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INOD > SEC Filings for INOD > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for INNODATA INC

Form 10-Q for INNODATA INC


7-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Disclosures in this Form 10-Q contain certain forward-looking statements, including without limitation, statements concerning our operations, economic performance, and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words "estimate," "believe," "expect," "anticipate," "intend" and other similar expressions generally identify forward-looking statements, which speak only as of their dates.

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

Our actual results could differ materially from the results referred to in the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the results referred to in the forward-looking statements contained in this Form 10-Q will occur.

We undertake no obligation to update or review any guidance or other forward-looking information, whether as a result of new information, future developments or otherwise.

Business Overview

Innodata Inc. (NASDAQ: INOD) is a leading provider of business process, technology and consulting services, as well as products and solutions, that help our valued clients create, manage, use and distribute digital information. Propelled by a culture that emphasizes quality, service and innovation, we have developed a client base that includes many of the world's preeminent media, publishing and information services companies, as well as leading enterprises in information-intensive industries such as aerospace, defense, financial services, government, healthcare, high technology, insurance, intelligence, manufacturing and law.

We operate in two reporting segments.

Our Content Services (CS) segment provides services that support the creation, enhancement, and repurposing of digital content. These services include high-accuracy conversion to digital text; data analysis and enhancement of legal, financial, medical and technical information; information technology services related to digital content management and products; and consulting services to help clients with strategic and tactical aspects of digital content operations.

Our clients include legal and business information providers; scientific, technical and medical publishers; providers of mobile computing devices and digital content distribution platforms; enterprises that create and manage large volumes of product support content; and governmental agencies that manage large volumes of content in support of mission.

Most of our business information and publishing clients are in the process of transforming from print publishing to online publishing; from online publishing to multiple-channel distribution that includes web as well as mobile, tablet and eReading devices; or from search-based information products to workflow-based information products. These transformations require the adoption of new strategies, technologies and processes. We help our clients set digital content production and product strategies; integrate new technologies and processes; improve the quality and efficiency of content creation, enrichment and transformation; publish through multiple channels (including portable devices); and build new digital products.

In the second quarter of 2011, we launched Innodata Advanced Data Solutions (IADS) as a separate segment to perform advanced data analysis. IADS operates through two subsidiaries: Synodex and docGenix. Synodex offers a range of document and data analysis services that are tailored to healthcare, medical and insurance companies. docGenix provides financial services institutions with software products and services that facilitate the analysis and management of legal documentation relating primarily to derivatives. We presently own 77% of Synodex and 78% of docGenix, both limited liability companies.

Total operating costs for the IADS segment from inception in the second quarter of 2011 through September 30, 2012, including direct operating costs and selling and administrative costs, were $7.4 million net of intersegment profits. During the same period we invested approximately $3.6 million in capital expenditures for this segment.

Each of our segments is organized and managed around three vectors: a vertical industry focus, a horizontal service/process focus, and a supportive operations focus.

The vertically-aligned groups understand our clients' businesses and strategic initiatives. The vertical group for each particular industry includes experts hired from that industry.

Our service/process-aligned groups include engineering personnel and delivery personnel. Our engineering teams are responsible for creating secure and efficient custom workflows and integrating proprietary and third-party technologies to automate manual processes and improve the consistency and quality of our work product. These tools include categorization engines that utilize pattern recognition algorithms based on comprehensive rule sets and related heuristics, data extraction tools that automatically retrieve specific types of information from large data sources, and workflow systems that enable various tasks and activities to be performed across our multiple facilities.

Our globally distributed delivery personnel are responsible for executing our client engagements in accordance with service-level agreements. We deliver services from facilities in the United States, India, the Philippines, Sri Lanka and Israel.

Other support groups are responsible for managing diverse enabling functions including human resources, organizational development, network and communications technology infrastructure support and physical infrastructure and facilities management.

Our sales staff, program managers and consultants operate primarily from our North American offices, European locations, as well as from client sites.

