================================================================================-------------------------------------------------------------------------------- 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 OF 1934 For the fiscal year ended December 31, 2004|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934Commission file number 0-22196 INNODATA ISOGEN, INC. (Exact name of registrant as specified in its charter) Delaware 13-3475943 (State or other jurisdiction of (I.R.S. Employer 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|Indicate by check mark whether the registrant is an accelerated filer (asdefined in Exchange Act Rule 12b-2). Yes |_| No |X|State the aggregate market value of the voting and non-voting common equity heldby non-affiliates computed by reference to the price at which the common equitywas last sold, or the average bid and asked price of such common equity, as ofthe last business day of the registrant's most recently completed second fiscalquarter. $72,400,000 ===========State the number of shares outstanding of each of the issuer's classes of commonequity, as of the latest practicable date. 22,693,138 shares of common stock, $.01 par value, as of February 28, 2005. 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 our operations, economicperformance, and financial condition. These forward-looking statements are madepursuant to the safe harbor provisions of the Private Securities LitigationReform Act of 1995. The words "estimate," "believe," "expect," and "anticipate"and other similar expressions generally identify forward-looking statements,which speak only as of their dates.These forward-looking statements are based largely on our current expectations,and are subject to a number of risks and uncertainties, including withoutlimitation, continuing revenue concentration in a limited number of clients,continuing reliance on project-based work, worsening of market conditions,changes in external market factors, the ability and willingness of our clientsand prospective clients to execute business plans which give rise torequirements for digital content and professional services in knowledgeprocessing, difficulty in integrating and deriving synergies from acquisitions,potential undiscovered liabilities of companies that we acquire, changes in ourbusiness or growth strategy, the emergence of new or growing competitors,various other competitive and technological factors, and other risks anduncertainties indicated from time to time in our filings with the Securities andExchange Commission.Our actual results could differ materially from the results referred to in theforward-looking statements. In light of these risks and uncertainties, there canbe no assurance that the results referred to in the forward-looking statementscontained in this release will occur.We undertake no obligation to update or review any guidance or otherforward-looking information, whether as a result of new information, futuredevelopments or otherwise.Item 1. Description of Business.General Innodata Isogen is a leading provider of business services that helporganizations create, manage, use and distribute information more effectivelyand economically. We provide outsourced content services and content-relatedinformation technology (IT) professional services. Our outsourced contentservices focus on fabrication services and knowledge services. Fabricationservices include digitization, imaging, data conversion, XML and mark-upservices, as well as language translation and content creation services. XML, orExtensible Markup Language, is a universally accepted notation for identifyinginformation elements in documents, and is designed to meet the challenges oflarge-scale electronic publishing. Knowledge services include contentenhancement, taxonomy, controlled vocabulary development, hyperlinking, mark-upindexing, abstracting and general editorial services. Our IT professionalservices focus on the design, implementation, integration and deployment ofsystems used to author, manage and distribute content. We believe our integrated offering of outsourced content services and ITprofessional services allows us to offer our clients a suite of comprehensiveand sophisticated technology-based solutions that span the entire content supplychain, which is the series of integrated activities needed to create, manage,use and distribute information. In 2004, we provided our services to approximately 100 clients in fourcontent-intensive sectors. Organizations within each of these sectors, which arelisted below, face a distinct set of challenges in creating, managing, using anddistributing information more effectively and economically: o publishing, media and information services, including EBSCO and Reed Elsevier; o Global 2000 enterprises, including Hamilton Sundstrand and Lockheed Martin; I-1 o educational and cultural institutions, including Cornell University and Harvard Business School Publishing; and o government agencies, including several U.S. intelligence agencies. We typically service our clients in multi-year relationships.Approximately 76% of our largest 25 clients by revenues in the year endedDecember 31, 2004 have been clients in each year since 2001. We provide outsourced content services for business processes that weanticipate will continue for an indefinite period and therefore generate what weregard as recurring revenues. We derived 47% and 53% of our revenues from theseengagements for the years ended December 31, 2004 and 2003, respectively. We are headquartered in Hackensack, New Jersey, just outside New YorkCity. We have two additional solutions centers in North America, sevenproduction facilities in Asia (the Philippines, India and Sri Lanka) and atechnology and tools development center in India. We were incorporated inDelaware in 1988.Innodata Isogen's Services Our services encompass both outsourced content services that focus onfabrication services and knowledge services and information technology (IT)professional services that focus on the design, implementation, integration anddeployment of systems used to author, manage and distribute content. We definecontent as all forms of unstructured data, including text, formatted text suchas HTML, high-fidelity information such as XML, interactive and /or dynamic Webpages, images, graphics animation, video and sound files.Outsourced Content Services Our outsourced content services focus on fabrication services andknowledge services. We undertake fabrication projects for enterprises deployingcontent management solutions, and we build customized content products foronline publishers and information providers. In addition, we provide outsourcedservices for content-intensive enterprises and information service providers. The services we provide may vary in size and duration. Outsourced contentservices that are provided for a specific project generate revenues thatterminate on completion of a defined task and we regard these revenues asnon-recurring. We also provide outsourced content services for businessprocesses that we anticipate will continue for an indefinite period andtherefore generate what we regard as recurring revenue. Our methodology typically involves building customized workflow managementtools and content authoring tools that we operate on advanced technologyplatforms in our content processing facilities. We typically gather data frommultiple sources, normalize disparate data formats, digitize non-digital assetsand create XML files that are uploaded to a client's digital warehouse. As partof this process, we may engineer links that enable cross-referencing amongdigital assets, index data assets to an organizational structure, such astaxonomy or ontology, copyedit content or author content synopsis and abstracts.Fabrication Services. Our fabrication services include digitization, imaging,data conversion, XML and mark-up services, as well as language translation andcontent creation services. We use leading-edge technologies to capture ourclients' relevant content and convert it into XML and other related mark-upstandards. These technologies include high-speed scanning; a variety ofcommercial and proprietary optical/intelligent character recognition, orOCR/ICR, applications; structured workflow processes; and proprietaryapplications and tools designed to create meaningful, accurate and consistentdata. To convert the captured content to XML, tags are inserted within thecontent to provide a marker that computers can process. Our proprietarytechnology includes production-grade, auto-tagging applications that utilizepattern recognition algorithms based on comprehensive rule sets and heuristiconline databases. This technology enables the mass creation or conversion of XMLcontent from complex, unstructured data or content. I-2 We price our translation and content conversion services based on thequantity delivered or resources utilized. As an example, a major educational publisher sought to build the definitive digital archive of leading newspapers in North America. On behalf ofthis client, we digitized production runs of major world newspapers, providingfull page viewing, as well as threaded articles with searchable digital text.The process included treating the digital images with the latest digitaltechnology to visually repair the original images.Knowledge Services. Our knowledge services add value to a client's content andthese services include content enhancement, taxonomy, controlled vocabularydevelopment, hyperlinking, mark up indexing, abstracting and general editorialservices, including the provision of synopses and annotations. We also provideresearch services that cover a wide spectrum of expertise, including medicine,law, basic sciences, applied sciences, humanities, engineering, management andfinance. We have organized knowledge teams to provide these services, each ofwhich consists of a number of educated and highly trained people with expertisein the relevant subject. We typically price our knowledge services based on thequantity delivered or resources utilized. As an example, a major publisher of scientific, technical and medicalinformation sought to build one of the world's largest databases of scientificjournal citations and references. We created records of nearly 15,000 journaltitles going back almost 13 years, encoded in a way that supported integratedweb searches and seamless linking. Under a long-term engagement, we maintain thedatabase with daily updates, managing on behalf of our client a productionprocess in which we aggregate, digitize, convert and enhance data.IT Professional Services Our IT professional services focus on the design, implementation,integration and deployment of systems used to author, manage and distributecontent. These services include: o consulting; o systems integration; o custom application development; and o other IT professional services, including application maintenance support, evaluation and implementation and training. Clients that use our IT professional services typically requirepublishing, performance support or process automation systems that enablemultiple authors to collaborate on content and enable multiple products to begenerated from single-source XML repositories. Our IT professional servicesundertake a standards-based approach to development and integration. Projects vary in size and duration. Our IT professional services aretypically provided on a project basis that involves a defined task that, uponcompletion, does not generate any significant amount of continuing revenues.Each project typically involves all aspects of the software development process,including defining, designing, prototyping, programming, module integration andinstallation of the custom application. We typically work on-site at clients todevelop specifications and define requirements and to interact with end-users ofthe application. Detailed design, implementation and testing are generallyperformed at our Dallas and Austin, Texas offices, as well as offshore at ourGurgaon, India office. I-3Consulting. We offer consulting services that focus on evaluating, advising,creating, overseeing or reviewing processes and/or technology designs that arenecessary for a client to improve its management, use or distribution ofinformation. We assist our clients by first understanding their businessobjectives and then analyzing and recommending the appropriate hardware andsoftware specifications, as well as process and engineering changes that willfulfill these objectives. Our consultants have a broad mix of functional andindustry expertise. Our highly skilled process analysts, workflow architects andproject managers enable clients to outsource