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INOD > SEC Filings for INOD > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for INNODATA INC

Form 10-K for INNODATA INC


14-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this report. In addition to historical information, this discussion includes forward-looking information that involves risks and assumptions which could cause actual results to differ materially from management's expectations. See "Forward-Looking Statements" included elsewhere in this report.

Executive Overview

We are a global provider of business process, information technology (IT) and
professional services that are focused on digital enablement. We operate in two
reporting segments: Content Services (CS) and Innodata Advanced Data Solutions
(IADS).

The following table sets forth, for the period indicated, certain financial data
expressed for the three years ended December 31, 2013:

(Dollars in millions)
                                                      Years Ended December 31,
                              2013    % of revenue       2012     % of revenue       2011     % of revenue

Revenues                   $   64.2          100.0 %   $   86.6          100.0 %   $   73.9          100.0 %
Direct operating costs         49.1           76.5 %       57.4           66.3 %       50.1           67.8 %
Selling and
administrative expenses        17.3           26.9 %       22.2           25.6 %       19.1           25.8 %
Impairment charge               5.5            8.6 %        0.5            0.6 %          -              -
Income (loss) from
operations                    (7.7)          -12.0 %        6.5            7.5 %        4.7            6.4 %
Other income                  (0.3)                       (0.3)                       (0.6)
Income (loss) before
provision for
(benefit from) income
taxes                         (7.4)                         6.8                         5.3
Provision for income
taxes                           5.4                         1.1                         1.4
Net income (loss)            (12.8)                         5.7                         3.9
Loss attributable to
non-controlling interest        2.2                         1.8                         0.6
Net income (loss)
attributable to Innodata
Inc. and Subsidiaries      $ (10.6)                    $    7.5                    $    4.5

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.

Direct Operating Costs

Direct operating costs consist of direct payroll, lease rentals and occupancy costs, depreciation and amortization, travel, telecommunications, computer services and supplies, realized gains and losses on settlement of foreign currency forward contracts 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 and incentives, sales and marketing costs, new services research and related software development, professional fees and consultant costs and other administrative overhead costs.

Results of Operations

Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012

Revenues

Total revenues were $64.2 million for the year ended December 31, 2013, a 26% decrease from the $86.6 million for the year ended December 31, 2012. Revenues from the CS segment were $63.1 million and $85.4 million for the years ended December 31, 2013 and 2012, respectively. Revenues from the IADS segment were $1.1 million and $1.2 million for the years ended December 31, 2013 and 2012, respectively.

The $22.3 million decrease in the CS segment is principally attributable to an $18.9 million decline in revenues from e-book related services that we perform for one of our significant clients, partly offset by a $3.4 million increase in revenues from our non-e-book related services. In 2014, we expect that revenues from one of our non-e-book clients will decline by $5.0 million.

Two clients generated approximately 26%, 41% and 30% of our total revenues in the fiscal years ended December 31, 2013, 2012 and 2011, respectively. Another client accounted for 15% of our total revenues for the year ended December 31, 2013, but accounted for less than 10% for the years ended December 31, 2012 and 2011. One other client accounted for 11% of our total revenues for the year ended December 31, 2013 but accounted for less than 10% for the year ended December 31, 2012 and 14% for the year ended December 31, 2011. No other client accounted for 10% or more of total revenues during these periods. Further, in the years ended December 31, 2013, 2012 and 2011, revenues from non-US clients accounted for 35%, 24% and 30%, respectively, of the Company's revenues.

Direct Operating Costs

Direct operating costs were approximately $49.1 million and $57.4 million for the years ended December 31, 2013 and 2012, respectively, a decrease of $8.3 million or approximately 14%. Direct operating costs for the CS segment were $43.9 million and $53.3 million for the years ended December 31, 2013 and 2012, respectively, a decrease of $9.4 million or approximately 18%. Direct operating costs for the IADS segment were approximately $5.2 million and $4.1 million for the respective periods, net of intersegment profits.

