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 March 31, 2005
|_| 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
incorporation or organization) Identification No.)
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.
22,696,238 shares of common stock, $.01 par value, as of April 30, 2005.
PART I. FINANCIAL INFORMATION Page No.
- ------- --------------------- --------
Condensed Consolidated Balance Sheets 2
Condensed Consolidated Statements of Operations 3
Condensed Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Quantitative and Qualitative Disclosures about
Market Risk 20
Controls and Procedures 20
PART ll. OTHER INFORMATION 21
1
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
March 31, December 31,
2005 2004
---- ----
Unaudited Derived from
audited
financial
statements
ASSETS
CURRENT ASSETS:
Cash and equivalents $23,422 $20,663
Accounts receivable-net 6,058 8,019
Prepaid expenses and other current assets 882 1,757
Deferred income taxes 607 645
------- -------
Total current assets 30,969 31,084
PROPERTY AND EQUIPMENT - NET 4,275 4,559
OTHER ASSETS 969 893
GOODWILL 675 675
------- -------
TOTAL $36,888 $37,211
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 3,210 $ 3,412
Accrued salaries, wages and related benefits 3,884 3,979
Income and other taxes 984 1,304
Current portion of capital lease obligations 180 180
------- -------
Total current liabilities 8,258 8,875
------- -------
DEFERRED INCOME TAXES 1,432 1,449
------- -------
OBLIGATIONS UNDER CAPITAL LEASE 108 150
------- -------
STOCKHOLDERS' EQUITY:
Serial preferred stock; 5,000,000 shares authorized, none
outstanding
Common stock, $.01 par value; 75,000,000 shares
authorized; 22,693,000 and 22,679,000 shares issued and
outstanding at March 31, 2005 and December 31, 2004,
respectively 227 227
Additional paid-in capital 14,968 14,914
Retained earnings 11,895 11,596
------- -------
Total stockholders' equity 27,090 26,737
------- -------
TOTAL $36,888 $37,211
======= =======
See notes to unaudited condensed consolidated financial statements
2
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004 (In thousands,
except per share amounts)
(Unaudited)
- --------------------------------------------------------------------------------
2005 2004
---- ----
REVENUES $11,190 $12,157
------- -------
OPERATING COSTS AND EXPENSES:
Direct operating expenses 8,203 7,775
Selling and administrative expenses 2,684 2,254
Bad debt recovery - net -- (963)
Interest (income) expense - net (81) 1
------- -------
Total 10,806 9,067
------- -------
INCOME BEFORE PROVISION FOR INCOME TAXES 384 3,090
PROVISION FOR INCOME TAXES 85 1,010
------- -------
NET INCOME $ 299 $ 2,080
======= =======
BASIC INCOME PER SHARE $ .01 $ .09
======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING 22,691 21,952
======= =======
DILUTED INCOME PER SHARE $ .01 $ .08
======= =======
ADJUSTED DILUTIVE SHARES OUTSTANDING 25,110 24,527
======= =======
3
INNODATA ISOGEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2005 and 2004
(In thousands)
(Unaudited)
- --------------------------------------------------------------------------------
2005 2004
---- ----
OPERATING ACTIVITIES:
Net income $ 299 $ 2,080
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 824 1,046
Non-cash compensation 6 13
Deferred income taxes 21 945
Changes in operating assets and liabilities:
Accounts receivable 1,961 552
Refundable income taxes -- 1,075
Prepaid expenses and other current assets 684 (314)
Other assets (93) (56)
Accounts payable and accrued expenses (202) 47
Accrued salaries and wages (95) 473
Income and other taxes (309) 23
------- -------
Net cash provided by operating activities 3,096 5,884
------- -------
INVESTING ACTIVITIES:
Capital expenditures (332) (604)
------- -------
FINANCING ACTIVITIES:
Payment of obligations under capital lease (42) (37)
Proceeds from exercise of stock options 37 22
------- -------
Net cash used in financing activities (5) (15)
------- -------
INCREASE IN CASH 2,759 5,265
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 20,663 5,051
------- -------
CASH AND EQUIVALENTS, END OF PERIOD $23,422 $10,316
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 6 $ 4
======= =======
Income taxes $ 464 $ 15
======= =======
4
INNODATA ISOGEN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Unaudited)
- --------------------------------------------------------------------------------
1. Innodata Isogen, Inc. and subsidiaries (the "Company"), is a leading
provider of content supply chain services and solutions. The Company
manufactures content by providing digitization, imaging, data conversion,
XML and markup, metadata creation, advanced classification, editorial,
knowledge and related services. It also designs, implements, integrates
and deploys systems used to manage content. 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 March 31, 2005, the results of operations and the cash
flows for the three months ended March 31, 2005 and 2004. The results of
operations for the three months ended March 31, 2005 and 2004 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,
2004 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, 2004 financial statements.
