in facilities located there. We fund these operations by sending US dollars to these countries. We benefit from labor rate arbitrage, the use of local engineering production improvements, and the application of technology to our processes.

In 2007, due to a weakening US dollar, our requirement to send dollars went up significantly, thus increasing our offshore unit costs. For example, if both the Philippine Peso and the Indian Rupee had remained at the same exchange rate to the US dollar, throughout 2007 as they each started the year at, we would have experienced higher gross margins than what we have reported.

Our strategy in 2007 to mitigate the impact of the falling dollar on our production expenses included hedging our exposure by entering into forward contracts. Implementing these hedging strategies enabled us to mitigate some of the effects of currency fluctuations on our cost structure. That strategy, combined with the continuous implementation of production efficiencies, improvements in our technology in a more favorable revenue mix of higher margin KPO services, enabled us to overcome the impact of currency and consistently generate higher margins throughout 2007.

We will continue to examine all means available to us, including forward contracts, to protect our margins in 2008. Therefore, despite the impact of our operating cost challenges, we saw our full year gross margin grow to 28% of revenue in 2007 from 17% of revenue in 2006.

In analyzing this increase in margin percent, it's helpful to examine the operating leverage, which we derived by dividing the incremental gross margin by the incremental revenue. In 2007, we achieved a total gross margin of $19.1 million, which included $12.3 million of incremental margin on $26.8 million in additional revenue for an incremental margin of 46%.

Even more significant, is that we've been able to seen most of that gross margin operating leverage benefit flow all the way down to the bottom line. In order to understand how we were able to achieve this, we will now examine our selling and administrative expenses or SG&A. In 2007, SG&A costs were $15.3 million, which was $1 million or 7% increase from the $14.3 million in 2006, but as a percentage of revenue, declined to 23% in 2007 from 35% in 2006.

The $1 million SG&A increase occurred in the fourth quarter, where we experienced higher auditing costs related to being a first time filer in 2007 under Sarbanes-Oxley or Sox, as well as significant marketing initiatives and an increase to our bonus accrual. The auditing expenses are typically higher in both the fourth and first quarters of the year and marketing expenses are generally greater in the fourth quarter.

Even taking these Q4 SG&A increases into account, we were able to achieve close to $12 million bottom line improvement in 2007 over 2006, as we went to pre-tax profit of $4.5 million from a pre-tax loss in 2006 of $7.4 million. This approximate $12 million improvement was 44% of the revenue increase of $26.8 million. We believe that once we cover ordinary annual cost increases, such as basic pay raises, typical audit and regulatory expenses and normal increases in other operating costs, we will be able to achieve meaningful operating leverage to the bottom line over broad periods of time. Therefore, as we increase revenues, we have the opportunity to create cash flow that we can reinvest in the business either by building capability organically, or through acquisition.

In completing our look at the income statement, on a quarterly pre-tax basis we earned $1.9 million in Q4, 2007, compared to pre-tax earnings of $2.3 million in Q3 and compared to a pre-tax loss of $1.1 million in Q4 of 2006.

Fourth quarter 2007 results included a benefit from income taxes of $330,000, primarily representing an income tax refund attributable to certain foreign operations. In regards to taxes, the company has established a cumulative valuation allowance of approximately $4.6 million due to net operating loss carry forwards or NOL's.

Once we achieved several profitable quarters for US tax purposes and have satisfied other criteria, we may be in a position to begin recognizing the NOL as a tax benefit. For the full year after tax, we earned $4.6 million or $0.18 per diluted share in 2007, as compared to a net loss of $7.3 million or a loss of $0.30 per diluted share in 2006.

On a quarterly basis after taxes, we earned $2.2 million or $0.09 per diluted share in Q4 2007, compared to net earnings of $2.1 million or $0.08 per diluted share in Q3 2007 and compared to a net loss of $800,000 or $0.03 per diluted share in Q4 2006.

Now we will take a look at the balance sheet and cash flow. Our cash flow from operations was $6 million in 2007, which represented a $9.4 million improvement over the cash used by operations of $3.4 million in 2006.

In 2007, we generated the $6 million in cash from operations by adding net income of $4.6 million, depreciation and amortization of $3.2 million and other non-cash items of $700,000 for a total of $8.5 million, reduced by $2.5 million representing cash used for working capital process. We ended the year with $14.8 million in cash, which is a $1.2 million increase from the prior year.

