Innodata Inc. — Q2 2014 Form 10-Q
Business context and period. Unaudited results for the three and six months ended June 30, 2014. Innodata provides digital-content, business-process, IT and professional services through Content Services (CS) and Innodata Advanced Data Solutions (IADS). Unless noted, amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $14.3m | $16.2m | $28.4m | $33.1m |
| Direct operating costs | $11.3m | $13.4m | $21.6m | $26.2m |
| Selling and administrative expenses | $3.9m | $4.4m | $7.7m | $9.0m |
| Pretax loss | $0.8m | $1.5m | $0.9m | $1.9m |
| Net income (loss) attributable to Innodata | $(0.7)m | $(0.1)m | $(0.5)m | $0.2m |
| Basic and diluted EPS | $(0.03) | $(0.00) | $(0.02) | $0.01 |
| Operating cash flow | Not separately reported for the quarter | $4.4m | $1.7m |
Revenue less direct operating costs, a simple margin proxy rather than a reported gross margin, was about 20.9% in Q2 2014 versus 17.0% in Q2 2013, and 23.9% for the first half versus 20.7% in the prior-year period. Direct costs declined faster than revenue; management attributed this to lower production headcount, restructuring and productivity improvements. S&A was about 27% of revenue in both Q2 periods and both first-half periods.
At June 30, cash and cash equivalents were $28.1m, working capital was $30.1m, and current assets and current liabilities were $40.0m and $9.9m. Total assets were $52.1m. Long-term obligations, including their current portion, totaled $6.1m and included pension obligations, lease obligations and vendor obligations. The $15m uncommitted bank line expired in June without borrowings. Cash increased $3.4m in the first half; investing used $1.5m, principally for capital expenditures, and financing provided $0.4m.
Changes versus the prior comparable period
- Q2 revenue fell 11% year over year; first-half revenue fell 14%. CS revenue declined 12% in Q2 and 13% for the first half. Management linked the first-half CS decline chiefly to reduced e-book work from one client ($2.0m) and reduced other services from another ($2.3m).
- Q2 consolidated net loss attributable to Innodata widened to $0.7m from $0.1m. First-half results shifted from attributable income of $0.2m to a loss of $0.5m. The company cited higher tax expense, including comparison with prior-year tax benefits, as a key factor in the CS earnings decline.
- IADS revenue was $0.2m in Q2 and $0.3m for the first half, while its first-half net loss was $2.8m. Its loss improved from $3.1m in the prior-year half, reflecting lower headcount and administrative costs.
- First-half operating cash flow rose to $4.4m from $1.7m, helped by working-capital sources, including $2.5m from accounts-receivable collections. DSO was approximately 68 days, compared with 74 days at year-end 2013.
Outlook, risks and unusual items
- Management said existing cash and internally generated funds should meet financial needs for the next 12 months. It expected to invest $1.3m–$1.5m per quarter in IADS in the immediate future, while noting that investment could be curtailed if internal funds proved insufficient and outside financing was unattractive. IADS had accumulated approximately $27m of investment and had minimal revenue; all its fixed assets had been written off.
- Expected capital expenditures over the next 12 months were $3.0m–$4.5m, with a portion potentially financed. The filing gives no specific full-year revenue or earnings guidance.
- On July 28, 2014, after quarter-end, Innodata acquired MediaMiser. Non-contingent consideration was C$5.78m (approximately US$5.38m), including C$4.40m cash at closing; contingent consideration could reach C$5.0m (approximately US$4.60m), based on future revenue and EBITDA. The Q2 financial statements do not reflect this transaction.
- Customer concentration is significant: two clients together generated approximately 32% of Q2 revenue and 32% of first-half revenue. At June 30, three clients represented 47% of receivables. The company also relies on project-based work and clients may reduce, delay or cancel projects.
- Foreign-exchange exposure arises because much operating cost is incurred in local currencies. Forward contracts had a $17.5m notional amount; management stated that a 10% U.S. dollar appreciation against hedged currencies could reduce their fair value by about $1.6m, with the underlying hedged cash flows expected to substantially offset changes. Foreign subsidiaries held $23.5m of cash; management intended to permanently reinvest it abroad.
- Tax contingencies include approximately $1.8m of unrecognized tax benefits. Indian and Philippine tax matters remain under challenge or review. A Philippines employment judgment involving approximately $8.0m of back wages and benefits is described as unlikely to be recoverable against Innodata, according to management and counsel; the filing also says reasonably possible adverse outcomes on other claims could total about $0.25m beyond recorded amounts.
- Management identified wage inflation, project replacement and startup timing, competition, technology changes, acquisition integration and IADS execution among risks. The filing says disclosure controls were effective and reports no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether CS revenue stabilizes and whether the company can offset continued dependence on a small number of large clients.
- Whether cost reductions and productivity gains sustain improved direct-cost margins as revenue changes.
- IADS revenue traction, ongoing quarterly investment needs and the potential for further losses or impairment.
- Cash availability and deployment after the MediaMiser acquisition, including any earn-out, share issuance or financing needs.
- Collection trends, client receivable concentration, foreign-currency exposure and the outcome of tax and legal contingencies.