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QuinStreet SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K(Mark One)/x/ Annual report under section 13 or 15(d) of the securities exchange act of1934 For the fiscal year ended December 31, 2001/ / Transition report under section 13 or 15(d) of the securities exchange actof 1934Commission file number 0-22196 INNODATA CORPORATION (Exact name of registrant as specified in its charter) Delaware 13-3475943 (State or other jurisdiction of (I.R.S. Employer Identification No.)incorporation or organization) Three University Plaza Hackensack, New Jersey 07601 (Address of principal executive offices) (Zip Code) (201) 488-1200 (Registrant's telephone number)Securities registered under Section 12(b) of the Exchange Act: NoneSecurities registered under Section 12(g) of the Exchange Act: Common Stock, $.01 par valueIndicate by check mark whether the Registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe past twelve months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes /x/ No / /Indicate by check mark if disclosure of delinquent filers in response to Item405 of Regulation S-K is not contained herein, and will not be contained, to thebest of Registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. /x/State the aggregate market value of the voting stock held by non-affiliates ofthe registrant based on the closing price of the Company's Common Stock onFebruary 28, 2002 of $2.18 per share. $41,154,000State the number of shares outstanding of each of the issuer's classes of commonequity, as of the latest practicable date. 21,450,550 shares of common stock, $.01 par value, as of February 28, 2002. DOCUMENTS INCORPORATED BY REFERENCE [SEE INDEX TO EXHIBITS] PART I Disclosures in this Form 10-K contain certain forward-looking statements,including without limitation, statements concerning the Company's operations,economic performance and financial condition. These forward-looking statementsare made pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995. The words "intend", "believe," "expect,""anticipate" and other similar expressions generally identify forward-lookingstatements. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of their dates. Theseforward-looking statements are based largely on the Company's currentexpectations and are subject to a number of risks and uncertainties, includingwithout limitation, those described under "Risk Factors", and other risks anduncertainties indicated from time to time in the Company's filings with theSecurities and Exchange Commission. Actual results could differ materially fromthe results referred to in the forward-looking statements. In light of theserisks and uncertainties, there can be no assurance that the results referred toin the forward-looking statements contained in this Form 10-K will in factoccur. We make no commitment to revise or update any forward-looking statementsin order to reflect events or circumstances after the date any such statement ismade.Item 1. Description of Business.General We deliver content manufacturing and XML- related digital asset services toonline information providers and companies in the telecommunications,technology, healthcare, defense, and Internet commerce sectors. We have over 100active clients, including Amazon.com, Dow Jones & Company, Lockheed MartinCorporation, ProQuest Company, Reed Elsevier, Reuters, Simon & Schuster, TheThomson Corporation, and Wolters Kluwer. We operate through three divisions. Our Content Division aggregates,converts, tags and editorially enhances digital content - services we refer tocollectively as "content manufacturing" services. We offer content manufacturingservices as a comprehensive outsourcing solution and individually as discreteactivities. The Content Division also transforms data to Extensible MarkupLanguage (XML). Our Systems Division offers system design, custom applicationdevelopment, consulting services, and systems integration conforming to XML andrelated standards. Our Training Division provides a broad range of introductoryas well as advanced curricula and training on XML and other knowledge managementstandards. Our content manufacturing clients often have time-critical outsourcingneeds, with content that requires regular updating or enhancement. We typicallyservice these needs through multi-year contracts or relationships. Approximately92% of our 2001 revenues were derived from clients that used our services formore than one year, and approximately 64% of our 2001 revenues were derived formclients that used our services more than two years. Our XML transformation clients typically engage us to assist in buildingnew, large-scale XML-compliant information repositories or in transforminglarge-scale legacy electronic information repositories to XML-compliantinformation repositories. Our XML Content Factory is the largest dedicatedfactory purpose-built to create XML content. We are headquartered in Hackensack, New Jersey and have four other officesin North America (Dallas, Austin, Minneapolis and Bellevue), seven productionfacilities in the Philippines, India, and Sri Lanka, and a technologydevelopment center in India. Our largest production facility is the XML ContentFactory, in Mandaue, the Philippines. Our wide area network and communicationssystems enable multiple production processes to be performed simultaneously atvarious of our production facilities. Two of our manufacturing facilities havebeen accorded ISO 9003 and 9002 certifications. We use server-based information technology to operate through a structuredworkflow using advanced tools. We drive efficiency and quality by using advancedmanufacturing and management techniques including total quality management andstatistical process control.Content Manufacturing and Outsourcing By capitalizing on the benefits of our scale and specialization, we aim tobe a strategic long-term provider of comprehensive content manufacturingservices that complement our customers' in-house capabilities and enable them torespond to market challenges. Our business strategy is to expand our client base and enhance our service offerings in this area. A critical component of our content manufacturing and outsourcing servicesis the conversion of hardcopy and paper collections and legacy-formatted data toa variety of output formats including XML and XML derivatives, HTML, SGML, OpeneBook (OeB), Microsoft Reader (.LIT), Rocket eBook (.RB), and PDF. For thispurpose, we use high-speed scanning; a variety of commercial and proprietaryOCR/ICR (optical/intelligent character recognition) applications; structuredworkflow processes; and proprietary applications and tools designed to createaccurate, consistent