5
2. An analysis of the changes in each caption of stockholders' equity for the
three months ended March 31, 2005 and 2004 (in thousands) is as follows.
Additonal
Common Stock Paid-in Retained Treasury
Shares Amount Capital Earnings Stock Total
------ ------ ------- -------- ----- -----
January 1, 2005 22,679 $227 $14,914 $11,596 -- $26,737
Net income -- -- -- 299 -- 299
Issuance of common stock
upon exercise of stock options 14 -- 37 -- -- 37
Tax benefit from exercise
of options -- -- 11 -- -- 11
Non-cash compensation -- -- 6 -- -- 6
------ ---- ------- ------- ---------- -------
March 31, 2005 22,693 $227 $14,968 $11,895 -- $27,090
====== ==== ======= ======= ========== =======
January 1, 2004 22,535 $226 $15,413 $ 3,739 $ (1,974) $17,404
Net income -- -- -- 2,080 -- 2,080
Issuance of common stock
upon exercise of stock options 19 -- 22 -- -- 22
Tax benefit from exercise
of options -- -- 14 -- -- 14
Non-cash compensation -- -- 13 -- -- 13
------ ---- ------- ------- ---------- -------
March 31, 2004 22,554 $226 $15,462 $ 5,819 $ (1,974) $19,533
====== ==== ======= ======= ========== =======
Basic income per share is based on the weighted average number of common
shares outstanding without consideration of potential common stock.
Diluted income per share is based on the weighted average number of common
and potential common shares outstanding. The difference between weighted
average common shares outstanding and adjusted dilutive shares outstanding
represents the dilutive effect of outstanding options. Options to purchase
1.1 million shares of common stock in 2005 and 1.3 million shares of
common stock in 2004 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.
6
The basis of the earnings per share computation for the three months ended
March 31, 2005 and 2004 (in thousands, except per share amounts) is as
follows:
2005 2004
---- ----
Net income $ 299 $ 2,080
------- -------
Weighted average common shares outstanding 22,691 21,952
Dilutive effect of outstanding options 2,419 2,575
------- -------
Adjusted for dilutive computation 25,110 24,527
======= =======
Basic income per share $ .01 $ .09
======= =======
Diluted income per share $ .01 $ .08
======= =======
3. The Company accounts for its stock options issued to employees and outside
directors pursuant to Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees" and has adopted the disclosure
requirements of SFAS No. 123, "Accounting for Stock-Based Compensation,"
and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - an Amendment of FASB Statement No. 123." Accordingly, no
compensation expense has been recognized in connection with the issuance
of stock options for the three months ended March 31, 2005 and 2004.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation.
