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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER 0-22196
INNODATA ISOGEN, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3475943
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
THREE UNIVERSITY PLAZA
HACKENSACK, NEW JERSEY 07601
(Address of principal executive offices) (Zip Code)
(201) 488-1200
(Registrant's telephone number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK,
$.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes |_| No |X|
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. $25,500,000
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
21,951,000 SHARES OF COMMON STOCK, $.01 PAR VALUE, AS OF FEBRUARY 29, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
[SEE INDEX TO EXHIBITS]
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PART I
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ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL DESCRIPTION
Innodata Isogen, Inc., formerly known as Innodata Corporation, improves
the way companies create, manage and distribute information - helping them
reduce content-related costs, achieve better outcomes and compete more
effectively in demanding global markets.
Our solutions encompass both the manufacture of content (for which we
provide services such as digitization, imaging, data conversion, XML and markup
services, metadata creation, advanced classification services, editorial and
knowledge services) as well as the design, implementation, integration and
deployment of the systems used to manage content (for which we provide custom
application development, consulting and training.)
We serve leading organizations in four content-rich segments: (1)
publishing, media and information services, (2) culture and education, (3)
government and (4) global enterprise - including Global 2000 companies across
more than a dozen sectors, such as aerospace, defense, engineering, financial
services, e-commerce, healthcare, information technology, intelligence,
manufacturing, pharmaceuticals, retail and telecommunications.
We have more than a hundred active clients, including Amazon.com, Reed
Elsevier, Thomson, Wolters Kluwer, EBSCO, ProQuest, Simon & Schuster, McGraw
Hill, Derwent Information, John Wiley & Sons, Lockheed Martin, Hamilton
Sunstrand, Primerica, CAB International and the Smithsonian Institution.
We typically service these clients in multi-year relationships. In 2003,
more than 90 percent of our revenue was derived from clients that used our
services for more than one year, and more than 80 percent of our revenue was
derived from clients that used our services for more than two years.
We were incorporated in Delaware in June 1988 and are headquartered in
Hackensack, New Jersey, just outside New York City. We have two additional
solutions centers in North America, seven production facilities in Asia (the
Philippines, India and Sri Lanka), and a technology and tools development center
in India.
THE CONTENT SUPPLY CHAIN
Our wide range of content-related offerings is organized in a clear
conceptual framework - the content supply chain. A content supply chain is the
series of integrated activities necessary to create, manage and distribute
information products.
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Another way to describe the content supply chain is the business process
that transforms ideas into actual information products. This business process is
the strategic focus of our company at present.
Innodata Isogen optimizes content supply chains. Our clients can choose
from an array of point solutions or deploy an integrated set of services - or
they can simply outsource their entire content supply chain to us to maximize
the value of their operational dollars.
Each client we serve makes a distinct set of demands on content. Each has
different objectives. Each, therefore, has somewhat distinct challenges in its
content supply chain.
For instance, many of our publishing clients are under enormous
competitive pressure to cut costs, while at the same time, manufacturing and
marketing information products with enhanced features, functionality and quality
in rapid response to market conditions.
In the wider enterprise arena, requirements for greater and more accurate
technical, product and regulatory documentation are increasing. The result is
that the burden of content creation, management and distribution is also
growing. These spiraling costs multiply further as global enterprises broach new
nations, markets and cultures, and these costs come right out of a company's
bottom line.
At the same time, major cultural and educational institutions, as well as
a number of important government agencies, are seeking new and better ways of
leveraging vast stores of aggregated content to fulfill their respective
missions - even as greater demands are being placed on their limited human,
technical and financial resources.
Whether a client uses content to support products and services (as in the
case of equipment manufacturers), or sells content as the basis of a business
model (as in the case of publishers), we can help them realize significant cost
savings and greater productivity, maintain or improve content quality, and
achieve better overall outcomes.
BASIC STRUCTURE OF OPERATIONS
We have two main operating units: content services and professional
services. (We formerly referred to the professional services unit as systems and
training services).
In addition to providing sophisticated content creation and editorial
services (such as indexing & abstracting), the content services unit collects,
processes, digitizes and encodes large volumes of content. The content services
unit also transforms content to Extensible Markup Language (XML), creating large
XML-compliant content repositories for single-source publishing and other
activities.
Our largest XML production facility, the XML Content Factory in the
Philippines, is the largest known purpose-built for the manufacture of XML
content.
The professional services unit designs and builds powerful XML-based
content management and publishing systems, and provides data modeling, systems
integration, custom application development and consulting services.
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Professional services also instructs both front-line technologists and
their executive managers on structured information standards (such as XML) and
their larger implications for business systems.
CONTENT SERVICES
At present, the conversion of hardcopy and paper collections and
legacy-formatted electronic data to a variety of output formats - including XML
other related markup standards - is an important part of our overall offerings.
For this purpose, we use high-speed scanning; a variety of commercial and
proprietary OCR/ICR (optical/intelligent character recognition) applications;
structured workflow processes; and proprietary applications and tools (including
custom filters and parsers) designed to create accurate, consistent markup and
data. We use proprietary technology for data enhancement and validation, and
create automated procedures - utilizing industry standards-compliant software
tools to ensure validated SGML and XML markup.
Another important offering is knowledge services. We employ hundreds of
highly educated subject matter experts in fields such as law, finance,
education, science, medicine, and engineering. They provide content development
and enhancement, taxonomy and controlled vocabulary development, hyperlinking,
tagging, indexing and abstracting and general editorial services. We typically
price these services on a resource-utilization basis or quantity-delivered
basis.
An increasing number of publishing organizations are migrating to
XML-based, single-source publishing systems, creating a single content
repository from which to create multiple information products (as opposed to
having to build a separate data store for each information product) to save time
and money.
What's more, publishers who maintain their content in XML can syndicate
content and spontaneously synthesize content for interactive Web services. XML
content transformation is the prerequisite for content owners to accomplish
these outcomes.
To transform content to XML, tags are inserted within the content to give
the content context and meaning that computers can process. Our proprietary
technology includes production-grade, auto-tagging applications that utilize
pattern recognition algorithms based on comprehensive rule sets and heuristic
online databases. This technology enables mass creation or conversion of XML
content from complex, unstructured information.
We also translate desktop publishing documents (QuarkXPress, PDF, MS Word,
etc.) to XML variants, from which we generate a variety of file formats (HTML,
OeB, PDF, proprietary eBook formats, etc.) to support multiple channels of
distribution. We typically price these services based on units of data produced
or transformed.
Underlying all content services activities is a sophisticated information
technology and communications infrastructure, which enables multiple production
processes to be performed simultaneously across any number of our production
facilities.
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We use server-based information technology to operate through a structured
workflow using advanced tools. We drive efficiency and quality by using advanced
manufacturing and management techniques including total quality management and
statistical process control.
PROFESSIONAL SERVICES (FORMERLY SYSTEMS AND TRAINING SERVICES)
Clients who use our professional services typically require publishing,
performance support or process automation systems that enable multiple authors
to collaborate on content and enable multiple products to be generated from
single-source XML repositories.
We design and build these powerful XML-based systems, and provide
full-service consulting and systems integration services to configure, improve,
and validate these and other software systems and technologies. Services are
provided in accordance with ISO, IEC, ANSI, IETF, and W3C standards.
We deliver sophisticated classification services, using topic maps,
taxonomies and ontologies, and provide clients training in the associated tools
and methodologies. We also provide clients with professional training,
courseware and continuing education in XML and other structured information
standards.
In addition, our professional services division fields skilled process
analysts, workflow architects and project managers, which enables us to offer
our clients the opportunity to not only outsource operations, but also to
transform and enhance them. This enables our clients to achieve even greater
value from outsourcing, and is often referred to as business transformation
outsourcing.
We typically price professional services on either an hourly basis for
actual time and expense incurred, or on a fixed-fee, turnkey basis. Revenue for
services billed under fixed-fee arrangements is recognized using the
percentage-of-completion method under contract accounting as services are
performed or output milestones are reached. The percentage completed is measured
either by the percentage of labor hours incurred to date in relation to
estimated total labor hours or in consideration of achievement of certain output
milestones, depending on the specific nature of each contract. Revenue for
contracts billed on a time and materials basis is recognized as services are
performed.
BUSINESS STRATEGY
We aim to be a principal strategic partner to information-intensive
organizations worldwide, providing comprehensive content supply chain solutions
that enable them to compete more aggressively and better respond to market
challenges.
To accomplish this, we intend to capitalize on the increased willingness
of organizations in our markets to (a) use business process outsourcing to
reduce expenses associated with content creation, management and distribution,
(b) leverage the concentrated expertise, talent and capital investment of
business process specialists, and (c) focus internal resources on other critical
competitive activities, such as business strategy, product definition and
development, sales and marketing and customer relationship management to
generate more unique value for their customers.
I-4
We aim to respond to our clients' increased interest in publishing
information more efficiently and economically from a single repository to
multiple channels (i.e., Web, print, CD, print-on-demand, PDA, mobile phone and
other formats and devices) and to re-use existing content assets to quickly
create new products.
We understand that there is a vast quantity of textual, audio, and video
content that will be made available via digital processes and technologies. We
believe many publishers will choose XML and its related standards to help
accomplish this. We intend to be the first choice for organizations requiring
large-scale, high fidelity XML transformations, as well as XML systems
development and training.
TARGET MARKETS
We will target our business development efforts to information-intensive
organizations, such as leading commercial publishers, media companies and
information services providers, Global 2000 enterprises, major cultural and
educational institutions and government agencies.
Specifically, we plan to drive opportunities with these organizations by:
o Expanding existing relationships and developing new, long-term
relationships with organizations that have substantial and recurring
requirements for content supply chain services; and
o Leveraging our business process and technical expertise, worldwide data
manufacturing capabilities, high-value talent pool and information
technology infrastructure to achieve substantial cost savings for clients,
while enabling them to deliver high-quality information products more
rapidly.
Furthermore, we aim to dominate the market for XML transformation,
systems, and training by:
o Deploying existing and emerging technologies to develop large-scale XML
content repositories more efficiently;
o Maintaining our position as a preferred provider of large-scale XML
content services, while extending our leadership in XML systems and
consulting;
o Entering into additional engagements with high-profile clients for
large-scale XML content services; and
o Continuing to take an active role in developing structured information
standards.
In addition, we intend to:
o Extend our offerings consistent with our position as a leading provider of
content supply chain solutions;
I-5
o Design customized, value-added offerings to meet the unique needs of
clients in targeted vertical markets;
o Embrace new technology initiatives that are strategic for our clients; and
o Maintain a significant base of business to continue to generate economies
of scale, which enable us to achieve competitive costs.
CLOSE RELATIONSHIPS WITH CLIENTS
We view our long-term relationship with clients as a critical element in
our historical and future success.
To continue to meet the needs of existing and prospective clients in a
timely fashion, we work directly with our clients to identify and develop new
and improved offerings.
To promote continued close relationships with clients, we provide 24/7
project support through our Asia-based customer service center, and maintain
sales, solutions and strategic support in North America and Europe, in proximity
to the business operations of most of our current clients.
We generally perform our work for our clients under project-specific
contracts, requirements-based agreements, or long-term arrangements. Contracts
are typically subject to numerous termination provisions.
One client accounted for 33% and 17% of our revenues for the years ended
December 31, 2003 and 2002 respectively, and a second client accounted for 30%
of our revenues for the year ended December 31, 2002. One other client, which
substantially curtailed operations, accounted for 30% in the year ended December
31, 2001. No other client accounted for 10% or more of revenues during this
period. Further, in the years ended December 31, 2003, 2002 and 2001, export
revenues, substantially all of which were derived from European clients,
accounted for 47%, 23%, and 13%, respectively, of our revenues.
We are from time to time required by clients to enter into non-disclosure
agreements pursuant to which we agree not to disclose their identity or the
nature of our relationship with them.
Reasons for requiring such arrangements vary, but typically involve a
preference on the part of the client not to publicize its outsourcing strategy
or to telegraph to competitors a new product development initiative.
COMPREHENSIVE SERVICE OFFERINGS
The breadth and depth of our service offering distinguishes us from our
competitors. Many competitors offer only a single service, such as data capture,
but do not offer the full complement of content supply chain solutions that
large, content-rich organizations increasingly require.
I-6
We provide a wide range of content-related services to enable its clients
to obtain the full benefit from their content assets, while reducing their costs
of production, ownership and distribution.
INNOVATIVE TECHNOLOGY-BASED SOLUTIONS
We have invested substantially in our information technology and
communications systems to ensure clients a reliable and highly redundant
infrastructure, and to enable us to employ the latest tools to drive significant
process efficiencies.
INFORMATION AS TO OPERATING SEGMENTS
The applicable information on our operating segments for the three years
ended December 31, 2003 and as of December 31, 2003 and 2002, is included in
Note 8 to the Company's financial statements.
SALES AND MARKETING
We primarily market our solutions directly to end-user organizations, with
some business development activity channeled through a limited number of highly
qualified partner organizations.