to us their entire contentoperations, and thereby enhance the client's ability to manage, use anddistribute the content. As an example, a major defense contractor was awarded a multi-billiondollar military contract to build a new war plane. The military required that the technical documentation be delivered in electronic format and be useable byfield technicians using handheld PDAs, as well as by pilots in the cockpit. Thedefense contractor hired us to recommend an XML-based publishing approach. Overseveral months, our team made several recommendations and redesigned theclient's core business processes and systems architecture to achieve itsobjectives, including the ability to support high-volume, link-intensive data.We were then engaged by the client to develop the system. The completed systemprovided an end-to-end workflow that included link management, support forcomplex graphics, customized backend databases to support fast search andretrieval and customized user interfaces.Systems Integration. Our systems integration services include the integration ofdisparate authoring tools, content/knowledge management systems and compositiontools into an overall IT infrastructure, and often also include the developmentof software that enhances the compatibility among various components of theoverall IT infrastructure. We also undertake the management of programs andvendors during this process. Many of our systems integration projects involveorganizations that are migrating to XML and other standards-based publishingsystems or are seeking to integrate disparate data sources into a commonenvironment. Our IT projects often include content analysis and the developmentof information architectures. For example, one of the world's most successful IT equipment manufacturerswas faced with the challenge of producing increasingly complex technicaldocumentation faster, in more languages and across multiple platforms, as wellas in print. This was necessary because of shortening product life cycles andthe desire to market products in remote global markets. Over a 12-month period,our team of information architects and developers provided strategy and processconsulting, product evaluation and information engineering services. Weaddressed complex content authoring, translation and localization and documentrendition requirements. The result was a completely re-engineeredstandards-based product documentation system that enabled our client to easilyrevise and re-use content and translate that content into 35 languagesseamlessly. We improved our client's time-to-market by significantly reducingthe turnaround time for documentation and revisions and substantially reducedits overall product documentation-related costs. Our team of two domesticproject managers and five offshore developers continue to provide the clientongoing systems enhancement and maintenance under a long-term engagement.Custom Application Development. Our custom application development services helpour clients create new applications and enhance the functionalities of ourclients' existing software applications. We perform system design and softwarecoding and run pilots, while transition planning, user training and deploymentactivities are performed at the client's site. Our application developmentservices span the entire range of client server and Internet technologies. OurIT professional services staff are experts at XML and related informationstandards, as well as emerging computing platforms. Our programmers are skilledin a wide range of programming languages, as well as a diverse set ofapplication program interfaces, applications servers and database technologies. As an example, a client in the information services industry needed tobuild an enterprise-scale publishing platform for a new online informationservice utilizing the latest knowledge processing technologies. Our team ofonshore and offshore technologists designed and built the platform over a periodof several months, including authoring and classification workflow systems,backend database and user interface. Our content services department aggregated,digitized and enhanced multiple gigabytes of data for the successful productpilot. Our single program manager coordinated the efforts of our IT professionalservices team, our outsourced content services team and other vendors on-site atthe client. I-4Other IT Professional Services. We assist our clients in the evaluation andimplementation of software packages developed by third party vendors. Wespecialize in enterprise content management systems developed by severalvendors, including: Documentum, Content@, XHive Corporation and Vasont Systems;and document authoring systems developed by vendors including Arbortext andBlast Radius; publishing tools developed by vendors including TopLeaf, AntennaHouse and FrameMaker; as well as various content analysis and extraction tools. We provide support for our client's content-related applications, ensuringthat systems remain operational and responsive to changing user requirements. In doing so, we are often able to enhance processes and improve service levels.Through our domestic, on-site and offshore delivery model, we are able toprovide a range of support services to our clients. We also provide clients professional training, courseware and continuingeducation in XML and other structural information services.Clients We view our relationship with our clients as a critical element of ourhistorical success and an important basis for our future growth. We workdirectly with existing and prospective clients to identify and refine theirobjectives and to design, implement, integrate and deploy new and improvedservice solutions to satisfy those objectives. We believe we provide highquality, value-added services to our clients on a timely basis and havedeveloped a close relationship with them as a result. To enhance thoserelationships, we provide project support 24 hours a day, seven days a week,through our Asia-based customer service center, and we maintain sales, serviceand strategic support in North America and Europe in proximity to the operationsof most of our clients. We offer our services to approximately 100 businesses and organizations infour content-intensive sectors. The following sets forth a selected list of ourclients in the four content-intensive sectors that we serve: o Publishing, media and information services: EBSCO; John Wiley & Sons; McGraw-Hill; ProQuest; Reed Elsevier; Thomson and Wolters Kluwer; o Global 2000 enterprises: Amazon.com; Bausch & Lomb; Boeing; Hamilton Sundstrand; John Deere; Lockheed Martin and Primerica; o Educational and cultural institutions: CAB International; Cornell University; Harvard Business School Publishing and The Smithsonian Institution; and o Government agencies: The Federal Reserve Board and several U.S. intelligence agencies. Outsourced content services that are provided for a specific projectgenerate revenues that terminate on completion of a defined task and we regardthese revenues as non-recurring. We also provide outsourced content services forbusiness processes that we anticipate will continue for an indefinite period andtherefore generate what we regard as recurring revenue. Approximately 76% of our largest 25 clients by revenues in the year endedDecember 31, 2004 have been clients in each year since 2001. I-5 One client accounted for 23%, 33% and 17% of our total revenues for theyears ended December 31, 2004, 2003 and 2002, respectively. One other clientaccounted for 31% and 30% of our revenues for the years ended December 31, 2004and 2002, respectively. No other client accounted for 10% or more of our totalrevenues during these periods. Revenues from clients located in foreigncountries (principally in Europe) accounted for 30%, 47% and 23% of our totalrevenues for the years ended December 31, 2004, 2003 and 2002, respectively. Some of our clients require us to enter into nondisclosure agreementspursuant to which we agree not to disclose their identities or the nature of ourrelationship. Typically these arrangements are required because the client doesnot want to publicize its outsourcing strategy or a new product developmentinitiative before it is introduced in the market.Sales and Marketing We currently have four executive-level business development professionalsand five full-time sales personnel and are planning to increase our full-time salesperson headcount to between 10 and 12 in 2005. Historically, our salesefforts depended heavily on senior management. We are transitioning to a morestructured direct sales model in which we implement additional salesinfrastructure, add dedicated sales support personnel and add additional salespersons. In this model, our executive-level business development professionalswill continue to manage key client relationships through targeted interactionwith our clients' senior management, while sales professionals will beresponsible for identifying prospective clients and the execution of day-to-daysales strategies. Our sales organization is responsible for qualifying and otherwisepursuing prospects, securing direct personal access to decision-makers atexisting and prospective clients and obtaining orders for our services andsolutions. Our sales professionals work directly with clients to identify theirrequirements and with our engineering teams to define the solutions that bestfit our clients' specific needs. Sales activities include the design and generation of presentations andproposals, account and client relationship management and the organization ofaccount activities. Consulting personnel from our project analysis group and our engineeringservices group closely support our direct sales effort. These individuals assistthe sales force in understanding the technical needs of clients and providingresponses to these needs, including demonstrations, prototypes, pricingquotations and time estimates. In addition, account managers from our customerservice group support our direct sales effort by providing ongoingproject-level, post-sale support to our clients. We constantly seek to expand the nature and scope of our engagements withexisting clients by increasing the volume of our business and extending thebreadth and value of services offered. For existing clients, our sales personneland our on-site project personnel proactively identify client needs and workwith our sales team to structure solutions to address those needs. Our marketing organization is responsible for: o developing and increasing the visibility and awareness of our brand and our service offerings; o defining and communicating our value proposition; and o generating leads and furnishing effective sales support tools. Over the past 12 months, we have improved our brand management andenhanced our lead generation capability. In addition, we have created a partnerprogram pursuant to which we have formed collaborative relationships withselected leading software vendors and service providers in many of our keymarkets. We believe that our partner program is an important way for our salesforce to generate more and better quality leads. Furthermore, the partnerprogram helps us gain technical insights that allow us to evaluate better theeffectiveness of the various tools that we recommend to our clients. I-6 Primary marketing outreach activities include: o event marketing (including exhibiting at trade shows, conferences and seminars); o direct and database marketing; o public and media relations (including speaking engagements and active participation in industry and technical standard bodies); and o web marketing (including search engine optimization, search engine marketing and the maintenance and continued development of external web sites).Competition The markets for our services are highly competitive. The most significantcompetitive factors are: o experience and expertise; o quality and reliability of services; o price of services; o the scope and scale of service offerings; o the quality of supporting services; o retention of highly skilled employees; and o technical competence. Our ability to compete favorably is dependent upon our ability to reactappropriately to short- and long-term trends, harness new technology and deliverlarge-scale requirements. With respect to outsourced content services, competition is highlyfragmented and intense; however, we believe we compete successfully by offeringhigh quality services and favorable pricing by leveraging our technical skills,IT infrastructure, process knowledge, offshore model and economies of scale. SPI Technologies, Apex CoVantage, Techbooks and Jouve, among others,compete with us in providing content services. However, we