Revenues

We are a leading provider of business process, technology and consulting services, as well as products and solutions. We operate in two reporting segments. Within our content segment, we provide services that support the creation, enhancement, and repurposing of digital content. We price our services based on the quantity delivered or resources utilized and we recognize revenue in the period in which the services are performed and delivered. A substantial majority of our technology and consulting services are provided on a project basis. We price such services on an hourly basis for actual time and expense incurred, or on a fixed-fee, turn-key basis. Revenues for contracts billed on a time-and-materials basis are recognized as services are performed. Revenues under fixed-fee contracts, which are not significant to the overall revenues, are recognized on the percentage of completion method of accounting, as services are performed or milestones are achieved.

We consider standard accounting criteria for determining whether to report revenue gross as a principal versus net as an agent. Factors considered include whether we are the primary obligor, have risks and rewards of ownership, and bear the risk that the client may not pay for the services performed. If there are circumstances where the above criteria are not met and therefore we are not the principal in providing services, amounts received from client are presented net of payments in the condensed consolidated statement of operations.

Revenues include reimbursement of out-of-pocket expenses, with the corresponding out-of-pocket expenses included in direct operating costs.

Direct Operating Costs

Direct operating costs consist of direct payroll, occupancy costs, depreciation and amortization, travel, telecommunications, computer services and supplies, and other direct expenses that are incurred in providing services to our clients.

Selling and Administrative Expenses

Selling and administrative expenses consist of management and administrative salaries, sales and marketing costs, new services research and related software development, professional fees and consultant costs, and other administrative overhead costs.

Results of Operations

Three Months Ended September 30, 2012 and 2011

Revenues

Total revenues were $19.7 million for the three months ended September 30, 2012, a 2% increase from $19.2 million in the third quarter of 2011, and a 13% sequential decline from $22.8 million in the second quarter of 2012. Revenues for the Content Services segment were $19.7 million, $19.2 million and $22.7 million for the three months ended September 30, 2012, September 30, 2011 and June 30, 2012, respectively. Revenues from the IADS segment were $0.1 million for the three months ended June 30, 2012. There were no revenues from the IADS segment for the three months ended September 30, 2012 and 2011.

The $0.5 million increase in Content Services segment revenues for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 is principally attributable to revenue from e-book-related services that we performed for one of our significant clients, and the 13% decrease in revenues compared to the second quarter of 2012 reflects a sequential decline in revenues from this client for such services. Revenue from this client will likely decline further during the fourth quarter of 2012.

Three clients generated approximately 46% and 31% of our total revenues for the three months ended September 30, 2012 and 2011, respectively. Another client accounted for less than 10% of our total revenues for the three months ended September 30, 2012, and for 12% of our total revenues for the three months ended September 30, 2011. No other client accounted for 10% or more of our total revenues in either period. Further, for the three months ended September 30, 2012 and 2011, revenues from non-US clients accounted for 28% and 30%, respectively, of the Company's total revenues.

Direct Operating Costs

Direct operating costs were $13.5 million and $12.8 million for the three months ended September 30, 2012 and 2011, respectively, an increase of $0.7 million or approximately 5%. Direct operating costs for the Content Services segment were $12.9 million and $12.4 million for the three months ended September 30, 2012 and 2011, respectively, an increase of $0.3 million or approximately 3%. Direct operating costs for the IADS segment were $0.6 million and $0.4 million for the respective periods, net of intersegment profits.

The increase in direct operating costs for the Content Services segment was principally attributable to an increase in operating costs in support of increased revenues. The increase in direct operating costs for the IADS segment represents additional start-up costs.

Direct operating costs as a percentage of total revenues increased to 69% for the three months ended September 30, 2012 compared to 67% for the three months ended September 30, 2011. Direct operating costs for the Content Services segment as a percentage of Content Services segment revenues were 65% for both the three months ended September 30, 2012 and three months ended September 30, 2011.