Our sales organization is responsible for qualifying and otherwise
pursuing prospects, securing direct personal access to decision-makers at
existing and prospective clients, and obtaining orders for our services and
solutions. Full-time sales professionals work directly with clients to identify
and define the solutions that best fit their needs.
Sales activities include the design and generation of presentations and
proposals, account and client relationship management and otherwise organizing
account activities.
Consulting personnel from our project analysis group and our professional
services group closely support the direct sales effort. These individuals assist
the sales force in understanding the technical needs of clients and providing
responses to these needs, including demonstrations, prototypes, pricing
quotations, and time estimates. In addition, account managers from our customer
service group support our direct sales effort by providing ongoing project-level
post-sale support to customers.
Our marketing organization is responsible for raising visibility and
awareness of the company and our offerings, defining and communicating our value
proposition, generating leads and furnishing effective sales support tools.
Marketing, in conjunction with sales, is the primary architect of market
definition, strategy and messaging and is responsible, when appropriate, for
securing market intelligence and research, and providing accompanying analysis,
including competitive analysis.
Primary marketing outreach activities include event marketing (including
exhibiting at trade shows, conferences and seminars), direct and database
marketing, public and media relations (including speaking engagements and active
participation in industry and technical standards bodies), and Web marketing
(including search engine optimization, search engine marketing and the
I-7
maintenance and continued development of external Web sites). Marketing also
supports our partner activities.
COMPETITION
The markets for our services are highly competitive. The most significant
competitive factors are quality and reliability of services, price of services,
scope and scale, quality of supporting services, and technical competence.
We are not aware of any single competitor that provides the same
comprehensive range of content supply chain solutions that we do, and we believe
that we have created significant differentiation relative to our specific
business process expertise, the high quality and reliability of our services, as
well as our scope of services and scale of services.
However, our industry is highly fragmented and we face significant
competition in each of our service areas.
In terms of content services, we believe we compete successfully by
offering high quality services and favorable pricing by leveraging our technical
skills, process knowledge and economies of scale.
Competition is highly fragmented here. However, we have substantially
greater resources than most of our competitors, resulting in greater breadth of
services, as well as scope and scale. Thus, we have a greater ability to obtain
client contracts where the undertaking required is technically sophisticated,
sizable in scope or scale, or requires significant investment.
With respect to XML data transformation, companies compete on the basis of
quality, accuracy, price, and consistency, as well as on the ability to deliver
large-scale, tag-intensive requirements quickly. Our ability to compete
favorably is, therefore, dependent upon its ability to react appropriately to
short and long-term trends, harness new technology, and deliver large-scale
requirements quickly.
SPI Technologies, Apex CoVantage, Techbooks and Jouve, among others,
compete for content services business.
What's more, as a provider of outsourced services, we compete at times
with in-house personnel at current or prospective clients, who may attempt to
duplicate our services using in-house staffers.
In terms of our professional services, a number of large and mid-sized
technology and business consulting practices offer content-related integration
and consulting services as part of their broad and generalized offerings.
Major companies such as IBM, EDS, Bearing Point, Accenture, Booz Allen and
others compete for content supply chain dollars, though few, if any, focus
exclusively on this niche. There are fewer firms, most with lesser capacity,
with a narrower strategic focus on the content supply chain - Thomas Technology
Solutions and RivCom are among them. In addition, we must frequently compete
with our clients' own internal information technologies capability.
I-8
RESEARCH AND DEVELOPMENT
We maintain a research and development capability to evaluate, on an
ongoing basis, advances in computer software, hardware and peripherals, computer
networking, telecommunication systems and Internet-related technologies as they
relate to our business and to develop and install enhancements to our
proprietary systems.
During the last three fiscal years, we invested in the development and
integration of proprietary applications for use in our various facilities.
Applications development was predominantly associated with improving accuracy,
consistency, and speed of complex XML tagging for large-scale requirements. We
intend to make further investments in applications development and integration
to respond to market opportunities.
EMPLOYEES
As of February 29, 2004, we employed an aggregate of approximately 80
persons in the United States and Europe, and approximately 7,500 persons in five
production facilities in the Philippines, one production facility in Sri Lanka,
one production facility in India, and a software development center in India.
No employees are currently represented by a labor union and we believe
that our relations with our employees are satisfactory.
To retain our qualified personnel, we offer highly competitive base
salaries that are supplemented by results-based incentives.
Senior managers are eligible for bonuses and stock options. Our
compensation structure is coupled with an extensive benefits package, tailored
by region, that can include comprehensive health insurance coverage, paid
vacation and holiday leaves, rice, clothing and optical allowances, and
continuing education programs
Moreover, at many of our overseas locations, we provide overtime premiums,
holiday pay, bereavement and birthday leave, as well as maternity and paternity
benefits.
At all of our locations, we enforce vigorous policies to protect our
employees against sexual harassment and discrimination based on age, race,
gender or sexual orientation. The average age of our employees is approximately
25 to 30 years. Most of our employees have graduated from at least a two-year
college program. Many of our employees hold advanced degrees in law, business,
technology, medicine, and social sciences.
RISK FACTORS
The nature of our business, as well as our strategy, the size and location
of our facilities, and other factors entail a certain amount of risk. These
risks may include, but are not limited to, the following:
I-9
RISK OF CONTINUATION OR WORSENING OF PRESENT MARKET CONDITIONS
The current economic uncertainty has curtailed business initiatives by our
clients and potential clients. To address this sales challenge and to reduce the
percentage of total revenue that are often non-recurring, we have begun to
refocus our sales force to emphasize our content manufacturing outsourcing
services. Nevertheless, a material recovery in revenues and earnings will in
substantial part depend on removal of the current uncertainty and a return to
more vigorous economic growth.
RISKS OF EXPANDED OPERATIONS
We have expanded our operations rapidly in recent years. As a result, we
have incurred new fixed operating expenses associated with our expansion
efforts, including increases in depreciation expense, rental expense, and
overall increases in cost of sales. In order to capitalize on this investment,
we need to develop new client relationships and expand existing ones. If our
revenues do not increase sufficiently to offset these expenses, our operating
results may be adversely affected.
RISKS OF ACQUISITIONS
Acquisitions involve a number of risks and challenges. These include, but
are not limited to: diversion of management's attention; the need to integrate
acquired operations; potential loss of key employees and clients of the acquired
companies; lack of experience operating in the market of the acquired business;
and an increase in expenses and working capital requirements.
To integrate acquired operations, we must implement management information
systems and operating systems and assimilate and manage the personnel of the
acquired operations. Geographic distances may further complicate integration.
The integration of acquired businesses may not be successful and could result in
disruption to other parts of our business.
Any of these and other factors could adversely affect our ability to
achieve anticipated levels of profitability of acquired operations or realize
other anticipated benefits of an acquisition. Furthermore, any future
acquisitions may require us to incur debt or obtain additional equity financing,
which could increase our leverage or be dilutive to our existing shareholders.
No assurance can be given that we will consummate any additional acquisitions in
the future.
VARIABILITY OF CLIENT REQUIREMENTS AND OPERATING RESULTS
A number of our significant client contracts are requirements-based.
Clients may cancel their production requirements, change their production
requirements, or delay their production requirements for a number of reasons.
Cancellations, reductions, or delays by a significant client or by a group of
clients would adversely affect our results of operations. In addition, other
factors may contribute to fluctuations in our results of operations. These
factors include: the timing of client orders; the volume of these orders
relative to our capacity; market acceptance of clients' new products; the timing
of our expenditures in anticipation of future orders; our effectiveness in
managing manufacturing processes; changes in economic conditions; and local
factors and events that may affect our production volume (such as local
holidays) or unforeseen events (e.g., earthquakes, storms, civil unrest).
I-10
We make significant decisions based on our estimates of client
requirements, including decisions about the levels of business that we will seek
and accept, production schedules, equipment procurement, personnel hiring, and
other resource acquisition. The nature of our clients' commitments and the
possibility of changes in demand for their products may reduce our ability to
estimate accurately future client requirements. On occasion, clients may require
rapid increases in production, which can stress our resources. Although we have
increased our content conversion capacity and plan further increases, there can
be no assurance we will have sufficient capacity at any given time to meet all
of our clients' demands. In addition, because many of our costs and operating
expenses are relatively fixed, a reduction in client demand can adversely affect
our margins.
VARIABILITY OF QUARTERLY OPERATING RESULTS
We expect our revenues and operating results to vary from quarter to
quarter. Such variations are likely to be caused by many factors that are, to
some extent, outside our control, including: mix and timing of client projects;
completing client projects; timing of new contracts; and one-time non-recurring
and unusual charges.
Accordingly, we believe that quarter-to-quarter comparisons of operating
results for preceding quarters are not necessarily meaningful. You should not
rely on the results of one quarter as an indication of our future performance.
CLIENT CONCENTRATION; DEPENDENCE ON THE ONLINE INFORMATION INDUSTRY
One client accounted for 33% and 17% of our revenues for the years ended
December 31, 2003 and 2002 respectively, and a second client accounted for 30%
of our revenues for the year ended December 31, 2002. One other client, which
substantially curtailed operations, accounted for 30% in the year ended December
31, 2001. No other client accounted for 10% or more of revenues during this
period. Further, in the years ended December 31, 2003, 2002 and 2001, export
revenues, substantially all of which were derived from European clients,
accounted for 47%, 23%, and 13%, respectively, of our revenues. A significant
amount of our revenues are derived from clients in the online information
industry. Accordingly, our accounts receivable generally include significant
amounts due from such clients. In addition, as of December 31, 2003,
approximately 39% of the Company's accounts receivable was from foreign
(principally European) clients. On occasion, we may lose a client as a result of
a business failure, contract expiration, or the selection of another service
provider. We cannot guarantee that we will be able to retain long-term
relationships or secure renewals of short-term relationships with our major
clients in the future. Moreover, revenue derived from certain of our
relationships depend upon the level of services we perform, which may vary from
period to period depending on client requirements.
Factors affecting the online information industry generally could have a
material adverse effect on our clients and, as a result, on our performance.
Such factors include: the inability of our clients to adapt to rapidly changing
technology and evolving industry standards, the inability of our clients to
develop and market their products, some of which are new and untested; and,
recessionary periods in our clients' markets. If clients' products become
obsolete or fail to gain widespread commercial acceptance, our business may be
materially and adversely affected.
I-11
RISK OF INCREASED TAXES
We have structured our operations in a manner designed to maximize income
in countries where tax incentives have been extended to encourage foreign
investment or where income tax rates are low. Our taxes could increase if these
tax incentives are not renewed upon expiration, or tax rates applicable to us
are increased. Substantially all of the services provided by our Asian
subsidiaries are performed on behalf of clients based in North America and
Europe. We believe that profits from our Asian operations are not sufficiently
connected to jurisdictions in North America or Europe to give rise to income
taxation there. However, tax authorities in jurisdictions in North America and
Europe could challenge the manner in which profits are allocated among our
subsidiaries, and we may not prevail in any such challenge. If our Asian profits
became subject to income taxes in such other jurisdictions, our worldwide
effective tax rate could increase.
RISKS OF COMPETITION
The markets for our services are extremely competitive and fragmented. As
a result of this highly competitive environment, we may lose customers or have
difficulty in acquiring new customers and our results of operations may be
adversely affected. A significant source of competition for us is the in-house
capability of our target client base. There can be no assurance that these
clients will outsource more of their needs or that such businesses will not
bring in-house services that they currently outsource.
RISKS OF INTERNATIONAL OPERATIONS
While the major part of our operations are carried on in the Philippines,
India, and Sri Lanka, our headquarters are in the United States and our clients
are primarily located in North America and Europe. As a result, we are not as
affected by economic conditions overseas as we would be if we depended on
revenues from sources internal to those countries. However, such adverse
economic factors as inflation, external debt, negative balance of trade, and
underemployment may significantly impact us.
Certain aspects of overseas economies directly affect us. Overseas
operations remain vulnerable to political unrest, which could interfere with our
operations. Political instability could also change the present satisfactory
legal environment for us through the imposition of restrictions on foreign
ownership, repatriation of funds, adverse labor laws, and the like.
Our Indian operations are conducted through wholly-owned subsidiaries that
have been granted an income tax holiday through March 31, 2006. Accordingly,
minimal income taxes will be payable on earnings from operations of the
subsidiaries during such period, unless repatriated to the U.S.
We fund our overseas operations through transfers of U.S. dollars only as
needed and generally do not maintain any significant amount of funds or monetary
assets overseas. To the extent that we need to bring currency to the United
States from our overseas operations, we may be affected by currency control
regulations.
The Philippines is subject to relatively frequent earthquakes, volcanic
eruptions, floods, and other natural disasters, which may disrupt our
operations. Further, power outages lasting for periods of as long as eight hours
per day have occurred. Our facilities are equipped with standby generators that
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have produced electric power during these outages; however, there can be no
assurance that our operations will not be adversely affected should municipal
power production capacity deteriorate.
