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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
------------------
[ ] 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)
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 preceeding 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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
22,567,462 SHARES OF COMMON STOCK, $.01 PAR VALUE, AS OF OCTOBER 31, 2004.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
See pages 2-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
See pages 12-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk
See page 20-21
Item 4. Controls and Procedures
See page 21
PART II. OTHER INFORMATION
See page 22
1
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
SEPTEMBER 30, DECEMBER 31,
2004 2003
-------- --------
Unaudited Derived from
audited
financial
statements
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 16,109 $ 5,051
Cash and equivalents - restricted -- 1,000
Accounts receivable-net 10,611 8,497
Refundable income taxes -- 1,075
Prepaid expenses and other current assets 1,383 999
Deferred income taxes 307 1,421
-------- --------
Total current assets 28,410 18,043
PROPERTY AND EQUIPMENT - NET 4,860 5,628
OTHER ASSETS 932 800
GOODWILL 675 675
-------- --------
TOTAL $ 34,877 $ 25,146
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 2,657 $ 2,451
Accrued salaries and wages 4,104 2,865
Income and other taxes 1,286 598
Current portion of capital lease obligations 156 146
-------- --------
Total current liabilities 8,203 6,060
-------- --------
DEFERRED INCOME TAXES PAYABLE 1,423 1,410
-------- --------
OBLIGATIONS UNDER CAPITAL LEASE 152 272
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized 75,000,000 shares; issued
23,142,000 and 22,535,000 shares at September 30, 2004 and
December 31, 2003 respectively 231 226
Additional paid-in capital 16,343 15,413
Retained earnings 10,499 3,739
-------- --------
27,073 19,378
Less: treasury stock - at cost; 584,000 shares (1,974) (1,974)
-------- --------
Total stockholders' equity 25,099 17,404
-------- --------
TOTAL $ 34,877 $ 25,146
======== ========
See notes to unaudited condensed consolidated financial statements
2
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(In thousands, except per share amounts)
(Unaudited)
- --------------------------------------------------------------------------------
2004 2003
-------- --------
REVENUES $ 15,927 $ 11,184
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 8,847 7,225
Selling and administrative expenses 2,847 2,002
Interest income - net (14) (4)
-------- --------
Total 11,680 9,223
-------- --------
INCOME BEFORE PROVISION FOR
INCOME TAXES 4,247 1,961
PROVISION FOR INCOME TAXES 1,144 471
-------- --------
NET INCOME $ 3,103 $ 1,490
======== ========
INCOME PER SHARE:
Basic $ .14 $ .07
======== ========
Diluted $ .13 $ .06
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 22,429 21,593
======== ========
Diluted 24,659 23,225
======== ========
See notes to unaudited condensed consolidated financial statements
3
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(In thousands, except per share amounts)
(Unaudited)
- --------------------------------------------------------------------------------
2004 2003
-------- --------
REVENUES $ 40,438 $ 25,893
-------- --------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 24,481 19,458
Selling and administrative expenses 7,514 6,561
Bad debt recovery - net (963) --
Interest income - net (13) (19)
-------- --------
Total 31,019 26,000
-------- --------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES 9,419 (107)
PROVISION FOR INCOME TAXES 2,659 152
-------- --------
NET INCOME (LOSS) $ 6,760 $ (259)
======== ========
INCOME (LOSS) PER SHARE:
Basic $ .30 $ (.01)
======== ========
Diluted $ .28 $ (.01)
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 22,176 21,499
======== ========
Diluted 24,541 21,499
======== ========
See notes to unaudited condensed consolidated financial statements
4
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(In thousands)
(Unaudited)
2004 2003
-------- -------
OPERATING ACTIVITIES:
Net income (loss) $ 6,760 $ (259)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 3,042 3,325
Non-cash compensation 44 650
Deferred income taxes 1,127 (189)
Changes in operating assets and liabilities:
Accounts receivable (2,114) (3,945)
Refundable income taxes 1,075 416
Prepaid expenses and other current assets (937) (988)
