INNODATA INC - Annual Report: 2008 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
(Mark
One)
þ Annual
report under section 13 or 15(d) of the securities exchange act of
1934
For
the fiscal year ended December 31,
2008
o 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
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13-3475943
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(State
or other jurisdiction of
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(I.R.S.
Employer Identification No.)
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incorporation
or organization)
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Three
University Plaza
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Hackensack,
New Jersey
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07601
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(Address
of principal executive offices)
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(Zip
Code)
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(201)
371-2828
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(Registrant's
telephone number)
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Securities
registered under Section 12(b) of the Exchange Act:
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Title of Each Class
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Name of Each Exchange on Which
Registered
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Common
Stock $.01 par value
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The
Nasdaq Stock Market,
LLC
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Securities registered under Section
12(g) of the Exchange
Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes o No
þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act. Yes o No
þ
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
past twelve months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes þ No
o
Indicate
by check mark if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes o No
þ
The
aggregate market value of the registrant’s common stock held by non-affiliates
of the registrant (based on the closing price reported on the Nasdaq Stock
Market on June 30, 2008) was $60,184,071.
The
number of outstanding shares of the registrant’s common stock, $.01 par value,
as of February 28, 2009 was 24,119,499.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive
proxy statement for the 2009 Annual Meeting of Stockholders are incorporated by
reference in Items 10,11,12,13 and 14 of Part III of this Form
10-K.
INNODATA
ISOGEN, INC
Form
10-K
For
the Year Ended December 31, 2008
TABLE
OF CONTENTS
Page
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Part I
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Item
1.
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Business
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1
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Item
1A.
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Risk
Factors
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9
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Item
1B.
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Unresolved
Staff Comments
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13
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Item
2.
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Properties
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13
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Item
3.
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Legal
Proceedings
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13
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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14
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Part
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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15
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Item
6.
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Selected
Financial Data
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16
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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17
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Item
7A.
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Quantitative
and Qualitative Disclosures about Market Risks
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32
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Item
8.
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Financial
Statements and Supplementary Data
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32
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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32
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Item
9A.
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Controls
and Procedures
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33
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Report
of Management on Internal Control over Financial Reporting
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33
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Report
of Independent Registered Public Accounting Firm
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34
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Item
9B.
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Other
Information
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35
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Part
III
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Item
10.
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Directors
and Executive Officers and Corporate Governance
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36
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Item
11.
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Executive
Compensation
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36
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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36
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Item
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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36
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Item
14.
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Principal
Accountant Fees and Services
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36
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Part
IV
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Item
15.
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Exhibits,
Financial Statement Schedules and Reports on Form 8-K
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37
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Signatures
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38
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PART I
Disclosures
in this Form 10-K 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, the primarily at-will nature of the Company’s contracts with its
customers and the ability of customers to reduce, delay or cancel projects,
including projects that the Company regards as recurring, continuing revenue
concentration in a limited number of clients, continuing reliance on
project-based work, inability to replace projects that are completed, cancelled
or reduced, depressed 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 set forth under “Risk
Factors.”
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.
Item
1. Description of Business.
Business
Overview
We
provide knowledge process outsourcing (KPO) services, as well as publishing and
related information technology (IT) services, that help leading media,
publishing and information services companies create, manage and maintain their
products. We also provide our services to companies in other
information-intensive industries, such as information technology, manufacturing,
aerospace, defense, government, law and intelligence.
We help
our clients lower costs, realize productivity gains and improve operations,
enabling them to compete more effectively in demanding global
markets.
Our
publishing services include digitization, conversion, composition, data modeling
and XML encoding. Our KPO services include research and analysis,
authoring, copy-editing, abstracting, indexing and other content creation
activities. We often combine publishing services and KPO services within a
single client engagement, providing an end-to-end content supply chain
solution.
Our staff
of IT systems professionals design, implement, integrate and deploy systems and
technologies used to improve the efficiency of authoring, managing and
distributing content.
1
We use a
distributed global resource model. Our onshore workforce (consisting of
consultants, information architects, solution architects, and program managers)
works from our North American and European offices, as well as from client
sites. Our distributed global workforce (consisting of encoders, graphic
artists, project managers, programmers, data architects performing publishing
services, and advanced degree holders such as physicians, attorneys, MBAs and
engineers who perform our KPO services) deliver those services from our ten
offshore facilities in India, the Philippines, Sri Lanka and
Israel.
For
fiscal 2008, our revenue was $75.0 million, representing an increase of 11% over
2007, and our net income before income taxes was $5.5 million, an increase of
23% compared to a net income before income taxes in 2007 of $4.5 million. For
fiscal 2007, our revenue was $67.7 million, representing an increase of 65% over
2006, and our income before income taxes was $4.5 million, as compared to a loss
before income taxes in 2006 of $7.4 million.
Services that we anticipate a client
will require for an indefinite period generate what we regard as recurring
revenues. Services that terminate upon completion of a defined task generate
what we regard as project, or non-recurring, revenues. Approximately 68% of our
revenues were recurring in the fiscal year ended December 31, 2008 as compared
to 61% in the fiscal years ended December 31, 2007 and 2006.
In 2008, we provided our services to
approximately 170 clients primarily in four content-intensive
sectors:
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·
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Media,
publishing and information services, including clients such as EBSCO and
Reed Elsevier;
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Defense
and aerospace, including clients such as Hamilton Sundstrand and Lockheed
Martin;
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Government
and advanced programs, including clients such as the Defense Intelligence
Agency and the Financial Accounting Standards Board;
and
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Commercial
and technology, including clients such as Alcatel-Lucent and
Nortel.
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Our business is organized and managed
around three vectors: a vertical industry focus, a horizontal service/process
focus, and a focus on supportive operations.
Our vertically-aligned groups
understand our clients’ businesses and strategic initiatives and are able to
help them meet their goals. With respect to media, publishing and information
services, for example, we have continued to hire experts out of that sector to
establish solutions and services tailored to companies in that sector. They work
with many of the world’s leading media, publishing and information services
companies, dealing with challenges involving new product creation, product
maintenance, digitization, content management and content creation.
Our service/process-aligned groups are
comprised of engineering and delivery personnel responsible for creating the
most efficient and cost-effective custom workflows. These workflows integrate
proprietary and third-party technologies, while harnessing the benefits of a
globally distributed workforce. They are responsible for executing our client
engagements in accordance with our service-level agreements and ensuring client
satisfaction.
Our support groups are responsible for
managing a diverse group of enabling functions, including human resources and
recruiting, global technology infrastructure and physical infrastructure and
facilities.
Our
Opportunity
Media, publishing and information
services companies, as well as companies in other content-intensive sectors, are
increasingly seeking ways to reduce content costs as well as to accelerate
delivery times and improve quality. Increasingly, they view outsourcing, along
with technology and process re-engineering, as crucial strategies for
accomplishing these objectives.
2
The trend toward outsourcing has
accelerated in recent years. Businesses are outsourcing their internal processes
– often to offshore providers – to improve productivity and manage costs. By
leveraging offshore talent, companies are increasingly boosting their profits,
productivity, quality levels, business value and performance. As
outsourcing to offshore providers has become more accepted, a growing number of
organizations have become more confident in making the decision to outsource
business operations to Asia and other high-value labor markets. Moreover, the
notion of what can be outsourced and the benefits that can be achieved via
outsourcing continue to expand. Client demands are evolving toward higher
value-added and more complex services, including research and analysis,
editorial tasks and other knowledge-based functions. This trend is driven by
competitive pressures as well as by advances in technology.
The KPO market is in its formative
stages, but is expected to become quite large. Overall demand is
expected to range in the tens of billions of dollars within the next decade. An
increasing number of companies are outsourcing high-end knowledge work as they
seek to gain cost-savings and operational efficiencies and access the highly
talented workforce in countries such as the Philippines and India. Universities
in those countries are graduating thousands of qualified lawyers, doctors and
scientists each year. As technology makes it possible to move vast amounts of
data across the globe at relatively low cost, it is now quite cost effective for
companies to tap into this labor pool.
With respect to information and content
processes, there is growing awareness that labor cost reduction is only part of
the solution. Advances in technologies for creating, managing, finding, sharing
and delivering content (including text analytics, semantic technologies and
search technologies) have enabled what were previously manual tasks to become
either fully or partially automated.
As a
result, content-driven companies, like media, publishing and information
services companies, are increasingly relying on service providers, such as
Innodata Isogen, to provide both outsourcing and related IT services.
To meet this demand, we have assembled
dedicated teams of scientists, doctors, lawyers and other subject matter
experts, armed with an in-depth understanding of complex technical material. For
increasing numbers of clients, we are becoming an extended part of their work
teams, helping them enhance and create content, write technical documentation
and deliver research and analysis
services utilizing global resources as well as advanced
technologies.
Our
Services
We believe that we have developed an
effective set of core competencies that enable us to help information-intensive
companies reduce their operating costs, realize benefits of scale and flexible
cost structures and achieve significant process improvements. Our business model
combines a global offshore staff, on-site staff and technologists who integrate
internally-developed and best-in-class third party products to continually
improve the efficiency of our processes.
We provide a broad and expanding range
of publishing services, knowledge process outsourcing services and engineering
and consulting services.
Publishing Services – Our
publishing services include activities such as digitization, conversion,
composition, data modeling and XML encoding. Typically, we bill
clients for services based upon the units of information we produce and
deliver.
3
For example, we are helping several
publishers take advantage of the growing interest in eBooks. We are digitizing
and converting thousands of books into an eBook-ready format for a global
electronics manufacturer that has recently launched a new digital reading device
for consumers.
We are
also helping leading publishers of scientific, technical and medical journals
aggregate content, copy-edit author submissions and compose journal pages for
both online and print publication. For one such publisher, seeking to build one
of the world’s largest databases of scientific journal citations and references,
we created records of nearly 15,000 journal titles going back almost 13 years,
encoded in a way that supports integrated web searches and seamless
linking.
Knowledge Processing Outsourcing
(KPO) Services – Our KPO services specifically target processes that
demand advanced information analysis and interpretation, as well as judgment and
decision-making. For information and media companies, these services include
content creation and enhancement, analytics, taxonomy and controlled vocabulary
development, hyperlinking, indexing, abstracting, technical writing and editing,
copy-editing and general editorial services, including the provision of synopses
and annotations. These services cover a wide spectrum of disciplines,
including medicine, law, engineering, management, finance, science and the
humanities. To provide these services, we have organized knowledge
teams that consist of educated and highly trained people with expertise in
relevant subjects. We typically price our knowledge services based on
the quantity delivered or resources utilized.
For example, we support several
providers of medical informatics products and clinical decision support
systems. Our physicians and health care professionals create content
for these systems by analyzing the latest medical journal articles and
conference proceedings.
In many of our engagements, we perform
end-to-end services that combine publishing and KPO services, using advanced
technologies, to provide fully outsourced content supply chain
solutions. For example, under a long-term engagement, we maintain a
leading bibliographic citations database, managing, on behalf of our client, a
continuing production process in which we first aggregate, digitize and convert
data from multiple sources and then have healthcare professionals perform
analyses of the data and create derivative data for inclusion in the client
database. Our engineering staff continues to drive the automation of
several of these underlying processes.
We are also using our KPO delivery
capabilities that we use to support information companies as a springboard to
enable us to enter new markets and provide new services. For example,
we are using our legal subject matter experts who deliver KPO services to media,
publishing and information services companies to also provide select KPO
services - such as research and document review - to corporate law offices and
law firms.
In 2007,
we launched two new KPO services: research and analysis and technical writing.
For research and analysis projects, we form dedicated teams of subject matter
experts to provide expert research and analysis on a wide range of topics, from
media analysis and medical studies to technical patent submissions and reports
on energy markets.
For
example, we are helping a leading publisher provide detailed information on
patents to its subscribers – executives at Fortune 500 companies and inventors
and scientists at leading research institutes. We are also helping a leading
information services provider deliver critical news to executives in several
industries. We put in place a streamlined process and an advanced set of
tools to enable our employees to monitor incoming news, select relevant
stories and write daily summaries, which we then post directly to our client’s
website.
We are
also building upon our extensive experience in technical documentation to
provide outsourcing services for corporate technical writing teams. Most
departments responsible for delivering vital technical information about
products or services are also under increasing pressure to cut costs. We offer
them the ability to blend internal and external resources by basing key staff at
headquarters while pushing content development to offshore locations. In this
way, we deliver cost savings to our clients, enabling them to provide better
documentation and improve efficiency and productivity.
4
As an
example, we are providing technical writing services for a leading global
technology manufacturer. We have expanded our team approximately
ten-fold in about 24 months, growing from five resources in early 2007 to more
than 50 by December 2008, which include project managers, writers and editors
who work from multiple locations across China, the Philippines, Sri Lanka and
the United States. Co-locating technical documentation teams in China, where our
client manufactures equipment, and our production centers in other Asian
locales, has eased collaboration and has helped our client establish a stronger
working relationship between its engineers and the writing team. Just as
important, our outsourcing team is helping the company continue to generate
quality documentation – ensuring that our client’s customers use its products
effectively – while also reducing our client’s overall costs.
Technology
Services — Both our publishing services and KPO services are
supported by our technology engineering teams, comprised of solution architects,
analysts, programmers and systems integrators. A number of our
engineering staff have played leadership roles in the development of structured
information standards such as Standard General Markup Language (SGML),
Extensible Markup Language (XML), as well as XML-based standards such as Darwin
Typing Information Architecture (DITA) and S1000D.
Our technologists build the workflow
and tools that we utilize internally for projects that we perform for clients on
an outsourced basis. They also provide services directly to
clients.
Their role in outsourced projects is to
improve efficiency and quality. They continually design and develop
productivity tools to automate manual processes and improve the consistency and
quality of our work product. These tools include categorization engines that
utilize pattern recognition algorithms based on comprehensive rule sets and
related heuristics, data extraction tools that automatically retrieve specific
types of information from large data sources, and workflow systems that enable
various tasks and activities to be performed across our multiple
facilities.
When working directly for clients, our
engineers provide IT services (which include systems integration, custom
application development, applications maintenance, tool evaluation and training)
which are typically provided on a project basis that does not generate
significant amounts of recurring revenue. Clients who use these
services typically require publishing, performance support or process automation
systems that enable information to be created, managed and distributed utilizing
the most cost efficient and effective technologies.
For example, we helped the world’s
leading software company create automated processes for reducing the cost of
creating online help information. Our engineering staff created the systems that
are used by one of the world’s largest manufacturers of computers and
peripherals to create and publish multi-lingual product support and technical
information. It also collaborated with Lockheed Martin to build a content
management system and digital asset management system for the F-35 Joint Strike
Fighter program. For a leading electronic publisher of financial data, it
automated the process of extracting and normalizing detailed financial
information from public company filings. Our staff define client
requirements (often working on-site at clients during this process), write
specifications and design, develop, test and integrate technologies. Projects
vary in size and duration.
To better support an ongoing engagement
with a $10 billion information services company, our engineering staff developed
a machine-aided indexing solution that uses lemmatization (the process that
determines the most crucial term in a sentence to reflect its meaning and
context) and semantically-driven natural language analysis to deliver precision
and recall at 95% accuracy. Once the text is tokenized or assigned a value
according to the words in a particular sentence, a set of rules and linguistic
filters are then used to identify candidate term phrases within the text. The
system also extracts terms and ranks them based on the decreasing likelihood of
accuracy against a thesaurus that applies simple string matching. This
automation enables us to add millions of additional topics to the publisher’s
database, which may then be further enhanced by our editorial
teams.
5
Consulting Services — Our
publishing services and KPO services are also supported by our consulting staff,
who collaborate with clients in analyzing their publishing and business
environments, identifying opportunities for optimization and creating roadmaps
for significant cost savings and productivity improvement. Their expertise
includes offshoring strategy, technology strategy and business process
re-engineering related to information and content creation, management and
distribution.
For example, our consulting staff is
working with one of the world’s largest special interest publishers, helping it
create an optimized content processing function drawing upon outsourced services
and the latest content technologies. With more than 3,000 titles in print, the
client desires an end-to-end publishing solution that addresses its current and
anticipated requirements for print and online publishing.
A leading $5 billion global information
services company engaged our consulting group to help re-engineer internal
processes and provide recommendations regarding outsourcing tasks and activities
presently performed in-house. The team performed a detailed as-is analysis and
collaborated with the client in developing a future-state solution that
specifically supported the ability to re-purpose content, using existing content
to develop new information products.
Clients
In 2008, we provided our services to
approximately 170 clients.
Four clients generated approximately
57%, 61% and 54% of our total revenues in the fiscal years ended December 31,
2008, 2007 and 2006, respectively. Revenues from clients located in foreign
countries (principally in Europe) accounted for 21%, 23% and 37% of our total
revenues for each of these respective fiscal years.
We have long standing relationships
with many of our clients. We have been continually providing services to our top
four clients for over eight years. Approximately 95% of clients are recurring
clients, meaning that they have continued to provide additional projects to us
after their initial engagement. Our track record of delivering high-quality
services helps us to solidify client relationships and gain increased business
from our existing clients. As a result, our history of client retention enables
us to derive a significant proportion of revenue from repeat
clients.
A substantial portion of the services
we provide to our clients is subject solely to their
requirements. Our agreements with clients are in most cases
terminable on 30 to 90 days' notice.
Competitive
Strengths
Our vertical
expertise. We are primarily focused on the media, publishing
and information services vertical market. We maintain a staff of highly
skilled experts to provide a range of end-to-end business solutions. In
addition, we utilize our underlying domain experts in law, medicine, finance and
engineering to provide additional value-added KPO services directly to these
sectors.
Our global delivery
model. We have operations in seven countries in North
America, Europe and Asia. We provide services to our clients through a
comprehensive global delivery model that integrates both local and global
resources to obtain the best economic results. For example, we create high-end
website content using teams from India, the Philippines and Israel that together
constitute a global workflow. We use a similar approach in providing technical
writing services to a large telecommunications company, virtually joining
resources from the United States, the Philippines and China. Our offshore
outsourcing centers are ISO 9001:2000 certified and our engineering and IT
facility in Noida, India meets ISO/IEC 27001:2005 specifications.
Our proven track record and reputation. By consistently
providing high-quality services, we have achieved a track record of project
successes. This track record is embodied by our reputation as a leader in the
KPO marketplace, especially within the media, publishing and information
services sector. This reputation or brand provides an assurance of expertise,
quality execution and risk mitigation.
6
Our focus on technology and
engineering. Rather than simply relying on labor cost
arbitrage to create value for clients, our engineering team optimizes efficiency
by integrating proprietary and best-in-class third party tools into our
workflows. In addition, our engineering team provides work directly to our
clients, helping them achieve better improved efficiencies within their own
operations.
Our long-term relationships with
clients. We have long-term relationships with many of our
clients, who frequently retain us for additional projects after a successful
initial engagement. In 2008, existing clients from prior years generated
more than 97% of our revenues. We believe there are significant
opportunities for additional growth with our existing clients, and we seek to
expand these relationships by increasing the depth and breadth of the services
we provide. This strategy allows us to use our in-depth client-specific
knowledge to provide more fully integrated KPO services and develop closer
relationships with those clients.
Our ability to
scale. We have demonstrated the ability to expand our teams
and facilities to meet the needs of our clients. By virtue of the significant
numbers of professional staff working on projects, we are able to build teams
for new engagements quickly. We have also demonstrated the ability to hire and
train people quickly.
Our internal
infrastructure. We utilize established facilities, technology
and communications infrastructure to support our business model. We own
and operate some of the most advanced content production facilities in the
world, which are linked by multi-redundant data connections. Our Wide Area
Network – along with our Local Area Networks, Storage Area Networks and data
centers – is configured with full redundancy, often with more than one backup to
ensure 24x7 availability. Our infrastructure is built to accommodate
advanced tools, processes and technologies that support our content and
technical experts.
Our focus on
quality. We believe strongly in quality throughout our
organization. We maintain independent quality assurance capabilities in all
geographies where we operate. Our quality teams are compliant and
certified to the ISO 9000:2000 quality management system standards.
Sales
and Marketing
We market and sell our services
directly through our professional staff, senior management and direct sales
personnel operating out of our corporate headquarters in Hackensack, New Jersey,
just outside New York City, our Dallas, Texas office and our Paris, France
office. We have four executive-level business development and marketing
professionals, and during 2008, we maintained approximately 13 full-time sales
and marketing personnel. We also deploy solutions architects, technical support
experts and consultants who support the development of new clients and new
client engagements. These resources work within teams (both permanent and ad
hoc) that provide support to clients.
