Innodata Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Unaudited results; dollar amounts below are in millions unless stated otherwise. Innodata provides digital content, business-process, IT and professional services through Content Services (CS) and Innodata Advanced Data Solutions (IADS).
Financial performance
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Revenue | $16.9 | $25.1 |
| Direct operating costs | $12.8 | $16.1 |
| Revenue less direct operating costs | $4.1 | $9.0 |
| Income (loss) before income taxes | $(0.4) | $3.7 |
| Income tax provision (benefit) | $(0.5) | $0.9 |
| Net income attributable to Innodata | $0.3 | $3.4 |
| Diluted EPS | $0.01 | $0.13 |
| Cash from operating activities | $3.1 | $7.7 |
Revenue less direct operating costs was approximately 24% of revenue, versus 36% a year earlier. This is not a reported operating margin. CS revenue was $16.3 million, down about 34%; IADS revenue was $0.6 million. CS reported a $1.0 million pretax segment profit before intersegment eliminations, while IADS reported a $1.4 million pretax loss on that basis. After eliminations, segment pretax results were approximately $0.7 million for CS and $(1.1) million for IADS.
Liquidity, debt and cash flow
- At March 31, cash and cash equivalents were $27.1 million and short-term investments were $3.6 million; working capital was $32.0 million, down from $32.8 million at year-end 2012.
- Current assets were $44.8 million and current liabilities $12.8 million. Long-term obligations were $3.6 million, with a further $0.6 million current portion. No amount was outstanding on the $15 million receivables-backed credit line, which expires in June 2013.
- Operating cash flow of $3.1 million included a $4.1 million source from accounts receivable collections, partly offset by a $1.0 million decrease in accrued salaries and benefits. Cash increased $1.7 million during the quarter.
- Capital expenditures were $0.9 million. Management anticipated $4–$5 million of capital expenditures over the next 12 months and intended to renew the credit line in Q2 2013.
- Approximately $20 million of cash was held by foreign subsidiaries; foreign locations held approximately $24 million of cash and short-term investments in total.
Material changes and management commentary
- Revenue fell about 33%, principally because of lower eBook-related work for a significant CS client. The top three clients represented 42% of revenue, down from 56% a year earlier.
- Direct costs declined only about 21% as revenue fell; management cited fixed costs, initial engagement and pilot costs, and overhead at a new Asian delivery center. CS direct costs rose to 73% of CS revenue from 59%.
- Selling and administrative expenses declined about 14%, reflecting 2012 restructuring savings and lower professional fees. As a share of revenue, they increased to approximately 27% from 21%.
- Management stated that existing cash, investments, expected operating cash flow and available credit should meet needs for the next 12 months, but noted that changed circumstances could require debt or equity financing. No specific revenue or earnings guidance was provided.
Risks, contingencies and unusual items
- Client concentration, project-based work, contract reductions or cancellations, and the ability to replace completed work expose revenue and margins to volatility. IADS remains an early-stage business with limited revenue and continuing losses.
- Foreign-currency exposure is partly hedged with forward contracts totaling $32 million notional; foreign-held cash and investments are also exposed to currency movements. Management cautioned that currency changes could adversely affect results.
- Tax matters include approximately $2.4 million of unrecognized tax benefits. Indian tax assessments remain disputed, including an approximately $1.1 million assessment for fiscal 2008 for which the company recorded a $0.3 million provision. A Philippine subsidiary received an informal $3.8 million assessment; no provision was recorded, and management noted the deadline for formal notice expired April 15, 2013.
- A Philippine employment judgment involving an inactive subsidiary seeks approximately $8.5 million in back wages and benefits. Management, based on legal advice, considered recovery against Innodata unlikely, but warned that an adverse outcome could be material. Other legal matters could result in approximately $0.3 million of losses beyond recorded amounts that management considered reasonably possible.
- Management disclosed a material weakness identified in the 2012 year-end close concerning accounting for certain non-routine transactions. The error was corrected in the 2012 audited statements; additional policies and review procedures were implemented in Q1 2013. Disclosure controls were judged effective as of quarter-end.
Important facts for investors to verify
- Whether the significant client’s reduced eBook work continued, and whether replacement projects restored CS revenue and margins.
- Renewal and terms of the credit facility expiring in June 2013, and actual capital spending against the $4–$5 million estimate.
- Developments in the Philippine tax assessment, Indian tax appeals, and Philippine employment litigation, including any change in recorded reserves.
- Progress in remediating the non-routine-transaction control weakness and whether remediation is operating effectively.
- Cash accessibility and foreign-exchange exposure for funds held outside the United States.