10-Q 1 v359238_10q.htm FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
EXCHANGE ACT OF 1934
 
 
 
 
 
For the quarterly period ended September 30, 2013
 
 
 
 
 
OR
 
 
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from ________________ to ________________
 
Commission file number:  0-22196
 
INNODATA INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
13-3475943
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
Three University Plaza
 
07601
Hackensack, New Jersey
 
(Zip Code)
(Address of principal executive offices)
 
 
 
(201) 371-8000
(Registrant’s telephone number, including area code)
 
[None]
(Former name, former address and former fiscal year, if changed since last report)
 
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 preceding 12 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 ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ         No   ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨ Accelerated filer þ Non-accelerated filer    ¨      Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨   No þ
 
The number of outstanding shares of the registrant’s common stock, $.01 par value, as of October 31, 2013 was 25,049,889.
 
 
 
INNODATA INC. AND SUBSIDIARIES
For the Quarter Ended September 30, 2013
 
INDEX 
 
Part I – Financial Information
 
 
Page No.
Item 1.
Condensed Consolidated Financial Statements (Unaudited):
 
 
Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012
1
 
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended September 30, 2013 and 2012
2
 
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the nine months ended September 30, 2013 and 2012
3
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012
4
 
Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2013 and 2012
5
 
Notes to Condensed Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
18
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
28
Item 4.
Controls and Procedures
29
 
 
 
 
Part II – Other Information
 
Item 1.
Legal Proceedings
30
Item 1A.
Risk Factors
30
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
30
Item 3.
Defaults Upon Senior Securities
30
Item 4.
Mine Safety Disclosures
30
Item 5.
Other Information
30
Item 6.
Exhibits
31
 
Signatures
 
 
 
 
INNODATA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share data)
 
 
 
September 30,
 
December 31,
 
 
 
2013
 
2012
 
ASSETS
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
25,104
 
$
25,425
 
Short term investments – other
 
 
1,115
 
 
3,091
 
Accounts receivable, net
 
 
10,805
 
 
14,317
 
Prepaid expenses and other current assets
 
 
2,117
 
 
2,561
 
Deferred income taxes
 
 
168
 
 
1,104
 
Total current assets
 
 
39,309
 
 
46,498
 
 
 
 
 
 
 
 
 
Property and equipment, net
 
 
6,331
 
 
10,656
 
Other assets
 
 
3,210
 
 
3,504
 
Deferred income taxes
 
 
780
 
 
4,848
 
Goodwill
 
 
675
 
 
675
 
 
 
 
 
 
 
 
 
Total assets
 
$
50,305
 
$
66,181
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
Accounts payable
 
$
1,074
 
$
1,618
 
Accrued expenses
 
 
3,867
 
 
2,482
 
Accrued salaries, wages and related benefits
 
 
5,117
 
 
6,584
 
Income and other taxes
 
 
1,384
 
 
2,155
 
Current portion of long term obligations
 
 
317
 
 
818
 
Deferred income taxes
 
 
-
 
 
57
 
Total current liabilities
 
 
11,759
 
 
13,714
 
 
 
 
 
 
 
 
 
Deferred income taxes
 
 
190
 
 
182
 
Long term obligations
 
 
3,794
 
 
3,374
 
Commitments and contingencies
 
 
 
 
 
 
 
Non-controlling interests
 
 
(3,315)
 
 
(1,598)
 
STOCKHOLDERS’ EQUITY:
 
 
 
 
 
 
 
Serial preferred stock; 5,000,000 shares authorized, none outstanding
 
 
-
 
 
-
 
Common stock, $.01 par value; 75,000,000 shares authorized; 26,597,000 shares issued and 25,050,000 outstanding at September 30, 2013 and 26,439,000 shares issued and 24,892,000 outstanding at December 31, 2012
 
 
266
 
 
264
 
Additional paid-in capital
 
 
22,753
 
 
22,140
 
Retained earnings
 
 
20,860
 
 
32,356
 
Accumulated other comprehensive income (loss)
 
 
(1,714)
 
 
37
 
 
 
 
42,165
 
 
54,797
 
Less: treasury stock, 1,547,000 shares at cost
 
 
(4,288)
 
 
(4,288)
 
Total stockholders’ equity
 
 
37,877
 
 
50,509
 
Total liabilities and stockholders’ equity
 
$
50,305
 
$
66,181
 
 
See notes to condensed consolidated financial statements.
 
 
1

 
INNODATA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands, except per share amounts)
 
 
 
Three Months Ended
 
 
 
September 30,
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Revenues
 
$
15,746
 
$
19,710
 
Operating costs and expenses:
 
 
 
 
 
 
 
Direct operating costs
 
 
11,973
 
 
13,509
 
Selling and administrative expenses
 
 
3,992
 
 
5,233
 
Impairment charge
 
 
5,524
 
 
-
 
Interest income, net
 
 
(57)
 
 
(32)
 
Totals
 
 
21,432
 
 
18,710
 
Income (loss) before income taxes
 
 
(5,686)
 
 
1,000
 
Provision for income taxes
 
 
7,297
 
 
136
 
Net income (loss)
 
 
(12,983)
 
 
864
 
Loss attributable to non-controlling interests
 
 
1,291
 
 
425
 
Net income (loss) attributable to Innodata Inc. and Subsidiaries
 
$
(11,692)
 
$
1,289
 
 
 
 
 
 
 
 
 
Income (loss) per share attributable to Innodata Inc. and Subsidiaries:
 
 
 
 
 
 
 
Basic and diluted
 
$
(0.47)
 
$
0.05
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
 
 
25,053
 
 
24,883
 
Diluted
 
 
25,053
 
 
27,446
 
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
Net income (loss)
 
$
(12,983)
 
$
864
 
Pension liability adjustment, net of taxes
 
 
18
 
 
9
 
Change in fair value of derivatives, net of taxes of $676 and $309 for the three months ended September 30, 2013 and 2012, respectively
 
 
(575)
 
 
526
 
Other Comprehensive income (loss)
 
 
(557)
 
 
535
 
Total Comprehensive income (loss)
 
 
(13,540)
 
 
1,399
 
Comprehensive loss attributed to non-controlling interests
 
 
1,291
 
 
425
 
Comprehensive income (loss) attributable to Innodata Inc. and Subsidiaries
 
$
(12,249)
 
$
1,824
 
 
See notes to condensed consolidated financial statements.
 
 
2

 
INNODATA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands, except per share amounts)
 
 
 
Nine Months Ended
 
 
 
September 30,
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Revenues
 
$
48,809
 
$
67,613
 
Operating costs and expenses:
 
 
 
 
 
 
 
Direct operating costs
 
 
38,183
 
 
44,267
 
Selling and administrative expenses
 
 
12,972
 
 
16,819
 
Impairment charge
 
 
5,524
 
 
-
 
Interest income, net
 
 
(314)
 
 
(212)
 
Totals
 
 
56,365
 
 
60,874
 
Income (loss) before income taxes
 
 
(7,556)
 
 
6,739
 
Provision for income taxes
 
 
5,809
 
 
1,409
 
Net income (loss)
 
 
(13,365)
 
 
5,330
 
Loss attributable to non-controlling interests
 
 
1,869
 
 
1,479
 
Net income (loss) attributable to Innodata Inc. and Subsidiaries
 
$
(11,496)
 
$
6,809
 
 
 
 
 
 
 
 
 
Income (loss) per share attributable to Innodata Inc. and Subsidiaries:
 
 
 
 
 
 
 
Basic
 
$
(0.46)
 
$
0.27
 
Diluted
 
$
(0.46)
 
$
0.26
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
 
 
24,977
 
 
24,808
 
Diluted
 
 
24,977
 
 
26,226
 
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
Net income (loss)
 
$
(13,365)
 
$
5,330
 
Pension liability adjustment, net of taxes
 
 
54
 
 
26
 
Change in fair value of derivatives, net of taxes of $(46) and $756 for the nine months ended September 30, 2013 and 2012, respectively
 
 
(1,805)
 
 
1,287
 
Other Comprehensive income (loss)
 
 
(1,751)
 
 
1,313
 
Total Comprehensive income (loss)
 
 
(15,116)
 
 
6,643
 
Comprehensive loss attributed to non-controlling interests
 
 
1,869
 
 
1,479
 
Comprehensive income (loss) attributable to Innodata Inc. and Subsidiaries
 
$
(13,247)
 
$
8,122
 
 
See notes to condensed consolidated financial statements.
 
