INNODATA: Management’s discussion and analysis of financial condition and results of operations. (Form 10-K)

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The following discussion should be read in conjunction with our consolidated
financial statements and the related notes thereto included elsewhere in this
report, which are incorporated by reference herein. In addition to historical
information, this discussion includes forward-looking information that involves
risks and assumptions based upon management's current expectations. Our actual
results could differ materially from the results referred to in any
forward-looking statements. See "Cautionary Note Regarding Forward-Looking
Statements" included elsewhere in this report.



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Correction of Immaterial Errors - During the preparation of the September 30,
2020 condensed consolidated financial statements, certain historical errors were
identified relating to the accounting for capital leases under ASC Topics 840
and 842. The lease obligations under certain leases were not recorded at their
present values at the inception of the leases; in addition, the asset buyout
prices were not reassessed in December 2019 by the Company, both of which
resulted in an understatement of expenses from December 31, 2017 to December 31,
2019 and an overstatement of expenses for the nine months ended September 30,
2020.



The errors were not material, either quantitatively or qualitatively, in any of
the reported periods. However, the corrections, if recorded in the three-month
period ended September 30, 2020 would have been material to such period.
Accordingly, the prior period financial statements were corrected by revising
such consolidated financial statements for comparability. For the December 31,
2019 consolidated financial statements included in this Form 10-K, the
corrections are as follows:



An increase in the net loss of $540,000 for the year ended December 31, 2019.

An increase in expenditure of $540,000 for the year ended December 31, 2019.

An increase in the loss per share of $0.02 for the year ended the 31st of December,

    2019.



  · An increase in liabilities of $528,000 as of December 31, 2019.


A decrease in retained earnings of $777,000 and $237,000 from the 31st of December,

    2019 and 2018, respectively.



  · A decrease in total assets of $249,000 as of December 31, 2019.



  · The impact on cash flows for the year ended December 31, 2019 was:


A decrease in net cash flow from operating activities of $573,000.



  · A decrease in net cash flows used in investing activities of $102,000.




  · A decrease in net cash flows used in financing activities of $471,000.




Executive Overview



We are a global data engineering company. We operate in three reporting segments: Digital Data Solutions (DDS), Synodex and Agility.



The following table sets forth certain financial data for the two years ended
December 31, 2020 and 2019:



                                                            (Dollars in millions)
                                                          Years Ended December 31,
                                           2020        % of revenue         2019        % of revenue
Revenues                                $     58.2             100.0 %   $     55.9             100.0 %
Direct operating costs                        38.4              66.0 %         37.3              66.7 %
Selling and administrative expenses           18.7              32.0 %         19.5              34.9 %
Income (loss) from operations                  1.1               2.0 %         (0.9 )            (1.6 )%
Other expense                                  0.1                         

0.1

Income (loss) before provision for
income taxes                                   1.0                             (1.0 )
Provision for income taxes                     0.4                              1.1
Net income (loss)                              0.6                             (2.1 )




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Results of Operations


All percentages have been calculated using rounded amounts.

Year ended December 31, 2020 Compared to the year ended December 31, 2019


Revenues


Total revenue was $58.2 million for the year ended December 31, 2020, an augmentation of $2.3 million or 4% of the total turnover of $55.9 million for the year ended December 31, 2019.

Revenues from the DDS segment were $42.0 million and $41.3 million for the years
ended December 31, 2020 and 2019, respectively, an increase of $0.7 million or
approximately 2%. The increase was due to higher volume from one client,
partially offset by lower volume from two clients of the DDS segment.



Revenues from the Synodex segment were $4.8 million and $3.9 million for the
years ended December 31, 2020 and 2019, respectively, an increase of $0.9
million or approximately 23%. The increase was primarily due to higher volume
from three clients, partially offset by lower volume from two clients.



Revenues from the Agility segment were $11.4 million and $10.7 million for the
year ended December 31, 2020 and 2019, respectively, an increase of $ 0.7
million or approximately 7%. The increase was attributable to higher revenues
from subscriptions to our Agility media database.



One client in the DDS segment generated approximately 14% and 16% of the
Company's total revenues in the fiscal years ended December 31, 2020 and 2019,
respectively. Another client in the DDS segment generated 10% of the Company's
total revenues for the fiscal year ended December 31, 2019. No other client
accounted for 10% or more of total revenues during these periods. Further, in
the years ended December 31, 2020 and 2019, revenues from non-US clients
accounted for 54% and 55% of the Company's revenues respectively.



