SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September, 30, 2003
/_/ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
COMMISSION FILE NUMBER 0-22196
INNODATA CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 13-3475943
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
THREE UNIVERSITY PLAZA
HACKENSACK, NEW JERSEY 07601
(Address of principal executive offices) (Zip Code)
(201) 488-1200
(Registrant's telephone number)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceeding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No /_/
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes /_/ No /X/
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
21,670,000 SHARES OF COMMON STOCK, $.01 PAR VALUE, AS OF OCTOBER 31, 2003.
PART I. FINANCIAL INFORMATION
- ------- ---------------------
Item 1. Financial Statements
See pages 2-11
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
See pages 12-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
See pages 19-20
Item 4. Controls and Procedures
-----------------------
See page 20
PART ll. OTHER INFORMATION
- -------- -----------------
See page 21
1
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2003 2002
-------- --------
Unaudited Derived from
audited
financial
statements
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 5,766 $ 7,255
Cash and equivalents - restricted 1,000 --
Accounts receivable-net 7,198 3,253
Refundable income taxes 1,075 1,491
Prepaid expenses and other current assets 1,238 706
Deferred income taxes 1,570 1,501
-------- --------
Total current assets 17,847 14,206
PROPERTY AND EQUIPMENT - NET 6,140 6,707
OTHER ASSETS 853 1,109
GOODWILL 675 675
-------- --------
TOTAL $ 25,515 $ 22,697
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term borrowings $ 1,000 $ --
Accounts payable and accrued expenses 2,982 2,655
Accrued salaries and wages 3,074 2,526
Income and other taxes 583 455
Current portion of capital lease obligations 146 --
-------- --------
Total current liabilities 7,785 5,636
-------- --------
DEFERRED INCOME TAXES PAYABLE 1,372 1,492
-------- --------
OBLIGATIONS UNDER CAPITAL LEASE 307 --
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized 75,000,000 shares;
issued, 22,295,000 and 22,046,000 shares at September 30, 2003
and December 31, 2002, respectively. 223 220
Additional paid-in capital 14,869 14,084
Retained earnings 3,005 3,264
-------- --------
18,097 17,568
Less: treasury stock - at cost; 645,000 and 610,000 shares at
September 30, 2003 and December 31, 2002 respectively (2,046) (1,999)
-------- --------
Total stockholders' equity 16,051 15,569
-------- --------
TOTAL $ 25,515 $ 22,697
======== ========
See notes to unaudited condensed consolidated financial statements
2
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
- --------------------------------------------------------------------------------
2003 2002
-------- --------
REVENUES $ 11,184 $ 7,278
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 7,225 7,124
Selling and administrative expenses 2,002 2,740
Interest income - net (4) (13)
-------- --------
Total 9,223 9,851
-------- --------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM)
INCOME TAXES 1,961 (2,573)
PROVISION FOR (BENEFIT FROM) INCOME TAXES 471 (52)
-------- --------
NET INCOME (LOSS) $ 1,490 $ (2,521)
======== ========
BASIC INCOME (LOSS) PER SHARE $ .07 $ (.12)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 21,593 21,733
======== ========
DILUTED INCOME (LOSS) PER SHARE $ .06 $ (.12)
======== ========
ADJUSTED DILUTIVE SHARES OUTSTANDING 23,225 21,733
======== ========
See notes to unaudited condensed consolidated financial statements
3
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
- --------------------------------------------------------------------------------
2003 2002
-------- --------
REVENUES $ 25,893 $ 30,223
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 19,458 25,668
Selling and administrative expenses 6,561 7,810
Interest income - net (19) (34)
-------- --------
Total 26,000 33,444
-------- --------
LOSS BEFORE PROVISION FOR (BENEFIT FROM) INCOME
INCOME TAXES (107) (3,221)
PROVISION FOR (BENEFIT FROM) INCOME TAXES 152 (44)
-------- --------
NET LOSS $ (259) $ (3,177)
======== ========
BASIC LOSS PER SHARE $ (.01) $ (.15)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 21,499 21,589
======== ========
DILUTED LOSS PER SHARE $ (.01) $ (.15)
======== ========
ADJUSTED DILUTIVE SHARES OUTSTANDING 21,499 21,589
======== ========
See notes to unaudited condensed consolidated financial statements
4
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS)
(Unaudited)
- --------------------------------------------------------------------------------
2003 2002
------- -------
OPERATING ACTIVITIES:
Net loss $ (259) $(3,177)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 3,325 4,050
Non-cash compensation 650 523
Tax benefit from exercise of stock options 3 110
Deferred income taxes (189) 237
Changes in operating assets and liabilities:
Accounts receivable (3,945) 4,312
Refundable income taxes 416 --
Prepaid expenses and other current assets (988) (1,206)
Other assets 206 947
Accounts payable and accrued expenses 327 (657)
Accrued salaries and wages 548 (706)
Income and other taxes 128 (464)
------- -------
Net cash provided by operating activities 222 3,969
------- -------
INVESTING ACTIVITIES:
Increase in restricted cash (1,000) --
Capital expenditures (1,785) (609)
------- -------
(2,785) (609)
------- -------
FINANCING ACTIVITIES:
Short term borrowings 1,000 --
Payment of obligations under capital lease (14) --
Payment of acquisition notes -- (650)
Purchase of treasury stock -- (270)
Proceeds from exercise of stock options 88 80
------- -------
Net cash provided by (used in) financing activities 1,074 (840)
------- -------
(DECREASE) INCREASE IN CASH (1,489) 2,520
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 7,255 6,267
------- -------
CASH AND EQUIVALENTS, END OF PERIOD $ 5,766 $ 8,787
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 2 $ 29
======= =======
Income taxes $ 23 $ 224
======= =======
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property and equipment utilizing capital leases $ 467 $ --
