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INOD > SEC Filings for INOD > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for INNODATA INC


6-May-2013

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. The words "project," "head start," "believe," "expect," "should," "anticipate," "indicate," "point to," "forecast," "likely" and other similar expressions generally identify forward-looking statements, which speak only as of their dates.

These forward-looking statements are based largely on our current expectations, and are subject to a number of risks and uncertainties, including without limitation, that contracts could be terminated by clients, projected or committed volumes of work may not materialize; that our Innodata Advanced Data Solutions segment has not reported any substantial revenues to date and is subject to the risks and uncertainties of early-stage companies; the primarily at-will nature of the contracts with our clients and the ability of our 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 venture 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 changes in status of client contracts, client relationships, or other forward-looking information, whether as a result of new information, future developments or otherwise.

Business Overview

Innodata (NASDAQ: INOD) is a global provider of business process, information technology (IT) and professional services that are focused on digital enablement. Our clients comprise several of the world's leading digital retailers that sell digital content; preeminent publishers and other providers of online business information products; and enterprises in information-intensive industries (such as aerospace, defense, financial services, healthcare, high technology, insurance, and manufacturing) that create and manage large volumes of content to support their products or operations.

We operate in two reporting segments: Content Services (CS) and Innodata Advanced Data Solutions (IADS).

Our CS segment provides solutions to digital retailers, information services companies, publishers and enterprises that have one or more of the following broad business requirements: development of digital content (including eBooks); development of new digital information products; and operational support of existing digital information products and systems.

Many of our clients are driving or are responding to rapid and fundamental changes in the way end users discover, consume and create published information. For some of our publishing and information services clients, this means transforming information products from print to digital; for others, it means migrating already-digital products from web-only distribution to multiple-channel distribution that includes mobile and tablet devices and incorporates mobility, social platform and semantic search; and for others still it means re-tooling pure search-based information products into workflow-imbedded analytical tools that combine content with software to enable context-aware decision-making; and for a select number of our information services clients, it means embracing the content-as-a-service model to integrate content with other tools, applications and data. Each of these transformations requires shifts in products, as well as the technology and the operations that support them.

We are one of the largest producers of eBooks, serving four of the five leading digital retailers of eBooks as well as 80 leading trade, education and professional publishers that sell eBooks. We manufacture both standard eBooks and interactive eBooks in a variety of formats (including EPUB, Mobi and Kindle) and in 12 major languages (including Japanese and Chinese). In addition, we distribute eBooks on behalf of publishers and authors to more than 25 eBook retailers across North America, the United Kingdom, Australia and 24 countries in the European Union. We have produced over one million eBooks since the third quarter of 2011.

We help our clients develop high-value information products and knowledge repositories. Our clients include four of the ten largest information industry companies in the world, spanning financial, legal, healthcare and scientific information.

We formed our IADS segment in mid-2011 to design and develop new capabilities to enable clients in the financial services, insurance, medical and healthcare sectors to improve decision-support through digital technologies. We believe that by creating and commercializing innovative business strategies and technology solutions, we will be able to accelerate growth and reduce revenue volatility. IADS operates through two subsidiaries. Synodex offers a range of services for healthcare, medical and insurance companies, and docGenix provides services to financial services institutions. As of March 31, 2013, Innodata owns 85% of Synodex and 94% of docGenix, both limited liability companies.

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 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. 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 a 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 clients are presented net of payments in the condensed consolidated statements 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 March 31, 2013 and 2012

Revenues

Total revenues were $16.9 million for the three months ended March 31, 2013 compared to $25.1 million for the three months ended March 31, 2012, a decline of $8.2 million or approximately 33%. Revenues from the CS segment were $16.3 million and $24.5 million for the three months ended March 31, 2013 and 2012, respectively, a decline of $8.2 million or approximately 34%. Revenues from the IADS segment were $0.6 million for both the three months ended March 31, 2013 and 2012.

The $8.2 million decrease in CS segment revenues is principally attributable to lower revenues from eBook-related services that we performed for one of our significant clients.

Our top three clients generated approximately 42% and 56% of our total revenues for the three months ended March 31, 2013 and 2012, respectively. No other client accounted for 10% or more of total revenues during these periods. Further, for the three months ended March 31, 2013 and 2012, revenues from non-U.S. clients accounted for 29% and 20%, respectively, of our total revenues.

Direct Operating Costs

Direct operating costs were $12.8 million and $16.1 million for the three months ended March 31, 2013 and 2012, respectively, a decline of $3.3 million or approximately 21%. Direct operating costs for the CS segment were $11.8 million and $14.5 million for the three months ended March 31, 2013 and 2012, respectively, a decline of $2.7 million or approximately 19%. Direct operating costs for the IADS segment were $1.0 million and $1.6 million for the respective periods, net of intersegment profits.