markup and data. We use proprietary technology for dataenhancement and validation, and create automated procedures - utilizing industrystandards-aware software tools such as Omnimark, XMetaL, Epic, etc. - to ensurevalidated SGML and XML markup. Another critical component of our content manufacturing and outsourcingservices is the enhancement of content. Our engineers and programmers developcustom conversion filters and parsers for this purpose. Our subject matterexperts in fields such as law, education, science, medicine, and engineeringprovide taxonomy and controlled vocabulary development, hyperlinking, tagging,general editorial services, and indexing and abstracting. We typically price our services on a resource-utilization basis orquantity-delivered basis.XML Transformation Content publishers seek to migrate to XML-based publishing systems in orderto save money and save time by creating a single data store from which to createmultiple information products (as opposed to having to build a separate datastore for each information product). In addition, publishers who maintain theircontent in XML can syndicate content and spontaneously synthesize data intointeractive "web services." XML content transformation is the prerequisite forcontent owners to accomplish these outcomes. To transform content to XML, tags are inserted within the content to givethe content meaning which computers can read. Our proprietary technologyincludes production-grade, auto-tagging applications that utilize patternrecognition based on comprehensive rule sets and heuristic online databases. Thetechnology enables mass creation or conversion of XML content from complex,unstructured documents. We also translate desktop publishing documents (QuarkXPress, PDF, MS Word,etc.) to XML variants, from which we generate multiple file formats (HTML, OeB,PDF, proprietary eBook formats, etc.) to support multiple channels ofdistribution. We typically price these services based on units of data produced ortransformed.XML Systems and Training Clients who use our XML systems engineering and consulting servicestypically require publishing systems or performance support / process automationsystems that enable multiple authors to collaborate on content and enablemultiple products to be generated from single-source XML assemblies. Our SystemsDivision provides full-service consulting and information system design andsystems integration to configure, improve, and validate these and other softwaresystems and technologies. Services are provided in ISO, IEC, ANSI, IETF, and W3Cstandards. Our Training Division provides clients with professional training,courseware, and briefings in XML and other formal public standards. We typically price these services on a fixed-fee turnkey basis.Business Strategy We seek to capitalize on the increased willingness of companies in ourmarkets to explore outsourcing as a way of reducing expenses associated withcontent manufacture while reserving internal resources to focus on strategiccore competencies such as high-level editorial processes, product development,and publishing. We also seek to respond to our customers' increased interest inpublishing information from a single repository to multiple channels (i.e., web,print, CD, print-on-demand, PDA) and to re-use existing digital assets toquickly create new products. We believe that there is a vast quantity of textual, audio, and video datasources that will be made available on the Web by electronic publishers, andthat many of them will choose XML and its related standards as the underlyingtechnology. We intend to be partner of choice for clients requiring large-scaleXML transformations as well as XML systems development and training. We intend to target publishers and information providers, knowledge serviceand eLearning companies, Internet content portals, information aggregators,e-content vendors, rich media owners, and corporations with online commerce andknowledge management initiatives. Specifically, we plan to drive content manufacturing and outsourcingopportunities by: Expanding existing client relationships and developing long-term relationships with new clients who have recurring requirements for content manufacturing and outsourcing services; Leveraging our subject matter expertise, world-wide data manufacturing capabilities, and information technology infrastructure to drive substantial cost savings for clients while decreasing their product latency and enabling them to launch products more quickly in response to market opportunities; and Offering custom-tailored XML-based business solutions using a variety of proprietary and third-party licensed software on multiple hardware and systems software platforms and domestic and international workforces. We aim to be a leader in the market for XML content transformation,systems, and training by: Further leveraging existing and emerging technologies to create increasingly efficient tools for creating large-scale XML content repositories; Maintaining our position as the preferred supplier of large-scale XML content services, while extending our leadership in XML architecture and XML consulting; Entering into additional high-profile client partnerships for large-scale XML content services; and Continuing to take an active role in developing key structured information standards. Furthermore, we plan to: Extend our service offerings into other strategic areas consistent with our position as a leading provider of digital asset services and solutions; Design customized service offerings to meet the unique needs of targeted vertical markets; Respond to opportunities to provide increased value-added services to our clients; Expand our delivery capabilities to embrace new technology initiatives that are strategic for our clients; and Cultivate and maintain a significant client and project base to create economies of scale that enable us to achieve competitive costs. Close Relationships With Clients Innodata views its long-term partnership with our clients as a criticalelement in its historical and future success. To continue to meet the needs of existing and prospective clients in atimely fashion, Innodata works directly with its clients to identify and developnew and improved service offerings. To promote a close and continuingrelationship with clients, we sell through our North American Solutions Centerand provide 24/7 project support through our Asia-based customer service center. We generally perform our work for our clients under project-specificcontracts, requirements-based contracts, or long-term contracts. Contracts aretypically subject to numerous termination provisions. One client accounted for 30% of our revenues in 2001 and 54% of