Q&A With KIT Digital’s CEO Kaleil Isaza Tuzman

Each week I spend a lot of time trading emails with CEOs in the industry and simply due to time restraints, many of the conversations never go up on my blog. While probably half of what they tell me I'm not able to disclose anyway, there is a lot of information they share that I can make public, especially when it comes to the trends they are seeing in the market. With that in mind, this post with KIT Digital's CEO Kaleil Isaza Tuzman kicks off a new CEO Q&A format that I am going to try and do each week on my blog. If you want your company interviewed, send me an email and let me know as I already have a bunch of these Q&A posts in the hopper and will always be looking for more executives to interview.

Over the past two years, KIT Digital has made quite a name for themselves with all of the acquisitions they have done in the market. As a result of these acquisitions, KIT Digital is now selling a very rich product set across all three screens and into multiple verticals in the U.S, Europe and Asia. From a product standpoint, I hear KIT Digital get mentioned a lot in the context of Brightcove, yet the two companies are quite different. While there are some similarities between Brightcove and KIT Digital's online video platform offerings, KIT Digital is also focusing on IPTV services, signal acquisition and ingestion, live events and a whole host of broadcast and professional services that Brightcove is not in the business of.

With all of the platforms and technologies that KIT Digital has acquired, it hard to think of just one company to compare them to. They have a lot of competitors for various aspects of their business, but their product set tends to be a lot more diverse. While that can be a good thing, it could also cause problems for the company. Trying to integrate so many companies into the fold can be difficult, time consuming and end up costing more money than originally expected. In addition, with so much going on under one roof, trying to explain to the market what your focus is and who you are can be very challenging. These are some of the points that I've been discussing with KIT Digital's CEO Kaleil Isaza Tuzman who answered some of these questions in a Q&A interview I conducted via email.

Question: As a result of the company making so many acquisitions over the past two years, it's very hard to tell what the real organic growth is within the company. How would you break out the rate that KIT digital's core business is growing without all of the acquisitions?

Kaleil: It's a question we get pretty often, so we've run the numbers in detail: Using previously acquired company revenue run-rates and top-line growth prior to acquisition, we estimate that over the last three years our overall growth has been about 55% organic and 45% from complementary accretive acquisition. We expect our growth in 2010 to follow a similar pattern. We are not a “roll-up”. We believe in consolidation of our industry-and the scale in G&A and R&D that comes with it-but our strategy is one of a vanguard of organic growth with complementary, accretive acquisitions at the margin.

Our acquisitions have also been quite small. Over the last several years, there have been several statistically insignificant transactions (the buy-in of our minority interest in a subsidiary, for example, or the purchase of a two-person consultancy firm) and five “real” acquisitions that have comprised between 5-15% of our consolidated revenues in each case at the time of the transaction in question.

Question: What percentage of revenue that you acquired over the past 18 months is still with the company? As an example, when you acquired The FeedRoom they were doing $6M in revenue, but eight months later, how much of that $6M stayed at the company?

Kaleil: We have retained virtually all of The FeedRoom's original revenue to date and have upsold acquired clients and won new business with The FeedRoom team. This has helped us to rapidly realize bottom-line profitability from an asset that was losing money prior to us acquiring it. Over the last several years in general our client attrition has been under 1% annually _ which we believe is the best in our industry. Integrating acquired assets is always a challenge and involves discipline and difficult decisions at times, but I am very proud of our team's hard work to make these transitions as seamless as possible for our collective client base. But it is not only about retaining the clients from acquired companies; it is also about helping their businesses grow. When we integrate operations with an acquired company, we quickly focus on offering our newly acquired clients new functionality (like mobile and connected TV capability) that they may not have had access to before. Realizing revenue synergies through this type of cross-selling and upselling is key to our M&A strategy.

Question: With all the acquisitions KIT digital has made in the past 18 months, successfully integrating so many new technologies and platforms into the company has to be a major concern for management. What is KIT digital doing to make sure those integrations go smoothly? To date, I don't recall seeing many details on how each integration is going or how long each one will take.

Kaleil: As I said before, successfully integrating assets requires discipline and the willingness to make unbiased and unpopular decisions at times-and this has been true relative to the integration of the four acquisitions we've made in the last 18 months.

Again, our strategy is one of organic-led growth coupled with accretive acquisitions at the margin. This is based on a thesis that the enterprise end of the "video ERP" market (one way to describe the IP video asset management segment in which we operate) or as we call it, Video Asset Management software/solutions (or VAMs), should eventually have a 60%-70% market share leader _ to fully realize operating and R&D-related economies scale. Therefore, our acquisitions have been more focused on market share expansion _ by geographical area of focus or sales vertical expertise _ and less on technology addition.