Three months ended March 31,
----------------------------
2005 2004
---- ----
(in thousands, except
per share amounts)
Net income as reported $ 299 $ 2,080
Deduct: Total stock-based employee
compensation determined under fair value
based method, net of related tax effects (266) (515)
-------- ---------
Pro forma net income $ 33 $ 1,565
-------- ---------
Income per share:
Basic - as reported $ .01 $ .09
======== =========
Basic - pro forma $ .00 $ .07
======== =========
Diluted - as reported $ .01 $ .08
======== =========
Diluted - pro forma $ .00 $ .06
======== =========
7
4. The Company's operations are classified into two reporting segments: (1)
outsourced content services and (2) IT professional services. The
outsourced content services segment focuses on fabrication services and
knowledge services. Fabrication services include digitization and data
conversion services, content creation and XML services. Knowledge services
include content enhancement, hyperlinking, indexing and general editorial
services. The IT professional services segment focuses on the design,
implementation, integration and deployment of systems used to author,
manage and distribute content. The Company's outsourced content services
revenues are generated principally from its production facilities located
in the Philippines, India and Sri Lanka. The Company does not depend on
revenues from sources internal to the countries in which the Company
operates; nevertheless, the Company is subject to certain adverse economic
and political risks relating to overseas economies in general, such as
inflation, currency fluctuations and regulatory burdens.
Three Months
Ended March 31,
--------------------------
2005 2004
---- ----
(in thousands)
Revenues:
Outsourced content services $10,007 $ 8,821
IT professional services 1,183 3,336
------- -------
Total consolidated $11,190 $12,157
======= =======
Depreciation and amortization:
Outsourced client services $ 726 $ 959
IT professional services 27 20
Selling and corporate administration 71 67
------- -------
Total consolidated $ 824 $ 1,046
======= =======
Income before income taxes:
Outsourced client services $ 2,826 $ 3,334
IT professional services (93) 1,762
Selling and corporate administration (2,349) (2,006)
------- -------
Total consolidated $ 384 $ 3,090
======= =======
March 31, December 31,
2005 2004
---- ----
(in thousands)
Total assets:
Outsourced content services $11,346 $15,937
IT professional services 1,263 2,033
Corporate (includes corporate cash) 24,279 19,241
------- -------
Total consolidated $36,888 $37,211
======= =======
8
One client accounted for 29% and 23% of the Company's revenues for the
three months ended March 31, 2005 and 2004, respectively. A second client
accounted for 19% and 24% of the Company's revenues for the three months
ended March 31, 2005 and 2004, respectively. No other client accounted for
10% or more of revenues during these periods. Further, in the three months
ended March 31, 2005 and 2004, revenues to non-US clients accounted for
28% and 36%, 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 March 31, 2005, approximately 22% of the Company's accounts
receivable was from foreign (principally European) clients and 47% of
accounts receivable was due from two clients.
5. 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% LIBOR plus 3%. The line, which expires in May 2005,
and is expected to be renewed under similar terms, is secured by the
company's accounts receivable. The Company has not borrowed against its
credit line in 2005.
6. In the three months ended March 31, 2005, the provision for income taxes
as a percentage of income before income taxes was 22%, 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 three months ended March 31, 2004, the provision for
income taxes as a percentage of income before income taxes was 33%, which
is lower than the US 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
US unless repatriated. In addition, the provision for income taxes for the
three months ended March 31, 2004 included a provision for state and local
income taxes of approximately $150,000.
7. 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 three months ended March 31, 2004.
8. In connection with the cessation of all operations at certain foreign
subsidiaries, certain former employees have filed various actions against
one of the Company's Philippine subsidiaries, and have purported to also
sue the Company and certain of its officers and directors, seeking to
require reinstatement of employment and to recover back wages for an
allegedly illegal facility closing on June 7, 2002 based on the terms of a
collective bargaining agreement with this subsidiary. The Company has
prevailed in substantially all stages of this litigation to date, although
several appeals by complainants are still pending. If the complainants'
claims had merit, they could be entitled to back wages of up to $5.0
million for the period from June 7, 2002 to June 6, 2005, consistent with
prevailing jurisprudence. Based upon consultation with legal counsel,
management believes the claims are without merit and is defending against
them vigorously.
9
In August 2004, the Internal Revenue Service ("IRS") promulgated
regulations, effective August 12, 2004, that treated certain of the
Company's subsidiaries that are incorporated in foreign jurisdictions and
also domesticated as Delaware limited liability companies as U.S.
corporations for U.S. federal income tax purposes. In the preamble to such
regulations, the IRS expressed its view that dual registered companies
described in the preceding sentence are also treated as U.S. corporations
for U.S. federal income tax purposes for periods prior to August 12, 2004.