ourrevenues in 2000. We do not expect to generate any additional revenues from thisclient. One other client accounted for 27% of our revenues in 2001. In 1999, oneclient accounted for 17% of our revenues. No other client accounted for 10% ormore of our revenues. Further, in 2001, 2000, and 1999, export revenues, thevast majority of which were derived from European customers, accounted for 13%,10% and 20%, respectively, of our revenues. We are from time to time required by clients to enter into non-disclosureagreements pursuant to which we agree not to disclose their identity or thenature of our relationship with them. Reasons for requiring such arrangementsvary, but typically involve a preference on the part of the client not topublicize its outsourcing strategy or to telegraph to competitors a new productdevelopment initiative. Comprehensive Service Offering Our comprehensive service offering distinguishes us from our competitors.Many competitors offer only a single service, such as data capture, but do notoffer the full complement of specialized services large organizations require inorder to build large-scale XML repositories or manufacture large-scale digitalcontent. Innodata provides a broad range of content-related services to enableits clients to obtain the full benefit of outsourcing within a seamlessoperational framework premised on our accountability to our clients. Innovative Technology-Based Solutions We have invested substantially in our manufacturing infrastructure in orderto ensure clients a reliable and highly redundant infrastructure and to enableus to employ the latest tools to drive significant process efficiencies.Sales and Marketing Our full-time direct sales force primarily conducts sales and marketingfunctions. Sales and marketing activities consist primarily of exhibiting attrade shows in the United States and Europe, and seeking direct personal accessto decision-makers at existing and prospective clients. We have also obtainedvisibility by way of articles published in the trade press, throughparticipation in industry conferences and standards organizations, and byspeaking engagements at industry events. To date, Innodata has not conducted anysignificant advertising campaign in the general media. Consulting personnel from our new project analysis group closely supportthe direct sales effort. These individuals assist the sales force inunderstanding the technical needs of clients and providing responses to theseneeds, including demonstrations, prototypes, pricing quotations, and timeestimates. In addition, account managers from our customer service groupsupport our direct sales effort by providing ongoing project-level post-salesupport to customers.Competition The markets for our services are highly competitive. The most significantcompetitive factors are price of services, quality of services, reliability ofservices, scope and scale, quality of supporting services, and technicalcompetence. We are not aware of any single competitor that provides the samerange of services as we do, and we believe that we have created significantdifferentiation relative to our quality of services as well as our scope ofservices and scale of services. However, our industry is highly fragmented andwe face significant competition in each of our service areas. In terms of content manufacturing/outsourcing, we believe we competesuccessfully by offering high quality services and favorable pricing byleveraging our technical skills, process knowledge, and economies of scale.Competition is highly fragmented and depends on the specific service provided.We have substantially greater resources than most of our competitors, resultingin greater breadth of services as well as scope and scale. Thus, we have agreater ability to obtain client contracts where the undertaking required istechnically sophisticated, sizable in scope or scale, or requires significantinvestment. Our outsourcing services also compete with clients' and potentialclients' "in-sourcing" personnel, who may attempt to duplicate our services using in-house staff. In terms of XML data transformation, companies compete on the basis ofquality, accuracy, and consistency, as well as ability to deliver large-scale,tag-intensive requirements quickly. Innodata's ability to compete favorably is,therefore, dependent upon its ability to react appropriately to short andlong-term trends, harness new technology, and deliver large-scale requirementsquickly. SPI, Inc. and Jouve, S.A. among others, compete for the XML contentcreation business. With respect to XML systems and consulting, Thomas Technology Solutions,Inc., ArchiTag, KPMG Consulting, and Booz Allen Hamilton are among thoseproviding competitive services. In addition, we must frequently compete with ourclients' own internal information technology capability.Research and Development We maintain a research and development capability to evaluate, on anongoing basis, advances in computer software, hardware and peripherals, computernetworking, telecommunication systems and Internet-related technologies as theyrelate to our business and to develop and install enhancements to ourproprietary systems. During fiscal year 2001, we invested heavily in thedevelopment and integration of proprietary applications for use in our XMLContent Factory. Applications development was predominantly associated withimproving accuracy, consistency, and speed of complex XML tagging forlarge-scale requirements. We intend to make further investments in applicationsdevelopment and integration in order to respond to market opportunities. In2001, all research and development expenditures were charged as developmentexpenses.Employees As of February 28, 2002, we employed an aggregate of approximately 75persons in the United States, and approximately 10,000 persons in fourproduction facilities in the Philippines, one production facility in Sri Lanka,one production facility in India, and a software development center in India.Approximately 800 employees at our Manila facility are members of a union, whosecollective bargaining agreement expired on March 31, 2001. We and the uniondeadlocked in negotiations for a new collective bargaining agreement. In August2001, the Philippine Department of Labor and Employment assumed jurisdictionover the labor dispute and, in October 2001, mandated a settlement pursuant towhich membership was granted wage increases approximating 2% per annum throughMarch 2004, plus 50% of any subsequently mandated by law minimum wage increases.The union filed a motion for reconsideration that was denied in January 2002. InMarch 2002, the union filed a petition with the Philippine Court of Appeals. Noother employees are represented by a labor