Our sales professionals identify and
qualify prospects, securing direct personal access to decision makers at
existing and prospective clients. They facilitate interactions between client
personnel and our service teams to better define ways in which we can assist
clients with their goals. For each prospective client engagement, we assemble a
team of our senior employees drawn from various disciplines within our company.
The team members assume assigned roles in a formalized process, using their
combined knowledge and experience to understand the client’s goals and
collaborate with the client on a solution.
Sales activities include the design and
generation of presentations and proposals, account and client relationship
management and the organization of account activities.
7
Personnel from our project analysis
group and our engineering services group closely support our direct sales
effort. These individuals assist the sales force in understanding the
technical needs of clients and providing responses to these needs, including
demonstrations, prototypes, pricing quotations and time estimates. In addition,
account managers from our customer service group support our direct sales effort
by providing ongoing project-level support to our clients.
Our marketing organization is
responsible for developing and increasing the visibility and awareness of our
brand and our service offerings, defining and communicating our value
proposition, generating qualified, early-stage leads and furnishing effective
sales support tools.
Primary marketing outreach activities
include event marketing (including exhibiting at trade shows, conferences and
seminars), direct and database marketing; public and media relations (including
speaking engagements and active participation in industry and technical standard
bodies), and web marketing (including integrated marketing campaigns, search
engine optimization, search engine marketing and the maintenance and continued
development of external websites).
Research
and Development
We did not incur any research and
development costs in 2008 and 2007. In 2006, we spent approximately $922,000 on
research and development.
Competition
The market for publishing services and
related KPO and IT services is highly competitive, fragmented and
intense. Our major competitors include SPI Technologies, Apex
CoVantage, Aptara, Thomson Digital, MacMillan India and Cenveo.
We believe that we compete successfully
by offering high-quality services and favorable pricing that leverages our
technical skills, IT infrastructure, process knowledge, offshore model and
economies of scale. Our competitive advantages are especially
attractive to clients for undertakings that are technically sophisticated,
require “high-end” talent, are sizable in scope or scale, are continuing, or
that require a highly fail-safe environment with technology
redundancy.
As a provider of these services, we
also compete with in-house personnel at existing or prospective clients who may
attempt to duplicate our services in-house.
Locations
We are headquartered in Hackensack, New
Jersey, just outside New York City. We have additional offices in Dallas, Texas;
Paris, France; and Beijing, China. We have ten production facilities in the
Philippines, India, Sri Lanka and Israel. We were incorporated in Delaware in
1988.
Employees
As of December 31, 2008, we employed
approximately 45 persons in the United States and Europe and approximately 6,700
persons in ten production facilities in the Philippines, India, Sri Lanka
and Israel. Most of our employees have graduated from at least a
two-year college program. Many of our employees hold advanced degrees in law,
business, technology, medicine and social sciences. No employees are
currently represented by a labor union, and we believe that our relations with
our employees are satisfactory.
8
Corporate
Information
Our principal executive offices are
located at Three University Plaza, Hackensack, New Jersey 07601, and our
telephone number is (201) 371-2828. Our website is www.innodata-isogen.com, and
information contained on our website is not included as a part of, or
incorporated by reference into, this Annual Report on Form
10-K. There we make available, free of charge, our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any
amendments to those reports as soon as reasonably practical after we
electronically file that material with, or furnish it to, the Securities and
Exchange Commission (SEC). Our SEC reports can be obtained through the Investor
Relations section of our website or from the Securities and Exchange Commission
at www.sec.gov.
Item
1A. Risk Factors.
We
have historically relied on a very limited number of clients that have accounted
for a significant portion of our revenues, and our results of operations could
be adversely affected if were to lose one or more of these significant
clients.
We have historically relied on a very
limited number of clients that have accounted for a significant portion of our
revenues. Four clients generated approximately 57%, 61% and 54% of
our revenues in the fiscal years ended December 31, 2008, 2007 and 2006,
respectively. 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 client’s selection of another
service provider.
In addition, the volume of work
performed for our major clients may vary from year to year, and services they
require from us may change from year to year. If the volume of work performed
for our major clients varies or if the services they require from us change, 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.
A
significant portion of our services is provided on a non-recurring basis for
specific projects, and our inability to replace large projects when they are
completed has adversely affected, and could in the future adversely affect, our
revenues and results of operations.
We provide a portion of our services
for specific projects that generate revenues that terminate on completion of a
defined task, and we regard these revenues as
non-recurring. Non-recurring revenues derived from these
project-based arrangements accounted for approximately 32%, 39% and 39% of our
total revenues in the fiscal years ended December 31, 2008, 2007 and 2006,
respectively. While we seek, wherever possible, on completion of large projects,
to counterbalance periodic declines in revenues with new arrangements to provide
services to the same client or others, our inability to obtain sufficient new
projects to counterbalance any decreases in such work may adversely affect our
future revenues and results of operations.
A
large portion of our accounts receivable is payable by a limited number of
clients; the inability of any of these clients to pay its accounts receivable
would adversely affect our results of operations.
Several significant clients account for
a large percentage of our accounts receivable. As of
December 31, 2008, 51% or $7.2 million, of our accounts
receivable was due from two clients. If any of these clients were
unable, or refused, for any reason, to pay our accounts receivable, our
financial condition and results of operations would be adversely
affected.
Quarterly
fluctuations in our results of operations could make financial forecasting
difficult and could negatively affect our stock price.
We have experienced, and expect to
continue to experience, significant fluctuations in our quarterly revenues and
results of operations. During the past eight quarters, our income
(loss) before income taxes ranged from a loss of approximately
$(0.6) million to a profit of approximately $3.0
million.
9
We experience fluctuations in our
revenue and earnings as we replace and begin new projects, which may have some
normal start up delays, or we may be unable to replace a project entirely. These and other factors
may contribute to fluctuations in our results of operations from quarter to
quarter.
A high percentage of our operating
expenses, particularly personnel and rent, are relatively fixed in advance of
any particular quarter. As a result, unanticipated variations in the number and
timing of our projects, or in employee wage levels and utilization rates, may
cause us to significantly underutilize our production capacity and employees,
resulting in significant variations in our operating results in any particular
quarter, and could result in losses.
We
compete in highly competitive markets that have low barriers to
entry.
The markets for our services are highly
competitive and fragmented. We may not be able to compete
successfully against our competitors in the future. Some of our
competitors have longer operating histories, significantly greater financial,
human, technical and other resources and greater name recognition than we
do. If we fail to be competitive with these companies in the future,
we may lose market share, which could adversely affect our revenues and results
of operations.
There are relatively few barriers
preventing companies from competing with us. We do not own any
patented technology that would preclude or inhibit others from entering our
market. As a result, new market entrants also pose a threat to our
business. We also compete with in-house personnel at current and
prospective clients, who may attempt to duplicate our services using their own
personnel. We cannot assure you that our clients will outsource more
of their needs to us in the future, or that they will not choose to provide
internally the services that they currently obtain from us. If we are
not able to compete effectively, our revenues and results of operations could be
adversely affected.
We
are the subject of continuing litigation, including litigation by certain of our
former employees.
We are
subject to various legal proceedings and claims that arise in the ordinary
course of business.
In
addition, the Supreme Court of the Republic of the Philippines has refused to
review a decision of the Court of Appeals in Manila against a Philippines
subsidiary of the Company that is inactive and has no material assets, and
purportedly also against Innodata Isogen, Inc., that orders the reinstatement of
certain former employees of the subsidiary to their former positions and payment
of back wages and benefits that aggregate approximately $7.5 million.
Complainants have moved for execution of this decision before the Department of
Labor and Employment National Labor Relations Commission, Republic of the
Philippines, and the Department of Labor and Employment office of the Secretary
of Labor and Employment, Republic of the Philippines. Based on consultation with
legal counsel, the Company believes that recovery against the Company is
nevertheless unlikely.
While we
currently believe that the ultimate outcome of 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.
Substantial recovery against the Company in the above referenced Philippines
actions could have a material adverse impact on the Company, and unfavorable
rulings or recoveries in the other proceedings could have a material adverse
impact on the operating results of the period in which the ruling or recovery
occurs. In addition, our 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. See “Legal Proceedings”.
10
Our
international operations subject us to risks inherent in doing business on an
international level, any of which could increase our costs and hinder our
growth.
The major part of our operations is
carried on in the Philippines, India and Sri Lanka, while our headquarters are
in the United States and our clients are primarily located in North America and
Europe. While we do not depend on revenues from sources internal to
the countries in which we operate, we are nevertheless subject to certain
adverse economic factors relating to overseas economies generally, including
inflation, external debt, a negative balance of trade and
underemployment. Other risks associated with our international
business activities include:
•
|
difficulties
in staffing international projects and managing international operations,
including overcoming logistical and communications
challenges;
|
•
|
local
competition, particularly in the Philippines, India and Sri
Lanka;
|
•
|
imposition
of public sector controls;
|
•
|
trade
and tariff restrictions;
|
•
|
price
or exchange controls;
|
•
|
currency
control regulations;
|
•
|
foreign
tax consequences;
|
•
|
labor
disputes and related litigation and
liability;
|
•
|
limitations
on repatriation of earnings;
and
|
•
|
the
burdens of complying with a wide variety of foreign laws and
regulations.
|
One or more of these factors could
adversely affect our business and results of operations.
Our
international operations subject us to currency exchange fluctuations, which
could adversely affect our results of operations.
To date, most of our revenues have been
denominated in U.S. dollars, while a significant portion of our expenses,
primarily labor expenses in the Philippines, India and Sri Lanka, is incurred in
the local currencies of countries in which we operate. For financial
reporting purposes, we translate all non-United States denominated transactions
into dollars in accordance with accounting principles generally accepted in the
United States. As a result, we are exposed to the risk that
fluctuations in the value of these currencies relative to the dollar could
increase the dollar cost of our operations and therefore adversely affect our
results of operations.
The Philippines and India, have at
times experienced high rates of inflation and major fluctuations in the exchange
rate between the Philippine peso and the U.S. dollar and the Indian rupee and
the U.S. dollar. Continuing inflation without a corresponding devaluation of the
peso against the dollar, or any other increase in the value of the peso relative
to the dollar, could adversely affect our results of operations.
There is no guarantee that our
financial results will not be adversely affected by currency exchange rate
fluctuations or that any efforts by us to engage in foreign currency hedging
activities will be effective. Finally, as most of our expenses are incurred in
currencies other than those in which we bill for the related services, any
increase in the value of certain foreign currencies against the U.S. Dollar
could increase our operating costs.
11
New
regulations of the Internal Revenue Service may impose significant U.S. income
taxes on our subsidiaries in the Philippines.
Our subsidiaries incorporated in the
Philippines were domesticated in Delaware as limited liability
companies. In August 2004, the Internal Revenue Service promulgated
regulations, effective August 12, 2004, that treat certain companies
incorporated in foreign jurisdictions and also domesticated as Delaware limited
liability companies as U.S. corporations for U.S. federal income tax
purposes. We have effected certain filings with the Secretary of
State of the State of Delaware to ensure that these subsidiaries are no longer
domesticated in Delaware. As a result, commencing
January 1, 2005, these subsidiaries are not treated as U.S.
corporations for U.S. federal income tax purposes under the regulations and are
not subject to U.S. federal income taxes commencing as of such
date.
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. In 2006, the IRS
issued its final regulations, stating that neither the temporary regulations nor
these final regulations are retroactive. Further, additional guidance
was released by the IRS which clarified that the regulations upon which we
relied were not binding on pre-existing entities until May 2006. For
periods prior to this date (i.e., prior to August 12, 2004) these final
regulations apply, and the classification of dually chartered entities is
governed by the pre-existing regulations. As such, we believe that
our 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 we have made no provision for U.S. taxes in its financial statements for
these entities for the periods prior to August 12, 2004.
However, we cannot assure you that the
Internal Revenue Service will not assert other positions with respect to the
foregoing matters, including positions with respect to our treatment of the tax
consequences of the termination of the status of our Philippine subsidiaries as
Delaware limited liability companies that, if successful, could increase
materially our liability for U.S. federal income taxes.
If
certain tax authorities in North America and Europe challenge the manner in
which we allocate our profits, our net income could decrease.
Substantially all of the services
provided by our Asian subsidiaries are performed on behalf of clients based in
North America and Europe. We believe that profits from our Asian
operations are not sufficiently connected to jurisdictions in North America or
Europe to give rise to income taxation in those jurisdictions. Tax
authorities in any of our jurisdictions could, however, challenge the manner in
which we allocate our profits among our subsidiaries, and we may not prevail in
this type of challenge. If such a challenge were successful, our
worldwide effective tax rate could increase, thereby decreasing our net
income.
An
expiration or termination of our current tax holidays could adversely affect our
results of operations.
We currently benefit from income tax
holiday incentives in the Philippines, India and Sri Lanka which provide
that we pay reduced income taxes in those jurisdictions for a fixed period of
time that varies depending on the jurisdiction. An expiration or
termination of our current tax holidays could substantially increase our
worldwide effective tax rate, thereby decreasing our net income and adversely
affecting our results of operations. The income tax holiday of one of
our Philippine subsidiaries will expire in May 2009 and one of our Indian
subsidiaries will expire in March 2009.
12
Regional
instability in the Philippines, India and Sri Lanka could adversely affect
business conditions in those regions, which could disrupt our operations and
adversely affect our business and results of operations.
We conduct a majority of our operations
in the Philippines, India and Sri Lanka. These operations remain
vulnerable to political unrest. Political instability could adversely
affect the legal environment for our business activities in those
regions.
In particular, the Philippines have
experienced ongoing problems with insurgents. The Abu Sayyaf group of
kidnappers, which is purported to have ties to the Al Qaeda terrorist
organization, is concentrated on Basilan Island. While Basilan Island
is not near our facilities and the government of the Philippines has taken
action to eradicate this group, we cannot assure you that these efforts will be
successful or that the Abu Sayyaf group will not attempt to disrupt activities
or commit terrorist acts in other areas of the Philippines or South
Asia.
While the threat of military
confrontation between India and Pakistan in Kashmir has receded, political
uncertainty in Pakistan may have spill over effects to its relationship with
India. Further, the government of Sri Lanka has terminated the
Norwegian-brokered ceasefire with its rebels and there are concerns that
hostilities may escalate.
Further political tensions and an
escalation in these hostilities could adversely affect our operations based in
India, the Philippines and Sri Lanka and therefore adversely affect our revenues
and results of operations.
Terrorist
attacks or a war could adversely affect our results of operations.
Terrorist attacks, such as the attacks
of September 11, 2001 in the United States and the recent attacks in
Mumbai, India in November 2008, and other acts of violence or war, such as the
conflict in Iraq, could affect us or our clients by disrupting normal business
practices for extended periods of time and reducing business
confidence. In addition, these attacks may make travel more difficult
and may effectively curtail our ability to serve our clients' needs, any of
which could adversely affect our results of operations.
It
is unlikely that we will pay dividends.
We have not paid any cash dividends
since our inception and do not anticipate paying any cash dividends in the
foreseeable future. We expect that our earnings, if any, will be used
to finance our growth.
Item
1B. Unresolved Staff Comments.
None
Item
2. Properties.
Our services are primarily performed
from our Hackensack, New Jersey headquarters, our Dallas, Texas office, and ten
overseas production facilities, all of which are leased. The square footage of
all our leased properties is approximately 450,000.
We currently lease property sufficient
for our business operations, although we may need to lease additional property
in the future. We also believe that we will be able to obtain suitable
additional facilities on commercially reasonable terms on an “as needed”
basis.
Item
3. Legal Proceedings.
The
Supreme Court of the Republic of the Philippines has refused to review a
decision of the Court of Appeals in Manila against a Philippines subsidiary of
the Company that is inactive and has no material assets, and purportedly also
against Innodata Isogen, Inc., that orders the reinstatement of certain former
employees of the subsidiary to their former positions and payment of back wages
and benefits that aggregate approximately $7.5 million. Complainants have moved
for execution of this decision. Based on consultation with legal counsel, the
Company believes that recovery against the Company is nevertheless
unlikely.
13
The Court
of Appeals decision was rendered in Case Nos. CA-G.R. SP No. 93295 Innodata
Employees Association (IDEA), Eleanor Tolentino, et al. vs. Innodata
Philippines, Inc., et al., and CA-G.R. SP No. 90538 Innodata Philippines, Inc.
vs. Honorable Acting Secretary Manuel G. Imson, et al. 28 June 2007). The
motions for execution were filed by complainants with the Department of Labor
and Employment National Labor Relations Commission, Republic of the Philippines
(NLRC-NCR-Case No.07-04713-2002, et al., Innodata Employees Association (IDEA)
and Eleanor A. Tolentino, et al. vs. Innodata Philippines, Inc., et al), and the
Department of Labor and Employment Office of the Secretary of Labor and
Employment, Republic of the Philippines (Case No. OS-AJ-0015-2001, In Re: Labor
Dispute at Innodata Philippines Inc.)
The
Company is also subject to various legal proceedings and claims which arise in
the ordinary course of business.
While
management currently believes that the ultimate outcome of 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. Substantial recovery against the Company in the above referenced
Philippines actions could have a material adverse impact on the Company, and
unfavorable rulings or recoveries in the other proceedings could have a material
adverse impact on the operating results of the period in which the ruling or
recovery occurs.
Item
4. Submission of Matters to a Vote of Security Holders
None
14
PART II
Item
5. Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
Innodata Isogen, Inc. (the “Company”)
Common Stock is quoted on the Nasdaq National Market System under the symbol
“INOD.” On February 18, 2009, there were 102 stockholders of record
of the Company’s Common Stock based on information provided by the Company's
transfer agent. Virtually all of the Company’s publicly held shares
are held in “street name” and the Company believes the actual number of
beneficial holders of its Common Stock to be approximately 3,570.
The following table sets forth the high
and low sales prices on a quarterly basis for the Company's Common Stock, as
reported on Nasdaq, for the two years ended December 31, 2008.
Common
Stock
|
||||||||
Sale
Prices
|
||||||||
2007
|
High
|
Low
|
||||||
First
Quarter
|
$ | 3.75 | $ | 1.95 | ||||
Second
Quarter
|
4.25 | 2.55 | ||||||
Third
Quarter
|
4.30 | 2.56 | ||||||
Fourth
Quarter
|
6.38 | 3.36 | ||||||
2008
|
High
|
Low
|
||||||
First
Quarter
|
$ | 6.55 | $ | 4.19 | ||||
Second
Quarter
|
5.10 | 2.70 | ||||||
Third
Quarter
|
3.30 | 2.30 | ||||||
Fourth
Quarter
|
2.65 | 1.32 |
Dividends
The Company has never paid cash
dividends on its Common Stock and does not anticipate that it will do so in the
foreseeable future. The future payment of dividends, if any, on the
Common Stock is within the discretion of the Board of Directors and will depend
on the Company's earnings, its capital requirements and financial condition and
other relevant factors.
15
Securities
Authorized for Issuance Under Equity Compensation Plans
The following table sets forth the
aggregate information for the Company's equity compensation plans in effect as
of December 31, 2008:
Number
of
|
||||||||||||
Securities
to be Issued
|
Weighted-Average
|
Number
of Securities
|
||||||||||
Upon
Exercise of
|
Exercise
Price of
|
Remaining
Available For
|
||||||||||
Outstanding
Options,
|
Outstanding
Options,
|
Future
Issuance Under
|
||||||||||
Plan
Category
|
Warrants
and Rights
|
Warrants
and Rights
|
Equity
Compensation Plans
|
|||||||||
(a)
|
(b)
|
(c)
|
||||||||||
Equity
compensation plans approved by security holders (1)
|
3,173,000 | $ | 2.68 | 836,000 | ||||||||
Equity
compensation plans not approved by security holders
|
- | - | - | |||||||||
Total
|
3,173,000 | $ | 2.68 | 836,000 |
(1) 2001 and 2002 Stock Option Plans,
approved by the stockholders, see Note 9 to Consolidated Financial Statements,
contained elsewhere herein.
Purchase
of Equity Securities
In May 2008, our Board of Directors
authorized the repurchase of up to $2.0 million of our common stock. There is no
expiration date associated with the program. As of December 31, 2008, we
repurchased 606,000 shares of our common stock at a cost of approximately $1.9
million, and approximately $0.1 million remains available for repurchase under
the program. This authorization replaced a prior authorization made in August
2006.
Item
6. Selected Financial Data
The
following table sets forth our selected consolidated historical financial data
as of the dates and for the periods indicated. Our selected consolidated
financial data set forth below as of December 31, 2008 and 2007 and for
each of the three years in the period ended December 31, 2008 has been
derived from the audited financial statements included elsewhere herein. Our
selected consolidated financial data set forth below as of December 31,
2006, 2005 and 2004 and for each of the years ended December 31, 2005 and
2004 are derived from the audited financial statements not included elsewhere
herein. Our selected consolidated financial information for 2008, 2007 and 2006
should be read in conjunction with the Consolidated Financial Statements and the
Notes and “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” which are included elsewhere in this Annual
Report on Form 10-K.