The geographical distances between Asia, the Americas, and Europe create
logistical and communications challenges which we must overcome.
The Philippines has ongoing problems with Muslim insurgents. The Abu
Sayyaf group of kidnappers, which is purported to have ties to the Al Qaeda
terrorist organization, is concentrated on Basilan Island, an island far away
from our facilities, and the government has stepped up activities to eradicate
the group. There can be no assurances that these efforts will be successful or
that the group will not attempt to disrupt activities or commit terrorist acts
in other areas.
RISKS OF CURRENCY FLUCTUATIONS AND HEDGING OPERATIONS
The Philippines has historically experienced high rates of inflation and
major fluctuations in exchange rate between the Philippine peso and the U.S.
dollar. Continuing inflation without corresponding devaluation of the peso
against the dollar, or any other increase in value of the peso relative to the
dollar, may have a material adverse effect on our operations and financial
condition. Since 1997, we have not purchased foreign currency futures contracts
for pesos. However, we may choose to do so in the future.
DEPENDENCE ON KEY PERSONNEL
Our success depends to a large extent upon the continued services of our
key executives and skilled personnel. Several of our officers and key employees
are bound by employment or non-competition agreements. However, there can be no
assurance that we will retain our officers and key employees. We could be
materially and adversely affected by the loss of such personnel.
VOLATILITY OF MARKET PRICE OF COMMON STOCK
The stock market in recent years has experienced significant price and
volume fluctuations that have affected the market prices for the common stock of
technology and Internet-related companies. Such fluctuations have often been
unrelated to or disproportionately impacted by the operating performance of such
companies. The market for our common stock may be subject to similar
fluctuations. Factors such as fluctuations in our operating results,
announcements of new contracts, partnerships, acquisitions and alliances,
technological innovations or events affecting other companies in the Internet or
technology industry generally, as well as currency fluctuations and general
market conditions, may have a significant effect on the market price of our
common stock.
ITEM 2. DESCRIPTION OF PROPERTY.
Our services are primarily performed from our Hackensack, New Jersey
corporate headquarters, two other North American offices, and seven overseas
production facilities, including our 100,000 square foot XML Content Factory
complex located in Mandaue, the Philippines. In addition, we have a software
development facility in Gurgaon, India. All facilities are leased for terms
expiring on various
I-13
dates through 2010, and many are cancelable at our option. Annual rental
payments on property leases are expected to approximate $1,600,000.
We believe that we maintain adequate fire, theft and liability insurance
for our facilities and that our facilities are adequate for our present needs.
ITEM 3. LEGAL PROCEEDINGS.
In connection with the cessation of all operations at certain foreign
subsidiaries, certain former employees have filed various illegal dismissal
actions in the Philippines seeking, among other remedies, reinstatement of
employment, payment of back wages and damages approximating one million dollars.
Outside counsel has advised management that under the circumstances, the Company
is not legally obligated to pay severance to such terminated employees. Based
upon the advice of counsel, management believes the actions are substantially
without merit and intends to defend the actions vigorously.
In addition, one of the foreign subsidiaries which ceased operations has
been presented with a tentative tax assessment by the Philippine Bureau of
Internal Revenue for an amount approximating $400,000, plus applicable interest
and penalties. Management believes the tentative assessment is principally
without substance and any amounts that the Company estimates might ultimately be
paid in settlement (which are not expected to be material) have been accrued.
In addition, the Company is subject to various legal proceedings and
claims which arise in the ordinary course of business.
While management currently believes that that ultimate outcome of all
these proceedings will not have a material adverse effect on the Company's
financial position or overall trends in results of operations, litigation is
subject to inherent uncertainties. Were an unfavorable ruling to occur, there
exists the possibility of a material adverse impact on the operating results of
the period in which the ruling occurs. In addition, the estimate of potential
impact on the Company's financial position or overall results of operations for
the above legal proceedings could change in the future.
I-14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The following matters were voted on at the November 14, 2003 Annual
Meeting of Stockholders. The total shares voted were 20,658,017.
ELECTION OF DIRECTORS:
NOMINEE FOR WITHHELD Against ABSTAIN
------- --- -------- ------- -------
Jack Abuhoff 20,402,506 255,511 - -
Charles Goldfarb 20,531,888 126,129 - -
John Marozsan 20,517,896 140,121 - -
Todd Solomon 20,402,806 255,211 - -
Louise Forlenza 20,517,896 140,121 - -
Haig Bagerdjian 20,517,896 140,121 - -
APPOINTMENT OF AUDITORS 20,600,091 - 18,101 39,825
AMENDMENT TO COMPANY'S 20,633,034 1 14,482 10,500
CERTIFICATE OF INCORPORATION
TO CHANGE THE COMPANY'S NAME
TO INNODATA ISOGEN, INC.
I-15
PART II
-------
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Innodata Isogen, Inc. (the "Company") Common Stock is quoted on the Nasdaq
National Market System under the symbol "INOD." On February 29, 2004, there were
133 stockholders of record of the Company's Common Stock based on information
provided by the Company's transfer agent. Virtually all of the Company's
publicly held shares are held in "street name" and the Company believes the
actual number of beneficial holders of its Common Stock to be approximately
3,500.
The following table sets forth the high and low sales prices on a
quarterly basis for the Company's Common Stock, as reported on Nasdaq, for the
two years ended December 31, 2003.
COMMON STOCK
SALE PRICES
2002 HIGH LOW
---- ---- ---
First Quarter $3.30 $1.81
Second Quarter 2.60 1.05
Third Quarter 1.50 0.75
Fourth Quarter 1.07 0.60
2003 HIGH LOW
---- ---- ---
First Quarter $1.09 $0.73
Second Quarter 1.47 0.84
Third Quarter 2.60 1.11
Fourth Quarter 4.96 2.42
DIVIDENDS
The Company has never paid cash dividends on its Common Stock and does not
anticipate that it will do so in the foreseeable future. The future payment of
dividends, if any, on the Common Stock is within the discretion of the Board of
Directors and will depend on the Company's earnings, its capital requirements
and financial condition and other relevant factors.
II-1
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth the aggregate information for the Company's
equity compensation plans in effect as of December 31, 2003:
NUMBER OF
SECURITIES TO BE ISSUED WEIGHTED-AVERAGE NUMBER OF SECURITIES
UPON EXCERCISE OF EXERCISE PRICE OF REMAINING AVAILABLE FOR
OUTSTANDING OPTIONS OUTSTANDING OPTIONS FUTURE ISSUANCE UNDER
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS EQUITY COMPENSATION PLANS
(A) (B) (C)
Equity compensation plans
approved by security holders 6,575,000 $2.24 1,696,000
Equity compensation plans
not approved by security holders 1,015,000 (1) $0.84 500,000 (2)
--------- ----- ---------
Total 7,590,000 $2.45 2,196,000
========= ===== =========
(1) Consists of stock options to purchase 1,015,164 shares of common
stock granted to the Company's current Chairman pursuant to an
agreement entered into at time of hire.
(2) Consists of 500,000 shares of common stock which were reserved to
use for future equity grants by the Company's Board of Directors as
it deems appropriate.
II-2
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, 2003 2002 2001 2000 1999
---- ---- ---- ---- ----
REVENUES $ 36,714 $ 36,385 $ 58,278 $ 50,731 $ 27,490
-------- -------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Direct operating costs 27,029 32,005 44,354 34,458 17,854
Selling and administrative 8,898 10,038 8,337 7,248 6,783
Provision for doubtful accounts -- -- 2,942 -- --
Restructuring costs and asset impairment -- 244 865 -- --
Interest expense 9 29 9 43 10
Interest income (30) (89) (216) (155) (111)
-------- -------- -------- -------- --------
Total 35,906 42,227 56,291 41,594 24,536
-------- -------- -------- -------- --------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES 808 (5,842) 1,987 9,137 2,954
PROVISION FOR (BENEFIT FROM) INCOME TAXES 333 (677) 639 2,969 841
-------- -------- -------- -------- --------
NET INCOME (LOSS) $ 475 $ (5,165) $ 1,348 $ 6,168 $ 2,113
======== ======== ======== ======== ========
BASIC INCOME (LOSS) PER SHARE $ .02 $ (.24) $ .06 $ .30 $ .11
======== ======== ======== ======== ========
DILUTED INCOME (LOSS) PER SHARE $ .02 $ (.24) $ .05 $ .26 $ .10
======== ======== ======== ======== ========
CASH DIVIDENDS PER SHARE -- -- -- -- --
-------- -------- -------- -------- --------
DECEMBER 31, 2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
WORKING CAPITAL $ 11,983 $ 8,570 $ 8,854 $ 9,505 $ 5,966
======== ======== ======== ======== ========
TOTAL ASSETS $ 25,146 $ 22,697 $ 30,094 $ 27,946 $ 15,646
======== ======== ======== ======== ========
LONG-TERM DEBT 272 -- -- -- $ 5
======== ======== ======== ======== ========
STOCKHOLDERS' EQUITY $ 17,404 $ 15,569 $ 20,362 $ 19,316 $ 11,652
======== ======== ======== ======== ========
II-3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003 AND 2002
Revenues were $36,714,000 for the year ended December 31, 2003 compared to
$36,385,000 for the similar period in 2002. Revenues from the content services
segment decreased 9% to $29,997,000 for the year ended December 31, 2003
compared to $33,089,000 for the similar period in 2002. The decrease principally
reflects the decline in revenues of approximately $11 million from two clients
whose largest projects were substantially completed in 2002. The shortfall was
replaced in part by a $9 million increase in revenues from three other clients.
Revenues from the Company's professional services (formerly referred to as
systems integration and training) segment were $6,737,000 for the year ended
December 31, 2003 and $3,296,000 for the similar period in 2002, an increase of
104%. The increase was principally attributable to an increase in the quantity
and size of the system integration projects booked in 2003.
One client accounted for 33% and 17% of the Company's revenues for the
years ended December 31, 2003 and 2002, respectively, and a second client
accounted for 30% of the Company's revenues for the year ended December 31,
2002. No other client accounted for 10% or more of revenues during this period.
Further, in the years ended December 31, 2003 and 2002, export revenues, most of
which were derived from European clients, accounted for 47% and 23%,
respectively, of the Company's revenues.
A significant portion of the Company's services are provided on a
requirements basis, and more than half of its revenues are project-based. This
work tends to vary from period to period. Often times, when a particular project
for a large client is completed, the large client contracts with us for a new
project. Additionally, the Company seeks wherever possible to counter-balance
periodic declines in work for some clients with increased work for others. To
reduce the percentage of total revenue that is non-recurring, the Company has
begun to refocus its sales force to sources of recurring revenue.
Direct operating expenses were $27,029,000 for the year ended December 31,
2003 and $32,005,000 for the year ended December 31, 2002, a decrease of 16%.
Direct operating expenses as a percentage of revenues were 74% in 2003 and 88%
in 2002. Direct operating expenses for the content services segment were
$23,070,000 and $28,053,000 in the years ended December 31, 2003 and 2002,
respectively, a decrease of 18%. Direct operating expenses as a percentage of
revenues for the content services segment were 77% and 85% in the years ended
December 31, 2003 and 2002, respectively. The dollar decline, as well as the
decline in such costs as a percent of sales for the content services segment in
the 2003 period, was principally due to a reduction in labor and in fixed costs
associated with the Company's cost reduction initiatives. Direct operating
expenses primarily include direct payroll, telecommunications, depreciation,
computer services, supplies and occupancy. Direct operating expenses for the
Company's professional services segment were $3,959,000, or 59% of professional
services segment revenues, for the year ended December 31, 2003 and $3,952,000
or 120% of such revenues, for the year ended December 2002. The decrease in
direct operating costs as a
II-4
percent of professional services segment revenue was primarily attributable to
an increase in revenue without a corresponding increase in direct operating
costs.
Selling and administrative expenses were $8,898,000 and $10,038,000 in the
years ended December 31, 2003 and 2002, respectively, a decrease of 11%. Selling
and administrative expenses for the content services segment were $7,348,000 and
$8,525,000 for the years ended December 31, 2003 and 2002, respectively, a
decrease of 14%. The decrease is primarily attributable to the cost reduction
initiatives that were implemented during the second half of 2002. Selling and
administrative expenses as a percentage of revenues for the content services
segment were 25% and 26% for years ended December 31, 2003 and 2002,
respectively. Selling and administrative expenses for the professional services
segment were $1,550,000 or 23% of sales, in the year ended December 31, 2003
compared to $1,513,000, or 46% of sales, for the year ended December 2002. This
decrease in professional services segment selling and administrative expenses as
a percent of sales is primarily due to an increase in revenue without a
corresponding increase in selling and administrative costs. Selling and
administrative expenses primarily include management and administrative
salaries, sales and marketing costs, and administrative overhead.