Selling and Administrative Expenses

Selling and administrative expenses were $5.2 million, or approximately 26% as a percentage of total revenues during the three months ended September 30, 2012, and $4.6 million, or approximately 24% as a percentage of total revenues for the three months ended September 30, 2011. Selling and administrative expenses for the Content Services segment were $4.5 million and $4.2 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $0.7 million and $0.4 million, net of intersegment profits.

The increase in selling and administrative expenses for the three months ended September 30, 2012 is principally attributable to compensation costs of new personnel hired for sales and marketing and an increase in other administrative costs including $0.3 million of other administrative costs for the IADS segment.

Selling and administrative expenses for the Content Services segment as a percentage of Content Services segment revenues were 23% for the three months ended September 30, 2012 compared to 22% for the three months ended September 30, 2011.

Restructuring Costs

In the third quarter of 2012, we restructured certain operations, and recorded a one-time charge of approximately $0.2 million ($0.1 million in direct operating costs and $0.1 million in selling, general and administrative costs) representing severance and other personnel-related expenses. We expect cost savings of approximately $1.8 to 2.0 million per annum from this restructuring activity.

Income Taxes

For the three months ended September 30, 2012, the provision for income taxes primarily relates to provisions made for some but not all of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates, thereby lowering our overall effective tax rate compared to the U.S. statutory tax rate. In addition, certain overseas income is not subject to tax in the U.S. unless repatriated. The provision for income taxes for the three months ended September 30, 2012 was partially offset by the benefit recorded for the U.S. entity.

For the three months ended September 30, 2011, we recorded a provision for income taxes for the U.S. entity and certain but not all of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates. In addition, certain overseas income is not subject to tax in the U.S. unless repatriated.

The effective tax rate was lower for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 as the income attributable to our higher tax jurisdiction was lower.

Net Income

We generated net income of $1.3 million in the three months ended September 30, 2012 compared to $1.4 million in the three months ended September 30, 2011 and $2.1 million in the three months ended June 30, 2012. Net income for the Content Services segment was $3.2 million, $2.2 million and $3.5 million for the three months ended September 30, 2012, September 30, 2011 and June 30, 2012, respectively. The increase in net income for the Content Services segment during the three months ended September 30, 2012 compared to the three months ended September 30, 2011 was primarily due to an increase in gross margins resulting from higher revenues. This increase was partly offset by an increase in selling and administrative expenses primarily due to the hiring of new sales and marketing personnel, and an increase in other administrative costs. A lower provision for income taxes and higher losses attributable to non-controlling interests in the three months ended September 30, 2012 compared to the similar period in 2011 also contributed to an increase in net income. The decline in net income for the Content Services segment during the three months ended September 30, 2012 compared to the second quarter of 2012 was primarily due to a sequential decline in revenues. Net loss for the IADS segment was $1.9 million, $0.8 million and $1.4 million for the three months ended September 30, 2012, September 30, 2011 and June 30, 2012, respectively.

Nine Months Ended September 30, 2012 and 2011

Revenues

Total revenues were $67.6 million for the nine months ended September 30, 2012, a 35% increase from $50.2 million for the similar period in 2011. Revenues from the Content Services segment were $66.8 million and $50.2 million for the nine months ended September 30, 2012 and 2011, respectively. Revenues from the IADS segment were $0.8 million for the nine months ended September 30, 2012. There were no revenues from the IADS segment for the nine months ended September 30, 2011.

The $16.6 million increase in the Content Services segment is principally attributable to higher revenues from e-book-related services that we performed for one of our significant clients. We experienced a sequential decline in revenue from this customer in the second and third quarters of 2012 as compared to the first quarter of 2012. Revenue from this client will likely decline further during the fourth quarter of 2012.

Two clients generated approximately 45% and 24% of our total revenues for the nine months ended September 30, 2012 and 2011, respectively. Another client accounted for less than 10% of our total revenues for the nine months ended September 30, 2012, and for 15% of our total revenues for the nine months ended September 30, 2011. No other client accounted for 10% or more of our total revenues in either period. Further, for the nine months ended September 30, 2012 and 2011, revenues from non-US clients accounted for 23% and 32%, respectively, of the Company's revenues.