are not aware of anysingle competitor that provides the same comprehensive range of outsourcedcontent services as we do, and we believe that we have created significantdifferentiation as a result of: o our specific business process expertise and the greater resources that we provide to our clients; o the high quality and reliability of our services; and o the scope and scale of our services. I-7 Thus, we believe we are well positioned to obtain client contracts whenthe undertaking required is technically sophisticated, sizable in scope orscale, or when clients require a highly fail-safe environment with technologyredundancy. We also believe that the timeliness with which we provide ourservices enables our clients to reduce the time it takes for them to releasetheir products to the market, thereby providing a competitive advantage to theclient. With respect to our IT professional services, a number of large andmid-sized technology and business consulting practices offer content-relatedintegration and consulting services as part of their broad and generalizedofferings. Major companies such as IBM, EDS, Bearing Point, Accenture, BoozAllen and others compete for entire content supply chain dollars, though few, ifany, focus exclusively on our niche. There are fewer firms, most with lessercapacity, with a narrower strategic focus on the content supply chain, such asThomas Technology Solutions and RivCom. As a provider of outsourced content services and IT professional services,we also compete at times with in-house personnel at existing or prospectiveclients who may attempt to duplicate our services using in-house personnel. Some of our competitors have longer operating histories, significantlygreater financial, human, technical and other resources and greater namerecognition than we do, and we cannot assure you that we will continue tocompete effectively with them.Employees As of February 28, 2005, we employed an aggregate of approximately 85persons in the United States and Europe and 7,400 persons in five productionfacilities in the Philippines, one production facility in Sri Lanka, oneproduction facility in India and a technology and tools development center inIndia. Most of our employees have graduated from at least a two-year collegeprogram. Many of our employees hold advanced degrees in law, business,technology, medicine and social sciences. We take great pride in our company culture and values, which are extremelyservice oriented. We have designed processes to foster consistent employeebehavior that promotes our clients' successes and delivers dependable outcomes.At the same time, we promote operating efficiencies. Within our IT professionalservices team, we have assembled what we believe is a highly talented group oftechnologists. Our culture is non-hierarchical, encouraging the iteration ofideas to address complex technical challenges. We have developed specializedinternal software applications to facilitate meaningful communication amongemployees. To retain our qualified personnel, we offer competitive base salaries thatare supplemented by results-based incentives. Senior managers are eligible forbonuses and stock options. Our compensation structure is coupled with anextensive benefits package, tailored by region, which can include comprehensivehealth insurance coverage, paid vacation and holiday leaves, allowances andcontinuing education programs. No employees are currently represented by a labor union, and we believethat our relations with our employees are satisfactory.Item 2. Description of Property. Our services are primarily performed from our Hackensack, New Jerseyheadquarters, our Dallas and Austin, Texas offices, and seven overseasfacilities, all of which are leased. In addition, we have a technology and toolsdevelopment facility in Gurgaon, India, which is also leased. The square footageof all our leased properties is approximately 218,000. Rental payments onproperty leases were approximately $1,725,000 in 2004. I-8Item 3. Legal Proceedings. The Innodata Employees Association (IDEA), Jomarie Deles and othercomplainants have sued one of our Philippines subsidiaries, and have purportedalso to sue us and certain of our officers and directors, in InnodataPhilippines Employees Association (IDEA) v Innodata Philippines, Inc. (filedJuly 27, 2001 at the National Conciliation and Mediation Board of the PhilippineDepartment of Labor and Employment in Manila); Innodata Employees Association(IDEA), Jomarie Deles, et al v. Innodata Philippines, Inc. (filed July 1, 2002in the National Labor Relations Commission of the Republic of the Philippines inManila); and in related cases and proceedings filed in the Philippines SupremeCourt, the Philippine Court of Appeals and the Philippines Department of Laborand Employment. Complainants seek to require reinstatement of employment and torecover back wages for an allegedly illegal facility closing on June 7, 2002based on the terms of a collective bargaining agreement with this subsidiary. Wehave prevailed in substantially all stages of this litigation to date, althoughseveral appeals by complainants are still pending. If complainants' claims hadmerit they could be entitled to back wages of up to $5.0 million for the periodfrom June 7, 2002 to June 6, 2005, consistent with prevailing jurisprudence.After consultation with counsel, we believe that the complainants' claims arewithout merit and we intend to defend against them vigorously. In addition, we are subject to various legal proceedings and claims whicharise in the ordinary course of business. While we currently believe that theultimate outcome of these proceedings will not have a material adverse affect onour financial condition or results of operations, litigation is subject toinherent uncertainties. Were an unfavorable ruling to occur, it could have amaterial adverse effect on our financial condition and results of operations.Item 4. Submission of Matters to a Vote of Security Holders. None. I-9 PART IIItem 5. Market for Common Equity and Related Stockholder Matters. Innodata Isogen, Inc. (the "Company") Common Stock is quoted on the NasdaqNational Market System under the symbol "INOD." On February 28, 2005, there were115 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 approximately4,500. The following table sets forth the high and low sales prices on aquarterly basis for the Company's Common Stock, as reported on Nasdaq, for thetwo years ended December 31, 2004. Common Stock Sale Prices 2003 High Low ---- ---- --- First Quarter $ 1.09 $ 0.73 Second Quarter 1.47 0.84 Third Quarter 2.60 1.11 Fourth Quarter 4.96 2.42 2004 High Low ---- ---- --- First Quarter $ 4.95 $ 3.09 Second Quarter 4.20 2.80 Third Quarter 4.60 3.15 Fourth Quarter 9.99 3.28Dividends 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. II-1Securities Authorized for Issuance Under Equity Compensation Plans The following table sets forth the aggregate information for the Company'sequity compensation plans in effect as of December 31, 2004: Number of Securities to be Issued Weighted-Average Number of Securities Upon Exercise of Exercise Price of Remaining Available For Outstanding Options, Outstanding Options, Future Issuance UnderPlan Category Warrants and Rights Warrants and Rights Equity Compensation Plans (a) (b) (c) Equity compensation plansapproved by security holders 6,011,000 $2.62 1,424,000Equity compensation plansnot approved by security holders 1,015,000 (1) $0.84 -- --------- ----- ---------Total 7,026,000 $2.36 1,424,000 ========= ===== =========(1) Consists of stock options to purchase 1,015,164 shares of common stock granted to the Company's current Chairman pursuant to an agreement entered into at time of hire. II-2Item 6. Selected Financial Data (In thousands, except per share amounts). Year Ended December 31, ----------------------- 2004 2003 2002 2001 2000 ---- ---- ---- ---- ---- (In thousands, except per share data) STATEMENT OF OPERATIONS DATA:REVENUES $ 53,949 $ 36,714 $ 36,385 $ 58,278 $ 50,731 --------- --------- --------- --------- ---------OPERATING COSTS AND EXPENSES: Direct operating expenses 33,050 27,029 32,005 44,354 34,458 Selling and administrative 10,205 8,898 10,038 8,337 7,248 Terminated offering costs 625 -- -- -- -- Provision for doubtful accounts -- -- -- 2,942 -- Bad debt recovery, net (963) -- -- -- -- Restructuring costs and asset impairment -- -- 244 865 -- Interest expense 25 9 29 9 43 Interest income (87) (30) (89) (216) (155) --------- --------- --------- --------- --------- Total 42,855 35,906 42,227 56,291 41,594 ========= ========= ========= ========= =========INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES 11,094 808 (5,842) 1,987 9,137PROVISION FOR (BENEFIT FROM) INCOME TAXES 3,237 333 (677) 639 2,969 --------- --------- --------- --------- ---------NET INCOME (LOSS) $ 7,857 $ 475 $ (5,165) $ 1,348 $ 6,168 ========= ========= ========= ========= =========INCOME (LOSS) PER SHARE: Basic $ .35 $ .02 $ (.24) $ .06 $ .30 ========= ========= ========= ========= ========= Diluted $ .32 $ .02 $ (.24) $ .05 $ .26 ========= ========= ========= ========= =========Cash dividends per share -- -- -- -- -- --------- --------- --------- --------- --------- December 31, ------------ 2004 2003 2002 2001 2000 ---- ---- ---- ---- ---- (In thousands) BALANCE SHEET DATA:WORKING CAPITAL $ 22,209 $ 11,983 $ 8,570 $ 8,854 $ 9,505 ========= ========= ========= ========= =========TOTAL ASSETS $ 37,211 $ 25,146 $ 22,697 $ 30,094 $ 27,946 ========= ========= ========= ========= =========LONG TERM DEBT $ 150 $ 272 -- -- -- ========= ========= ========= ========= =========STOCKHOLDERS' EQUITY $ 26,737 $ 17,404 $ 15,569 $ 20,362 $ 19,316 ========= ========= ========= ========= ========= II-3 Item 7. Management's Discussion and Analysis Of Financial Condition and Results Of Operations.Revenues We derive the majority of our revenues from outsourced content services.These services consist of fabrication and knowledge services. Outsourced contentservices that are provided for a specific project generate revenues thatterminate on completion of a defined task and we regard these revenues asnon-recurring. We also provide outsourced content services for businessprocesses that we anticipate will continue for an indefinite period andtherefore generate what we regard as recurring revenues. We price our outsourcedcontent services based on the quantity delivered or resources utilized. Revenuesfor outsourced content services are recognized in the period in which theservices are performed and delivered. We also derive a portion of our revenues from IT professional services. Asubstantial majority of our IT professional services is provided on a projectbasis that generates non-recurring revenues. These services consist ofconsulting, systems integration, custom application development and otherprofessional services. We price our professional services on an hourly basis foractual time and expense incurred, or on a fixed-fee turn-key basis. Revenues forcontracts billed on a time and materials basis are recognized as services areperformed. Revenues under fixed-fee contracts are recognized on the percentageof completion method of accounting as services are performed or milestones areachieved. Recurring revenues consisted of 47% and 53% of total revenues for theyears ended December 31, 2004 and 2003, respectively. The substantial majorityof our recurring revenues is derived from outsourced content services. A smallportion of our recurring revenues is derived from the application maintenanceagreements related to our IT professional services. Non-recurring revenues varydepending on the size and completion dates of specific projects. While we seek, wherever possible, to counterbalance periodic declines inrevenues on completion of large projects with new arrangements to provideservices to the same client or others, we may not be able to avoid declines inrevenues when large projects are completed. Our inability in any period toobtain sufficient new projects to counterbalance any decreases in such work willadversely affect our revenues and results of operations for the period. By wayof example, we expect a decline in year-over-year revenues in the first half of2005, principally because we expect that revenues from existing projects and newprojects will not be sufficient to offset the decline in revenues resulting fromprojects that were concluded, terminated or delayed. We have historically relied on a very limited number of clients that haveaccounted for a significant portion of our revenues. One client accounted for23%, 33% and 17% of our total revenues for the years ended December 31, 2004,2003 and 2002, respectively. One other client