Notwithstanding this view, the Company believes that its historic
treatment of these subsidiaries as not having been required to pay taxes
in the United States for the period prior to August 12, 2004 is correct,
and intends to vigorously defend its treatment if challenged. As such, the
Company has made no provision for U.S. taxes in its financial statements
for these entities for the periods prior to August 12, 2004. However, if
challenges by the IRS were ultimately successful, the Company's potential
U.S. federal income tax liability could approximate $2.5 million,
excluding interest and potential penalties. Furthermore, the Company
cannot assure that the IRS will not assert other positions with respect to
the foregoing matters that, if successful, could increase materially the
Company's liability for U.S. federal income taxes. In December 2004, the
Company effected certain filings in Delaware to ensure that these
subsidiaries will not be treated as U.S. corporations for U.S. federal
income tax purposes as of the date of filing and as such, will not be
subject to U.S. federal income taxes commencing January 1, 2005.
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.
9. 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.
10. 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 March 31, 2005, the
Company has not recorded liability for any obligations arising as a result
of these indemnifications.
10
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 our 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 "estimate," "believe," "expect," and "anticipate"
and other similar expressions generally identify forward-looking statements,
which speak only as of their dates.
These forward-looking statements are based largely on our current
expectations, and are subject to a number of risks and uncertainties, including
without limitation, continuing revenue concentration in a limited number of
clients, continuing reliance on project-based work, worsening of market
conditions, changes in external market factors, the ability and willingness of
our 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 we acquire, changes in our
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 our filings with the Securities and
Exchange Commission.
Our 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 release will occur.
We undertake no obligation to update or review any guidance or other
forward-looking information, whether as a result of new information, future
developments or otherwise.
The Company
Innodata Isogen is a leading provider of business services that help
organizations create, manage, use and distribute information more effectively
and economically. We provide outsourced content services and content-related
information technology (IT) professional services. Our outsourced content
services focus on fabrication services and knowledge services. Fabrication
services include digitization, imaging, data conversion, XML and mark-up
services, as well as language translation and content creation services. XML, or
Extensible Markup Language, is a universally accepted notation for identifying
information elements in documents, and is designed to meet the challenges of
large-scale electronic publishing. Knowledge services include content
enhancement, taxonomy, controlled vocabulary development, hyperlinking, mark-up
indexing, abstracting and general editorial services. Our IT professional
services focus on the design, implementation, integration and deployment of
systems used to author, manage and distribute content.
11
Our services encompass both outsourced content services that focus on
fabrication services and knowledge services and information technology (IT)
professional services that focus on the design, implementation, integration and
deployment of systems used to author, manage and distribute content. We define
content as all forms of unstructured data, including text, formatted text such
as HTML, high-fidelity information such as XML, interactive and /or dynamic Web
pages, images, graphics animation, video and sound files.
Outsourced content services for business processes that we anticipate a
client will require for an indefinite period generate what we regard as
recurring revenues. Outsourced content services for a specific project generate
revenues that we regard as non-recurring. A substantial majority of our IT
professional services is provided on a project basis that generates
non-recurring revenues.
While we seek, wherever possible, to counterbalance periodic declines in
revenues on completion of large projects with new arrangements to provide
services to the same client or others, we may not be able to avoid declines in
revenues when large projects are completed. Our inability in any period to
obtain sufficient new projects to counterbalance any decreases in such work will
adversely affect our revenues and results of operations for the period.
We have historically relied on a very limited number of clients that have
accounted for a significant portion of our revenues. We may lose any of these or
our other major clients as a result of our failure to meet or satisfy our
clients' requirements; the completion or termination of a project or engagement;
or the selection of another service provider.
In addition, the revenues we generate from our major clients may decline
or grow at a slower rate in future periods than in the past. If we lose any of
our significant clients, our revenues and results of operations could be
adversely affected and we may incur a loss from operations. Our services are
typically subject to client requirements, and in most cases are terminable upon
30 to 90 days' notice.