======= =======
See notes to unaudited condensed consolidated financial statements
5
INNODATA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(Unaudited)
- --------------------------------------------------------------------------------
1. Innodata Corporation and subsidiaries (the "Company") is a provider of
digital asset services and solutions. Innodata delivers content
manufacturing / outsourcing, XML transformation, and XML (and related
standards-based) systems engineering and training through offices located
both in the U.S. and Asia. The consolidated financial statements include
the accounts of the Company and its subsidiaries, all of which are wholly
owned. All intercompany transactions and balances have been eliminated in
consolidation. In the third quarter 2003, the Company began doing business
as Innodata Isogen.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of
only normal recurring accruals) necessary to present fairly the financial
position as of September 30, 2003, the results of operations for the three
and nine months ended September 30, 2003 and 2002, and the cash flows for
the nine months ended September 30, 2003 and 2002. The results of
operations for the nine months ended September 30, 2003 are not necessarily
indicative of results that may be expected for any other interim period or
for the full year.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 2002 included
in the Company's Annual Report on Form 10-K. The accounting policies used
in preparing these financial statements are the same as those described in
the December 31, 2002 financial statements.
2. An analysis of the changes in each caption of stockholders' equity for the
nine months ended September 30, 2003 (in thousands) is as follows.
ADDITIONAL
COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
------ ------ ---------- -------- --------- -----
JANUARY 1, 2003 22,046 $ 220 $ 14,084 $ 3,264 $ (1,999) $ 15,569
Net loss -- -- -- (259) -- (259)
Issuance of common stock
upon exercise of stock options 249 3 132 -- (47) 88
Tax benefit from exercise
of options -- -- 3 -- -- 3
Non-cash compensation -- -- 650 -- -- 650
------- ------- -------- -------- -------- --------
SEPTEMBER 30, 2003 22,295 $ 223 $ 14,869 $ 3,005 $ (2,046) $ 16,051
======= ======= ======== ======== ======== ========
6
3. Basic income (loss) per share is based on the weighted average number of
common shares outstanding without consideration of potential common stock.
Diluted income per share is based on the weighted average number of common
and potential common shares outstanding. The difference between weighted
average common shares outstanding and adjusted dilutive shares outstanding
represents the dilutive effect of outstanding options.
Diluted net loss per share does not include potential common shares derived
from stock options because they are antidilutive. The number of
antidilutive securities excluded from the dilutable loss per share
calculation were 1,172,000 for the three months ended September 30, 2002,
and 999,000 and 1,821,000 for the nine months ended September 30, 2003 and
2002, respectively.
The basis of the earnings per share computation for the three and nine
months ended September 30, 2003 and 2002 (in thousands, except per share
amounts) is as follows:
THREE MONTHS NINE MONTHS
------------ -----------
2003 2002 2003 2002
-------- -------- ------- --------
Net income (loss) $ 1,490 $ (2,521) $ (259) $ (3,177)
======== ======== ======= ========
Weighted average common shares outstanding 21,593 21,733 21,499 21,589
Dilutive effect of outstanding options 1,632 -- -- --
-------- -------- ------- --------
Adjusted for dilutive computation 23,225 21,733 21,499 21,589
======== ======== ======= ========
Basic income (loss) per share $ .07 $ (.12) $ (.01) $ (.15)
======== ======== ======= ========
Diluted income (loss) per share $ .06 $ (.12) $ (.01) $ (.15)
======== ======== ======= ========
4. The Company has various stock-based employee compensation plans, which it
accounts for under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. In general, no stock-based employee compensation cost is
reflected in the results of operations, unless options granted under such
plans have an exercise price less than the market value of the underlying
common stock on the date of grant. The following table illustrates the
effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS, EXCEPT (IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS) PER SHARE AMOUNTS)
Net income (loss) as reported $ 1,490 $ (2,521) $ (259) $ (3,177)
Deduct: Total stock-based employee
compensation determined under fair value
based method, net of related tax effects (607) (939) (2,753) (2,158)
Add: Compensation expense included in
the determination of net income as
reported, net of related tax effects,
related to the extension of stock options -- 318 455 318
--------- --------- --------- ---------
7
Pro forma net loss $ 883 $ (3,142) $ (2,557) $ (5,017)
========= ========= ========= =========
Income (loss) per share:
Basic - as reported $ .07 $ (.12) $ (.01) $ (.15)
========= ========= ========= =========
Basic - pro forma $ .04 $ (.14) $ (.12) $ (.23)
========= ========= ========= =========
Diluted - as reported $ .06 $ (.12) $ (.01) $ (.15)
========= ========= ========= =========
Diluted - pro forma $ .04 $ (.14) $ (.12) $ (.23)
========= ========= ========= =========
5. The Company's operations are classified into two reporting segments: (1)
content services and (2) systems integration and training. The content
services operating segment aggregates, converts, tags and editorially
enhances digital content and performs XML transformations. The Company
offers such services as a comprehensive outsourcing solution and
individually as discrete activities. The Company's systems integration and
training operating segment offers system design, custom application
development, consulting services, and systems integration conforming to XML
and related standards and provides a broad range of introductory as well as
advanced curricula and training on XML and other knowledge management
standards.