Direct Operating Costs



Direct operating costs consist of direct payroll, occupancy costs, data center
hosting fees, content acquisition costs, depreciation and amortization, travel,
telecommunications, computer services and supplies, realized gain (loss) on
forward contracts, foreign currency remeasurement gain (loss), and other direct
expenses that are incurred in providing services to our clients.



Direct operating costs were $38.4 million and $37.3 million for the years ended
December 31, 2020 and 2019, respectively, an increase of $1.1 million or
approximately 3%. This increase was primarily due to an increase in labor
related costs of $2.1 million, and technology-related expenditures in connection
with our BCP in response to the COVID-19 pandemic of $1.1 million. The increase
was offset in part by reductions in occupancy and related costs of $1.1 million,
content acquisition costs of $0.2 million, and a decrease of $0.8 million due to
reversal of a one-time charge of $0.4 million made in the second quarter of 2019
for an assessment of retroactive foreign social security contributions that was
successfully adjudicated. Direct operating costs as percentage of total revenues
were 66% and 67% for the years ended December 31, 2020 and 2019, respectively.



Direct operating costs for the DDS segment were $28.5 million and $27.5 million
for the years ended December 31, 2020 and 2019, respectively, an increase of
$1.0 million or approximately 4%. This increase was primarily due to an increase
in labor related costs of $1.8 million, and technology-related expenditures in
connection with our BCP in response to the COVID-19 pandemic of $1.1 million.
The increase was offset in part by reductions in occupancy and related costs of
$1.0 million and a decrease of $0.8 million due to reversal of a one-time charge
of $0.4 million made in the second quarter of 2019 for an assessment of
retroactive foreign social security contributions that was successfully
adjudicated. Direct operating costs for the DDS segment as a percentage of DDS
segment revenues were 68% and 67% for the years ended December 31, 2020 and
2019, respectively.



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Direct operating costs for the Synodex segment were approximately $3.4 million
and $3.2 million for the years ended December 31, 2020 and 2019, respectively,
an increase of $0.2 million or 6%. The increase was principally due to labor
related costs associated with the increase in volume. Direct operating costs for
the Synodex segment as a percentage of segment revenues were 71% and 82% for the
years ended December 31, 2020 and 2019, respectively. The decrease in Direct
operating costs as a percentage of segment revenues during the year was
primarily due to higher revenue.



Direct operating costs for the Agility segment were approximately $6.5 million
and $6.6 million for the years ended December 31, 2020 and 2019, respectively, a
decrease of $0.1 million or 2%. This decrease was primarily due to a reduction
in content acquisition costs. Direct operating costs for the Agility segment as
a percentage of Agility segment revenues were 57% and 62% for the years ended
December 31, 2020 and 2019, respectively. The decrease in Direct operating costs
as a percentage of segment revenues during the year was primarily due to higher
revenue from subscriptions to our Agility intelligent data platform and newswire
products.


Selling and administrative expenses



Selling and administrative expenses consist of management and administrative
salaries, sales and marketing costs including commissions, new services research
and related software development, third-party software, advertising and trade
conferences, professional fees and consultant costs, and other administrative
overhead costs.



Selling and administrative expenses were $18.7 million for the year ended
December 31, 2020 compared to $19.5 million for the year ended December 31,
2019, a decrease of $0.8 million or 4%. This decrease was primarily due to lower
marketing, travel and occupancy expenses of $0.3 million and professional fees
of $0.5 million. Selling and administrative expenses as a percentage of total
revenues were 32% and 35% for the years ended December 31, 2020 and 2019,
respectively. The decrease in selling and administrative expenses as percentage
of revenues during the year was primarily due to higher revenues and lower
selling and administrative costs.



Selling and administrative expenses for the DDS segment were $12.4 million for
the year ended December 31, 2020 compared to $13.1 million for the year ended
December 31, 2019, a decrease of $0.7 million or 5%. This decrease was primarily
due to lower marketing, travel and occupancy expenses of $0.2 million and
professional fees of $0.5 million. As a percentage of DDS revenues, DDS selling
and administrative expenses were 30% and 32% for the years ended December 31,
2020 and 2019, respectively. The decrease in selling and administrative expenses
as a percentage of revenues was due to higher revenues and lower selling and
administrative expenses.



Selling and administrative expenses for the Synodex segment was $0.9 million for
the year ended December 31, 2020 compared to $0.7 million for the year ended
December 31, 2019, an increase of $0.2 million or 29%. This increase was
primarily due to labor related expenses. Selling and administrative expenses for
the Synodex segment as a percentage of Synodex segment revenues were 19% and 18%
for the years ended December 31, 2020 and 2019, respectively.