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.
We have experienced, and expect to continue to experience, significant
fluctuations in our quarterly revenues and results of operations. Numerous
factors, some of which are beyond our control, may affect our quarterly results
of operations, including completions, terminations, cancellations or deferrals
of projects or engagements; the size, mix, timing and terms and conditions of
client projects; variations in the duration, size and scope of our projects or
engagements; market acceptance of our clients' new products and services; our
ability to manage costs; local factors and events that affect our production
volume, such as local holidays; unforeseen events, such as earthquakes, storms
and civil unrest; currency exchange fluctuations; changes in pricing policies by
us or our competitors; the introduction of new services by us or our
competitors; and acquisition and integration costs related to possible
acquisitions of other businesses.
12
Direct operating costs for both our outsourced content services and IT
professional services consist of direct payroll, occupancy costs, depreciation,
telecommunications, computer services and supplies. We intend to reduce direct
operating costs of our IT professional services as a percentage of revenues from
our IT professional services by increasing our offshore IT professional services
staff.
Selling and administrative expenses for both our outsourced content
services and IT professional services consist of management and administrative
salaries, sales and marketing costs and administrative overhead. We anticipate
selling and administrative expenses to increase in absolute terms as we continue
to grow our business.
Results of Operations
Three Months Ended March 31, 2005 and 2004
Revenues
Revenues were $11.2 million for the quarter ended March 31, 2005 compared
to $12.2 million for the similar period in 2004. Our quarterly revenues for the
three months ended March 31, 2005 decreased 17% from fourth quarter 2004
revenues of approximately $13.5 million. The decline in revenues in the first
quarter primarily reflects the unexpected termination of a major outsourced
content services project, and the scheduled completion of a large outsourced
content services project for a second client. We expect that revenues will
continue to decline to continue in the second quarter, principally because we
expect that revenues from existing projects and new projects will continue to be
insufficient to offset the decline in revenues resulting from projects that were
concluded, terminated or delayed.
One client accounted for 29% and 23% of our total revenues for the
quarters ended March 31, 2005 and 2004, respectively. A second client accounted
for 19% and 24% of our revenues for the quarters ended March 31, 2005 and 2004
respectively. No other client accounted for 10% or more of our total revenues
for these periods. Further, for the quarters ended March 31, 2005 and 2004,
revenues from clients located in foreign countries (principally in Europe)
accounted for 28% and 36% of our total revenues, respectively.
Revenues from outsourced content services increased 13% to $10.0 million
for the quarter ended March 31, 2005 from $8.8 million for the similar period in
2004. The increase was primarily due to increased revenues from several
projects.
Revenues from IT professional services decreased 65% to $1.2 million for
the quarter ended March 31, 2005 from $3.3 million for the similar period in
2004. The decrease was primarily due to decreased revenues from two clients
whose projects were completed in 2004.
For the quarter ended March 31, 2005, approximately 59% of our revenue was
recurring and the 41% balance was non-recurring, compared with 52% and 48%,
respectively, for the quarter ended March 31, 2004.
13
Direct Operating Costs
Direct operating costs were $8.2 million and $7.8 million for the quarters
ended March 31, 2005 and 2004, respectively, an increase of 6%. Direct operating
costs as a percentage of revenues for the quarters ended March 31, 2005 and
2004, were 73% and 64% respectively.
Direct operating costs for outsourced content services were $6.9 million
and $6.2 million for the quarters ended March 31, 2005 and 2004, respectively,
an increase of 11%. Direct operating costs of outsourced content services as a
percentage of revenues from outsourced content services were 68% and 71% for the
quarters ended March 31, 2005 and 2004, respectively. The dollar increase for
the content services segment in the 2005 period principally reflects increased
labor costs related to increased revenues. The decrease in direct operating
costs of outsourced content services as a percentage of revenues from outsourced
content services for the 2005 period was principally due to a 13% increase in
revenues as compared to a 3% decrease in fixed non-labor costs.