In early 2002, the Company closed a facility in Asia, resulting in the
write-off of property and equipment associated with the closed facility totaling
approximately $244,000. Such write-off of equipment was classified as
Restructuring Costs and Asset Impairment for the year ended December 31, 2002.
For the year ended December 31, 2003, the provision for income taxes was
41% of pre-tax income, compared to a 12% benefit from income taxes as a percent
of pre-tax loss in the year ended December 31, 2002. For the year ended December
31, 2002, the income tax benefit was lower as a percentage of pre-tax loss than
the federal statutory rate primarily as a result of certain overseas foreign
source losses for which no tax benefit is available. The provision for income
taxes for the year ended December 30, 2003 is higher as a percentage of pre-tax
loss than the federal statutory rate due primarily to foreign and state income
taxes, and to certain foreign source losses for which no tax benefit is
available, partially offset by the effect of income in tax jurisdictions
currently under tax holiday.
YEARS ENDED DECEMBER 31, 2002 AND 2001
Revenues decreased 38% to $36,385,000 for the year ended December 31, 2002
compared to $58,278,000 for the similar period in 2001. Revenues from the
content services segment decreased 43% to $33,089,000 for the year ended
December 31, 2002 compared to $57,825,000 for the similar period in 2001. The
decrease principally resulted from the loss in revenues from one client which
substantially curtailed operations, which accounted for approximately $17
million of the Company's content services segment revenues in 2001, and from the
decline in revenues from a second client, whose projects were substantially
completed in 2002. Revenues from the Company's professional services segment
were $3,296,000 for the year ended December 31, 2002 and $453,000 for the one
month period from December 1, 2001 (date of acquisition) to December 31, 2001.
One client accounted for 30% and 27% of the Company's revenues for the
year ended December 31, 2002 and 2001 respectively and a second client accounted
for 16% of the Company's revenues for the year ended December 31, 2002. One
other client, which substantially curtailed operations, accounted for 30% of the
Company's revenues in the year ended December 31, 2001. No
II-5
other client accounted for 10% or more of revenues during this period. Further,
in the year ended December 31, 2002 and 2001, export revenues, substantially all
of which were derived from European clients, accounted for 23% and 13%,
respectively, of the Company's revenues.
In early 2001, a significant portion of the Company's revenue increase
came from XML transformation projects by early-stage companies that had raised
significant venture capital to pursue digital library and e-business
initiatives. The downturn in the technology industry in 2001 resulted in a
falloff of revenues from companies in this industry sector. The economic
downturn also caused many blue-chip publishers to curtail discretionary spending
and new initiatives on XML transformation projects. To address this sales
challenge and to reduce the percentage of total revenue that are often
non-recurring, the Company has begun to refocus its sales force to emphasize its
content outsourcing services.
Direct operating expenses were $32,005,000 for the year ended December 31,
2002 and $44,354,000 for the year ended December 31, 2001, a decrease of 28%.
Direct operating expenses as a percentage of revenues were 88% in 2002 and 76%
in 2001. Direct operating expenses for the content services segment were
$28,053,000 and $44,039,000 in the year ended December 31, 2002 and 2001,
respectively, a decrease of 36%. Direct operating expenses as a percentage of
revenues for the content services segment were 85% and 76% in the year ended
December 31, 2002 and 2001, respectively. The dollar decrease for the content
services segment in the 2002 period is principally due to a reduction in labor
costs associated with lower revenues, and to reductions in fixed costs
associated with the Company's cost reduction initiatives. The percentage
increase for the content services segment in the 2002 period is primarily
attributable to the decrease in revenues without a corresponding decrease in
non-labor costs. Labor costs as a percentage of revenue remained consistent.
Direct operating expenses for the Company's professional services segment were
$3,952,000, or 120% of professional services segment revenues, for the year
ended December 31, 2002 and $315,000, or 70% of revenues, for the month of
December 2001. Direct operating expenses primarily include direct payroll,
telecommunications, depreciation, equipment maintenance and upgrade costs,
computer services, supplies and occupancy.
Selling and administrative expenses were $10,038,000 and $8,337,000 in the
year ended December 31, 2002 and 2001, respectively, an increase of 20%. Selling
and administrative expenses for the content services segment were $8,525,000 and
$8,227,000 for the year ended December 31, 2002 and 2001, respectively, an
increase of 4%. The increase for the content services segment is primarily due
to a non-cash compensation charge of approximately $500,000, and an increase in
selling and marketing costs of approximately $684,000, offset by a 14% reduction
in general and administrative expenses. Selling and administrative expenses as a
percentage of revenues for the content services segment increased to 26% in the
2002 period from 19% in the 2001 period due primarily to the decrease in
revenues without a corresponding decrease in such expenses. Selling and
administrative expenses for the professional services segment were $1,513,000,
or 46% of sales, in the year ended December 31, 2002 compared to $110,000, or
24% of sales, for the one month period December 2001. Selling and administrative
expenses primarily include management and administrative salaries, sales and
marketing costs, and administrative overhead.
For the year ended December 31, 2001, the Company provided an allowance
for doubtful accounts of approximately $2.6 million representing the remaining
balance due at December 31, 2001 from a client that accounted for 30% of its
2001 revenues because the client has reported an inability to
II-6
raise further operating funds required to make payment. In January 2004, the
Company reached a settlement with this client to pay $1,000,000 cash as full
satisfaction of the outstanding balance due to the Company. The $1,000,000 will
be reflected as a bad debt recovery income in the Company's first quarter 2004
financial statements. In addition, in 2001 the Company provided approximately
$350,000 for other client bad debts incurred in the ordinary course of business.
During the fourth quarter 2001, the Company commenced certain actions to
reduce production operations at a wholly owned Asian subsidiary that was
operating at a loss and to reduce overall excess capacity in Asia. Such
activities, which culminated in the cessation and closure of all operations at
the subsidiary and included employee layoffs, were completed in 2002. In
addition, during 2002, the Company closed a second facility, resulting in the
write-off of property and equipment associated with the closed facility totaling
approximately $244,000. Such write-off of equipment has been classified as
Restructuring Costs and Asset Impairment for the year ended December 31, 2002.
Included in Restructuring Costs and Asset Impairment for the year ended December
31, 2001 are estimated facility closure costs, including employee related costs,
approximating $600,000, and the write-off of leasehold improvement costs
totaling approximately $265,000. In 2002, the Company paid approximately
$350,000 in closing costs.
For the year ended December 31, 2002, the income tax benefit was lower as
a percentage of pre-tax loss than the federal statutory rate due primarily to
certain overseas foreign source losses for which no tax benefit is available.
LIQUIDITY AND CAPITAL RESOURCES
Selected measures of liquidity and capital resources are as follows:
December 31, 2003 December 31, 2002
----------------- -----------------
Cash and Cash Equivalents - unrestricted $5,051,000 $7,255,000
Working Capital 11,983,000 8,570,000
Stockholders' Equity Per Common Share* $.79 $.73
*Represents total stockholders' equity divided by the actual number of
common shares outstanding (which excludes treasury stock).
NET CASH PROVIDED BY OPERATING ACTIVITIES
Net cash provided by operating activities was $682,000 in the year ended
December 31, 2003 compared to $3,050,000 provided by operating activities for
the year ended December 31, 2002, a decrease of approximately $2.4 million. The
decrease was primarily due to a $7.3 million net increase in operating assets
and liabilities and a decrease in non-cash charges of approximately $600,000,
partially offset by an increase of $5.6 million in net income. The $7.3 million
net increase in operating assets and liabilities was principally comprised of a
$9.8 million increase in accounts receivable net of a $1.6 million increase in
accrued salaries and a $1.4 million decrease in refundable income taxes.
Accounts receivable totaled $8,497,000 at December 31, 2003, representing
approximately 71 days of sales outstanding, compared to $3,253,000, or 52 days,
at December 31, 2002. The increase in accounts receivable resulted principally
from a 76% increase in revenues in the three months ended
II-7
December 31, 2003, as compared to the three months ended December 31, 2002. The
increase in amount and in days sales outstanding is also attributable to
significant accounts receivable balances from two clients, most of which was
subsequently collected.
A significant amount of the Company's revenues are derived from clients in
the publishing industry. Accordingly, the Company's accounts receivable
generally include significant amount due from such clients. In addition, as of
December 31, 2003, approximately 39% of the Company's accounts receivable was
from foreign (principally European) clients, and approximately 27% of accounts
receivable was due from one client.
NET CASH USED IN INVESTING ACTIVITIES
During the year ended December 31, 2003, the Company spent approximately
$2,408,000 for capital expenditures, compared to approximately $1,162,000 in the
year ended December 31, 2002. In addition, the Company acquired equipment
totaling approximately $467,000 in 2003 utilizing capital leases. During the
next 12 months, the Company anticipates similar to modest increases in capital
spending levels. Such past and anticipated capital spending relates to project
requirement specific equipment for certain new projects, normal ongoing
equipment upgrades and replacement, and costs related to the purchase and
implementation of new management information systems.
AVAILABILITY OF FUNDS
The Company has a $1 million bank line of credit which is secured by a $1
million certificate of deposit. Interest is charged at the bank's alternate base
rate (4% at December 31, 2003). The line expires on May 31, 2004. No loans were
outstanding at December 31, 2003.
Management believes that existing cash, internally generated funds and
short term bank borrowings will be sufficient for reasonably anticipated working
capital and capital expenditure requirements during the next 12 months. The
Company funds its foreign expenditures from its U.S. corporate headquarters on
an as-needed basis.
CONTRACTUAL OBLIGATIONS
The table below reflects the Company's contractual cash obligations,
expressed in thousands, at December 31, 2003.
PAYMENTS DUE BY PERIOD
LESS THAN AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
Capital lease obligations $ 457 $ 171 $ 286 $ -- $ --
Non-cancelable Operating leases 3,817 600 1,751 1,222 244
------ ------ ------ ------ ------
Total contractual cash obligations $4,274 $ 771 $2,037 $1,222 $ 244
====== ====== ====== ====== ======
II-8
INFLATION, SEASONALITY AND PREVAILING ECONOMIC CONDITIONS
To date, inflation has not had a significant impact on the Company's
operations. The Company generally performs its work for its clients under
project-specific contracts, requirements-based contracts or long-term
arrangements. Contracts are typically subject to numerous termination
provisions. The Company's revenues are not significantly affected by
seasonality.
CRITICAL ACCOUNTING POLICIES
Basis of Presentation and Use of Estimates
Management's discussion and analysis of its results of operations and
financial condition is based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to accounts receivable.
Management bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Allowance for Doubtful Accounts
The Company establishes credit terms for new clients based upon
management's review of their credit information and project terms, and performs
ongoing credit evaluations of its customers, adjusting credit terms when
management believes appropriate based upon payment history and an assessment of
their current credit worthiness. The Company records an allowance for doubtful
accounts for estimated losses resulting from the inability of its clients to
make required payments. The Company determines its allowance by considering a
number of factors, including the length of time trade accounts receivable are
past due, the Company's previous loss history, the client's current ability to
pay its obligation to the Company, and the condition of the general economy and
the industry as a whole. While credit losses have generally been within
expectations and the provisions established, the Company cannot guarantee that
credit loss rates in the future will be consistent with those experienced in the
past. In addition, there is credit exposure if the financial condition of one of
the Company's major clients were to deteriorate. In the event that the financial
condition of the Company's clients were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
necessary.
Revenue Recognition
Revenue for content manufacturing and outsourcing services is recognized
in the period in which services are performed and delivered.
The Company recognizes revenues from custom application and systems
integration development which requires significant production, modification or
customization of software in accordance with Statement of Position ("SOP") No.
97-2 "Software Revenue Recognition" and SOP No. 81-1 "Accounting for Performance
of Construction-Type and Certain Production-Type
II-9
Contracts". Revenue for such contracts billed under fixed fee arrangements is
recognized using the percentage-of-completion method under contract accounting
as services are performed or output milestones are reached. The percentage
completed is measured either by the percentage of labor hours incurred to date
in relation to estimated total labor hours or in consideration of achievement of
certain output milestones, depending on the specific nature of each contract.
For arrangements in which percentage-of completion accounting is used, the
Company records cash receipts from customers and billed amounts due from
customers in excess of recognized revenue as billings in excess of revenues
earned on contracts in progress (which is included in accounts receivable).
Revenue for contracts billed on a time and materials basis is recognized as
services are performed.
Property and Equipment
Property and equipment is depreciated on the straight-line method over the
estimated useful lives of the related assets, which is generally two to five
years. Leasehold improvements are amortized on a straight-line basis over the
shorter of their estimated useful lives or the lives of the leases. The Company
makes estimates regarding the useful lives of these assets and any changes in
actual lives could result in material changes in the net book value of these
assets. The Company evaluates the recoverability of long-lived assets whenever
adverse events or changes in business climate indicate that the expected
undiscounted future cash flows from the related asset may be less than
previously anticipated. If the net book value of the related asset exceeds the
undiscounted future cash flows of the asset, the carrying amount would be
reduced to the present value of its expected future cash flows and an impairment
loss would be recognized. This analysis requires the Company to make significant
estimates and assumptions, and changes in facts and circumstances could result
in material changes in the carrying value of the assets and the related
depreciation expense.