That said, I think we've been pretty good at staying clear-eyed and unbiased vis-à-vis the technology gained from acquired companies. At the core of our current VX-one IP video platform solution, for example, are our “VX Media Suite” and “VX Enterprise” products. VX Media Suite (which is appropriate for over-the-top browser and off-deck mobile deployments) is based on functionality obtained through our Multicast acquisition, while VX Enterprise (which is better suited for complex, head-end deployments for telcos, network operators and major broadcasters) takes advantage of technology acquired from Nunet.

In certain cases, however, it is easier to discard the technology from an acquired asset, and migrate clients entirely to our existing technology platform. We employ a services-oriented architecture approach that makes this possible. Development and integration takes advantage of an enterprise service bus, or ESB, allowing us to integrate modular functionality and port over clients from acquired assets without disrupting the core data layer.

This approach also allows for the relatively rapid realization of sales synergies, because new clients and upsold clients can be quickly onboarded to a master platform solution. We acquire client vertical knowledge and geographical reach (like the not-for-profit and faith-based experience we obtained through the Multicast acquisition or the South and Southeast Asia presence we acquired through Benchmark) and then extend our broader product set across these specific client bases. That's at the crux of our integration strategy.

Question: The core message on KIT digital's home page talks to "IP video management for the enterprise," and also mentions "monetization" but most enterprise customers are not trying to monetize their content. What does KIT digital classify as an "enterprise" customer and what specific verticals are you selling into?

Kaleil: I appreciate you asking this question, because it affords us an opportunity to clarify an important difference in lexicon amongst IP video platform providers. Some of our competitors use the word "enterprise" to distinguish from media customers. When we say enterprise, we mean large customers with complex needs (whether they are media companies or not), particularly globally-oriented organizations that need to centrally and securely ingest and manage video content while also being able to allow for access and publishing of this content in multiple geographical locations, on multiple device types, and in different languages and network contexts.

The application of our VX-one platform solutions range from traditional commercial video distribution (i.e., entertainment video for end-consumer audiences) to internal corporate deployments, including corporate communications, human resources, training, security and surveillance. We provide solutions for clients across a wide variety of industries, including but not limited to media and entertainment, telecommunications, retail, consumer and packaged goods, shipping and logistics, pharmaceuticals, automotive and financial services, government, non-profit and faith-based organizations. Across all of these verticals, we help our clients apply VAM solutions to drive revenues, reduce costs, or both.

Our media & entertainment and network operator clients (which we often refer to as "front-end" customers) use VX primarily to monetize video content through advertising and subscriptions to end-users. Once content is hosted in an Internet Protocol environment, our clients have the flexibility to apply various business models and pricing structures against their content-in both online and mobile contexts. The performance of these models is logged and reported through our analytics suite, allowing clients to run more fiscally optimized content-serving businesses. Our clients in these verticals include telecommunications companies like Vodafone, which use VX to deliver live channels and video-on-demand to the three screens (browser, mobile devices and IP-enabled television). Publishers like the New York Post use VX to promote online and off-deck mobile content and create video news and entertainment experiences.

Other corporate customers (which we refer to as "back-end") use VX to increase internal efficiencies and save costs relative to older, closed-circuit and other traditional video systems. For example, clients like General Motors, Home Depot and FedEx use VX as a virtual internal communications tool for staff and stakeholders as well as for online training and employee management.

Question: With all of KIT's acquisitions, your services are now very deep across content ingestion, management and delivery for mobile, set-top-boxes and the PC. The more companies and platforms you acquire, the harder it becomes to try and easily explain all the services you provide. How do you plan to streamline the message you deliver to the market about who KIT digital is and what you provide without making it look like your product portfolio is not focused?

Kaleil: Again, appreciate you asking the question, because we believe there is some confusion in the market regarding the difference between companies that provide online video platform (OVP)-only solutions, and the space in which KIT digital operates, which we see as deeper-in-the-stack, multi-screen, A-to-Z video asset management solutions (VAMs).

The simplicity of OVP businesses is appealing on the face of it and well-suited for marketing materials, but we think the OVP-only model is ultimately ill-suited to profitable growth and unable to meet the complex needs of large-scale IP video deployments. We see the OVP business (which is mostly about putting video players on websites) as commoditizing. It is technically straightforward and relatively undifferentiated, and is largely about reselling bandwidth and storage. As such, we see margins in the OVP business compressing, with competitive advantages increasingly harder to defend. All of the OVP-focused companies in the industry are privately held, which affords them the advantage of not having to disclose revenue breakdown (including bandwidth reselling) or cash-burn levels.