Direct operating costs for IT professional services were $1.3 million and
$1.6 million for the quarters ended March 31, 2005 and 2004, respectively, a
decrease of 18%. Direct operating costs of IT professional services as a
percentage of revenues from IT professional services were 108% and 46% for the
quarters ended March 31, 2005 and 2004, respectively. The dollar decrease in
direct operating costs of IT professional services for the 2005 period was
principally due to a reduction in both labor and non-labor costs. The increase
in direct operating costs of IT professional services as a percentage of
revenues from IT professional services for the 2005 period was primarily
attributable to decreased revenues without a corresponding decrease in labor
costs.
Selling and Administrative Expenses
Selling and administrative expenses were $2.7 million and $2.3 million for
the quarters ended March 31, 2005 and 2004, respectively, an increase of 19%.
Selling and administrative expenses as a percentage of revenues were 24% and 19%
for the quarters ended March 31, 2005 and 2004, respectively, primarily as a
result of increased payroll costs attributable to the hiring of additional
business development, management and sales support personnel.
Other
In January 2004, we reached a settlement agreement and received $1.0
million in cash from a former client in full satisfaction of a $2.6 million
outstanding balance that we had fully written off as a bad debt in 2001. The
$1.0 million receipt, net of $37,000 in recovery costs, is reflected as bad debt
recovery for the three months ended March 31, 2004.
14
For the three months ended March 31, 2005, the provision for income taxes
as a percentage of income before income taxes was 22%, 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 three
months ended March 31, 2004, the provision for income taxes as a percentage of
income before income taxes was 33%, which is lower than the US 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 US unless repatriated. In addition, the provision for income taxes
for the three months ended March 31, 2004 included a provision for state and
local income taxes of approximately $150,000.
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 March
31, 2005, the Company has not recorded liability for any obligations arising as
a result of these indemnifications.
Liquidity and Capital Resources
Selected measures of liquidity and capital resources, expressed in
thousands are as follows:
March 31, 2005 December 31, 2004
-------------- -----------------
Cash and Cash Equivalents $23,422 $20,663
Working Capital 22,711 22,209
Net Cash Provided By Operating Activities
Net cash provided by operating activities was $3.1 million for the quarter
ended March 31, 2005 compared to $5.9 million provided by operating activities
for the quarter ended March 31, 2004, a decrease of approximately $2.8 million.
The net cash provided by operating activities for the 2005 period is principally
due to net income approximating $300,000, accounts receivable approximating $2.0
million, non-cash charges approximating $900,000, and changes in operating
assets and liabilities of $100,000.
Accounts receivable totaled $6.1 million at March 31, 2005, representing
approximately 51 days of sales outstanding compared to $8.0 million, or 57 days,
at December 31, 2004. The decrease in days outstanding resulted from increased
accounts receivable collections during 2005.
15
A significant amount of our revenues is derived from clients in the
publishing industry. Accordingly, our accounts receivable generally include
significant amounts due from such clients. In addition, as of March 31, 2005,
approximately 22% of our accounts receivable was from foreign (principally
European) clients, and 47% of accounts receivable was due from two clients.
Net Cash Used in Investing Activities
For the quarter ended March 31, 2005, we spent approximately $300,000 for
capital expenditures, compared to approximately $600,000 for the quarter ended
March 31, 2004. Capital spending in 2005 and 2004 related principally to normal
ongoing equipment upgrades, project requirement specific equipment, and for
improvements in infrastructure. We expect that the capital expenditures for
these purposes will approximate $3.0 million in the next 12 months, excluding
any potential capital expenditures related to future facilities expansion.
Availability of Funds
We have a $5.0 million line of credit pursuant to which we 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, and is expected to
be renewed under similar terms, is secured by our accounts receivable. There are
no amounts outstanding under this facility.