16
Year
Ended December 31,
|
||||||||||||||||||||
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
(In
thousands, except per share data)
|
||||||||||||||||||||
STATEMENT
OF OPERATIONS DATA:
|
||||||||||||||||||||
Revenues
|
$ | 75,001 | $ | 67,731 | $ | 40,953 | $ | 42,052 | $ | 53,949 | ||||||||||
Operating
costs and expenses
|
||||||||||||||||||||
Direct operating
expenses
|
53,525 | 48,581 | 34,316 | 30,920 | 33,050 | |||||||||||||||
Selling and
administrative expenses
|
16,134 | 15,281 | 14,713 | 13,684 | 10,205 | |||||||||||||||
69,659 | 63,862 | 49,029 | 44,604 | 43,255 | ||||||||||||||||
Income
(loss) from operations
|
5,342 | 3,869 | (8,076 | ) | (2,552 | ) | 10,694 | |||||||||||||
Other
(income) expenses
|
||||||||||||||||||||
Terminated offering
costs
|
- | - | - | - | 625 | |||||||||||||||
Bad debt recovery,
net
|
- | - | - | - | (963 | ) | ||||||||||||||
Interest
expense
|
56 | 33 | 7 | 18 | 25 | |||||||||||||||
Interest
income
|
(262 | ) | (678 | ) | (683 | ) | (457 | ) | (87 | ) | ||||||||||
Income
(loss) before provision for (benefit from) income
taxes
|
5,548 | 4,514 | (7,400 | ) | (2,113 | ) | 11,094 | |||||||||||||
Provision
for (benefit from) income taxes
|
(2,036 | ) | (52 | ) | (77 | ) | (462 | ) | 3,237 | |||||||||||
Net
income (loss)
|
$ | 7,584 | $ | 4,566 | $ | (7,323 | ) | $ | (1,651 | ) | $ | 7,857 | ||||||||
Income
(loss) per share:
|
||||||||||||||||||||
Basic
|
$ | .31 | $ | .19 | $ | (.30 | ) | $ | (.07 | ) | $ | .35 | ||||||||
Diluted
|
$ | .30 | $ | .18 | $ | (.30 | ) | $ | (.07 | ) | $ | .32 | ||||||||
Cash
dividends per share
|
$ | - | $ | - | $ | - | $ | - | $ | - |
December 31,
|
||||||||||||||||||||
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
(In
thousands)
|
||||||||||||||||||||
BALANCE
SHEET DATA:
|
||||||||||||||||||||
Working
capital
|
$ | 22,807 | $ | 16,329 | $ | 14,292 | $ | 21,432 | $ | 22,209 | ||||||||||
Total
assets
|
$ | 45,385 | $ | 38,449 | $ | 30,329 | $ | 37,611 | $ | 37,211 | ||||||||||
Long
term obligations
|
$ | 1,671 | $ | 2,128 | $ | 1,564 | $ | 548 | $ | 150 | ||||||||||
Stockholders’
equity
|
$ | 30,188 | $ | 23,230 | $ | 19,009 | $ | 26,814 | $ | 26,737 |
Item
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion should be read
in conjunction with our consolidated financial statements and the related notes
included elsewhere in this report. In addition to historical information, this
discussion includes forward-looking information that involves risks and
assumptions which could cause actual results to differ materially from
management’s expectations. See “Forward-Looking Statements” included elsewhere
in this report.
Executive
Overview
We provide a broad and expanding range
of knowledge process outsourcing services as well as publishing and related
information technology services that help companies create and manage
information more effectively and economically. Our solutions enable
organizations to find new ways to transform inefficient business processes,
improve operations and reduce costs.
17
In 2007,
we commenced a reorganization of our management and operating structure. Prior
to 2007, our operations were classified into two operating segments: (1)
content-related BPO and KPO services and (2) IT professional
services. In this reorganization, we merged the content-related BPO
and KPO services and IT professional services segments (ceasing to monitor our
operations by these two segments). With this reorganization, our Company
consists of one business that generates revenues and expenses. The structure of
our current operating segment reflects the way the chief operating decision
maker looks at the overall Company to evaluate performance and makes executive
decisions (including the allocation of resources) about the business. There is
no end to end responsibility or management other than at the consolidated level,
and discrete financial information is available at the consolidated
level.
The
following table sets forth, for the period indicated, certain financial data
expressed for the three years ended December 31, 2008:
(Dollars
in millions)
Years
Ended December 31,
|
||||||||||||||||||||||||
2008
|
%
of revenue
|
2007
|
%
of revenue
|
2006
|
%
of revenue
|
|||||||||||||||||||
Revenues
|
$ | 75.0 | 100.0 | % | $ | 67.7 | 100.0 | % | $ | 41.0 | 100.0 | % | ||||||||||||
Direct
operating costs
|
53.5 | 71.4 | % | 48.6 | 71.8 | % | 34.3 | 83.7 | % | |||||||||||||||
Selling
and administrative expenses
|
16.1 | 21.5 | % | 15.3 | 22.6 | % | 14.7 | 35.9 | % | |||||||||||||||
Income
(loss) from operations
|
5.4 | 7.1 | % | 3.8 | 5.6 | % | (8.0 | ) | (19.6 | )% | ||||||||||||||
Other
(income) expenses
|
(0.2 | ) | (0.7 | ) | (0.6 | ) | ||||||||||||||||||
Income
(loss) before provision for (benefit from) income
taxes
|
5.6 | 4.5 | (7.4 | ) | ||||||||||||||||||||
Benefit
from income taxes
|
(2.0 | ) | (0.1 | ) | (0.1 | ) | ||||||||||||||||||
Net
income (loss)
|
$ | 7.6 | $ | 4.6 | $ | (7.3 | ) |
Revenues
Our publishing services include
digitization, conversion, composition, data modeling and XML encoding, and KPO
services include research and analysis, authoring, copy-editing, abstracting,
indexing and other content creation activities. Our IT system professionals
support the design, implementation, integration and deployment of digital
systems used to author, manage and distribute content. Services that we
anticipate a client will require for an indefinite period generate what we
regard as recurring revenues. Services that are provided for a specific project
generate revenues that terminate on completion of a defined task and we regard
these revenues as non-recurring. We price our publishing services and KPO
services based on the quantity delivered or resources utilized and we recognize
revenue in the period in which the services are performed and delivered.
A substantial majority of our IT professional services is provided on a
project basis that generates non-recurring revenues. We price our professional
services on an hourly basis for actual time and expense incurred, or on a
fixed-fee turn-key basis. Revenues for contracts billed on a
time-and-materials basis are recognized as services are
performed. Revenues under fixed-fee contracts, which are not
significant to the overall revenues, are recognized on the percentage of
completion method of accounting, as services are performed or milestones are
achieved.
Recurring revenues consisted of 68%,
61% and 61% of total revenues for the years ended December 31, 2008, 2007 and
2006, respectively. We have historically relied on a very limited
number of clients that have accounted for a significant portion of our revenues.
Four clients generated approximately 57%, 61% and 54% of our total revenues in
the fiscal years ended December 31, 2008, 2007 and 2006,
respectively. 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 client’s selection
of another service provider.
18
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.
Refer to
“Risk Factors.”
Direct
Operating Costs
Direct operating costs consist of
direct payroll, occupancy costs, depreciation, telecommunications, computer
services and supplies.
Selling
and Administrative Expenses
Selling and administrative expenses
consist of management and administrative salaries, sales and marketing costs,
new services research and related software development, professional fees and
consultant costs and other administrative overhead costs.
Results
of Operations
Year
Ended December 31, 2008 Compared to the Year Ended December 31,
2007
Revenues
Revenues
were $75.0 million for the year ended December 31, 2008 compared to
$67.7 million for the similar period in 2007, an increase of approximately
11%. The $7.3 million increase in revenues reflects a $9.7 million increase
from recurring revenue and a decline of $2.4 million from non-recurring project
revenue.
Four
clients generated approximately 57% and 61% of our revenues in the fiscal year
ended December 31, 2008 and 2007, respectively. Further, for the year ended
December 31, 2008 and 2007, revenues from clients located in foreign countries
(principally in Europe) accounted for 21% and 23% respectively, of our
total revenues.
For the
year ended December 31, 2008, approximately 68% of our revenue was recurring and
the 32% balance was non-recurring, compared with 61% and 39%,
respectively, for the year ended December 31, 2007. The increase in the
percentage of recurring revenues is due to ongoing growth in existing client
relationships.
We have
provided services to approximately 170 clients in 2008 as compared to
approximately 150 clients in 2007.
Direct
Operating Costs
Direct operating costs were
$53.5 million and $48.6 million for the years ended December 31,
2008 and 2007, respectively, an increase of approximately 10%. Direct
operating costs as a percentage of revenues were 71% for the year ended
December 31, 2008 and 72% for the year ended December 31,
2007.
The increase in direct operating costs
reflects higher compensation, benefit costs and other operating costs in support
of increased revenue, the impact of foreign exchange rates of approximately $1.1
million in direct operating costs resulting from a weakened US dollar against
the Philippine peso and Indian rupee as well as approximately $1.1 million in
losses from the settlement of forward contracts.
19
If no
effect were given to the approximately $1.1 million resulting from foreign
exchange fluctuation and $1.1 million of losses resulting from the settlement of
foreign currency forward contracts, direct operating costs would have increased
by approximately 6% in 2008 as compared to 2007 and as a percentage of revenues
would have been 68% in 2008, compared to 72% in 2007.
Selling
and Administrative Expenses
Selling and administrative expenses
were $16.1 million and $15.3 million for the years ended
December 31, 2008 and 2007, respectively, an increase of approximately
5%. Selling and administrative expenses as a percentage of revenues
were 22% and 23% for the years ended December 31, 2008 and 2007,
respectively. The lower percentage reflects sustained cost levels on
a higher revenue base.
The increase in selling and
administrative expenses principally reflects increased sales and administrative
payroll and payroll related costs.
Restructuring
Costs
As part of our overall cost reduction
plan to reduce operating costs, in December 2008, we announced a restructuring
plan reducing our global work force by approximately 260 employees. The majority
of these employees were based in Asia and were terminated by December 31,
2008.
In connection with the restructuring,
we recorded a one-time charge of approximately $0.5 million ($0.3 million in
cost of sales and $0.2 million in selling and administrative expenses)
representing severance and other personnel-related expenses. As of December 31,
2008, $0.3 million of the total restructuring cost was paid, and we expect the
remaining amount to be paid during the first two quarters of 2009.
We expect that this restructuring
activity should yield an estimated $0.6 million pre-tax quarterly cost savings
beginning in the first quarter of 2009.
Income
Taxes
For the
year ended December 31, 2008, the benefit from income taxes resulted primarily
from the reversal of a valuation allowance previously recorded on the U.S.
portion of deferred tax assets. We recorded no provision for U.S. income taxes,
other than for alternative minimum tax, because we utilized net operating losses
for which we had previously recorded a valuation allowance against the
corresponding deferred tax asset. The income tax benefit was partially reduced
by the provision for foreign income taxes attributable to overseas
subsidiaries.
For the year ended
December 31, 2007, the benefit from income taxes represents a
deferred tax benefit arising due to the nature of timing differences in certain
overseas entities. In addition, certain overseas income is neither subject
to foreign income taxes because of tax holidays granted to us, nor subject to
tax in the U.S. unless repatriated. No provision for income taxes, other than
alternative minimum tax, was recorded for our U.S. entity primarily due to
utilization of net operating losses for which a valuation allowance was
previously recorded against the corresponding deferred tax asset. In 2007, we
recorded a benefit for the refund of taxes paid and interest from the IRS
amounting to $395,000 and $60,000, respectively, which was the outcome of the
final regulation from the IRS resulting in termination of the status of our
Philippine subsidiaries as Delaware limited liability companies (Refer to “Risk
Factors”).
20
In assessing the realization of
deferred tax assets, we consider whether it is more likely than not that all or
some portion of the deferred tax assets will not be realizable. The
ultimate realization of the deferred tax assets is dependent upon the generation
of future taxable income during the periods in which temporary differences are
deductible and net operating losses are available. We consider many factors when
assessing the likelihood of future realization of the deferred tax assets,
including our Company’s recent cumulative earnings experience by taxing
jurisdiction, expectation of future taxable income, the carryforward periods
available to us for tax reporting purposes, and other relevant factors. Based
upon the management’s assessment and the available evidence, in 2008 we reversed
the entire portion of the valuation allowance previously recorded on the U.S.
portion of deferred tax assets resulting in a non-cash tax benefit amounting to
$3.3 million. The decline in the valuation allowance in 2008 also resulted from
the utilization of net operating losses. In 2008, we utilized $3.8 million of
net operating losses. The remaining valuation allowance at December 31, 2008
represents the portion we have established on deferred tax assets of our foreign
subsidiaries.
We
currently intend to remit to the United States approximately $5.1 million of
foreign earnings for which we have recorded a deferred tax liability. These
earnings represent a portion of our foreign profits earned prior to 2002.
Beginning in 2002, 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
because such earnings are not anticipated to be remitted to the United States.
If such earnings were to be distributed, we may be subject to United States
income taxes that may not be fully offset by foreign tax credits.
Pursuant
to an income tax audit by the Indian Bureau of Taxation, in March 2006, one of
our Indian subsidiaries received a tax assessment approximating $434,000,
including interest through December 31, 2008, for the fiscal tax year ended
March 31, 2003. We disagree with the basis of the tax assessment, and
have filed an appeal against the assessment, which we will
contest vigorously. The Indian Bureau of Taxation has also completed an
audit of our Indian subsidiary’s income tax return for the fiscal tax year ended
March 31, 2004. The ultimate outcome was favorable, and there was no
tax assessment imposed for the fiscal tax year ended March 31, 2004.
In December 2008, we received a final tax assessment from the India Bureau of
Taxation for the fiscal year ended March 31, 2005 for which we have provided
adequate tax provision, including interest through December 31, 2008. We
disagree with the basis of the tax assessment, filed an appeal against the
assessment and will contest it vigorously. In 2008, the Indian Bureau of
Taxation commenced an audit of our subsidiary’s income tax return for the fiscal
year ended 2006. The ultimate outcome cannot be determined at this
time.
We had
unrecognized tax benefits of $840,000 and $740,000 at December 31, 2008 and
2007, respectively. The portion of unrecognized tax benefits relating to
interest and penalties were $253,000 and $153,000 at December 31, 2008 and 2007,
respectively. $664,000 and $564,000 of our unrecognized tax benefits as of
December 31, 2008 and 2007, respectively if recognized, would have an impact on
our effective tax rate.
We are
subject to various tax audits and claims which arise in the ordinary course of
business. Management currently believes that the ultimate outcome of these
audits and claims will not have a material adverse effect on our consolidated
financial position or results of operations.
Net
Loss/Income
We
generated net income of $7.6 million in 2008 compared with net income of
$4.6 million in 2007. The change was principally attributable to the
increase in gross margin resulting from increased revenues and lower selling and
administrative expenses as a percentage of revenues, a reversal of a valuation allowance
previously recorded on the U.S. portion of
the deferred tax assets amounting to $3.3 million, offset by a decrease
in interest income on available cash that reflected a decline in interest rates,
and an increase in foreign effective tax rates resulting in increase in income
taxes attributable to our overseas subsidiaries.
21
Year
Ended December 31, 2007 Compared to the Year Ended December 31,
2006
Revenues
Revenues
were $67.7 million for the year ended December 31, 2007 compared to
$41.0 million for the similar period in 2006, an increase of approximately
65%. The $26.7 million increase in revenues, which is principally
attributable to four clients (three existing clients and one new client),
reflects a $20.9 million increase from recurring revenue and $5.8 million from
non-recurring project revenue. Furthermore, more than 62% of the total
revenue increase is attributable to knowledge services.
Four
clients generated approximately 61% and 54% of our revenues in the fiscal year
ended December 31, 2007 and 2006, respectively. Further, for the year
ended December 31, 2007 and 2006, revenues from clients located in foreign
countries (principally in Europe) accounted for 23% and 37% respectively,
of our total revenues.
For the
years ended December 31, 2007 and 2006, approximately 61% of our revenue was
recurring and the 39% balance was non-recurring.
We have
provided our services to approximately 150 clients in 2007 as compared to
approximately 130 clients in 2006.
Direct
Operating Costs
Direct operating costs were
$48.6 million and $34.3 million for the years ended December 31,
2007 and 2006, respectively, an increase of approximately 42%. Direct
operating costs as a percentage of revenues were 72% for the year ended
December 31, 2007 and 84% for the year ended December 31,
2006.
The increase in direct operating costs
was principally attributable to the increase in variable labor (management and
production personnel) and other operating costs in support of higher revenue
volume. The direct operating expenses as a percentage of revenues
were lower in 2007 as compared to 2006, principally due to decreased variable
costs as a percent of revenues, and increased operating leverage resulting from
the increase in revenues with no significant increase in fixed costs. These
favorable results were offset in part by $2.6 million in direct operating costs
resulting from a weakened US dollar against the Philippine peso and India
rupee.
Selling
and Administrative Expenses
Selling and administrative expenses
were $15.3 million and $14.7 million for the years ended
December 31, 2007 and 2006, respectively, an increase of approximately
4%. Selling and administrative expenses as a percentage of revenues
were 23% and 36% for the years ended December 31, 2007 and 2006
respectively. The lower percentage reflects sustained operating costs
levels on a higher revenue base.
Selling and administrative expenses in
2006 include approximately $246,000 received as an inducement to terminate our
Dallas office lease prior to its contractual expiration dates, accrued severance
costs of approximately $275,000 related to the termination of an executive’s
employment and approximately $922,000 in research and development costs for new
services. After excluding the effect of these non-recurring adjustments, the
resulting increase in selling and administrative expenses principally reflects
increased sales and administrative payroll and payroll related costs associated
with annual salary increases and increased professional fees, including fees
associated with Section 404 of the Sarbanes-Oxley Act incurred in
2007.
22
Restructuring
Costs
As part of an overall cost reduction
plan to reduce operating costs, in September 2006 we announced a worldwide
workforce reduction of slightly under 300 employees, the majority of whom were
based in Asia. Most employees were terminated prior to September 30, and we
substantially implemented the plan at the end of 2006.
As a result, we recorded total charges
of $604,000 in 2006 associated with the restructuring plan. The 2006 charge
consisted of $531,000 of employee severance costs and $73,000 of costs to
implement the plan. Of the total amount, $60,000 represents charges relating to
stock option modifications.
In connection with the restructuring,
we paid cash of $544,000 and recognized costs amounting to $60,000 for stock
option modifications. We currently expect no future costs to be incurred
associated with the 2006 restructuring plan.
As of December 31, 2006, accrued
expenses included approximately $102,000 related to the restructuring charges,
which were paid in 2007.
Income
Taxes
For the
year ended December 31, 2007, the benefit from income taxes as a percentage
of income before income taxes was 1%. The 2007 benefit from income taxes is
lower than the U.S. Federal statutory rate, principally due to the U.S. net
operating losses which were not recognized as a result of a valuation
allowance. In addition, certain overseas income is neither subject to
foreign income taxes because of tax holidays granted to us, nor subject to tax
in the U.S. unless repatriated.
For the
year ended December 31, 2006, the benefit from income taxes as a percentage
of loss before income taxes was 1%. The 2006 benefit from income
taxes is lower than the U.S. Federal statutory rate, principally due to the U.S.
net operating losses which were not recognized as a result of a valuation
allowance. In addition, certain overseas income is neither subject to
foreign income taxes because of tax holidays granted to us, nor subject to tax
in the U.S. unless repatriated.
In
assessing the realization of deferred tax assets, we consider whether it is more
likely than not that all or some portion of our deferred tax assets will not be
realized. Our ultimate realization of the deferred tax assets is dependent upon
our generating future taxable income during the periods in which temporary
differences are deductible and net operating losses are utilized. Based on a
consideration of these factors, we have established a valuation allowance of
approximately $4.6 million at December 31, 2007. In 2007, we utilized $2.1
million of net operating losses.