THREE MONTHS NINE MONTHS
------------ -----------
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS) (IN THOUSANDS)
Revenues
- --------
Content services $ 9,128 $ 6,969 $ 21,489 $ 27,568
Systems and training services 2,056 309 4,404 2,655
-------- -------- -------- --------
Total consolidated $ 11,184 $ 7,278 $ 25,893 $ 30,223
======== ======== ======== ========
Income (loss) before income taxes (a)
- -------------------------------------
Content services $ 1,224 $ (1,339) $ (744) $ (1,252)
Systems and training services 737 (1,234) 637 (1,969)
-------- -------- -------- --------
Total consolidated $ 1,961 $ 2,573 $ (107) $ (3,221)
======== ======== ======== ========
SEPTEMBER 30, DECEMBER 31,
------------- ------------
2003 2002
---- ----
(IN THOUSANDS)
Total assets
- ------------
Content services $22,178 $20,721
Systems and training services 3,337 1,976
------- -------
Total consolidated $25,515 $22,697
======= =======
(a) In 2002, corporate overhead was not allocated to the systems and training
services segment. In 2003, corporate overhead has been allocated to the systems
and training services segment based upon a percentage of consolidated sales. For
comparative purposes, income before income taxes for the three and nine months
ended September 30, 2002 has been reclassified to allocate corporate overhead
using a method consistent with 2003.
8
6. Restricted cash at September 30, 2003 represents a 90 day certificate of
deposit, which collateralizes a $1 million bank line of credit.
7. The Company has a $1 million line of credit with a bank, which, is secured
by a $1 million certificate of deposit. Interest is charged at the bank's
alternate base rate (4% at September 30, 2003). The line expires on May
31, 2004. At September 30, 2003 the company borrowed $1,000,000 against
the line which was repaid in full in October 2003.
8. During the three months ended September 30, 2003, the Company entered into
a three year lease for certain equipment located in one of its Philippine
facilities. The equipment was capitalized at its fair market value of
approximately $641,000, which represented the present value of the minimum
lease payments plus trade-in value of exchanged equipment of $175,000. The
loss on such trade-in approximated $58,000.
Pursuant to the capital lease obligation, annual payments approximate
$171,000, including imputed interest at 7% per annum. In addition, the
lease contains a one dollar purchase option at the end of the lease term.
9. In the second quarter 2003, the Company extended the expiration date of
options granted to certain officers, directors and employees,
substantially all of which were vested, to purchase 315,000, 566,000,
522,000 and 133,000 shares of its common stock at $.47, $.50, $.67 and
$2.00, respectively. In connection with the extension, the option holders
agreed not to sell shares of stock acquired upon exercise of the extended
options for designated periods of time ending between June 2004 to March
2005. In connection with this transaction, compensation expense of
approximately $650,000 was recorded in the second quarter of 2003 based
upon the difference between the exercise price and the market price of the
underlying common stock on the date the options were extended.
Compensation expense is included as a component of selling and
administrative expenses.
In the third quarter 2002, the Company extended the expiration date of
options to the Chief Executive Officer to purchase 6,672, 248,496,
360,000, 399,996 and 123,996 shares of its common stock at $.42, $.50,
$.58, $1.29 and $.25, per share, respectively. In connection with this
transaction, compensation expense of approximately $513,000 was recorded
in the third quarter as selling and administrative expenses.
During the nine months ended September 30, 2002, the Company granted
options to an officer, to purchase 153,750 shares of its common stock at
$4.00 per share; and to employees, to purchase 3,000 shares of its common
stock at $4.60 per share and 4,000 shares of its common stock at $3.75 per
share. In addition, the Company issued 11,587 shares of its common stock
pursuant to an employment agreement with an officer of the Company.