Direct operating costs as a percentage of total revenues increased to 76% for the year ended December 31, 2013 compared to 66% for the year ended December 31, 2012. Direct operating costs for the CS segment as a percentage of CS segment revenues were 70% for the year ended December 31, 2013 compared to 62% for the year ended December 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 and fixed costs do not change proportionately to changes in revenues.

Direct operating costs for the IADS segment consist primarily of certain production costs for pilot and other initial engagements, as well as facility overhead costs for our new delivery center in Asia.

As of December 31, 2013, all fixed assets of IADS have been written off. Starting in the fourth quarter of 2013, all capital expenditures incurred for IADS are expensed as direct operating costs.

Impairment Charge

The Synodex subsidiary of our IADS segment has not achieved significant revenue to date and has incurred losses since inception. As a result, in the third quarter of 2013, we evaluated the carrying value of the fixed assets of our Synodex subsidiary compared to its fair value and concluded that that the carrying value exceeds its fair value. This resulted in an impairment charge of $5.5 million for the year ended December 31, 2013.

In the fourth quarter of 2012, we evaluated the carrying value of the fixed assets of our docGenix subsidiary compared to its fair value and concluded that the carrying value exceeds its fair value. This resulted in an impairment charge of $0.5 million for the year ended December 31, 2012.

Selling and Administrative Expenses

Selling and administrative expenses were $17.3 million and $22.2 million for the years ended December 31, 2013 and 2012, respectively, a decrease of $4.9 million, or approximately 22%. Selling and administrative costs for the CS segment were $15.2 million and $19.3 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $2.1 million and $2.9 million, net of intersegment profits.

We restructured our operations over the past few quarters which resulted in cost savings in the second half of 2013. This led to a decline in selling and administrative expenses for the CS segment during the year ended December 31, 2013 compared to the year ended December 31, 2012.

Selling and administrative expenses for the CS segment, as a percentage of CS segment revenues, increased to 24% for the year ended December 31, 2013, from 23% for the year ended 2012, primarily as a result of lower revenues and the fixed component of our selling and administrative expenses. A significant portion of our selling and administrative expenses is fixed in nature.

The decline in selling and administrative expenses for the IADS segment is primarily on account of restructuring our docGenix operations in the fourth quarter of 2012.

Income Taxes

For the year ended December 31, 2013, we recorded a provision for income taxes in accordance with local tax regulations for our foreign subsidiaries. Some of our foreign subsidiaries are subject to tax holidays or preferential tax rates which reduce 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.

The Synodex subsidiary of our IADS segment has not achieved significant revenue to date and has incurred losses since inception. Our U.S. entity incurred losses primarily on account of the losses of Synodex. In assessing the realization of deferred tax assets, we considered whether it is more likely than not that all or some portion of the U.S. deferred tax assets will not be realizable. As the expectation of future taxable income resulting from Synodex cannot be predicted with certainty, we created a valuation allowance against all the U.S. deferred tax assets starting in the third quarter of 2013. As of December 31, 2013, we have a valuation allowance of $8.1 million against all of our U.S. deferred tax assets.

For the year ended December 31, 2012, our U.S. entity recorded a benefit from income tax on account of losses incurred by our U.S. entity. With respect to our foreign subsidiaries, we recorded a provision for income taxes in accordance with the local tax regulations. As some of our foreign subsidiaries are subject to tax holidays or preferential tax rates, our overall effective tax rate was lower 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.

Beginning in 2002, unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements without giving effect to the United States taxes that may be payable on distribution to the United States, because such earnings are not anticipated to be remitted to the United States. If such earnings were to be distributed, we could be subject to United States income taxes that may not be fully offset by foreign tax credits. It is not practicable at this time to determine the amount of unrecognized deferred tax liability related to these earnings.