Direct Operating Costs

Direct operating costs were $44.3 million and $34.9 million for the nine months ended September 30, 2012 and 2011, respectively, an increase of $9.4 million or approximately 27%. Direct operating costs for the Content Services segment were $41.1 million and $34.4 million for the nine months ended September 30, 2012 and 2011, respectively, an increase of $6.6 million or approximately 19%. Direct operating costs for the IADS segment were approximately $3.2 million and $0.5 million for the respective periods, net of intersegment profits.

The increase in direct operating costs for the Content Services segment was principally attributable to an increase in production headcount and other operating costs in support of increased revenues. The increase in direct operating costs was partially offset by a decrease in direct labor costs achieved primarily from productivity gains. The productivity gains were principally the result of increased efficiency, improvements in our processes and innovation in our technology. The increase in direct operating costs for the IADS segment represents additional start-up costs.

Direct operating costs as a percentage of total revenues declined to 65% for the nine months ended September 30, 2012 compared to 69% for the nine months ended September 30, 2011. Direct operating costs for the Content Services segment as a percentage of Content Services segment revenues were approximately 62% for the nine months ended September 30, 2012, compared to 69% for the nine months ended September 30, 2011.

Selling and Administrative Expenses

Selling and administrative expenses were $16.8 million, or approximately 25% as a percentage of total revenues during the nine months ended September 30, 2012, and $12.7 million or approximately 25% of total revenues for the nine months ended September 30 2011. Selling and administrative costs for the Content Services segment were $14.5 million and $12.1 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $2.3 million and $0.6 million, net of intersegment profits.

The increase in selling and administrative expenses for the nine months ended September 30, 2012 is principally attributable to compensation costs of new personnel hired for sales and marketing and an increase in other administrative costs including $1.7 million of other administrative costs for the IADS segment. During the nine months ended September 30, 2011, we recorded approximately $0.5 million from the recovery of bad debts from a previously fully reserved account receivable.

Selling and administrative expenses for the Content Services segment, as a percentage of Content Services segment revenues, was 22% for the nine months ended September 30, 2012 compared to 24% for the nine months ended September 30, 2011.

Restructuring Costs

In the third quarter of 2012, we restructured our operations, and recorded a one-time charge of approximately $0.2 million ($0.1 million in direct operating costs and $0.1 million in selling, general and administrative costs) representing severance and other personnel-related expenses. We expect cost savings of approximately $1.8 to 2.0 million per annum from this restructuring activity.

Income Taxes

For the nine months ended September 30, 2012, we recorded a provision for income taxes for the U.S. entity and certain but not all of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates, thereby lowering our overall effective tax rate compared to the U.S. statutory tax rate. In addition, certain overseas income is not subject to tax in the U.S. unless repatriated.

For the nine months ended September 30, 2011, we recorded a provision for income taxes for the U.S. entity and certain, but not all of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates. In addition, certain overseas income is not subject to tax in the U.S. unless repatriated.

The effective tax rate was lower for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 as the income attributable to our higher tax jurisdiction was lower.

Net Income

We generated net income of $6.8 million in the nine months ended September 30, 2012 compared to $2.2 million in the nine months ended September 30, 2011. Net income for the Content Services segment was $12.8 million and $3.3 million for the nine months ended September 30, 2012 and 2011, respectively. The increase in net income for the Content Services segment was primarily due to an increase in gross margins resulting from higher revenues, and an increase in productivity due to improvements in processes and technology. This increase was partly offset by an increase in selling and administrative expenses primarily due to the hiring of new sales and marketing personnel, and an increase in other administrative costs. A lower provision for income taxes and higher losses attributable to non-controlling interests in the nine months ended September 30, 2012 compared to the similar period in 2011 also contributed to an increase in net income. Net loss for the IADS segment was $6.0 million and $1.1 million for the nine months ended September 30, 2012 and 2011, respectively.