Pursuant
to an income tax audit by the Indian Bureau of Taxation, on March 27, 2006, one
of our Indian subsidiaries received a tax assessment approximating $404,000,
including interest through December 31, 2007, for the fiscal tax year ended
March 31, 2003. We disagree with the basis of the tax assessment, and
have filed an appeal against the assessment, which we will fight vigorously. The
Indian Bureau of Taxation has also completed an audit of our Indian subsidiary’s
income tax return for the fiscal tax year ended March 31, 2004. The
ultimate outcome was favorable, and there was no tax assessment imposed for the
fiscal tax year ended March 31, 2004. On March 20, 2007, the
Indian bureau of taxation commenced an audit of our subsidiary’s income tax
return for the fiscal year ended 2005. We cannot determine the ultimate outcome
at this time.
As a
result of an IRS audit settlement, we recognized approximately $234,000 of
previously unrecognized tax benefits for the year ended December 31, 2007. An
additional $176,000 of unrecognized tax benefits relating to uncertain income
tax positions was provided for the year ended December 31, 2007.
We are
subject to various tax audits and claims which arise in the ordinary course of
business. Management currently believes that the ultimate outcome of these
audits and claims will not have a material adverse effect on our financial
position or results of operations.
23
Our
liability for net unrecognized tax benefits at December 31, 2007 and 2006
was approximately $411,000 and $481,000, respectively. This liability represents
an accrual relating to uncertain income tax positions we have taken on our
domestic and foreign tax returns. We report interest expense and penalties
related to income tax liabilities as a component of our provision for income
taxes. As of December 31, 2007 and 2006, we had accrued a liability for interest
and penalties totaling approximately $153,000 and $138,000,
respectively.
Furthermore
we had unrecognized tax benefits of $176,000 and $167,000 as of December 31,
2007 and December 31, 2006, respectively, which, if recognized, would increase
our net operating loss carry forward. This increase, if recognized, would not
have an impact on our effective tax rate since the increase to our deferred tax
assets would result in a corresponding increase to our valuation
allowance.
In August
2004, the IRS promulgated regulations, effective August 12, 2004, that had the
effect of making certain of our overseas entities 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. As a result, in December 2004, the Company effected certain filings in
Delaware to ensure that these subsidiaries would not be treated as U.S.
corporations for U.S. federal income tax purposes as of the date of filing and
as such, were not subject to U.S. federal income taxes commencing
January 1, 2005. On January 30, 2006, the IRS issued its final
regulations, stating that neither the temporary regulations nor these final
regulations are retroactive. In December 2007, the Company received a
notification from the IRS for the entitlement of the refund for taxes paid and
the interest amounting to approximately $395,000 and $60,000, respectively. The
Company appropriately recorded a benefit and an income tax receivable at
December 31, 2007.
Net
Loss/Income
We
recorded net income of $4.6 million in 2007 compared with a net loss of
$7.3 million in 2006. The change was principally attributable to the
increase in gross margin resulting from increased revenues and lower selling and
administrative expenses as a percentage of revenues.
Liquidity
and Capital Resources
Selected measures of liquidity and
capital resources, expressed in thousands are as follows:
December
31,
|
||||||||||||
2008
|
2007
|
2006
|
||||||||||
Cash
and cash equivalents
|
$ | 13,875 | $ | 14,751 | $ | 13,597 | ||||||
Working
capital
|
22,807 | 16,329 | 14,292 |
At December 31, 2008, we had cash and
cash equivalents of $13.9 million. We have used, and plan to use, such cash for
(i) expansion of existing operations; (ii) general corporate purposes, including
working capital; and (iii) possible acquisitions of related businesses. As of
December 31, 2008, we had no third party debt and had working capital of
approximately $22.8 million as compared to working capital of approximately
$16.3 million at December 31, 2007. Accordingly, we do not anticipate any
near-term liquidity issues.
Our quarterly operating results are
also subject to certain seasonal fluctuations. We generally experience lower
revenue in the first quarter as we replace projects that were brought to end in
the fourth quarter and we begin new projects, which may have some normal start
up delays during the first quarter. These and other seasonal factors may
contribute to fluctuations in our results of operations from quarter to
quarter.
24
Net
Cash Provided By (Used In) Operating Activities
Cash provided by our operating
activities in 2008 was $4.5 million resulting from a net income of $7.6 million,
adjustments for non-cash items of $0.8 million and $3.9 million used for working
capital. Adjustments for non-cash items primarily consisted of $3.7 million for
depreciation and amortization, $3.6 million for deferred taxes primarily
resulting from a reversal of valuation allowance for the U.S. entity amounting
to $3.3 million and $0.4 million for pension costs. Working capital activities
primarily consisted of a use of cash of $3.3 million for an increase in accounts
receivable primarily related to an increase in revenue and use of cash of $0.6
million for decline in accounts payable and accrued expenses representing the
timing of expenditures and payments.
Cash provided by our operating
activities in 2007 was $6 million resulting from a net income of $4.6 million,
adjustments for non-cash items of $3.9 million and $2.5 million used for working
capital. Adjustments for non-cash items primarily consisted of $3.2 million for
depreciation and amortization and $0.7 million for pension costs. Working
capital activities primarily consisted of a use of cash of $4.2 million for an
increase in accounts receivable primarily related to an increase in revenue, a
source of cash of $1.0 million of an increase in accounts payable due to timing
of expenditure, a source of cash of $1.7 million for an increase in accrued
salaries and wages due to an increase in the number of employees and higher
labor rates in support of higher revenue volume and a use of cash of $1.5
million due to payment of minimum withholding taxes on the net settlement of
stock options exercised by our Chairman and CEO.
Cash used in our operating activities
in 2006 was $3.4 million resulting from a net loss of $7.3 million, offset by
adjustments for non-cash items of $3.8 million and $0.1 million generated by
working capital. Adjustments for non-cash items primarily consisted of $3.4
million for depreciation and amortization and $0.3 million for pension costs.
Working capital activities primarily consisted of a source of cash of $0.7
million for a decrease in accounts receivable primarily related to a decrease in
our revenues and timing of collections, a use of cash of $0.5 million for a
decrease in accounts payable representing payments made to vendors, a source of
cash of $0.7 million for an increase in accrued expenses and accrued salaries
and wages primarily related to the accruals for bonus and retirement benefits
and a use of cash of $0.7 million due to increase in prepaid expenses and other
current assets.
At December 31, 2008, our days’ sales
outstanding were approximately 62 days as compared to 52 days as of December 31,
2007 and 56 days as of December 31, 2006.
Net
Cash Used in Investing Activities
During 2008, 2007 and 2006, cash used
in our investing activities was $2.5 million, $4.4 million and $2.3 million,
respectively for capital expenditures. Capital expenditures in 2008 and 2007
related principally to routine purchasing of technology equipment and facility
upgrades. Capital spending in 2006 related principally to normal ongoing
equipment upgrades, project requirement specific equipment, and improvements in
infrastructure. Furthermore, in 2008 and 2007, we acquired certain computer and
communications equipment approximating $0.1 million and $0.8 million,
respectively, through finance leases (non-cash). During the next twelve months,
we anticipate that capital expenditures for ongoing technology, hardware,
equipment and infrastructure upgrades will approximate $4.0 to $5.0 million, a
portion of which we may finance.
Net
Cash Provided by Financing Activities
Cash proceeds received from the
exercise of stock options amounted to approximately $0.1 million, $0.5 million
and $0.4 million in 2008, 2007 and 2006, respectively.
25
In May 2008, we announced that our
Board of Directors authorized the repurchase of up to $2 million of our common
stock. As of December 31, 2008, we acquired approximately 606,000 shares of our
common stock for approximately $1.9 million at a volume weighted average price
of $3.08 per share. This authorization replaced a prior authorization made in
August 2006, whereby
the Board of Directors authorized the repurchase of up to $1.0 million of our
common stock of which we repurchased approximately 182,000 shares. We paid $0.3
million to repurchase these shares in 2006. No shares were repurchased in
2007.
In March 2008, we renewed a vendor
agreement, which expired in February 2008, to acquire certain additional
software licenses and to receive support and subsequent software upgrades on
these and other currently owned software licenses through February 2011, for a
total cost of approximately $1.7 million, representing a non-cash investing and
financing activity. As of December 31, 2008, we paid $0.5 million under this
agreement. The agreement, which expired in February 2008, was originally entered
into in February 2005 for a total cost of approximately $1.6 million. In
conjunction with this agreement, we paid approximately $0.6 million and $0.5
million in 2007 and 2006, respectively.
In 2006, additional software licenses
amounting to $164,000 were acquired under staggered payment terms. Total payment
made on these purchases in 2007 and 2006 amounted to $78,000 and $82,000,
respectively, with the remaining balance paid in January 2008.
As we operate in a number of countries
around the world, we face exposure to adverse movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve and may have a material adverse impact on our consolidated financial
results. Our primary exposure relates to non-U.S. based operating expenses in
Asia. Our U.S. Corporate headquarters has historically funded expenditures for
our foreign subsidiaries based in the Philippines and India. We are exposed to
foreign exchange risk and therefore we sometimes use foreign currency forward
contracts to mitigate our exposure to fluctuating future cash flows arising from
changes in foreign exchange rates. In 2007 and 2008, we entered into foreign
currency forward contracts, with a maximum term of six months and an aggregate
notional amount of $4.5 million and $11.6 million, respectively, to sell U.S.
Dollars for Philippine Pesos and Indian Rupees that were all settled at December
31, 2007 and 2008. All realized gains and losses were reported in our
consolidated statement of operations. We may continue to enter
into such instruments, or other instruments in the future, to reduce foreign
currency exposure to appreciation or depreciation in the value of these foreign
currencies.
Other than the aforementioned forward
contracts, we have not engaged in any hedging activities nor have we entered
into off-balance sheet transactions, arrangements or other relationships with
unconsolidated entities or other persons that are likely to affect liquidity or
the availability of our requirements for capital resources.
Future
Liquidity and Capital Resource Requirements
We have a $7.0 million line of
credit pursuant to which we may borrow up to 80% of eligible accounts
receivable. Borrowings under the credit line bear interest at the bank’s
alternate base rate plus ½% or LIBOR plus 3%. The line, which expires in June
2009, is collateralized by our Company’s accounts receivable. We have no
outstanding obligations under this credit line as of December 31, 2008. We plan
on renewing the line of credit in the second quarter of 2009.
We believe that our existing cash and
cash equivalents, funds generated from our operating activities and funds
available under our credit facility will provide sufficient sources of liquidity
to satisfy our financial needs for the next twelve months. However, if
circumstances change, we may need to raise debt or additional equity capital in
the future. We have historically funded our foreign expenditures from our U.S.
Corporate headquarters on an as-needed basis.
26
Contractual
Obligations
The table below summarizes our
contractual obligations (in thousands) at December 31, 2008, and the effect that
those obligations are expected to have on our liquidity and cash flows in future
periods.
Payments Due by Period
|
||||||||||||||||||||
Contractual Obligations
|
Total
|
Less than
1 year
|
1-3 years
|
4-5 years
|
After
5 years
|
|||||||||||||||
Capital
lease obligations
|
$ | 453 | $ | 277 | $ | 176 | $ | - | $ | - | ||||||||||
Non-cancelable
operating leases
|
1,525 | 787 | 625 | 113 | - | |||||||||||||||
Long-term
vendor obligations
|
1,100 | 550 | 550 | - | - | |||||||||||||||
Total
contractual cash obligations
|
$ | 3,078 | $ | 1,614 | $ | 1,351 | $ | 113 | $ | - |
Future expected obligations under the
Company’s pension benefit plans have not been included in the contractual cash
obligations table above.
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 subject to certain fluctuations. We experience
fluctuations in our revenue and earnings as we replace and begin new projects,
which may have some normal start up delays, or we may be unable to replace a
project entirely. These and other factors
may contribute to fluctuations in our operating results from quarter to
quarter.
Critical
Accounting Policies and Estimates
Basis
of Presentation and Use of Estimates
Our
discussion and analysis of our results of operations, liquidity and capital
resources are based on our consolidated financial statements which have been
prepared in conformity with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates and judgments, including those related to revenue recognition,
allowance for doubtful accounts and billing adjustments, long-lived assets,
goodwill, valuation of deferred tax assets, value of securities underlying
stock-based compensation, litigation accruals, pension benefits, valuation of
derivative instruments and estimated accruals for various tax exposures. We base
our estimates on historical and anticipated results and trends and on various
other assumptions that we believe are reasonable under the circumstances,
including assumptions as to future events. These estimates form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. By their nature, estimates are subject
to an inherent degree of uncertainty. Actual results may differ from our
estimates and could have a significant adverse effect on our consolidated
results of operations and financial position. We believe the following critical
accounting policies affect our more significant estimates and judgments in the
preparation of our consolidated financial statements.
27
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 in the period in
which we perform services and deliver in accordance with Staff Accounting
Bulletin 104.
We recognize IT professional services
revenues from custom application and systems integration development which
requires significant production, modification or customization of software 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, which
are not significant to our overall revenues, 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 each of the three years in
the period ended December 31, 2008. We recognize revenue billed
on a time and materials basis as we perform the services.
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. We
did not recognize an impairment in any of our long-lived assets in each of the
three years in the period ended December 31, 2008.
28
Income
Taxes
We determine our deferred taxes based
on the difference between the financial statement and tax basis 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 all or some portion of the deferred tax assets will not be
realized. We provide a valuation allowance for net operating loss
carryforwards which may not be realized and for deferred tax assets in foreign
jurisdictions which may not be realized because of our current tax holidays.
While we consider future taxable income in assessing the need for the valuation
allowance, in the event we were to determine that we would be able to realize
the deferred tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax assets would increase income in the period such
determination was made. Change in valuation allowance from period to period is
included in our tax provision in the period of change. We have recorded a
deferred tax liability on approximately $5.1 million of foreign earnings, which
represents a portion of foreign profits earned prior to 2002. Beginning in 2002,
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 because such
earnings are not anticipated to be remitted to the United States.
In
addition we have provided for an accrual for potential tax obligations resulting
from income tax audits and other potential tax obligations.
We
adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48
(“FIN 48”) “Accounting
for Uncertainty in Income Taxes” on January 1, 2007. The adoption of FIN
48 did not have an effect on our results of operations or financial position. We
recognize interest and penalties related to uncertain tax positions in income
tax expense in our consolidated statement of operations.
Goodwill
and Other Intangible Assets
SFAS 142, “Goodwill and Other Intangible
Assets” (“SFAS 142”) requires that we test goodwill annually for
impairment using a two-step fair value based test. The first step of
the goodwill impairment test, 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. Our most
recent test for impairment was conducted as of September 30, 2008, in which the
estimated fair values of the reporting unit exceeded its carrying amount,
including goodwill. As such, no impairment was identified or
recorded.
Accounting
for Stock-Based Compensation
We are authorized to grant stock
options to officers, directors and employees of the Company under various Stock
Option Plans approved by stockholders.
Effective January 1, 2006, we were
required to account for stock-based awards in accordance with the fair value
recognition provisions of SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS
123(R)”), which required the measurement and recognition of stock-based
compensation expense for all share-based payment awards made to employees and
directors based on estimated fair value at the grant date and is recognized over
the requisite service period. Determining the fair value of stock-based awards
at the grant date requires judgment, including estimating the expected term of
stock options and the expected volatility of our stock. The fair value is
determined using the Black-Scholes option-pricing model. We recorded stock-based
compensation expense of approximately $220,000, $174,000 and $241,000 for the
years ended December 31, 2008, 2007 and 2006, respectively.
29
Legal
Proceedings
We are
subject to various legal proceedings and claims which arise in the ordinary
course of business. Our legal reserves related to these
proceedings and claims are based on a determination of whether or not the loss
is probable. We review outstanding claims and proceedings with external counsel
to assess probability and estimates of loss. The reserves are adjusted if
necessary. If circumstances change, we may be required to record adjustments
that could be material to our reported financial condition and results of
operations. Based on consultation with legal counsel, we believe that recovery
against us for the legal proceedings and claims would nevertheless be
unlikely.
Pensions
Most of
our non-U.S. subsidiaries provide for government mandated defined pension
benefits covering those employees who meet certain eligibility requirements.
Pension assumptions are significant inputs to actuarial models that measure
pension benefit obligations and related effects on operations. Two critical
assumptions – discount rate and rate of increase in compensation levels – are
important elements of plan expense and asset/liability measurements. These
critical assumptions are evaluated at least annually on a plan and a country
specific basis. Other assumptions involving demographic factors such as
retirement age, mortality and turnover are evaluated periodically and are
updated to reflect actual experience and expectations for the future. Actual
results in any given year will often differ from actuarial assumptions because
of economic and other factors, and in accordance with generally accepted
accounting principles, the impact of these differences are accumulated and
amortized over future periods.
Development
Costs of Software
We
expense research and development costs for the development of new software to be
sold, leased, or otherwise marketed as a separate product or as part of a
product or process, and substantial enhancements to such existing software
products, until technological feasibility has been established, at which time
any additional development costs are capitalized until the product is available
for general release to customers. We expense all other research and
development costs as incurred.
We did not capitalize any software
development costs during any of the three years in the period ended
December 31, 2008. Included in our selling and administrative expense
are research and development costs totaling approximately $922,000 for the year
ended December 31, 2006. The Company did not incur any research and development
costs in 2008 and 2007.
Recent
Accounting Pronouncements
Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”), for financial assets and liabilities carried at fair value. SFAS
157 defines fair value, establishes a framework for measuring fair value and
expands disclosures about fair value measurements. Our adoption of SFAS 157 did
not have a material effect on our consolidated financial statements for
financial assets and liabilities and any other assets and liabilities carried at
fair value. In accordance with FASB Staff Position No. FAS 157-2 (“FSP 157-2”),
we elected to defer until January 1, 2009 the adoption of SFAS 157 for all
non-financial assets and liabilities that are not recognized or disclosed at
fair value in the consolidated financial statements. We do not believe that the
adoption of SFAS 157-2 will have a material impact on our consolidated financial
statements. In October 2008, the Financial Accounting Standards Board (“FASB”)
issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (“FSP 157-3”), which
clarifies the application of SFAS 157 when the market for a financial asset
is inactive. The guidance in FSP 157-3 was effective upon issuance and did
not have a material effect on our consolidated financial
statements.
30
Effective
January 1, 2008, we adopted SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” (“SFAS 159”), which expands
opportunities to use fair value measurements in financial reporting and permits
entities to choose to measure many financial instruments and certain other items
at fair value. Under SFAS 159, entities that elect the fair value option (by
instrument) will report unrealized gains and losses in earnings at each
subsequent reporting date. The fair value option election is irrevocable, unless
a new election date occurs. We chose not to elect the fair value option for our
financial assets and liabilities existing at January 1, 2008, and did not
elect the fair value option on financial assets and liabilities transacted in
2008. Therefore, the adoption of SFAS 159 had no impact on our consolidated
financial statements.
In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”
(“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations, but the effect is dependent upon acquisitions at that
time.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB
No. 51” (“SFAS 160”). SFAS 160 requires entities to report
noncontrolling (minority) interests as a component of shareholders’ equity on
the balance sheet; include all earnings of a consolidated subsidiary in
consolidated results of operations and treat all transactions between an entity
and noncontrolling interest as equity transactions between the parties. SFAS 160
is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Earlier adoption is prohibited.
SFAS 160 must be applied prospectively as of the beginning of the fiscal year in
which SFAS 160 is initially applied, except for the presentation and disclosure
requirements. The presentation and disclosure requirements are applied
retroactively for all periods presented. We do not have a noncontrolling
interest in one or more subsidiaries. Accordingly, we do not anticipate that the
initial application of SFAS 160 will have an impact on the consolidated
financial statements.
In
March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement
No. 133” (“SFAS 161”), which amends and expands the
disclosure requirements of SFAS 133 to require qualitative disclosure about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
agreements. SFAS 161 is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early
application encouraged. We are currently evaluating the impact of adopting SFAS
161 on our consolidated financial statements.
In April
2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that
should be considered in developing assumptions about renewal or extension used
in estimating the useful life of a recognized intangible asset under SFAS No.
142. This standard is intended to improve the consistency between the useful
life of a recognized intangible asset under SFAS 142 and the period of expected
cash flows used to measure the fair value of the asset under SFAS 141(R), “ Business
Combinations” and other generally accepted accounting
principles. FSP 142-3 is effective for financial statements issued for fiscal
years beginning after December 15, 2008. The measurement provisions of this
standard will apply only to intangible assets of the Company acquired after the
effective date.
31
Item
7A. Quantitative and Qualitative Disclosures About Market
Risk.
Interest
rate 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 (3.25% at December 31, 2008)
plus ½% or LIBOR (0.46% at December 31, 2008) plus 3%. We have not
borrowed under this line in 2008. 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.
Foreign
currency risk
We have operations in several
international markets that are subject to foreign currency fluctuations.
