Innodata Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; comparisons are with the same periods in 2012 unless otherwise noted. Innodata provides digital content, information technology and professional services through Content Services (CS) and Innodata Advanced Data Solutions (IADS). Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $15.7 million | $19.7 million | $48.8 million | $67.6 million |
| Income (loss) before taxes | $(5.7) million | $1.0 million | $(7.6) million | $6.7 million |
| Net income (loss) attributable to Innodata | $(11.7) million | $1.3 million | $(11.5) million | $6.8 million |
| Basic and diluted EPS | $(0.47) | $0.05 | Basic $(0.46); diluted $(0.46) | Basic $0.27; diluted $0.26 |
| Operating cash flow | Not separately reported | Not separately reported | $1.5 million | $13.1 million |
Revenue fell approximately 20% in Q3 and 28% year to date, primarily because a significant client reduced eBook-related work. CS accounted for $15.6 million of Q3 revenue and $47.9 million year to date; IADS revenue was $0.2 million and $0.9 million, respectively.
Direct operating costs were 76% of revenue in Q3 versus 69% a year earlier, and 78% year to date versus 65%. On that basis, the implied gross margin was approximately 24% for Q3 and 22% year to date, compared with approximately 31% and 35%, respectively. Selling and administrative expense declined 24% in Q3 and 23% year to date, but lower revenue and weaker cost absorption pressured margins.
Balance sheet, liquidity and cash flow
- At September 30, cash and cash equivalents were $25.1 million, short-term investments $1.1 million, and working capital $27.6 million, down from $32.8 million at year-end 2012. Cash and investments totaled $26.2 million; approximately $23.5 million was held by foreign subsidiaries and may be subject to tax if repatriated.
- Total assets were $50.3 million, down from $66.2 million at December 31, 2012. Stockholders’ equity was $37.9 million, down from $50.5 million.
- Long-term obligations were $3.8 million, with a further $0.3 million current portion. The company had no borrowings on its $15 million receivables-backed credit line, which expires in June 2014.
- Nine-month operating cash flow of $1.5 million compared with $13.1 million in 2012. Investing activities used $1.5 million, including $3.5 million of capital expenditures offset by $2.0 million from investment maturities. Cash declined by $0.3 million over the period.
- Accounts receivable was $10.8 million, down from $14.3 million at year-end; reported DSO was approximately 70 days, compared with 76 days at December 31, 2012.
Material changes and unusual items
- In Q3, Innodata recorded a $5.5 million impairment of Synodex fixed assets. Synodex has generated no significant revenue to date and has incurred losses since inception.
- The company established a $7.1 million valuation allowance against U.S. deferred tax assets, citing uncertainty about future taxable income from Synodex, and a $0.7 million allowance against deferred tax assets related to unrealized foreign-exchange forward losses. The Q3 tax provision was $7.3 million despite a pretax loss; the nine-month provision was $5.8 million.
- IADS’s pretax loss after intersegment eliminations was $7.1 million in Q3 and $10.3 million for the nine months. CS pretax income after eliminations was $1.4 million and $2.7 million, respectively.
- Three clients generated approximately 42% of Q3 revenue; two clients generated 27% of nine-month revenue. Four clients accounted for 62% of accounts receivable at quarter-end.
- Accumulated other comprehensive loss was $1.7 million at September 30, largely reflecting foreign-currency derivative fair-value changes. Forward contracts had a $26 million notional amount and a $1.7 million liability fair value.
Outlook, risks and contingencies
Management said existing cash, operating cash generation and available credit should be sufficient for financial needs over the next 12 months. It expected to invest an amount similar to Q3’s approximately $2.2 million in IADS during Q4, and anticipated $4–$5 million of capital expenditures over the next 12 months. No specific revenue or earnings guidance was provided. Management cautioned that continued IADS investment without significant revenue could require additional debt or equity financing.
Key risks include client concentration, project-based and potentially cancellable work, difficulty replacing completed or reduced projects, weak IADS revenue and continuing losses, and exposure to wage inflation and foreign-exchange movements. Management cited approximately $8.5 million of back-wage claims in a Philippines legal matter and believes recovery against Innodata is unlikely; it also said adverse outcomes beyond recorded legal reserves of approximately $0.3 million in aggregate are reasonably possible. Tax assessments and audits in India and the Philippines remain matters to monitor. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether CS revenue and margins stabilize after the major client’s reduction in eBook-related work.
- Whether Synodex or other IADS operations can generate meaningful revenue relative to their continuing costs and planned investment.
- The basis and potential future effects of the deferred-tax valuation allowances and the unusually large tax provision during a loss period.
- Cash availability and repatriation costs, foreign-exchange exposure, and the company’s ability to fund planned investment and capital expenditures.
- Developments in tax disputes and legal proceedings, including the Philippines claims and possible losses beyond recorded reserves.