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 JUNE 30, 2004
-------------
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
COMMISSION FILE NUMBER 0-22196
INNODATA ISOGEN, INC.
(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.
22,312,411 SHARES OF COMMON STOCK, $.01 PAR VALUE, AS OF JULY 30, 2004.
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 page 21
Item 4. Controls and Procedures
See page 21
PART ll. OTHER INFORMATION
See pages 22-23
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
JUNE 30, DECEMBER 31,
2004 2003
--------- ------------
Unaudited Derived from
audited
financial
statements
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 13,336 $ 5,051
Cash and equivalents - restricted 1,000 1,000
Accounts receivable-net 7,674 8,497
Refundable income taxes -- 1,075
Prepaid expenses and other current assets 1,322 999
Deferred income taxes 278 1,421
-------- --------
Total current assets 23,610 18,043
PROPERTY AND EQUIPMENT - NET 4,886 5,628
OTHER ASSETS 868 800
GOODWILL 675 675
-------- --------
TOTAL $ 30,039 $ 25,146
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 2,677 $ 2,451
Accrued salaries and wages 3,393 2,865
Income and other taxes 622 598
Current portion of capital lease obligations 153 146
-------- --------
Total current liabilities 6,845 6,060
-------- --------
DEFERRED INCOME TAXES PAYABLE 1,401 1,410
-------- --------
OBLIGATIONS UNDER CAPITAL LEASE 192 272
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized 75,000,000
shares; issued 22,897,000 and 22,535,000 shares at
June 30, 2004 and December 31, 2003 respectively 230 226
Additional paid-in capital 15,949 15,413
Retained earnings 7,396 3,739
-------- --------
23,575 19,378
Less: treasury stock - at cost; 584,000 shares (1,974) (1,974)
-------- --------
Total stockholders' equity 21,601 17,404
-------- --------
TOTAL $ 30,039 $ 25,146
======== ========
See notes to unaudited condensed consolidated financial statements
2
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
- --------------------------------------------------------------------------------
2004 2003
-------- --------
REVENUES $ 12,354 $ 8,056
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 7,859 6,408
Selling and administrative expenses 2,413 2,513
Interest (income) - net -- (6)
-------- --------
Total 10,272 8,915
-------- --------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM)
INCOME TAXES 2,082 (859)
PROVISION FOR (BENEFIT FROM) INCOME TAXES 505 (223)
-------- --------
NET INCOME (LOSS) $ 1,577 $ (636)
======== ========
BASIC INCOME (LOSS) PER SHARE $ .07 $ (.03)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 22,145 21,466
======== ========
DILUTED INCOME (LOSS) PER SHARE $ .06 $ (.03)
======== ========
ADJUSTED DILUTIVE SHARES OUTSTANDING 24,433 21,466
======== ========
See notes to unaudited condensed consolidated financial statements
3
INNODATA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
- --------------------------------------------------------------------------------
2004 2003
-------- --------
REVENUES $ 24,511 $ 14,709
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 15,634 12,233
Selling and administrative expenses 4,667 4,559
Bad debt recovery - net (963) --
Interest expense (income) - net 1 (15)
-------- --------
Total 19,339 16,777
-------- --------
16,777
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM)
INCOME TAXES 5,172 (2,068)
PROVISION FOR (BENEFIT FROM) INCOME TAXES 1,515 (319)
-------- --------
NET INCOME (LOSS) $ 3,657 $ (1,749)
======== ========
BASIC INCOME (LOSS) PER SHARE $ .17 $ (.08)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 22,049 21,451
======== ========
DILUTED INCOME (LOSS) PER SHARE $ .15 $ (.08)
======== ========
ADJUSTED DILUTIVE SHARES OUTSTANDING 24,480 21,451
======== ========
See notes to unaudited condensed consolidated financial statements
4
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(IN THOUSANDS)
(Unaudited)
- --------------------------------------------------------------------------------
2004 2003
-------- --------
OPERATING ACTIVITIES:
Net income (loss) $ 3,657 $ (1,749)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 2,068 2,131
Non-cash compensation 39 650
Deferred income taxes 1,134 (192)