Compensation expense of approximately $10,000 was recorded in the third
quarter of 2002 as selling and administrative expenses.
9
10. In the three months ended September 30, 2003, the provision for income
taxes as a percentage of income before income taxes was 24%, which is
lower than the U.S. Federal statutory rate principally due to certain
overseas income that will not be taxed unless repatriated due to tax
holidays granted to the Company. In the nine months ended September 30,
2003, the provision for income taxes is primarily a result of taxable
income attributable to certain expenses not deductible for income tax
purposes, and to the taxability of income in certain state and foreign tax
jurisdictions. In the three and nine months ended September 30, 2002, the
income tax benefit was substantially lower as a percentage of the loss
before income taxes than the U.S. Federal statutory rate, principally due
to a non-cash compensation charge of approximately $500,000, which is not
deductible for income tax purposes, and to losses attributable to certain
overseas subsidiaries not subject to income taxes.
11. In connection with the cessation of all operations at certain foreign
subsidiaries, certain former employees have filed various illegal
dismissal actions in the Philippines seeking, among other remedies,
reinstatement of employment, payment of back wages and damages
approximating one million dollars. Outside counsel has advised management
that under the circumstances, the Company is not legally obligated to pay
severance to such terminated employees. Based upon the advice of counsel,
management believes the actions are substantially without merit and
intends to defend the actions vigorously.
In addition, one of the foreign subsidiaries which ceased operations has
been presented with a tentative tax assessment by the Philippine Bureau of
Internal Revenue for an amount approximating $400,000, plus applicable
interest and penalties. Management believes the tentative assessment is
principally without substance and any amounts that might ultimately be
paid in settlement (which is not expected to be material) have been
accrued.
In addition, the Company is subject to various legal proceedings and
claims which arise in the ordinary course of business.
While management currently believes that the ultimate outcome of all these
proceedings will not have a material adverse effect on the Company's
financial position or overall trends in results of operations, litigation
is subject to inherent uncertainties. Were an unfavorable ruling to occur,
there exists the possibility of a material adverse impact on the operating
results of the period in which the ruling occurs. In addition, the
estimate of potential impact on the Company's financial position or
overall results of operations for the above legal proceedings could change
in the future.
12. The Company's production facilities are located in the Philippines, India
and Sri Lanka. To the extent that the currencies of these countries
fluctuate, the Company is subject to risks of changing costs of production
after pricing is established for certain customer projects. However, most
significant contracts contain provisions for price renegotiation.
13. The Company is obligated under certain circumstances to indemnify
directors and certain officers against costs and liabilities incurred in
actions or threatened actions
10
brought against such individual because such individual acted in the
capacity of director and/or officer of the Company. In addition, the
Company has contracts with certain clients pursuant to which the Company
has agreed to indemnify the client for certain specified and limited
claims. These indemnification obligations are in the ordinary course of
business and, in many cases, do not include a limit on maximum potential
future payments. As of September 30, 2003, the Company does not have a
liability for any obligations arising as a result of these
indemnifications.
14. In connection with the procurement of tax incentives at one of the
company's foreign subsidiaries, the foreign zoning authority was granted a
first lien on the subsidiary's property and equipment. As of September 30,
2003, such equipment had a book value of approximately $611,000.
15. In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Guarantees of Indebtedness of Others (FIN 45).
FIN 45 elaborates on the disclosures to be made by a guarantor in its
financial statements about its obligations under certain agreements and
warranties it has issued. It also requires the guarantor to recognize, at
the inception of the guarantee, a liability for the fair value of an
obligation undertaken in issuing the guarantee. The recognition
requirements are effective for guarantees initiated after December 31,
2002. The adoption of the fair value provisions of FIN 45 did not have an
impact on the Company's consolidated financial statements as there were no
guarantees or modifications of guarantees for the nine months ended
September 30, 2003.
16. In January, 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 provides guidance for
identifying a controlling interest in a Variable Interest Entity (VIE)
established by means other than voting interests. FIN 46 also requires
consolidation of a VIE by an enterprise that holds such controlling
interest. Companies are required to adopt the provisions of FIN 46 for any
variable interest entity created prior to February 1, 2003, by the end of
the current fiscal year. Based on management's review of FIN 46,
management believes the Company has no interests qualifying as VIEs and
does not anticipate that the provisions of FIN 46 will have any near term
impact on its consolidated financial statements.
17. In May, 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 established standards for how an issuer
classifies and measures certain financial instruments with characteristics
of both liabilities and equity. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective beginning in the third quarter of 2003. The adoption of SFAS No.
150 does not have an impact on the Company's consolidated financial
statements and management does not anticipate SFAS No. 150 will have any
near term impact on its consolidated financial statements.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE COMPANY
Disclosures in this Form 10-Q contain certain forward-looking
statements, including without limitation, statements concerning the Company's
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 "intend", "believe,"
"expect," "anticipate" and other similar expressions generally identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates.