 
3

 
INNODATA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Nine Months Ended
 
 
 
September 30
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Cash flow from operating activities:
 
 
 
 
 
 
 
Net income (loss)
 
$
(13,365)
 
$
5,330
 
Adjustments to reconcile net income (loss) to net cash
     provided by operating activities:
 
 
 
 
 
 
 
Impairment charge
 
 
5,524
 
 
-
 
Depreciation and amortization
 
 
2,930
 
 
2,881
 
Stock-based compensation
 
 
725
 
 
819
 
Deferred income taxes
 
 
4,995
 
 
(58)
 
Pension cost
 
 
358
 
 
434
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable
 
 
3,512
 
 
4,207
 
Prepaid expenses and other current assets
 
 
183
 
 
416
 
Other assets
 
 
(226)
 
 
(608)
 
Accounts payable and accrued expenses
 
 
(885)
 
 
(661)
 
Accrued salaries, wages and related benefits
 
 
(1,467)
 
 
624
 
Restricted shares withheld for taxes
 
 
(31)
 
 
-
 
Income and other taxes
 
 
(771)
 
 
(264)
 
Net cash provided by operating activities
 
 
1,482
 
 
13,120
 
 
 
 
 
 
 
 
 
Cash flow from investing activities:
 
 
 
 
 
 
 
Capital expenditures
 
 
(3,473)
 
 
(5,698)
 
Sale of investments – other
 
 
1,976
 
 
5,828
 
Net cash provided by (used in) investing activities
 
 
(1,497)
 
 
130
 
 
 
 
 
 
 
 
 
Cash flow from financing activities:
 
 
 
 
 
 
 
Proceeds from exercise of stock options
 
 
73
 
 
574
 
Payment of long term obligations
 
 
(379)
 
 
(131)
 
Net cash provided by (used in) financing activities
 
 
(306)
 
 
443
 
 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
 
(321)
 
 
13,693
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, beginning of period
 
 
25,425
 
 
11,389
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, end of period
 
$
25,104
 
$
25,082
 
 
 
 
 
 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
 
 
 
 
Cash paid for income taxes
 
$
1,129
 
$
1,389
 
 
See notes to condensed consolidated financial statements
 
 
4

 
INNODATA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
(In thousands)
 
 
 
Common Stock
 
 
 
 
Additional 
Paid-in
 
Retained
 
Accumulated
Other
Comprehensive
 
Treasury
 
 
 
 
 
 
Shares
 
Amount
 
Capital
 
Earnings
 
Income (Loss)
 
Stock
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
January 1, 2013
 
24,889
 
$
264
 
$
22,140
 
$
32,356
 
$
37
 
$
(4,288)
 
$
50,509
 
Net loss
 
-
 
 
-
 
 
-
 
 
(11,496)
 
 
-
 
 
-
 
 
(11,496)
 
Stock-based compensation
 
-
 
 
-
 
 
725
 
 
-
 
 
-
 
 
-
 
 
725
 
Issuance of common stock upon exercise of stock options
 
164
 
 
2
 
 
70
 
 
-
 
 
-
 
 
-
 
 
72
 
Restricted shares withheld for taxes
 
(3)
 
 
-
 
 
(31)
 
 
-
 
 
-
 
 
-
 
 
(31)
 
Acquisition of non-controlling interest
 
-
 
 
-
 
 
(151)
 
 
-
 
 
-
 
 
-
 
 
(151)
 
Pension liability adjustments, net of taxes
 
-
 
 
-
 
 
-
 
 
-
 
 
54
 
 
-
 
 
54
 
Change in fair value of derivatives, net of taxes
 
-
 
 
-
 
 
-
 
 
-
 
 
(1,805)
 
 
-
 
 
(1,805)
 
September 30, 2013
 
25,050
 
$
266
 
$
22,753
 
$
20,860
 
$
(1,714)
 
$
(4,288)
 
$
37,877
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
January 1, 2012
 
24,691
 
$
262
 
$
21,338
 
$
24,883
 
$
(1,027)
 
$
(4,288)
 
$
41,168
 
Net income
 
-
 
 
-
 
 
-
 
 
6,809
 
 
-
 
 
-
 
 
6,809
 
Stock-based compensation
 
-
 
 
-
 
 
819
 
 
-
 
 
-
 
 
-
 
 
819
 
Issuance of common stock upon exercise of stock options
 
202
 
 
2
 
 
572
 
 
-
 
 
-
 
 
-
 
 
574
 
Restricted shares withheld for taxes
 
(4)
 
 
-
 
 
-
 
 
-
 
 
-
 
 
-
 
 
-
 
Pension liability adjustments, net of taxes
 
-
 
 
-
 
 
-
 
 
-
 
 
26
 
 
-
 
 
26
 
Change in fair value of derivatives, net of taxes
 
-
 
 
-
 
 
-
 
 
-
 
 
1,287
 
 
-
 
 
1,287
 
September 30, 2012
 
24,889
 
$
264
 
$
22,729
 
$
31,692
 
$
286
 
$
(4,288)
 
$
50,683
 
 
See notes to condensed consolidated financial statements
 
 
5

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
1.
Description of Business and Summary of Significant Accounting Policies
 
Description of Business- Innodata Inc. and subsidiaries (the “Company”) is a global provider of business process, information technology and professional services that are focused on digital enablement. Innodata’s clients comprise several of the world’s leading digital retailers that sell digital content; preeminent publishers and other providers of online business information products; and enterprises in information-intensive industries (such as aerospace, defense, financial services, healthcare, high technology, insurance, and manufacturing) that create and manage large volumes of content to support their products or operations.
 
The Company operates in two reporting segments: Content Services (CS) and Innodata Advanced Data Solutions (IADS).
 
The Company’s CS segment provides solutions to digital retailers, information services companies, publishers and enterprises that have one or more of the following broad business requirements: development of digital content (including eBooks); development of new digital information products; and operational support of existing digital information products and systems.
 
The Company formed its IADS segment in mid-2011 to design and develop new capabilities to enable clients in the financial services, insurance, medical and healthcare sectors to improve decision-support through digital technologies. IADS operates through two subsidiaries. Synodex offers a range of services for healthcare, medical and insurance companies, and docGenix provides services to financial services institutions. As of September 30, 2013, Innodata owns 83% of Synodex and 94% of docGenix, both limited liability companies.
 
Basis of Presentation-The condensed consolidated financial statements for the interim periods included herein are unaudited; however, they contain all adjustments (consisting of only normal recurring adjustments) which, in the opinion of management, are necessary to present fairly the consolidated financial position of the Company as of September 30, 2013, and the results of its operations and comprehensive income (loss), cash flows and stockholders’ equity for the three and nine months ended September 30, 2013 and 2012.  The results of operations for the interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year.
 
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012, included in the Company's Annual Report on Form 10-K.  Unless otherwise noted, the accounting policies used in preparing these condensed consolidated financial statements are the same as those described in the December 31, 2012 consolidated financial statements.
 
Principles of Consolidation-The condensed consolidated financial statements include the accounts of Innodata Inc. and its wholly-owned subsidiaries and the Synodex and docGenix limited liability companies that are majority-owned by the Company.  The non-controlling interests in the Synodex and docGenix limited liability companies are accounted for in accordance with Financial Accounting Standards Board (FASB) non-controlling interest guidance.  All significant intercompany transactions and balances have been eliminated in consolidation.
 