Changes in operating assets and liabilities:
Accounts receivable 823 (1,963)
Refundable income taxes 1,075 24
Prepaid expenses and other current assets (692) (370)
Other assets (101) 224
Accounts payable and accrued expenses 226 402
Accrued salaries and wages 528 368
Income and other taxes 219 (25)
-------- --------
Net cash provided by (used in) operating activities 8,976 (500)
-------- --------
INVESTING ACTIVITIES:
Capital expenditures (924) (1,006)
-------- --------
FINANCING ACTIVITIES:
Payment of obligations under capital lease (73) --
Proceeds from exercise of stock options 306 38
-------- --------
Net cash provided by financing activities 233 38
-------- --------
INCREASE (DECREASE) IN CASH 8,285 (1,468)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 5,051 7,255
-------- --------
CASH AND EQUIVALENTS, END OF PERIOD $ 13,336 $ 5,787
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 9 $ --
======== ========
Income taxes $ 120 $ 2
======== ========
See notes to unaudited condensed consolidated financial statements
5
INNODATA ISOGEN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(Unaudited)
- --------------------------------------------------------------------------------
1. Innodata Isogen, Inc. and subsidiaries (the "Company") is a provider of
digital asset services and solutions. The Company's solutions encompass
both the manufacture of content (for which the Company provides services
such as digitization, imaging, data conversion, XML and markup services,
metadata creation, advanced classification services, editorial and
knowledge services) as well as the design, implementation, integration and
deployment of the systems used to manage content (for which the Company
provides custom application development, consulting and training) through
offices located both in the U.S. and Asia. The consolidated financial
statements include the accounts of Innodata Isogen, Inc. and its
subsidiaries, all of which are wholly owned. All intercompany transactions
and balances have been eliminated in consolidation.
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 June 30, 2004, the results of operations for the three and
six months ended June 30, 2004 and 2003, and the cash flows for the six
months ended June 30, 2004 and 2003. The results of operations for the
three and six months ended June 30, 2004 and 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,
2003 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, 2003 financial statements.
6
2. An analysis of the changes in each caption of stockholders' equity for the
six months ended June 30, 2004 and 2003, (in thousands) is as follows.
ADDITIONAL
COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
-------- -------- -------- -------- -------- --------
JANUARY 1, 2004 22,535 $ 226 $ 15,413 $ 3,739 $ (1,974) $ 17,404
Net income -- -- -- 3,657 -- 3,657
Issuance of common stock
upon exercise of stock options 362 4 302 -- -- 306
Tax benefit from exercise
of options -- -- 195 -- -- 195
Non-cash compensation -- -- 39 -- -- 39
-------- -------- -------- -------- -------- --------
JUNE 30, 2004 22,897 $ 230 $ 15,949 $ 7,396 $ (1,974) $ 21,601
======== ======== ======== ======== ======== ========
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 -- -- -- (1,749) -- (1,749)
Issuance of common stock
upon exercise of stock options 171 2 83 -- (47) 38
Tax benefit from exercise
of options -- -- 3 -- -- 3
Non-cash compensation -- -- 650 -- -- 650
-------- -------- -------- -------- -------- --------
JUNE 30, 2003 22,217 $ 222 $ 14,820 $ 1,515 $ (2,046) $ 14,511
======== ======== ======== ======== ======== ========
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 (loss) 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. Options
to purchase 1.3 and 4.4 million shares of common stock at June 30, 2004
and 2003, respectively, were outstanding but not included in the
computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares and
therefore, the effect would have been antidilutive. In addition, for 2003,
diluted net loss per share does not include 723,000 and 683,000 potential
common shares derived from stock options for the three months and six
months ended June 30, 2003 respectively, because they are antidilutive.
