Innodata Inc. — Q2 2013 Form 10-Q
Business and period: Unaudited results for the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. Innodata provides digital-content, business-process and technology services through Content Services (CS) and Innodata Advanced Data Solutions (IADS). Unless stated otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $16.16m | $22.77m | $33.06m | $47.90m |
| Direct operating costs | $13.42m | $14.65m | $26.21m | $30.76m |
| Selling and administrative expense | $4.36m | $6.19m | $8.98m | $11.59m |
| Income (loss) before tax | ($1.50m) | $2.02m | ($1.87m) | $5.74m |
| Net income (loss) attributable to Innodata | ($0.12m) | $2.09m | $0.20m | $5.52m |
| Operating cash flow | — | $1.67m | $10.19m |
Revenue fell approximately 29% in Q2 and 31% for the six-month period. Direct operating costs were 83% of revenue in Q2 and 79% for the half, versus 64% in both 2012 comparison periods. Revenue less direct operating costs was approximately 17% of revenue in Q2 and 21% for the half, down from approximately 36% in each 2012 period. The filing does not present a separate consolidated operating-margin figure.
Consolidated net loss was $0.49m in Q2 2013 and $0.38m for the first half; losses attributable to non-controlling interests resulted in positive attribution to Innodata of $0.20m for the half. Attributable diluted EPS was approximately break-even in Q2 and $0.01 for the half, versus $0.08 and $0.21, respectively, in 2012.
Liquidity, debt and cash flow
- At June 30, 2013, cash and cash equivalents were $24.38m, short-term investments were $2.77m, working capital was $28.60m, and total assets were $64.85m. Cash and investments declined from $28.52m at December 31, 2012 to $27.15m.
- Long-term obligations were $4.22m, including $0.54m current and $3.68m long-term. The company had no borrowings under its $15m receivables-backed credit line, which expires in June 2014.
- First-half operating cash flow of $1.67m compared with $10.19m in 2012. Investing used $2.65m, including $2.97m in capital expenditures; financing used $0.06m. Cash declined by $1.05m during the half.
- Days sales outstanding improved to approximately 60 days from 76 at year-end 2012. About $20m of cash and $2.77m of short-term investments were held by foreign subsidiaries.
Changes, outlook and risks
- The revenue decline was principally due to reduced eBook-related work for a significant CS client. CS revenue fell about 30% in Q2 and 32% for the half; IADS revenue remained small at $0.15m in Q2 and $0.79m for the half.
- Management attributed lower selling and administrative costs in part to a 2012 restructuring. However, lower volumes did not reduce direct costs proportionally, compressing margins. IADS reported a first-half segment loss of approximately $3.1m after intersegment eliminations.
- Management expected IADS investment to continue at approximately the Q2 level of $2.2m in each of Q3 and Q4. Planned capital expenditures for the next 12 months were approximately $4m–$5m. No revenue or earnings guidance was provided. Management believed available cash, operating cash flow and credit availability would meet needs for the next 12 months.
- Customer and project concentration remain material: two clients generated approximately 27% of first-half revenue, and two other clients together generated 25%. Contracts may be at-will or project-based, and volumes may be reduced, delayed, canceled or not replaced. IADS had not yet generated substantial revenue.
- Foreign-exchange exposure is partly hedged with forward contracts totaling $33.2m notional; their June 30 fair value was a $1.83m liability, with a substantial first-half adverse change recorded in other comprehensive income. Foreign-held cash and investments were not hedged against currency movements.
- Tax matters include approximately $2.18m of unrecognized tax benefits and disputed Indian assessments. A Philippine subsidiary received an informal $3.8m tax assessment; no provision was recorded, and management considered a successful contest reasonably likely. A separate Philippine employment judgment of approximately $8.5m was disclosed; management believed recovery against Innodata was unlikely. Other legal matters could result in estimated losses of approximately $0.3m beyond recorded amounts.
- Non-cancelable operating lease commitments totaled $9.31m. Management cited wage inflation, quarterly project-transition variability, and the risk that fixed or variable client work may not offset rising costs. Disclosure controls were reported effective, with no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether CS can replace or recover the lost eBook-related work and improve direct-cost ratios as revenue changes.
- Customer concentration, project renewals and the timing and commercial traction of IADS investments.
- Cash generation and the planned $4m–$5m capital spending, including the location and availability of foreign-held funds.
- Outcomes of Indian and Philippine tax matters, the Philippine employment litigation, and changes to related reserves or exposures.
- Foreign-currency hedge valuation and the sensitivity of costs and cash holdings to exchange-rate movements.