These forward-looking statements are based largely on the Company's
current expectations, and are subject to a number of risks and uncertainties,
including without limitation, continuation or worsening of present depressed
market conditions, changes in external market factors, the ability and
willingness of the Company's 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, potential undiscovered liabilities of companies
that the Company acquires, changes in the Company's 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 the Company's filings with the Securities and Exchange Commission.
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 in fact occur. We make no commitment
to revise or update any forward-looking statements in order to reflect events or
circumstances after the date any such statement is made.
THE COMPANY
Innodata Corporation ("Innodata" or the "Company") is a leading
provider of digital content outsourcing services. It delivers content
manufacturing and XML- related digital asset services to online information
providers and companies in the telecommunications, technology, healthcare,
defense, and Internet commerce sectors. It has over 100 active clients,
including Amazon.com, Dow Jones & Company, Lockheed Martin Corporation, ProQuest
Company, Reed Elsevier, Reuters, Simon & Schuster, The Thomson Corporation, and
Wolters Kluwer.
The Company operates through three divisions. Its Content Division
aggregates, converts, tags and editorially enhances digital content - services
the Company refers to collectively as "content manufacturing" services. The
Company offers content manufacturing services as a comprehensive outsourcing
solution and individually as discrete
12
activities. The Content Division also transforms data to Extensible Markup
Language (XML). The Company's Systems Division offers system design, custom
application development, consulting services, and systems integration conforming
to XML and related standards. The Company's Training Division provides a broad
range of introductory as well as advanced curricula and training on XML and
other knowledge management standards.
For financial reporting purposes, the Company's operations have been
classified into two reporting segments: (1) content services and (2) systems
integration and training. The results of the Training Division, which are below
the level required for reporting as a separate segment, have been combined with
the results of the Systems Division due to the nature of services provided.
In the third quarter 2003, the Company began doing business as Innodata
Isogen.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Revenues increased 54% to $11,184,000 for the three months ended
September 30, 2003 compared to $7,278,000 for the similar period in 2002.
Revenues from the content services segment increased 31% to $9,128,000 for the
three months ended September 30, 2003 compared to $6,969,000 for the similar
period in 2002. The increase principally reflected approximately $1.7 million of
revenues received in the third quarter of 2003 from a short duration project for
an ongoing client. The project was substantially completed in the third quarter
2003. In addition, revenues from a second client increased approximately $2.5
million, offsetting the decline in content services segment revenues of
approximately $2.1 million from a client whose largest project was substantially
completed in 2002.
Revenues from the Company's systems and training segment were
$2,056,000 for the three months ended September 30, 2003 and $309,000 for the
similar period in 2002. The increase was principally attributable to an increase
in the quantity and size of system integration projects booked in 2003. In
addition, revenues for the three months ended September 30, 2003 included
approximately $800,000 from a systems integration project sold to a content
services client. For the three months ended September 30, 2003, two clients
accounted for approximately 60% of systems and training segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 37% and 20% of the Company's revenues for the three months ended
September 30, 2003 and 2002, respectively. A second client accounted for 15% of
the Company's revenues for the three months ended September 30, 2003. In
addition, one other client, whose largest project was substantially completed in
2002, accounted for 29% of the Company's revenues in the three months ended
September 30, 2002. Further, in the three months ended September 30, 2003 and
2002, revenues from clients located in foreign countries (principally Europe),
accounted for 42% and 28%, respectively, of the Company's revenues.
13
Direct operating expenses were $7,225,000 and $7,124,000 for the three
months ended September 30, 2003 and 2002, respectively, an increase of 1%.
Direct operating expenses as a percentage of revenues were 65% in 2003 and 98%
in 2002. Direct operating expenses for the content services segment were
$6,260,000 and $6,115,000 in the three months ended September 30, 2003 and 2002,
respectively, an increase of 2%. Direct operating expenses as a percentage of
revenues for the content services segment were 69% and 88% in the three months
ended September 30, 2003 and 2002, respectively. The decrease as a percent of
sales for the content services segment in the 2003 period was principally due to
the reductions in fixed costs associated with the Company's cost reduction
initiatives, and to higher revenues without a corresponding increase in direct
operating costs. Direct operating expenses primarily include direct payroll,
telecommunications, depreciation, computer services, supplies and occupancy.
Direct operating expenses for the Company's systems and training
segment were $965,000 and $1,009,000 for the three months ended September 30,
2003 and 2002, respectively, a decrease of 4%. Direct operating expenses as a
percent of revenues for the Company's systems and training segment were 47% and
327% in the three months ended September 30, 2003 and 2002, respectively. The
dollar decrease in the 2003 period was principally due to a reduction in labor
costs associated with the Company's cost reduction initiatives. The decrease as
a percent of revenues for the systems and training segment was primarily
attributable to the cost reduction initiatives described above coupled with the
increase in revenues.