7
The basis of the earnings (loss) per share computation for the three and
six months ended June 30, 2004 and 2003 (in thousands, except per share
amounts) is as follows:
THREE MONTHS SIX MONTHS
2004 2003 2004 2003
------- ------- ------- --------
Net income (loss) $ 1,577 $ (636) $ 3,657 $ (1,749)
======= ======= ======= ========
Weighted average common shares outstanding 22,145 21,466 22,049 21,451
Dilutive effect of outstanding options 2,288 -- 2,431 --
------- ------- ------- --------
Adjusted for dilutive computation 24,433 21,466 24,480 21,451
======= ======= ======= ========
Basic income (loss) per share $ .07 $ (.03) $ .17 $ (.08)
======= ======= ======= ========
Diluted income (loss) per share $ .06 $ (.03) $ .15 $ (.08)
======= ======= ======= ========
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
------- ------- ------- --------
Net income (loss) as reported $ 1,577 $ (636) $ 3,657 $ (1,749)
Deduct: Total stock-based employee
compensation determined under fair value
based method, net of related tax effects (903) (1,527) (1,418) (2,146)
Add: Compensation expense included in
the determination of net income as
reported, net of related tax effects,
related to the extension of stock options -- 455 -- 455
Pro forma net income (loss) $ 674 $(1,708) $ 2,239 $ (3,440)
======= ======= ======= ========
Income (loss) per share:
Basic - as reported $ .07 $ (.03) $ .17 $ (.08)
======= ======= ======= ========
Basic - pro forma $ .03 $ (.08) $ .10 $ (.16)
======= ======= ======= ========
Diluted - as reported $ .06 $ (.03) $ .15 $ (.08)
======= ======= ======= ========
Diluted - pro forma $ .03 $ (.08) $ .09 $ (.16)
======= ======= ======= ========
8
5. The Company's operations are classified into two reporting segments: (1)
content services and (2) professional services. The content services
operating segment aggregates, converts, tags and editorially enhances
digital content and performs XML transformations. The Company's
professional services 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.
Commencing October 1, 2003, the Company unified its selling and related
activities for its content and professional services segments. As such,
selling and corporate administrative costs are not segregated by, nor are
they allocated to, operating segments. The income (loss) before income
taxes, by operating segment for the 2003 periods, have been reclassified
for comparative purposes.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN THOUSANDS) (IN THOUSANDS)
Revenues
Content services $ 9,683 $ 6,591 $ 18,504 $ 12,361
Professional services 2,671 1,465 6,007 2,348
-------- -------- -------- --------
Total consolidated $ 12,354 $ 8,056 $ 24,511 $ 14,709
======== ======== ======== ========
Income (loss) before income taxes
Content services $ 2,939 $ 1,026 $ 6,254 $ 1,824
Professional services 1,255 631 3,017 703
Selling and corporate administration (2,112) (2,516) (4,099) (4,595)
-------- -------- -------- --------
Total consolidated $ 2,082 $ (859) $ 5,172 $ (2,068)
======== ======== ======== ========
JUNE 30, DECEMBER, 31,
2004 2003
-------- --------
(IN THOUSANDS)
Total assets
Content services $ 27,049 $ 20,986
Professional services 2,990 4,160
-------- --------
Total consolidated $ 30,039 $ 25,146
======== ========
6. Restricted cash at June 30, 2004 represents a certificate of deposit which
collateralizes a $1 million line of credit. The Company has not borrowed
against the line in 2004. In August 2004, the Company replaced this line
with a $5 million line of credit pursuant to which it may borrow up to 80%
of eligible accounts receivable at the bank's alternate base rate plus
1/2% or LIBOR plus 3%. The line, which expires in May, 2005, is secured by
the company's accounts receivable.
On June 1, 2004, the Company issued a $322,000 standby letter of credit
related to software license purchases which expires on November 1, 2004.