union, and we believe that ourrelations with our employees are satisfactory. At all of our locations, we enforce vigorous policies to protect ouremployees against sexual harassment and discrimination based on age, race,gender or sexual orientation. The average age of our employees is approximately25 years. Over 50% of our staff is female. Most of our employees have graduatedfrom at least a two-year college program. Many of our employees hold advanceddegrees in law, business, technology, medicine, and social sciences. To retain our qualified personnel, Innodata offers highly competitive basesalaries that are supplemented by results-based incentives. Senior management iseligible for bonuses and stock options. Our compensation structure is coupledwith an extensive benefits package that includes comprehensive health insurancecoverage, canteen and grocery subsidies, paid holiday leaves, continuingeducation programs, clothing and optical allowances, and a retirement program.Moreover, Innodata provides overtime premiums, holiday pay, bereavement andbirthday leaves, as well as maternity and paternity benefits. We provide employees a range of workplace amenities, including: internetcafes, where employees can surf the web during breaks; on-site,Company-subsidized restaurants; and on-site stores where employees can purchasedry goods and groceries on credit, arranging purchases from their workstationsover a corporate intranet.Risk Factors The nature of our business, as well as our strategy, the size and locationof our facilities, and other factors entail a certain amount of risk. Theserisks may include, but are not limited to, the following: Risks of Expanded Operations We have expanded our operations rapidly in recent years. As a result, wehave incurred new fixed operating expenses associated with our expansionefforts, including increases in depreciation expense, rental expense, andoverall increases in cost of sales. In order to capitalize on this investment,we need to develop new client relationships and expand existing ones. If ourrevenues do not increase sufficiently to offset these expenses, our operatingresults may be adversely affected. Risks of Acquisitions Acquisitions involve a number of risks and challenges. These include, butare not limited to: diversion of management's attention; the need to integrateacquired operations; potential loss of key employees and clients of the acquiredcompanies; lack of experience operating in the market of the acquired business;and an increase in expenses and working capital requirements. To integrate acquired operations, we must implement management informationsystems and operating systems and assimilate and manage the personnel of theacquired operations. Geographic distances may further complicate integration.The integration of acquired businesses may not be successful and could result indisruption to other parts of our business. Any of these and other factors could adversely affect our ability toachieve anticipated levels of profitability of acquired operations or realizeother anticipated benefits of an acquisition. Furthermore, any futureacquisitions may require us to incur debt or obtain additional equity financing,which could increase our leverage or be dilutive to our existing shareholders.No assurance can be given that we will consummate any additional acquisitions inthe future. Variability of Client Requirements and Operating Results A number of our significant client contracts are requirements-based.Clients may cancel their production requirements, change their productionrequirements, or delay their production requirements for a number of reasons.Cancellations, reductions, or delays by a significant client or by a group ofclients would adversely affect our results of operations. In addition, otherfactors may contribute to fluctuations in our results of operations. Thesefactors include: the timing of client orders; the volume of these ordersrelative to our capacity; market acceptance of clients' new products; the timingof our expenditures in anticipation of future orders; our effectiveness inmanaging manufacturing processes; changes in economic conditions; and localfactors and events that may affect our production volume (such as localholidays) or unforeseen events (e.g., earthquakes, storms, civil unrest). We make significant decisions based on our estimates of clientrequirements, including decisions about the levels of business that we will seekand accept, production schedules, equipment procurement, personnel hiring, andother resource acquisition. The nature of our clients' commitments and thepossibility of changes in demand for their products may reduce our ability toestimate accurately future client requirements. On occasion, clients may requirerapid increases in production, which can stress our resources. Although we haveincreased our content conversion capacity and plan further increases, there canbe no assurance we will have sufficient capacity at any given time to meet allof our clients' demands. In addition, because many of our costs and operatingexpenses are relatively fixed, a reduction in client demand can adversely affectour margins. Variability of Quarterly Operating Results We expect our revenues and operating results to vary from quarter toquarter. Such variations are likely to be caused by many factors that are, tosome extent, outside our control, including: mix and timing of client projects;completing client projects; timing of new contracts; and one-time non-recurringand unusual charges. Accordingly, we believe that quarter-to-quarter comparisons of operatingresults for preceding quarters are not necessarily meaningful. You should notrely on the results of one quarter as an indication of our future performance. Client Concentration; Dependence on the Online Information Industry One client accounted for 30% of our revenues in 2001 and 54% of ourrevenues in 2000. We do not expect to generate any additional revenues from thisclient in 2002. One other client accounted for 27% of our revenues in 2001. In1999, one client accounted for 17% of our revenues. No other client accountedfor 10% or more of our revenues. Further, in 2001, 2000, and 1999, exportrevenues, the vast majority of which were derived from European customers,accounted for 13%, 10% and 20%, respectively, of our revenues. A significantamount of our revenues are derived from clients in the online informationindustry. Accordingly, our accounts receivable generally include significantamounts due from such clients. On occasion, we may lose a client as a result ofa business failure, contract expiration, or the selection of another serviceprovider. We cannot guarantee that we will be able to retain