Other assets (182) 206
Accounts payable and accrued expenses 206 327
Accrued salaries and wages 1,239 548
Income and other taxes 909 131
-------- -------
Net cash provided by operating activities 11,169 222
-------- -------
INVESTING ACTIVITIES:
Capital expenditures (1,671) (1,785)
Restricted cash 1,000 (1,000)
-------- -------
Net cash used in investing activities (671) (2,785)
-------- -------
FINANCING ACTIVITIES:
Payment of obligations under capital lease (110) (14)
Short-term borrowings -- 1,000
Proceeds from exercise of stock options 670 88
-------- -------
Net cash provided by financing activities 560 1,074
-------- -------
INCREASE (DECREASE) IN CASH 11,058 (1,489)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 5,051 7,255
-------- -------
CASH AND EQUIVALENTS, END OF PERIOD $ 16,109 $ 5,766
======== =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 11 $ 2
======== =======
Income taxes $ 616 $ 23
======== =======
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property and equipment utilizing capital leases $ -- $ 467
======== =======
See notes to unaudited condensed consolidated financial statements
5
INNODATA ISOGEN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Unaudited)
- --------------------------------------------------------------------------------
1. Innodata Isogen, Inc. and subsidiaries (the "Company") is a provider of
content supply chain 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.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of
only normal recurring accruals) necessary to present fairly the financial
position as of September 30, 2004, the results of operations for the three
and nine months ended September 30, 2004 and 2003, and the cash flows for
the nine months ended September 30, 2004 and 2003. The results of
operations for the three and nine months ended September 30, 2004 and 2003
are not necessarily indicative of results that may be expected for any
other interim period or for the full year.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 2003 included
in the Company's Annual Report on Form 10-K. The accounting policies used
in preparing these financial statements are the same as those described in
the December 31, 2003 financial statements.
See notes to unaudited condensed consolidated financial statements
6
2. An analysis of the changes in each caption of stockholders' equity for the
nine months ended September 30, 2004 and 2003, (in thousands) is as
follows.
ADDITIONAL
COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
-------- -------- -------- -------- -------- --------
JANUARY 1, 2004 22,535 $ 226 $ 15,413 $ 3,739 $ (1,974) $ 17,404
Net income -- -- -- 6,760 -- 6,760
Issuance of common stock
upon exercise of stock options 607 5 665 -- -- 670
Tax benefit from exercise
of options -- -- 221 -- -- 221
Non-cash compensation -- -- 44 -- -- 44
-------- -------- -------- -------- -------- --------
SEPTEMBER 30, 2004 23,142 $ 231 $ 16,343 $ 10,499 $ (1,974) $ 25,099
======== ======== ======== ======== ======== ========
ADDITIONAL
COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
-------- -------- -------- -------- -------- --------
JANUARY 1, 2003 22,046 $ 220 $ 14,084 $ 3,264 $ (1,999) $ 15,569
Net loss -- -- -- (259) -- (259)
Issuance of common stock
upon exercise of stock options 249 3 132 -- (47) 88
Tax benefit from exercise
of options -- -- 3 -- -- 3
Non-cash compensation -- -- 650 -- -- 650
-------- -------- -------- -------- -------- --------
SEPTEMBER 30, 2003 22,295 $ 223 $ 14,869 $ 3,005 $ (2,046) $ 16,051
======== ======== ======== ======== ======== ========
3. Basic income (loss) per share is based on the weighted average number of
common shares outstanding without consideration of potential common stock.
Diluted income (loss) per share is based on the weighted average number of
common and potential common shares outstanding. The difference between
basic weighted average common shares outstanding and diluted shares
outstanding represents the dilutive effect of outstanding options. Options
to purchase 1.4 and 2.7 million shares of common stock at September 30,
2004 and 2003, respectively, were outstanding but not included in the
computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares and
therefore, the effect would have been antidilutive. In addition, for the
nine months ended September 30, 2003, diluted net loss per share does not
include 999,000 potential common shares derived from stock options because
they are antidilutive.