9
7. In the three and six months ended June 30, 2004, the provision for income
taxes as a percentage of income before income taxes was 24% and 29%,
respectively, which is lower than the U.S. Federal statutory tax rate,
principally due to certain overseas income which is neither subject to
foreign income taxes because of tax holidays granted to the Company, nor
subject to tax in the U.S. unless repatriated. In the three and six months
ended June 30, 2003, 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 losses attributable to certain overseas
subsidiaries not subject to income taxes, and certain domestic losses for
which tax benefits may not be available.
8. In January 2004, the Company signed a settlement agreement and received
$1,000,000 cash from a former client as full satisfaction of a $2.6
million remaining outstanding balance that the Company had fully written
off as a bad debt in 2001. The $1,000,000 receipt, net of $37,000 in
recovery costs, is reflected as bad debt recovery income in the statement
of operation for the six months ended June 30, 2004.
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 and
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. Such
compensation expense is included as a component of selling and
administrative expenses.
10. In connection with the cessation of all operations at certain foreign
subsidiaries, certain former employees have filed various actions in the
Philippines relating to their dismissal 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, 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.
10
11. 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.
12. The Company is obligated under certain circumstances to indemnify
directors and certain officers against costs and liabilities incurred in
actions or threatened actions 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 June 30, 2004, the
Company is not aware of liability for any obligations arising as a result
of these indemnifications.
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, worsening of present 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 Isogen, Inc. (the "Company") is a leading provider of
digital asset services and solutions. The Company's solutions encompass both the
manufacture of content (for which the Company provides services such as
digitization, imaging, data conversion, XML and markup services, metadata
creation, advanced classification services, editorial and knowledge services) as
well as the design, implementation, integration and deployment of the systems
used to manage content (for which the Company provides custom application
development, consulting and training) through offices located both in the US and
Asia. The Company has approximately 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.
12
The Company's management currently monitors its operations through
two reporting segments: (1) content services and (2) professional services
(formerly referred to as systems integration and training). The content services
operating segment aggregates, converts, tags and editorially enhances digital
content and performs XML transformations. The Company's professional services
operating segment offers system design, custom application development,
consulting services and systems integration conforming to SML and related
standards and provides a broad range of introductory as well as advanced
curricula and training on XML and other knowledge management standards.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues increased 53% to $12,354,000 for the three months ended June
30, 2004 compared to $8,056,000 for the similar period in 2003.
Revenues from the content services segment increased 47% to
$9,683,000 for the three months ended June 30, 2004 compared to $6,591,000 for
the similar period in 2003. The increase was principally due to increased
revenues from two existing clients (one of which accounted for approximately 75%
of the total increase) and one client added late in 2003.
Revenues from the Company's professional services segment increased
82% to $2,671,000 for the three months ended June 30, 2004 compared to
$1,465,000 for the similar period in 2003. The increase was principally
attributable to an increase in the quantity and size of systems integration and
consulting projects. For the three months ended June 30, 2004, revenues from
four clients accounted for substantially all of professional services segment
revenues; in the similar period in 2003, two clients accounted for approximately
50% of professional services segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 24% and 37% of the Company's revenues for the three months ended
June 30, 2004 and 2003, respectively. A second client accounted for 27% of the
Company's revenues for the three months ended June 30, 2004. Further, in the
three months ended June 30, 2004, and 2003, revenues from clients located in
foreign countries (principally in Europe), accounted for 30% and 49%
respectively, of the Company's revenues.
During the quarter, the Company provided approximately 50% of its
total services under project-based arrangements and provided the balance of its
services under outsourcing-type arrangements. Both types of services are
typically subject to client requirements, and many are terminable upon notice.
Outsourcing arrangements tend to continue for relatively longer periods, while
revenues for project-based work vary depending on the size and completion dates
of specific projects. The Company seeks wherever possible to counterbalance
periodic declines in revenues on completion of large projects by entering into
arrangements for new projects with the same client or others. The Company has
refocused its sales force to seek to increase the relative percentage of
services that the Company performs on an outsourcing basis.