Pursuant to an income tax audit by the Indian Bureau of Taxation in March 2006, one of our Indian subsidiaries received a tax assessment approximating $263,000, including interest, through December 31, 2013, for the fiscal tax year ended March 31, 2003. We disagree with the basis of the tax assessment and filed an appeal with the Appeal Officer against the assessment. In October 2010, the matter was resolved with a judgment in our favor. Under the Indian Income Tax Act, however, the income tax assessing officer has the right to appeal against the judgment passed by the Appeal Officer. In December 2010, the income tax assessing officer exercised this right, against which we have filed an application to defend the case, and we intend to contest it vigorously. The Indian Bureau of Taxation has also completed an audit of our Indian subsidiary's income tax return for the fiscal tax year ended March 31, 2004. The ultimate outcome was favorable, and there was no tax assessment imposed for the fiscal tax year ended March 31, 2004. In 2008 and 2009, the Indian subsidiary received a final tax assessment for the fiscal years ended March 31, 2005 and 2006 from the Indian Bureau of Taxation. The tax assessment amounted to $285,000 and $290,000, including interest through December 31, 2013, for the fiscal years ended March 31, 2005 and 2006, respectively. We disagree with the basis of these tax assessments, have filed an appeal against the assessments and are contesting them vigorously. In January 2012, the Indian subsidiary received a final tax assessment of approximately $1.0 million, including interest, for the fiscal year ended March 31, 2008, from the Indian Bureau of Taxation. We disagree with the basis of this tax assessment, and have filed an appeal against it. Due to this assessment, we recorded a tax provision amounting to $453,000 including interest through December 31, 2013. Based on recent experience and the current regulatory environment, we believe that the tax provision of $453,000 including interest is adequate. The Indian Bureau of Taxation has also completed an audit of our Indian subsidiary's income tax return for the fiscal tax year ended March 31, 2009. The ultimate outcome was favorable, and there was no tax assessment imposed for the fiscal tax year ended March 31, 2009. The Indian Bureau of Taxation commenced an audit of this subsidiary's income tax return for the fiscal year ended March 31, 2010. The ultimate outcome cannot be determined at this time. As the Company is continually subject to tax audits by the Indian Bureau of Taxation, we continuously assesses the likelihood of an unfavorable assessment for all fiscal years for which the Company has not been audited, and as of December 31, 2013, the Company recorded a tax provision amounting to $1,162,000 including interest.

In January 2013, one of our Philippine subsidiaries received an informal tax assessment from the Internal Revenue Service of the Philippines for an amount totaling $3.8 million for the year ended December 31, 2009. We disagreed with the basis of the informal tax assessment and contested it vigorously. The ultimate outcome was favorable, and, accordingly, we did not record any tax provision.

We had unrecognized tax benefits of $2.5 million and $2.4 million at December 31, 2013 and 2012, respectively. The portion of unrecognized tax benefits relating to interest and penalties was $0.8 million and $0.7 million at December 31, 2013 and 2012, respectively. The unrecognized tax benefits as of December 31, 2013 and 2012, if recognized, would have an impact on our effective tax rate.

We are subject to various tax audits and claims which arise in the ordinary course of business. Management currently believes that the ultimate outcome of these audits and claims will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Net Loss

We generated a net loss of $10.6 million in the year ended December 31, 2013, compared to net income of $7.5 million in the year ended December 31, 2012. The loss is primarily attributable to the $7.1 million valuation allowance referred to in "Income Taxes," the $5.0 million impairment charge referred to in "Impairment Charge," a decline in gross margins of the CS segment resulting from lower revenues offset in part by a decline in selling and administrative expenses, and continuing losses from operations of the IADS segment.

Net income for the CS segment was $1.2 million for the year ended December 31, 2013 compared to $13.8 million for the year ended December 31, 2012. Net loss for the IADS segment was $11.8 million for the year ended December 31, 2013 compared to $6.3 million for the year ended December 31, 2012, net of intersegment profits.

Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Revenues

Total revenues were $86.6 million for the year ended December 31, 2012, a 17% increase from the $73.9 million for the year ended December 31, 2011. Revenues from the CS segment were $85.4 million and $73.9 million for the years ended December 31, 2012 and 2011, respectively. Revenues from the IADS segment were $1.2 million for the year ended December 31, 2012. There were no revenues from the IADS segment for the year ended December 31, 2011.

The $11.5 million increase in the CS segment is principally attributable to higher revenues from e-book related services that we perform for one of our significant clients. We experienced sequential declines in revenue from this client in the last three quarters of 2012.

Our top two clients generated $35 million or 41% and $22.2 million or 30% of our total revenues in the fiscal years ended December 31, 2012 and 2011, respectively. Another client accounted for less than 10% of our total revenues for the year ended December 31, 2012, but for 14% of our total revenues for the year ended December 31, 2011. No other client accounted for 10% or more of revenues during these periods.

Further, in the years ended December 31, 2012 and 2011, revenues from non-U.S. clients accounted for 24% and 30%, respectively, of our total revenues.

Direct Operating Costs

Direct operating costs were approximately $57.4 million and $50.2 million for the years ended December 31, 2012 and 2011, respectively, an increase of $7.2 million or approximately 14%. Direct operating costs for the CS segment were $53.3 million and $49.6 million for the years ended December 31, 2012 and 2011, respectively, an increase of $3.7 million or approximately 7%. Direct operating costs for the IADS segment were approximately $4.1 million and $0.6 million for the respective periods, net of intersegment profits.

The increase in direct operating costs for the CS 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 production costs for initial engagements, increase in production labor costs to perform pilot engagements and facility overhead costs for our new delivery center in Asia.

Direct operating costs as a percentage of total revenues declined to 66% for the year ended December 31, 2012 compared to 68% for the year ended December 31, 2011. Direct operating costs for the CS segment as a percentage of CS segment revenues were approximately 62% for the year ended December 31, 2012, compared to 67% for the year ended December 31, 2011.

Selling and Administrative Expenses

Selling and administrative expenses were $22.2 million and $19.1 million for the years ended December 31, 2012 and 2011, respectively, an increase of $3.1 million, or approximately 16%. Selling and administrative costs for the CS segment were $19.3 million and $17.5 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $2.9 million and $1.6 million, net of intersegment profits.

The increase in selling and administrative expenses for the CS segment for the year ended December 31, 2012 is principally attributable to compensation costs of new hires, wage increases and an increase in other miscellaneous administrative costs. During the year ended December 31, 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 CS segment, as a percentage of CS segment revenues, declined to 23% for the year ended December 31, 2012, from 24% for the year ended 2011, and this was primarily as a result of higher revenues.

The $1.3 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.

Impairment Charge

In the fourth quarter of 2012, we evaluated the carrying value of the fixed assets of our docGenix subsidiary compared to its fair value and concluded that the carrying value exceeds its fair value. This resulted in an impairment charge of $0.5 million.

Restructuring Costs

In the second half 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 $3.0 million per year from this restructuring activity.

Income Taxes

For the year ended December 31, 2012, our U.S. entity recorded a benefit from income tax on account of losses incurred by our U.S. entity. With respect to our foreign subsidiaries, we recorded a provision for income taxes in accordance with the local tax regulations. As some of our foreign subsidiaries are subject to tax holidays or preferential tax rates, our overall effective tax rate was lower 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 year ended December 31, 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, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.

The effective tax rate at 17% was lower for the year ended December 31, 2012 compared to 26% for the year ended December 31, 2011 as the income attributable to our higher tax jurisdictions was lower.

Beginning in 2002, unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements without giving effect to the United States taxes that may be payable on distribution to the United States, because such earnings are not anticipated to be remitted to the United States. If such earnings were to be distributed, we could be subject to United States income taxes that may not be fully offset by foreign tax credits. It is not practicable at this time to determine the amount of unrecognized deferred tax liability related to these earnings.