7
The basis of the earnings (loss) per share computation for the three and
nine months ended September 30, 2004 and 2003 (in thousands, except per
share amounts) is as follows:
THREE MONTHS NINE MONTHS
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income (loss) $ 3,103 $ 1,490 $ 6,760 $ (259)
======== ======== ======== ========
Weighted average common shares outstanding 22,429 21,593 22,176 21,499
Dilutive effect of outstanding options 2,230 1,632 2,365 --
-------- -------- -------- --------
Adjusted for dilutive computation 24,659 23,225 24,541 21,499
======== ======== ======== ========
Basic income (loss) per share $ .14 $ .07 $ .30 $ (.01)
======== ======== ======== ========
Diluted income (loss) per share $ .13 $ .06 $ .28 $ (.01)
======== ======== ======== ========
4. The Company has various stock-based employee compensation plans, which it
accounts for 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 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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2004 2003 2004 2003
------- ------ ------ -------
Net income (loss) as reported $ 3,103 $1,490 $6,760 $ (259)
Deduct: Total stock-based employee
compensation determined under fair value
based method, net of related tax effects (615) (607) (2,033) (2,753)
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
------- ------ ------ -------
Pro forma net income (loss) $ 2,488 $ 883 $4,727 $(2,557)
======= ====== ====== =======
Income (loss) per share:
Basic - as reported $ .14 $ .07 $ .30 $ (.01)
======= ====== ====== =======
Basic - pro forma $ .11 $ .04 $ .21 $ (.12)
======= ====== ====== =======
Diluted - as reported $ .13 $ .06 $ .28 $ (.01)
======= ====== ====== =======
Diluted - pro forma $ .10 $ .04 $ .19 $ (.12)
======= ====== ====== =======
8
5. The Company's operations are classified into two reporting segments: (1)
content services and (2) professional services. 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.
Commencing October 1, 2003, the Company unified its selling and related
activities for its content and professional services segments. As such,
selling and corporate administrative costs are not segregated by, nor are
they allocated to, operating segments. The income (loss) before income
taxes, by operating segment for the 2003 periods, have been reclassified
for comparative purposes.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN THOUSANDS) (IN THOUSANDS)
Revenues
Content services $ 13,071 $ 9,128 $ 31,575 $ 21,489
Professional services 2,856 2,056 8,863 4,404
-------- -------- -------- --------
Total consolidated $ 15,927 $ 11,184 $ 40,438 $ 25,893
======== ======== ======== ========
Income (loss) before income taxes
Content services $ 5,391 $ 2,819 $ 11,645 $ 4,643
Professional services 1,467 1,089 4,484 1,792
Selling and corporate administration (2,611) (1,947) (6,710) (6,542)
-------- -------- -------- --------
Total consolidated $ 4,247 $ 1,961 $ 9,419 $ (107)
======== ======== ======== ========
SEPTEMBER 30, DECEMBER, 31,
2004 2003
-------- --------
(IN THOUSANDS)
Total assets
Content services $ 13,935 $ 12,330
Professional services 3,505 3,533
Corporate (includes corporate cash) 17,437 9,283
-------- --------
Total consolidated $ 34,877 $ 25,146
======== ========
One client, comprising multiple entities and divisions worldwide, accounted
for $22% and 37% of the Company's revenues for the three months ended
September 30, 2004 and 2003, respectively; and 23% and 36% of the Company's
revenues for the nine months ended September 30, 2004 and 2003,
respectively. A second client accounted for 37% and 29% of the Company's
revenues for the three and nine months ended September 30, 2004,
respectively.
6. The Company has a $5 million line of credit pursuant to which it may borrow
up to 80% of eligible accounts receivable at the bank's alternate base rate
plus 1/2% or LIBOR plus 3%. The line, which expires in May, 2005, is
secured by the company's accounts receivable. The Company has not borrowed
against its credit line in 2004.