long-termrelationships or secure renewals of short-term relationships with our majorclients in the future. Moreover, revenue derived from certain of ourrelationships depend upon the level of services we perform, which may vary fromperiod to period depending on client requirements. Factors affecting the online information industry generally could have amaterial adverse effect on our clients and, as a result, on our performance.Such factors include: the inability of our clients to adapt to rapidly changingtechnology and evolving industry standards, the inability of our clients todevelop and market their products, some of which are new and untested; and,recessionary periods in our clients' markets. If clients' products becomeobsolete or fail to gain widespread commercial acceptance, our business may bematerially and adversely affected. Risk of Increased Taxes We have structured our operations in a manner designed to maximize incomein countries where tax incentives have been extended to encourage foreigninvestment or where income tax rates are low. Our taxes could increase if thesetax incentives are not renewed upon expiration, or tax rates applicable to usare increased. Substantially all of the services provided by our Asiansubsidiaries are performed on behalf of clients based in North America andEurope. We believe that profits from our Asian operations are not sufficientlyconnected to jurisdictions in North America or Europe to give rise to incometaxation there. However, tax authorities in jurisdictions in North America andEurope could challenge the manner in which profits are allocated among oursubsidiaries, and we may not prevail in any such challenge. If our Asian profitsbecame subject to income taxes in such other jurisdictions, our worldwideeffective tax rate could increase. Risks of Competition The markets for our services are extremely competitive and fragmented. As aresult of this highly competitive environment, we may lose customers or havedifficulty in acquiring new customers and our results of operations may beadversely affected. A significant source of competition for us is the in-housecapability of our target client base. There can be no assurance that theseclients will outsource more of their needs or that such businesses will notbring in-house services that they currently outsource. Risks of International Operations While the major part of our operations are carried on in the Philippines,India, and Sri Lanka, our headquarters are in the United States and our clientsare primarily located in North America and Europe. As a result, we are not asaffected by economic conditions overseas as we would be if we depended onrevenues from sources internal to those countries. However, such adverseeconomic factors as inflation, external debt, negative balance of trade, andunderemployment may significantly impact us. Certain aspects of overseas economies directly affect us. Overseasoperations remain vulnerable to political unrest, which could interfere with ouroperations. Political instability could also change the present satisfactorylegal environment for us through the imposition of restrictions on foreignownership, repatriation of funds, adverse labor laws, and the like. Our Indian operations are conducted through a wholly-owned subsidiary thathas been granted an income tax holiday through December 31, 2004. Accordingly,no income taxes will be payable on earnings from operations of the subsidiaryduring such period, unless repatriated to the U.S. We fund our overseas operations through transfers of U.S. dollars only asneeded and generally do not maintain any significant amount of funds or monetary assets overseas. To the extent that we need to bring currency to the UnitedStates from our overseas operations, we may be affected by currency controlregulations. The Philippines is subject to relatively frequent earthquakes, volcaniceruptions, floods, and other natural disasters, which may disrupt ouroperations. Further, power outages lasting for periods of as long as eight hoursper day have occurred. Our facilities are equipped with standby generators thathave produced electric power during these outages; however, there can be noassurance that our operations will not be adversely affected should municipalpower production capacity deteriorate. The geographical distances between Asia, the Americas, and Europe createlogistical and communications challenges which we must overcome. The Philippines has ongoing problems with Muslim insurgents. The Abu Sayafgroup of kidnappers, which is purported to have ties to the Al Queda terroristorganization, is concentrated on Basilan Island, an island far away from ourfacilities, and the government has stepped up activities to eradicate the group.There can be no assurances that these efforts will be successful or that thegroup will not attempt to disrupt activities or commit terrorist acts in otherareas. Risks of Currency Fluctuations and Hedging Operations The Philippines has historically experienced high rates of inflation andmajor fluctuations in exchange rate between the Philippine peso and the U.S.dollar. Continuing inflation without corresponding devaluation of the pesoagainst the dollar, or any other increase in value of the peso relative to thedollar, may have a material adverse effect on our operations and financialcondition. Since 1997, we have not purchased foreign currency futures contractsfor pesos. However, we may choose to do so in the future. Dependence on Key Personnel Our success depends to a large extent upon the continued services of ourkey executives and skilled personnel. Several of our officers and key employeesare bound by employment or non-competition agreements. However, there can be noassurance that we will retain our officers and key employees. We could bematerially and adversely affected by the loss of such personnel. Volatility of Market Price of Common Stock The stock market in recent years has experienced significant price andvolume fluctuations that have affected the market prices for the common stock oftechnology and Internet-related companies. Such fluctuations have often beenunrelated to or disproportionately impacted by the operating performance of suchcompanies. The market for our common stock may be subject to similarfluctuations. Factors such as fluctuations in our operating results,announcements of new contracts, partnerships, acquisitions and alliances,technological innovations or events affecting other companies in the Internet ortechnology industry generally, as well as currency fluctuations and generalmarket conditions, may have a significant effect on the market price of ourcommon stock.Item 2. Description of Property. Our services are primarily performed