Selling and administrative expenses for the Agility segment were $5.4 million
and $5.7 million for the years ended December 31, 2020 and 2019, respectively, a
decrease of $0.3 million or 5%. This decrease was primarily due to labor related
expenses. Selling and administrative expenses for the Agility segment as a
percentage of Agility segment revenues were 47% and 53% for the years ended
December 31, 2020 and 2019, respectively. The decrease in selling and
administrative expenses as a percentage of revenues was due to higher revenues
and lower selling and administrative expenses.



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Goodwill Impairment



On March 31, 2020, we determined that adverse changes in macroeconomic trends as
a consequence of the continuing COVID-19 pandemic constituted a triggering event
under the Financial Accounting Standards Board's (the "FASB") Accounting
Standards Codification ("ASC") No. 350, "Intangibles - Goodwill and Other" and
ASC No. 360, "Impairment or Disposal of Long-Lived Assets"). We completed our
impairment analysis procedures as of March 31, 2020. We determined that there
was no impairment of long-lived assets in any of the reporting units as of
March
31, 2020.


At September 30, 2020, we performed our annual goodwill assessment for the Agility segment in accordance with the provisions of FASB Accounting Standards Update (“ASU”) 2017-04, “Intangibles – Good will et al. (subject 350),” using a one-step approach that assesses the carrying value of goodwill and compares it to the fair value of the reporting unit. Our conclusion was consistent with the results of the study March 31, 2020 impairment test.



Income Taxes



We recorded a provision for income taxes of approximately $0.4 million and $1.1
million for the years ended December 31, 2020 and 2019, respectively.
Tax-related charges primarily consisted of a provision for foreign taxes
recorded in accordance with the local tax regulations by our foreign
subsidiaries. Effective income tax rates are disproportionate primarily due to
the valuation allowance recorded on the deferred taxes on the U.S. and Canadian
entities. See Note 4, "Income Taxes" of the notes to the consolidated financial
statements for additional information.



The reconciliation of the U.S. statutory rate with the Company's effective tax
rate for the years ended December 31, 2020 and 2019 are summarized in the table
below:



                                                                2020           2019
Federal income tax expense (benefit) at statutory rate             21.0 %        (21.0 )%
Effect of:
Change in valuation allowance                                     137.7    

22.4

Increase in unrecognized tax benefits (ASC 740)                    31.5    

55.1

Tax effects of foreign operations                                  57.7    

59.7

Permanent Differences from Foreign Operations – Foreign Exchange Gains and Losses

                                          (1.3 )        (12.2 )
Deemed interest                                                    (2.1 )  

State income tax net of federal benefit                            (4.3 )  

1.3

Foreign rate differential                                          (8.6 )  

0.8

Effect of share based compensation                                (10.9 )  
         -
Return to provision true up                                       (10.8 )         (2.6 )
Change in rates                                                  (172.7 )            -
Withholding tax                                                     1.5            6.0
Other                                                              (0.3 )         (7.3 )
Effective tax rate                                                 38.4 %        102.2 %




Despite access to overseas earnings and the resulting toll charge, we intend to
indefinitely reinvest earnings and profits in our foreign subsidiaries on
account of the foreign jurisdiction withholding taxes that we would have to
incur on the actual remittances. Unremitted foreign earnings and profits
amounted to approximately $47.0 million at December 31, 2020. If such foreign
earnings and profits are repatriated in the future, or are no longer deemed to
be indefinitely reinvested, we would have to accrue the applicable amount of
foreign jurisdiction withholding taxes associated with such remittances.



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We have a valuation allowance on all of our U.S. deferred tax assets on account
of continuing losses incurred by our U.S. entity. In addition, we also have a
valuation allowance on the deferred tax assets of our Canadian subsidiaries. Our
Canadian subsidiaries also have research and development credits available to
reduce taxable income in future years, which may be carried forward
indefinitely. The potential benefits from these balances have not been
recognized for financial statement purposes.



Tax Assessments



In September 2015, our Indian subsidiary was subject to an inquiry by the
Service Tax Department in India regarding the classification of services
provided by this subsidiary, asserting that the services provided by this
subsidiary fall under the category of online information and database access or
retrieval services (OID Services), and not under the category of business
support services (BS Services) that are exempt from service tax as historically
indicated in the subsidiary's service tax filings. We disagree with the Service
Tax Department's position. In November 2019, the Commissioner of Central Tax,
GST & Central Excise issued an order confirming the Service Tax Department's
position. We are vigorously contesting this order in an appeal to the Customs,
Excise and Service Tax Appellate Tribunal. In the event the Service Tax
Department is ultimately successful in proving that the services fall under the
category of OID Services, the revenues earned by our Indian subsidiary for the
period July 2012 through November 2016 would be subject to a service tax of
between 12.36% and 15%, and this subsidiary may also be liable to pay interest
and penalties. The revenue of our Indian subsidiary during this period was
approximately $64.0 million. In accordance with new rules promulgated by the
Service Tax Department, as of December 1, 2016 service tax is no longer
applicable to OID or BS Services. Based on our counsel's assessment, we have not
recorded any tax liability for this case.