7. In the three months ended September 30, 2004 and 2003, the provision for
income taxes as a percentage of income before income taxes was 27% and 24%,
respectively, which is lower than the U.S. Federal statutory tax rate,
principally due to certain overseas income which is neither subject to
foreign income taxes because of tax holidays granted to the Company, nor
subject to tax in the U.S. unless repatriated. In the nine months ended
September 30, 2004, the provision for income taxes as a percentage of
income before income taxes was 28%, which is lower than the U.S. Federal
statutory rate principally due to certain overseas income which is neither
subject to foreign income taxes because of tax holidays granted to the
Company, nor subject to tax in the U.S. unless repatriated. In the nine
months ended September 30, 2003, the provision for income taxes is
primarily a result of taxable income attributable to certain expenses not
deductible for income tax purposes, and to the taxability of income in
certain state and foreign tax jurisdictions.
9
8. In January 2004, the Company signed a settlement agreement and received
$1,000,000 cash from a former client as full satisfaction of a $2.6 million
remaining outstanding balance that the Company had fully written off as a
bad debt in 2001. The $1,000,000 receipt, net of $37,000 in recovery costs,
is reflected as bad debt recovery income in the statement of operations for
the nine months ended September 30, 2004.
9. In the third quarter 2004, the Company granted options to an officer to
purchase 100,000 shares of its common stock at $3.75 per share and to
employees to purchase 114,000 shares of its common stock at prices ranging
between $3.60 and $3.75 per share.
In the second quarter 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 September, 2004 and 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. Such
compensation expense is included as a component of selling and
administrative expenses for the nine months ended September 30, 2003.
10. During the three months ended September 30, 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.
11. In connection with the cessation of all operations at certain foreign
subsidiaries, certain former employees have filed various actions in the
Philippines relating to their dismissal 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.
10
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 the 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.
12. 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.
13. 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 individual
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 maximum
potential future payments. As of September 30, 2004, the Company is not
aware of liability for any obligations arising as a result of these
indemnifications.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Disclosures in this Form 10-Q 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", "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, continuing revenue concentration in a limited
number of clients and continuing reliance on project-based work, worsening of
present 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 the Company acquires, changes in the Company's business or growth strategy,
the emergence of new or growing competitors, various other competitive and
technological 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-Q 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.
THE COMPANY
Innodata Isogen, Inc. (the "Company") is a leading provider of content
supply chain services and solutions to Global 2000 Enterprises, secondary
publishers, governments and major archives, libraries and museums. 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 US and Asia. The Company has approximately 100 active clients,
including Amazon.com, Dow Jones & Company, Lockheed Martin Corporation, ProQuest
Company, Reed Elsevier, Reuters, Simon & Schuster, The Thomson Corporation, and
Wolters Kluwer.
12
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 SML and related standards and
provides a broad range of introductory as well as advanced curricula and
training on XML and other knowledge management standards.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Revenues increased 42% to $15,927,000 for the three months ended September
30, 2004 compared to $11,184,000 for the similar period in 2003.
Revenues from the content services segment increased 43% to $13,071,000
for the three months ended September 30, 2004 compared to $9,128,000 for the
similar period in 2003. The increase was primarily due to increased revenues
from new projects for several existing clients.
Revenues from the Company's professional services segment increased 39% to
$2,856,000 for the three months ended September 30, 2004 compared to $2,056,000
for the similar period in 2003. The increase was principally attributable to
favorable growth from certain existing clients. For the three months ended
September 30, 2004, revenues from two clients accounted for 67% of professional
services segment revenues; in the similar period in 2003, two clients accounted
for approximately 60% of professional services segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 22% and 37% of the Company's revenues for the three months ended
September 30, 2004 and 2003, respectively. A second client accounted for 37% of
the Company's revenues for the three months ended September 30, 2004. Further,
in the three months ended September 30, 2004, and 2003, revenues from clients
located in foreign countries (principally in Europe), accounted for 23% and 42%,
respectively, of the Company's revenues.