Selling and administrative expenses were $2,002,000 and $2,740,000 for
the three months ended September 30, 2003 and 2002, respectively. Selling and
administrative expenses for the three months ended September 30, 2002 include a
non-cash compensation charge of approximately $513,000 (described in the notes
to the Condensed Consolidated Financial Statements). Excluding this charge,
overall selling and administrative expenses for the three months ended September
30, 2003 would have decreased by approximately $215,000 or 10% from the similar
period in 2002. This decrease was primarily attributable to the Company's cost
reduction initiatives. Selling and administrative expenses primarily include
management and administrative salaries, sales, marketing cost, and
administrative overhead.
Selling and administrative expenses for the content services segment
were $1,649,000 and $2,336,000 for the three months ended September 30, 2003 and
2002, respectively, a decrease of 29%. The reasons for the decline are described
above. Selling and administrative expenses as a percentage of revenues for the
content services segment decreased to 18% in the 2003 period compared to 34% in
the 2002 period. Excluding the non-cash compensation charge in 2002 described
above, selling and administrative expenses as a percentage of revenues for the
content services segment would have been 26% in the 2002 period compared to 18%
in the 2003 period. This decrease as a percent of sales was primarily
attributable to an increase in sales without a corresponding increase in selling
and administrative costs and to the cost reduction initiatives previously
described.
14
Selling and administrative expenses for the Company's systems and
training segment were $353,000 and $404,000 for the three months ended September
30, 2003 and 2002 respectively, a decrease of 13%. Selling and administrative
expenses as a percentage of revenues for the systems and training segment
decreased to 17% from 131% in the 2002 period. The decrease as a percent of
sales was primarily attributable to an increase in sales.
In the three months ended September 30, 2003, the provision for income
taxes as a percentage of income before income taxes was 24%, which is lower than
the U.S. Federal statutory tax rate principally due to certain overseas income
that will not be taxed unless repatriated due to tax holidays granted to the
Company. In the three months ended September 30, 2002 the income tax benefit was
substantially lower as a percentage of the loss before income taxes than the
U.S. Federal statutory tax rate, principally due to a non-cash compensation
charge of approximately $500,000, which is not deductible for income tax
purposes, and to losses attributable to certain overseas subsidiaries not
subject to income taxes.
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Revenues decreased 14% to $25,893,000 for the nine months ended
September 30, 2003 compared to $30,223,000 for the similar period in 2002.
Revenues from the content services segment decreased 22% to $21,490,000 for the
nine months ended September 30, 2003 compared to $27,568,000 for the similar
period in 2002. The decrease principally reflects the decline in revenues of
approximately $13 million from two clients whose largest projects were
substantially completed in 2002. The shortfall was replaced in part by increased
revenue from two other clients totaling approximately $7 million.
Revenues from the Company's systems and training segment were
$4,403,000 for the nine months ended September 30, 2003 and $2,655,000 for the
similar period in 2002. The increase was principally attributable to an increase
in the quantity and size of system integration projects booked in 2003. For the
nine months ended September 30, 2003, projects for two clients accounted for
approximately 50% of systems and training segment revenues; in the similar
period in 2002, two clients (one of which generated no revenues in 2003)
accounted for approximately 63% of systems and training segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 36% and 13% of the Company's revenues for the nine months ended
September 30, 2003 and 2002, respectively. Two other clients, whose largest
projects were substantially completed in 2002, accounted for 35% and 13% of the
Company's revenues in the nine months ended September 30, 2002. Further, in the
nine months ended September 30, 2003 and 2002, revenues from clients located in
foreign countries (principally Europe), accounted for 43% and 20%, respectively,
of the Company's revenues.
Direct operating expenses were $19,458,000 and $25,668,000 for the nine
months ended September 30, 2003 and 2002, respectively, a decrease of 24%.
Direct operating expenses as a percentage of revenues were 75% in 2003 and 85%
in 2002. Direct operating expenses for the content services segment were
$16,847,000 and $22,553,000 in the nine months ended September 30, 2003 and
15
2002, respectively, a decrease of 25%. Direct operating expenses as a percentage
of revenues for the content services segment were 78% and 82% in the nine months
ended September 30, 2003 and 2002, respectively. The dollar decrease for the
content services segment in the 2003 period was principally due to a reduction
in labor costs associated with lower revenues, and to reductions in fixed costs
associated with the Company's cost reduction initiatives. The percentage
decrease for the content services segment was primarily attributable to the
reductions in fixed costs described above. Direct operating expenses primarily
include direct payroll, telecommunications, depreciation, computer services,
supplies and occupancy.