 
6

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
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, 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, valuation of securities underlying stock-based compensation, litigation accruals, pension benefits, valuation of derivative instruments and estimated accruals for various tax exposures.
 
Recent Accounting Pronouncements- In the first quarter of 2013, the Company adopted changes issued by the FASB to the reporting of amounts reclassified out of accumulated other comprehensive income. These changes require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. These requirements are to be applied to each component of accumulated other comprehensive income. Other than the additional disclosure requirements, the adoption of these changes had no impact on the Company’s condensed consolidated financial statements.
 
In July 2013, the FASB issued guidance on presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This update clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In situations where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This accounting guidance is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. Retroactive application is permitted. The Company is currently evaluating the potential impact of this adoption on its condensed consolidated financial statements.

2.
Property and equipment
 
Property and equipment are stated at costs less accumulated depreciation and amortization (in thousands), and consist of the following:
 
 
 
September 30,
 
December 31,
 
 
 
2013
 
2012
 
Equipment
 
$
17,312
 
$
23,798
 
Software
 
 
4,035
 
 
7,583
 
Furniture and equipment
 
 
2,646
 
 
3,400
 
Leasehold improvements
 
 
6,094
 
 
7,362
 
Total
 
 
30,087
 
 
42,143
 
Less: accumulated depreciation and amortization
 
 
(23,756)
 
 
(31,487)
 
 
 
$
6,331
 
$
10,656
 
 
 
7

  
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
Depreciation and amortization expense of property and equipment was approximately $0.9 million and $0.8 million for the three months ended September 30, 2013 and 2012, respectively. Depreciation and amortization expense of property and equipment was approximately $2.4 million and $2.3 million for the nine months ended September 30, 2013 and 2012, respectively.
 
The Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. As a result in the third quarter of 2013, the Company evaluated the carrying value of the fixed assets of its Synodex subsidiary compared to its fair value and concluded that that the carrying value exceeds its fair value. This resulted in an impairment charge of $5.5 million for the three and nine months ended September 30, 2013.

3.
Income Taxes
 
The Company had unrecognized tax benefits of approximately $2.1 million at September 30, 2013 and $2.4 million at December 31, 2012.  The portion of unrecognized tax benefits relating to interest and penalties was approximately $0.7 million at both September 30, 2013 and December 31, 2012.  The unrecognized tax benefits as of September 30, 2013 and December 31, 2012, if recognized, would have an impact on the Company’s effective tax rate.
 
The following presents a roll-forward of the Company’s unrecognized tax benefits and associated interest for the nine months ended September 30, 2013 (amounts in thousands):
 
 
 
Unrecognized tax
benefits
 
Balance - January 1, 2013
 
$
2,350
 
Interest accrual
 
 
27
 
Foreign currency revaluation
 
 
(284)
 
Balance – September 30, 2013
 
$
2,093
 
 
The Company is subject to Federal income tax, as well as income tax in various states and foreign jurisdictions.  The Company is no longer subject to examination by Federal tax authorities for years prior to 2006 and by New Jersey tax authorities for years prior to 2012.  Various foreign subsidiaries currently have open tax years from 2003 through 2012.
 
The Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. The Company's U.S. entity has incurred losses primarily on account of the losses of Synodex. In assessing the realization of deferred tax assets, management considered whether it is more likely than not that all or some portion of the U.S. deferred tax assets will not be realizable. As the expectation of future taxable income resulting from Synodex cannot be predicted with certainty, the Company created a $7.1 million valuation allowance against all the U.S. deferred tax assets.  The Company also recorded a valuation allowance of $0.7 million on all deferred tax assets arising from unrealized losses on foreign currency forward contracts.
 
 
8

  
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
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 $259,000, including interest, through September 30, 2013, for the fiscal tax year ended March 31, 2003.  Management disagreed with the basis of the tax assessment and filed an appeal with the Appeal Officer against the assessment. In October 2010, the matter was resolved with a judgment in the Company’s favor. Under the Indian Income Tax Act, however, the income tax assessing officer has the right to appeal against the judgment passed by the Appeal Officer. In December 2010, the income tax assessing officer exercised this right, against which the Company has filed an application to defend the case, and the Company intends to contest it 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 2008 and 2009, the Indian subsidiary received a final tax assessment for the fiscal years ended March 31, 2005 and 2006 from the Indian Bureau of Taxation. The tax assessment amounted to $280,000 and $281,000, including interest through September 30, 2013, for the fiscal years ended March 31, 2005 and 2006, respectively. Management disagrees with the basis of these tax assessments, has filed an appeal against the assessments and is contesting them vigorously. In January 2012, the Indian subsidiary received a final tax assessment of approximately $1.0 million, including interest, for the fiscal year ended March 31, 2008, from the Indian Bureau of Taxation. Management disagrees with the basis of this tax assessment, and has filed an appeal against it. Due to this assessment, the Company recorded a tax provision amounting to $439,000 including interest through September 30, 2013. Based on recent experience and the current regulatory environment, management believes that the tax provision of $439,000 including interest is adequate. 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, 2009. The ultimate outcome was favorable, and there was no tax assessment imposed for the fiscal tax year ended March 31, 2009. The Indian Bureau of Taxation commenced an audit of this subsidiary’s income tax return for the fiscal year ended March 31, 2010. The ultimate outcome cannot be determined at this time. As the Company is continually subject to tax audits by the Indian Bureau of Taxation, the Company continuously assesses the likelihood of an unfavorable assessment for all fiscal years for which the Company has not been audited, and as of September 30, 2013, the Company recorded a tax provision amounting to $834,000 including interest.
 
In January 2013, one of the Company’s Philippine subsidiaries received an informal tax assessment from the Internal Revenue Service of the Philippines for an amount totaling $3.8 million for the year ended December 31, 2009. The Company disagreed with the basis of the informal tax assessment and contested it vigorously. The Company has not yet received a formal notice of this assessment and the statute of limitations expired on April 15, 2013, for formal notice of the assessment. Management believes that it is reasonably likely that it will be successful in contesting an assessment, if any. Accordingly, the Company recorded no tax provision on said informal tax assessment. The Company will continuously monitor this matter and will record an appropriate tax provision in the event there is any change in circumstances.

4.
Commitments and Contingencies
 
Line of Credit-The Company has a $15.0 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 0.5%, or LIBOR plus 2.5%.  The line, which expires in June 2014, is collateralized by the Company’s accounts receivable.  The Company has no outstanding obligations under this credit line as of September 30, 2013.
 
Litigation-In 2008, the Supreme Court of the Republic of the Philippines 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 Inc., that orders the reinstatement of certain former employees of the subsidiary to their former positions and also orders the payment of back wages and benefits that aggregate approximately $8.5 million. Based on consultation with legal counsel, the Company believes that recovery against the Company is unlikely.
 
 
 
9

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
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 action 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.
 
The Company’s legal reserves related to legal proceedings and claims are based on a determination of whether or not a loss is probable. The Company reviews outstanding proceedings and claims with external counsel to assess probability and estimates of loss. The reserves are adjusted if necessary. While the Company intends to defend these matters vigorously, adverse outcomes that it estimates could reach approximately $300,000 in the aggregate beyond recorded amounts are reasonably possible. If circumstances change, the Company may be required to record adjustments that could be material to its reported financial condition and results of operations.