accounted for 31% and 30% of ourrevenues for the years ended December 31, 2004 and 2002, respectively. We maylose any of these or our other major clients as a result of: o our failure to meet or satisfy our clients' requirements; o the completion or termination of a project or engagement; or o the selection of another service provider. In addition, the revenues we generate from our major clients may declineor grow at a slower rate in future periods than in the past. If we lose any ofour significant clients, our revenues and results of operations could beadversely affected and we may incur a loss from operations. Our services aretypically subject to client requirements, and in most cases are terminable upon30 to 90 days' notice. II-4 We have experienced, and expect to continue to experience, significantfluctuations in our quarterly revenues and results of operations. During thepast eight quarters, our net income ranged from a loss of approximately $1.1million to a profit of approximately $3.1 million. Numerous factors, some ofwhich are beyond our control, may affect our quarterly results of operations,including completions, terminations, cancellations or deferrals of projects orengagements; the size, mix, timing and terms and conditions of client projects; variations in the duration, size and scope of our projects or engagements;market acceptance of our clients' new products and services; our ability tomanage costs; local factors and events that affect our production volume, suchas local holidays; unforeseen events, such as earthquakes, storms and civilunrest; currency exchange fluctuations; changes in pricing policies by us or ourcompetitors; the introduction of new services by us or our competitors; andacquisition and integration costs related to possible acquisitions of otherbusinesses. Our quarterly operating results are also subject to certain seasonalfluctuations. Our fourth and first quarters include the months of December andJanuary, when billable services activity by professional staff, as well asengagement decisions by clients, may be reduced due to client budget planningcycles. Demand for our services generally may be lower in the fourth quarter dueto reduced activity during the holiday season and fewer working days for ourPhilippines-based staff during this period. These and other seasonal factors maycontribute to fluctuations in our results of operations from quarter to quarter.Direct Operating Costs Direct operating costs for both our outsourced content services and ITprofessional services consist of direct payroll, occupancy costs, depreciation,telecommunications, computer services and supplies. We intend to reduce directoperating costs of our IT professional services as a percentage of revenues fromour IT professional services by increasing our offshore IT professional servicesstaff.Selling and Administrative Expenses Selling and administrative expenses for both our outsourced contentservices and IT professional services consist of management and administrativesalaries, sales and marketing costs and administrative overhead. We anticipateselling and administrative expenses to increase in absolute terms as we continueto grow our business. Commencing October 1, 2003, we unified our selling andrelated activities for our outsourced content services and IT professionalservices segments. As such, selling and corporate administrative costs are notsegregated by, nor are they allocated to, operating segments for periodscommencing January 1, 2004.Results of OperationsYear Ended December 31, 2004 Compared to the Year Ended December 31, 2003Revenues Revenues were $53.9 million for the year ended December 31, 2004 comparedto $36.7 million for the similar period in 2003. One client accounted for 23% and 33% of our total revenues for the yearsended December 31, 2004 and 2003, respectively. A second client accounted for31% of our revenues for the year ended December 31, 2004. No other clientaccounted for 10% or more of our total revenues for these periods. Further, forthe years ended December 31, 2004 and 2003, revenues from clients located inforeign countries (principally in Europe) accounted for 30% and 47% of our totalrevenues, respectively. Revenues from outsourced content services increased 46% to $43.7 millionfor the year ended December 31, 2004 from $30.0 million for the similar periodin 2003. The increase was primarily due to increased revenues from several newprojects. Of the $43.7 million of revenues for the year ended December, 31,2004, approximately $13.8 million, or 31%, resulted from new projects,substantially all of which were for existing clients. II-5 Revenues from IT professional services increased 52% to $10.2 million forthe year ended December 31, 2004 from $6.7 million for the similar period in2003. This increase was primarily due to increased revenues from new projects.Approximately $9.5 million, or 93%, of revenues from IT professional servicesfor the year ended December 31, 2004 resulted from new projects, a majority ofwhich were for existing clients. For the year ended December 31, 2004, approximately 53% of our revenue wasnon-recurring and the 47% balance was recurring, compared with 47% and 53%,respectively, for the year ended December 31, 2003.Direct Operating Costs Direct operating costs were $33.1 million and $27.0 million for the yearsended December 31, 2004 and 2003, respectively, an increase of 23%. Directoperating costs as a percentage of revenues were 61% for the year ended December31, 2004 and 74% for the year ended December 31, 2003. Direct operating costs for outsourced content services were $27.5 millionand $23.0 million for the years ended December 31, 2004 and 2003, respectively,an increase of 19%. Direct operating costs of outsourced content services as apercentage of revenues from outsourced content services were 63% and 77% for theyears ended December 31, 2004 and 2003, respectively. The dollar increase forthe content services segment in the 2004 period was principally due to increasesin both labor and non-labor costs as a result of increased revenues. Thedecrease in direct operating costs of outsourced content services as apercentage of revenues from outsourced content services for the 2004 period wasprincipally due to lower labor costs as a percentage of revenues resulting fromimproved process efficiencies and aggressive project cost management, as well asa 46% increase in revenues compared to a 12% increase in fixed non-labor costs. Direct operating costs for IT professional services were $5.6 million and$4.0 million for the years ended December 31, 2004 and 2003 respectively. Directoperating costs of IT professional services as a percentage of revenues from ITprofessional services were 54% and 59% for the years ended December 31, 2004 and2003, respectively. The dollar increase in direct operating costs of ITprofessional services for the 2004 period was principally due to increases inpersonnel and related costs. The decrease in direct operating costs of ITprofessional services as a percentage of revenues from IT professional servicesfor the 2004 period was primarily attributable to increased resource utilizationresulting in a 4% decrease in non-labor costs as a percentage of revenues fromIT professional services, and a one percent decrease in direct labor costs as apercentage of revenues.Selling and Administrative Expenses Selling and administrative expenses were $10.2 million and $8.9 millionfor the years ended December 31, 2004 and 2003, respectively, an increase of15%. Selling and administrative expenses as a percentage of revenues were 19%and 24% for the years ended December 31, 2004 and 2003, respectively. Sellingand administrative expenses for the year ended December 31, 2003 include anon-cash compensation charge of approximately $650,000. Excluding this charge,selling and administrative expenses for the year ended December 31, 2004 wouldhave increased by approximately $2.0 million, or 24%, from the similar period in2003. Approximately $1.7 million of the increase in selling and administrativeexpenses relates to increases in selling and marketing costs, primarilyattributable to the hiring of additional business development, management andsales support personnel, as well as to increased marketing programs andactivities.Other On January 5, 2005, we announced our intent to raise funds and filed aregistration statement on Form S-3 to register 4,250,000 shares of our commonstock, plus 3,250,000 shares of common stock currently held by certain of ourdirectors and officers. On March 23, 2005, we terminated the offering and assuch, in the fourth quarter 2004, expensed approximately $625,000 of offeringcosts. In January 2004, we reached a settlement agreement with and received $1.0million in cash from a former client in full satisfaction of a $2.6 millionoutstanding balance that we had fully written off as a bad debt in 2001. The$1.0 million receipt, net of $37,000 in recovery costs, is reflected as bad debtrecovery for the year ended December 31, 2004. II-6 For the year ended December 31, 2004, the provision for income taxes as apercentage of income was 29%. The 2004 provision is lower than the U.S. Federalstatutory rate, principally due to certain overseas income which is neither subject to foreign income taxes because of tax holidays granted to us, norsubject to tax in the U.S. unless repatriated. In August 2004, the IRS promulgated regulations, effective August 12,2004, that had the effect of making certain of our overseas entities taxable inthe United States for U.S. federal income tax purposes. As a result, in thefourth quarter 2004, we provided approximately $450,000 for U.S. income taxesattributable to these applicable overseas entities. In addition, in December2004, we effected certain filings in Delaware to ensure that these subsidiarieswill not be treated as U.S. corporations for U.S. federal income tax purposes asof the date of filing and as such, will not be subject to U.S. federal incometaxes commencing January 1, 2005. The provision for income taxes for the year ended December 31, 2003 ishigher as a percentage of pre-tax income than the federal statutory rate dueprimarily to foreign and state income taxes, and to certain foreign sourcelosses for which no tax benefit is available, partially offset by the effect ofincome in tax jurisdictions currently under tax holiday.Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002Revenues Revenues were $36.7 million for the year ended December 31, 2003 comparedto $36.4 million for the similar period in 2002. One client accounted for 33% and 17% of our total revenues for the yearsended December 31, 2003 and 2002, respectively. A second client accounted for30% of our revenues for the year ended December 31, 2002. No other clientaccounted for 10% or more of our total revenues for these periods. Further, forthe years ended December 31, 2003 and 2002, revenues from clients located inforeign countries (principally in Europe) accounted for 47% and 23% of our totalrevenues, respectively. Revenues from outsourced content services decreased 9% to $30.0 millionfor the year ended December 31, 2003 from $33.1 million for the similar periodin 2002. The decrease was primarily due to the decline in revenues ofapproximately $11.0 million from two clients whose largest projects weresubstantially completed in 2002. The shortfall was replaced in part by a $9.0million increase in revenues from three existing clients. Revenues from IT professional services increased 104% to $6.7 million forthe year ended December 31, 2003 from $3.3 million for the similar period in2002. The increase was primarily due to an increase in the quantity and size ofsystem integration projects for both new and existing clients. Approximately$5.2 million, or 78%, of revenues from IT professional services for the yearended December 31, 2003 resulted from new projects, a majority of which were forexisting clients. For the year ended December 31, 2003, approximately 47% of our totalrevenues was non-recurring and the 53% balance was recurring, compared with 58%and 42%, respectively, for the year ended December 31, 2002.Direct Operating Costs Direct operating costs were $27.1 million and $32.0 million for the yearsended December 31, 2003 and 2002, respectively, a decrease of 16%. Directoperating costs as a percentage of revenues were 74% for the year ended December31, 2003 and 88% for the year ended December 31, 2002. II-7 Direct operating costs for outsourced content services were $23.1 millionand $28.0 million for the years ended December 31, 2003 and 2002, respectively,a decrease of 18%. Direct operating costs of outsourced content services as apercentage of