13
Direct operating expenses were $7,859,000 and $6,408,000 for the
three months ended June 30, 2004 and 2003, respectively, an increase of 23%.
Direct operating expenses as a percentage of revenues were 64% in 2004 and 80%
in 2003.
Direct operating expenses for the content services segment were
$6,443,000 and $5,574,000 in the three months ended June 30, 2004 and 2003,
respectively, an increase of 16%. Direct operating expenses as a percentage of
revenues for the content services segment were 67% and 85% in the three months
ended June 30, 2004 and 2003, respectively. The dollar increase for the content
services segment in the 2004 period was principally due to increases in costs
for the increased revenues. The decrease as a percent of sales for the content
services segment in the 2004 period was principally due to lower production
labor costs as a percent of revenues, and to a 47% increase in revenues compared
to a 22% increase in fixed non-labor costs. Direct operating expenses primarily
include direct payroll, telecommunications, depreciation, computer services,
supplies and occupancy.
Direct operating expenses for the Company's professional services
segment were $1,416,000 and $834,000 for the three months ended June 30, 2004
and 2003, respectively, an increase of 70%. Direct operating expenses as a
percent of revenues for the Company's professional services segment were 53% and
57% in the three months ended June 30, 2004 and 2003, respectively. The dollar
increase for the professional services segment in the 2004 period was
principally due to increases in personnel and related costs for the increased
revenues. The decrease as a percent of revenues for the professional services
segment in the 2004 period was primarily attributable to an 82% increase in
revenue without a proportionate increase in direct operating expenses.
Commencing October 1, 2003, the Company unified its selling and
related activities for its content and professional services segments. As such,
selling and corporate administrative costs are not segregated by, nor are they
allocated to, operating segments.
Selling and administrative expenses were $2,413,000 and $2,513,000
for the three months ended June 30, 2004 and 2003, respectively, a decrease of
4%. Selling and administrative expenses as a percentage of revenues decreased to
20% in the 2004 period compared to 31% in the 2003 period. Selling and
administrative expenses for the three months ended June 30, 2003 include a
non-cash compensation charge of approximately $650,000 (described in note 9 to
the Condensed Consolidated Financial Statements). Excluding this charge, overall
selling and administrative expenses for the three months ended June 30, 2004
would have increased by approximately $550,000 or 30% from the similar period in
2003. This increase was primarily attributable to increases in marketing costs,
which are expected to continue to grow modestly as the Company expands its sales
and marketing activities, and to increases in administrative costs. Selling and
administrative expenses primarily include management and administrative
salaries, sales, marketing cost, and administrative overhead.
14
In the three months ended June 30, 2004, 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
which is neither subject to income taxes because of tax holidays granted to the
Company, nor subject to tax in the U.S. unless repatriated. In the second
quarter 2003, the income tax benefit as a percentage of the loss before income
taxes was 26%, which is lower than the U.S. Federal statutory tax rate
principally due to losses attributable to certain overseas subsidiaries not
subject to income taxes, and certain domestic losses for which tax benefits may
not be available.
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues increased 67% to $24,511,000 for the six months ended June
30, 2004 compared to $14,709,000 for the similar period in 2003.
Revenues from the content services segment increased 50% to
$18,504,000 for the six months ended June 30, 2004 compared to $12,361,000 for
the similar period in 2003. The increase was principally due to increased
revenues from four existing clients (one of which accounted for 58% of the total
increase) and one client added late in 2003.
Revenues from the Company's professional services segment increased
156% to $6,007,000 for the six months ended June 30, 2004 compared to $2,348,000
for the similar period in 2003. The increase was principally attributable to an
increase in the quantity and size of systems integration and consulting
projects. For the three months ended June 30, 2004, revenues from four clients
accounted for approximately 90% of professional services segment revenues; in
the similar period in 2003, two clients accounted for approximately 47% of
professional services segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 24% and 36% of the Company's revenues for the six months ended
June 30, 2004 and 2003, respectively. A second client also accounted for 25% of
the Company's revenues for the six months ended June 30, 2004. Further, in the
six months ended June 30, 2004, and 2003, revenues from clients located in
foreign countries (principally in Europe), accounted for 30% and 47%
respectively, of the Company's revenues.
