Innodata Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results; dollar amounts below are in millions unless stated otherwise. Innodata provides digital data services and solutions through Digital Data Solutions (DDS), Innodata Advanced Data Solutions (IADS), and Media Intelligence Solutions (MIS).
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $15.30 | $15.64 | $30.25 | $31.34 |
| Loss before tax | $(0.14) | $(1.61) | $(1.53) | $(1.20) |
| Net loss attributable to Innodata | $(0.17) | $(1.78) | $(1.90) | $(1.78) |
| Basic and diluted loss per share | $(0.01) | $(0.07) | $(0.07) | $(0.07) |
| Adjusted EBITDA | $0.96 | $(0.68) | $0.79 | $0.67 |
For Q2, direct operating costs were 74% of revenue and selling and administrative expenses were $4.04 million, or about 26% of revenue. For the first half, direct operating costs were $23.12 million (about 76% of revenue) and selling and administrative expenses were $8.67 million (about 29%). The filing does not present a separate consolidated operating-margin figure.
- Segment revenue, Q2: DDS $11.80 million (down 11% year over year); IADS $1.21 million (roughly flat); MIS $2.29 million (up 92%).
- Segment revenue, first half: DDS $23.16 million (down 14%); IADS $2.21 million (up 7%); MIS $4.89 million, up from $2.40 million, primarily reflecting the Agility acquisition.
- Cash flow, first half: Operating cash flow was $3.66 million, investing cash outflow $2.30 million, and financing cash outflow $0.25 million. Cash increased $1.10 million to $15.28 million. Operating cash flow less capital expenditures was approximately $1.36 million.
- Liquidity and obligations: Working capital was $11.56 million, down from $14.41 million at December 31, 2016. Current liabilities were $16.71 million. Long-term obligations were $4.57 million, with a further $2.00 million current portion; these include pension, lease, software-license, and acquisition-related obligations. The company reported no bank facilities or lines of credit.
Changes and notable items
- Consolidated revenue fell 2% in Q2 and 3% for the first half. Management attributed the DDS decline mainly to reduced volume from a key e-book client ($1.8 million in Q2 and $2.8 million in the first half) and lower volume from other clients. A new customer ramp-up partly offset the first-half decline.
- Q2 results improved substantially versus 2016, including positive Adjusted EBITDA, alongside a $1.51 million reduction in selling and administrative expenses. The prior-year quarter included $1.25 million of DDS legal, professional, and other costs for an internal investigation. Q2 2017 expenses also benefited from client receivable recoveries.
- Q2 DDS revenue included $1.1 million previously deferred from September 2016 and recognized on a cash basis; the client paid its outstanding balance during the quarter. The filing also notes recovery of a $0.1 million receivable reserve and $0.11 million from another client.
- The Agility business, acquired in July 2016 for approximately $4.2 million, contributed to MIS growth. In March 2017, the company issued 253,622 shares for 70% of the first supplemental MediaMiser purchase-price installment and paid the remaining 30% in cash.
- Capital expenditures were $2.30 million in the first half, versus $0.87 million a year earlier, mainly for U.S. and Canadian office relocations and technology infrastructure.
Outlook, risks, and contingencies
- Management expects existing cash and internally generated funds to meet financial needs for the next 12 months, but warns that continued material cash reductions could adversely affect the company. It has no credit lines. Approximately $11.8 million of the $15.3 million cash balance was held by foreign subsidiaries; repatriation could incur U.S. federal taxes. Management expects $7.0 million of additional deferred intercompany payments through 2018 due to insufficient U.S. entity cash, with related deemed dividends offset against U.S. net operating loss carryforwards.
- Expected capital expenditures for the next 12 months are $2.0 million to $3.0 million, with a portion potentially financed. Management intends to continue investing net of revenues in IADS at approximately $0.1 million to $0.4 million per quarter; the segment has incurred losses since inception.
- Customer concentration remains significant: two DDS clients generated approximately 28% of Q2 revenue and 29% of first-half revenue; another DDS client generated 10% of Q2 revenue. Project-based work, client cancellations or reduced volumes, and dependence on a limited number of clients are identified risks.
- A Philippine labor judgment orders reinstatement and payment of back wages and benefits totaling approximately $7.0 million, plus accrued legal interest. Management, after consulting counsel, believes financial recovery against Innodata is unlikely; a substantial recovery could nevertheless materially affect the company. Other proceedings could also produce adverse results.
- Tax exposures include Indian assessments and an ongoing dispute over whether an Indian subsidiary’s services are subject to approximately 14.5% service tax. The subsidiary’s 2016 revenue was $16.8 million; the company contests the tax authority’s position. The filing also reports approximately $1.27 million of unrecognized tax benefits and ongoing Philippine tax proceedings.
- Foreign exchange exposure is partly hedged with forward contracts totaling $24.8 million notional; the reported unrealized loss was about $0.2 million. Wage inflation in operating countries and project start-up or replacement delays may pressure margins. Management also notes seasonal fluctuations in Synodex activity.
- The company plans to adopt the new revenue standard on January 1, 2018, using the modified retrospective method; its impact was still under assessment. It expects the new lease standard to increase reported assets and liabilities, potentially materially. No full-year revenue or earnings guidance is provided.
Important facts for investors to verify
- Whether DDS revenue declines and client concentration persist, and whether the new customer ramp-up can offset lower e-book volumes.
- How much of Q2’s improvement reflects sustainable cost performance versus prior-year investigation costs, client recoveries, and recognition of previously deferred revenue.
- Whether operating cash flow remains adequate after capital expenditures, continued IADS investment, and upcoming contractual obligations.
- Developments in the Philippine labor case, Indian service-tax dispute, and other tax assessments, including potential cash and earnings impacts.
- The eventual effects of revenue-standard adoption and lease accounting on reported results, assets, liabilities, and disclosures.