revenues from outsourced content services were 77% and 85% for theyears ended December 31, 2003 and 2002, respectively. The dollar decline, aswell as the decline in such costs as a percentage of revenues from outsourcedcontent services in the 2003 period, were primarily due to a reduction in laborand in fixed costs associated with our cost reduction initiatives. Direct operating costs for IT professional services were $4.0 million ineach of the years ended December 31, 2003 and 2002. Direct operating costs of ITprofessional services as a percentage of revenues from IT professional services were 59% and 120% for the years ended December 31, 2003 and 2002, respectively.The decrease in direct operating costs of IT professional services as apercentage of IT professional services revenues was primarily attributable toincreased resource utilization and fixed cost leverage.Selling and Administrative Expenses Selling and administrative expenses were $8.9 million and $10.0 millionfor the years ended December 31, 2003 and 2002, respectively, a decrease of 11%.Selling and administrative expenses as a percentage of revenues were 24% and 28%for the years ended December 31, 2003 and 2002, respectively. The decrease inselling and administrative expenses is primarily attributable to the costreduction initiatives that were implemented during the second half of 2002.Other In early 2002, we closed a facility in Asia, resulting in the write-off ofproperty and equipment associated with the closed facility totalingapproximately $244,000. This write-off of equipment was classified asrestructuring costs and asset impairment for the year ended December 31, 2002. For the year ended December 31, 2003, the provision for income taxes was41% of pre-tax income, compared to a 12% benefit from income taxes as apercentage of pre-tax loss for the year ended December 31, 2002. The provisionfor income taxes for the year ended December 30, 2003 is higher as a percentageof pre-tax income than the federal statutory rate due primarily to foreign andstate income taxes and to certain foreign source losses for which no tax benefitis available, partially offset by the effect of income in tax jurisdictionscurrently under tax holiday. For the year ended December 31, 2002, the incometax benefit was lower as a percentage of pre-tax loss than the federal statutoryrate primarily as a result of certain overseas foreign source losses for whichno tax benefit is available.Liquidity and Capital Resources Selected measures of liquidity and capital resources, expressed inthousands are as follows: December 31, 2004 December 31, 2003 ----------------- ----------------- Cash and Cash Equivalents $20,663 $ 6,051 Working Capital 22,209 11,983Net Cash Provided By Operating Activities Net cash provided by operating activities was $15.7 million for the yearended December 31, 2004 compared to $.7 million provided by operating activitiesfor the year ended December 31, 2003, an increase of approximately $15.0million. The net cash provided by operating activities for the 2004 period isprincipally due to net income approximating $7.9 million, non-cash chargesapproximating $4.8 million, and changes in operating assets and liabilities of$3.0 million. II-8 Accounts receivable totaled $8.0 million at December 31, 2004,representing approximately 57 days of sales outstanding, compared to $8.5million, or 71 days, at December 31, 2003. The decrease in days outstandingresulted from increased accounts receivable collections during 2004. A significant amount of our revenues is derived from clients in thepublishing industry. Accordingly, our accounts receivable generally includesignificant amounts due from such clients. In addition, as of December 31, 2004,approximately 27% of our accounts receivable was from foreign (principallyEuropean) clients, and 69% of accounts receivable was due from two clients.Net Cash Used in Investing Activities For the year ended December 31, 2004, we spent approximately $2.1 millionfor capital expenditures, compared to approximately $2.4 million for the yearended December 31, 2003. Capital spending in 2004 and 2003 related principallyto normal ongoing equipment upgrades, project requirement specific equipment, and for improvements in infrastructure. We expect that the capital expendituresfor these purposes will approximate $3.0 million in 2005, excluding anypotential capital expenditures related to future facilities expansion.Availability of Funds We have a $5.0 million line of credit pursuant to which we may borrow upto 80% of eligible accounts receivable at the bank's alternate base rate plus1/2% or LIBOR plus 3%. The line, which expires in May, 2005, is secured by ouraccounts receivable. There are no amounts outstanding under this facility. We believe that existing cash and internally generated funds will besufficient for our reasonably anticipated working capital and capitalexpenditure requirements during the next 12 months. We fund our foreignexpenditures from our U.S. corporate headquarters on an as-needed basis.Contractual Obligations The table below reflects our contractual cash obligations, expressed inthousands, at December 31, 2004. Payments Due by Period ----------------------Contractual Obligations Total Less than 1-3 years 4-5 years After----------------------- ----- 1 year --------- --------- 5 years ------ ------- Capital lease obligations $ 355 $ 199 $ 156 $ -- $ --Non-cancelable operating leases 2,203 460 1,286 457 -- ------ --------- --------- --------- -------Total contractual cash obligations $2,558 $ 659 $ 1,442 $ 457 $ -- ====== ========= ========= ========= =======Inflation, Seasonality and Prevailing Economic Conditions To date, inflation has not had a significant impact on our operations. Wegenerally perform work for our clients under project-specific contracts,requirements-based contracts or long-term contracts. Contracts are typicallysubject to numerous termination provisions. Our quarterly operating results are subject to certain seasonalfluctuations. Our fourth and first quarters include the months of December andJanuary, when billable services activity by professional staff, as well asengagement decisions by clients, may be reduced due to client budget planningcycles. Demand for our services generally may be lower in the fourth quarter dueto reduced activity during the holiday season and fewer working days for ourPhilippines-based staff during this period. These and other seasonal factors maycontribute to fluctuations in our operating results from quarter to quarter. II-9Critical Accounting Policies and EstimatesBasis of Presentation and Use of Estimates Management's discussion and analysis of its results of operations andfinancial condition is based upon our consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure of contingentassets and liabilities. On an on-going basis, we evaluate our estimates,including those related to accounts receivable. Management bases its estimateson historical experience and on various other assumptions that are believed tobe reasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. Allowance for Doubtful Accounts We establish credit terms for new clients based upon management's reviewof their credit information and project terms, and perform ongoing creditevaluations of our customers, adjusting credit terms when management believesappropriate based upon payment history and an assessment of their current creditworthiness. We record an allowance for doubtful accounts for estimated lossesresulting from the inability of our clients to make required payments. Wedetermine this allowance by considering a number of factors, including thelength of time trade accounts receivable are past due, our previous losshistory, our estimate of the client's current ability to pay its obligation tous, and the condition of the general economy and the industry as a whole. Whilecredit losses have generally been within expectations and the provisionsestablished, we cannot guarantee that credit loss rates in the future will beconsistent with those experienced in the past. In addition, we have creditexposure if the financial condition of one of our major clients were todeteriorate. In the event that the financial condition of our clients were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be necessary.Revenue Recognition We recognize revenue for content manufacturing and outsourcing services inthe period in which we perform services and deliver in accordance with StaffAccounting Bulletin 104. We recognize IT professional services revenue from custom application andsystems integration development which requires significant production,modification or customization of software in accordance with Statement ofPosition ("SOP") No. 97-2 "Software Revenue Recognition" and in a manner similarto SOP No. 81-1 "Accounting for Performance of Construction-Type and CertainProduction-Type Contracts". We recognize revenue for such services billed underfixed fee arrangements using the percentage-of-completion method under contractaccounting as we perform services or reach output milestones. We measure thepercentage completed either by the percentage of labor hours incurred to date inrelation to estimated total labor hours or in consideration of achievement ofcertain output milestones, depending on the specific nature of each contract.For arrangements in which percentage-of completion accounting is used, we recordcash receipts from customers and billed amounts due from customers in excess ofrecognized revenue as billings in excess of revenues earned on contracts inprogress (which is included in accounts receivable). Revenues from fixed-feeprojects accounted for less than 10% of our total revenue for each of the threeyears ended December 31, 2004, respectively. We receive revenue billed on a timeand materials basis as we perform the services.Property and Equipment Property and equipment is stated at cost and is depreciated on thestraight-line method over the estimated useful lives of the related assets,which is generally two to five years. Leasehold improvements are amortized on astraight-line basis over the shorter of their estimated useful lives or thelives of the leases. II-10Long-lived Assets We account for long lived assets under Statement of Financial AccountingStandards ("SFAS") 144, Accounting for the Impairment or Disposal of Long LivedAssets. We assess the recoverability of our long-lived assets, which consistprimarily of fixed assets and intangible assets with finite useful lives,whenever events or changes in circumstance indicate that the carrying value maynot be recoverable. The following factors, if present, may trigger an impairmentreview: (i) significant underperformance relative to expected historical orprojected future operating results; (ii) significant negative industry oreconomic trends; (iii) significant decline in our stock price for a sustainedperiod; and (iv) a change in our market capitalization relative to net bookvalue. If the recoverability of these assets is unlikely because of theexistence of one or more of the above-mentioned factors, we perform animpairment analysis using a projected discounted cash flow method. We must makeassumptions regarding estimated future cash flows and other factors to determinethe fair value of these respective assets. If these estimates or relatedassumptions change in the future, we may be required to record an impairment charge. Impairment charges would be included in general and administrativeexpenses in our statements of operations, and would result in reduced carryingamounts of the related assets on our balance sheets.Income Taxes We determine our deferred taxes based on the difference between thefinancial statement and tax bases of assets and liabilities, using enacted taxrates, as well as any net operating loss or tax credit carryforwards expected toreduce taxes payable in future years. We provide a valuation allowance when itis more likely than not that some or all of a deferred tax asset will not berealized. Unremitted earnings of foreign subsidiaries have been included in theconsolidated financial statements without giving effect to the United Statestaxes that may be payable on distribution to the United States to the extentsuch earnings are not anticipated to be remitted to the United States.Goodwill and Other Intangible Assets SFAS 142 requires that we test goodwill for impairment using a two-stepfair value based test. The first step of the goodwill impairment test, used toidentify potential impairment, compares the fair value of a reporting unit withits carrying amount, including goodwill. If the carrying amount of the reportingunit exceeds its fair value, the second step of the goodwill impairment testmust be performed to measure the amount of the impairment loss, if any. Ifimpairment is determined, we will recognize additional charges to operatingexpenses in the period in which they are identified, which would result in areduction of operating results and a reduction in the amount of goodwill.Accounting for Stock-Based Compensation We account for our stock options issued to employees and outside directorspursuant to Accounting Principles Board Opinion ("APB") No. 25, "Accounting forStock Issued to Employees" and has adopted the disclosure requirements of SFASNo. 