During the fourth quarter, we generated $4.2 million in cash from operations. This amount is calculated by adding $2.2 million in the fourth quarter net income, the $800,000 in depreciation and amortization plus $1.2 million of net changes to other assets and our liabilities. The $14.8 million in cash we ended the fourth quarter with is a $2.6 million increase from the ending cash balance after third quarter.

Our free cash flow in 2007 was $1.5 million, which is the result of subtracting $4.5 million of capital spending from the $6 million in cash flow from operations. In 2006, our capital spending was higher than cash flow from operations, resulting in a decrease in the overall cash balance. We anticipate that capital spending for ongoing technology equipment and infrastructure upgrades will be in the range of $4.5 million in 2008.

Working capital improved by $2 million, from $14.3 million in 2006 to $16.3 million in 2007, primarily due an increase in cash and receivables. At December 31, 2007, we still maintain our $5 million line of credit. We have no outstanding obligations under this credit line.

It now concludes my detailed review of the financial results of the company. In summary, during 2007, the company was able to drive year-over-year revenue growth of $26.8 million or 65% over 2006. Approximately 44% of this increase, close to $12 million flow to the bottom line.

In the same fashion, our diluted earnings per share increased to $0.18 for the year and provided $6 million in cash from operations. We believe the significant operating leverage and incremental revenue over the broad periods is achievable and an important feature of our business model. As we increase revenues, we have the opportunity to create free cash flow we can reinvest in the business either by building capability organically or through acquisition.

Okay, that wraps up my presentation for now. Thank you everyone. Looking forward to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). We'll go first to Shane Kim with Camden Partners.

Shane Kim - Camden Partners

Hi, guys, great quarter. If you look at your outlook in the most recent quarter it was revenue growth in the 80% range and you obviously exceeded that. Is there any seasonality in the revenue cycles for your customers?

Jack Abuhoff

Hi, Shane. Yeah, I think our outlook was for 75%, we did 83%, and there is seasonality. There is often times a push at yearend to hit some goals, customer goals. There is sometimes some budget that needs to be used up. So I think generally speaking, we do see that, and then new programs start, there is some ramp up, and we accelerate through year.

Shane Kim - Camden Partners

So were you essentially surprised, because I think based on your guidance, which was not too long ago, that it would sort of put the revenue figures somewhere in the $18 million range, and so, did somehow perhaps revenue from Q1 of '08 surprise you sort of falling into Q4 '07 or are they mutually exclusive?

Jack Abuhoff

There is a little of that. Clearly, if we could design things perfectly, it might look a little bit different. But the fact is that we're banking on very satisfied clients.

Shane Kim - Camden Partners

Okay. And you had a comment about you believe that perhaps your business maybe have some countercyclical aspects to it in the past three months. Are you seeing aspects of that or is that your expectation?

Jack Abuhoff

I think it's both. My expectation is based on my experience. We do two things. We help people to save money, reduce cost from current operations, and increasingly we're helping people with their new products builds, rather than building it first internally and then outsourcing to us three years later, they are coming to us first. We are not seeing any slowdown in new product plans; the budgets are intact at our customers. But they are coming to us.

Shane Kim - Camden Partners

Great. And, on a year-over-year basis, you grew revenues in absolute figures of about $26 million. How much can you break that out versus new customers that were sort of new in calendar 2007 versus growth that came from existing customers that you had been working with in 2006 or exiting the year in '06?

Jack Abuhoff

Yeah. You know I don’t have that precise breakout with me. I can probably crank that for you in another point in time. But I think, what we are seeing is, a couple of things. We've brought in a lot of new clients this past year, 30. It's almost growing our business by a third in terms of clients.

Shane Kim - Camden Partners

Right.

Jack Abuhoff

What happens in our business is clients don’t typically come in with huge requirements. They come in and they sample. They see how well we are doing. They see how attentive we are to them, and how well we can help them accomplish goals, and then they stay with us. You know, 95% of our clients stay with us. Even if the revenue is not recurring, they become recurring clients. So the fact that we can bring them in, acquire them, we can retain them and then we can expand them as key. Our biggest clients are clients in the past three years, we've doubled in size. Now what we need to do is, is to do that with more people. So the key strategy, acquire, retain and expand, that’s what we are going to be doing.

