Innodata Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results. Innodata provides digital-content services and solutions through Content Services and its early-stage Innodata Advanced Data Solutions (IADS) segment.
Financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $19.7m | $19.2m | $67.6m | $50.2m |
| Income before taxes | $1.0m | $2.0m | $6.7m | $3.0m |
| Net income | $0.9m | $1.2m | $5.3m | $2.0m |
| Net income attributable to Innodata | $1.3m | $1.4m | $6.8m | $2.2m |
| Basic / diluted EPS attributable to Innodata | $0.05 / $0.05 | $0.06 / $0.06 | $0.27 / $0.26 | $0.09 / $0.09 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $13.1m | $0.9m |
Q3 revenue increased 2% year over year but declined 13% sequentially from Q2 2012. Nine-month revenue rose 35%, principally from e-book-related work for a significant Content Services client. Direct costs were 69% of revenue in Q3 versus 67% a year earlier, implying gross margin of about 31% versus 33%; for the nine months, direct costs were 65% versus 69%, implying gross margin of about 35% versus 31%. Selling and administrative expenses were 26% of revenue in Q3 versus 24%, and approximately 25% in both nine-month periods.
At September 30, cash and cash equivalents were $25.1m, working capital was $33.1m, and total assets were $65.7m. Cash rose from $11.4m at year-end 2011; the company also used $5.8m of short-term investments that matured during the period. Total current liabilities were $13.7m. Long-term obligations were $3.3m, plus $0.6m current; the $15m receivables-backed credit facility was undrawn. Nine-month capital expenditures were $5.7m. Stockholders’ equity was $50.7m.
Changes, outlook, and commentary
- Q3 income attributable to Innodata declined to $1.3m from $1.4m, despite modest revenue growth; pretax income fell to $1.0m from $2.0m. For the nine months, attributable income increased to $6.8m from $2.2m.
- Content Services drove growth and profitability. IADS remained loss-making: its reported pretax loss was $1.9m in Q3 and $6.0m for nine months, after intersegment eliminations. The company said cumulative IADS operating costs since inception through September 2012 were $7.4m and related capital investment was approximately $3.6m.
- Management said revenue from the significant e-book client had already declined sequentially in Q2 and Q3 and would likely decline further in Q4 2012. The filing also reports significant customer concentration: three clients generated about 46% of Q3 revenue; two generated about 45% of nine-month revenue.
- A Q3 restructuring incurred a one-time charge of approximately $0.2m; management expects annual savings of $1.8m–$2.0m. Planned capital expenditures over the next 12 months were approximately $4m–$5m.
- Management expected existing cash, operating cash generation and available credit to meet needs for the next 12 months, while noting future financing might be needed if circumstances change. A shelf registration permits offers of up to $70m in securities.
Risks and unusual items
- Days sales outstanding increased to approximately 86 days from 66 at year-end, attributed to higher revenue and slow payment by a significant client. Two clients accounted for 47% of receivables at quarter-end.
- Foreign-exchange exposure arises because much revenue is denominated in U.S. dollars while operating costs are incurred abroad. Forward contracts had a $25m notional amount; management cautioned currency movements could adversely affect results.
- Indian tax assessments remain contested, including a roughly $1.1m assessment for fiscal 2008. The company recorded a $316,000 provision for that assessment and approximately $1.0m of additional provision in prior quarters for other potential exposures. Unrecognized tax benefits were approximately $2.3m.
- A Philippines employment-related matter seeks approximately $7.5m in back wages and benefits. Management, based on legal advice, believes recovery against Innodata is unlikely, but substantial recovery could materially affect the company.
- Management cited at-will and project-based contracts, reliance on concentrated clients, potential project reductions or cancellations, wage inflation, competition, and early-stage IADS operations as risks. The filing reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the pace and Q4 impact of the major client’s e-book revenue decline, and the concentration and payment status of customer receivables.
- Track whether restructuring savings are realized and whether IADS revenue growth can reduce its losses.
- Review cash conversion, elevated DSO, planned capital spending, and the June 2013 expiry of the undrawn credit line.
- Follow outcomes of Indian tax disputes and the Philippines litigation, including any change in recorded provisions or exposure.
- Reconcile an inconsistency in the filing: the segment table reports $40,000 of Q3 2012 IADS revenue, while the MD&A says there were no IADS revenues for that quarter.