During the six months ended June 30, 2004, the Company provided
approximately 50% of its total services under project-based arrangements and
provided the balance of its services under outsourcing-type arrangements. Both
types of services are typically subject to client requirements, and many are
terminable upon notice. Outsourcing arrangements tend to continue for relatively
longer periods, while revenues for project-based work vary depending on the size
and completion dates of specific projects. The company seeks wherever possible
to counterbalance periodic declines in revenues on completion of large projects
by entering into arrangements for new projects with the same client or others.
The Company has refocused its sales force to seek to increase the relative
percentage of services that the Company performs on an outsourcing basis.
15
Direct operating expenses were $15,634,000 and $12,233,000 for the
six months ended June 30, 2004 and 2003, respectively, an increase of 28%.
Direct operating expenses as a percentage of revenues were 64% in 2004 and 83%
in 2003.
Direct operating expenses for the content services segment were
$12,669,000 and $10,587,000 in the six months ended June 30, 2004 and 2003,
respectively, an increase of 20%. Direct operating expenses as a percentage of
revenues for the content services segment were 68% and 86% in the six months
ended June 30, 2004 and 2003, respectively. The dollar increase for the content
services segment in the 2004 period was principally due to increases in costs
for the increased revenues. The decrease as a percent of sales for the content
services segment in the 2004 period was principally due to lower production
labor costs as a percent of revenues, and to a 50% increase in revenues compared
to a 22% increase in fixed non-labor costs. Direct operating expenses primarily
include direct payroll, telecommunications, depreciation, computer services,
supplies and occupancy.
Direct operating expenses for the Company's professional services
segment were $2,965,000 and $1,646,000 for the six months ended June 30, 2004
and 2003, respectively, an increase of 80%. Direct operating expenses as a
percent of revenues for the Company's professional services segment were 49% and
70% in the six months ended June 30, 2004 and 2003, respectively. The dollar
increase for the professional services segment in the 2004 period was
principally due to increases in personnel and related costs for the increased
revenues. The decrease as a percent of revenues for the professional services
segment in the 2004 period was primarily attributable to a 156% increase in
revenue without a proportionate increase in direct operating expenses and a 17
percentage point decrease in direct labor costs as a percent of revenues.
Commencing October 1, 2003, the Company unified its selling and
related activities for its content and professional services segments. As such,
selling and corporate administrative costs are not segregated by, nor are they
allocated to, operating segments.
Selling and administrative expenses were $4,667,000 and $4,559,000
for the six months ended June 30, 2004 and 2003, respectively, an increase of
2%. Selling and administrative expenses as a percentage of revenues decreased to
19% in the 2004 period compared to 31% in the 2003 period. Selling and
administrative expenses for the six months ended June 30, 2003 include a
non-cash compensation charge of approximately $650,000 (described in note 9 to
the Condensed Consolidated Financial Statements). Excluding this charge, overall
selling and administrative expenses for the six months ended June 30, 2004 would
have increased by approximately $758,000, or 19%, from the similar period in
2003. This increase was primarily attributable to increases in marketing costs,
which are expected to continue to grow modestly as the Company expands its sales
and marketing activities, and to increases in administrative costs. Selling and
administrative expenses primarily include management and administrative
salaries, sales, marketing cost, and administrative overhead.
16
In January 2004, the Company reached a settlement agreement and
received $1,000,000 cash from a former client as full satisfaction of a $2.6
million dollar remaining outstanding balance that the Company had fully written
off as a bad debt in 2001. The $1,000,000 receipt, net of $37,000 in recovery
costs, is reflected as bad debt recovery income in the statement of operations
for the six months ended June 30, 2004.