Income Taxes
Deferred taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities, using enacted tax
rates, as well as any net operating loss or tax credit carryforwards expected to
reduce taxes payable in future years. A valuation allowance is provided when it
is more likely than not that some or all of a deferred tax asset will not be
realized. Unremitted earnings of foreign subsidiaries have been included in the
consolidated financial statements without giving effect to the United States
taxes that may be payable on distribution to the United States to the extent
such earnings are not anticipated to be remitted to the United States.
Goodwill and Other Intangible Assets
Statement of Financial Accounting Standard ("SFAS") 142 requires that
goodwill be tested for impairment at the reporting unit level (segment or one
level below a segment) on an annual basis and between annual tests in certain
circumstances. Application of the goodwill impairment test requires judgment,
including the identification of reporting units, assigning assets and
liabilities to reporting units, assigning goodwill to reporting units, and
determining the fair value of each reporting unit. Significant judgments
required to estimate the fair value of reporting units include estimating future
cash flows, determining appropriate discount rates and other assumptions.
Changes in these estimates and assumptions could materially affect the
determination of fair value for each reporting unit.
II-10
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related Interpretations. In general, no
stock-based employee compensation cost is reflected in the results of
operations, unless options granted under those plans have an exercise price that
is less than the market value of the underlying common stock on the date of
grant.
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS No. 150"). SFAS No. 150 clarifies the accounting for certain financial
instruments with characteristics of both liabilities and equity and requires
that those instruments be classified as liabilities. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003 and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 did not impact the Company's
Consolidated Financial Statements.
Consolidation of Variable Interest Entities
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN No. 46"). FIN No.46 explains how to identify
variable interest entities and how an enterprise assesses its interests in a
variable interest entity to decide whether to consolidate that entity. In
December, 2003, the FASB issued FIN 46R which clarifies and modifies certain
provisions of FIN 46. The Company has evaluated FIN No. 46 and determined that
this interpretation did not have any impact on the Company's Consolidated
Financial Statements as the Company has no variable interest entities.
FORWARD-LOOKING STATEMENTS
Disclosures in this Form 10-K contain certain forward-looking statements,
including without limitation, statements concerning the Company's operations,
economic performance and financial condition. These forward-looking statements
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The words "intend","may", "plan", "believe,"
"expect," "anticipate" and other similar expressions generally identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates.
These forward-looking statements are based largely on the Company's
current expectations, and are subject to a number of risks and uncertainties,
including without limitation, continuation or worsening of present depressed
market conditions, changes in external market factors, the ability and
willingness of the Company's clients and prospective clients to execute business
plans which give rise to requirements for digital content and professional
services in knowledge processing, difficulty in integrating and deriving
synergies from acquisitions, potential undiscovered liabilities of companies
that Innodata acquires, changes in the Company's business or growth strategy,
the emergence of new
II-11
or growing competitors, various other competitive and technological factors,
risks and uncertainties described under "Risk Factors", and other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.
Actual results could differ materially from the results referred to in the
forward-looking statements. In light of these risks and uncertainties, there can
be no assurance that the results referred to in the forward-looking statements
contained in this Form 10-K will in fact occur. We make no commitment to revise
or update any forward-looking statements in order to reflect events or
circumstances after the date any such statement is made.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate change market risk with respect to
its credit facility with a financial institution, which is priced based on the
bank's alternate base rate (4% at December 31, 2003. At December 31, 2003, there
were no borrowings under the credit facility. Changes in the prime interest rate
during 2004 will have a positive or negative effect on the Company's interest
expense. Such exposure will increase accordingly should the Company utilize its
line of credit during 2004.
The Company has operations in foreign countries. While it is exposed to
foreign currency fluctuations, the Company presently has no financial
instruments in foreign currency and does not maintain funds in foreign currency
beyond those necessary for operations.
II-12
ITEM 8. FINANCIAL STATEMENTS.
INNODATA ISOGEN, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report II-14
Consolidated Balance Sheets as of December 31, 2003 and 2002 II-15
Consolidated Statements of Operations for the three years ended II-16
December 31, 2003
Consolidated Statement of Stockholders' Equity for the three II-17
years ended December 31, 2003
Consolidated Statements of Cash Flows for the three years ended II-18
December 31, 2003
Notes to Consolidated Financial Statements II-19-32
II-13
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Innodata Isogen, Inc.
We have audited the accompanying consolidated balance sheets of Innodata Isogen,
Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Innodata Isogen,
Inc. and subsidiaries as of December 31, 2003 and 2002, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.
We have also audited Schedule II for each of the three years in the period ended
December 31, 2003. In our opinion, this schedule, when considered in relation to
the basic financial statements taken as a whole, presents fairly, in all
material respects, the information therein.
/s/ Grant Thornton LLP
- ------------------------------
Grant Thornton LLP
New York, New York
March 11, 2004
II-14
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
(DOLLARS IN THOUSANDS)
2003 2002
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 5,051 $ 7,255
Cash and equivalents - restricted 1,000 --
Accounts receivable-net of allowance for doubtful
accounts of $1,219 in 2003 and $1,254 in 2002 8,497 3,253
Prepaid expenses and other current assets 999 706
Refundable income taxes 1,075 1,491
Deferred income taxes 1,421 1,501
-------- --------
TOTAL CURRENT ASSETS 18,043 14,206
PROPERTY AND EQUIPMENT - NET 5,628 6,707
OTHER ASSETS 800 1,109
GOODWILL 675 675
-------- --------
TOTAL $ 25,146 $ 22,697
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,299 $ 647
Accrued expenses 1,152 2,008
Accrued salaries and wages 2,865 2,526
Income and other taxes 598 455
Current portion of capital lease obligations 146 --
-------- --------
TOTAL CURRENT LIABILITIES 6,060 5,636
-------- --------
DEFERRED INCOME TAXES 1,410 1,492
-------- --------
OBLIGATIONS UNDER CAPITAL LEASE 272 --
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value-authorized 75,000,000
shares; issued - 22,535,000 shares in 2003 and
22,046,000 shares in 2002 226 220
Additional paid-in capital 15,413 14,084
Retained earnings 3,739 3,264
-------- --------
19,378 17,568
Less: treasury stock - at cost; 584,000 and
610,000 shares in 2003 and 2002, respectively (1,974) (1,999)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 17,404 15,569
-------- --------
TOTAL $ 25,146 $ 22,697
======== ========
See notes to consolidated financial statements
II-15
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2003 2002 2001
REVENUES $ 36,714 $ 36,385 $ 58,278
-------- -------- --------
OPERATING COSTS AND EXPENSES
Direct operating costs 27,029 32,005 44,354
Selling and administrative expenses 8,898 10,038 8,337
Provision for doubtful accounts -- -- 2,942
Restructuring costs and asset impairment -- 244 865
Interest expense 9 29 9
Interest income (30) (89) (216)
-------- -------- --------
TOTAL 35,906 42,227 56,291
-------- -------- --------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT
FROM) INCOME TAXES 808 (5,842) 1,987
PROVISION FOR (BENEFIT FROM) INCOME TAXES 333 (677) 639
-------- -------- --------
NET INCOME (LOSS) $ 475 $ (5,165) $ 1,348
======== ======== ========
BASIC INCOME (LOSS) PER SHARE $ .02 $ (.24) $ .06
======== ======== ========
DILUTED INCOME (LOSS) PER SHARE $ .02 $ (.24) $ .05
======== ======== ========
See notes to consolidated financial statements
II-16
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
ADDITIONAL
COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
------ ------ ------- -------- ----- -----
JANUARY 1, 2001 21,688 $ 217 $ 12,239 $ 7,081 $ (221) $ 19,316
Net income -- -- -- 1,348 -- 1,348
Issuance of common
stock upon exercise of
stock options 605 6 384 -- -- 390
Purchase of treasury stock -- -- -- -- (1,639) (1,639)
Retirement of treasury stock (577) (6) (215) -- 221 --
Income tax benefit
from exercise of stock
options -- -- 947 -- -- 947
-------- -------- -------- -------- -------- --------
DECEMBER 31, 2001 21,716 217 13,355 8,429 (1,639) 20,362
Net loss -- -- -- (5,165) -- (5,165)
Issuance of common
stock upon exercise of
stock options 318 3 107 -- -- 110
Purchase of treasury stock -- -- -- -- (360) (360)
Non-cash compensation 12 -- 523 -- -- 523
Income tax benefit
from exercise of stock
options -- -- 99 -- -- 99
-------- -------- -------- -------- -------- --------
DECEMBER 31, 2002 22,046 220 14,084 3,264 (1,999) 15,569
Net income -- -- -- 475 -- 475
Issuance of common stock
upon exercise of stock
options 515 6 565 -- -- 571
Retirement of treasury
stock (26) -- (25) -- 25 --
Income tax benefit from
exercise of stock
options -- -- 132 -- -- 132
Non-cash compensation -- -- 657 -- -- 657
-------- -------- -------- -------- -------- --------
DECEMBER 31, 2003 22,535 $ 226 $ 15,413 $ 3,739 $(1,974) $17,404
======== ======== ======== ======== ======== ========
See notes to consolidated financial statements
II-17
INNODATA ISOGEN INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
2003 2002 2001
---- ---- ----
OPERATING ACTIVITIES:
Net income (loss) $ 475 $(5,165) $ 1,348
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 4,528 5,228 4,790
Non-cash compensation 657 523 --
Provision for doubtful accounts -- -- 2,942
Loss on disposal of fixed assets 147 -- --
Tax benefit from exercise of stock options 132 99 947
Restructuring costs and asset impairment -- 244 865
Deferred income taxes (2) 30 (463)
Changes in operating assets and liabilities, net of
acquisition:
Accounts receivable (5,244) 4,593 (3,913)
Prepaid expenses and other current assets (947) (680) 545
Refundable income taxes 416 (982) (509)
Other assets 242 894 (723)
Accounts payable 652 (811) (907)
Accrued expenses (856) 601 365
Accrued salaries and wages 339 (1,244) (71)
Income and other taxes 143 (280) (376)
------- ------- -------
Net cash provided by operating activities 682 3,050 4,840
------- ------- -------
INVESTING ACTIVITIES:
Increase in restricted cash (1,000) -- --
Capital expenditures (2,408) (1,162) (5,568)
Payments in connection with acquisition -- -- (796)
------- ------- -------
Net cash used in investing activities (3,408) (1,162) (6,364)
------- ------- -------
FINANCING ACTIVITIES:
Payments of obligations under capital lease (49) -- --
Payment of acquisition notes -- (650) --
Proceeds from exercise of stock options 571 110 390
Purchase of treasury stock -- (360) (1,639)
------- ------- -------
Net cash provided by (used in) financing activities 522 (900) (1,249)
------- ------- -------
(DECREASE) INCREASE IN CASH AND EQUIVALENTS (2,204) 988 (2,773)
CASH AND EQUIVALENTS, BEGINNING OF YEAR 7,255 6,267 9,040
------- ------- -------
CASH AND EQUIVALENTS, END OF YEAR $ 5,051 $ 7,255 $ 6,267
======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Income taxes $ 417 $ 261 $ 1,513
Interest expense $ 23 $ 29 $ --
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of equipment utilizing capital leases $ 467 $ -- $ --
See notes to consolidated financial statements
II-18
INNODATA ISOGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
--------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND BASIS OF PRESENTATION - Innodata Isogen, Inc. and
subsidiaries (the "Company"), which on November 14, 2003 changed its name from
Innodata Corporation to Innodata Isogen, Inc., is a leading provider of digital
asset services and solutions. The Company's solutions encompass both the
manufacture of content (for which the Company provides services such as
digitization, imaging, data conversion, XML and markup services, metadata
creation, advanced classification services, editorial and knowledge services) as
well as the design, implementation, integration and deployment of the systems
used to manage content (for which the Company provides custom application
development, consulting and training.) through offices located both in the U.S.
and Asia. The consolidated financial statements include the accounts of Innodata
Isogen, Inc. and its subsidiaries, all of which are wholly owned. All
intercompany transactions and balances have been eliminated in consolidation.
USE OF ESTIMATES - In preparing financial statements in conformity with
generally accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and revenues and expenses during the reporting
period. Actual results could differ from those estimates.
REVENUE RECOGNITION - Revenue for content manufacturing and outsourcing
services is recognized in the period in which services are performed and
delivered.
The company recognizes revenues from custom application and systems
integration development which requires significant production, modification or
customization of software in accordance with Statement of Position ("SOP") No.