from our Hackensack, New Jerseycorporate headquarters, four other North American offices, and seven overseasproduction facility complexes, including our 100,000 square foot XML ContentFactory complex located in Mandaue, the Philippines. In addition, we have asoftware development facility in Gurgaon, India. All facilities are leased forterms expiring on various dates through 2009, and many are cancelable at ouroption. Annual rental payments on property leases currently approximate$1,900,000. We believe that we maintain adequate fire, theft and liability insurancefor our facilities and that our facilities are adequate for our present needs.Item 3. Legal Proceedings. There is no material litigation pending to which we are a party or of whichany of our property is the subject.Item 4. Submission of Matters to a Vote of Security Holders. See Part II, Item 4 of Form 10-Q for June 30, 2001 as to results of votingat our Annual Meeting held on July 31, 2001. PART IIItem 5. Market for Common Equity and Related Stockholder Matters. Innodata Corporation (The "Company") Common Stock is quoted on the NasdaqNational Market System under the symbol "INOD." On February 28, 2002, there were108 stockholders of record of the Company's Common Stock based on informationprovided by the Company's transfer agent. Virtually all of the Company'spublicly held shares are held in "street name" and the Company believes theactual number of beneficial holders of its Common Stock to be approximately4,000. The following table sets forth the high and low sales prices on a quarterlybasis for the Company's Common Stock, as reported on Nasdaq, for the two yearsended December 31, 2001, after giving retroactive effect to a three-for-onestock dividend paid on September 9, 1999, a two-for-one stock dividend paid onDecember 7, 2000 and a two-for-one stock dividend paid on March 23, 2001. Common Stock Sale Prices 2000 High Low ---- ---- --- First Quarter 4--3/16 2 Second Quarter 2--3/8 1--5/16 Third Quarter 3--1/8 1--7/8 Fourth Quarter 5--5/8 2--3/16 2001 High Low ---- ---- --- First Quarter 7--3/4 3--7/8 Second Quarter 9--1/4 3--1/16 Third Quarter 4 1--1/4 Fourth Quarter 3--3/4 2Dividends The Company has never paid cash dividends on its Common Stock and does notanticipate that it will do so in the foreseeable future. The future payment ofdividends, if any, on the Common Stock is within the discretion of the Board ofDirectors and will depend on the Company's earnings, its capital requirementsand financial condition and other relevant factors. The Company paid athree-for-one stock dividend on September 9, 1999, a two-for-one stock dividendon December 7, 2000, and a two-for-one stock dividend on March 23, 2001.Item 6. Selected Financial Data (Dollars in Thousands)Year ended December 31, 2001 2000 1999 1998 1997REVENUES $58,278 $50,731 $27,490 $19,593 $20,117 ------- ------- ------- ------- -------OPERATING COSTS AND EXPENSESDirect operating costs 44,354 34,458 17,854 13,069 16,007Selling and administrative 8,337 7,248 6,783 4,982 5,284Provision for doubtful accounts 2,942 - - - - Restructuring costs and asset impairment 865 - - 133 1,500(Gain) loss on settlement of currency contracts - - - (487) 1,400Interest expense 9 43 10 77 85Interest income (216) (155) (111) (98) (59) ------- ------- ------- ------- -------Total 56,291 41,594 24,536 17,676 24,217 ------- ------- ------- ------- -------INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT) 1,987 9,137 2,954 1,918 (4,100)INCOME TAXES (BENEFIT) 639 2,969 841 (332) 100 ------- ------- ------- ------- -------NET INCOME (LOSS) $ 1,348 $ 6,168 $ 2,113 $ 2,250 $(4,200) ======= ======= ======= ======= =======BASIC INCOME (LOSS) PER SHARE $.06 $.30 $.11 $.13 $(.23) ==== ==== ==== ==== =====DILUTED INCOME (LOSS) PER SHARE $.05 $.26 $.10 $.12 $(.23) ==== ==== ==== ==== =====CASH DIVIDENDS PER SHARE - - - - - ======= ======= ======= ======= =======December 31, 2001 2000 1999 1998 1997WORKING CAPITAL $ 8,854 $ 9,505 $ 5,966 $ 4,749 $ 2,092 ======= ======= ======= ======= =======TOTAL ASSETS $30,094 $27,946 $15,646 $10,596 $10,029 ======= ======= ======= ======= =======LONG-TERM DEBT - - $ 5 $ 24 $ 80 ======= ======= ======= ======= =======STOCKHOLDERS' EQUITY $20,362 $19,316 $11,652 $ 7,485 $ 5,254 ======= ======= ======= ======= =======Item 7. Management's Discussion And Analysis of Financial Condition and Results of OperationsResults of OperationsYears Ended December 31, 2001 and 2000 Revenues increased 15% to $58,278,000 for the year ended December 31, 2001compared to $50,731,000 for the similar period in 2000. Sales to one client whoaccounted for $27.4 million (54%) of the Company's revenues in 2000 declined byapproximately $10 million in 2001. In 2002, the Company does not expect togenerate any revenues from this client. The Company replaced this shortfall in2001 by a $14.4 million increase in revenues from another client and netincreases in revenues from various other new and existing clients. As a result,total revenues in 2001 increased by $7.5 million from 2000. One client accounted for 30% and 54% of the Company's revenues in 2001 and2000, respectively. As stated above, in 2002, the Company does not expect togenerate any revenues from this client. One other client accounted for 27% ofthe Company's revenues in 2001. No other client accounted for 10% or more of theCompany's revenues. Further, in 2001 and 2000, export revenues, the vastmajority of which were derived from European customers, accounted for 13% and10%, respectively, of the Company's revenues. In considering the consequence to expected results in 2002 from theanticipated absence of revenues from the one client who accounted for 30% of theCompany's revenues in 2001, we note that in the fourth quarter of 2001, revenuesfrom this client had declined to approximately $500,000 from an average ofapproximately $5.6 million per quarter for the first three quarters of 2001.However, because of a total of approximately $12 million in revenues during thefourth quarter from other clients, in the fourth quarter the Company earnedapproximately $900,000 before a bad debt provision and before restructuringcosts. Similarly, the impact on the Company's results of operations due to theabsence of revenues from this client in 2002 will depend upon the extent towhich the Company is successful in its marketing efforts to achieve compensatingrevenues from new or other existing clients. In 2000, a significant portion of the Company's revenue increase came fromXML transformation projects by early-stage companies that had raised significantventure capital to pursue digital library and e-business initiatives. Thedownturn in the technology industry in 2001 resulted in a falloff of