Direct operating expenses for the Company's systems and training
segment were $2,611,000 and $3,115,000 for the nine months ended September 30,
2003 and 2002, respectively, a decrease of 16%. Direct operating expenses as a
percent of revenues for the Company's systems and training segment were 59% and
117% in the nine months ended September 30, 2003 and 2002, respectively. The
dollar decrease in the 2003 period were principally due to a reduction in labor
costs associated with the company's cost reduction initiatives that were
implemented during the second half of 2002. The decrease as a percent of the
systems and training segment was primarily attributable to the cost reductions
described above and the increase in revenues.
Selling and administrative expenses were $6,561,000 and $7,810,000 for
the nine months ended September 30, 2003 and 2002, respectively, a decrease of
16%. This decrease was primarily attributable to our previously described cost
reduction initiatives. Selling and administrative expenses as a percentage of
revenues were 25% and 26% in the 2003 and 2002 periods, respectively.
Selling and administrative expenses for the content services segment
were $5,407,000 and $6,576,000 for the nine months ended September 30, 2003 and
2002, respectively, a decrease of 18%. The reasons for the decline are described
above. Selling and administrative expenses as a percentage of revenues for the
content services segment increased to 25% in the 2003 period from 24% in the
2002 period.
Selling and administrative expenses for the systems and training
segment were $1,154,000, or 26% of revenues, in the nine months ended September
30, 2003 compared to $1,234,000, or 46% of revenues, for nine months ended
September 30, 2002. The percentage decrease is primarily due to an increase in
revenue without a corresponding increase in selling and administrative expenses.
In the nine months ended September 30, 2003, the provision for income
taxes is primarily a result of taxable income attributable to certain expenses
not deductible for income tax purposes, and to the taxability of income in
certain state and foreign tax jurisdictions. In the nine months ended September
30, 2002, the income tax benefit was substantially lower as a percentage of the
loss before income taxes than the U.S. Federal statutory tax rate, principally
due to a non-cash compensation charge of approximately $500,000, which is not
deductible for income tax purposes, and to losses attributable to certain
overseas subsidiaries not subject to income taxes.
16
LIQUIDITY AND CAPITAL RESOURCES
Selected measures of liquidity and capital resources are as follows:
September 30, 2003 December 31, 2002
------------------ -----------------
Cash and Cash Equivalents $ 5,766,000 $7,255,000
Working Capital $10,062,000 $8,570,000
Stockholders' Equity Per Common Share* $.74 $.73
*Represents total stockholders' equity divided by the actual number of
common shares outstanding (which excludes treasury stock).
Net Cash Provided By Operating Activities
-----------------------------------------
Net cash provided by operating activities was $222,000 in the nine
months ended September 30, 2003 compared to $3,969,000 provided by operating
activities for the nine months ended September 30, 2002, a decrease of
approximately $3.7 million. The decrease was primarily due to a $5.5 million net
increase in operating assets and liabilities and a decrease in non-cash charges
of approximately $1.1 million, partially offset by a decrease of $2.9 million in
the net loss. The $5.5 million net increase in operating assets and liabilities
was principally comprised of an $8.3 million increase in accounts receivable net
of a $3.5 million increase in accounts payable and accrued expenses.
Accounts receivable totaled $7,198,000 at September 30, 2003,
representing approximately 62 days of sales outstanding, compared to $3,253,000,
or 52 days, at December 31, 2002. The increase in accounts receivable resulted
principally from an 81% increase in revenues in the three months ended September
30, 2003, as compared to the three months ended December 31, 2002. The increase
in amount and in days sales outstanding is also attributable to a significant
accounts receivable balance from one client, most of which was subsequently
collected.
A significant amount of the Company's revenues are derived from clients
in the publishing industry. Accordingly, the Company's accounts receivable
generally include significant amounts due from such clients. In addition, as of
September 30, 2003, approximately 58% of the Company's accounts receivable was
from foreign (principally European) clients, and approximately 50% of accounts
receivable was due from one client.
Net Cash Used in Investing Activities
-------------------------------------
During the nine months ended September 30, 2003, the Company spent
approximately $1,785,000 for capital expenditures, compared to approximately
$609,000 in the nine months ended September 30, 2002. During the next 12 months,
the Company anticipates modest increases in capital spending levels. Such 2003
past and anticipated capital spending relates to project requirement specific
equipment for certain new projects, normal ongoing equipment upgrades and
replacement, and costs related to the purchase and implementation of new
management information systems.
17
Availability of Funds
---------------------
The Company replaced its expired line of credit with a $1 million bank
line of credit which is secured by a $1 million certificate of deposit. Interest
is charged at the bank's alternate base rate. The line expires on May 31, 2004.
At September 30, 2003 the company borrowed $1,000,000 against the line. The loan
was repaid in full in October 2003.
Management believes that existing cash and internally generated funds
will be sufficient for reasonably anticipated working capital and capital
expenditure requirements during the next 12 months. The Company funds its
foreign expenditures from its U.S. corporate headquarters on an as-needed basis.