In the six months ended June 30, 2004, the provision for income taxes
as a percentage of income before income taxes was 29%, which is lower than the
U.S. Federal statutory tax rate, principally due to certain overseas income
which is neither subject to foreign income taxes because of tax holidays granted
to the Company, nor subject to tax in the U.S. unless repatriated. In the three
and six months ended June 30, 2003, 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 losses attributable to certain overseas
subsidiaries not subject to income taxes, and certain domestic losses for which
tax benefits may not be available.
LIQUIDITY AND CAPITAL RESOURCES
Selected measures of liquidity and capital resources are as follows:
June 30, 2004 December 31, 2003
------------- -----------------
Cash and Cash Equivalents $13,336,000 $ 5,051,000
Working Capital 16,765,000 11,983,000
Stockholders' Equity Per Common Share* $.97 $.79
*Represents total stockholders' equity divided by the actual number
of common shares outstanding (which excludes treasury stock).
Net Cash Provided By (Used In) Operating Activities
Net cash provided by operating activities was $8,976,000 in the six
months ended June 30, 2004 compared to $500,000 used in operating activities for
the six months ended June 30, 2003, an increase of approximately $9.5 million.
The net cash provided by operating activities in the 2004 period is principally
due to net income approximating $3.7 million, non-cash charges approximating
$3.2 million and a $1.0 million income tax refund.
Accounts receivable totaled $7,674,000 at June 30, 2004, representing
approximately 56 days of sales outstanding, compared to $8,497,000, or 71 days,
at December 31, 2003. The decrease in days outstanding resulted from significant
accounts receivable collections during the first six months of 2004.
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 June 30, 2004, approximately 22% of the Company's accounts
receivable was from foreign (principally European) clients, and 41% of accounts
receivable were due from two clients.
17
Net Cash Used in Investing Activities
During the six months ended June 30, 2004, the Company spent
approximately $924,000 for capital expenditures, compared to approximately
$1,006,000 in the six months ended June 30, 2003. During the next 12 months, the
Company currently anticipates capital spending levels to be in the $3 million
range. Such spending in the first six months of 2004 and anticipated capital
spending relates principally to normal ongoing equipment upgrades, to project
requirement specific equipment for certain new projects, and for improvements in
infrastructure.
Availability of Funds
In August 2004, the Company replaced its existing line of credit with
a $5 million line of credit pursuant to which it may borrow up to 80% of
eligible accounts receivable at the bank's alternate base rate plus 1/2% or
LIBOR plus 3%. The line, which expires in May, 2005, is secured by the company's
accounts receivable.
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.
18
Allowance for Doubtful Accounts
The Company establishes credit terms for new clients based upon
management's review of their credit information and project terms, and performs
ongoing credit evaluations of its customers, adjusting credit terms when
management believes appropriate based upon payment history and an assessment of
their current credit worthiness. The Company records an allowance for doubtful
accounts for estimated losses resulting from the inability of its clients to
make required payments. The Company determines its allowance by considering a
number of factors, including the length of time trade accounts receivable are
past due, the Company's previous loss history, the client's current ability to
pay its obligation to the Company, and the condition of the general economy and
the industry as a whole. While credit losses have generally been within
expectations and the provisions established, the Company cannot guarantee that
credit loss rates in the future will be consistent with those experienced in the
past. In addition, there is credit exposure if the financial condition of one of
the Company's major clients were to deteriorate. In the event that 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 for content manufacturing and outsourcing services is
recognized in the period in which services are performed and delivered.
The Company recognizes revenues from custom application and systems
integration development which requires significant production, modification or
customization of software in accordance with Statement of Position ("SOP") No.