97-2 "Software Revenue Recognition" and SOP No. 81-1 "Accounting for Performance
of Construction-Type and Certain Production-Type Contracts". Revenue for such
services billed under fixed fee arrangements is recognized using the
percentage-of-completion method under contract accounting as services are
performed or output milestones are reached. The percentage completed is measured
either by the percentage of labor hours incurred to date in relation to
estimated total labor hours or in consideration of achievement of certain output
milestones, depending on the specific nature of each contract. For arrangements
in which percentage-of completion accounting is used, the Company records cash
receipts from customers and billed amounts due from customers in excess of
recognized revenue as billings in excess of revenues earned on contracts in
progress (which is included in accounts receivable). Revenue for contracts
billed on a time and materials basis is recognized as services are performed.
FOREIGN CURRENCY - The functional currency for the Company's production
operations located in the Philippines, India and Sri Lanka is U.S. dollars. As
such, transactions denominated in Philippine pesos, Indian and Sri Lanka rupees
were translated to U.S. dollars at rates which approximate those in effect on
transaction dates. Monetary assets and liabilities denominated in foreign
currencies at December 31, 2003 and 2002 were translated at the exchange rate in
effect as of those dates. Exchange losses resulting from such transactions
totaled approximately $9,000 and $59,000 in 2003 and 2002, respectively.
Exchange gains in 2001 resulting from such transactions totaled $75,000.
II-19
STATEMENT OF CASH FLOWS - For financial statement purposes (including cash
flows), the Company considers all highly liquid debt instruments purchased with
an original maturity of three months or less to be cash equivalents.
Supplemental disclosure of non-cash investing activities in 2001 (in thousands)
is as follows:
Acquisition costs $1,514
Acquisition notes issued (650)
Other amounts payable (68)
------
Payments in connection with acquisition $ 796
======
DEPRECIATION - Property and equipment is depreciated on the straight-line
method over the estimated useful lives of the related assets, which is generally
two to five years. Leasehold improvements are amortized on a straight-line basis
over the shorter of their estimated useful lives or the lives of the leases. The
Company makes estimates regarding the useful lives of these assets and any
changes in actual lives could result in material changes in the net book value
of these assets. The Company evaluates the recoverability of long-lived assets
whenever adverse events or changes in business climate indicate that the
expected undiscounted future cash flows from the related asset may be less than
previously anticipated. If the net book value of the related asset exceeds the
undiscounted future cash flows of the asset, the carrying amount would be
reduced to the present value of its expected future cash flows and an impairment
loss would be recognized. This analysis requires the Company to make significant
estimates and assumptions, and changes in facts and circumstances could result
in material changes in the carrying value of the assets and the related
depreciation expense.
GOODWILL AND OTHER INTANGIBLE ASSETS - Statement of Financial Accounting
Standard ("SFAS") 142 requires that goodwill be tested for impairment at the
reporting unit level (segment or one level below a segment) on an annual basis
and between annual tests in certain circumstances. Application of the goodwill
impairment test requires judgment, including the identification of reporting
units, assigning assets and liabilities to reporting units, assigning goodwill
to reporting units, and determining the fair value of each reporting unit.
Significant judgments required to estimate the fair value of reporting units
include estimating future cash flows, determining appropriate discount rates and
other assumptions. Changes in these estimates and assumptions could materially
affect the determination of fair value for each reporting unit.
INCOME TAXES - Deferred taxes are determined based on the difference
between the financial statement and tax bases of assets and liabilities, using
enacted tax rates, as well as any net operating loss or tax credit carryforwards
expected to reduce taxes payable in future years. A valuation allowance is
provided when it is more likely than not that some or all of a deferred tax
asset will not be realized. Unremitted earnings of foreign subsidiaries have
been included in the consolidated financial statements without giving effect to
the United States taxes that may be payable on distribution to the United States
to the extent such earnings are not anticipated to be remitted to the United
States.
ACCOUNTING FOR STOCK-BASED COMPENSATION - At December 31, 2003, the
Company has various stock-based employee compensation plans, which are described
more fully in Note 7. The Company accounts for those plans under the recognition
and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. In general, no stock-based employee
compensation cost is reflected in the results of operations, unless options
granted under such plans have an exercise price less than the market value of
the underlying common stock on the date of
II-20
grant. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
YEAR ENDED DECEMBER 31, 2003 2002 2001
(in thousands, except per share amounts)
Net income (loss), as reported $ 475 $(5,165) $ 1,348
Deduct: Total stock-based employee compensation
determined under fair value based method, net of
related tax effects (3,193) (2,315) (2,185)
Add: Compensation expense included in the
determination of net income as reported, net of
related tax effects, related to the extension of stock
options 455 318 --
------- ------- -------
Pro forma net (loss) income $(2,263) $(7,162) $ (837)
======= ======= =======
Income (loss) per share:
Basic - as reported $ .02 $ (.24) $ .06
======= ======= =======
Basic - pro forma $ (.10) $ (.33) $ (.04)
======= ======= =======
Diluted - as reported $ .02 $ (.24) $ .05
======= ======= =======
Diluted - pro forma $ (.10) $ (.33) $ (.04)
======= ======= =======
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company has estimated the fair
value of financial instruments using available market information and other
valuation methodologies in accordance with SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments." Management of the Company believes that the
fair value of financial instruments for which estimated fair value has not been
specifically presented, primarily cash and accounts receivable, is not
materially different than the related carrying value. Determinations of fair
value are based on subjective data and significant judgment relating to timing
of payments and collections and the amounts to be realized. Different
assumptions and/or estimation methodologies might have a material effect on the
fair value estimates. Accordingly, the estimates of fair value are not
necessarily indicative of the amounts the Company would realize in a current
market exchange.
ACCOUNTS RECEIVABLE - The majority of the Company's accounts receivable
are due from secondary publishers and information providers. The Company
establishes credit terms for new clients based upon management's review of their
credit information and project terms, and performs ongoing credit evaluations of
its customers, adjusting credit terms when management believes appropriate based
upon payment history and an assessment of their current credit worthiness. The
Company records an allowance for doubtful accounts for estimated losses
resulting from the inability of its clients to make required payments. The
Company determines its allowance by considering a number of factors, including
the length of time trade accounts receivable are past due, the Company's
previous loss history, the client's current ability to pay its obligation to the
Company, and the condition of the general economy and the
II-21
industry as a whole. The Company writes-off accounts receivable when they become
uncollectible, and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts. While credit losses have
generally been within expectations and the provisions established, the Company
cannot guarantee that credit loss rates in the future will be consistent with
those experienced in the past. In addition, there is credit exposure if the
financial condition of one of the Company's major clients were to deteriorate.
In the event that the financial condition of the Company's clients were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be necessary.
INCOME (LOSS) PER SHARE - Basic earnings per share is based on the
weighted average number of common shares outstanding without consideration of
potential common stock. Diluted earnings per share is based on the weighted
average number of common and, if dilutive, potential common shares outstanding.
The calculation takes into account the shares that may be issued upon exercise
of stock options, reduced by the shares that may be repurchased with the funds
and tax benefits received from the exercise, based on average prices during the
year.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY - In May 2003, the FASB issued SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS No. 150"). SFAS No. 150 clarifies the accounting for certain
financial instruments with characteristics of both liabilities and equity and
requires that those instruments be classified as liabilities. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS No. 150 did not impact the
Company's Consolidated Financial Statements.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES - In January 2003, the FASB
issued Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN No. 46"). FIN No.46 explains how to identify variable interest entities
and how an enterprise assesses its interests in a variable interest entity to
decide whether to consolidate that entity. In December, 2003, the FASB issued
FIN 46R which clarifies and modifies certain provisions of FIN 46. The Company
has evaluated FIN No. 46 and determined that this interpretation did not have
any impact on the Company's Consolidated Financial Statements as the Company has
no variable interest entities.
2. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost less accumulated depreciation and
amortization (in thousands), consist of the following:
DECEMBER 31, 2003 2002
Equipment $14,608 $16,136
Furniture and office equipment 820 1,037
Leasehold improvements 2,342 2,314
------- -------
Total 17,770 19,487
Less accumulated depreciation
and amortization 12,142 12,780
------- -------
$ 5,628 $ 6,707
======= =======
II-22
As of December 31, 2003 and 2002, the net book value of property and
equipment located at the Company's production facilities in the Philippines,
India, and Sri Lanka was approximately $4,766,000 and $6,361,000, respectively.
In 2003, the Company entered into a three year lease for certain equipment
located in one of its Philippine facilities. The equipment was capitalized at
its fair market value of approximately $641,000, which represented the present
value of the minimum lease payments plus trade-in value of exchanged equipment
of $175,000. The loss on such trade-in approximated $58,000.
3. ACQUISITION
As of December 1, 2001, the Company acquired the operating assets, and
assumed certain designated liabilities, of the ISOGEN International operating
division of DataChannel, Inc. ISOGEN International ("ISOGEN") helps clients
across a variety of industries with the design, architecture, implementation,
integration and deployment of the systems that they use to manage information.
It specializes in consulting and training in the knowledge-processing
technologies of XML (Extensible Markup Language), SGML (Standard Generalized
Markup Language), and other standards.
The purchase price, including acquisition costs, consisted of $796,000 in
cash, two acquisition promissory notes, each for $325,000, plus an additional
$68,000 payable September 30, 2002 subject to realization of certain events. The
promissory notes accrued interest at a rate of 7% per annum, and were paid in
2002.
4. INCOME TAXES
The significant components of the provision for (benefit from) income
taxes (in thousands) are as follows:
2003 2002 2001
Current income tax expense (benefit):
Foreign $ 29 $ 97 $ (7)
Federal 230 (827) 906
State and local 76 23 203
------- ------- -------
335 (707) 1,102
Deferred income tax expense (benefit) provision (2) 30 (463)
------- ------- -------
Provision for (benefit from) income taxes $ 333 $ (677) $ 639
======= ======= =======
II-23
Reconciliation of the U.S. statutory rate with the Company's effective
tax rate is summarized as follows:
2003 2002 2001
Federal statutory rate 35.0% (35.0)% 35.0%
Effect of:
State income taxes (net of federal tax
benefit) 5.9 0.6 1.8
Foreign source losses for which no tax
benefit is available 7.3 23.8 -
Effect of foreign tax holiday, net of
foreign income not deemed
permanently reinvested (24.0) (3.4) (5.3)
Foreign taxes 7.6 - 0.9
Non deductible compensation 5.9 - -
Other 3.5 2.4 (0.2)
----- ----- -----
Effective rate 41.2% (11.6)% 32.2%
===== ===== =====
As of December 31, 2003 and 2002, the composition of the Company's net
deferred income taxes (in thousands) is as follows:
2003 2002
Deferred income tax assets:
Allowances not currently deductible $ 1,358 $ 1,435
Depreciation and amortization 114 230
Equity compensation not currently deductible 348 150
Expenses not deductible until paid 63 66
------- -------
1,883 1,881
======= =======
Deferred income tax liabilities:
Foreign source income, not taxable
until repatriated (1,872) (1,872)
------- -------
Net deferred asset $ 11 $ 9
======= =======
Net deferred income tax asset - current $ 1,421 $ 1,501
Net deferred income tax liability - non current (1,410) (1,492)
------- -------
Net deferred income tax asset $ 11 $ 9
======= =======
5. COMMITMENTS AND CONTINGENT LIABILITIES
LINE OF CREDIT - The Company has $1 million line of credit with a bank,
which is secured by a $1 million certificate of deposit. Interest is charged at
the bank's alternate base rate (4% at December 31, 2003). The line expires on
May 31, 2004.
LEASES - The Company is obligated under various operating lease agreements
for office and production space. Certain agreements contain escalation clauses
and requirements that the Company pay taxes, insurance and maintenance costs.
The lease agreements for production space in most overseas facilities, which
expire through 2010, contain provisions pursuant to which the Company may cancel
the leases upon three months notice, generally subject to forfeiture of security
deposit. The annual rental for the cancelable leased space is approximately
$1,000,000. For the years ended December 31, 2003, 2002 and 2001, rent expense
for office and production space totaled approximately $1,700,000, $2,100,000 and
$1,900,000, respectively.
II-24
In addition, the Company leases certain equipment under short-term
operating lease agreements. For the years ended December 31, 2003, 2002 and
2001, rent expense for equipment totaled approximately $36,000, $46,000 and
$400,000, respectively.
At December 31, 2003, future minimum annual rental commitments on
non-cancelable leases (excluding operating leases with terms less than one year)
(in thousands) are as follows:
OPERATING CAPITAL
LEASES LEASES
2004 $ 600 $ 171
2005 587 171
2006 585 115
2007 579 -
2008 611 -
Thereafter 855 -
------- -------
$ 3,817 457
=======
Less: Amounts representing interest
(7% per annum) 39
-------
Present value of minimum lease payments $ 418
=======
LITIGATION AND FOREIGN TAX ASSESSMENTS - In connection with the cessation
of all operations at certain foreign subsidiaries (Note 10), certain former
employees have filed various illegal dismissal actions in the Philippines
seeking, among other remedies, reinstatement of employment, payment of back
wages and damages approximating one million dollars. Outside counsel has advised
management that under the circumstances, the Company is not legally obligated to
pay severance to such terminated employees. Based upon the advice of counsel,
management believes the actions are substantially without merit and intends to
defend the actions vigorously.