Although our more complex VAM solutions are more difficult to distill in a blog, we are serving large clients' needs as the IP video market matures beyond video players on websites. We believe VAMs will become more distinguishable from OVPs in much the same way that specialized needs became clear in the last wave of video systems evolution between analog and traditional digital video. This was particularly true in areas like file-based digital asset management, digital conditional access, storage servers, as well as with other systems and tools that are vital to broadcasters and MSOs today in distributing traditional digital video. VAMs are similar to what Digital Asset Management systems, or DAMs, companies have been doing in the traditional digital video space for many years, but applied to next-generation, IP video technology.

Our VX software platform deployments are often complemented by marketing, branding and interface design services, as well as systems integration services related to digital play-out facilities, recording and editing suites, and content acquisition. Our professional services team is ISO 9001-compliant, certified by all the major Hollywood studios for content handling, and has won several awards for our creative services and website design capabilities. We are the only company in the industry with sophisticated digital marketing services and broadcast systems integration capabilities, allowing us to engage in more complex deployments for Global 1000 companies. So, we are much more than an online video player company-and less than 5% of our revenues are related to bandwidth or storage costs.

We believe our comprehensive approach to IP video systems deployment and our focus on advanced, multi-point, multi-device publishing capabilities better meets the needs of a maturing IP video marketplace.

Question: IPTV services have been a big push for KIT digital lately, especially outside of the U.S. What are some of the trends and adoption rates you are seeing for IPTV services in other countries and do you think that IPTV products will ever be offered in the U.S. on any large scale?

Kaleil: The U.S. is about two to four years behind much of East Asia, Europe and the United Kingdom when it comes to “IPTV”-which refers to set-top box and direct IP-enabled television sets within the context of cable-type, controlled network delivery. The U.S., which is at an early stage with services like Verizon FiOS and AT&T U-verse, does not come close to the penetration you see elsewhere in the world, including 80%+ penetration in places like Singapore, Hong Kong, Korea and Japan, and 40%+ penetration in Dubai, Taiwan, Spain, France and Germany. We've been operating in these markets for years, serving major telcos like Vodafone, Telefonica, Orascom, Vodacom and others, and are best positioned to take advantage as the IPTV and connected TV wave arrives in the U.S. Every day, we're seeing more telcos and MSOs globally making capex decisions in the direction of IP-based systems as the backbone to their management and provision of content.

Question: What is the breakdown on the number of customers KIT digital has today across the different verticals? How many of those customers are taking more than one product or service offering from the company?

Kaleil: We currently have over 1,000 clients across a range of industry verticals. We estimate that 40%-45% of our business globally is on the corporate or "back-end" side of video use, including large pharmaceutical companies, banks, governments, non-profits and faith-based organizations, automotive, CPG companies and so forth. We estimate 50%-55% of our business globally is in media and entertainment, or the "front-end" of video use, including MSOs, telcos, content providers and syndicators, IPTV cable providers and others.

In terms of the usage of our solutions by network or device type, we estimate about 40% of our clients are primarily engaged in browser-based delivery, with the remainder being roughly equally split between mobile device delivery (including tablets) and closed-network IPTV or behind the firewall, head-end deployments. That said, mobile network deployments is probably the area of fastest growth over the near- and medium-term in our industry.

Over half of our customers use KIT digital for more than one type of network delivery, and we see this number growing rapidly as our clients, and the industry in general, becomes more sophisticated. While some OVPs give lip service to mobile and IPTV/connected TV capabilities, we've been offering these services commercially for years.

Question: By my estimates, KIT digital has a chance to do more than $100M in total revenue this year. At that size, the company starts to become a real potential candidate to be acquired by a larger company. What is the long-term goal for KIT digital and do you see a Telco as being the most likely candidate interested in KIT's product offering?

Kaleil: Our financial guidance for 2010, which we issued at the beginning of the year, was for revenues to exceed $75 million (versus $47 million in 2009), with an operating EBITDA (earnings before interest tax, depreciation and amortization) margin for the year of at least 17.5%. We expect to exceed these targets on an organic basis, but I imagine your reference to $100 million in revenues assumes full-year results of our acquisitions of Multicast and Benchmark-which we actually didn't acquire until mid-way through the first half of this year.