During both the third quarter 2004 and 2003, the Company provided
approximately 55% of its total services under project-based arrangements and the
45% balance under outsourcing-type arrangements. Both types of services are
typically subject to client requirements, and many are terminable upon notice.
Outsourcing arrangements tend to continue for relatively longer periods, while
revenues for project-based work vary depending on the size and completion dates
of specific projects.
The Company's results will fluctuate in part based on whether it succeeds
in counterbalancing periodic declines in revenues on project completions or
cancellations by entering into arrangements for new projects with the same
clients or others. The Company has refocused its sales force to seek to increase
the relative percentage of services that the Company performs on an outsourcing
basis, but the Company continues to enter into project-based arrangements that
become available to it on attractive terms without regard to the resulting
effect on this relative percentage.
13
Direct operating expenses were $8,847,000 and $7,225,000 for the three
months ended September 30, 2004 and 2003, respectively, an increase of 22%.
Direct operating expenses as a percentage of revenues were 56% in 2004 and 65%
in 2003.
Direct operating expenses for the content services segment were $7,486,000
and $6,260,000 in the three months ended September 30, 2004 and 2003,
respectively, an increase of 20%. Direct operating expenses as a percentage of
revenues for the content services segment were 57% and 69% in the three months
ended September 30, 2004 and 2003, respectively. The dollar increase for the
content services segment in the 2004 period was principally due to increases in
costs for the increased revenues. The decrease as a percent of sales for the
content services segment in the 2004 period was principally due to lower
production labor costs as a percent of revenues and to a 43% increase in
revenues compared to a 6% increase in fixed non-labor costs. 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 $1,361,000 and $965,000 for the three months ended September 30, 2004 and
2003, respectively, an increase of 41%. Direct operating expenses as a percent
of revenues for the Company's professional services segment were 48% and 47% in
the three months ended September 30, 2004 and 2003, respectively. The dollar
increase for the professional services segment in the 2004 period was
principally due to increases in personnel and related costs for the increased
revenues.
Commencing October 1, 2003, the Company unified its selling and related
activities for its content and professional services segments. As such, selling
and corporate administrative costs are not segregated by, nor are they allocated
to, operating segments.
Selling and administrative expenses were $2,847,000 and $2,002,000 for the
three months ended September 30, 2004 and 2003, respectively, an increase of
42%. This increase was primarily attributable to increases in selling and
marketing costs, which are expected to continue to grow modestly as the Company
expands its selling and marketing activities, and to increases in administrative
costs. Selling and administrative expenses as a percentage of revenues were 18%
in the 2004 and 2003 periods. Selling and administrative expenses primarily
include management and administrative salaries, selling and marketing costs, and
administrative overhead.
In the three months ended September 30, 2004 and 2003, the provision for
income taxes as a percentage of income before income taxes was 27% and 24%
respectively, which is lower than the U.S. Federal statutory tax rate,
principally due to certain overseas income which is neither subject to foreign
income taxes because of tax holidays granted to the Company nor subject to tax
in the U.S. unless repatriated.
14
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Revenues increased 56% to $40,438,000 for the nine months ended September
30, 2004 compared to $25,893,000 for the similar period in 2003.
Revenues from the content services segment increased 47% to $31,575,000
for the nine months ended September 30, 2004 compared to $21,489,000 for the
similar period in 2003. The increase was primarily due to increased revenues
from new projects for several existing clients.
Revenues from the Company's professional services segment increased 101%
to $8,863,000 for the nine months ended September 30, 2004 compared to
$4,404,000 for the similar period in 2003. The increase was principally
attributable to favorable growth from certain existing clients. For the nine
months ended September 30, 2004, revenues from four clients accounted for
approximately 83% of professional services segment revenues; in the similar
period in 2003, two clients accounted for approximately 50% of professional
services segment revenues.