5.
Stock Options
 
The Company adopted, with stockholder approval, the Innodata Inc. 2013 Stock Plan (the “2013 Plan”). The maximum number of shares of common stock that may be delivered, purchased or used for reference purposes with respect to awards granted under the 2013 Plan is 1,041,096 shares, plus any shares subject to an award or portion of any award under the Innodata Isogen, Inc. 2009 Stock Plan, as amended and restated (the “Prior Plan”) that were outstanding as of June 4, 2013 that expire or terminate unexercised, become unexercisable or are forfeited or otherwise terminated, surrendered or canceled as to any shares without the delivery of shares of stock or other consideration. Shares of stock subject to options or stock appreciation rights (“SARs”) granted under the 2013 Plan count against the share reserve as one share for every one share subject to such option or SAR and shares subject to any other type of award granted under the 2013 Plan count against the share reserve as two shares for every one share subject to such award. If any award, or portion of an award, under the 2013 Plan expires or terminates unexercised, becomes unexercisable or is forfeited or otherwise terminated, surrendered or canceled as to any shares without the delivery of shares of stock or other consideration, the shares subject to such award will thereafter be available for further awards under the 2013 Plan as provided in the next sentence. Shares of stock that again become available for awards pursuant to the expiration, termination, forfeiture or cancellation of any award (other than an option or SAR) granted under the 2013 Plan, or of any award (other than an option or SAR) granted after March 31, 2011 under the Prior Plan, will be added back as two shares for every one share subject to such award or Prior Plan award. All other awards under the 2013 Plan and all other awards under the Prior Plan will be added back as one share for every one share subject to such award or Prior Plan award. The number of shares used for reference purposes in connection with these awards will be considered "delivered" for purposes of computing the maximum number of shares that may be delivered under the Plan.
 
A summary of option activity under the Company’s stock option plans as of September 30, 2013, and changes during the period then ended, is presented below:
 
 
10

  
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
 
 
Number of Shares
 
Weighted-Average
Exercise Price
 
Weighted-Average Remaining
Contractual Term (years)
 
Aggregate Intrinsic
Value
 
 
 
 
 
 
 
 
 
 
 
 
 
Outstanding at January 1, 2013
 
2,986,057
 
$
2.75
 
 
 
 
 
 
Granted
 
1,014,022
 
 
3.39
 
 
 
 
 
 
Exercised
 
(201,500)
 
 
0.96
 
 
 
 
 
 
Forfeited/Expired
 
(433,444)
 
 
2.99
 
 
 
 
 
 
Outstanding at September 30, 2013
 
3,365,135
 
$
3.02
 
4.49
 
$
381,872
 
Exercisable at September 30, 2013
 
1,100,057
 
$
3.00
 
1.87
 
$
352,722
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested and expected to vest at
 
 
 
 
 
 
 
 
 
 
 
September 30, 2013
 
3,365,135
 
$
3.02
 
4.49
 
$
381,872
 
 
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:
 
 
 
Nine months ended
 
 
 
September 30,
 
 
 
2013
 
 
2012
 
 
 
 
 
 
 
 
 
 
Weighted average fair value of options granted
 
$
1.89
 
 
$
2.37
 
 
 
 
 
 
 
 
 
 
Risk-free interest rate
 
 
0.76
%
 
 
0.65
%
Expected life (years)
 
 
5-7
 
 
 
5
 
Expected volatility factor
 
 
67.37
%
 
 
68.61
%
Expected dividends
 
 
-
 
 
 
-
 
 
A summary of restricted shares under the Company’s stock option plans as of September 30, 2013, and changes during the period then ended, are presented below:
 
 
 
Number of Shares
 
Weighted-Average Grant
Date Fair Value
 
 
 
 
 
 
 
 
Unvested at January 1, 2013
 
32,500
 
$
3.14
 
Granted
 
-
 
 
-
 
Vested
 
(7,500)
 
 
2.59
 
Forfeited/Expired
 
-
 
 
-
 
Unvested at September 30, 2013
 
25,000
 
$
3.31
 
 
The total compensation cost related to non-vested stock awards not yet recognized as of September 30, 2013 totaled approximately $2.0 million. The weighted-average period over which these costs will be recognized is twenty-five months.
 
The stock-based compensation expense related to the Company’s various stock awards was allocated as follows (in thousands):
 
 
11

   
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Direct operating costs
 
$
76
 
$
25
 
$
205
 
$
70
 
Selling and administrative expenses
 
 
160
 
 
212
 
 
520
 
 
749
 
Total stock-based compensation
 
$
236
 
$
237
 
$
725
 
$
819
 

6.
Comprehensive Income (loss)
 
Accumulated other comprehensive income (loss), as reflected in the condensed consolidated balance sheets, consists of pension liability adjustments, net of taxes, and changes in fair value of derivatives, net of taxes.  The components of accumulated other comprehensive income (loss) as of September 30, 2013, and reclassifications out of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2013 and 2012, were as follows (net of tax):
 
 
 
 
Pension Liability
 
Fair value of
 
Accumulated Other
 
 
 
Adjustment
 
Derivatives
 
Comprehensive Income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Balance at June 1, 2013
 
$
(7)
 
$
(1,150)
 
$
(1,157)
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
Net change from periodic revaluations, net of taxes
 
 
-
 
 
301
 
 
301
 
Total other comprehensive income (loss) before reclassifications, net of taxes
 
 
(7)
 
 
(849)
 
 
(856)
 
Net amount reclassified to earnings
 
 
18
 
 
(876)
 
 
(858)
 
Balance at September 30, 2013
 
$
11
 
$
(1,725)
 
$
(1,714)
 
 
 
 
Pension Liability
 
Fair value of
 
Accumulated Other
 
 
 
Adjustment
 
Derivatives
 
Comprehensive Income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Balance at June 1, 2012
 
$
113
 
$
(362)
 
$
(249)
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
Net change from periodic revaluations, net of taxes
 
 
-
 
 
969
 
 
969
 
Total other comprehensive income (loss) before reclassifications, net of taxes
 
 
113
 
 
607
 
 
720
 
Net amount reclassified to earnings
 
 
8
 
 
(442)
 
 
(434)
 
Balance at September 30, 2012
 
$
121
 
$
165
 
$
286
 
 
 
 
Pension Liability
 
Fair value of
 
Accumulated Other
 
 
 
Adjustment
 
Derivatives
 
Comprehensive Income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
 
$
(43)
 
$
80
 
$
37
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
Net change from periodic revaluations, net of taxes
 
 
-
 
 
(1,198)
 
 
(1,198)
 
Total other comprehensive income (loss) before reclassifications, net of taxes
 
 
(43)
 
 
(1,118)
 
 
(1,161)
 
Net amount reclassified to earnings
 
 
54
 
 
(607)
 
 
(553)
 
Balance at September 30, 2013
 
$
11
 
$
(1,725)
 
$
(1,714)
 
 
 
 
Pension Liability
 
Fair value of
 
Accumulated Other
 
 
 
Adjustment
 
Derivatives
 
Comprehensive Income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2012
 
$
95
 
$
(1,122)
 
$
(1,027)
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
Net change from periodic revaluations, net of taxes
 
 
-
 
 
2,402
 
 
2,402
 
Total other comprehensive income (loss) before reclassifications, net of taxes
 
 
95
 
 
1,280
 
 
1,375
 
Net amount reclassified to earnings
 
 
26
 
 
(1,115)
 
 
(1,089)
 
Balance at September 30, 2012
 
$
121
 
$
165
 
$
286
 
 
All reclassifications out of accumulated other comprehensive income (loss) had an impact on direct operating costs in the condensed consolidated statement of operations and comprehensive income (loss).
 
 
12

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
7.         Segment Reporting and Concentrations
 
The Company’s operations are classified into two reportable segments: Content Services (CS) and Innodata Advanced Data Solutions (IADS).
 
The CS segment provides solutions to digital retailers, information services companies, publishers and enterprises that have one or more of the following broad business requirements: development of digital content (including eBooks); development of new digital information products; and operational support of existing digital information products and systems.
 
In the second quarter of 2011, the Company launched its IADS segment to perform advanced data analysis. IADS operates through two subsidiaries: Synodex and docGenix. Synodex offers a range of data analysis services in the healthcare, medical and insurance areas. DocGenix provides services to certain financial services institutions.
 
A significant portion of the Company’s revenues are generated from its production facilities in the Philippines, India, Sri Lanka and Israel.
 