INFLATION, SEASONALITY AND PREVAILING ECONOMIC CONDITIONS
To date, inflation has not had a significant impact on the Company's
operations. The Company generally performs its work for its clients under
project-specific contracts, requirements-based contracts or long-term contracts.
Contracts are typically subject to numerous termination provisions. The
Company's revenues are not significantly affected by seasonality.
CRITICAL ACCOUNTING POLICIES
Basis of Presentation and Use of Estimates
------------------------------------------
Management's discussion and analysis of its results of operations and
financial condition is based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to accounts receivable.
Management bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Allowance for Doubtful Accounts
-------------------------------
The Company records an allowance for doubtful accounts for estimated
losses resulting from the inability of its clients to make required payments. If
the financial condition of the Company's clients were to deteriorate, resulting
in an impairment of their ability to make payments, additional allowances may be
necessary.
Revenue Recognition
-------------------
Revenue is recognized in the period in which services are performed and
delivered.
18
Depreciation
------------
Depreciation is provided on the straight-line method over the estimated
useful lives of the related assets, which is two to five years. Leasehold
improvements are amortized on a straight-line basis over the shorter of their
estimated useful lives or the lives of the leases.
Income Taxes
------------
Deferred taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities, using enacted tax
rates, as well as any net operating loss or tax credit carryforwards expected to
reduce taxes payable in future years. A valuation allowance is provided when it
is more likely than not that some or all of a deferred tax asset will not be
realized. 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 to the extent
such earnings are not anticipated to be remitted to the United States.
Goodwill and Other Intangible Assets
------------------------------------
SFAS 142 requires that goodwill be tested for impairment at the
reporting unit level (segment or one level below a segment) on an annual basis
and between annual tests in certain circumstances. Application of the goodwill
impairment test requires judgment, including the identification of reporting
units, assigning assets and liabilities to reporting units, assigning goodwill
to reporting units, and determining the fair value of each reporting unit.
Significant judgments required to estimate the fair value of reporting units
include estimating future cash flows, determining appropriate discount rates and
other assumptions. Changes in these estimates and assumptions could materially
affect the determination of fair value for each reporting unit.
Accounting for Stock-Based Compensation
---------------------------------------
The Company accounts for stock-based compensation plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related Interpretations. In general, no
stock-based employee compensation cost is reflected in the results of
operations, unless options granted under those plans have an exercise price that
is less than the market value of the underlying common stock on the date of
grant.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate change market risk with respect
to its credit facility with a financial institution which is priced based on the
bank's alternate bank rate (4% at September 30, 2003). At September 30, 2003,
$1,000,000 was borrowed under the credit facility. To the extent the Company
utilizes all or a portion of its line of credit, changes in the interest rate
19
during fiscal 2003 will have a positive or negative effect on the Company's
interest expense. The loan was fully repaid in October 2003.
The Company has operations in foreign countries. While it is exposed to
foreign currency fluctuations, the Company presently has no financial
instruments in foreign currency and does not maintain funds in foreign currency
beyond those necessary for operations.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation has been carried out under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Accounting Officer, of the effectiveness of the design and the operation of our
"disclosure controls and procedures" (as such term is defined in Rules 13a-14(c)
under the Securities Exchange Act of 1934) as of September 30, 2003. Based on
such evaluation, our Chief Executive Officer and Chief Accounting Officer have
concluded that, as of September 30, 2003, the disclosure controls and procedures
are reasonably designed and effective to ensure that (i) information required to
be disclosed by us in the reports we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and (ii) such information
is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Accounting Officer, as appropriate to allow timely decisions
regarding required disclosure.
20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. Not Applicable
------------------
Item 2. Changes in Securities. Not Applicable
----------------------
Item 3. Defaults upon Senior Securities. Not Applicable
--------------------------------
Item 4. Submission of Matters to a Vote of Security Holders.
----------------------------------------------------
Not Applicable
Item 5. Other Information. Not Applicable
------------------
Item 6. (a) Exhibits.
---------
31.1 Certification of Chief Executive Officer required by Rule
13a-14(a) under the Securities Exchange Act of 1934.
31.2 Certification of Principal Financial Officer required by Rule
13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer required by Rule
13a-14(b) under the Securities Exchange Act of 1934.
32.2 Certification of Principal Financial Officer required by Rule
13a-14(b) under the Securities Exchange Act of 1934.
(b) Form 8-K Report.
----------------
During the quarter for which this report is filed, the Company
furnished a current report on Form 8-K dated August 12, 2003 which reported the
Company's results for the second quarter ended June 30, 2003 under Item 9.
21
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNODATA CORPORATION
Date: November 12, 2003 /s/ Jack Abuhoff
----------------- -------------------------------------
Jack Abuhoff
Chairman of the Board of Directors,
Chief Executive Officer and President
Date: November 12, 2003 /s/ Stephen Agress
----------------- -------------------------------------
Stephen Agress
Vice President - Finance
Chief Accounting Officer
22