Innodata Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited. Innodata provides digital data, advanced data and media intelligence services through its DDS, IADS and MIS segments.
Financial performance and position
- Revenue: Q3 revenue was $16.1 million, up 6% year over year; nine-month revenue was $47.4 million, up 10%. Q3 DDS revenue fell 11% to $12.1 million, while IADS rose 100% to $1.0 million and MIS rose 125% to $3.0 million. Nine-month growth was led by IADS (+121%) and MIS (+50%), including Agility revenue after its July acquisition.
- Profit and margins: Q3 net loss attributable to Innodata was $2.8 million versus $0.4 million of income a year earlier; diluted loss per share was $0.11. Nine-month attributable loss was $4.5 million versus $2.2 million, or $0.18 per diluted share. Q3 Adjusted EBITDA was a loss of $0.4 million versus $1.7 million of income; nine-month Adjusted EBITDA was income of $0.3 million versus $1.0 million. Direct costs were 79% of Q3 revenue (69% prior year) and 75% for nine months (76% prior year); selling and administrative costs were 32% and 31%, respectively, versus 26% and 29%.
- Cash flow: Nine-month operating cash flow was negative $1.1 million, versus positive $2.3 million in 2015. Investing cash outflow was $6.1 million, including $4.1 million for Agility and $2.1 million of capital expenditures. Cash declined $7.6 million to $17.3 million.
- Liquidity and obligations: Working capital was $15.5 million, down from $25.0 million at December 31, 2015. Cash was $17.3 million, including $15.7 million held by foreign subsidiaries. Total current and long-term obligations were $5.5 million, including pension obligations and acquisition-related liabilities; the filing does not identify material conventional bank borrowings. Contractual cash obligations were $3.6 million, principally operating leases.
- Balance sheet: Total assets were $50.9 million and stockholders’ equity was $34.8 million at September 30, 2016. Goodwill was $2.7 million and net intangible assets were $8.6 million, reflecting the Agility acquisition.
Material changes and unusual items
- Agility was acquired on July 14 for $4.1 million cash. The preliminary allocation included $5.7 million of identifiable assets, $2.9 million of assumed liabilities and $1.2 million of goodwill. Agility contributed to MIS revenue only from the acquisition date.
- The MediaMiser supplemental purchase price was amended to a fixed $1.5 million, payable in two equal installments in 2017 and 2018, with up to 70% payable in Innodata shares. The amendment generated a $1.0 million Q3 expense.
- Management reported approximately $1.5 million of legal and professional costs through September related to an internal investigation into potentially improper payments by foreign subsidiary employees; up to $100,000 of additional Q4 costs was expected. The employees involved are no longer employed. The company voluntarily contacted the DOJ and SEC and said it could not predict any government action or penalties.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management expects $2.0–$3.0 million of capital expenditures over the next 12 months and plans to invest $0.5–$0.7 million per quarter in IADS. Management believes cash and internally generated funds will meet needs for the next 12 months, but may curtail investment or reduce expenses if liquidity proves insufficient and attractive financing is unavailable.
- IADS has incurred losses since inception; management intends to continue investing. DDS depends on project-based work and a limited number of clients: two clients generated 30% of nine-month revenue. The filing cites contract cancellations or reductions, project replacement, wage inflation, competition, integration challenges and foreign exchange movements as risks.
- Indian tax matters include an inquiry over whether services are subject to a 14.5% service tax rather than an asserted exemption. The Indian subsidiary generated $12.7 million of revenue in the first nine months; the company contests the position. Appeals also challenge prior service-tax refunds, which management expects may be delayed. The filing reports a separate approximately $8.0 million Philippines labor judgment; management believes recovery against Innodata is unlikely, but says an adverse outcome could be material.
- Management projected a U.S. entity cash shortfall from deferred payments to Asian subsidiaries through 2018. The filing gives different estimates—approximately $2.2 million in the tax note and $2.4 million in MD&A. The deferrals create deemed dividends taxable in the U.S. and offset against net operating loss carryforwards.
- The company uses foreign-currency forward contracts with $17.7 million notional value; management noted continuing exposure to currencies and foreign-held cash. Quarterly results may also fluctuate with project start-ups, holiday overtime and Synodex seasonality.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether DDS revenue and profitability stabilize after Q3’s revenue decline and margin deterioration, and whether client concentration changes.
- Agility’s revenue contribution, integration progress, operating costs and realized strategic benefits.
- Cash generation and liquidity, including foreign-cash availability, planned capital spending and the conflicting $2.2 million/$2.4 million projected cash-shortfall estimates.
- Outcomes and potential costs of the DOJ/SEC-related investigation, Indian service-tax matters and the Philippines litigation.
- The sustainability of IADS investment and whether the segment can reduce its operating losses.