Liquidity and Capital Resources



Selected measures of liquidity and capital resources, expressed in thousands,
are as follows:



                                       September 30, 2012       December 31, 2011

    Cash and cash equivalents        $             25,082     $            11,389
    Short term investments - other                      -                   5,828
    Working capital                                33,077                  28,148

At September 30, 2012, we had cash and cash equivalents of approximately $25.1 million. We have used, and plan to use, such cash for (i) expansion of existing operations; (ii) general corporate purposes, including working capital; and
(iii) possible business acquisitions. As of September 30, 2012, we had working capital of approximately $33.1 million as compared to working capital of approximately $28.1 million as of December 31, 2011. Accordingly, we do not anticipate any near-term liquidity issues.

Net Cash Provided By Operating Activities

Cash provided by our operating activities for the nine months ended September 30, 2012 was $13.1 million, resulting from net income of $5.3 million, adjustments for non-cash items of $4.1 million and $3.7 million provided by working capital changes. Adjustment for non-cash items primarily consisted of $2.9 million for depreciation and amortization and $0.8 million for stock-based compensation expense. Working capital activities primarily consisted of a source of cash of $4.2 million as a result of net collections of accounts receivable.

Cash provided by our operating activities for the nine months ended September 30, 2011 was $0.9 million resulting from a net income of $2.0 million, adjustments for non-cash items of $2.9 million and $3.9 million used in working capital changes. Adjustments for non-cash items primarily consisted of $2.3 million for depreciation and amortization, $0.5 million for stock-based compensation and $(0.3) million for deferred income taxes. Working capital activities primarily consisted of a use of cash of $4.2 million for an increase in accounts receivable primarily related to an increase in revenue, and a source of cash of $1.0 million for accounts payable, accrued expenses and accrued salaries, wages and related benefits representing the timing of expenditures and payments.

At September 30, 2012, our days' sales outstanding were approximately 86 days as compared to 66 days as of December 31, 2011. The increase is due to higher revenues and slow payments from one of our significant clients and a correspondingly high concentration of accounts receivable balances.

Net Cash Provided By (Used in) Investing Activities

For the nine months ended September 30, 2012 and 2011, cash used in our investing activities for capital expenditures was $5.7 million and $2.8 million, respectively. Capital spending in 2012 principally consisted of the purchase of technology equipment including workstations, computer software, and leasehold improvements. Also included within capital expenditures are costs incurred to develop computer software for the IADS segment, amounting to $1.7 million, and to establish delivery centers in Asia. Capital spending in 2011 related principally to the purchase of technology equipment and computer software. During the next twelve months, we anticipate that capital expenditures for ongoing technology, hardware, software, leasehold improvements, fittings, equipment and infrastructure upgrades, development of proprietary tools and technologies for the IADS segment and establishment of new delivery centers will approximate $4.0 to $5.0 million, a portion of which we may finance. Also included in investing activities is the sale of short-term investments primarily representing proceeds on the maturity of $5.8 million and $2.4 million of certificates of deposit for the nine months ended September 30, 2012 and 2011, respectively.

Net Cash Provided by (Used in) Financing Activities

Total payments of long-term obligations approximated $0.1 million and $0.5 million for the nine months ended September 30, 2012 and 2011, respectively. Proceeds from the exercise of stock options amounted to $0.6 million during the three months ended September 30, 2012. There were no stock option exercises during the nine months ended September 30, 2011.

During the nine months ended September 30, 2011, we repurchased 494,000 shares of our common stock at a cost of approximately $1.3 million, at a volume-weighted average price of $2.69 per share. No shares were repurchased during the nine months ended September 30, 2012.

Future Liquidity and Capital Resource Requirements

We have a $15.0 million line of credit pursuant to which we may borrow up to 80% of eligible accounts receivable. Borrowings under the credit line bear interest . . .

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