Although the majority of our contracts are denominated in U.S. Dollars, a
substantial portion of the costs incurred to render services under these
contracts is incurred in the local currencies of several international markets
where we carry operations. Our significant operations are based in the
Philippines and India where revenues are generated in U.S. Dollars and the
corresponding expenses are generated in Philippine pesos and Indian
rupees.
To
mitigate the exposure of fluctuating future cash flows due to changes in foreign
exchange rates, we entered into foreign currency forward contracts in 2008.
These forward contracts were entered into for a maximum term of six months and
had an aggregate notional amount of $11.6 million. We may continue to enter into
such instruments or other instruments in the future to reduce foreign currency
exposure to appreciation or depreciation in the value of these foreign
currencies.
The
impact of foreign currency will continue to present economic challenges to us
and could negatively impact our overall results of operations. Any increase or
decrease in the fair value of our currency exchange rate sensitive forward
contracts would be substantially offset by a corresponding decrease or increase
in the fair value of the hedged underlying cash flows. As of December 31, 2008,
there were no outstanding foreign currency forward contracts.
Other
than the aforementioned forward contracts, we have not engaged in any hedging
activities nor have we entered into off-balance sheet transactions, arrangements
or other relationships with unconsolidated entities or other persons that are
likely to affect our liquidity or the availability of our requirements for
capital resources.
As of December 31, 2008, our foreign
locations held cash totaling approximately $7.9 million.
Item
8. Financial Statements and Supplementary Data.
See Financial Statements and Financial
Statement Index commencing on page F-1 hereof.
Item
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
On September 12, 2008, the Audit
Committee of our Board of Directors approved the dismissal of Grant Thornton LLP
as the Company’s independent registered public accounting firm and approved the
engagement of J.H. Cohn LLP as our independent registered public accounting firm
for the fiscal year ending December 31, 2008. In connection with our change in
accountants, there were no disagreements or reportable events required to be
disclosed pursuant to Regulation S-K, Item 304(a)(1)(iv) and item
304(a)(1)(v).
32
Item
9A. Controls and Procedures.
Evaluation of Disclosure Controls and
Procedures
In
accordance with Exchange Act Rules 13a-15(e), we carried out an evaluation,
under the supervision and with the participation of management, including our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as
of the end of the period covered by this report. Based on that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31,
2008.
Changes
in Internal Control over Financial Reporting
There
have been no changes in the Company’s internal controls over financial reporting
(as such term is defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act)
during the last fiscal quarter to which this report relates that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
Report
of Management on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting for the Company. Internal control over
financial reporting is a process to provide reasonable assurance regarding the
reliability of our financial reporting for external purposes in accordance with
accounting principles generally accepted in the United States of America.
Internal control over financial reporting includes maintaining records that in
reasonable detail accurately and fairly reflect our transactions; providing
reasonable assurance that transactions are recorded as necessary for preparation
of our financial statements; providing reasonable assurance that receipts and
expenditures of company assets are made in accordance with management
authorization; and providing reasonable assurance that unauthorized acquisition,
use or disposition of company assets that could have a material effect on our
financial statements would be prevented or detected on a timely basis. Because
of its inherent limitations, internal control over financial reporting is not
intended to provide absolute assurance that a misstatement of our financial
statements would be prevented or detected.
Management
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation, management concluded that the
Company’s internal control over financial reporting was effective as of December
31, 2008. There were no changes in our internal control over financial reporting
during the quarter ended December 31, 2008 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
The
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2008, was audited by J.H. Cohn LLP, our independent registered
public accounting firm, as stated in their report appearing below, which
expressed an unqualified opinion on the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2008.
33
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board
of Directors and Stockholders of Innodata Isogen, Inc.:
We have
audited Innodata Isogen, Inc. and Subsidiaries’ (“Innodata”) internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Innodata’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Report of Management on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion on the
effectiveness of Innodata’s internal control over financial reporting based on
our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, assessing the risk that
a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk and performing such
other procedures as we consider necessary in the circumstances. We believe that
our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of America. A
company’s internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the United States of
America, and that receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could
have a material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, Innodata maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2008, based on the COSO
criteria.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet as of December
31, 2008, and the related consolidated statements of operations, stockholders’
equity and cash flows for the year then ended, of Innodata Isogen, Inc. and
Subsidiaries and our report dated March 9, 2009, expressed an unqualified
opinion thereon.
/s/J.H.
Cohn LLP
Roseland,
New Jersey
March 9,
2009
34
Item
9B. Other information.
None
35
PART III
Item
10. Directors, Executive Officers and Corporate
Governance.
The
information called for by Item 10 is incorporated by reference from the
Company’s definitive proxy statement for the 2009 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Exchange Act no later than 120
days after the end of the Company’s 2008 fiscal year.
The
Company has a code of ethics that applies to all of its employees, officers, and
directors, including its principal executive officer, principal financial and
accounting officer, and controller. The text of the Company’s code of
ethics is posted on its website at www.innodata-isogen.com. The Company intends
to disclose future amendments to, or waivers from, certain provisions of the
code of ethics for executive officers and directors in accordance with
applicable NASDAQ and SEC requirements.
Item
11. Executive Compensation.
The
information called for by Item 11 is incorporated by reference from the
Company’s definitive proxy statement for the 2009 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Exchange Act no later than 120
days after the end of the Company’s 2008 fiscal year.
Item
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.
The
information called for by Item 12 is incorporated by reference from the
Company’s definitive proxy statement for the 2009 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Exchange Act no later than 120
days after the end of the Company’s 2008 fiscal year.
Item
13. Certain Relationships and Related Transactions, and Director
Independence.
The
information called for by Item 13 is incorporated by reference from the
Company’s definitive proxy statement for the 2009 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Exchange Act no later than 120
days after the end of the Company’s 2008 fiscal year.
Item
14. Principal Accountant Fees and Services.
The
information called for by Item 14 is incorporated by reference from the
Company’s definitive proxy statement for the 2009 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Exchange Act no later than 120
days after the end of the Company’s 2008 fiscal year.
36
PART
IV
Item
15. Exhibits, Financial Statement Schedules and Reports on Form
8-K.
(a) 1. Financial
Statements. See Item 8. Index to Financial Statements.
2. Financial
Statement Schedules. Schedule II – Valuation and Qualifying
Accounts.
3. Exhibits – See Exhibit
Index attached hereto and incorporated by reference herein.
37
SIGNATURES
In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
By
|
/s/ Jack Abuhoff
|
Jack
Abuhoff
|
|
Chairman
of the Board,
|
|
Chief
Executive Officer and
President
|
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature
|
Title
|
Date
|
||
/s/ Jack
Abuhoff
|
Chairman of the
Board,
|
March 11,
2009
|
||
Jack
Abuhoff
|
Chief Executive Officer and President
|
|||
/s/ Steven L.
Ford
|
Executive Vice
President,
|
March 11,
2009
|
||
Steven
L. Ford
|
Chief Financial
Officer
and
Principal Accounting Officer
|
|||
/s/ Todd
Solomon
|
Director
|
March 11,
2009
|
||
Todd
Solomon
|
||||
/s/ Louise C.
Forlenza
|
Director
|
March 11,
2009
|
||
Louise
C. Forlenza
|
||||
/s/ John R.
Marozsan
|
Director
|
March 11,
2009
|
||
John
R. Marozsan
|
||||
/s/ Peter H.
Woodward
|
Director
|
March 11,
2009
|
||
Peter
H. Woodward
|
||||
/s/ Haig S.
Bagerdjian
|
Director
|
March 11,
2009
|
||
Haig
S. Bagerdjian
|
38
Item
8. Financial Statements.
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
|
|
Reports
of Independent Registered Public Accounting Firms
|
F-2,
F-3
|
Consolidated
Balance Sheets as of December 31, 2008 and 2007
|
F-4
|
Consolidated
Statements of Operations for the three years ended December 31,
2008
|
F-5
|
Consolidated
Statements of Stockholders’ Equity for the three years ended December 31,
2008
|
F-6
|
Consolidated
Statements of Cash Flows for the three years ended December 31,
2008
|
F-7
|
Notes
to Consolidated Financial Statements
|
F-8
|
F-1
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
The Board
of Directors and Stockholders of Innodata Isogen, Inc.:
We have
audited the accompanying consolidated balance sheet of Innodata Isogen, Inc. and
Subsidiaries as of December 31, 2008, and the related consolidated statements of
operations, stockholders’ equity and cash flows for the year then ended. Our
audit of the basic financial statements included the financial statement
schedule listed in the index appearing under Item 15. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit. The consolidated financial statements and financial statement schedule as
of December 31, 2007, and for the years ended December 31, 2007 and 2006, were
audited by other auditors whose report dated March 11, 2008 expressed an
unqualified opinion on these statements.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Innodata Isogen, Inc. and
Subsidiaries as of December 31, 2008, and their results of operations and cash
flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Innodata Isogen Inc. and Subsidiaries’ internal
control over financial reporting as of December 31, 2008 based on criteria
established in Internal Control – Integrated Framework issued by the Committee
of Sponsoring Organization of the Treadway Commission (COSO) and our report
dated March 9, 2009, expressed an unqualified opinion thereon.
/s/ J.H.
Cohn LLP
Roseland,
New Jersey
March 9,
2009
F-2
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of
Directors and Stockholders of
Innodata
Isogen, Inc.
We have
audited the accompanying consolidated balance sheet of Innodata Isogen, Inc. and
subsidiaries (the “Company”) as of December 31, 2007, and the related
consolidated statements of operations, stockholders’ equity, and cash flows for
the years ended December 31, 2007 and 2006. Our audits of the basic
financial statements included the financial statement schedule listed in the
index appearing under Item 15. The Company’s management is
responsible for these financial statements and financial statement schedule. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Innodata Isogen, Inc. and
subsidiaries’ as of December 31, 2007, and the results of their operations and
their cash flows for the years ended December 31, 2007 and 2006 in conformity
with accounting principles generally accepted in the United States of America.
Also in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
As
discussed in Note 6 to the consolidated financial statements, the Company has
adopted Statement of Financial Accounting Standards No. 158, “ Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans”, in
2006.
/s/ GRANT
THORNTON LLP
Edison,
New Jersey
March 11,
2008
F-3
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
DECEMBER
31, 2008 AND 2007
(in
thousands, except share data)
2008
|
2007
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 13,875 | $ | 14,751 | ||||
Accounts
receivable-net of allowance for doubtful accounts of $466 and $127 at
December 31, 2008 and 2007, respectively
|
14,017 | 10,673 | ||||||
Prepaid
expenses and other current assets
|
2,246 | 2,117 | ||||||
Refundable
income taxes
|
- | 453 | ||||||
Deferred
income taxes
|
4,115 | 202 | ||||||
Total
current assets
|
34,253 | 28,196 | ||||||
Property
and equipment, net
|
6,726 | 7,160 | ||||||
Other
assets
|
2,825 | 2,037 | ||||||
Deferred
income taxes
|
906 | 381 | ||||||
Goodwill
|
675 | 675 | ||||||
Total
assets
|
$ | 45,385 | $ | 38,449 | ||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 1,053 | $ | 1,973 | ||||
Accrued
expenses
|
2,540 | 2,227 | ||||||
Accrued
salaries, wages and related benefits
|
5,289 | 5,244 | ||||||
Income
and other taxes
|
1,649 | 2,053 | ||||||
Current
portion of long term obligations
|
915 | 370 | ||||||
Total
current liabilities
|
11,446 | 11,867 | ||||||
Deferred
income taxes
|
2,080 | 1,224 | ||||||
Long
term obligations
|
1,671 | 2,128 | ||||||
Commitments
and contingencies
|
||||||||
STOCKHOLDERS’
EQUITY:
|
||||||||
Serial
preferred stock; 5,000,000 shares authorized, none
outstanding
|
- | - | ||||||
Common
stock, $.01 par value; 75,000,000 shares authorized; 24,907,000 issued and
24,119,000 outstanding at December 31, 2008; and 24,881,000 issued and
24,699,000 outstanding at December 31, 2007
|
249 | 249 | ||||||
Additional
paid-in capital
|
16,614 | 16,323 | ||||||
Retained
earnings
|
14,772 | 7,188 | ||||||
Accumulated
other comprehensive income (loss)
|
742 | (211 | ) | |||||
32,377 | 23,549 | |||||||
Less:
treasury stock, 788,000 shares at December 31, 2008 and 182,000 shares at
December 31, 2007, at cost
|
(2,189 | ) | (319 | ) | ||||
Total
stockholders’ equity
|
30,188 | 23,230 | ||||||
Total
liabilities and stockholders’ equity
|
$ | 45,385 | $ | 38,449 |
See notes
to consolidated financial statements.
F-4
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
YEARS
ENDED DECEMBER 31, 2008, 2007 AND 2006
(In
thousands, except per share amounts)
2008
|
2007
|
2006
|
||||||||||
Revenues
|
$ | 75,001 | $ | 67,731 | $ | 40,953 | ||||||
Operating
costs and expenses
|
||||||||||||
Direct
operating costs
|
53,525 | 48,581 | 34,316 | |||||||||
Selling
and administrative expenses
|
16,134 | 15,281 | 14,713 | |||||||||
69,659 | 63,862 | 49,029 | ||||||||||
Income
(loss) from operations
|
5,342 | 3,869 | (8,076 | ) | ||||||||
Other
(income) expenses
|
||||||||||||
Interest
expense
|
56 | 33 | 7 | |||||||||
Interest
income
|
(262 | ) | (678 | ) | (683 | ) | ||||||
Income
(loss) before benefit from income taxes
|
5,548 | 4,514 | (7,400 | ) | ||||||||
Benefit
from income taxes
|
(2,036 | ) | (52 | ) | (77 | ) | ||||||
Net
income (loss)
|
$ | 7,584 | $ | 4,566 | $ | (7,323 | ) | |||||
Income
(loss) per share:
|
||||||||||||
Basic:
|
$ | .31 | $ | .19 | $ | (.30 | ) | |||||
Diluted:
|
$ | .30 | $ | .18 | $ | (.30 | ) | |||||
Weighted
average shares outstanding:
|
||||||||||||
Basic:
|
24,390 | 24,142 | 24,021 | |||||||||
Diluted:
|
25,137 | 25,327 | 24,021 |
See notes
to consolidated financial statements.
F-5
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS
ENDED DECEMBER 31, 2008, 2007 AND 2006
(In
thousands)
Accumulated
|
||||||||||||||||||||||||||||
|
Additional
|
Other
|
||||||||||||||||||||||||||
Common Stock
|
Paid-in
|
Retained
|
Comprehensive
|
Treasury
|
||||||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Earnings
|
Income (Loss)
|
Stock
|
Total
|
||||||||||||||||||||||
January
1, 2006
|
23,669 | $ | 237 | $ | 16,632 | $ | 9,945 | - | - | $ | 26,814 | |||||||||||||||||
Net
loss
|
- | - | - | (7,323 | ) | - | - | (7,323 | ) | |||||||||||||||||||
Issuance
of common stock upon exercise of stock options
|
418 | 4 | 352 | - | - | - | 356 | |||||||||||||||||||||
Purchase
of treasury stock
|
(182 | ) | - | - | - | - | (319 | ) | (319 | ) | ||||||||||||||||||
Non-cash
equity compensation
|
- | - | 241 | - | - | - | 241 | |||||||||||||||||||||
Adjustment
to initially apply FASB Statement 158, net of tax
|
- | - | - | - | (760 | ) | - | (760 | ) | |||||||||||||||||||
December
31, 2006
|
23,905 | 241 | 17,225 | 2,622 | (760 | ) | (319 | ) | 19,009 | |||||||||||||||||||
Net
income
|
- | - | - | 4,566 | - | - | 4,566 | |||||||||||||||||||||
Issuance
of common stock upon exercise of stock options
|
794 | 8 | 447 | - | - | - | 455 | |||||||||||||||||||||
Payment
of minimum withholding taxes on net settlement of stock
options
|
- | - | (1,523 | ) | - | - | - | (1,523 | ) | |||||||||||||||||||
Non-cash
equity compensation
|
- | - | 174 | - | - | - | 174 | |||||||||||||||||||||
Change
in transitional projected benefit obligation, net of tax
|
- | - | - | - | 549 | - | 549 | |||||||||||||||||||||
December
31, 2007
|
24,699 | 249 | 16,323 | 7,188 | (211 | ) | (319 | ) | 23,230 | |||||||||||||||||||
Net
income
|
- | - | - | 7,584 | - | - | 7,584 | |||||||||||||||||||||
Issuance
of common stock upon exercise of stock options
|
26 | - | 71 | - | - | - | 71 | |||||||||||||||||||||
Non-cash
equity compensation
|
- | - | 220 | - | - | - | 220 | |||||||||||||||||||||
Change
in transitional projected benefit obligation, net of tax
|
- | - | - | - | 953 | - | 953 | |||||||||||||||||||||
Purchase
of treasury stock
|
(606 | ) | - | - | - | - | (1,870 | ) | (1,870 | ) | ||||||||||||||||||
December
31, 2008
|
24,119 | $ | 249 | $ | 16,614 | $ | 14,772 | $ | 742 | $ | (2,189 | ) | $ | 30,188 |
See notes
to consolidated financial statements.
F-6
INNODATA
ISOGEN INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
YEARS
ENDED DECEMBER 31, 2008, 2007 AND 2006
(In
thousands)
2008
|
2007
|
2006
|
||||||||||
Cash
flow from operating activities:
|
||||||||||||
Net
income (loss)
|
$ | 7,584 | $ | 4,566 | $ | (7,323 | ) | |||||
Adjustments
to reconcile net income (loss) to net cash provided by (used in) operating
activities:
|
||||||||||||
Depreciation
and amortization
|
3,702 | 3,156 | 3,437 | |||||||||
Stock-based
compensation
|
220 | 174 | 241 | |||||||||
Deferred
income taxes
|
(3,582 | ) | (87 | ) | (222 | ) | ||||||
Pension
cost
|
439 | 667 | 313 | |||||||||
Changes
in operating assets and liabilities, net of acquisitions:
|
||||||||||||
Accounts
receivable
|
(3,344 | ) | (4,189 | ) | 685 | |||||||
Prepaid
expenses and other current assets
|
204 | (976 | ) | (665 | ) | |||||||
Refundable
income taxes
|
453 | 609 | 153 | |||||||||
Other
assets
|
(206 | ) | (147 | ) | (189 | ) | ||||||
Accounts
payable
|
(920 | ) | 986 | (542 | ) | |||||||
Accrued
expenses
|
313 | 258 | 367 | |||||||||
Payment
of minimum withholding taxes on net settlement of stock
options
|
- | (1,523 | ) | - | ||||||||
Accrued
salaries and wages
|
45 | 1,745 | 379 | |||||||||
Income
and other taxes
|
(404 | ) | 758 | (68 | ) | |||||||
Net
cash provided by (used in) operating activities
|
4,504 | 5,997 | (3,434 | ) | ||||||||
Cash
flows from investing activities:
|
||||||||||||
Capital
expenditures
|
(2,452 | ) | (4,449 | ) | (2,329 | ) | ||||||
Net
cash used in investing activities
|
(2,452 | ) | (4,449 | ) | (2,329 | ) | ||||||
Cash
flows from financing activities:
|
||||||||||||
Payment
of long-term obligations
|
(1,129 | ) | (849 | ) | (736 | ) | ||||||
Proceeds
from exercise of stock options
|
71 | 455 | 356 | |||||||||
Purchase
of treasury stock
|
(1,870 | ) | - | (319 | ) | |||||||
Net
cash used in financing activities
|
(2,928 | ) | (394 | ) | (699 | ) | ||||||
(Decrease)
Increase in cash and cash equivalents
|
(876 | ) | 1,154 | (6,462 | ) | |||||||
Cash
and cash equivalents, beginning of year
|
14,751 | 13,597 | 20,059 | |||||||||
Cash
and cash equivalents, end of year
|
$ | 13,875 | $ | 14,751 | $ | 13,597 | ||||||
Supplemental
disclosures of cash flow information:
|
||||||||||||
Cash
paid for income taxes
|
$ | 1,099 | $ | 325 | $ | 340 | ||||||
Cash
paid for interest
|
$ | 56 | $ | 33 | $ | 7 | ||||||
Non-cash
investing and financing activities:
|
||||||||||||
Acquisition
of equipment utilizing capital leases
|
$ | 81 | $ | 770 | $ | - | ||||||
Vendor
financed software licenses acquired
|
$ | 1,650 | $ | - | $ | 164 |
See notes
to consolidated financial statements
F-7
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
Description
of Business and Summary of Significant Accounting
Policies
|
Description of
Business-Innodata Isogen, Inc. and subsidiaries (the “Company”), is
a leading provider of knowledge process outsourcing (“KPO”) services as well as
publishing and related information technology services that help organizations
create, manage and maintain their products. Our publishing services include
digitization, conversion, composition, data modeling and XML encoding, and KPO
services include research and analysis, authoring, copy-editing, abstracting,
indexing and other content creation activities. Our IT system professional
supports the design, implementation, integration and deployment of digital
systems used to author, manage and distribute content.