In addition, one of the foreign subsidiaries which ceased operations has
been presented with a tentative tax assessment by the Philippine Bureau of
Internal Revenue for an amount approximating $400,000, plus applicable interest
and penalties. Management believes the tentative assessment is principally
without substance and any amounts that might ultimately be paid in settlement
(which is not expected to be material) have been accrued.
In addition, the Company is subject to various legal proceedings and
claims which arise in the ordinary course of business.
While management currently believes that that ultimate outcome of all
these proceedings will not have a material adverse effect on the Company's
financial position or overall trends in results of operations, litigation is
subject to inherent uncertainties. Were an unfavorable ruling to occur, there
exists the possibility of a material adverse impact on the operating results of
the period in which the ruling occurs. In addition, the estimate of potential
impact on the Company's financial position or overall results of operations for
the above legal proceedings could change in the future.
II-25
FOREIGN CURRENCY - The Company's production facilities are located in the
Philippines, India and Sri Lanka. To the extent that the currencies of these
countries fluctuate, the Company is subject to risks of changing costs of
production after pricing is established for certain customer projects. However,
most significant contracts contain provisions for price renegotiation.
EMPLOYMENT AGREEMENTS - On January 1, 2004, the Company entered into a
four year employment agreement with the co-founder of ISOGEN to serve as
Executive Vice President of the Company. Pursuant to the agreement, he will be
compensated at a rate of $250,000 per annum for the first year, subject to
annual review for discretionary annual increases thereafter, and will be
eligible to receive an annual cash bonus, the amount of which will be based upon
meeting certain goals. In addition, on November 10, 2003, he was granted an
option to purchase 200,000 shares of the Company's common stock at $3.35 per
share. In connection with his previous employment agreement, in 2002 the
executive was granted an option to purchase 150,000 shares of the Company's
common stock at $4.00 per share, and was issued 11,587 unregistered shares of
the Company's common stock. Compensation expense of approximately $10,000 was
recorded in the year ended December 31, 2002 as selling and administrative
expenses pursuant to the stock issuance.
In May 2001, the Company entered into an agreement with its then Chairman
of the Board pursuant to which he will continue to serve as a part-time employee
at a salary of $2,000 per month for five years. In addition, the Company paid
him $400,000 in exchange for a six year non-compete agreement, which is included
in other assets and is being amortized over the term of the agreement. On
December 31, 2003, the unamortized balance was $222,000.
PHILIPPINE PENSION REQUIREMENT - The Philippine government enacted
legislation requiring businesses to provide a lump-sum pension payment to
employees working at least five years and who are employed by the Company at age
60. Those eligible employees are to receive approximately 60% of one month's pay
for each year of employment with the Company. The liability for the future
payment is insignificant at December 31, 2003. Under the legislation, the
Company is not required to fund future costs, if any.
INDEMNIFICATIONS - The Company is obligated under certain circumstances to
indemnify directors and certain officers against costs and liabilities incurred
in actions or threatened actions brought against such individual because such
individuals acted in the capacity of director and / or officer of the Company.
In addition, the Company has contracts with certain clients pursuant to which
the Company has agreed to indemnify the client for certain specified and limited
claims. These indemnification obligations are in the ordinary course of business
and, in many cases, do not include a limit on a maximum potential future
payments. As of December 31, 2003, the Company has not recorded a liability for
any obligations arising as a result of these indemnifications.
LIENS - In connection with the procurement of tax incentives at one of the
company's foreign subsidiaries, the foreign zoning authority was granted a first
lien on the subsidiary's property and equipment. As of December 31, 2003, such
equipment had a book value of $543,000.
II-26
6. CAPITAL STOCK
COMMON STOCK - On March 23, 2001, the Company paid a two-for-one stock
dividends. In addition, in 2001 the stockholders increased the number of common
shares the Company is authorized to issue to 75,000,000. The financial
statements and notes thereto, including all share and per share amounts, have
been restated to reflect such split.
PREFERRED STOCK - The Board of Directors is authorized to fix the terms,
rights, preferences and limitations of the preferred stock and to issue the
preferred stock in series which differ as to their relative terms, rights,
preferences and limitations.
STOCKHOLDER RIGHTS PLAN - On December 16, 2002, the Board of Directors
adopted a Stockholder Rights Plan ("Rights Plan") in which one right ("Right")
was declared as a dividend for each share of the Company's common stock
outstanding. The purpose of the plan is to deter a hostile takeover of the
Company. Each Right entitles its holders to purchase, under certain conditions,
one one-thousandth of a share of newly authorized Series C Participating
Preferred Stock ("Preferred Stock"), with one one-thousandth of a share of
Preferred Stock intended to be the economic and voting equivalent of one share
of the Company's common stock. Rights will be exercisable only if a person or
group acquires beneficial ownership of 15% (25% in the case of specified
executive officers of the Company) or more of the Company's common stock or
commences a tender or exchange offer, upon the consummation of which such person
or group would beneficially own such percentage of the common stock. Upon such
an event, the Rights enable dilution of the acquiring person's or group's
interest by providing that other holders of the Company's common stock may
purchase, at an exercise price of $4.00, the Company's common stock having a
market value of $8.00 based on the then market price of the Company's common
stock, or at the discretion of the Board of Directors, Preferred Stock, having
double the value of such exercise price. The Company will be entitled to redeem
the Rights at $.001 per right under certain circumstances set forth in the
Rights Plan. The Rights themselves have no voting power and will expire on
December 26, 2012, unless earlier exercised, redeemed or exchanged.
COMMON STOCK RESERVED - As of December 31, 2003, the Company had reserved
for issuance approximately 9,285,000 shares of common stock pursuant to the
Company's stock option plans (including an aggregate of 1,015,164 options issued
to the Company's Chairman which were not granted pursuant to stockholder
approved stock option plans) and 500,000 shares of common stock to use for
..grants as the Company's Board of Directors deems appropriate.
TREASURY STOCK - During the year ended December 31, 2002, the Company
repurchased 340,000 shares of its common stock at a cost of $360,000.
In August 2002, the Board of Directors authorized the repurchase of up to
$1.5 million of the Company's common stock, of which approximately $1,140,000
remains available for repurchase under the program at December 31, 2003.
7. STOCK OPTIONS
The Company adopted, with stockholder approval, 1993, 1994, 1994
Disinterested Director, 1995, 1996, 1998, 2001, and 2002 Stock Option Plans (the
"1993 Plan," "1994 Plan," "1994 DD Plan," "1995 Plan," "1996 Plan," "1998 Plan,"
"2001 Plan," and "2002 Plan") which provide for the granting of options to
purchase not more than an aggregate of 1,050,000, 1,260,000, 210,000, 2,400,000,
1,999,992, 3,600,000, 900,000, and 950,000 shares of common stock, respectively,
subject to adjustment under certain circumstances. Such options may be incentive
stock options ("ISOs") within the meaning of the Internal Revenue Code of 1986,
as amended, or options that do not qualify as ISOs ("Non-Qualified Options").
II-27
The option exercise price per share may not be less than the fair market
value per share of common stock on the date of grant (110% of such fair market
value for an ISO, if the grantee owns stock possessing more than 10% of the
combined voting power of all classes of the Company's stock). Options may be
granted under the Stock Option Plan to all officers, directors, and employees of
the Company and, in addition, Non-Qualified Options may be granted to other
parties who perform services for the Company. No options may be granted under
the 1994 Plan and 1994 DD Plan after May 19, 2004; under the 1995 Plan after May
16, 2005; under the 1996 Plan after July 8, 2006; under the 1998 Plan after July
8, 2008; under the 2001 Plan after May 31, 2011; and under the 2002 Plan until
after June 30, 2012.
The Plans may be amended from time to time by the Board of Directors of
the Company. However, the Board of Directors may not, without stockholder
approval, amend the Plans to increase the number of shares of common stock which
may be issued under the Plans (except upon changes in capitalization as
specified in the Plans), decrease the minimum exercise price provided in the
Plans or change the class of persons eligible to participate in the Plans.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock Based Compensation." Accordingly, to the extent the
exercise price of options granted to employees is equal to or greater than the
market value of the underlying common stock on the date of grant, compensation
expense is not recognized for stock options granted to employees. Had
compensation cost for the Company's stock option grants been determined based on
the fair value at the grant date for awards in 2003, 2002, and 2001, consistent
with the provisions of SFAS No. 123, the Company would have reflected a net loss
of approximately $2.3 million or $(.10) basic and diluted in 2003; a net loss of
approximately $7.1 million or $(.33) basic and diluted in 2002; and a net loss
of $837,000 or $(.04) per share, basic and diluted, in 2001. The fair value of
options at date of grant was estimated using the Black-Scholes pricing model
with the following weighted average assumptions: expected life of six years for
options granted in 2003 and four years for options granted in 2002 and 2002;
risk free interest rate of 4.2% in 2003, 3.5% in 2002, and 5% in 2001, expected
volatility of 140% in 2003, 119% in 2002 and 118% in 2001.
The following table presents information related to stock options for
2003, 2002 and 2001.
II-28
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
PER SHARE REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
PRICES
------------ ---------- ---------- -------- ---------- --------
Balance 1/1/01 $0.25 - 0.47 1,019,640 2 $0.34 1,019,640 $0.34
$0.50 - 0.75 2,858,632 3 $0.58 2,429,632 $0.56
$1.29 399,996 2 $1.29 399,996 $1.29
$1.56 - 2.25 2,699,108 4 $1.90 295,984 $1.73
$2.50 - 2.69 343,200 5 $2.52 - -
---------- ----------
7,320,576 4,145,252
==========
Cancelled $2.00 - 6.10 (156,127) $3.83
Granted $3.05 - 6.57 1,292,200 $5.42
Exercised $0.25 - 4.00 (605,357) $0.71
----------
Balance 12/31/01 $0.25 - 0.47 979,644 1 $0.35 979,644 $0.35
$0.50 - 0.75 2,406,818 2 $0.58 2,406,818 $0.58
$1.29 399,996 1 $1.29 399,996 $1.29
$1.56 - 2.25 2,564,992 4 $1.89 928,903 $1.87
$2.50 - 2.69 277,642 4 $2.50 80,519 $2.50
$3.05 - 4.60 29,200 4 $3.70 0 -
$5.43 - 5.89 1,180,000 4 $5.45 0 -
$6.00 - 6.57 13,000 4 $6.21 0 -
---------- ----------
7,851,292 4,795,880
========== ==========
Cancelled $0.25 - 6.22 (489,482) $1.29
Granted $1.00 - 4.60 220,750 $3.64
Exercised $0.25 - 0.50 (317,676) $0.35
----------
Balance 12/31/02 $0.25 - 0.47 445,668 2 $0.41 445,668 $0.41
$0.50 - 0.75 2,347,922 2 $0.59 2,347,922 $0.59
$1.00 - 1.29 409,996 5 $1.28 399,996 $1.28
$1.56 - 2.25 2,421,548 3 $1.88 1,524,469 $1.87
$2.50 228,800 3 $2.50 124,026 $2.50
$3.00 - 4.60 232,950 5 $3.74 12,105 $3.68
$5.43 - 5.89 1,170,000 4 $5.45 544,855 $5.45
$6.00 - 6.57 8,000 4 $6.24 3,416 $6.25
---------- ----------
7,264,884 5,402,457
==========
Cancelled (127,176) $2.42
Granted 1,002,000 $3.40
Exercised (550,328) $1.14
----------
Balance 12/31/03 $0.25 - 0.47 445,668 7 $0.41 445,668 $0.41
$0.50 - 0.75 2,003,472 7 $0.59 2,003,472 $0.59
$1.00 - 1.29 409,996 4 $1.28 400,551 $1.29
$1.56 - 2.25 2,172,294 2 $1.86 1,836,132 $1.84
$2.50 194,200 2 $2.50 152,808 $2.50
$3.00 - 4.60 1,185,750 9 $3.49 112,679 $3.86
$5.43 - 5.89 1,170,000 2 $5.45 823,478 $5.45
$6.00 - 6.57 8,000 2 $6.24 5,416 $6.25
---------- ----------
7,589,380 5,780,204
========== ==========
II-29
Options granted prior to 2003 vest over a four year period and have a five
year life. In 2003, substantially all options granted vest over a four year
period and have a ten year life. The weighted average fair value as of the date
of grant for options granted in 2003, 2002 and 2001 is $3.21, $3.64, and $4.25,
respectively.