Shane Kim - Camden Partners

Right. And two final questions. You saw an increase. So the increase in SG&A has nothing to do with currency and that’s more in the cost of sales, operating cost. So, have you not been accruing a bonus accrual? I am trying to get a sense of this $1 million increase from Q3 to Q4.

Jack Abuhoff

A lot of that change was and I will let Steve address this, but I will just start it. Most of that was you know the double edged sword of success, when it comes to Sox compliance. That was our first time having to comply with Sox, that’s not an inexpensive process. Once you get all the consultants and everybody lining up. And we had to [play] the piper.

Shane Kim - Camden Partners

But did you not incur some of those expenses during the year?

Steve Ford

Shane, the way it works from an accounting standpoint, this is Steve Ford speaking. We have to recognize those expenses in the period that they are incurred. In our particular situation, in 2007, we became a first time filer effective June 30 of the year, and that’s because our market cap was over $75 million. So they measured on that day. So then of course, you have to engage your consultants in whom we did in the third quarter, to represent us the bulk of the work that takes place in the fourth quarter, the way the accounting rules work now, you have to recognize it in the period that it has incurred.

Shane Kim - Camden Partners

Okay

Steve Ford

And that’s just the reason why we've got this big bulge in the fourth quarter related to Sox and we'll have a little bit of that also spilling over into the first quarter of the year, as the yearend audit is completed. So it’s a very unusual, but required method that we must recognize it.

Shane Kim - Camden Partners

And so, can you give us a sense, and I am not asking for guidance here. Obviously it doesn’t appear that SG&A as a percentage of sales at 23% or close to $19 million in annualized expenses is probably not a fair figure. But you did mention, you did spend some more dollars in marketing, you should have bonus accruals. So I am just trying to get a sense for, we shouldn’t expect SG&A to run at $3.5 million anymore. But it’s probably also fair that it's not going to run at $4.7 million a quarter either.

Jack Abuhoff

So, both of your comments, I think easily kind of refer to our actual Q3 SG&A, and our actual Q4 SG&A that's out there. So if you kind of take an average of those, recognizing that Q4 is a little bit higher, I think that will help you, if you do the math there, to come up with a more reasonable number, which quintessentially will kind of fall in between the numbers you mentioned.

Operator

Thank you. We'll go next to Glenn Mattson with GTK Capital.

Glenn Mattson - GTK Capital

Hi guys. Congratulation again on a great quarter.

Jack Abuhoff

Hey Glenn. Thanks for joining us today.

Glenn Mattson - GTK Capital

This might have been covered and I might have missed it. But on the yearly guidance, what is that based on? Do you have any new contract signings factored into that, or is part of it, the standard uptake you get from these new customers as they become bigger customers?

Steve Ford

I mean, the answer is all of the above. Our planning process is a very detailed one, we look at our project backlog. We look at our recurring revenue, we make projections at very granular level. We look, of course, what's coming down the pipe in terms of sales and opportunities and we take a conservative approach. You know, one of the things we do is anything that's in our pipeline, that's outside two standard deviations of our sale, meaning statistical outliers, the real big wins, we don't even count them. We take those down. So we want to take a conservative approach. We want to pleasantly surprise, not disappoint, and then we operationalize around that. We went into this year, projecting much, much more conservative results than we delivered and it's because we go after some of the big wins that we're planning.

Glenn Mattson - GTK Capital

But significant new project wins are not then included in the guidance?

Jack Abuhoff

No. In other words, we don't want to depend on that.

Glenn Mattson - GTK Capital

Right. Okay, great. I think you guys are doing a very nice job of diversifying the revenue bases especially. So keep it up.

Jack Abuhoff

Thank you.

Operator

Thank you we'll go next to next Tim Clarkson with Van Clemens.

Tim Clarkson - Van Clemens

Great quarter, guys. Always good to see the revenues go up. And if the revenues go up in the nature of your business, the earnings are always going to be there.

Couple of questions. This is just a big picture question. There was an article in the Wall Street Journal, I think it was on Tuesday and they talked about knowledge management. And I've been trying to think about this, so I can articulate what you guys do a little bit better. Maybe this is oversimplifying it, but would you say when your processing information the endpoint is to come up with knowledge that is actionable, that can create profits for this business versus at the beginning point you just have bunch of disorganized information that maybe doesn't have much meaning? Is that kind of the goal of what you're trying to accomplish in doing what you do there?