Principles of
Consolidation-The consolidated financial statements include the accounts
of Innodata Isogen, Inc. and its subsidiaries, all of which are wholly
owned. All significant intercompany transactions and balances have
been eliminated in consolidation.
Use of Estimates-In preparing
financial statements in conformity with accounting principles generally accepted
in the United States of America, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Significant
estimates include those related to revenue recognition, allowance for doubtful
accounts and billing adjustments, long-lived assets, goodwill, valuation of
deferred tax assets, value of securities underlying stock-based compensation,
litigation accruals, pension benefits, valuation of derivative instruments and
estimated accruals for various tax exposures.
Revenue Recognition-Revenue is
recognized in the period in which services are performed and delivery has
occurred and when all the criteria of Staff Accounting Bulletin 104 have been
met.
The Company recognizes its IT
professional services revenues from custom application and systems integration
development which requires significant production, modification or customization
of software in a manner similar to SOP No. 81-1 “Accounting for Performance of
Construction-Type and Certain Production-Type
Contracts.” Revenue from such services billed under fixed fee
arrangements, which are not significant to the overall revenue, 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). Revenues from
fixed-fee projects accounted for less than 10% of our total revenue for each of
the three years in the period ended December 31, 2008. Revenue
billed on a time and materials basis is recognized as services are
performed.
Foreign Currency
Translation-The functional currency for the Company’s production
operations located in the Philippines, India and Sri Lanka is U.S.
dollars. As such, transactions denominated in Philippine pesos,
Indian and Sri Lanka rupees were translated to U.S. dollars at rates which
approximate those in effect on transaction dates. Monetary assets and
liabilities denominated in foreign currencies at December 31, 2008 and 2007
were translated at the exchange rate in effect as of those dates. Nonmonetary
assets, liabilities, and stockholders’ equity are translated at the appropriate
historical rates. Included in direct operating costs are exchange (gains) losses
resulting from such transactions of approximately $(190,000), $925,000 and
$283,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.
F-8
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Derivative Instruments-The
Company accounts for its foreign exchange derivative instruments under Statement
of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“SFAS 133”), as amended. SFAS 133
requires that an entity recognize derivatives as either assets or liabilities on
the balance sheet and measure those instruments at fair value. The accounting
for changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation.
The
Company has designated its derivative (foreign currency forward contracts) as
cash flow hedge based upon criteria established by SFAS No. 133. Accordingly,
the effective portion of the derivative’s gain or loss is initially reported as
a component of accumulated other comprehensive income or loss and is
subsequently reclassified to earnings when the hedge exposure affects earnings.
The Company formally documents all relationships between hedging instruments and
hedged items, as well as its risk management objective and strategy for
undertaking various hedging activities.
Cash Equivalents-For financial
statement purposes (including cash flows), the Company considers all highly
liquid debt instruments purchased with an original maturity of three months or
less to be cash equivalents.
Property and
Equipment-Property and equipment are stated at cost and are 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. Certain assets under capital leases are
amortized over the lives of the respective leases or the estimated useful lives
of the assets, whichever is shorter.
Long-lived Assets-The Company
accounts for long-lived assets under SFAS No. 144, “Accounting for the Impairment or
Disposal of Long Lived Assets” (“SFAS 144”). Management
assesses the recoverability of its 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 the Company’s stock price for a sustained
period; and (iv) a change in the Company’s 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, an impairment analysis is performed
initially using a projected undiscounted cash flow method. Management
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, the Company may be required to record
an impairment charge. Impairment charges, which would be based on discounted
cash flows, would be included in general and
administrative expenses in the Company’s
statements of operations, and would result in reduced carrying
amounts of the related assets on the Company’s balance
sheets. No impairment charges were recorded in the three years ended
December 31, 2008.
Goodwill and Other Intangible
Assets-Goodwill represents the excess purchase price paid over the fair
value of net assets acquired. Effective July 1, 2002, the Company
adopted SFAS No. 142, “Goodwill and Other Intangible
Assets” (“SFAS 142”). Under SFAS 142, the Company tests its
goodwill on an annual basis using a two-step fair value based
test. The first step of the goodwill impairment test, 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, the Company 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.
F-9
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to 2007, the Company’s operations
were classified into two operating segments: (1) content-related BPO services
and (2) IT professional services. These operating segments qualified as
reporting units under SFAS 142. In 2007, the Company commenced a reorganization
of its management and operating structure. In this reorganization, management
merged the content-related BPO and KPO services and IT professional services
segments (Refer Note 11 to consolidated financial statements). The Company's
current operating segment structure reflects the way the chief operating
decision maker looks at the overall Company to evaluate performance and makes
executive decisions (including the allocation of resources) about the business.
With this reorganization, the Company no longer has two reporting units and two
operating segments, but consists of one business that generates revenues and
expenses. Thus, the entire goodwill is allocated to the consolidated company for
the purposes of goodwill impairment test.
In the annual impairment test conducted
by the Company on September 30, 2008, 2007 and 2006 the estimated fair values of
the reporting unit exceeded its carrying amount, including
goodwill. As such, no impairment was identified or
recorded.
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 all or some portion of the deferred tax assets will not be
realized. While the Company considers future taxable income in assessing the
need for the valuation allowance, in the event that the Company would determine
that it would be able to realize the deferred tax assets in the future in excess
of its net recorded amount, an adjustment to the deferred tax assets would
increase income in the period such determination was made. Change in valuation
allowance from period to period is included in the Company’s tax provision in
the period of change. The Company has recorded a deferred tax liability on
approximately $5.1 million of foreign earnings, which represents a portion of
foreign profits earned prior to 2002. Beginning in 2002, 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 because such earnings are not anticipated to
be remitted to the United States.
The
Company adopted Financial Accounting Standards Board (“FASB”) Interpretation
No. 48 (“FIN 48”) “Accounting for Uncertainty in Income
Taxes” on January 1, 2007. The adoption of FIN 48 did not have an effect
on the results of operations or financial position of the Company. The Company
recognizes interest and penalties related to uncertain tax positions in income
tax expense in the consolidated statement of operations.
Accounting for Stock-Based
Compensation –
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS No. 123 (Revised 2004) Share-Based Payment (“SFAS
123(R)”), which required the measurement and recognition of stock-based
compensation expense for all share-based payment awards made to employees and
directors based on estimated fair value at the grant date. The stock-based
compensation expense is recognized over the requisite service period. The fair
value is determined using the Black-Scholes option-pricing model.
The stock-based compensation expense
related to the Company’s various stock option plans was allocated as follows (in
thousands):
F-10
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Years
Ended December 31,
|
||||||||||||
2008
|
2007
|
2006
|
||||||||||
Direct
operating costs
|
$ | 46 | $ | 74 | $ | 80 | ||||||
Selling
and adminstrative expenses
|
174 | 100 | 161 | |||||||||
Total
stock-based compensation
|
$ | 220 | $ | 174 | $ | 241 |
Fair Value of Financial
Instruments-The carrying amounts of financial instruments, including cash
and cash equivalents, accounts receivable and accounts payable, accrued expenses
and other current assets and liabilities approximated fair value as of December
31, 2008 and 2007 because of the relative short maturity of these
instruments. The carrying amounts of long term obligations
approximate their fair value as of December 31, 2008 and 2007 based upon rates
currently available to the Company.
Effective
January 1, 2008, the Company adopted SFAS 157 for financial assets and
liabilities except as it applies to the non financial assets and non financial
liabilities subject to FSP 157-2. The adoption of SFAS 157 did not have an
impact on the Company’s consolidated financial position and consolidated results
of operations or liquidity. SFAS 157 establishes a fair value hierarchy that
prioritizes the inputs used to measure fair value into three levels. The three
levels are defined as follows:
|
·
|
Level 1: Unadjusted
quoted price in active market for identical assets and
liabilities.
|
|
·
|
Level 2: Observable
inputs other than those included in Level
1.
|
|
·
|
Level 3: Unobservable
inputs reflecting management’s own assumptions about the inputs used in
pricing the asset or
liability.
|
SFAS 157
does not require any new fair value measurements; however, it eliminates
inconsistencies in the guidance provided in previous accounting pronouncements.
The Company records foreign currency forward contracts in accordance with SFAS
133. As of December 31, 2008, there were no outstanding foreign currency forward
contracts.
Accounts Receivable-The
majority of the Company’s accounts receivable are due from secondary publishers
and information providers. The Company establishes credit terms for
new clients based upon management’s review of their credit information and
project terms, and performs ongoing credit evaluations of its customers,
adjusting credit terms when management believes appropriate based upon payment
history and an assessment of their current credit worthiness. The
Company records an allowance for doubtful accounts for estimated losses
resulting from the inability of its clients to make required
payments. The Company determines its allowance by considering a
number of factors, including the length of time trade accounts receivable are
past due (accounts outstanding longer than the payment terms are considered 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.
Concentration of Credit
Risk-The Company maintains its cash with high quality financial
institutions, located primarily in the United States. To the extent
that such cash exceeds the maximum insurance levels, the Company is
uninsured. The Company has not experienced any losses in such
accounts.
F-11
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Income (Loss) per Share- Basic income
(loss) per share is computed using the weighted-average number of common shares
outstanding during the year. Diluted income (loss) per share is computed by
considering the impact of the potential issuance of common shares, using the
treasury stock method, on the weighted average number of shares outstanding. As
the Company was in a net loss position for the year ended December 31, 2006, the
potential common shares derived from stock options were excluded from the
calculation of diluted income (loss) per share as these shares would have had an
anti-dilutive effect.
Development Costs for
Software-Costs for the development of new software to be sold, leased, or
otherwise marketed as a separate product or as part of a product or process, and
substantial enhancements to such existing software products, are expensed as
research and development costs as incurred until technological feasibility has
been established, at which time any additional development costs are capitalized
until the product is available for general release to customers. All other
research and development costs are expensed as incurred.
No software development costs were
capitalized during each of the three years in the period ended December 31,
2008. The Company did not incur any research and development costs in 2008
and 2007. Included in selling and administrative expense are research and
development costs totaling approximately $922,000 for the year ended December
31, 2006.
Pension-The Company records
annual pension costs based on calculations, which include various actuarial
assumptions including discount rates, compensation increases and other
assumptions involving demographic factors. The Company reviews its actuarial
assumptions on an annual basis and makes modifications to the assumptions based
on current rates and trends. The Company believes that the assumptions used in
recording its pension obligations are reasonable based on its experience, market
conditions and inputs from its actuaries.
Deferred revenue-Deferred
revenue represents payments received from customers in advance of providing
services and amounts deferred if conditions for revenue recognition have not
been met. Included in accrued expenses on the accompanying consolidated balance
sheets as of December 31, 2008 and 2007 is deferred revenue amounting to
$1,296,000 and $863,000, respectively.
Reclassifications-Certain
reclassifications have been made to the prior years’ consolidated financial
statements to conform to the current year’s presentation.
Recent
Accounting Pronouncements
Effective
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”), for financial assets and liabilities carried at fair value. This
pronouncement defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. The Company’s
adoption of SFAS 157 did not have a material effect on the Company’s
consolidated financial statements for financial assets and liabilities and any
other assets and liabilities carried at fair value. In accordance with FASB
Staff Position No. FAS 157-2 (“FSP 157-2”), the Company elected to defer until
January 1, 2009 the adoption of SFAS 157 for all non-financial assets and
liabilities that are not recognized or disclosed at fair value in the
consolidated financial statements. The Company does not believe that the
adoption of SFAS 157-2 will have a material impact on our consolidated financial
statements. In October 2008, the Financial Accounting Standards Board (“FASB”)
issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (“FSP 157-3”), which
clarifies the application of SFAS 157 when the market for a financial asset
is inactive. The guidance in FSP 157-3 was effective upon issuance and did
not have a material effect on the Company’s consolidated financial
statements.
F-12
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Effective
January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” (“SFAS 159”), which expands
opportunities to use fair value measurements in financial reporting and permits
entities to choose to measure many financial instruments and certain other items
at fair value. Under SFAS 159, entities that elect the fair value option (by
instrument) will report unrealized gains and losses in earnings at each
subsequent reporting date. The fair value option election is irrevocable, unless
a new election date occurs. The Company chose not to elect the fair value option
for its financial assets and liabilities existing at January 1, 2008, and
did not elect the fair value option on financial assets and liabilities
transacted in 2008. Therefore, the adoption of SFAS 159 had no impact on the
Company’s consolidated financial statements.
In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”
(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations, but the effect is dependent upon acquisitions at that
time.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51
(“SFAS 160”).
SFAS 160 requires entities to report noncontrolling (minority) interests as a
component of shareholders’ equity on the balance sheet; include all earnings of
a consolidated subsidiary in consolidated results of operations; and treat all
transactions between an entity and noncontrolling interest as equity
transactions between the parties. SFAS 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after
December 15, 2008. Earlier adoption is prohibited. SFAS 160 must be applied
prospectively as of the beginning of the fiscal year in which SFAS 160 is
initially applied, except for the presentation and disclosure requirements. The
presentation and disclosure requirements are applied retroactively for all
periods presented. The Company does not have a noncontrolling interest in one or
more subsidiaries. Accordingly, the Company does not anticipate that the initial
application of SFAS 160 will have an impact on the Company’s consolidated
financial statements.
In
March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement
No. 133” (“SFAS 161”), which amends and expands the
disclosure requirements of SFAS 133 to require qualitative disclosure about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
agreements. SFAS 161 is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the impact of
adopting SFAS 161 on its consolidated financial statements.
In April
2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that
should be considered in developing assumptions about renewal or extension used
in estimating the useful life of a recognized intangible asset under SFAS No.
142. This standard is intended to improve the consistency between the useful
life of a recognized intangible asset under SFAS 142 and the period of expected
cash flows used to measure the fair value of the asset under SFAS 141(R)
(revised 2007), “ Business
Combinations” and other generally accepted accounting
principles. FSP 142-3 is effective for financial statements issued for fiscal
years beginning after December 15, 2008. The measurement provisions of this
standard will apply only to intangible assets of the Company acquired after the
effective date.
F-13
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2.
|
Property
and equipment
|
Property and equipment, which include
amounts recorded under capital leases, are stated at cost less accumulated
depreciation and amortization (in thousands), and consist of the
following:
December 31,
|
||||||||
2008
|
2007
|
|||||||
Equipment
|
$ | 18,831 | $ | 18,648 | ||||
Software
|
3,671 | 3,293 | ||||||
Furniture
and office equipment
|
1,878 | 1,672 | ||||||
Leasehold
improvements
|
4,149 | 3,550 | ||||||
Total
|
28,529 | 27,163 | ||||||
Less
accumulated depreciation and amortization
|
(21,803 | ) | (20,003 | ) | ||||
$ | 6,726 | $ | 7,160 |
Depreciation and amortization expense
of property and equipment was approximately $3,129,000, $2,622,000 and
$2,750,000 for each of the three years in the period ended December 31,
2008.
At December 31, 2008 and 2007,
equipment under capital leases had a gross cost of approximately $1,562,000 and
$1,481,000, respectively. Amortization of assets under capital leases is
included under depreciation expense.
3.
|
Income
taxes
|
The significant components of the
provision for (benefit from) income taxes for each of the three years in the
period ended December 31, 2008 (in thousands) are as follows:
2008
|
2007
|
2006
|
||||||||||
Current
income tax expense:
|
||||||||||||
Foreign
|
$ | 1,531 | $ | 441 | $ | 191 | ||||||
Federal
|
72 | (359 | ) | (35 | ) | |||||||
State
and local
|
20 | (54 | ) | (11 | ) | |||||||
1,623 | 28 | 145 | ||||||||||
Deferred
income tax benefit:
|
||||||||||||
Foreign
|
$ | (342 | ) | $ | (103 | ) | $ | (222 | ) | |||
Federal
|
(2,439 | ) | 31 | - | ||||||||
State
and local
|
(878 | ) | (8 | ) | - | |||||||
$ | (3,659 | ) | $ | (80 | ) | $ | (222 | ) | ||||
Benefit
from income taxes
|
$ | (2,036 | ) | $ | (52 | ) | $ | (77 | ) |
F-14
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The reconciliation of the U.S. statutory rate with the Company’s
effective tax rate for each of the three years ended December 31 is
summarized as follows:
2008
|
2007
|
2006
|
||||||||||
Federal
statutory rate
|
34.0 | % | 34.0 | % | (34.0 | )% | ||||||
Effect
of:
|
||||||||||||
State
income taxes (net of federal tax benefit)
|
4.6 | (11.3 | ) | - | ||||||||
Taxes
on foreign income at rates that differ from US
|
||||||||||||
statutory
rate
|
6.9 | (2.5 | ) | (6.4 | ) | |||||||
Change
in valuation allowance on deferred tax assets
|
(83.2 | ) | (4.8 | ) | 39.1 | |||||||
IRS
refund for foreign subsidiaries
|
- | (8.7 | ) | - | ||||||||
Other
|
1.0 | (7.8 | ) | 0.3 | ||||||||
Effective
rate
|
(36.7 | )% | (1.1 | )% | (1.0 | )% |
No tax benefits related to stock option
exercises was recorded for each of the three years in the period ended
December 31, 2008 due to net operating loss
carryforwards.
Deferred tax assets and liabilities are
classified as current or non-current according to the classification of the
related asset or liability. Significant components of the Company’s
deferred tax assets and liabilities as of December 31, are as follows (in
thousands):
2008
|
2007
|
|||||||
Deferred
income tax assets:
|
||||||||
Allowances
not currently deductible
|
$ | 267 | $ | 88 | ||||
Depreciation
and amortization
|
297 | 95 | ||||||
Equity
compensation not currently deductible
|
265 | 212 | ||||||
Net
operating loss carryforwards
|
3,381 | 4,682 | ||||||
Expenses
not deductible until paid
|
836 | 885 | ||||||
Other
|
43 | 5 | ||||||
Total
gross deferred income tax assets before valuation
allowance
|
5,089 | 5,967 | ||||||
Valuation
allowance
|
(68 | ) | (4,627 | ) | ||||
Net
deferred income tax assets
|
5,021 | 1,340 | ||||||
Deferred
income tax liabilities:
|
||||||||
Foreign
source income, not taxable until repatriated
|
(1,981 | ) | (1,981 | ) | ||||
Other
|
(99 | ) | - | |||||
Totals
|
(2,080 | ) | (1,981 | ) | ||||
Net
deferred asset (liability)
|
$ | 2,941 | $ | (641 | ) | |||
Net
deferred income tax asset-current
|
$ | 4,115 | $ | 202 | ||||
Net
deferred income tax asset-long term
|
906 | 381 | ||||||
Net
deferred income tax liability-non-current
|
(2,080 | ) | (1,224 | ) | ||||
Net
deferred income tax asset (liability)
|
$ | 2,941 | $ | (641 | ) |
In assessing the realization of
deferred tax assets, management considers whether it is more likely than not
that all or some portion of the deferred tax assets will not be
realizable. The ultimate realization of the deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which temporary differences are deductible and net operating losses are
available. The Company considered many factors when assessing the likelihood of
future realization of the deferred tax assets, including the Company’s recent
cumulative earnings experience by taxing jurisdiction, expectation of future
taxable income, the carryforward periods available for tax reporting purposes,
and other relevant factors. Based upon management’s assessment and the available
evidence, in 2008 the Company reversed the entire portion of the valuation
allowance previously recorded on the U.S. portion of deferred tax assets
resulting in a non-cash tax benefit amounting to $3.3 million. The decline in
valuation allowance in 2008 also resulted from the utilization of net operating
losses. The remaining valuation allowance at December 31, 2008 represents the
portion the Company has established on deferred tax assets of its foreign
subsidiaries.
F-15
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The Company
currently intends to remit to the United States approximately $5.1 million of
foreign earnings for which it has recorded a deferred tax liability. These
earnings represent a portion of its foreign profits earned prior to 2002.
Beginning in 2002, 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
because such earnings are not anticipated to be remitted to the United States.
Undistributed
earnings of foreign subsidiaries amount to $9.5 million at December
31, 2008. These earnings are considered to be indefinitely reinvested, and,
accordingly, no provision for U.S. Federal or state income taxes has been
made.