We believe that existing cash and internally generated funds will be
sufficient for our reasonably anticipated working capital and capital
expenditure requirements during the next 12 months. We fund our foreign
expenditures from our 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 our operations. We
generally perform work for our clients under project-specific contracts,
requirements-based contracts or long-term contracts. Contracts are typically
subject to numerous termination provisions.
Our quarterly operating results are also subject to seasonal fluctuations.
Our fourth and first quarters include the months of December and January, when
billable services activity by professional staff, as well as engagement
decisions by clients, may be reduced due to client budget planning cycles. In
addition, demand for our services may be lower in the fourth quarter due to
reduced activity during the holiday season and fewer working days for our
Philippines based staff during this period.
Critical Accounting Policies and Estimates
Basis of Presentation and Use of Estimates
Management's discussion and analysis of its results of operations and
financial condition is based upon our 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, we evaluate our 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.
16
Allowance for Doubtful Accounts
We establish credit terms for new clients based upon management's review
of their credit information and project terms, and perform ongoing credit
evaluations of our customers, adjusting credit terms when management believes
appropriate based upon payment history and an assessment of their current credit
worthiness. We record an allowance for doubtful accounts for estimated losses
resulting from the inability of our clients to make required payments. We
determine this allowance by considering a number of factors, including the
length of time trade accounts receivable are past due, our previous loss
history, our estimate of the client's current ability to pay its obligation to
us, 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, we cannot guarantee that credit loss rates in the future will be
consistent with those experienced in the past. In addition, we have credit
exposure if the financial condition of one of our major clients were to
deteriorate. In the event that the financial condition of our clients were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be necessary.
Revenue Recognition
We recognize revenue for content manufacturing and outsourcing services in
the period in which we perform services and deliver in accordance with Staff
Accounting Bulletin 104.
We recognize IT professional services revenue 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 in a manner similar
to SOP No. 81-1 "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". We recognize revenue for such services billed under
fixed fee arrangements using the percentage-of-completion method under contract
accounting as we perform services or reach output milestones. We measure the
percentage completed 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, we record
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). Revenues from fixed-fee
projects accounted for less than 10% of our total revenue for the quarters ended
March 31, 2005 and 2004, respectively. We receive revenue billed on a time and
materials basis as we perform the services.
17
Property and Equipment
Property and equipment is stated at cost and 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.
Long-lived Assets
We account for long lived assets under Statement of Financial Accounting
Standards ("SFAS") 144, Accounting for the Impairment or Disposal of Long Lived
Assets. We assess the recoverability of our long-lived assets, which consist
primarily of fixed assets and intangible assets with finite useful lives,
whenever events or changes in circumstance indicate that the carrying value may
not be recoverable. The following factors, if present, may trigger an impairment
review: (i) significant underperformance relative to expected historical or
projected future operating results; (ii) significant negative industry or
economic trends; (iii) significant decline in our stock price for a sustained
period; and (iv) a change in our market capitalization relative to net book
value. If the recoverability of these assets is unlikely because of the
existence of one or more of the above-mentioned factors, we perform an
impairment analysis using a projected discounted cash flow method. We must make
assumptions regarding estimated future cash flows and other factors to determine
the fair value of these respective assets. If these estimates or related
assumptions change in the future, we may be required to record an impairment
charge. Impairment charges would be included in general and administrative
expenses in our statements of operations, and would result in reduced carrying
amounts of the related assets on our balance sheets.
Income Taxes
We determine our deferred taxes 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. We provide a valuation allowance 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
SFAS 142 requires that we test goodwill for impairment using a two-step
fair value based test. The first step of the goodwill impairment test annually,
used to identify potential impairment, compares the fair value of a reporting
unit with its carrying amount, including goodwill. If the carrying amount of the
reporting unit exceeds its fair value, the second step of the goodwill
impairment test must be performed to measure the amount of the impairment loss,
if any. If impairment is determined, we will recognize additional charges to
operating expenses in the period in which they are identified, which would
result in a reduction of operating results and a reduction in the amount of
goodwill.