Jack Abuhoff

Tim, really what we're doing is we're helping some of the world's largest information services companies become efficient and create new products that they can grow their revenues with. So we're working with the largest information services providers. These are $5 billion, $10 billion companies that make markets in information.

Tim Clarkson - Van Clemens

Right. And the challenge is, is that information is often disorganized and doesn't have a lot of value, and after you do your various things, whether a strategic analysis or XML or whatever, at the endpoint you have information that's now become more meaningful and more actionable and can create value for these companies.

Jack Abuhoff

Absolutely, that's exactly right. And what we're able to do with a lot of these companies their roots are back in print. They publish books and you can imagine an author sitting there writing a book, and then he sends it to the printer and the printer publishes it.

Now that their businesses have transformed to electronic information, it's Internet-based information, and that lends itself to a whole new approach that we're able to bring to bear in terms of new technologies, in terms of obtaining the benefits of a distributed global workforce, in terms of creating an assembly line where these tasks and activities are disassembled, they are broken up, they are performed in different places using different technologies. It's a whole new world and we're helping them participate in that opportunity.

Tim Clarkson - Van Clemens

Do you have any idea on average what kind of return on investment your clients get by spending money with you?

Jack Abuhoff

We save them almost half or sometimes more than half of what they'd otherwise be spending.

Tim Clarkson - Van Clemens

Okay. This is a question for Steve. So, we're still looking essentially on a per quarter basis that your breakeven is around $16 million, and then incremental revenue is above that, 40%, 45% starts that fall to the bottom-line?

Steve Ford

We haven't actually come back with the calculation recently of breakeven. Obviously, our volumes have gone up. As we have experienced such a significant increase in 2007 over 2006, our breakeven is going up. I don't think what you said is unreasonable, but I haven't come out and produced a calculation.

Tim Clarkson - Van Clemens

How about on the gross margin? Is that 40%, 45%, is that ballpark of what you are expecting in terms of your breakeven of $16 million, $17 million or $18 million that's how it plays out?

Steve Ford

We've been talking about a range centering around 40%.

Tim Clarkson - Van Clemens

Right.

Steve Ford

So we do better sometimes, better mix, more favorable efficiencies, et cetera, we can improve on that. And depending on mix and other things, we may end up a little lower than that.

Tim Clarkson - Van Clemens

Was the entire bonus accrued in the fourth quarter?

Steve Ford

No, it was not. It was actually accrued over the year. But as you look at our quarters and you take a look at Q1 and you look at those results, that didn't exactly engender a larger bonus accrual, but as we went through the year, and of course, generated more favorable results. The way our formula works it was of an accrual in accordance with how we performed. So, hopefully, that helps you.

Operator

Thank you. We'll take our next question from Walter Ramsley with Walrus Partners.

Walter Ramsley - Walrus Partners

Congratulations. That was a great year and a great quarter. I have a few questions. The hedging operations, can you just tell us how much the company made on that?

Jack Abuhoff

The way we work is it actually is not a number we're disclosing. It gets buried in cost of sales. But what I can tell you is that the depreciations of the currencies were significant during the year, as you know. We were able to mitigate a lot of that, not only through hedging, but also through production efficiencies and generation of favorable mix. But we don't actually disclose that exact number.

Walter Ramsley - Walrus Partners

So on those contracts, were there any non-recognized profits?

Jack Abuhoff

Explain what you mean a little more by non-recognized profits.

Walter Ramsley - Walrus Partners

You know the contracts that you didn't actually close out that you carried over into the current year that's unrealized.

Jack Abuhoff

No they were not.

Walter Ramsley - Walrus Partners

Okay. So the hedges are still in place?

Jack Abuhoff

Actually, it's a program that we operate on a fairly continuous basis. So, as contracts close out, we take out new contracts.

Walter Ramsley - Walrus Partners

Okay. I mean it's kind of hard to believe, but the rupee has actually gone up a little bit this quarter, is that having a negative affect or is a --

Steve Ford

Actually, not really.

Walter Ramsley - Walrus Partners

Okay. Were there any stock option, 123 expenses?

Steve Ford

We're actually going to be filing our K, its due Monday. All the disclosures associated with that will be in there, and that will be filed hopefully no later than tomorrow.

Walter Ramsley - Walrus Partners

Okay. The growth in 2008, you indicated that double-digit growth and annual revenues. Is that just another way of saying in the teens or what if, I mean, it kind of covers a broad territory otherwise?