Revenues from external clients and segment operating profit (loss), and other reportable segment information are as follows (in thousands):
 
 
 
Three months ended
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
Content Services
 
$
15,591
 
$
19,670
 
$
47,867
 
$
66,860
 
IADS
 
 
155
 
 
40
 
 
942
 
 
753
 
Total consolidated
 
$
15,746
 
$
19,710
 
$
48,809
 
$
67,613
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) before provision for income taxes:(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Content Services
 
$
1,934
 
$
2,890
 
$
4,015
 
$
12,785
 
IADS
 
 
(7,620)
 
 
(1,890)
 
 
(11,571)
 
 
(6,046)
 
Total consolidated
 
$
(5,686)
 
$
1,000
 
$
(7,556)
 
$
6,739
 
 
 
 
 
September 30, 2013
 
December 31, 2012
 
Total assets:
 
 
 
 
 
 
 
 
Content Services
 
 
$
49,473
 
$
59,908
 
IADS
 
 
 
832
 
 
6,273
 
Total consolidated
 
 
$
50,305
 
$
66,181
 
 
(1) Before elimination of any inter-segment profits.
 
Income (loss) before provision for (benefit from) income taxes for CS and IADS was $1.4 million and $(7.1) million, respectively, for the three months ended September 30, 2013, after eliminating inter-segment profits. Income (loss) before provision for (benefit from) income taxes for CS and IADS was $2.7 million and $(10.3) million, respectively, for the nine months ended September 30, 2013, after eliminating inter-segment profits.
 
 
13

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
Income (loss) before provision for income taxes for CS and IADS was $2.3 million and $(1.3) million, respectively, for the three months ended September 30, 2012, after eliminating inter-segment profits. Income (loss) before provision for income taxes for CS and IADS was $11.4 million and $(4.7) million, respectively, for the nine months ended September 30, 2012, after eliminating inter-segment profits.
 
The following table summarizes revenues by geographic region (determined based upon customer’s domicile) (in thousands):
 
 
 
Three months ended
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
Unites States
 
$
9,846
 
$
14,134
 
$
32,749
 
$
51,981
 
United Kingdom
 
 
2,222
 
 
2,355
 
 
5,884
 
 
6,505
 
The Netherlands
 
 
2,364
 
 
2,072
 
 
6,574
 
 
5,549
 
Other - principally Europe
 
 
1,314
 
 
1,149
 
 
3,602
 
 
3,578
 
 
 
$
15,746
 
$
19,710
 
$
48,809
 
$
67,613
 
 
Long-lived assets as of September 30, 2013 and December 31, 2012, respectively, by geographic region, are comprised of (in thousands):
 
 
 
September 30,
 
December 31,
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
United States
 
$
1,201
 
$
3,978
 
 
 
 
 
 
 
 
 
Foreign countries:
 
 
 
 
 
 
 
Philippines
 
 
1,873
 
 
1,424
 
India
 
 
2,846
 
 
4,926
 
Sri Lanka
 
 
1,041
 
 
931
 
Israel
 
 
45
 
 
72
 
Total foreign
 
 
5,805
 
 
7,353
 
 
 
$
7,006
 
$
11,331
 
 
Three clients generated approximately 42% and 46% of our total revenues for the three months ended September 30, 2013 and 2012, respectively. One additional client accounted for 11% of our total revenues for the three months ended September 30, 2013 but accounted for less than 10% of our total revenues for the three months ended September 30, 2012. No other client accounted for 10% or more of total revenues during these periods. Further, for the three months ended September 30, 2013 and 2012, revenues from non-U.S. clients accounted for 37% and 28%, respectively, of our total revenues.
 
Two clients generated approximately 27% and 44% of our total revenues for the nine months ended September 30, 2013 and 2012, respectively. Two additional clients accounted for 25% of our total revenues for the nine months ended September 30, 2013 but each accounted for less than 10% of our total revenues for the nine months ended September 30, 2012. No other client accounted for 10% or more of total revenues during these periods. Further, for the nine months ended September 30, 2013 and 2012, revenues from non-U.S. clients accounted for 33% and 23%, respectively, of our total revenues.
 
 
14

 
 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
As of September 30, 2013, approximately 35% of the Company's accounts receivable was from foreign (principally European) clients and 62% of accounts receivable was due from four clients. As of December 31, 2012, approximately 30% of the Company's accounts receivable was from foreign (principally European) clients and 55% of accounts receivable was due from four clients.

8.
Income (Loss) Per Share
 
 
 
Three months ended
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
 
(in thousands, except per share amounts)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to
 
 
 
 
 
 
 
 
 
 
 
 
 
Innodata Inc. and Subsidiaries
 
$
(11,692)
 
$
1,289
 
$
(11,496)
 
$
6,809
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
25,053
 
 
24,883
 
 
24,977
 
 
24,808
 
Dilutive effect of outstanding options
 
 
-
 
 
2,563
 
 
-
 
 
1,418
 
Adjusted for dilution computation
 
 
25,053
 
 
27,446
 
 
24,977
 
 
26,226
 
 
Basic income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. 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. For those securities that are not convertible into a class of common stock, the “two-class” method of computing income per share is used.
 
Options to purchase 1.8 million shares and 0.1 million shares of common stock for the three months ended September 30, 2013 and 2012, respectively, were outstanding but not included in the computation of diluted income (loss) per share, because the options exercise price was greater than the average market price of the common shares and, therefore, the effect would have been antidilutive. In addition, diluted net income (loss) per share for the three months does not include 1.6 million potential common shares derived from the exercise of stock options because as a result of the Company’s incurring losses, their effect would have been antidilutive.
 
Options to purchase 1.7 million shares and 0.1 million shares of common stock for the nine months ended September 30, 2013 and 2012, respectively, were outstanding but not included in the computation of diluted income (loss) 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.

9.
Derivatives
 
The Company conducts a large portion of its operations in international markets that subject it to foreign currency fluctuations. The most significant foreign currency exposures occur when revenue and associated accounts receivable are collected in one currency and expenses to generate that revenue are incurred in another currency. The Company’s primary exchange rate exposure relates to payroll, other payroll costs and operating expenses in the Philippines, India, Sri Lanka and Israel.
 
 
15

 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
To manage its exposure to fluctuations in foreign currency exchange rates, the Company entered into foreign currency forward contracts, authorized under Company policies, with counterparties that were highly rated financial institutions. The Company utilized non-deliverable forward contracts expiring within twelve months to reduce its foreign currency risk.
 
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company does not hold or issue derivatives for trading purposes. All derivatives are recognized at their fair value and classified based on the instrument’s maturity date. The total notional amount for outstanding derivatives as of September 30, 2013 and December 31, 2012 was $26 million and $32.3 million, respectively, which is comprised of cash flow hedges denominated in U.S. dollars.
 
The following table presents the fair value of derivative instruments included within the condensed consolidated balance sheets as of September 30, 2013 and December 31, 2012 (in thousands):
 
 
 
Balance Sheet Location
 
Fair Value
 
 
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Prepaid expenses and
 
 
 
 
 
 
 
Foreign currency forward contracts
 
other current assets
 
$
-
 
$
125
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
Accrued expenses
 
$
1,726
 
$
-
 
 
The effects of foreign currency forward contracts designated as cash flow hedges on the Company’s condensed consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2013 and 2012, respectively, were as follows (in thousands):
 
 
 
Three months ended
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI (1)
 
$
(775)
 
$
675
 
$
(2,458)
 
$
928
 
Net loss reclassified from accumulated OCI into income (2)
 
$
(876)
 
$
(443)
 
$
(607)
 
$
(1,115)
 
Net gain (loss) recognized in income (3)
 
$
 
$
 
$
 
$
 
 
(1) Net change in the fair value of the effective portion classified in other comprehensive income ("OCI").
(2) Effective portion classified as direct operating costs.
(3) There were no ineffective portions for the periods presented.
 