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Accounting for Stock-Based Compensation
We account for our stock options issued to employees and outside directors
pursuant to Accounting Principles Board Opinion ("APB") No. 25, "Accounting for
Stock Issued to Employees" and have adopted the disclosure requirements of SFAS
No. 123, "Accounting for Stock-Based Compensation", and SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123". Accordingly, in 2005, we have not
recognized compensation expense in connection with the issuance of stock
options.
Significant New Accounting Pronouncements Not Yet Adopted
In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment",
which is a revision of SFAS No. 123 and supersedes Accounting Principles Board
("APB") Opinion No. 25. SFAS No. 123 (R) requires all share-based payments to
employees, including grants of employee stock options, to be valued at fair
value on the date of grant, and to be expensed over the applicable vesting
period. Pro forma disclosure of the income statement effects of share-based
payments is no longer an alternative. SFAS No. 123 (R) is effective for all
stock-based awards granted on or after January 1, 2006. In addition, companies
must also recognize compensation expense related to any awards that are not
fully vested as of the effective date. Compensation expense for the unvested
awards will be measured based on the fair value of the awards previously
calculated in developing the pro forma disclosures in accordance with the
provisions of SFAS No. 123. We are currently evaluating SFAS No. 123 (R),
including the method of adoption, and expect its adoption will result in
increased compensation expense in the future.
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS
109-1"), "Application of FASB Statement No. 109, `Accounting for Income Taxes,'
to the Tax Deduction on Qualified Production Activities provided by the American
Jobs Creation Act of 2004." The American Jobs Creation Act, or AJCA, creates a
temporary incentive for U.S. corporations to repatriate accumulated income
earned abroad by providing an 85% dividend received deduction for certain
qualified dividends from controlled foreign corporations. FAS 109-1 clarifies
that this tax deduction should be accounted for as a special tax deduction in
accordance with Statement 109. Our evaluation of the AJCA with respect to the
additional deduction is still in process and we expect to complete the
evaluation process in 2005. As such, we cannot reasonably estimate the income
tax effect of any such repatriation at the present time.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
assets exchanged. The guidance in that opinion, however, included certain
exceptions to that principle. This Statement amends APB No. 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS
No. 153 is not expected to have a material impact on our financial position and
results of operations.
19
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to interest rate change market risk with respect to our
credit line with a financial institution which is priced based on the bank's
alternate base rate (5.75% at March 31, 2005) plus 1/2% or LIBOR (2.875% at
March 31, 2005) plus 3%. We have not borrowed under this line in 2005. To the
extent we utilize all or a portion of this line of credit, changes in the
interest rate will have a positive or negative effect on our interest expense.
We have operations in foreign countries. While we are exposed to foreign
currency fluctuations, we presently have no financial instruments in foreign
currency and do not maintain significant funds in foreign currency beyond those
necessary for operations.
Item 4. Controls and Procedures
An evaluation has been carried out under the supervision and with the
participation of our management, including our Chief Executive Officer and
Principal Financial Officer, of the effectiveness of the design and the
operation of our "disclosure controls and procedures" (as such term is defined
in Rules 13a-15(e) under the Securities Exchange Act of 1934) as of March 31,
2005 ("Evaluation Date"). Based on such evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that, as of the Evaluation Date, the
disclosure controls and procedures are reasonably designed and effective to
ensure that (i) information required to be disclosed by us in the reports we
file or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (ii) such information is accumulated and communicated to our
management, including our Chief Executive Officer and Principal Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in our internal controls over financial reporting in
connection with the evaluation required by paragraph (d) of Rules 13a-15 or
15d-15 under the Exchange Act that occurred during our last fiscal quarter that
materially affected or are reasonably likely to materially affect the internal
controls over financial reporting.
20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. Not Applicable
Item 2. Changes in Securities. 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. (a) 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.
21
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: May 13, 2005 Jack Abuhoff
-----------------------------------
Jack Abuhoff
Chairman of the Board of
Directors, Chief Executive
Officer and President
Date: May 13, 2005 Stephen Agress
-----------------------------------
Stephen Agress
Vice President - Finance
Chief Accounting Officer