We are committed to building a long-term, profitable standalone business with satisfied clients and the deepest solution set in our industry. Our mission is to be disciplined operationally while being highly selective in terms of complementary acquisitions, with the goal of expanding our current estimated 15%-20% global market share position to more than 50% over the next couple of years. We will continue to target acquisitions that provide geographical and sales synergies, share similar corporate cultures, and constitute roughly 5%-15% of our pro forma combined revenue.

My experience has been that if you think about a potential sale or other corporate "exit," you lose focus on delivering day-to-day operating and financial results. We want to continue to grow revenues and cash-flow as we have over the last 10 quarters since we came in as new management in late 2007. If we continue to do so, I think the optimal corporate path will follow.

Question: On a recent earnings call you stated that you felt the company did not need to raise any more money to grow the business. But shortly after that, the company raised just over $50M in a stock offering. At what point does KIT digital stop needing to raise money and stop acquiring companies and just focuses all of their efforts on growing their business?

I want to be clear upfront that I stand by the original statement that we did not need to raise money; we chose to do so when the opportunity quickly arose, for strategic purposes–to finance for potential, future acquisitions. But you are correct, Dan, that the most recent capital raise was not part of management's original 2010 plan. As we mentioned on our investor call shortly afterwards, the raise was driven by an unsolicited reverse inquiry from a large institutional investor. It was a tough decision to take in the money (given the resultant dilution), but ultimately we felt it was the right thing to do in that it allows management to focus on building our business without the distraction of frequently accessing the capital markets to finance future strategic moves. It also gives us, without a doubt, the strongest balance sheet in our industry (with over $60 million of cash on hand, even after our recent acquisitions of Benchmark and Multicast).

We see a lot of sharp elbows in our industry. Our internal culture and approach at KIT digital is a little different: we call it "aggressive humility." We are aggressive in that we want to be the hands-down winner in the VAMs market and believe that the efficiency frontier of a software-as-a-service market like ours involves a 60%-70% type market share leader. We want to be that leader. At the same time, we always try to remain humble, looking to improve in the geographies we address or particular client verticals, as well as in product functionality–really, in any area where we may be weak or where competitors may be doing something better. In such cases, we try to always stay clear-eyed about ways we could benefit from joining forces with another company or corporate team in our market. Hence, our 2-3 acquisitions per year.

We think this is the right strategy in a fast-growing, land-grab type market like we're in, and we believe when looking back some years from now, this will be the period of consolidation and critical divvying up of the VAMs market-much like the early ERP wars in the '90s. And given the “stickiness” of VAMs deployments, we believe a dollar spent now on selective, accretive acquisitions like Multicast and Benchmark could be worth $10-$20 spent trying to dislodge clients from a competitor years later. Llike ERP systems, video asset management software is tied into many other client systems–like the CMS layer, advertising, content delivery, CRM, financial reporting, auditing, etc.–and switching out providers can involve customer dissatisfaction, internal re-training, data loss, system latency and significant down-time.

We want to get ahead of our competition in this period of consolidation, and as a result of the $50+ million raise we did earlier this year, we have the financial resources to act swiftly and efficiently. We believe taking the dilution versus the benefit of more cash on hand-providing for more efficiently executed and better-priced acquisitions-was the right tradeoff to take.

We also believe that having over $60 million of cash on our balance sheet provides comfort to our large corporate clients and client prospects, who can be nervous about the long-term viability of smaller, less well-capitalized competitors.

Question: Are you starting to see any real traction in the U.S. with regard to delivering video to mobile devices? Are any content owners monetizing the mobile platform, specific to video content? Can you say what percentage of the video your customers are delivering is in the mobile format?

Kaleil: Yes, we are. We see mobile as the highest area for video growth globally right now and estimate 25%+ of our business is already in a mobile network context.

Vis-à-vis the United States, mobile networks that are sufficiently provisioned and video-capable are still more mature by a one-to-three year spread in most of the other OECD countries-and even some of the emerging markets that have benefitted from command-and-control economies and better coordinated network capex decisions.

Unfortunately, the regulatory environment in this area has been of historical disservice to the end-consumer in the U.S., as the FCC never really enforced protocol standardization in mobile networks or truth-in-advertising laws (which force better competitiveness) in broadband ISP provisioning. But we are catching up and the wonderful thing about the technology services environment in the U.S. is it's incredibly adaptiveness. So once things change, they tend to change very quickly.

