INOD

Business Context and Reporting Period

Company: Innodata Isogen, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010
Business Overview: The Company provides knowledge process outsourcing (KPO) and publishing/information technology (IT) services to media, publishing, and information service companies. Services include digitization, content creation, research, and IT system deployment using a distributed global workforce.

Key Financial Metrics

Note: Direct operating costs as a percentage of revenue increased to 79% for the six months ended June 30, 2010, compared to 62% in the prior year period.

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 26% ($5.5 million) for the quarter and 27% ($11.1 million) for the six months compared to the prior year. This was primarily driven by a significant reduction in revenue from one of the Company's top two clients.
• Profitability Shift: The Company reported a net loss of $0.9 million for the quarter and $2.3 million for the six months, a reversal from net income of $3.2 million and $6.8 million, respectively, in the prior year periods.
• Expense Increases: Selling and administrative expenses increased 23% for the quarter and 19% for the six months, attributed to new sales hires and unfavorable foreign exchange rates.
• Foreign Exchange Impact: Strengthening of the Philippine peso and Indian rupee against the U.S. dollar increased direct operating costs by $1.5 million for the six-month period, partially offset by gains from foreign currency forward contracts.
• Investment Activity: The Company utilized $7.6 million in cash to purchase short-term and long-term investments (certificates of deposit) during the six-month period.

Guidance, Outlook, and Risks

• Client Concentration: The top two clients accounted for 29% of revenue for the six months ended June 30, 2010 (down from 55% in the prior year). Management considers it unlikely that revenue from the declining top client will resume 2009 levels in the near term.
• Liquidity: The Company maintains $19.4 million in cash and equivalents and a $7.0 million line of credit (currently unutilized). Management believes existing resources are sufficient for the next 12 months.
• Tax Contingencies: An Indian subsidiary is subject to ongoing tax audits. The Company recorded a $360,000 provision for uncertain tax positions for the six months ended June 30, 2010, and is contesting assessments totaling approximately $339,000 to $340,000 for prior years.
• Legal Proceedings: A Philippine subsidiary faces a court order for reinstatement of former employees and payment of back wages aggregating approximately $7.5 million. Management believes recovery against the parent company is unlikely but acknowledges the risk of material adverse impact if the ruling is enforced.
• Capital Expenditures: Anticipated capital expenditures for the next 12 months are estimated at $3.0 to $4.0 million.

Investor Verification Checklist

• Client Dependency: Verify the status of contracts with the top two clients, which historically drove over 50% of revenue but dropped to 29% in the current period.
• Foreign Currency Hedging: Review the effectiveness of the $34 million notional amount of foreign currency forward contracts in mitigating the impact of strengthening Asian currencies.
• Tax Exposure: Monitor the outcome of the Indian Bureau of Taxation audits and the potential for additional tax provisions beyond the $360,000 recorded.
• Legal Liability: Assess the likelihood of the $7.5 million Philippine labor judgment impacting the parent company's financial position.
• Recurring Revenue Mix: Confirm the sustainability of the shift toward recurring revenue (72% of total for the six months) versus project-based work.