 
16

 
 
 
INNODATA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
 
 
10.          Financial Instruments
 
The carrying amounts of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximated their fair value as of September 30, 2013 and December 31, 2012, because of the relative short maturity of these instruments.
 
Fair Value Measurements and Disclosures” defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
 
The accounting standard 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.
   
The following table sets forth the assets and liabilities as of September 30, 2013 and December 31, 2012 that the Company measured at fair value, on a recurring basis by level, within the fair value hierarchy (in thousands). As required by the standard, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement.
 
September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivatives
 
$
 
$
1,726
 
$
 
 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
 
 
 
Derivatives
 
$
 
$
125
 
$
 
 
                The Level 2 assets and liabilities contain foreign currency forward contracts. Fair value is determined based on the observable market transactions of spot and forward rates. The fair value of these contracts as of September 30, 2013 is included in accrued expenses and December 31, 2012 is included in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheets.
 
The Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. As a result in the third quarter of 2013, the Company evaluated the carrying value of the fixed assets of its Synodex subsidiary compared to its fair value and concluded that the carrying value exceeds its fair value. This resulted in an impairment charge of $5.5 million for the three and nine months ended September 30, 2013. The fixed assets were measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3).
 
 
17

 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 
Disclosures in this Form 10-Q contain certain forward-looking statements, including without limitation, statements concerning our operations, economic performance, and financial condition.  These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “project,” “head start,” "believe," "expect," “should,” "anticipate," "indicate," "point to," “forecast,” “likely” 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, that contracts could be terminated by clients, projected or committed volumes of work may not materialize; that our Innodata Advanced Data Solutions segment (“IADS”) is a new venture that has incurred losses since inception and has not reported any substantial revenues, and the Company has written off the assets of IADS and is currently continuing to invest in IADS; the primarily at-will nature of the contracts with our clients and the ability of our clients to reduce, delay or cancel projects; continuing Content Services segment revenue concentration in a limited number of clients; continuing Content Services segment reliance on project-based work; inability to replace projects that are completed, canceled 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, joint venture and strategic investments; potential undiscovered liabilities of companies that we acquire; changes in our business or growth strategy; the emergence of new or growing competitors; various other competitive and technological factors; and other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission.
 
Our actual results could differ materially from the results referred to in the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the results referred to in the forward-looking statements contained in this Form 10-Q will occur.
 
We undertake no obligation to update or review any guidance or changes in the status of client contracts, client relationships, or other forward-looking information, whether as a result of new information, future developments or otherwise.
 
Business Overview
 
Innodata (NASDAQ: INOD) is a global provider of business process, information technology and professional services that are focused on digital enablement. Our clients comprise several of the world’s leading digital retailers that sell digital content; preeminent publishers and other providers of online business information products; and enterprises in information-intensive industries (such as aerospace, defense, financial services, healthcare, high technology, insurance, and manufacturing) that create and manage large volumes of content to support their products or operations.
 
We operate in two reporting segments: Content Services (CS) and Innodata Advanced Data Solutions (IADS).
 
 
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Our CS segment provides solutions to digital retailers, information services companies, publishers and enterprises that have one or more of the following broad business requirements: development of digital content (including eBooks); development of new digital information products; and operational support of existing digital information products and systems.
 
Many of our clients are driving or are responding to rapid and fundamental changes in the way end users discover, consume and create published information. For some of our publishing and information services clients, this means transforming information products from print to digital; for others, it means migrating already-digital products from web-only distribution to multiple-channel distribution that includes mobile and tablet devices and incorporates mobility, social platform and semantic search; and for others still it means re-tooling pure search-based information products into workflow-embedded analytical tools that combine content with software to enable context-aware decision-making; and for a select number of our information services clients, it means embracing the content-as-a-service model to integrate content with other tools, applications and data. Each of these transformations requires shifts in products, as well as the technology and the operations that support them.
 
We are one of the largest producers of eBooks, serving four of the five leading digital retailers of eBooks as well as 80 leading trade, education and professional publishers that sell eBooks. We manufacture both standard eBooks and interactive eBooks in a variety of formats (including EPUB, Mobi and Kindle) and in 12 major languages (including Japanese and Chinese). In addition, we distribute eBooks on behalf of publishers and authors to more than 25 eBook retailers across North America, the United Kingdom, Australia and 24 countries in the European Union. We have produced over one million eBooks since the third quarter of 2011.
 
We help our clients develop high-value information products and knowledge repositories. Our clients include four of the ten largest information industry companies in the world, spanning financial, legal, healthcare and scientific information.
 
We formed our IADS segment in mid-2011 to design and develop new capabilities to enable clients in the financial services, insurance, medical and healthcare sectors to improve decision-support through digital technologies.. IADS operates through two subsidiaries. Synodex offers a range of services for healthcare, medical and insurance companies, and docGenix provides services to certain financial services institutions. As of September 30, 2013, Innodata owns 83% of Synodex and 94% of docGenix, both limited liability companies.
 
Each of our segments is organized and managed around three vectors: a vertical industry focus, a horizontal service/process focus, and a supportive operations focus.
 
The vertically-aligned groups understand our clients’ businesses and strategic initiatives.  The vertical group for each particular industry includes experts hired from that industry.
 
Our horizontal service/process-aligned groups include engineering personnel and delivery personnel.  Our engineering teams are responsible for creating secure and efficient custom workflows and integrating proprietary and third-party technologies 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. 
 
Our globally distributed delivery personnel are responsible for executing our client engagements in accordance with service-level agreements.  We deliver services from facilities in the United States, India, the Philippines, Sri Lanka and Israel.
 
 
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Other support groups are responsible for managing diverse enabling functions including human resources, organizational development, network and communications technology infrastructure support and physical infrastructure and facilities management. 
 
Our sales staff, program managers and consultants operate primarily from our North American offices, European locations, as well as from client sites.
 
Revenues
 
We price our services based on the quantity delivered or resources utilized, and we recognize revenue in the period in which the services are performed and delivered. 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.
 
We consider standard accounting criteria for determining whether to report revenue gross as a principal versus net as an agent.  Factors considered include whether we are the primary obligor, have risks and rewards of ownership, and bear the risk that a client may not pay for the services performed.  If there are circumstances where the above criteria are not met and therefore we are not the principal in providing services, amounts received from clients are presented net of payments in the condensed consolidated statements of operations and comprehensive income (loss).
 
Revenues include reimbursement of out-of-pocket expenses, with the corresponding out-of-pocket expenses included in direct operating costs.  
 
Direct Operating Costs
 
Direct operating costs consist of direct payroll, occupancy costs, depreciation and amortization, travel, telecommunications, computer services and supplies, realized gain (loss) on forward contracts, foreign currency revaluation gain (loss), and other direct expenses that are incurred in providing services to our clients. 
 
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
 
Three Months Ended September 30, 2013 and 2012
 
Revenues
 
Total revenues were $15.7 million for the three months ended September 30, 2013 compared to $19.7 million for the three months ended September 30, 2012, a decline of $4 million or approximately 20%. Revenues from the CS segment were $15.5 million and $19.7 million for the three months ended September 30, 2013 and 2012, respectively, a decline of $4.2 million or approximately 21%. This decline is principally attributable to a reduction in eBook-related services that we performed for one of our significant clients.  Revenues from the IADS segment were $0.2 million for the three months ended September 30, 2013.
 
 
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Three clients generated approximately 42% and 46% of our total revenues for the three months ended September 30, 2013 and 2012, respectively.  One additional client accounted for 11% of our total revenues for the three months ended September 30, 2013 but accounted for less than 10% of our total revenues for the three months ended September 30, 2012.  No other client accounted for 10% or more of total revenues during these periods.  Further, for the three months ended September 30, 2013 and 2012, revenues from non-U.S. clients accounted for 37% and 28%, respectively, of our total revenues.
 