97-2 "Software Revenue Recognition" and SOP No. 81-1 "Accounting for Performance
of Construction-Type and Certain Production-Type Contracts". Revenue for such
contracts billed under fixed fee arrangements is recognized using the
percentage-of-completion method under contract accounting as services are
performed or output milestones are reached. The percentage completed is measured
either by the percentage of labor hours incurred to date in relation to
estimated total labor hours or in consideration of achievement of certain output
milestones, depending on the specific nature of each contract. For arrangements
in which percentage-of completion accounting is used, the Company records cash
receipts from customers and billed amounts due from customers in excess of
recognized revenue as billings in excess of revenues earned on contracts in
progress (which is included in accounts receivable). Revenue for contracts
billed on a time and materials basis is recognized as services are performed.
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Property and Equipment
Property and equipment is depreciated on the straight-line method
over the estimated useful lives of the related assets, which is generally 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. The
Company makes estimates regarding the useful lives of these assets and any
changes in actual lives could result in material changes in the net book value
of these assets. The Company evaluates the recoverability of long-lived assets
whenever adverse events or changes in business climate indicate that the
expected undiscounted future cash flows from the related asset may be less than
previously anticipated. If the net book value of the related asset exceeds the
undiscounted future cash flows of the asset, the carrying amount would be
reduced to the present value of its expected future cash flows and an impairment
loss would be recognized. This analysis requires the Company to make significant
estimates and assumptions, and changes in facts and circumstances could result
in material changes in the carrying value of the assets and the related
depreciation expense.
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
Statement of Financial Accounting Standard ("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.
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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 base rate (4 1/4% at June 30, 2004). The company
has not borrowed against this line in 2004. To the extent the Company utilizes
all or a portion of its line of credit, changes in the interest rate will have a
positive or negative effect on the Company's interest expense.
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
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Principal Financial Officer to allow timely decisions
regarding required disclosure. Management necessarily applied its judgment in
assessing the costs and benefits of such controls and procedures which, by their
nature, can provide only reasonable assurance regarding management's control
objectives. Management, including the Company's Chief Executive Officer along
with the Company's Principal Financial Officer, concluded that the Company's
disclosure controls and procedures are effective in reaching the level of
reasonable assurance regarding management's control objectives.
The Company has carried out an evaluation, under the supervision and
with the participation of the Company's management, including the Company's
Chief Executive Officer along with the Company's Principal Financial Officer, of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon the
foregoing, as of June 30, 2004, the Company's Chief Executive Officer along with
the Company's Principal Financial Officer, concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's Exchange Act reports.
There has been no change during the Company's six months ended June 30, 2004 in
the Company's internal control over financial reporting that was identified in
connection with the foregoing evaluation which has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
21
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.
The following matters were voted on at the June 15, 2004 Annual
Meeting of Stockholders. The total shares voted were 20,684,682.
ELECTION OF DIRECTORS:
NOMINEE FOR WITHHELD AGAINST ABSTAIN
------- ---------- -------- ------- ----------
Jack Abuhoff 20,211,355 473,327
Todd Solomon 20,211,555 473,127
Haig Bagerdjian 20,637,338 47,344
Louise Forlenza 20,637,338 47,344
Charles Goldfarb 20,637,338 47,344
John Marozsan 20,637,338 47,344
APPOINTMENT OF AUDITORS 18,513,868 47,160 2,123,654
Item 5. Other Information. Not Applicable
Item 6. (a) Exhibits.
10.11 2004 Executive Management Incentive Compensation Plan
31.1 Certificate of Chief Executive Officer and Principal
Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
22
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(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 May 13, 2004, which reported the
Company's results for the three months and year ended March 31, 2004 under Items
7 and 12.
23
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 ISOGEN, INC.
Date: August 12, 2004 /s/ Jack Abuhoff
--------------- -------------------------------------
Jack Abuhoff
Chairman of the Board of Directors,
Chief Executive Officer and President
Date: August 12, 2004 /s/ Stephen Agress
--------------- -------------------------------------
Stephen Agress
Vice President - Finance
Chief Accounting Officer
24