Jack Abuhoff

Yeah, it does. And essentially, what we're doing is, we're trying to take an aggressive, but yet conservative approach in building expectation. And we just had a tremendous year and what we're trying to convey here is that we believe we can grow on top of that. We believe we can keep going. We're operationalizing around a conservative number. We're not counting on big wins. But we're working on them.

Operator

Thank you. (Operator Instructions). We'll go next to [Joe First with First Associates].

Joe First - First Associates

Good morning gentlemen and congratulations again on a very good quarter and a good year and a good outlook. I want to comment, I was pleased to see in your press release, you've mentioned that you're going to be making various investor presentations at conferences and (inaudible) I think it is a particularly good idea, because in spite of your good results like today your stock price was down anyway, I know it's a bad market day, but your company is not that well known and not so good. I am glad to see you get your story out to other people, because you have a very good story to tell.

Just one quick question, the top four or five customers you're talking about, that is the higher percentage of your business. Most of these people, are they recurring type of business, knowledge management or other that is the kind of thing as long as you are a key performer here, not likely to lose?

Jack Abuhoff

Joe, the same percentage that we've got of recurring work overall also holds up within those top clients. So we've successfully grown the recurring work that we're doing with those top clients importantly. And all these clients are very, very large enterprises. We've got big programs in place for them. We're very tied into them, and we've got new things in the pipeline, new things that we'll be doing for them.

So I think as we seek to diversify our revenue base, we will be de-risking the value proposition no doubt, but we'll also be trying to even things out a little bit. Right now, that's just the way the business works. Just the rhythm of the business, as we continue to grow and I think we've got the formula in place. We're acquiring lots of new clients, we're doing a really good job of retaining and then expanding them. I think that will just work itself out.

Joe First - First Associates

Thank you.

Operator

Thank you again. (Operator Instructions). Next we'll take a follow-up from Shane Kim with Camden Partners.

Shane Kim - Camden Partners

Yeah sorry. One last one. What is your net operating loss?

Steve Ford

The net operating loss we have, is approximately $12 million.

Shane Kim - Camden Partners

Okay. Thank you.

Steve Ford

Welcome.

Operator

Thank you. This time there are no further questions. I would like to turn the program back over to Jack Abuhoff for any additional or closing comments.

Jack Abuhoff

Thank you. And thanks everybody who is on the call with us today. Thank you for your questions. Thanks for spending your time us. Just a quick recap. We're growing our business, we're growing at a healthy pace. We're delivering strong financial performance, we're delivering what we say we're going to deliver. Fourth quarter 2007 revenues rose $20.5 million and so it was double $10.5 million from the same period last year. Our revenues on the year increased 65%, climbing from approximately $41 million to $68 million. We earned $2.2 million or $0.09 last quarter and approximately $4.5 million or $0.18 in 2007 overall.

We are continuing to demonstrate significant operating leverage, maintaining gross margins in a target range of 35% to 40% on incremental revenue with only minimal SG&A increases. Here we generated $6 million in cash from operations last year. We saw balances of cash rise. They were $15 million December 31. And again, 2008 looks good. We have a strong program in place. Without taking into account large possible project wins, we anticipate that we can drive double-digit annual revenue growth and deliver second consecutive year of record revenues and strong profitability.

We also anticipate continued improvement in recurring revenue levels, and that's going to be driven by new KPO engagements and expansions of existing programs. First quarter, we think it will be approximately $18 million, which is 40% year-over-year, completing several 2007 projects and starting to ramp up on 2008 stuff. By the end of year, I'd like to see us having moved progressively forward toward our stated goal of $100 million in revenue.

I think Joe asked a question about our IR program. Clearly, we're going to be increasing our activities in 2008. We are scheduling a number of road show style investor meetings for this spring starting next Monday actually. And we're planning to attend at least two or more investor conferences over the coming months. We're also going to try to increase the scope and frequency of information that we float to investors regarding significant new project wins and our KPO strategy.

So, I think that warps us up. Again, I want to thank you all for your continued support. We very much appreciate it, and we very much look forward to being with you next time. Thank you.

Operator

Thank you. That does conclude today's conference. If you'd like to listen to a replay of today's call, you may do so by dialing 888-203-1112 or 719-457-0820. The passcode is 7660964. The replay will be available from today, March the 13th at 1 PM Central Time through April the 12th at 1 PM Central. Again, that does conclude today's call. You may now disconnect.

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