INNODATA INC quarterly report, Q2 FY2016

Business context and reporting period

Innodata Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2016. The company provides digital content and data services through Digital Data Solutions (DDS), Innodata Advanced Data Solutions (IADS), and Media Intelligence Solutions (MIS, including MediaMiser). Unless stated otherwise, amounts below are in U.S. dollars.

Key financial metrics

Q2 direct operating costs were $11.685 million (74.7% of revenue) and selling and administrative expenses were $5.553 million (35.5%). The resulting loss before tax was $1.612 million; income tax expense was $0.258 million. For the six months, direct costs were $23.150 million (73.9% of revenue), selling and administrative expenses were $9.364 million, and the pretax loss was $1.203 million.

At June 30, cash and equivalents were $24.961 million, current assets $38.122 million, working capital $24.171 million, and total assets $52.053 million. Current liabilities were $13.951 million. Long-term obligations were $3.686 million, with a further $1.307 million current portion. Cash exceeded these stated obligations, although the company’s obligations include items such as pension liabilities. Stockholders’ equity was $37.145 million. Of cash, $21.2 million was held by foreign subsidiaries.

Material changes versus comparable periods

• Q2 revenue rose 11% from $14.063 million a year earlier. DDS increased 7% to $13.232 million; IADS increased to $1.165 million from $0.545 million; MIS revenue was approximately unchanged at $1.245 million.
• Q2 net loss attributable to Innodata widened to $1.778 million from $0.799 million. Selling and administrative expenses rose about 30%, chiefly reflecting $1.25 million of investigation-related legal and professional costs and new hires. Adjusted EBITDA loss widened from $0.223 million.
• For the first half, reported revenue was $31.340 million versus $27.865 million, while attributable net loss improved to $1.775 million from $2.639 million. Adjusted EBITDA improved from a $0.668 million loss to $0.672 million income.
• First-half operating cash flow improved to $1.169 million from $0.492 million, supported in part by higher accounts payable, accrued expenses, and accrued salaries. Cash increased by $0.053 million during the period.
• First-half DDS revenue grew 9% to $26.876 million; IADS grew 117% to $2.062 million; MIS was approximately flat at $2.402 million. IADS remained loss-making, while MIS’s reported segment loss increased.

Outlook, commentary, risks and unusual items

• Management said existing cash and internally generated funds should meet financial needs for the next 12 months. It projected third-quarter ending cash of $19–20 million, after the Agility purchase and investigation-related payments.
• Management expected capital expenditures of approximately $2.5–3.5 million over the next 12 months and planned to invest $0.5–0.7 million per quarter in IADS in the immediate future. It may reduce investment or operating costs if liquidity proves insufficient and attractive external financing is unavailable.
• After quarter-end, MediaMiser acquired Agility for $4.3 million cash, subject to a working-capital adjustment. Agility had approximately $5 million of 2015 revenue and brought more than 1,500 customers and about 50 employees. The transaction is not reflected in the June 30 financial statements.
• The company disclosed an internal investigation into potentially improper payments connected with local employment-tax compliance at a foreign subsidiary. It voluntarily contacted the U.S. Department of Justice and SEC; the employees involved are no longer employed. The company said the amounts were not material to its financial condition or results, but it could not predict government action. It incurred about $1.25 million of related costs in Q2 and expected up to $225,000 more in Q3. Disclosure controls were assessed as effective; supplemental employee training was planned.
• Tax exposures include an Indian service-tax dispute: if authorities prevail, services could be taxed at approximately 14.5% of relevant revenue; the Indian subsidiary generated $8.5 million of revenue in the first half. The company is contesting the matter. A separate Philippine employment case seeks approximately $8 million in back wages and benefits; management considers recovery against Innodata unlikely. Other tax and legal proceedings remain subject to uncertainty.
• Revenue is concentrated: two DDS clients generated about 33% of Q2 revenue, and three DDS clients together accounted for about 42% of first-half revenue. Management also cited at-will/project-based contracts, client volume changes, wage inflation, foreign-exchange exposure, and IADS’s continuing losses as risks.
• No formal revenue or earnings guidance was provided. The filing notes that results can fluctuate with project starts, cancellations, and seasonal operating patterns. The six-month MD&A calls the revenue change a “decline” of approximately 12%, but the financial statements show an increase from $27.865 million to $31.340 million; investors should verify this apparent textual error.

Important facts for investors to verify

• Confirm the first-half revenue comparison and the apparent MD&A wording error against the filed financial statements.
• Monitor investigation developments, remaining professional costs, and any government action or remediation requirements.
• Assess the outcome and potential cash or tax impact of the Indian service-tax disputes and other tax proceedings.
• Track customer concentration, project renewals and volumes, and whether IADS and MIS can improve profitability.
• Confirm post-closing adjustments and integration results for Agility, and compare actual cash, capital spending, and planned investments with management’s expectations.