Direct operating costs as a percentage of total revenues increased to 76% for the three months ended March 31, 2013 compared to 64% for the three months ended March 31, 2012. Direct operating costs for the CS segment as a percentage of CS segment revenues were 73% for the three months ended March 31, 2013 compared to 59% for the three months ended March 31, 2012.

The decline in direct operating costs for the CS segment was principally attributable to a decrease in production headcount due to a decline in CS revenues; however, direct operating costs as a percentage of CS segment revenues have increased. Since our direct operating costs are comprised of both fixed and variable costs, a decline in revenues does not translate into a proportionate decline in direct operating costs.

During the three months ended March 31, 2013 we incurred certain production costs for initial engagements including pilot engagements and facility overhead costs for our new delivery center in Asia. We incurred certain one-time costs for our IADS segment during the three months ended March 31, 2012.

Selling and Administrative Expenses

Selling and administrative expenses were $4.6 million, or approximately 27% as a percentage of total revenues during the three months ended March 31, 2013, and $5.4 million, or 21% as a percentage of total revenues for the three months ended March 31, 2012, and represents a decrease of $0.8 million or approximately 14%. Selling and administrative expenses for the CS segment were $3.9 million and $4.9 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $0.7 million and $0.5 million, net of intersegment profits.

In the second half of 2012, we restructured our operations, which resulted in cost savings in the first quarter of 2013. This, combined with lower professional fees, led to a decline in selling and administrative expenses for the CS segment during the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Selling and administrative expenses for the Content Services segment as a percentage of CS segment revenues were 24% for the three months ended March 31, 2013 compared to 20% for the three months ended March 31, 2012.

The $0.2 million increase in selling and administrative expenses for the IADS segment is primarily attributable to compensation costs of new personnel hired for sales and marketing and increases in other administrative costs.

Income Taxes

For the three months ended March 31, 2013 we recorded a net benefit from income taxes, as our U.S. entity recorded a benefit from income tax on account of losses it incurred; and with respect to our foreign subsidiaries, we recorded a provision for income taxes in accordance with local tax regulations. Some of our foreign subsidiaries are subject to tax holidays or preferential tax rates which reduces our overall effective tax rate when compared to the U.S. statutory tax rate. In addition, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.

For the three months ended March 31, 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, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.

Net Income

We generated net income of $0.3 million in the three months ended March 31, 2013 compared to $3.4 million in the three months ended March 31, 2012. Net income for the CS segment was $1.4 million for the three months ended March 31, 2013, compared to $4.9 million for the three months ended March 31, 2012. The change was primarily attributable to a decline in gross margins resulting from lower revenues offset by a decline in selling and administrative expenses. In addition, we recorded a benefit from income taxes for the three months ended March 31, 2013, compared to a provision for income taxes for the three months ended March 31, 2012. Net loss for the IADS segment was $1.1 million for the three months ended March 31, 2013 compared to $1.5 million for the three months ended March 31, 2012, net of intersegment profits.

Liquidity and Capital Resources



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



                                  March 31, 2013       December 31, 2012

Cash and cash equivalents        $        27,147     $            25,425
Short term investments - other             3,592                   3,091
Working capital                           32,022                  32,784

At March 31, 2013, we had cash and cash equivalents of $27.1 million, of which about $20.0 million was held by our foreign subsidiaries, and short term investments of $3.6 million, which was entirely held by our operating foreign subsidiaries located in Asia. We have used, and plan to use, such cash for (i) expansion of existing operations; (ii) general corporate purposes, including working capital; (iii) possible business acquisitions; and (iv) continuing investments in IADS. As of March 31, 2013, we had working capital of approximately $32.0 million, as compared to working capital of approximately $32.8 million as of December 31, 2012. Accordingly, we do not anticipate any near-term liquidity issues. Cash balances are held in bank deposits at leading U.S. and foreign commercial banks.

Net Cash Provided By Operating Activities

Cash provided by our operating activities for the three months ended March 31, 2013 was $3.1 million, resulting from net income of $0.1 million, adjustments for non-cash items of $0.5 million and $2.6 million provided by working capital changes. Adjustment for non-cash items primarily consisted of $0.9 million for depreciation and amortization and $0.3 million for stock-based compensation expense. Working capital activities primarily consisted of a source of cash of $4.1 million as a result of net collections of accounts receivable and a use of cash of $1.0 million for a decrease in accrued salaries, wages and related benefits.

Cash provided by our operating activities for the three months ended March 31, 2012 was $7.7 million resulting from net income of $2.8 million, adjustments for non-cash items of $1.6 million and $3.3 million provided by working capital changes. Adjustments for non-cash items primarily consisted of $0.9 million for depreciation and amortization and $0.3 million for stock-based compensation. Working capital activities primarily consisted of a source of cash of $2.6 million as a result of collections on accounts receivable and a source of cash of $0.4 million for increase in accounts payable and accrued expenses.