One client, comprising multiple entities and divisions worldwide,
accounted for 23% and 36% of the Company's revenues for the nine months ended
September 30, 2004 and 2003, respectively. A second client also accounted for
29% of the Company's revenues for the nine months ended September 30, 2004.
Further, in the nine months ended September 30, 2004, and 2003, revenues from
clients located in foreign countries (principally in Europe), accounted for 27%
and 43% respectively, of the Company's revenues.
During the nine months ended September 30, 2004, the Company provided
approximately 52% of its total services under project-based arrangements and the
48% balance under outsourcing-type arrangements, as compared with 47% and 53%,
respectively, during the nine months ended September 30, 2003. Both types of
services are typically subject to client requirements, and many are terminable
upon notice. Outsourcing arrangements tend to continue for relatively longer
periods, while revenues for project-based work vary depending on the size and
completion dates of specific projects.
The Company's results will fluctuate in part based on whether it succeeds
in counterbalancing periodic declines in revenues on project completion or
cancellations by entering into arrangements for new projects with the same
clients or others. The Company has refocused its sales force to seek to increase
the relative percentage of services that the Company performs on an outsourcing
basis, but the Company continues to enter into project-based arrangements that
become available to it on attractive terms without regard to the resulting
effect on this relative percentage.
15
Direct operating expenses were $24,481,000 and $19,458,000 for the nine
months ended September 30, 2004 and 2003, respectively, an increase of 26%.
Direct operating expenses as a percentage of revenues were 61% in 2004 and 75%
in 2003.
Direct operating expenses for the content services segment were
$20,155,000 and $16,848,000 in the nine months ended September 30, 2004 and
2003, respectively, an increase of 20%. Direct operating expenses as a
percentage of revenues for the content services segment were 64% and 78% in the
nine months ended September 30, 2004 and 2003, respectively. The dollar increase
for the content services segment in the 2004 period was principally due to
increases in costs for the increased revenues. The decrease as a percent of
sales for the content services segment in the 2004 period was principally due to
lower production labor costs as a percent of revenues and to a 47% increase in
revenues compared to a 16% increase in fixed non-labor costs. 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 $4,326,000 and $2,610,000 for the nine months ended September 30, 2004 and
2003, respectively, an increase of 66%. Direct operating expenses as a percent
of revenues for the Company's professional services segment were 49% and 59% in
the nine months ended September 30, 2004 and 2003, respectively. The dollar
increase for the professional services segment in the 2004 period was
principally due to increases in personnel and related costs for the increased
revenues. The decrease as a percent of revenues for the professional services
segment in the 2004 period was primarily attributable to a 101% increase in
revenue without a proportionate increase in direct operating expenses and an 8%
percentage point decrease in direct labor costs as a percent of revenues.
Selling and administrative expenses were $7,514,000 and $6,561,000 for the
nine months ended September 30, 2004 and 2003, respectively, an increase of 15%.
Selling and administrative expenses as a percentage of revenues decreased to 19%
in the 2004 period compared to 25% in the 2003 period. Selling and
administrative expenses for the nine months ended September 30, 2003 include a
non-cash compensation charge of approximately $650,000 (described in note 9 to
the Condensed Consolidated Financial Statements). Excluding this charge, overall
selling and administrative expenses for the nine months ended September 30, 2004
would have increased by approximately $1,603,000, or 27%, from the similar
period in 2003. This increase was primarily attributable to increases in selling
and marketing costs which are expected to continue to grow modestly as the
Company expands its selling and marketing activities, and to increases in
administrative costs. Selling and administrative expenses primarily include
management and administrative salaries, selling and marketing costs, and
administrative overhead.