revenuesfrom companies in this industry sector. Furthermore, the economic downturn thatbecame evident late in 2001 resulted in many blue-chip publishers that had shownincreased interest in XML transformation projects electing to curtaildiscretionary spending and slow down new initiatives. To in part address thissales challenge, the Company began to refocus its sales force to emphasize itscontent manufacturing/outsourcing services. Direct operating expenses were $44,354,000 for the year ended December 31,2001 and $34,458,000 for the year ended December 31, 2000, an increase of 29%.Direct operating expenses as a percentage of revenues were 76% in 2001 and 68%in 2000. The dollar increase in 2001, approximately 60% of which is comprised ofan increase in labor costs, is principally due to costs incurred for increasedrevenues. The percentage increase in 2001 is principally attributable to anincrease in fixed and certain labor costs incurred for increased productioncapacity which was underutilized during the second half of 2001. Directoperating expenses include primarily direct payroll, telecommunications,depreciation, equipment lease costs, computer services, supplies and occupancy. Selling and administrative expenses were $8,337,000 and $7,248,000 for theyears ended December 31, 2001 and 2000, respectively, representing an increaseof 15%. The increase is primarily attributable to an increase in selling andmarketing costs, travel costs and facility administrative overhead associatedwith the Company's continued growth. Selling and administrative expenses as apercentage of revenues were 14% in both the 2001 and 2000 periods. Selling andadministrative expense includes management and administrative salaries, salesand marketing costs and administrative overhead. The Company provided an allowance for doubtful accounts of approximately$2.6 million representing the remaining balance due at December 31, 2001 from aclient that accounted for 30% of its 2001 revenues because the client hasreported an inability to raise further operating funds required to make payment.In addition, the Company provided approximately $350,000 for other client baddebts incurred in the ordinary course of business. During the fourth quarter 2001, the Company took certain actions to reduceproduction operations at a wholly owned Asian subsidiary that was operating at aloss and to reduce overall excess capacity in Asia. Such activities included thetermination of leases and employee layoffs. Included in Restructuring Costs andAsset Impairment for the year ended December 31, 2001 are estimated facilityclosure costs, including employee related costs, approximating $600,000, and thewrite-off of leasehold improvement costs totaling approximately $265,000. As aresult of these actions, the Company expects a cost reduction of approximately$200,000 per quarter, of which approximately $100,000 was realized in the fourthquarter 2001.Years Ended December 31, 2000 and 1999 Revenues increased 85% to $50,731,000 for the year ended December 31, 2000compared to $27,490,000 for the similar period in 1999 principally resultingfrom a client who accounted for approximately 54% of the Company's revenue in2000. One other client accounted for 17% of the Company's revenues in 1999. Noother customer accounted for 10% or more of the Company's revenues. Further, in2000 and 1999, export revenues, substantially all of which were derived fromEuropean clients, accounted for 10% and 20%, respectively. Direct operating expenses were $34,458,000 for the year ended December 31,2000 and $17,854,000 for the similar period in 1999, an increase of 93%. Directoperating expenses as a percentage of revenues were 68% in 2000 and 65% in 1999.The dollar increase in 2000 is principally due to costs related to the increasedrevenues. Direct operating expenses as a percent of revenues increased by 3percentage points in 2000, resulting from additional costs incurred principallyfor the new XML Content Factory (including start-up costs) (which accounted forapproximately 9 percentage points) offset by a decline in the value of theforeign currencies of countries in which the Company's production facilities arelocated (which resulted in a cost reduction of approximately 6 percentagepoints). Direct operating expenses include primarily direct payroll,telecommunications, depreciation, equipment lease costs, computer services,supplies and occupancy. Selling and administrative expenses were $7,248,000 and $6,783,000 for theyears ended December 31, 2000 and 1999, respectively, representing an increase of 7% in 2000 from 1999. Selling and administrative expense as a percentage ofrevenues decreased to 14% in 2000 from 25% in 1999 due primarily to an increasein revenues without a corresponding increase in such expenses. Selling andadministrative expense includes management and administrative salaries, salesand marketing costs and administrative overhead. In 2000, income taxes were lower as a percentage of pre-tax income than thefederal statutory rate due primarily to certain overseas income that will not betaxed unless repatriated due to tax holidays granted to the Company.Liquidity and Capital Resources Selected measures of liquidity and capital resources are as follows: December 31, 2001 December 31, 2000 ------------------ ------------------Cash and Cash Equivalents $6,267,000 $9,040,000Working Capital $8,854,000 $9,505,000Stockholders' Equity Per Common Share* $.95 $.91 *Represents total stockholders' equity divided by the actual number of common shares outstanding (which excludes treasury stock).Net Cash Provided By Operating Activities During the year ended December 31, 2001, net cash provided by operatingactivities was $4,840,000 as compared to $12,387,000 in the 2000 comparativeperiod. The decrease was primarily due to a $4.8 million decrease in net incomeand a $3.3 million increase in net billings in excess of accounts receivablecollected, offset by a $4.7 million increase in non-cash charges. The balance isdue to a net decrease in changes in other operating asset and liabilityaccounts. The $3.3 million increase in net billings in excess of accountsreceivable collected is principally attributable to certain acceleratedcollections received in 2000.Net Cash Used in Investing Activities In the year ended December 31, 2001, the Company spent approximately$5,568,000 for capital expenditures, compared to approximately $7,403,000 in theyear ended December 31, 2000. Such capital expenditures include anticipatedcosts to complete the renovation, re-engineering and expansion of two of theCompany's facilities, capital investment in additional production technologies,and normal ongoing capital investments. In addition, in the