At March 31, 2013 our days' sales outstanding were approximately 66 days as compared to 76 days as of December 31, 2012. The decrease is on account of collection of outstanding amounts from one of our significant clients.

Net Cash Used in Investing Activities

For the three months ended March 31, 2013 and 2012, cash used in our investing activities for capital expenditures were $0.9 million and $2.1 million, respectively. Capital spending in 2013 principally consisted of the purchase of technology equipment including servers, network infrastructure and workstations. Also included within capital expenditures are costs incurred to develop our proprietary software platform, tools and technology for the IADS segment amounting to $0.3 million. Capital spending in 2012 principally consisted of the purchase of technology equipment including workstations, computer software, and leasehold improvements. During the next twelve months, we anticipate that capital expenditures for ongoing technology, equipment, infrastructure upgrades and development of our proprietary software platform, tools and technologies for both CS and IADS will approximate $4.0 to $5.0 million, a portion of which we may finance. Also included in investing activities for the three months ended March 31, 2013 is the purchase of short-term investments primarily representing proceeds on maturity of $0.5 million of certificates of deposit, and for the three months ended March 31, 2012, is the sale of short-term investments primarily representing proceeds on maturity of $1.0 million of certificates of deposit.

Net Cash Provided by (Used in) Financing Activities

Total payments of long-term obligations approximated $0.1 million for each of the three months ended March 31, 2013 and 2012. Proceeds from the exercise of stock options amounted to $0.1 million and $0.3 million during the three months ended March 31, 2013 and 2012, respectively.

Future Liquidity and Capital Resource Requirements

We havea $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 at the bank's alternate base rate plus 0.5%, or LIBOR plus 2.5%. The line, which expires in June 2013, is collateralized by our accounts receivable. We have no outstanding obligations under this credit line as of March 31, 2013. We intend to renew this credit line in the second quarter of 2013.

We believe that our existing cash and cash equivalents, short-term investments, funds generated from our operating activities and funds available under our credit facility will provide sufficient sources of liquidity to satisfy our financial needs for the next twelve months. However, if circumstances change, we may need to raise debt or additional equity capital in the future. We have historically funded our foreign expenditures from our U.S. corporate headquarters on an as-needed basis.

In the second quarter of 2012, we filed a shelf registration statement on Form S-3, which will give us the ability to offer, from time to time, up to an aggregate of $70 million of securities which may consist of common stock, preferred stock, debt securities, warrants, or units consisting of any of the foregoing. The registration is intended to give us flexibility should financing opportunities arise.

Contractual Obligations



The table below summarizes our contractual obligations (in thousands) at March
31, 2013 and the effects that those obligations are expected to have on our
liquidity and cash flows in future periods.



                                                              Payments Due by Period
                                                     Less than                                          After
Contractual Obligations                  Total          1 year       1-3 years       4-5 years        5 years

Vendor obligations                   $     270     $       270     $         -     $         -     $        -
Non-cancelable operating leases         10,436           1,856           3,854           2,507          2,219
Total contractual cash obligations   $  10,706     $     2,126     $     3,854     $     2,507     $    2,219

Future expected obligations under our pension benefit plan have not been included in the contractual cash obligations table above.

Inflation, Seasonality and Prevailing Economic Conditions

Our most significant costs are the salaries and related benefits of our employees in Asia. We are exposed to higher inflation in wage rates in the countries in which we operate. We generally perform work for our clients under project-specific contracts, requirements-based contracts or long-term contracts. We must adequately anticipate wage increases, particularly on our fixed-price contracts. There can be no assurance that we will be able to recover cost increases through increases in the prices that we charge for our services to our clients.

Our quarterly operating results are subject to certain fluctuations. We experience fluctuations in our revenue and earnings as we replace and begin new projects, which may have some normal start-up delays, or we may be unable to replace a project entirely. These and other factors may contribute to fluctuations in our operating results from quarter to quarter. In addition, as some of our Asian facilities are closed during holidays in the fourth quarter, we typically incur higher wages due to overtime that reduce our margins.

Critical Accounting Policies and Estimates

Our discussion and analysis of our results of operations, liquidity and capital resources is based on our condensed consolidated financial statements which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts and billing adjustments, long-lived assets, goodwill, valuation of deferred tax assets, value of securities underlying stock-based compensation, litigation accruals, pension benefits, valuation of derivative instruments and estimated accruals for various tax exposures. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates and could have a significant adverse effect on our results of operations and financial position. For a discussion of our critical accounting policies see Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2012. There have been no material changes to our critical accounting policies during the three months ended March 31, 2013.

Recent Accounting Pronouncements

In the first quarter of 2013, we adopted changes issued by the Financial Accounting Standard Board to the reporting of amounts reclassified out of accumulated other comprehensive income. These changes require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. These requirements are to be applied to each component of accumulated other comprehensive income. Other than the additional disclosure requirements, the adoption of these changes had no impact on our condensed consolidated financial statements.

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