The Company had established a valuation
allowance of approximately $4.6 million at December 31, 2007. The net
change in the total valuation allowance for the years ended December 31, 2008,
2007 and 2006 was a (decline) increase of $(4.6) million, $0.3 million and $3.2
million, respectively. In 2008 and 2007, the Company utilized $3.8 million and
$2.1 million of net operating loss carryforwards, respectively. The 2006
increase was offset by a reversal of a valuation allowance of approximately $0.4
million which has been recorded for one of the Company’s Indian
subsidiaries.
United States and foreign components of
income (loss) before income taxes for each of the three years ended December
31, (in thousands) are as follows:
2008
|
2007
|
2006
|
||||||||||
United
States
|
$ | 3,455 | $ | 2,750 | $ | (9,707 | ) | |||||
Foreign
|
2,093 | 1,764 | 2,307 | |||||||||
Total
|
$ | 5,548 | $ | 4,514 | $ | (7,400 | ) |
Certain of the Company’s foreign
subsidiaries are subject to tax holidays or preferential tax rates for years
ranging from 2008 to 2014, pursuant to which the income tax rate for these
subsidiaries is substantially reduced. The tax benefit for tax holidays was
approximately $378,000, $95,000 and $450,000 for each of the three years in the
period ended December 31, 2008. The income tax holiday of one of
our Philippine subsidiaries will expire in May 2009 and that of one of our
Indian subsidiaries will expire in March 2009.
At December 31, 2008, the Company has
U.S. Federal and New Jersey state net operating loss carryforwards available of
approximately $7.9 million and $10.2 million, respectively. These net operating
loss carryforwards expire at various times through 2026.
The Company adopted Financial
Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”)
“Accounting for Uncertainty in
Income Taxes” on January 1, 2007. The adoption of FIN 48 did not have an
effect on the results of operations or financial position of the
Company.
The Company had unrecognized tax
benefits of $840,000 and $740,000 at December 31, 2008 and 2007, respectively.
The portion of unrecognized tax benefits relating to interest and penalties were
$253,000 and $153,000 at December 31, 2008 and 2007, respectively. $664,000 and
$564,000 of our unrecognized tax benefits as of December 31, 2008 and 2007,
respectively, if recognized, would have an impact on the Company’s effective tax
rate.
F-16
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
following represents a roll forward of the Company’s unrecognized tax benefits
and associated interest for the year ended December 31, 2008 (amounts in
thousands):
Unrecognized tax
benefits
|
||||
Balance
- January 1, 2008
|
$ | 740 | ||
Interest
accrual
|
100 | |||
Balance
– December 31, 2008
|
$ | 840 |
The Company is subject to U.S. federal
income tax as well as income tax in various states and foreign jurisdictions. In
the third quarter of 2007, the IRS completed the audit for the Company’s 2004
and 2005 income tax returns, which resulted in a decrease to the Company’s net
operating loss carryforward of approximately $70,000. The Company is no longer
subject to examination of federal and New Jersey taxing authorities for years
prior to 2006. Various foreign subsidiaries currently have open tax years
ranging from 2004 through 2007.
Pursuant
to an income tax audit by the Indian Bureau of Taxation in March 2006, one of
the Company’s Indian subsidiaries received a tax assessment approximating
$434,000, including interest through December 31, 2008, for the fiscal tax year
ended March 31, 2003. Management disagrees with the basis of the tax
assessment, and has filed an appeal against the assessment, which it will
contest vigorously. The Indian Bureau of Taxation has also completed an
audit of the Company’s Indian subsidiary’s income tax return for the fiscal tax
year ended March 31, 2004. The ultimate outcome was favorable, and
there was no tax assessment imposed for the fiscal tax year ended
March 31, 2004. In December 2008, the Company received a final tax
assessment from the India Bureau of Taxation for the fiscal year ended March 31,
2005 for which the Company has provided adequate tax provision, including
interest through December 31, 2008. Management disagrees with the basis of the
tax assessment, has filed an appeal against the assessment and will contest it
vigorously. In 2008, the Indian Bureau of Taxation has commenced an audit of the
subsidiary’s income tax return for the fiscal year ended 2006. The ultimate
outcome cannot be determined at this time.
4.
|
Long
term obligations
|
Total long-term obligations as of
December 31, 2008 and 2007 consist of the following:
2008
|
2007
|
|||||||
Vendor
obligations
|
||||||||
Capital
lease obligations (1)
|
$ | 453 | $ | 659 | ||||
Deferred
lease payments
|
89 | 131 | ||||||
Microsoft
license (2)
|
1,100 | 4 | ||||||
Pension
obligations
|
||||||||
Accrued
pension liability
|
944 | 1,704 | ||||||
$ | 2,586 | $ | 2,498 | |||||
Less:
Current portion of long-term obligations
|
915 | 370 | ||||||
Total
|
$ | 1,671 | $ | 2,128 |
(1) In 2007 and
2008, the Company financed the acquisition of certain computer and communication
equipment. The capital lease obligations bear interest at rates ranging from 6%
to 12% and are payable over two to three years.
F-17
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(2) In
March 2008, the Company renewed a vendor agreement, where the original agreement
had expired in February 2008, to acquire certain additional software licenses
and to receive support and subsequent software upgrades on these and other
currently owned software licenses through February 2011. Pursuant to this
agreement, the Company is obligated to pay $137,500 on a quarterly basis over
the term of the agreement. The total cost (in thousands) was allocated to the
following asset accounts in 2008:
Prepaid
expenses and other current assets
|
$ | 496 | ||
Other
assets
|
992 | |||
Property
and equipment
|
162 | |||
$ | 1,650 |
Amortization
expense was approximately $573,000, $534,000 and $687,000 for each of the three
years in the period ended December 31, 2008.
The
future minimum lease payments required under the capital leases and the present
value of the net minimum lease payments as of December 31, 2008 are as follows
(in thousands):
2009
|
$ |
304
|
||
2010
|
158
|
|||
2011
|
27
|
|||
Total
minimum lease payments
|
489
|
|||
Less:
Amount representing interest
|
36
|
|||
Present
value of net minimum lease payments
|
453
|
|||
Less:
Current maturities of capital lease obligations
|
277
|
|||
Long-term
capital lease obligations
|
$ |
176
|
5.
|
Commitments
and contingencies
|
Line of Credit-The Company has
a $7.0 million line of credit pursuant to which it may borrow up to 80% of
eligible accounts receivable. Borrowings under the credit line bear interest at
the bank’s alternate base rate plus ½% or LIBOR plus 3%. The line, which expires
in June 2009, is collateralized by the Company’s accounts receivable. The
Company has no outstanding obligations under this credit line as of December 31,
2008. The Company plans on renewing the line of credit in the second quarter of
2009.
Leases-The Company is
obligated under various operating lease agreements for office and production
space. Certain agreements contain escalation clauses and requirements that the
Company pay taxes, insurance and maintenance costs. Company leases that include
escalated lease payments are expensed on a straight-line basis over the
non-cancelable base lease period in accordance with SFAS No. 13, “Accounting for Leases” (“SFAS
13").
Lease agreements for production space
in most overseas facilities, which expire through 2030, contain provisions
pursuant to which the Company may cancel the leases with a minimal notice
period, generally subject to forfeiture of security deposit. For each of the
three years in the period ended December 31, 2008, rent expense,
principally for office and production space, totaled approximately $3,037,000,
$2,575,000 and $2,163,000, respectively.
F-18
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, the Company leases certain
equipment under short-term operating lease agreements. For each of the three
years in the period ended December 31, 2008, rent expense for equipment
totaled approximately $70,000, $207,000 and $45,000, respectively.
Future minimum lease payments, by year
and in the aggregate, under non-cancelable operating leases with initial or
remaining terms of one year or more as of December 31, 2008 (in thousands) are
as follows:
Years Ending December 31,
|
||||
2009
|
$ | 787 | ||
2010
|
464 | |||
2011
|
161 | |||
2012
|
113 | |||
Total
minimum lease payments
|
$ | 1,525 |
In connection with the relocation of
the Company’s Dallas office, the lessor agreed to pay approximately $246,000 as
an incentive to terminate the lease prior to its contractual expiration
date. In connection with this transaction, the Company recognized
income of approximately $246,000 in 2006 and this is included in selling and
administrative expenses.
Litigation
– The Supreme Court of the
Republic of the Philippines has refused to review a decision of the Court of
Appeals in Manila against a Philippines subsidiary of the Company that is
inactive and has no material assets, and purportedly also against Innodata
Isogen, Inc., that orders the reinstatement of certain former employees of the
subsidiary to their former positions and payment of back wages and benefits that
aggregate approximately $7.5 million. Complainants have moved for execution of
this decision before the Department of Labor and Employment National Labor
Relations Commission, Republic of the Philippines, and the Department of Labor
and Employment Office of the Secretary of Labor and Employment, Republic of the
Philippines. Based on consultation with legal counsel, the Company believes that
recovery against the Company is nevertheless unlikely.
The
Company is also subject to various legal proceedings and claims which arise in
the ordinary course of business.
While
management currently believes that the ultimate outcome of 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. Substantial recovery against the Company in the above referenced
Philippines actions could have a material adverse impact on the Company, and
unfavorable rulings or recoveries in the other proceedings could have a material
adverse impact on the operating results of the period in which the ruling or
recovery occurs. In addition, the Company’s 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.
Foreign Currency-The Company’s
production facilities are located in the Philippines, India, Sri Lanka and
Israel. 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.
Indemnifications-The Company
is obligated under certain circumstances to indemnify directors, certain
officers and employees against costs and liabilities incurred in actions or
threatened actions brought against such individual because such individuals
acted in the capacity of director and/or officer or fiduciary of the Company. In
addition, the Company has contracts with certain clients pursuant to whom 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 potential maximum future payments.
As of December 31, 2008, the Company has not recorded a liability for any
obligations arising as a result of these indemnifications.
F-19
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Liens-In connection with the
procurement of tax incentives at one of the Company’s foreign subsidiaries, the
foreign zoning authority was granted a first lien on the subsidiary’s property
and equipment. As of December 31, 2008, the net book value of the
property and equipment was $801,000.
6.
|
Pension
benefits
|
U.S. Defined Contribution Pension
Plan - The Company has a defined contribution plan qualified under
Section 401(k) of the Internal Revenue Code, pursuant to which
substantially all of its U.S. employees are eligible to participate after
completing six months of service. Participants may elect to contribute a portion
of their compensation to the plan. Under the plan, the Company has the
discretion to match a portion of participants’ contributions. The Company
intends to match approximately $122,000 to the plan for the year ended December
31, 2008. For the years ended December 31, 2007 and 2006, the Company’s
matching contributions were approximately $123,000 and $131,000,
respectively.
Non-U.S. Pension benefits - In
September 2006, the FASB issued Statement No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87,
88, 106 and 132(R)” (“SFAS 158”). SFAS 158 requires an employer to
recognize a net liability or asset and an offsetting adjustment to accumulated
other comprehensive income to report the funded status of defined benefit
pension and other postretirement benefit plans effective for the Company’s year
ended December 31, 2006. As required, the Company has adopted this
statement and applied it prospectively beginning with the Company’s fiscal
year-end December 31, 2006. The adoption resulted in recognition in 2006 of
additional pension liabilities of $877,000, an increase of $117,000 to total
assets and a decrease to stockholders equity of $760,000.
Most of the non-U.S. subsidiaries
provide for government mandated defined pension benefits. For certain
of these subsidiaries, vested eligible employees are provided a lump sum payment
upon retiring from the Company at a defined age. The lump sum amount
is based on the salary and tenure as of retirement date. Other non-U.S
subsidiaries provide for a lump sum payment to vested employees on retirement,
death, incapacitation or termination of employment, based upon the salary and
tenure as of the date employment ceases. The liability for such defined benefit
obligations is determined and provided on the basis of actuarial valuations.
Pension expense for foreign subsidiaries totaled approximately $439,000,
$667,000 and $313,000 for each of the three years in the period ended
December 31, 2008.
The following table summarizes the
amounts recognized in accumulated other comprehensive income (loss), net of
taxes (in thousands):
F-20
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31,
|
||||||||||||
2008
|
2007
|
2006
|
||||||||||
Amount
recognized on adoption of SFAS 158
|
$ | — | $ | — | $ | (760 | ) | |||||
Amortization
of transition obligation
|
92 | 83 | — | |||||||||
Actuarial
gain
|
861 | 466 | — | |||||||||
Total
|
$ | 953 | $ | 549 | $ | (760 | ) | |||||
Amounts
in accumulated other comprehensive income (loss) not yet
reflected
in net periodic benefit cost, net of taxes:
|
||||||||||||
Acturial
gain
|
$ | 1,327 | $ | 466 | ||||||||
Transition
obligation
|
(585 | ) | (677 | ) | ||||||||
Total
|
$ | 742 | $ | (211 | ) | |||||||
Amounts
in accumulated other comprehensive income (loss) expected to
be
amortized in 2009 net periodic benefit cost, net of taxes:
|
||||||||||||
Acturial
gain
|
$ | 97 | ||||||||||
Transition
obligation
|
(83 | ) | ||||||||||
Total
|
$ | 14 |
The following table sets out the status
of the non-U.S pension benefits and the amounts (in thousands) recognized in the
Company’s consolidated financial statements.
Benefit
Obligations:
Change
in the Benefit Obligation:
|
2008
|
2007
|
2006
|
|||||||||
Projected
benefit obligation at beginning of the year
|
$ | 1,860 | $ | 1,580 | $ | 493 | ||||||
Service
cost
|
314 | 404 | 176 | |||||||||
Interest
cost
|
151 | 121 | 68 | |||||||||
Actuarial
loss (gain)
|
(1,022 | ) | (442 | ) | 903 | |||||||
Foreign
currency exchange rate changes
|
(170 | ) | 259 | 26 | ||||||||
Benefits
paid
|
(61 | ) | (62 | ) | (86 | ) | ||||||
Projected
benefit obligation at end of year
|
$ | 1,072 | $ | 1,860 | $ | 1,580 |
Components
of Net Periodic Pension Cost:
2008
|
2007
|
2006
|
||||||||||
Service
cost
|
$ | 314 | $ | 404 | $ | 176 | ||||||
Interest
cost
|
151 | 121 | 68 | |||||||||
Actuarial
loss (gain) recognized
|
(26 | ) | 142 | 69 | ||||||||
Net
periodic pension cost
|
$ | 439 | $ | 667 | $ | 313 |
The accumulated benefit obligation,
which represents benefits earned to date, was approximately $453,000 and
$395,000 at December 31, 2008 and 2007, respectively.
F-21
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Actuarial assumptions for all non-U.S.
plans are described below. The discount rates are used to measure the
year end benefit obligations and the earnings effects for the subsequent
year.
2008
|
2007
|
2006
|
||||||||||
Discount
rate
|
7.65%-12 | % | 8%-10 | % | 6.5%-10 | % | ||||||
Rate
of increase in compensation levels
|
7%-10 | % | 10%-13 | % | 7%-10 | % |
Estimated
Future Benefit Payments:
The following benefit payments (in
thousands), which reflect expected future service, as appropriate, are expected
to be paid:
Years Ending December 31,
|
|||||
2009
|
$ | 36 | |||
2010
|
45 | ||||
2011
|
51 | ||||
2011
|
55 | ||||
2013
|
64 | ||||
2014
to 2018
|
$ | 1,109 | |||
7.
|
Restructuring
Charges
|
2008
Restructuring Plan
As part of the overall cost reduction
plan to reduce operating costs, in December 2008 the Company announced a
restructuring plan to reduce its global work force by approximately 260
employees, the majority of whom were based in Asia. Most employees were
terminated by December 31, 2008.
In connection with the restructuring,
the Company recorded a one-time charge of approximately $475,000 for severance
and other personnel-related expenses. As of December 31, 2008, the Company paid
$265,000 of the total restructuring charges. The remaining balance will be paid
during the first two quarters of 2009 and is included in accrued salaries, wages
and related benefits in the consolidated balance sheets.
2006
Restructuring Plan
In September 2006, the
Company initiated a restructuring plan as part of an overall cost
reduction plan to reduce operating costs and announced a worldwide workforce
reduction of slightly under 300 employees, the majority of whom were based in
Asia. The plan was substantially implemented by the end of 2006.
As a result, the Company recorded total
charges of $604,000 in 2006 associated with the restructuring plan. The 2006
charge consisted of $531,000 of employee severance costs and $73,000 of costs to
implement the plan. Of the total amount, $60,000 represents charges relating to
stock option modifications.
F-22
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the restructuring,
the Company paid cash of $544,000 by fiscal 2007 and recognized costs amounting
to $60,000 for stock option modifications. The Company currently expects no
future costs to be incurred associated with the restructuring plan.
Relative to the 2006 restructuring, the
Company modified the expiration date of an option held by a departing officer to
purchase 100,000 shares of the Company’s common stock at an exercise price of
$2.59. The option, which was scheduled to expire at a rate of 20,000
shares per year commencing on May 31, 2009, was modified wherein 20,000 shares
continue to expire on May 31, 2009, 20,000 shares continue to expire on
May 31, 2010 and the remaining 60,000 shares will expire on May 31,
2010. The modification also provided that the option will survive the
termination of the officer’s employment with the Company. The Company
recognized, as part of the restructuring cost, $60,000 related to the stock
option modification.
The restructuring charges were recorded
in the consolidated statements of operations and were allocated as follows (in
thousands):
December 31,
|
||||||||||||
2008
|
2007
|
2006
|
||||||||||
Cost
of sales
|
$ | 255 | $ | - | $ | 175 | ||||||
Selling
and administrative expenses
|
220 | - | 429 | |||||||||
Total
|
$ | 475 | $ | - | $ | 604 |
8.
|
Capital
Stock
|
Common Stock -
The Company is authorized to issue 75,000,000 shares of common
stock. Each share of common stock has one vote. Subject to preferences that may
be applicable to any outstanding shares of preferred stock, the holders of
common stock are entitled to receive ratably such dividends, if any, as may be
declared by the Board of Directors. No common stock dividends have been declared
to date.
Preferred Stock – The Company
is authorized to issue 5,000,000 shares of preferred stock. The Board
of Directors is authorized to fix the terms, rights, preferences and limitations
of the preferred stock and to issue the preferred stock in series which differ
as to their relative terms, rights, preferences and limitations.
Stockholder Rights Plan - On
December 16, 2002, the Board of Directors adopted a Stockholder Rights Plan
(“Rights Plan”) in which one right (“Right”) was declared as a dividend for each
share of the Company’s common stock outstanding. The purpose of the plan is to
deter a hostile takeover of the Company. Each Right entitles its holders to
purchase, under certain conditions, one one-thousandth of a share of newly
authorized Series C Participating Preferred Stock (“Preferred Stock”), with
one one-thousandth of a share of Preferred Stock intended to be the economic and
voting equivalent of one share of the Company’s common stock. Rights will be
exercisable only if a person or group acquires beneficial ownership of 15% (25%
in the case of specified executive officers of the Company) or more of the
Company’s common stock or commences a tender or exchange offer, upon the
consummation of which such person or group would beneficially own such
percentage of the common stock. Upon such an event, the Rights enable dilution
of the acquiring person’s or group’s interest by providing that other holders of
the Company’s common stock may purchase, at an exercise price of $4.00, the
Company’s common stock having a market value of $8.00 based on the then market
price of the Company’s common stock, or at the discretion of the Board of
Directors, Preferred Stock, having double the value of such exercise price. The
Company will be entitled to redeem the Rights at $.001 per Right under certain
circumstances set forth in the Rights Plan. The Rights themselves have no voting
power and will expire on December 26, 2012, unless earlier exercised,
redeemed or exchanged.
F-23
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Common Stock Reserved - As of
December 31, 2008, the Company had reserved for issuance approximately
4,009,000 shares of common stock pursuant to the Company’s stock option
plans.
Treasury Stock - In May 2008,
the Company announced that the Board of Directors authorized the repurchase of
up to $2.0 million of its common stock. There is no expiration date associated
with the program. As of December 31, 2008, the Company repurchased 606,000
shares of its common stock at a cost of approximately $1.9 million, and
approximately $0.1 million remains available for repurchase under the program.
This authorization replaced a prior authorization made in August
2006.
9.
|
Stock
Options
|
The Company adopted, with stockholder
approval, 1998, 2001, and 2002 Stock Option Plans (the “1998 Plan,” “2001 Plan,”
and “2002 Plan”, collectively the “Plans”) which provide for the granting of
options to purchase not more than an aggregate of 3,600,000, 900,000 and 950,000
shares of common stock, respectively, subject to adjustment under certain
circumstances. Such options may be incentive stock options (“ISOs”) within the
meaning of the Internal Revenue Code of 1986, as amended, or options that do not
qualify as ISOs (“Non-Qualified Options”).