In January 2004, the Company reached a settlement agreement and received
$1,000,000 cash from a former client as full satisfaction of a $2.6 million
dollar remaining outstanding balance that the Company had fully written off as a
bad debt in 2001. The $1,000,000 receipt, net of $37,000 in recovery costs, is
reflected as bad debt recovery income in the statement of operations for the
nine months ended September 30, 2004.
16
In the nine months ended September 30, 2004, the provision for income
taxes as a percentage of income before income taxes was 28%, which is lower than
the U.S. Federal statutory rate principally due to certain overseas income which
is neither subject to foreign income taxes because of tax holidays granted to
the Company, nor subject to tax in the U.S. unless repatriated. In the nine
months ended September 30, 2003, the provision for income taxes is primarily a
result of taxable income attributable to certain expenses not deductible for
income tax purposes, and to the taxability of income in certain state and
foreign tax jurisdictions.
LIQUIDITY AND CAPITAL RESOURCES
Selected measures of liquidity and capital resources are as follows:
September 30, 2004 December 31, 2003
------------------ -----------------
Cash and Cash Equivalents $16,109,000 $ 5,051,000
Working Capital 20,207,000 11,983,000
Stockholders' Equity Per Common Share* $ 1.11 $ .79
*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 $11,169,000 in the nine
months ended September 30, 2004 compared to $222,000 provided by operating
activities for the nine months ended September 30, 2003, an increase of nearly
$11 million. The net cash provided by operating activities in the 2004 period is
principally due to net income approximating $6.8 million, non-cash charges
approximating $4.2 million, a $1.1 million income tax refund and a $1.2 million
net decrease in other current assets and liabilities, offset by a $2.1 million
increase in accounts receivable.
Accounts receivable totaled $10,611,000 at September 30, 2004,
representing approximately 61 days of sales outstanding, compared to $8,497,000,
or 71 days, at December 31, 2003. The decrease in days outstanding resulted from
increased accounts receivable collections during the first nine months of 2004.
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
September 30, 2004, approximately 22% of the Company's accounts receivable was
from foreign (principally European) clients, and 68% of accounts receivable were
due from two clients.
17
Net Cash Used in Investing Activities
During the nine months ended September 30, 2004, the Company spent
approximately $1,671,000 for capital expenditures, compared to approximately
$1,785,000 in the nine months ended September 30, 2003. During the next 12
months, the Company currently anticipates capital spending levels to be in the
$3 million range. Such spending in the first nine months of 2004 and anticipated
capital spending relates principally to normal ongoing equipment upgrades, to
project requirement specific equipment for certain new projects, and for
improvements in infrastructure.
Availability of Funds
The Company has a $5 million line of credit pursuant to which it may
borrow up to 80% of eligible accounts receivable at the bank's alternate base
rate plus 1/2% or LIBOR plus 3%. The line, which expires in May, 2005, is
secured by the company's accounts receivable.
Management believes that existing cash and internally generated funds 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.
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 contracts.
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.
18
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 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.
19
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.
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.
ITEM 3. 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 4.75% at September 30, 2004) plus 1/2%, or LIBOR
(1.875% at September 30, 2004 plus 3%). The company has not borrowed against
this line in 2004. To the extent the Company utilizes all or a portion of its
line of credit, changes in the interest rate will have a positive or negative
effect on the Company's interest expense.
20
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.
ITEM 4. 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 September 30, 2004, 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 nine months ended September 30, 2004 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.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. Not Applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. Not
Applicable
Item 3. Defaults upon Senior Securities. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders. Not Applicable
Item 5. Other Information. Not Applicable
Item 6. Exhibits.
31.1 Certificate of Chief Executive 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, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
22
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNODATA ISOGEN, INC.
Date: November 12, 2004 /s/ Jack Abuhoff
----------------- -----------------------------------------
Jack Abuhoff
Chairman of the Board of Directors,
Chief Executive Officer and President
Date: November 12, 2004 /s/ Stephen Agress
----------------- -----------------------------------------
Stephen Agress
Vice President - Finance
Chief Accounting Officer
23