In a separate action relating to service tax refunds, in October 2016, our
Indian subsidiary received notices from the Indian Service Tax Department in
India seeking to reverse service tax refunds of approximately $160,000
previously granted to our Indian subsidiary for three quarters in 2014,
asserting that the services provided by this subsidiary fall under the category
of OID Services and not BS Services. The appeal was determined in favor of the
Service Tax Department. We disagree with the basis of this decision and are
contesting it vigorously. We expect delays in our Indian subsidiary receiving
further service tax refunds until this matter is adjudicated with finality, and
currently have service tax credits of approximately $1.0 million recorded as a
receivable. Based on our counsel's assessment, we have not recorded any tax
liability for this case.



Net Income (Loss)



We had a net income of $0.6 million during the year ended December 31, 2020,
compared to a net loss of $2.1 million during the year ended December 31, 2019.
The $2.7 million improvement was attributable to higher revenues of $2.3
million, and a decrease in tax provision of $0.7 million, partially offset by
higher operating expenses of $0.3 million.



Net income for the DDS segment was $0.3 million for the year ended December 31,
2020, compared to a net loss of $0.5 million for the year ended December 31,
2019. The $0.8 million improvement was attributable to higher revenues of $0.7
million and a decrease in tax provisions of $0.4 million, partially offset by
higher operating expenses of $0.3 million.



Net income for the Synodex segment was $0.5 million for the year ended December
31, 2020, compared to breakeven for the year ended December 31, 2019. The $0.5
million increase was primarily attributable to the higher revenues of $0.9
million offset in part by higher operating expenses of $0.4 million.



Net loss for the Agility segment was $0.2 million for the year ended December
31, 2020, compared to a net loss of $1.6 million for the year ended December 31,
2019. The $1.4 million improvement was the result of higher revenues of $0.7
million, reductions in operating expenses of $0.4 million and a tax benefit
of
$0.3 million.



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Cash and capital resources



Selected measures of liquidity and capital resources, expressed in thousands,
are as follows:



                                                  December 31,
                                                2020         2019
                  Cash and cash equivalents   $ 17,573     $ 10,874
                  Working capital               13,515        8,250



On December 31, 2020, we had cash and cash equivalents of $17.6 million, of
which $10.2 million was held by our foreign subsidiaries, and $7.4 million was
held in the United States. Despite the passage of the new tax law under which we
may repatriate funds from overseas after paying the toll charge, it is our
intent, as of December 31, 2020, to permanently reinvest the overseas funds in
our foreign subsidiaries on account of the withholding tax that we would have to
incur on the actual remittances.



We have used, and plan to use, our cash and cash equivalents for (i) investments
in the Agility segment; (ii) the expansion of our other operations; (iii)
technology innovation; (iv) product management and strategic marketing; (v)
general corporate purposes, including working capital; and (vi) possible
business acquisitions. As of December 31, 2020, we had working capital of
approximately $13.5 million, as compared to working capital of approximately
$8.3 million as of December 31, 2019.



On May 4, 2020, we received loan proceeds of $579,700 under the Paycheck
Protection Program (PPP), which was established as part of the Coronavirus Aid,
Relief and Economic Security Act. The loans and accrued interest are forgivable,
as long as the borrower uses the loan proceeds for eligible purposes, including
payroll, benefits, rent and utilities, and maintains its payroll levels. The
unforgiven portion of the loan is payable over two years at an interest rate of
1% per year, with a deferral of payments until the date that the Small Business
Administration remits the borrower's loan forgiveness amount to the lender. On
January 29, 2021, we filed our loan forgiveness application for 100% of the
approved loan under the PPP.



Proceeds from the exercise of stock options for the year ended December 31, 2020 were
$2.6 million.

We had no significant capital expenditure commitments as of December 31, 2020.

We estimate that our existing cash and cash equivalents and our cash flow from operations will provide sufficient sources of liquidity to meet our financial needs for the next 12 months from the date of publication of these financial statements. However, as we do not have bank facilities or lines of credit, reductions in our cash and cash equivalents resulting from operating losses, capital expenditures, adverse court rulings, acquisitions or otherwise could have a material adverse effect on the Company.