In 2003, the Company extended the expiration date of options granted to
certain officers, directors and employees, substantially all of which were
vested, to purchase 315,000, 566,000, 522,000 and 133,000 shares of its common
stock at $.47, $.50, $.67 and $2.00, respectively. In connection with the
extension, the option holders agreed not to sell shares of stock acquired upon
exercise of the extended options for designated periods of time ending between
June 2004 to March 2005. In connection with this transaction, compensation
expense of approximately $650,000 was recorded in the second quarter of 2003
based upon the difference between the exercise price and the market price of the
underlying common stock on the date the options were extended. Compensation
expense is included as a component of selling and administrative expenses.
In 2002, the Company extended the expiration date of options to the Chief
Executive Officer to purchase 6,672, 248,496, 360,000, 399,996 and 123,996
shares of its common stock at $.42, $.50, $.58, $1.29 and $.25, per share,
respectively. In connection with this transaction, compensation expense of
approximately $513,000 was recorded in the third quarter as selling and
administrative expenses. In addition, the Company issued 11,587 shares of its
common stock pursuant to an employment agreement with an officer of the Company.
Compensation expense of approximately $10,000 was recorded in the third quarter
of 2002 as selling and administrative expenses. No compensation expense was
recognized in connection with stock option grants for the year ended December
31, 2001 since the exercise price of options granted equaled or exceeded the
market value of the underlying common stock on the date of grant.
8. SEGMENT REPORTING AND CONCENTRATIONS
As a result of the acquisition of ISOGEN International in December 2001,
the Company's management currently monitors its operations through two reporting
segments: (1) content services and (2) professional services (formerly referred
to as systems integration and training). The content services operating segment
aggregates, converts, tags and editorially enhances digital content and performs
XML transformations. The Company's professional services operating segment
offers system design, custom application development, consulting services, and
systems integration conforming to XML and related standards and provides a broad
range of introductory as well as advanced curricula and training on XML and
other knowledge management standards.
II-30
2003 2002 2001
(IN THOUSANDS)
Revenues
Content services $29,977 $33,089 $57,825
Professional services 6,737 3,296 453
-------- -------- --------
Total consolidated $36,714 $36,385 $58,278
======== ======== ========
Income (loss) before income taxes (a)
Content services $ (420) $(3,326) $ 1,959
Professional services 1,228 (2,516) 28
-------- -------- --------
Total consolidated $ 808 $(5,842) $ 1,987
======== ======== ========
(a) In 2002 and 2001, corporate overhead was not allocated to the
professional services segment. In 2003, corporate overhead has been allocated to
the professional services segment based upon a percentage of consolidated sales.
For comparative purposes, income before income taxes for the years ended
December 31 2002 and 2001 have been reclassified to allocate corporate overhead
using a method consistent with 2003.
DECEMBER 31,
2003 2002
(IN THOUSANDS)
Total assets
Content services $20,986 $20,721
Professional services 4,160 1,976
-------- --------
Total consolidated $25,146 $22,697
======== ========
One client accounted for 33% and 17% of the Company's revenues for the
years ended December 31, 2003 and 2002 respectively, and a second client
accounted for 30% of the Company's revenues for the year ended December 31,
2002. One other client, which substantially curtailed operations, accounted for
30% in the year ended December 31, 2001. No other client accounted for 10% or
more of revenues during this period. Further, in the years ended December 31,
2003, 2002 and 2001, export revenues, substantially all of which were derived
from European clients, accounted for 47%, 23%, and 13%, respectively, of the
Company's revenues.
A significant amount of the Company's revenues are derived from clients in
the publishing industry. Accordingly, the Company's accounts receivable
generally include significant amounts due from such clients. In addition, as of
December 31, 2003, approximately 39% of the Company's accounts receivable was
from foreign (principally European) clients.
9. INCOME (LOSS) PER SHARE
2003 2002 2001
(in thousands, except per share amounts)
Net income (loss) $ 475 $ (5,165) $ 1,348
======== ======== ========
Weighted average common shares
outstanding 21,570 21,489 21,332
Dilutive effect of outstanding options 1,396 - 3,312
-------- -------- --------
Adjusted for dilutive computation 22,966 21,489 24,644
======== ========= ========
Basic income (loss) per share $ .02 $ (.24) $.06
======== ========= ========
Diluted income (loss) per share $ .02 $ (.24) $.05
======== ========= ========
II-31
Diluted net loss per share in 2002 does not include potential common
shares derived from stock options because they are antidilutive. The number of
antidilutive securities excluded from the dilutable loss per share calculation
were 1,542,000 for the year ended December 31, 2002.
10. RESTRUCTURING COSTS AND ASSET IMPAIRMENT
During the fourth quarter 2001, the Company commenced certain actions to
reduce production operations at a wholly owned Asian subsidiary that was
operating at a loss and to reduce overall excess capacity in Asia. Such
activities, which culminated in the cessation and closure of all operations at
such subsidiary and included employee layoffs, were completed in 2002. In
addition, during 2002 the Company closed a second facility, resulting in the
write-off of property and equipment associated with the closed facility totaling
approximately $244,000. Such write-off of equipment has been classified as
Restructuring Costs and Asset Impairment for the year ended December 31, 2002.
Included in Restructuring Costs and Asset Impairment for the year ended
December 31, 2001 are estimated facility closure costs, including employee
related costs, approximating $600,000, and the write-off of leasehold
improvement costs totaling approximately $265,000. In 2002, the Company paid
approximately $350,000 in closing costs.
11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(in thousands, except per share)
2003
Revenues $6,653 $8,056 $11,184 $10,821
Net income (loss) (1,113) (636) 1,490 734
Net income (loss) per share $(.05) $(.03) $.07 $.03
Diluted net income (loss) per share $(.05) $(.03) $.06 $.03
2002
Revenues $12,556 $10,389 $7,278 $6,162
Net income (loss) 243 (899) (2,521) (1,988)
Net income (loss) per share $.01 $(.04) $(.12) $(.09)
Diluted net income (loss) per share $.01 $(.04) $(.12) $(.09)
12. SUBSEQUENT EVENT
For the year ended December 31, 2001, the Company provided an allowance
for doubtful accounts of approximately $2.6 million representing the remaining
balance due at December 31, 2001 from a client that accounted for 30% of its
2001 revenues because the client has reported an inability to raise further
operating funds required to make payment. In January 2004, the Company reached a
settlement with this client to pay $1,000,000 cash as full satisfaction of the
outstanding balance due to the Company. The $1,000,000 will be reflected as a
bad debt recovery income in the Company's first quarter 2004 financial
statements.
II-32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to the Company's management, including its Chief
Executive Officer and Principal Financial Officer to allow timely decisions
regarding required disclosure. Management necessarily applied its judgment in
assessing the costs and benefits of such controls and procedures which, by their
nature, can provide only reasonable assurance regarding management's control
objectives. Management, including the Company's Chief Executive Officer along
with the Company's Principal Financial Officer, concluded that the Company's
disclosure controls and procedures are effective in reaching the level of
reasonable assurance regarding management's control objectives.
The Company has carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chief
Executive Officer along with the Company's Principal Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon the
foregoing, as of December 31, 2003, the Company's Chief Executive Officer along
with the Company's Principal Financial Officer, concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's Exchange Act reports.
There has been no change during the Company's fiscal quarter ended December 31,
2003 in the Company's internal control over financial reporting that was
identified in connection with the foregoing evaluation which has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
II-33
PART III
ITEM 10. DIRECTORS, OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(A) OF THE EXCHANGE ACT.
The information concerning the Company's required by this Item is
incorporated by reference to the Company's proxy statement under the heading
"Executive Officers". The information concerning the Company's Directors
required by this Item is incorporated by reference to the Company's proxy
statement under the heading "Election of Directors". Information concerning
compliance by the Company's officers, Directors and 10% stockholders with
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference to the information contained in the Company's Proxy Statement under
the heading "Section 16(a) Beneficial Ownership Reporting Compliance."
Information regarding the presence of an audit committee financial expert
required by this Item is incorporated by reference to the Company's Proxy
Statement under the heading "Audit Committee."
The Company has adopted a code of ethics that applies to all of its
employees, officers, and directors, including its principal executive officer,
principal financial and accounting officer, and controller. The text of the
Company's code of ethics is posted on its website at www.innodata-isogen.com.
The Company intends to disclose future amendments to, or waivers from, certain
provisions of the code of ethics for executive officers and directors in
accordance with applicable NASDAQ and SEC requirements.
ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated by reference from
the Company's definitive proxy statement for the 2004 Annual Meeting of
Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no
later than 120 days after the end of the Company's 2003 fiscal year. Information
appearing under the captions "Report of the Compensation Committee; Report of
the Section 162(m) subcommittee"; "Report of the Audit Committee" and "Stock
Performance Graph" to be included in the Company's 2004 Proxy Statement is not
incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information called for by Item 12 is incorporated by reference from
the Company's definitive proxy statement for the 2004 Annual Meeting of
Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no
later than 120 days after the end of the Company's 2003 fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by Item 13 is incorporated by reference from
the Company's definitive proxy statement for the 2004 Annual Meeting of
Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no
later than 120 days after the end of the Company's 2003 fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by Item 14 is incorporated by reference from
the Company's definitive proxy statement for the 2004 Annual Meeting of
Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no
later than 120 days after the end of the Company's 2003 fiscal year.
III-1
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits which are indicated as being included in previous filings are
incorporated herein by reference.
EXHIBIT DESCRIPTION FILED AS EXHIBIT
3.1 (a) Restated Certificate of Filed herewith
Incorporation filed on
April 29, 1993
3.1 (b) Certificate of Amendment of Filed herewith
Certificate of
Incorporation of Innodata
Corporation filed on
March 1, 2001
3.1 (c) Certificate of Amendment of Filed herewith
Certificate of
Incorporation of Innodata
Corporation filed on
November 14, 2003
3.2 Form of Amended and Restated Exhibit 3.1 to Form 8-K dated December
By-Laws 16, 2002
3.3 Form of Certificate of Filed as Exhibit A to Exhibit 4.1 to Form
Designation of 8-K dated
Series C Participating December 16, 2002
Preferred Stock
4.2 Specimen of Common Stock Exhibit 4.2 to Form SB-2 Registration
certificate Statement No. 33-62012
4.3 Form of Rights Agreement, Exhibit 4.1 to Form 8-K dated December
dated as of 16, 2002
December 16, 2002 between
Innodata Corporation
and American Stock Transfer &
Trust Co., as
Rights Agent
10.1 1994 Stock Option Plan Exhibit A to Definitive Proxy dated
August 9, 1994
10.2 1993 Stock Option Plan Exhibit 10.4 to Form SB-2 Registration
Statement No. 33-62012
10.3 Form of Indemnification Exhibit 10.3 to Form 10-K dated December
Agreement 31, 2002
10.4 1994 Disinterested Directors Exhibit B to Definitive Proxy dated
Stock Option Plan August 9, 1994
10.5 1995 Stock Option Plan Exhibit A to Definitive Proxy dated
August 10, 1995
10.6 1996 Stock Option Plan Exhibit A to Definitive Proxy dated
November 7, 1996
10.7 1998 Stock Option Plan Exhibit A to Definitive Proxy dated
November 5, 1998
10.8 2001 Stock Option Plan Exhibit A to Definitive Proxy dated June
29, 2001
10.9 2002 Stock Option Plan Exhibit A to Definitive Proxy dated
September 3, 2002
10.10 Employment Agreement dated as Filed herewith
of January 1, 2004 with George
Kondrach
IV-1
21 Significant subsidiaries of Filed herewith the registrant
23 Consent of Grant Thornton LLP Filed herewith
31.1 Certificate of Chief Executive Filed herewith Officer and Principal
Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, Filed herewith
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, Filed herewith
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Form 8-K Report. None.
(d) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
IV-2
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNODATA ISOGEN, INC.
By /s/
-------------------------------------
Jack Abuhoff
Chairman of the Board of Directors,
Chief Executive Officer and President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
Chairman of the Board of March 26, 2004
/s/ Directors,
- ------------------------------
Jack Abuhoff Chief Executive Officer and
President
/s/ Vice Chairman of the Board of March 26, 2004
- ------------------------------
Todd Solomon Directors and Consultant
/s/ Vice President - Finance March 26, 2004
- ------------------------------
Stephen Agress Chief Accounting Officer
(Principal Accounting and
Financial Officer)
Director March 26, 2004
- ------------------------------
Haig S. Bagerdjian
/s/ Director March 26, 2004
- ------------------------------
Louise C. Forlenza
/s/ Director March 24, 2004
- ------------------------------
Dr. Charles F. Goldfarb
/s/ Director March 26, 2004
- ------------------------------
John R. Marozsan
INNODATA ISOGEN, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
Activity in the Company's allowance for doubtful accounts for the years ended
December 31, 2003, 2002 and 2001 was as follows:
ADDITIONS
-------------------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
PERIOD BEGINNING OF PERIOD COSTS AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD
- ------ ------------------- ------------------ -------------- ---------- -------------
2003 $1,254 $ - $ - $ (35) $1,219
2002 $1,853 $ - $ - $ (599) $1,254
2001 $ 884 $2,942 $ - $ (1,973) $1,853