Direct Operating Costs
 
Direct operating costs were $12 million and $13.5 million for the three months ended September 30, 2013 and 2012, respectively, a decline of $1.5 million or 11%. Direct operating costs for the CS segment were $10.6 million and $12.9 million for the three months ended September 30, 2013 and 2012, respectively, a decline of $2.3 million or 18%. Direct operating costs for the IADS segment were $1.4 million and $0.6 million for the respective periods, net of intersegment profits, an increase of $0.8 million.            
 
Direct operating costs as a percentage of total revenues increased to 76% for the three months ended September 30, 2013 compared to 69% for the three months ended September 30, 2012. Direct operating costs for the CS segment as a percentage of CS segment revenues were 68% for the three months ended September 30, 2013 compared to 66% for the three months ended September 30, 2012.
 
The decline in direct operating costs for the CS segment was principally attributable to a decrease in production headcount due to a decline in CS revenues; however, direct operating costs as a percentage of CS segment revenues have increased. Since our direct operating costs are comprised of both fixed and variable costs, a decline in revenues does not translate into a proportionate decline in direct operating costs.
 
Direct operating costs for the IADS segment represents certain production costs for initial engagements, including pilot engagements, and facility overhead costs for our new delivery center in Asia.
 
Impairment Charge
 
Our Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. As a result in the third quarter of 2013, we evaluated the carrying value of the fixed assets of our Synodex subsidiary compared to its fair value and concluded that that the carrying value exceeds its fair value. This resulted in an impairment charge of $5.5 million for the three months ended September 30, 2013.
 
Selling and Administrative Expenses
 
Selling and administrative expenses were $4.0 million, or 25% as a percentage of total revenues during the three months ended September 30, 2013, and $5.2 million, or approximately 27% as a percentage of total revenues for the three months ended September 30, 2012, and represents a decrease of $1.2 million or approximately 24%. Selling and administrative expenses for the CS segment were $3.6 million and $4.6 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $0.4 million and $0.7 million, net of intersegment profits.
 
We restructured our operations over the past few quarters which resulted in cost savings in the third quarter of 2013. This led to a decline in selling and administrative expenses for the CS segment during the three months ended September 30, 2013 compared to the three months ended September 30, 2012.
 
 
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Selling and administrative expenses for the CS segment as a percentage of CS segment revenues was 23% for both the three months ended September 30, 2013 and September 30, 2012.
 
The $0.3 million decrease in selling and administrative expenses for the IADS segment is primarily attributable to compensation costs of an executive who left the company at the end of 2012.
 
Income Taxes
 
Our Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. Our U.S. entity incurred losses primarily on account of the losses of Synodex. In assessing the realization of deferred tax assets, we considered whether it is more likely than not that all or some portion of the U.S. deferred tax assets will not be realizable. As the expectation of future taxable income resulting from Synodex cannot be predicted with certainty, we created a $7.1 million valuation allowance against all the U.S. deferred tax assets. The Company also recorded a valuation allowance of $0.7 million on all deferred tax assets arising from unrealized losses on foreign currency forward contracts.
 
For the three months ended September 30, 2013, we recorded a provision for income taxes in accordance with local tax regulations for our foreign subsidiaries. Some of our foreign subsidiaries are subject to tax holidays or preferential tax rates which reduces our overall effective tax rate when compared to the U.S. statutory tax rate. In addition, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.
 
For the three months ended September 30, 2012, we recorded a provision for income taxes for the U.S. entity and certain, but not all, of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates, thereby lowering our overall effective tax rate compared to the U.S. statutory tax rate. In addition, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.
 
Net Income (Loss)
 
We generated a net loss of $11.7 million in the three months ended September 30, 2013 compared to net income of $1.3 million in the three months ended September 30, 2012.  Net loss for the CS segment was $4.6 million for the three months ended September 30, 2013, compared to net income of $2.6 million for the three months ended September 30, 2012, net of intersegment profits. The change was primarily attributable to the $7.1 million valuation allowance  referred to in “Income Taxes” and a decline in gross margins resulting from lower revenues offset by a decline in selling and administrative expenses. Net loss for the IADS segment was $7.1 million for the three months ended September 30, 2013 compared to $1.3 million for the three months ended September 30, 2012, net of intersegment profits. The increase in net loss was primarily on account of the $5.5 million impairment charge for our Synodex subsidiary referred to in “Impairment Charge” in addition to continuing losses from operations.
 
 
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Nine Months Ended September 30, 2013 and 2012
 
Revenues
 
Total revenues were $48.8 million for the nine months ended September 30, 2013 compared to $67.6 million for the nine months ended September 30, 2012, a decline of $18.8 million or approximately 28%. Revenues from the CS segment were $47.9 million and $66.8 million for the nine months ended September 30, 2013 and 2012, respectively, a decline of $18.9 million or approximately 28%. This decline is principally attributable to a reduction in eBook-related services that we performed for one of our significant clients.  Revenues from the IADS segment were $0.9 million and $0.8 million for the nine months ended September 30, 2013 and 2012, respectively, most of which were attributable to the first half of 2013. 
 
Two clients generated approximately 27% and 44% of our total revenues for the nine months ended September 30, 2013 and 2012, respectively.  Two additional clients accounted for 25% of our total revenues for the nine months ended September 30, 2013 but each accounted for less than 10% of our total revenues for the nine months ended September 30, 2012.  No other client accounted for 10% or more of total revenues during these periods.  Further, for the nine months ended September 30, 2013 and 2012, revenues from non-U.S. clients accounted for 33% and 23%, respectively, of our total revenues.
 
Direct Operating Costs
 
Direct operating costs were $38.2 million and $44.3 million for the nine months ended September 30, 2013 and 2012, respectively, a decline of $6.1 million or approximately 14%. Direct operating costs for the CS segment were $34.2 million and $41.1 million for the nine months ended September 30, 2013 and 2012, respectively, a decline of $6.9 million or approximately 17%. Direct operating costs for the IADS segment were $4.0 million and $3.2 million for the respective periods, net of intersegment profits.     
 
Direct operating costs as a percentage of total revenues increased to 78% for the nine months ended September 30, 2013 compared to 65% for the nine months ended September 30, 2012. Direct operating costs for the CS segment as a percentage of CS segment revenues were 71% for the nine months ended September 30, 2013 compared to 62% for the nine months ended September 30, 2012.
 
The decline in direct operating costs for the CS segment was principally attributable to a decrease in production headcount due to a decline in CS revenues; however, direct operating costs as a percentage of CS segment revenues have increased. Since our direct operating costs are comprised of both fixed and variable costs, a decline in revenues does not translate into a proportionate decline in direct operating costs.
 
Direct operating costs for the IADS segment represents certain production costs for initial engagements, some of which have not generated follow-on engagements and some of which have not generated adequate revenues, and including pilot engagements, and facility overhead costs for our new delivery center in Asia.
 
Impairment Charge
 
Our Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. As a result in the third quarter of 2013, we evaluated the carrying value of the fixed assets of our Synodex subsidiary compared to its fair value and concluded that that the carrying value exceeds its fair value. This resulted in an impairment charge of $5.5 million for the nine months ended September 30, 2013.
 
 
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Selling and Administrative Expenses
 
Selling and administrative expenses were approximately $13.0 million, or approximately 27% as a percentage of total revenues during the nine months ended September 30, 2013, and $16.8 million, or 25% as a percentage of total revenues for the nine months ended September 30, 2012, and represents a decrease of $3.8 million or approximately 23%. Selling and administrative expenses for the CS segment were $11.3 million and $14.5 million in these respective periods. Selling and administrative expenses for the IADS segment for the respective periods were $1.7 million and $2.3 million, net of intersegment profits.
 
We restructured our operations over the past few quarters which resulted in cost savings in the third quarter of 2013. This led to a decline in selling and administrative expenses for the CS segment during the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.
 