In assessing the realization of deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realizable. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible and net operating losses are available. We consider many factors when assessing the likelihood of future realization of the deferred tax assets, including our recent cumulative earnings, expectation of future taxable income, the carryforward periods available to us for tax reporting purposes, and other relevant factors. At December 31, 2012 and 2011, we had no valuation allowance on our deferred tax assets.

We had unrecognized tax benefits of $2.4 million and $2.3 million at December 31, 2012 and 2011, respectively. The portion of unrecognized tax benefits relating to interest and penalties was $0.7 million and $0.6 million at December 31, 2012 and 2011, respectively. The unrecognized tax benefits as of December 31, 2012 and 2011, if recognized, would have an impact on our effective tax rate.

We are subject to various tax audits and claims which arise in the ordinary course of business. Management currently believes that the ultimate outcome of these audits and claims will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Net Income

We generated net income of $7.5 million in the year ended December 31, 2012 compared to $4.5 million in the year ended December 31, 2011. Net income for the CS segment was $13.8 million for the year ended December 31, 2012 compared to $6.7 million for the year ended December 31, 2011. The significant increase in net income for the CS 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 compensation costs of new hires, wage increases and an increase in other administrative costs. A lower provision for income taxes and higher losses attributable to non-controlling interests in the year ended December 31, 2012 compared to year ended December 31, 2011 also contributed to an increase in net income. Net loss for the IADS segment was $6.3 million for the year ended December 31, 2012 compared to $2.2 million for the year ended December 31, 2011, net of intersegment profits. The increase in net loss was principally on account of new personnel hired for operations, and sales and marketing, increase in facility overhead costs and other administrative costs, and a $0.5 million impairment charge for our docGenix subsidiary.

Liquidity and Capital Resources

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

                                     December 31,
                              2013       2012       2011

Cash and cash equivalents   $ 24,752   $ 25,425   $ 11,389
Short term investments             -      3,091      5,828
Working capital               28,844     32,784     28,148

At December 31, 2013 we had cash and cash equivalents of $24.8 million, of which $22.6 million was held by our foreign subsidiaries and the $2.2 million balance was held in the United States. If needed, amounts held by foreign subsidiaries could be repatriated to the United States to satisfy working capital needs of the U.S. entity, but under current law, would be subject to United States federal income taxes. As of December 31, 2013, our intent is to permanently reinvest these funds outside the United States.

We have used, and plan to use, such cash for (i) investments in IADS, which in 2013 aggregated approximately $7.2 million, net of revenues, and are expected to be at the rate of $1.5 million to $2.0 million per quarter in the immediate future, (ii) the expansion of our other operations; (iii) general corporate purposes, including working capital; and (iv) possible business acquisitions. As of December 31, 2013, we had working capital of approximately $28.8 million compared to working capital of approximately $32.8 million at December 31, 2012.

We have a $15.0 million uncommitted bank line that expires in June 2014 which provides that at the bank's discretion we may on a secured basis borrow amounts equal to up to 80% of our eligible accounts receivable at the bank's alternate base interest rate plus 0.5% or LIBOR plus 2.5%. At December 31, 2013, 80% of our eligible receivables aggregated approximately $5.5 million. We have not made any borrowings under this line. In February 2014, the bank advised that it did not intend to make any advances or extensions of credit or other financial accommodations under the line, and that it would not consider permitting advances in the future unless and until it has received from us designated financial and business information in form and substance satisfactory to the bank.

In March 2014 we borrowed $0.9 million in a three year sale leaseback transaction at an effective interest rate of 3%.

We believe that our existing cash and cash equivalents and internally generated funds will provide sufficient sources of liquidity to satisfy our financial needs for the next 12 months. However, we may curtail our continuing investments in our IADS segment if these funds are insufficient and outside financing is not available on terms we find attractive.

In the second quarter of 2012, we filed a shelf registration statement . . .

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