The option exercise price per share may
not be less than the fair market value per share of common stock on the date of
grant (110% of such fair market value for an ISO, if the grantee owns stock
possessing more than 10% of the combined voting power of all classes of the
Company’s stock). Options may be granted under the Stock Option Plans to all
officers, directors, and employees of the Company and, in addition,
Non-Qualified Options may be granted to other parties who perform services for
the Company. The 1998 Plan expired on July 8, 2008. No options may be granted
under the 2001 Plan after May 31, 2011; and under the 2002 Plan after
June 30, 2012.
The Plans may be amended from time to
time by the Board of Directors of the Company. However, the Board of Directors
may not, without stockholder approval, amend the Plans to increase the number of
shares of common stock which may be issued under the Plans (except upon changes
in capitalization as specified in the Plans), decrease the minimum exercise
price provided in the Plans or change the class of persons eligible to
participate in the Plans.
The fair value of stock options is
estimated on the date of grant using the Black-Scholes option pricing model. The
weighted average fair values of the options granted and weighted average
assumptions are as follows:
For the Years Ended December 31,
|
||||||||||||
2008
|
2007
|
2006 (1)
|
||||||||||
Weighted
average fair value of options granted
|
$ | 2.46 | $ | 2.99 | $ | — | ||||||
Risk-free
interest rate
|
3.61 | % | 4.61 | % | — | |||||||
Expected
life (years)
|
8.00 | 8.00 | — | |||||||||
Expected
volatility factor
|
97 | % | 122 | % | — | |||||||
Expected
dividends
|
None
|
None
|
— |
(1) There
were no options granted in 2006.
F-24
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The Company estimates the risk-free
interest rate using the U.S. Treasury yield curve for periods equal to the
expected term of the options in effect at the time of grant. The expected term
of options granted is based on a combination of vesting schedules, term of the
options and historical experience. Expected volatility was based on historical
volatility of the Company’s common stock. The Company uses an expected dividend
yield of zero since it has never declared or paid any dividends on its capital
stock.
A summary of option activity under the
Plans as of December 31, 2008, and changes during the year then ended is
presented below:
Number of Shares
|
Weighted-Average
Exercise Price
|
Weighted-Average Remaining
Contractual Term (years)
|
Aggregate Intrinsic
Value
|
|||||||||||||
Outstanding
as January 1, 2008
|
3,168,263 | $ | 2.69 | |||||||||||||
Granted
|
112,000 | 2.89 | ||||||||||||||
Exercised
|
(26,318 | ) | 2.69 | |||||||||||||
Forfeited/Expired
|
(80,834 | ) | 3.53 | |||||||||||||
Outstanding
as December 31, 2008
|
3,173,111 | $ | 2.68 | 4.76 | $ | 686,068 | ||||||||||
Exercisable
at December 31, 2008
|
3,057,193 | $ | 2.66 | 4.59 | $ | 686,068 |
The number and weighted-average
grant-date fair value of non-vested stock options is as follows:
Shares
|
Weighted Average
Grant-Date Fair Value
|
|||||||
Non-vested
January 1, 2008
|
78,928 | $ | 3.56 | |||||
Granted
|
112,000 | 2.46 | ||||||
Forfeited
|
- | - | ||||||
Vested
|
(75,010 | ) | 2.73 | |||||
Non-vested
December 31, 2008
|
115,918 | $ | 3.03 |
The total compensation cost related to
non-vested stock options not yet recognized as of December 31, 2008
totaled approximately $282,000. These costs are expected to be
recognized over a weighted- average term of 3.18 years.
Because
of the Company’s net operating loss carryforwards, no tax benefits resulting
from the exercise of stock options have been recorded, thus there was no effect
on cash flows from operating or financing activities.
The total intrinsic value of options
exercised for each of the three years in the period ended
December 31, 2008 was approximately $88,000, $4,339,000 and
$1,131,000, respectively. The total fair value of stock options vested during
the year ended December 31, 2008 was approximately $205,000.
The stock options granted have a
maximum term of up to ten years and generally vest over a four year period. In
2005, the Company granted to officers and directors, fully vested options to
purchase 760,000 shares of the Company's common stock ("Option Shares") at an
exercise price of ranging between $3.00 and $3.46 per share. The options expire
on the earlier of (i) ten years after date of grant, (ii) 60 days after
employment ceases and (iii) 12 months following the termination of employment as
a result of his or her death or disability. Furthermore, no Option Shares may be
sold during the first year after the date of grant; no more than 25% of the
Option Shares may be sold during the second year after the date of grant; no
more than 50% of the Option Shares may be sold during the second and third years
after the date of grant, and no more than 75% of the Option Shares may be sold
during the second, third and fourth years after the date of grant. No
restrictions on sales apply after the fourth anniversary of the date of
grant.
F-25
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
On
September 12, 2007, the Company’s Chairman and CEO (the “CEO”) exercised
1,139,160 stock options at a total exercise price of $882,844. The CEO paid the
exercise price by surrendering to the Company 229,310 of the shares of common
stock he would have otherwise received on the option exercise. In addition, the
CEO surrendered 395,695 shares to the Company in consideration of the payment by
the Company on his behalf of $1,523,426 of the Company’s minimum withholding tax
requirement payable in respect of the option exercise. Because the payment value
attributable to the surrendered shares upon settlement does not exceed the fair
value of the option, no compensation cost was recognized at the date of
settlement. In connection with this transaction, the Company issued a net total
of 514,155 shares of common stock to the CEO.
10. Comprehensive
income (loss)
The
components of comprehensive income (loss) are as follows (in
thousands):
December 31,
|
||||||||||||
2008
|
2007
|
2006
|
||||||||||
Net
income (loss)
|
$ | 7,584 | $ | 4,566 | $ | (7,323 | ) | |||||
Pension
liability adjustment
|
953 | 549 | (760 | ) | ||||||||
Comprehensive
income (loss)
|
$ | 8,537 | $ | 5,115 | $ | (8,083 | ) |
Accumulated
other comprehensive income (loss) as reflected in the consolidated balance
sheets consists of changes in transitional projected benefit obligation, net of
taxes.
11.
|
Segment
reporting and concentrations
|
In 2007,
the Company commenced a reorganization of its management and operating
structure. Prior to 2007, the Company’s operations were classified into two
operating segments: (1) content-related BPO and KPO services and (2) IT
professional services. In this reorganization, management merged the
content-related BPO services and IT professional services segments (ceasing to
monitor its operations by these two segments). With this reorganization, the
Company consists of one business that generates revenues and expenses. The
Company’s chief operating decision maker reviews the full operating results of
the entire Company at the consolidated level. Thus, the Company's current
operating segment structure reflects the way the chief operating decision maker
looks at the overall Company to evaluate performance and makes executive
decisions (including the allocation of resources) about the business. There is
no end to end responsibility or management other than at the consolidated level,
and discrete financial information is available at the consolidated level. Thus
the Company has had one operating segment since 2007.
The
Company’s services revenues are generated principally from its production
facilities located in the Philippines, India, Sri Lanka and
Israel. 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.
Long-lived assets as of December 31,
2008 and 2007, respectively by geographic region are comprised
of:
F-26
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
2008
|
2007
|
|||||||
(in
thousands)
|
||||||||
United
States
|
$ | 1,372 | $ | 1,643 | ||||
Foreign
countries:
|
||||||||
Philippines
|
3,379 | 3,785 | ||||||
India
|
1,675 | 1,886 | ||||||
Sri
Lanka
|
654 | 509 | ||||||
Israel
|
321 | 12 | ||||||
Total
foreign
|
6,029 | 6,192 | ||||||
$ | 7,401 | $ | 7,835 |
Four
clients generated approximately 57%, 61% and 54% of our total revenues in the
fiscal year ended December 31, 2008, 2007 and 2006, respectively. No other
client accounted for 10% or more of revenues during these periods. Further, in
the years ended December 31, 2008, 2007 and 2006, revenues to non-US
clients accounted for 21%, 23% and 37%, respectively, of the Company's
revenues.
Revenues
for each of the three years in the period ended December 31, by geographic
region (determined based upon customer’s domicile), are as follows:
2008
|
2007
|
2006
|
||||||||||
(in
thousands)
|
||||||||||||
United
States
|
$ | 59,042 | $ | 52,017 | $ | 25,951 | ||||||
The
Netherlands
|
7,564 | 9,070 | 10,200 | |||||||||
Other
- principally Europe
|
8,395 | 6,644 | 4,802 | |||||||||
$ | 75,001 | $ | 67,731 | $ | 40,953 |
A
significant amount of the Company's revenues are derived from clients in the
publishing industry. Accordingly, the Company's accounts receivable generally
include significant amounts due from such clients. In addition, as of
December 31, 2008, approximately 22% of the Company's accounts receivable
was from foreign (principally European) clients and 51% of accounts receivable
was due from two clients. As of December 31, 2007, approximately 18% of the
Company's accounts receivable was from foreign (principally European) clients
and 50% of accounts receivable was due from one client. No other clients
accounts for 10% or more of the receivables as of December 31, 2008 and
2007.
12.
|
Income
(Loss) per Share
|
2008
|
2007
|
2006
|
||||||||||
(in thousands, except per share amounts)
|
||||||||||||
Net
income (loss)
|
$ | 7,584 | $ | 4,566 | $ | (7,323 | ) | |||||
Weighted
average common shares outstanding
|
24,390 | 24,142 | 24,021 | |||||||||
Dilutive
effect of outstanding options
|
747 | 1,185 | - | |||||||||
Adjusted
for dilutive computation
|
25,137 | 25,327 | 24,021 | |||||||||
Basic
income (loss) per share
|
$ | .31 | $ | .19 | $ | (.30 | ) | |||||
Diluted
income (loss) per share
|
$ | .30 | $ | .18 | $ | (.30 | ) |
F-27
INNODATA
ISOGEN, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Basic income (loss) per share is
computed using the weighted-average number of common shares outstanding during
the year. Diluted income per share is computed by considering the impact of the
potential issuance of common shares, using the treasury stock method, on the
weighted average number of shares outstanding. Options to purchase 1.1 million
shares of common stock in 2008 and 2.8 million shares of common stock in 2006
were outstanding but not included in the computation of diluted income 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. All
options outstanding were included in the computation of diluted net income
(loss) per share in 2007 as the exercise price was lower than the average market
price. In addition, diluted net loss per share does not include 0.8
million potential common shares derived from stock options for the year ended
December 31, 2006 because as a result of the Company incurring losses, their
effect would have been antidilutive.
13.
|
Quarterly
Financial Data (Unaudited)
|
The quarterly results of operations
are summarized below:
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||||||
(in
thousands, except per share amounts)
|
||||||||||||||||
2008
|
||||||||||||||||
Revenues
|
$ | 18,400 | $ | 17,870 | $ | 18,333 | $ | 20,398 | ||||||||
Net
income
|
$ | 833 | $ | 36 | $ | 1,108 | $ | 5,607 | ||||||||
Basic
net income per share
|
$ | .03 | $ | - | $ | .05 | $ | .23 | ||||||||
Diluted
net income per share
|
$ | .03 | $ | - | $ | .05 | $ | .23 | ||||||||
2007
|
||||||||||||||||
Revenues
|
$ | 12,729 | $ | 16,347 | $ | 18,138 | $ | 20,517 | ||||||||
Net
loss
|
$ | (643 | ) | $ | 862 | $ | 2,115 | $ | 2,232 | |||||||
Basic
net loss per share
|
$ | (.03 | ) | $ | .04 | $ | .09 | $ | .09 | |||||||
Diluted
net loss per share
|
$ | (.03 | ) | $ | .03 | $ | .08 | $ | .09 |
14.
|
Financial
Instruments
|
The
Company has a large portion of its operations in international markets that are
subject to foreign currency fluctuations. The most significant foreign currency
exposures occur when revenue and associated accounts receivable are collected in
one currency and expenses incurred in order to generate that revenue in another
currency. The Company’s primary exchange rate exposure relates to payroll, other
payroll costs and operating expenses in the Philippines and India.
To manage
its exposure to fluctuations in foreign currency exchange rates, the Company
entered into foreign currency forward contracts in 2008 and in 2007, authorized
under Company policies, with counterparties that are highly rated financial
institutions. The Company has utilized non-deliverable forward contracts
expiring within six months to reduce its foreign currency risk.
As of
December 31, 2008 and 2007, there were no outstanding foreign currency forward
contracts. Any increase or decrease in the fair value of the Company’s currency
exchange rate sensitive forward contracts is substantially offset by a
corresponding decrease or increase in the fair value of the hedged cash
flows.
For the
years ended December 31, 2008 and 2007, the Company realized losses of
approximately $1.1 million and gains of approximately $0.1 million arising on
settlement of foreign currency forward contracts. These losses are reflected as
a component of direct operating costs and were substantially offset by a
corresponding increase in the fair value of the hedged cash
flows.
F-28
Exhibits
which are indicated as being included in previous filings are incorporated
herein by reference.
Exhibit
|
Description
|
Filed as Exhibit
|
||
3.1
(a)
|
Restated
Certificate of Incorporation filed on April 29,
1993
|
Filed
as Exhibit 3.1(a) to our Form 10-K for the year ended December
31, 2003
|
||
3.1
(b)
|
Certificate
of Amendment of Certificate of Incorporation of Innodata
Corporation filed on March 1, 2001
|
Filed
as Exhibit 3.1(b) to our Form 10-K for the year ended December 31,
2003
|
||
3.1
(c)
|
Certificate
of Amendment of Certificate of Incorporation of Innodata
Corporation Filed on November 14, 2003
|
Filed
as Exhibit 3.1(c) to our Form 10-K for the year ended December 31,
2003
|
||
3.2
|
Form
of Amended and Restated By-Laws
|
Exhibit
3.1 to Form 8-K dated December 16, 2002
|
||
3.3
|
Form
of Certificate of Designation of Series C Participating
Preferred Stock
|
Filed
as Exhibit A to Exhibit 4.1 to Form 8-K dated December 16,
2002
|
||
4.2
|
Specimen
of Common Stock certificate
|
Exhibit
4.2 to Form SB-2 Registration Statement No. 33-62012
|
||
4.3
|
Form
of Rights Agreement, dated as of December 16, 2002
between Innodata Corporation and American Stock Transfer and Trust Co.,
as Rights Agent
|
Exhibit
4.1 to Form 8-K dated December 16, 2002
|
||
10.1
|
1994
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated August 9, 1994
|
||
10.2
|
1993
Stock Option Plan
|
Exhibit
10.4 to Form SB-2 Registration Statement No. 33-62012
|
||
10.3
|
Form
of Indemnification Agreement between us and our directors and
one of our officers
|
Exhibit
10.3 to Form 10-K for the year ended December 31, 2002
|
||
10.4
|
1994
Disinterested Directors Stock Option Plan
|
Exhibit
B to Definitive Proxy dated August 9, 1994
|
||
10.5
|
1995
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated August 10, 1995
|
||
10.6
|
1996
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated November 7, 1996
|
||
10.7
|
1998
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated November 5, 1998
|
||
10.8
|
2001
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated June 29, 2001
|
||
10.9
|
2002
Stock Option Plan
|
Exhibit
A to Definitive Proxy dated September 3, 2002
|
||
10.10
|
Employment
Agreement dated as of January 1, 2004 with George
Kondrach
|
Filed
as Exhibit 10.10 to our Form 10-K for the year ended December 31,
2003
|
||
10.11
|
Letter
Agreement dated as of August 9, 2004, by and between us and The Bank of
New York
|
Filed
as Exhibit 10.2 to Form S-3 Registration statement No.
333-121844
|
||
10.12
|
Employment
Agreement dated as of December 22,2005 22, 2005, by and between
us and Steven L. Ford
|
Exhibit
10.1 to Form 8-K dated December 28, 2005
|
||
10.13
|
Form
of 2001 Stock Option Plan Grant Letter, dated December 22, 2005Employment
Agreement dated as of December 22,2005 Dated December 22,
2005
|
Exhibit
10.2 to Form 8-K dated December 28, 2005
|
||
10.14
|
Form
of 1995 Stock Option Agreement
|
Exhibit
10.4 to Form 8-K dated December 15, 2005
|
||
10.15
|
Form
of 1998 Stock Option Agreement for Directors
|
Exhibit
10.5 to Form 8-K dated December 15, 2005
|
||
10.16
|
Form
of 1998 Stock Option Agreement for Officers
|
Exhibit
10.6 to Form 8-K dated December 15,
2005
|
10.17
|
Form
of 2001 Stock Option Agreement
|
Exhibit
10.7 to Form 8-K dated December 15, 2005
|
||
10.18
|
Form
of new vesting and lock-up agreement for each of Haig Bagerdjian, Louise
Forlenza, John Marozsan and Todd Solomon
|
Exhibit
10.8 to Form 8-K dated December 15, 2005
|
||
10.19
|
Form
of new vesting and lock-up agreement for Jack Abuhoff
|
Exhibit
10.9 to Form 8-K dated December 15, 2005
|
||
10.20
|
Form
of new vesting and lock-up agreement for George Kondrach
|
Exhibit
10.10 to Form 8-K dated December 15, 2005
|
||
10.21
|
Form
of new vesting and lock-up agreement for Stephen Agress
|
Exhibit
10.11 to Form 8-K dated December 15, 2005
|
||
10.22
|
Form
of 2001 Stock Option Plan Grant Letter, dated December 31, 2005, for
Messrs. Abuhoff, Agress and Kondrach
|
Exhibit
10.2 to Form 8-K dated January 5, 2006
|
||
10.23
|
Form
of 2001 Stock Option Plan Grant Letter, dated December 31, 2005, for
Messrs. Bagerdjian and Marozsan and Ms. Forlenza
|
Exhibit
10.3 to Form 8-K dated January 5, 2006
|
||
10.24
|
Transition
Agreement Dated as of September 29, 2006 2006 with Stephen
Agress
|
Exhibit
10.1 to Form 8-K dated October 3, 2006
|
||
10.25
|
Form
of Stock Option Modification Agreement with With Stephen
Agress
|
Exhibit
10.2 to Form 8-K dated October 3, 2006
|
||
10.26
|
Employment
Agreement dated as of February 1, 2006 with Jack Abuhoff
|
Exhibit
10.2 to Form 8-K dated April 27, 2006
|
||
10.27
|
Employment
Agreement dated as of January 1, 2007 with Ashok
Mishra
|
Exhibit
10.1 to Form 10-Q for the quarter ended June 30,2007
|
||
10.28
|
Innodata
Isogen Incentive Compensation Plan
|
Exhibit
10.1 to Form 8-K dated February 13, 2008
|
||
10.29
|
Form
of 2002 Stock Option Plan Grant Letter, dated August 13, 2008, for Messrs.
Bagerdjian, Marozsan and Woodward, and Ms. Forlenza
|
Exhibit
10.1 to Form 10-Q for the quarter ended September 30,
2008
|
||
10.30
|
Amended
and Restated Employment Agreement dated as of December 24, 2008 with Jack
S. Abuhoff
|
Exhibit
10.1 to Form 8-K dated December 30, 2008
|
||
16
|
Letter
of Grant Thornton regarding change in certifying
accountant.
|
Exhibit
4.01 to Form 8-K dated September 12, 2008
|
||
21
|
Significant
subsidiaries of the registrant
|
Filed
herewith
|
||
23
|
Consent
of J.H. Cohn LLP
|
Filed
herewith
|
||
23.1
|
Consent
of Grant Thornton LLP
|
Filed
herewith
|
||
31.1
|
Certificate
of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
|
Filed
herewith
|
||
31.2
|
Certificate
of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|
Filed
herewith
|
32.1
|
Certification
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
|
Filed
herewith
|
||
32.2
|
Certification
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
|
Filed
herewith
|
INNODATA ISOGEN, INC. AND
SUBSIDIARES
SCHEDULE
II - VALUATION AND QUALIFYING ACCOUNTS
(Dollars
in Thousands)
Activity
in the Company's allowance for doubtful accounts for the years ended December
31, 2008, 2007 and 2006 was as follows:
Additions
|
||||||||||||||||||||
|
Charged
to
|
|
|
|||||||||||||||||
Period
|
Balance
at Beginning of Period |
Costs and
Expenses
|
Charged
to Other Accounts |
Deductions
|
Balance
at End of Period |
|||||||||||||||
2008
|
$ | 127 | $ | 341 | $ | - | $ | (2 | ) | $ | 466 | |||||||||
|
||||||||||||||||||||
2007
|
$ | 70 | $ | 108 | $ | - | $ | (75 | ) | $ | 127 | |||||||||
2006
|
$ | 111 | $ | (9 | ) | $ | - | $ | (33 | ) | $ | 70 |