Selling and administrative expenses for the CS segment as a percentage of CS segment revenues was 24% for the nine months ended September 30, 2013 compared to 21% for the nine months ended September 30, 2012.
 
Income Taxes
 
Our Synodex subsidiary of the IADS segment has not achieved significant revenue to date and has incurred losses since inception. Our U.S. entity incurred losses primarily on account of the losses of Synodex. In assessing the realization of deferred tax assets, we considered whether it is more likely than not that all or some portion of the U.S. deferred tax assets will not be realizable. As the expectation of future taxable income resulting from Synodex cannot be predicted with certainty, we created a $7.1 million valuation allowance against all the U.S. deferred tax assets. The Company also recorded a valuation allowance of $0.7 million on all deferred tax assets arising from unrealized losses on foreign currency forward contracts.
 
For the nine months ended September 30, 2013, we recorded a provision for income taxes in accordance with local tax regulations for our foreign subsidiaries. Some of our foreign subsidiaries are subject to tax holidays or preferential tax rates which reduces our overall effective tax rate when compared to the U.S. statutory tax rate. In addition, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.
 
For the nine months ended September 30, 2012, we recorded a provision for income taxes for the U.S. entity and certain, but not all, of our foreign subsidiaries, as certain foreign subsidiaries are subject to tax holidays or preferential tax rates, thereby lowering our overall effective tax rate compared to the U.S. statutory tax rate. In addition, the earnings of our foreign subsidiaries are not subject to tax in the U.S. unless the earnings are repatriated.
 
Net Income (loss)
 
We generated a net loss of $11.5 million in the nine months ended September 30, 2013 compared to net income of $6.8 million in the nine months ended September 30, 2012.  Net loss for the CS segment was $(1.2) million for the nine months ended September 30, 2013, compared to net income of $11.5 million for the nine months ended September 30, 2012, net of intersegment profits. The change was primarily attributable to the $7.1 million valuation allowance referred to in “Income Taxes” and a decline in gross margins resulting from lower revenues offset by a decline in selling and administrative expenses. Net loss for the IADS segment was $10.3 million for the nine months ended September 30, 2013 compared to $4.7 million for the nine months ended September 30, 2012, net of intersegment profits. The increase in net loss was primarily on account of a $5.5 million impairment charge for our Synodex subsidiary referred to in “Impairment Charge” in addition to continuing losses from operations.
 
 
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Liquidity and Capital Resources
 
Selected measures of liquidity and capital resources, expressed in thousands, are as follows:
 
 
 
September 30, 2013
 
December 31, 2012
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
25,104
 
$
25,425
 
Short term investments – other
 
 
1,115
 
 
3,091
 
Working capital
 
 
27,550
 
 
32,784
 
 
At September 30, 2013, we had cash and cash equivalents of $25.1 million, of which about $22.4 million was held by our foreign subsidiaries located in Asia, and short term investments of $1.1 million, which was entirely held by our foreign subsidiaries located in Asia. Cash balances are held in bank deposits at leading U.S. and foreign commercial banks. We have used, and plan to use, such cash for (i) investments in IADS, which in the third quarter aggregated approximately $2.2 million and is expected to require similar investments in the fourth quarter of 2013, (ii) the expansion of our other operations; (iii) general corporate purposes, including working capital; and (iv) possible business acquisitions. As of September 30, 2013, we had working capital of approximately $27.6 million, as compared to working capital of approximately $32.8 million as of December 31, 2012. We have a $15 million line of credit that expires in June 2014 pursuant to which we may borrow up to 80% of eligible accounts receivable. Cash and cash equivalents held by foreign subsidiaries is subject to income taxes if repatriated.
 
Net Cash Provided By Operating Activities
 
Cash provided by our operating activities for the nine months ended September 30, 2013 was $1.5 million, resulting from a net loss of $13.4 million, adjustments for non-cash items of $14.5 million, and $0.4 million provided by working capital changes. Adjustment for non-cash items primarily consisted of a $5.5 million impairment charge for our Synodex subsidiary, $2.9 million for depreciation and amortization and $5.0 million for a deferred income tax provision arising primarily on account of a $7.1 million valuation allowance on all of our U.S. deferred tax assets.  Working capital activities primarily consisted of a source of cash of $3.5 million as a result of net collections of accounts receivable, a use of cash of $1.5 million for a decrease in accrued salaries, a use of cash of $0.8 million for a decrease in income and other taxes and use of cash of $0.9 million for a decline in accounts payable and accrued expenses.
 
Cash provided by our operating activities for the nine months ended September 30, 2012 was $13.1 million, resulting from net income of $5.3 million, adjustments for non-cash items of $4.1 million, and $3.7 million provided by working capital changes.  Adjustment for non-cash items primarily consisted of $2.9 million for depreciation and amortization and $0.8 million for stock-based compensation expense.  Working capital activities primarily consisted of a source of cash of $4.2 million as a result of net collections of accounts receivable.
 
Our days’ sales outstanding (DSO) for the nine months ended September 30, 2013 was approximately 70 days as compared to 76 days for the year ended December 31, 2012. The decrease is on account of the collection of outstanding amounts from one of our significant clients. We calculate DSO by first dividing the total revenues for the period over average net accounts receivable, which is the sum of net accounts receivable at the beginning of the period and net accounts receivable at the end of the period, to yield an amount we refer to as the “accounts receivable turnover”. Then we take the total number of days within the period reported over the accounts receivable turnover to yield DSO expressed in number of days.  
 
 
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Net Cash Provided by (Used in) Investing Activities
 
For the nine months ended September 30, 2013 and 2012, cash used in our investing activities for capital expenditures was $3.5 million and $5.7 million, respectively. Capital spending in 2013 principally consisted of the purchase of technology equipment including servers, network infrastructure and workstations. Also included within capital expenditures are costs incurred to develop our proprietary software platform, tools and technology for the IADS segment amounting to $0.8 million.  Capital spending in 2012 principally consisted of the purchase of technology equipment including workstations, computer software, and leasehold improvements. During the next twelve months, we anticipate that capital expenditures for ongoing technology, equipment, infrastructure upgrades and development of our proprietary software platform, tools and technologies for both CS and IADS will approximate $4.0 to $5.0 million, a portion of which we may finance.  Also included in investing activities for the nine months ended September 30, 2013 and 2012 is the sale of short-term investments primarily representing proceeds on maturity of $2.0 million and $5.8 million of certificates of deposit, respectively.
 
Net Cash Provided by (Used in) Financing Activities
 
Total payments of long-term obligations approximated $0.4 million for the nine months ended September 30, 2013.  Proceeds from the exercise of stock options amounted to $0.1 million and $0.6 million during the nine months ended September 30, 2013 and 2012, respectively. 
 
Future Liquidity and Capital Resource Requirements
 
We have a $15.0 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 0.5%, or LIBOR plus 2.5%.  The line, which expires in June 2014, is collateralized by our accounts receivable. We have no outstanding obligations under this credit line as of September 30, 2013.
 
A significant portion of our cash and cash equivalents and short term investments is held by our foreign operating subsidiaries. Cash and cash equivalents held by foreign subsidiaries is subject to income taxes if repatriated.
 
We believe that our existing cash and cash equivalents, short-term investments, 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, or if we determine to continue to invest in IADS for an extended period without obtaining significant revenues, we may need to raise debt or additional equity capital which may or may not be available on a reasonable basis or at all. We have historically funded our foreign expenditures from our U.S. corporate headquarters on an as-needed basis.
 
In the second quarter of 2012, we filed a shelf registration statement on Form S-3, which gives us the ability to offer, from time to time, up to an aggregate of $70 million of securities which may consist of common stock, preferred stock, debt securities, warrants, or units consisting of any of the foregoing. The registration is intended to give us flexibility should financing opportunities arise.
 
 
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Contractual Obligations
 
The table below summarizes our contractual obligations (in thousands) at September 30, 2013 and the effects 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