North America is obviously the richest environment from mobile application, Smartphone device development and over-the-top consumer behavior perspectives, and is progressing very quickly. With the recent phone releases from major telcos in the U.S., Smartphone app/video delivery is becoming the key to capturing the U.S. mobile VAMs market. A highly developed ecosystem of Smartphones allows network operators-working in sync with content owners-to drive very rich content directly to the consumer. The beauty of IP delivery is that it gives our clients the opportunity to track very granular details about the uptake of their content and adjust their offering to optimize user engagement and boost ROI.

We are seeing VAMs-related request-for-proposals from all the major mobile network operators in the U.S., and this has been coincident with our decision to invest materially in the region during the back-half of 2009 and 2010. We are now at nearly 150 people strong in the Americas (out of a total of around 450 in KIT digital as a whole) across five office locations in the region, and are doing some level of work with several of the largest network operators in the Americas.

Question: In a recent 10K filing, KIT digital acknowledged that it is not strong when it comes to patents and intellectual property. How many patents does KIT digital now own from all of the acquisitions they have done? Do you see patents playing a larger role down the road specifically in the online video platform space?

Kaleil: Although it doesn't make for as good PR, the practical reality in the software field is that you're much better protected by usage precedent than by a patent filing. In fact, in cases where the code base in an application has been in commercial use for some time without a primacy challenge, it is almost always a bad decision to commence a patent filing that can effectively "reset" the IP clock. When we came into KIT digital as new management came towards the end of 2007, we actually made a strategic decision to terminate several pending patents because we felt our usage precedent was early enough and the code base had been in use for a sufficient period of time, that it was a better course of action not to spend money to reset the clock.

The vast majority of the OECD countries have a five-year usage precedent sunset provision on software-related intellectual property rights. In other words, once an application's core code and workflow has been in use and unchallenged for five years, it becomes almost impossible to dislodge the IP. Our IP strategy is similar to ERP players like Oracle or SAP, who rely on incremental improvement to core code that has been in constant commercial use for many years. In retrospect, we made the right decision in steering our energy away from patent filings (although we still do file patents in specific areas of modular development of our system) because we received no challenges. Our VX product family has been in continuous commercial use since 2003 or before, which is longer than any other active, directly-competitive market participant. As such, we believe KIT digital has the best IP protection in our industry.

Question: What aspect of KIT digital's business, that you can control, do you worry about the most? What is the biggest challenge the company faces today and what do you think the biggest challenge will be a year from now?

Kaleil: I think most CEOs in growth companies would agree that the biggest focus is always going to be on attracting and retaining great people. We have certain advantages in this respect, because KIT digital is a very dynamic environment, we are the largest player in our space and we offer employees growth opportunities in international markets (like Europe, the Middle East, Asia and Latin America) unavailable at other, similar companies. That said, we have gone through a number of developmental changes over the last several years, and the intense pace of work at KIT digital isn't right for everyone. Also, having operational hubs in places like Prague, Atlanta, Cologne, Singapore and Melbourne, Australia is great with respect to hiring technical and creative services talent, but can make hiring in certain other areas more challenging than in more “traditional” business centers like New York and San Francisco. Both this year and next, our objective is to build a cohesive and enduring culture of “aggressive humility” across our global business.

To be open, Dan, I worry at times about the distraction of being a public company. Unlike our private competitors, we cannot pick and choose what operational information we expose to the market, and it will always be easier for private companies to make unsubstantiated claims of market share, product traction or financial results. And even though our stock price as of today is up nearly 3x since we assumed control as new management in mid-December 2007, recent market volatility has us down around 40% from our highs, and with that comes the need to spend time with investors reminding them again what we see: an exciting, healthy and growing business in a great sector. At the end of the day, the key is to stay focused on delighting clients and delivering great products and services, and not get distracted by stock market trends and PR.

As we were talking about earlier, effectively integrating technology and operations from acquisitions is always going to be a top-of-mind area of focus as well. The key is to make the tough decisions early, including staffing, platform migration, and client management. My view is that in any business that is active on the acquisition front, leadership needs to be particularly steady and long-term oriented. Inevitably, with integration you are going to upset certain constituents-whether it be an employee who has been made redundant as a result of an acquisition, a loss-making customer you inherit which you choose to jettison, or a vendor whose services are no longer needed. But if we keep our eyes on the prize-which is profitability and overall dominant market share in the “enterprise” end of the IP video platform market-we will survive the occasional turbulence along the way. We've gone from a $10 million top-line, loss-making business three years ago to a business today that is approaching $100 million in revenues with decent and growing operating and cash-flow margins, so we're making progress.