Net cash from operating activities



Cash provided by our operating activities for the year ended December 31, 2020
was $5.7 million and was the result of the net income of $0.6 million, the
effect of adjustments for non-cash items of $3.4 million and sources of working
capital of $1.6 million. Adjustments for non-cash items primarily consisted of
$2.3 million for depreciation and amortization, stock-based compensation of $0.9
million and $0.2 million for other non-cash items. Working capital activities
primarily consisted of sources from a $1.4 million increase in accrued salaries,
wages and related benefits, a $0.8 million increase in income and other taxes,
offset by a $0.6 million increase in prepaid expenses and other current assets.
Refer to the Consolidated Statements of Cash Flows for further details.



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Cash provided by our operating activities for the year ended December 31, 2019
was $4.3 million and was the result of the net loss of $2.1 million, the effect
of adjustments for non-cash items of $3.6 million and sources of working capital
of $2.9 million. Adjustments for non-cash items primarily consisted of $2.7
million for depreciation and amortization, stock option expense of $0.8 million
and $0.1 million for other non-cash items. Working capital activities primarily
consisted of sources from a $1.2 million decrease in our accounts receivable, a
$1.2 million decrease in prepaid and other current assets, and a $0.9 million
increase in income and other taxes which was offset in part by a use of $0.5
million due to an increase in other working capital. The reduction in accounts
receivable is a result of higher collections during the year ended December 31,
2019. Refer to the Consolidated Statements of Cash Flows for further details.



Our days' sales outstanding were 62 days and 66 days December 31, 2020 and 2019,
respectively. We calculate DSO by first dividing the total revenues for the
period by 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 divide the total number of days within the period reported by
the accounts receivable turnover to yield DSO expressed in number of days.

Net cash used in investment activities

Cash used in our investing activities was $1.4 million and $1.7 million for the
years ended December 31, 2020 and 2019, respectively. These capital expenditures
were principally for the purchase of technology equipment including servers,
network infrastructure and workstations, and expenditures for internally
developed software. Capital expenditures for the year ended December 31, 2020
amounting to $1.4 million consisted of $0.6 million for the DDS segment and $0.8
million for the Agility segment.



For 2020, we expect capital expenditures for ongoing technology, equipment and infrastructure upgrades to approach $2.0 at $2.3 million, part of which we can fund.

Net cash used in fundraising activities

Cash provided by financing activities for the year ended December 31, 2020 was
from PPP loan proceeds of $0.6 million and proceeds from stock option exercises
of $2.6 million. Payments of long-term obligations were $0.9 million and $0.6
million for December 31, 2020 and 2019, respectively. Cash used in financing
activities for 2019 was $1.8 million for the repurchase of 1,503,095 shares of
our common stock at a volume-weighted average price of $1.23 per share.



Inflation, seasonality and prevailing economic conditions



Although most of our revenues are denominated in U.S. dollars, a significant
portion of our revenues is denominated in Canadian dollars, Pound Sterling and
Euros. In addition, a significant portion of our expenses, primarily labor
expenses in the Philippines, India, Sri Lanka, Germany, Canada and Israel, are
incurred in the local currencies of the countries in which we operate. For
financial reporting purposes, we translate all non-U.S. denominated transactions
into U.S. dollars in accordance with U.S. GAAP. Thus, we are exposed to the risk
that fluctuations in the value of these currencies relative to the U.S. dollar
could have a direct impact on our revenues and our results of operations.



The Philippines and India have at times experienced high rates of inflation as
well as major fluctuations in the exchange rate between the Philippine peso and
the U.S. dollar and the Indian rupee and the U.S. dollar. As of December 31,
2020, the aggregate notional amount of our hedges against the Indian rupee was
approximately $2.9 million, and $4.0 million for the Philippine peso.



                                       34




Exchange rate fluctuations also affect the value of funds held by our foreign subsidiaries. We do not currently intend to hedge these assets.



Our most significant costs are the salaries and related benefits of our
employees in Asia. We are exposed to high inflation in wage rates in the
countries in which we operate. We generally perform work for our clients under
project-specific contracts, requirements-based contracts or long-term contracts.
We must adequately anticipate wage increases, particularly on our fixed-price
contracts. There can be no assurance that we will be able to recover cost
increases through increases in the prices that we charge for our services to our
clients.



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. In addition, as
some of our Asian facilities are closed during holidays in the fourth quarter,
we typically incur higher wages, due to overtime, that reduce our margins.



Our Synodex subsidiary experiences seasonal fluctuations in revenues. Typically,
revenue is lowest in the third quarter of the calendar year and highest in the
fourth quarter of the calendar year. The seasonality is directly linked to the
number of life insurance applications received by the insurance companies.

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