year ended December31, 2001, the Company acquired the operating assets and assumed certaindesignated liabilities of the ISOGEN International operating division ofDataChannel, Inc. The purchase price, including acquisition costs, consisted of$796,000 in cash, two acquisition promissory notes, each for $325,000, plus anadditional $68,000 payable September 30, 2002 subject to realization of certainevents. The promissory notes accrue interest at a rate of 7% per annum, and arepayable on April 30, 2002 and September 30, 2002, respectively.Net Cash Provided By Financing Activities In the year ended December 31, 2001, net cash used in financing activitiestotaled approximately $1,249,000 primarily due to the repurchase of 270,000shares of the Company's common stock for $1,639,000, compared to $676,000provided by financing activities in the comparable period in 2000.Availability of Funds The Company has a $4 million line of credit with a bank pursuant to whichit may borrow up to 80% of eligible accounts receivable. The line, which is dueon demand and was unused at December 31, 2001, is collateralized by accounts receivable. Interest is charged at 1/2% above the bank's prime rate. Management believes that existing cash, internally generated funds andshort term bank borrowings will be sufficient for reasonably anticipated workingcapital and capital expenditure requirements during the next 12 months. TheCompany funds its foreign expenditures from its U.S. corporate headquarters onan as-needed basis.Critical Accounting Policies Management's discussion and analysis of its results of operations andfinancial condition is based upon the Company's consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires management to make estimates and judgements that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. On an on-going basis, theCompany evaluates its estimates, including those related to accounts receivable.Management bases its estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgements about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions. The Company records an allowance for doubtful accounts for estimated lossesresulting from the inability of its clients to make required payments. If thefinancial condition of the Company's clients were to deteriorate, resulting inan impairment of their ability to make payments, additional allowances may benecessary.Inflation, Seasonality and Prevailing Economic Conditions To date, inflation has not had a significant impact on the Company'soperations. The Company generally performs its work for its clients underproject-specific contracts, requirements-based contracts or long-term contracts.Contracts are typically subject to numerous termination provisions. TheCompany's revenues are not significantly affected by seasonality.Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to interest rate change market risk with respect toits credit facility with a financial institution, which is priced based on theprime rate of interest. At December 31, 2001, there were no outstandingborrowings under the credit facility. Changes in the prime interest rate during2002 will have a positive or negative effect on the Company's interest expense.Such exposure will increase accordingly should the Company maintain higherlevels of borrowing during 2002. The Company has operations in foreign countries. While it is exposed toforeign currency fluctuations, the Company presently has no financialinstruments in foreign currency and does not maintain funds in foreign currencybeyond those necessary for operations.Item 8. Financial Statements. INNODATA CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS PAGE ----Independent Auditors' Report II-9Consolidated Balance Sheets as of December 31, 2001 and 2000 II-10 Consolidated Statements of Income for the three years ended December 31, 2001 II-11Consolidated Statements of Stockholders' Equity for the three years ended December 31, 2001 II-12Consolidated Statements of Cash Flows for the three years ended December 31, 2001 II-13Notes to Consolidated Financial Statements II-14-23INDEPENDENT AUDITORS' REPORTBoard of Directors and StockholdersInnodata CorporationHackensack, New JerseyWe have audited the accompanying consolidated balance sheets of InnodataCorporation and subsidiaries as of December 31, 2001 and 2000, and the relatedconsolidated statements of income, stockholders' equity and cash flows for eachof the three years in the period ended December 31, 2001. These financialstatements are the responsibility of the Company's management. Ourresponsibility is to express an opinion on these financial statements based onour audits.We conducted our audits in accordance with auditing standards generally acceptedin the United States of America. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, inall material respects, the consolidated financial position of InnodataCorporation and subsidiaries as of December 31, 2001 and 2000, and theconsolidated results of their operations and their consolidated cash flows foreach of the three years in the period ended December 31, 2001 in conformity withaccounting principles generally accepted in the United States of America. /S/------------------------Grant Thornton LLPNew York, New YorkMarch 5, 2002 INNODATA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000 (Dollars in Thousands) 2001 2000 -------- --------ASSETSCURRENT ASSETS: Cash and equivalents $ 6,267 $ 9,040 Accounts receivable-net of allowance for doubtful accounts of $1,853,000 in 2001 and $884,000 in 2000 7,846 5,799 Prepaid expenses and other current assets 978 1,194 Deferred income taxes 1,793 839 ------- ------- Total current assets 16,884 16,872 PROPERTY AND EQUIPMENT - NET 10,236 9,464 OTHER ASSETS 2,351 1,610 GOODWILL 623 - ------- -------TOTAL $30,094 $27,946 ======= =======LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIES: Acquisition notes payable $ 650 $ - Accounts payable and accrued expenses 2,875 3,196 Accrued salaries and wages 3,770 3,060 Income and other taxes 735 1,111 ------- ------- Total current liabilities 8,030 7,367 ------- -------DEFERRED INCOME TAXES 1,702 1,263 ------- -------COMMITMENTS AND CONTINGENT LIABILITIESSTOCKHOLDERS' EQUITY: Common stock, $.01 par value-authorized 75,000,000 shares; issued - 21,716,000 shares in 2001 and 21,688,000 shares in 2000 217 217 Additional paid-in capital 13,355 12,239 Retained earnings 8,429 7,081 ------- ------- 22,001 19,537 Less: treasury stock - at cost; 270,000 shares and 577,000 shares in 2001 and 2000, respectively (1,639) (221) ------- ------- Total stockholders' equity 20,362 19,316 ------- -------TOTAL $30,094 $27,946 ======= =======
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