123, "Accounting for Stock-Based Compensation", and SFAS No. 148,"Accounting for Stock-Based Compensation - Transition and Disclosure - anAmendment of FASB Statement No. 123". Accordingly, in 2004, we have notrecognized compensation expense in connection with the issuance of stockoptions.Significant New Accounting Pronouncements Not Yet Adopted In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment",which is a revision of SFAS No. 123 and supersedes Accounting Principles Board("APB") Opinion No. 25. SFAS No. 123 (R) requires all share-based payments toemployees, including grants of employee stock options, to be valued at fairvalue on the date of grant, and to be expensed over the applicable vestingperiod. Pro forma disclosure of the income statement effects of share-basedpayments is no longer an alternative. II-11SFAS No. 123 (R) is effective for all stock-based awards granted on or afterJuly 1, 2005. In addition, companies must also recognize compensation expenserelated to any awards that are not fully vested as of the effective date.Compensation expense for the unvested awards will be measured based on the fairvalue of the awards previously calculated in developing the pro formadisclosures in accordance with the provisions of SFAS No. 123. We are currentlyevaluating SFAS No. 123 (R), including the method of adoption, and expect itsadoption will result in increased compensation expense in the future. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS109-1"), "Application of FASB Statement No. 109, `Accounting for Income Taxes,'to the Tax Deduction on Qualified Production Activities provided by the AmericanJobs Creation Act of 2004." The American Jobs Creation Act, or AJCA, creates atemporary incentive for U.S. corporations to repatriate accumulated incomeearned abroad by providing an 85% dividend received deduction for certainqualified dividends from controlled foreign corporations. FAS 109-1 clarifiesthat this tax deduction should be accounted for as a special tax deduction inaccordance with Statement 109. Our evaluation of the AJCA with respect to theadditional deduction is still in process and we expect to complete theevaluation process in 2005. As such, we cannot reasonably estimate the incometax effect of any such repatriation at the present time. In December 2004, the FASB issued SFAS No. 153, "Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29." The guidance in APB Opinion No. 29,Accounting for Nonmonetary Transactions, is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofassets exchanged. The guidance in that opinion, however, included certainexceptions to that principle. This Statement amends APB No. 29 to eliminate theexception for nonmonetary exchanges of similar productive assets that do nothave commercial substance. A nonmonetary exchange has commercial substance ifthe future cash flows of the entity are expected to change significantly as aresult of the exchange. SFAS No. 153 is effective for nonmonetary exchangesoccurring in fiscal periods beginning after June 15, 2005. The adoption of SFASNo. 153 is not expected to have a material impact on our financial position andresults of operations.Item 7A. Quantitative and Qualitative Disclosures About Market Risk. We are exposed to interest rate change market risk with respect to ourcredit line with a financial institution which is priced based on the bank'salternate base rate (5.25% at December 31, 2004) plus 1/2% or LIBOR (2.44% atDecember 31, 2004) plus 3%. We have not borrowed under this line in 2004. To theextent we utilize all or a portion of this line of credit, changes in theinterest rate will have a positive or negative effect on our interest expense. We have operations in foreign countries. While we are exposed to foreigncurrency fluctuations, we presently have no financial instruments in foreigncurrency and do not maintain significant funds in foreign currency beyond thosenecessary for operations. II-12Item 8. Financial Statements. INNODATA ISOGEN, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS PAGEReport of Independent Registered Public Accounting Firm II-14Consolidated Balance Sheets as of December 31, 2004 and 2003 II-15Consolidated Statements of Operations for the three years endedDecember 31, 2004 II-16Consolidated Statement of Stockholders' Equity for the three years endedDecember 31, 2004 II-17Consolidated Statements of Cash Flows for the three years endedDecember 31, 2004 II-18Notes to Consolidated Financial Statements II-19 II-13 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of Directors and Stockholders ofInnodata Isogen, Inc. We have audited the accompanying consolidated balance sheets of InnodataIsogen, Inc. and subsidiaries as of December 31, 2004 and 2003, and the relatedconsolidated statements of operations, stockholders' equity and cash flows foreach of the three years in the period ended December 31, 2004. 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 the standards of the PublicCompany Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company's internal control over financialreporting. Accordingly we express no such opinion. An audit includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements. An audit also includes assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide areasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,in all material respects, the consolidated financial position of InnodataIsogen, Inc. and subsidiaries as of December 31, 2004 and 2003, and theconsolidated results of their operations and their consolidated cash flows foreach of the three years in the period ended December 31, 2004 in conformity withaccounting principles generally accepted in the United States of America. We have also audited Schedule II for each of the three years in the periodended December 31, 2004. In our opinion, this schedule, when considered inrelation to the basic financial statements taken as a whole, presents fairly, inall material respects, the information therein.Grant Thornton LLPEdison, New JerseyMarch 9, 2005 II-14 INNODATA ISOGEN, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 AND 2003 (Dollars in Thousands) 2004 2003 ---- ---- ASSETSCURRENT ASSETS: Cash and cash equivalents $ 20,663 $ 5,051 Cash and cash equivalents-restricted -- 1,000 Accounts receivable-net of allowance for doubtful accounts of $135 and $1,219 at December 31, 2004 and 2003 respectively 8,019 8,497 Prepaid expenses and other current assets 1,757 999 Refundable income taxes -- 1,075 Deferred income taxes 645 1,421 -------- -------- Total current assets 31,084 18,043PROPERTY AND EQUIPMENT-NET 4,559 5,628OTHER ASSETS 893 800GOODWILL 675 675 -------- --------TOTAL $ 37,211 $ 25,146 ======== ========LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIES: Accounts payable $ 1,449 $ 1,299 Accrued expenses 1,963 1,152 Accrued salaries, wages and related benefits 3,979 2,865 Income and other taxes 1,304 598 Current portion of capital lease obligations 180 146 -------- -------- Total current liabilities 8,875 6,060 -------- --------DEFERRED INCOME TAXES 1,449 1,410 -------- --------OBLIGATIONS UNDER CAPITAL LEASE 150 272 -------- --------COMMITMENTS AND CONTINGENT LIABILITIESSTOCKHOLDERS' EQUITY: Serial preferred stock; 5,000,000 shares authorized, none outstanding -- -- Common stock, $.01 par value; 75,000,000 shares authorized; 22,679,000 and 22,535,000 shares issued; 22,679,000 and 21,951,000 outstanding as of December 31, 2004 and 2003, respectively 227 226 Additional paid-in capital 14,914 15,413 Retained earnings 11,596 3,739 -------- -------- 26,737 19,378 Less: treasury stock-at cost; 584,000 shares at December 31, 2003 -- (1,974) -------- -------- Total stockholders' equity 26,737 17,404 -------- --------TOTAL $ 37,211 $ 25,146 ======== ======== See notes to consolidated financial statements II-15 INNODATA ISOGEN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 (In thousands, except per share amounts) 2004 2003 2002 ---- ---- ---- REVENUES $ 53,949 $ 36,714 $ 36,385 -------- -------- --------OPERATING COSTS AND EXPENSES Direct operating costs 33,050 27,029 32,005 Selling and administrative expenses 10,205 8,898 10,038 Terminated offering costs 625 -- -- Bad debt recovery - net (963) -- -- Restructuring costs and asset impairment -- -- 244 Interest expense 25 9 29 Interest income (87) (30) (89) -------- -------- -------- Total 42,855 35,906 42,227 -------- -------- --------INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES 11,094 808 (5,842)PROVISION FOR (BENEFIT FROM) INCOME TAXES 3,237 333 (677) -------- -------- --------NET INCOME (LOSS) $ 7,857 $ 475 $ (5,165) ======== ======== ========INCOME PER SHARE: Basic: $ .35 $ .02 $ (.24) ======== ======== ======== Diluted: $ .32 $ .02 $ (.24) ======== ======== ========WEIGHTED AVERAGE SHARES OUTSTANDING: Basic: 22,288 21,570 21,489 ======== ======== ======== Diluted: 24,817 22,966 21,489 ======== ======== ======== See notes to consolidated financial statements II-16 INNODATA ISOGEN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 (In thousands) Additional Common Stock Paid-in Retained Treasury Shares Amount Capital Earnings Stock Total ------ ------ ---------- -------- -------- ----- January 1, 2002 21,716 217 13,355 8,429 (1,639) 20,362 Net loss -- -- -- (5,165) -- (5,165) Issuance of common stock upon exercise of stock options 318 3 107 -- -- 110 Purchase of treasury stock -- -- -- -- (360) (360) Non-cash equity compensation 12 -- 523 -- -- 523 Income tax benefit from exercise of stock options -- -- 99 -- -- 99 ------- -------- -------- -------- -------- -------December 31, 2002 22,046 220 14,084 3,264 (1,999) 15,569 Net income -- -- -- 475 -- 475 Issuance of common stock upon exercise of stock options 515 6 565 -- -- 571 Retirement of treasury stock (26) -- (25) -- 25 -- Income tax benefit from exercise of stock options -- 132 -- -- 132 Non-cash equity compensation -- -- 657 -- -- 657 ------- -------- -------- -------- -------- ------- December 31, 2003 22,535 226 15,413 3,739 (1,974) 17,404 Net income -- -- -- 7,857 -- 7,857 Issuance of common stock upon exercise of stock options 728 7 1,075 -- -- 1,082 Retirement of treasury stock (584) (6) (1,968) -- 1,974 -- Income tax benefit from exercise of stock options -- -- 358 -- -- 358 Non-cash equity compensation -- -- 36 -- -- 36 ------- -------- -------- -------- -------- -------December 31, 2004 22,679 $ 227 $ 14,914 $ 11,596 $ -0- $26,737 ======= ======== ======== ======== ======== ======= See notes to consolidated financial statements II-17 INNODATA ISOGEN INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 (In thousands) 2004 2003 2002 ---- ---- ---- OPERATING ACTIVITIES: Net income (loss) $ 7,857 $ 475 $ (5,165) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 3,924 4,528 5,228 Non-cash compensation 36 657 523 Loss on disposal of fixed assets -- 147 -- Restructuring costs and asset impairment -- -- 244 Deferred income taxes 815 (2) 30 Changes in operating assets and liabilities, net of acquisition: Accounts receivable 478 (5,244) 4,593 Prepaid expenses and other current assets (1,495) (947) (680) Refundable income taxes 1,075 416 (982) Other assets (160) 242 894 Accounts payable 150 652 (811) Accrued expenses 811 (856) 601 Accrued salaries and wages 1,114 339 (1,244) Income and other taxes 1,064 275 (181) -------- -------- -------- Net cash provided by operating activities 15,669 682 3,050 -------- -------- --------INVESTING ACTIVITIES: Decrease (increase) in restricted cash 1,000 (1,000) -- Capital expenditures (2,051) (2,408) (1,162) -------- -------- -------- Net cash used in investing activities (1,051) (3,408) (1,162) -------- -------- --------FINANCING ACTIVITIES: Payments of obligations under capital lease (88) (49) -- Payment of acquisition notes -- -- (650) Proceeds from exercise of stock options 1,082 571 110 Purchase of treasury stock -- -- (360) -------- -------- -------- Net cash provided by (used in) financing activities 994 522 (900) -------- -------- --------INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,612 (2,204) 988CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 5,051 7,255 6,267 -------- -------- --------CASH AND CASH EQUIVALENTS, END OF YEAR $ 20,663 $ 5,051 $ 7,255 ======== ======== ========SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 1,237 $ 417 $ 261 -------- -------- -------- Interest expense $ 25 $ 23 $ 29 -------- -------- --------NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition of equipment utilizing capital leases $ 66 $ 467 $ -- -------- -------- -------- See notes to consolidated financial statements II-18 INNODATA ISOGEN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2004, 2003 and 20021. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business-Innodata Isogen, Inc. and subsidiaries (the"Company"), is a leading provider of business services that help organizations create, manage, use and distribute information more effectively andeconomically. The Company provides outsourced content services andcontent-related information technology (IT) professional services. The Company'soutsourced content services focus on fabrication services and knowledgeservices. Fabrication services include digitization and data conversionservices, content creation and XML services. Knowledge services include contentenhancement, hyperlinking, indexing and general editorial services. TheCompany's IT professional services focus on the design, implementation,integration and deployment of systems used to author, manage and distributecontent. Principles of Consolidation-The consolidated financial statements includethe accounts of Innodata Isogen, Inc. and its subsidiaries, all of which arewholly owned. All significant intercompany transactions and balances have beeneliminated in consolidation. Use of Estimates-In preparing financial statements in conformity withaccounting principles generally accepted in the United States of America,management is required to make estimates and assumptions that affect thereported amounts of assets and liabilities, and the disclosure of contingentassets and liabilities at the date of the financial statements, and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. Revenue Recognition-Revenue for content manufacturing and outsourcingservices is recognized in the period in which services are performed anddelivery has occurred in accordance with Staff Accounting Bulletin 104. The Company recognizes its IT professional services revenues from customapplication and systems integration development which requires significantproduction, modification or customization of software in accordance withStatement of Position ("SOP") No. 97-2 "Software Revenue Recognition" and in amanner similar to SOP No. 81-1 "Accounting for Performance of Construction-Typeand Certain Production-Type Contracts". Revenue for such services billed underfixed fee arrangements is recognized using the percentage-of-completion methodunder contract accounting as services are performed or output milestones arereached. The percentage completed is measured either by the percentage of laborhours incurred to date in relation to estimated total labor hours or inconsideration of achievement of certain output milestones, depending on thespecific nature of each contract. For arrangements in which percentage-ofcompletion accounting is used, the Company records cash receipts from customersand billed amounts due from customers in excess of recognized revenue asbillings in excess of revenues earned on contracts in progress (which isincluded in accounts receivable). Revenues from fixed-fee projects accounted forless than 10% of our total revenue for each of the three years ended December31, 2004, respectively. Revenue billed on a time and materials basis isrecognized as services are performed. Foreign Currency-The functional currency for the Company's productionoperations located in the Philippines, India and Sri Lanka is U.S. dollars. Assuch, transactions denominated in Philippine pesos, Indian and Sri Lanka rupeeswere translated to U.S. dollars at rates which approximate those in effect ontransaction dates. Monetary assets and liabilities denominated in foreigncurrencies at December 31, 2004 and 2003 were translated at the exchange rate ineffect as of those dates. Exchange gains and losses resulting from suchtransactions were not material in 2004, 2003 and 2002. Cash Equivalents-For financial statement purposes (including cash flows),the Company considers all highly liquid debt instruments purchased with anoriginal maturity of three months or less to be cash equivalents. II-19 Property and Equipment-Property and equipment is stated at cost and isdepreciated on the straight-line method over the estimated useful lives of therelated assets, which is generally two to five years. Leasehold improvements areamortized on a straight-line basis over the shorter of their estimated usefullives or the lives of the leases. Long-lived Assets-The Company accounts for long lived assets underStatement of Financial Accounting Standards ("SFAS") 144, Accounting for theImpairment or Disposal of Long Lived Assets. Management assesses the recoverability of its long-lived assets, which consist primarily of fixed assetsand intangible assets with finite useful lives, whenever events or changes incircumstance indicate that the carrying value may not be recoverable. Thefollowing factors, if present, may trigger an impairment review: (i) significantunderperformance relative to expected historical or projected future operatingresults; (ii) significant negative industry or economic trends; (iii)significant decline in the Company's stock price for a sustained period; and(iv) a change in the Company's market capitalization relative to net book value.If the recoverability of these assets is unlikely because of the existence ofone or more of the above-mentioned factors, an impairment analysis is performedusing a projected discounted cash flow method. Management must make assumptionsregarding estimated future cash flows and other factors to determine the fairvalue of these respective assets. If these estimates or related assumptionschange in the future, the Company may be required to record an impairmentcharge. Impairment charges would be included in general and administrativeexpenses in the Company's statements of operations, and would result in reducedcarrying amounts of the related assets on the Company's balance sheets. Goodwill and Other Intangible Assets-Goodwill primarily includes theexcess purchase price paid over the fair value of net assets acquired. EffectiveJuly 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other IntangibleAssets." Under SFAS 142, the Company tests its goodwill on an annual basis usinga two-step fair value based test. The first step of the goodwill impairmenttest, used to identify potential impairment, compares the fair value of areporting unit, with its carrying amount, including goodwill. If the carryingamount of the reporting unit exceeds its fair value, the second step of thegoodwill impairment test must be performed to measure the amount of theimpairment loss, if any. If impairment is determined, the Company will recognizeadditional charges to operating expenses in the period in which they areidentified, which would result in a reduction of operating results and areduction in the amount of goodwill. Income Taxes-Deferred taxes are determined based on the difference betweenthe financial statement and tax bases of assets and liabilities, using enactedtax rates, as well as any net operating loss or tax credit carryforwardsexpected to reduce taxes payable in future years. A valuation allowance isprovided when it is more likely than not that some or all of a deferred taxasset will not be realized. Unremitted earnings of foreign subsidiaries havebeen included in the consolidated financial statements without giving effect tothe United States taxes that may be payable on distribution to the United Statesto the extent such earnings are not anticipated to be remitted to the UnitedStates. Accounting for Stock-Based Compensation-The Company accounts for its stockoptions issued to employees and outside directors pursuant to AccountingPrinciples Board Opinion ("APB") No. 25, "Accounting for Stock Issued toEmployees" and has adopted the disclosure requirements of SFAS No. 123,"Accounting for Stock-Based Compensation", and SFAS No. 148, "Accounting forStock-Based Compensation - Transition and Disclosure - an Amendment of FASBStatement No. 123". Accordingly, in 2004, no compensation expense has beenrecognized in connection with the issuance of stock options. The following table illustrates the effect on net income and earnings pershare if the Company had applied the fair value recognition provisions of SFASNo. 123 to stock-based employee compensation using the assumptions described innote 7, stock options. II-20 Year Ended December 31, ----------------------- 2004 2003 2002 ---- ---- ---- (in thousands, except per share amounts) Net income (loss), as reported $ 7,857 $ 475 $ (5,165) Deduct: Total stock-based employee compensation determined under fair value based method, net of related tax effects (3,200) (3,193) (2,315) Add: Compensation expense included in the determination of net income (loss) as reported, net of related tax effects, related to the extension of stock options -- 455 318 ------- ------- ---------Pro forma net income (loss) $ 4,657 $(2,263) $ (7,162) ======= ======= =========Income (loss) per share: Basic-as reported $ .35 $ .02 $ (.24) ======= ======= ========= Basic-pro forma $ .21 $ (.10) $ (.33) ======= ======= ========= Diluted-as reported $ .32 $ .02 $ (.24) ======= ======= ========= Diluted-pro forma $ .19 $ (.10) $ (.33) ======= ======= ========= Fair Value of Financial Instruments-The carrying amounts of financialinstruments, including cash and cash equivalents, accounts receivable andaccounts payable approximated fair value as of December 31, 2004 and 2003because of the relative short maturity of these instruments. Accounts Receivable-The majority of the Company's accounts receivable aredue from secondary publishers and information providers. The Company establishescredit terms for new clients based upon management's review of their creditinformation and project terms, and performs ongoing credit evaluations of itscustomers, adjusting credit terms when management believes appropriate basedupon payment history and an assessment of their current credit worthiness. TheCompany records an allowance for doubtful accounts for estimated lossesresulting from the inability of its clients to make required payments. TheCompany determines its allowance by considering a number of factors, includingthe length of time trade accounts receivable are past due (accounts outstandinglonger than the payment terms are considered past due), the Company's previousloss history, the client's current ability to pay its obligation to the Company,and the condition of the general economy and the industry as a whole. Whilecredit losses have generally been within expectations and the provisionsestablished, the Company cannot guarantee that credit loss rates in the futurewill be consistent with those experienced in the past. In addition, there iscredit exposure if the financial condition of one of the Company's major clientswere to deteriorate. In the event that the financial condition of the Company'sclients were to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be necessary. Concentration of Credit Risk-The Company maintains its cash with highquality financial institutions, located primarily in the United States. To theextent that such cash exceeds the maximum insurance levels, the Company isuninsured. The Company has not experienced any losses in such accounts. Income (Loss) Per Share- Basic earnings (loss) per share is computed bydividing income (loss) available to common shareholders by the weighted-averagenumber of common shares outstanding during the period. Diluted earnings (loss)per share is computed by dividing income (loss) available to common shareholdersby the weighted-average number of common shares outstanding during the periodincreased to include the number of additional common shares that would have beenoutstanding if the dilutive potential common shares had been issued. Thedilutive effect of the outstanding options is reflected in diluted earnings(loss) per share by application of the treasury stock method. II-21 New Accounting Pronouncements: In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment",which is a revision of SFAS No. 123 and supersedes Accounting Principles Board("APB") Opinion No. 25. SFAS No. 123 (R) requires all share-based payments toemployees, including grants of employee stock options, to be valued at fairvalue on the date of grant, and to be expensed over the applicable vestingperiod. Pro forma disclosure of the income statement effects of share-basedpayments is no longer an alternative. SFAS No. 123 (R) is effective for allstock-based awards granted on or after July 1, 2005. In addition, companies mustalso recognize compensation expense related to any awards that are not fullyvested as of the effective date. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated indeveloping the pro forma disclosures in accordance with the provisions of SFASNo. 123. The Company is currently evaluating SFAS No. 123 (R), including themethod of adoption, and expects its adoption will result in increasedcompensation expense in the future. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS109-1"), "Application of FASB Statement No. 109, `Accounting for Income Taxes,'to the Tax Deduction on Qualified Production Activities provided by the AmericanJobs Creation Act of 2004." The American Jobs Creation Act, or AJCA, creates atemporary incentive for U.S. corporations to repatriate accumulated incomeearned abroad by providing an 85% dividend received deduction for certainqualified dividends from controlled foreign corporations. FAS 109-1 clarifiesthat this tax deduction should be accounted for as a special tax deduction inaccordance with Statement 109. The Company's evaluation of the AJCA with respectto the additional deduction is still in process and is expected to be completedduring 2005. As such, the Company cannot reasonably estimate the income taxeffect of any such repatriation at the present time.2. PROPERTY AND EQUIPMENT Property and equipment, stated at cost less accumulated depreciation andamortization (in thousands), consist of the following: December 31, ------------ 2004 2003 ---- ----Equipment $15,204 $14,608Furniture and office equipment 977 820Leasehold improvements 2,433 2,342 ------- ------- Total 18,614 17,770Less accumulated depreciation and amortization 14,055 12,142 ------- ------- $ 4,559 $ 5,628 ======= ======= Depreciation expense was approximately $3,120,000, $3,807,000 and$4,380,000 for the three years ended December 31, 2004, respectively. In 2003, the Company entered into a three year lease for certain equipmentlocated in one of its Philippine facilities. The equipment was capitalized atits fair market value of approximately $641,000, which represented the presentvalue of the minimum lease payments plus trade-in value of exchanged equipmentof $175,000. The loss on such trade-in approximated $58,000. At December 31, 2004 and 2003, equipment under capital leases had a netbook value of approximately $312,000 and $587,000, respectively. II-223. INCOME TAXES The significant components of the provision for (benefit from) incometaxes for each of the three years ended December 31, 2004 (in thousands) are asfollows: 2004 2003 2002 ---- ---- ----Current income tax expense (benefit): Foreign $ 174 $ 29 $ 97 Federal 1,943 230 (827) State and local 305 76 23 ------ ------ ------ 2,422 335 (707)Deferred income tax expense (benefit) provision 815 (2) 30 ------ ------ ------Provision for (benefit from) income taxes $3,237 $ 333 $ (677) ====== ====== ====== The reconciliation of the U.S. statutory rate with the Company's effectivetax rate for each of the three years ended December 31 2004 is summarized asfollows: 2004 2003 2002 ---- ---- ---- Federal statutory rate 35.0% 35.0% (35.0)%Effect of: State income taxes (net of federal tax benefit) 2.5 5.9 0.6 Foreign source losses for which no tax benefit is available 1.5 7.3 23.8 Foreign entities subject to US federal income taxes 4.3 -- -- Effect of foreign tax holiday, net of foreign income not deemed permanently reinvested (12.3) (24.0) (3.4) Taxes on foreign income at rates that differ from US statutory rate (1.4) 7.6 -- Non deductible compensation -- 5.9 -- Other (0.4) 3.5 2.4 ----- ----- -----Effective rate 29.2% 41.2% (11.6)% ===== ===== ===== II-23 As of December 31, 2004 and 2003, the composition of the Company's netdeferred income taxes (in thousands) is as follows: 2004 2003 ---- ----Deferred income tax assets:Allowances not currently deductible $ 192 $ 1,358Depreciation and amortization 32 114Equity compensation not currently deductible 375 348Expenses not deductible until paid 469 63 ------- ------- 1,068 1,883 ------- -------Deferred income tax liabilities:Foreign source income, not taxable until repatriated (1,872) (1,872) ------- -------Net deferred (liability) asset $ (804) $ 11 ======= =======Net deferred income tax asset-current 645 1,421Net deferred income tax liability-non-current (1,449) (1,410) ------- -------Net deferred income tax (liability) asset $ (804) $ 11 ======= ======= United States and foreign components of income (loss) before income taxesfor each of the three years ended December 31, 2004 (in thousands) are asfollows: 2004 2003 2002 ---- ---- ----United States $ 6,731 $ 565 $(2,806)Foreign 4,363 243 (3,036) ------- ------- -------Total $11,094 $ 808 $(5,842) ======= ======= ======= Certain of the Company's foreign subsidiaries are subject to tax holidaysfor various periods ranging from 2005 to 2014, pursuant to which the income taxrate for these subsidiaries is substantially reduced. Unless renewed, as the tax holidays expire, the Company's overall effective tax rate will be negativelyimpacted. The tax benefit for tax holidays was approximately $900,000, $300,000and $600,000 for each of the three years ended December 31, 2004, respectively. In August 2004, the Internal Revenue Service ("IRS") promulgatedregulations, effective August 12, 2004, that treated certain of the Company'ssubsidiaries that are incorporated in foreign jurisdictions and alsodomesticated as Delaware limited liability companies as U.S. corporations forU.S. federal income tax purposes. In the preamble to such regulations, the IRSexpressed its view that dual registered companies described in the precedingsentence are also treated as U.S. corporations for U.S. federal income taxpurposes for periods prior to August 12, 2004. Notwithstanding this view, theCompany believes that its historic treatment of these subsidiaries as not havingbeen required to pay taxes in the United States for the period prior to August12, 2004 is correct, and intends to vigorously defend its treatment ifchallenged. As such, the Company has made no provision for U.S. taxes in itsfinancial statements for these entities for the periods prior to August 12,2004. However, if challenges by the IRS were ultimately successful, theCompany's potential U.S. federal income tax liability could approximate II-24$2.5 million, excluding interest and potential penalties. Furthermore, theCompany cannot be assured that the IRS will not assert other positions withrespect to the foregoing matters that, if successful, could increase materiallythe Company's liability for U.S. federal income taxes. In December 2004, theCompany effected certain filings in Delaware to ensure that these subsidiarieswill not be treated as U.S. corporations for U.S. federal income tax purposes asof the date of filing and as such, will not be subject to U.S. federal incometaxes commencing January 1, 2005.4. COMMITMENTS AND CONTINGENT LIABILITIES Line of Credit-The Company has a $5 million line of credit pursuant towhich it may borrow up to 80% of eligible accounts receivable at the bank'salternate base rate plus 1/2% or LIBOR plus 3%. The line, which expires in May,2005, is secured by the Company's accounts receivable. The Company has notborrowed against its credit line in 2004. Leases-The Company is obligated under various operating lease agreementsfor office and production space. Certain agreements contain escalation clausesand requirements that the Company pay taxes, insurance and maintenance costs.Company leases that include escalated lease payments are straight-lined over thenon-cancelable base lease period in accordance with SFAS 13. Lease agreements for production space in most overseas facilities, whichexpire through 2011, contain provisions pursuant to which the Company may cancelthe leases with a minimal notice period, generally subject to forfeiture ofsecurity deposit. The annual rental for the cancelable leased space isapproximately $1,100,000. For the years ended December 31, 2004, 2003 and 2002,rent expense for office and production space totaled approximately $1,725,000,$1,700,000 and $2,100,000, respectively. In addition, the Company leases certain equipment under short-term capitaland operating lease agreements. For the years ended December 31, 2004, 2003 and2002, rent expense for equipment totaled approximately $47,000, $36,000 and$46,000, respectively. At December 31, 2004, future minimum annual rental commitments onnon-cancelable leases (excluding operating leases with terms less than one year)(in thousands) are as follows:Leases Operating Leases Capital------ ---------------- ------- 2005 $460 $1992006 502 1382007 417 182008 367 --2009 367 --Thereafter 90 -- ------ ----- $2,203 355 ======Less: Amounts representing interest (7% - 9% per annum) 25 -----Present value of minimum lease payments $330 ===== Litigation -In connection with the cessation of all operations at certainforeign subsidiaries, certain former employees have filed various actionsagainst certain of the Company's Philippine subsidiaries, and have purported toalso sue the Company and certain of its officers and directors, seeking torequire reinstatement of employment and to recover back wages for an allegedlyillegal facility closing on June 7, 2002 based on the terms of a collectivebargaining agreement with this subsidiary. The Company has prevailed insubstantially all stages of this litigation to date, although several appeals bycomplainants are still pending. II-25If the complainants' claims had merit, they could be entitled to back wages ofup to $5.0 million for the period from June 7, 2002 to June 6, 2005, consistentwith prevailing jurisprudence. Based upon consultation with legal counsel,management believes the claims are without merit and is defending against themvigorously. In addition, the Company is subject to various legal proceedings andclaims which arise in the ordinary course of business. While management currently believes that the ultimate outcome of all theseproceedings will not have a material adverse effect on the Company's financialposition or overall trends in results of operations, litigation is subject toinherent uncertainties. Were an unfavorable ruling to occur, there exists thepossibility of a material adverse impact on the operating results of the periodin which the ruling occurs. In addition, the estimate of potential impact on theCompany's financial position or overall results of operations for the abovelegal proceedings could change in the future. Foreign Currency-The Company's production facilities are located in thePhilippines, India and Sri Lanka. To the extent that the currencies of thesecountries fluctuate, the Company is subject to risks of changing costs ofproduction after pricing is established for certain customer projects. However,most significant contracts contain provisions for price renegotiation. Employment Agreements-On January 1, 2004, the Company entered into a fouryear employment agreement with the co-founder of ISOGEN, an entity the Companyacquired in 2001, to serve as Executive Vice President of the Company. Pursuantto the agreement, he will be compensated at a rate of $250,000 per annum for thefirst year, subject to annual review for discretionary annual increasesthereafter, and will be eligible to receive an annual cash bonus, the amount ofwhich will be based upon meeting certain goals. In addition, on November 10,2003, he was granted an option to purchase 200,000 shares of the Company'scommon stock at $3.35 per share. In connection with his previous employmentagreement, in 2002 the executive was granted an option to purchase 150,000shares of the Company's common stock at $4.00 per share, and was issued 11,587unregistered shares of the Company's common stock. Compensation expense ofapproximately $10,000 was recorded in the year ended December 31, 2002 asselling and administrative expenses pursuant to the stock issuance. In May 2001, the Company entered into an agreement with its then Chairmanof the Board pursuant to which he will continue to serve as a part-time employeeat a salary of $2,000 per month for five years. In addition, the Company paidhim $400,000 in exchange for a six year non-compete agreement, which is includedin other assets and is being amortized over the term of the agreement. OnDecember 31, 2004, the unamortized balance was $155,000. Indemnifications-The Company is obligated under certain circumstances toindemnify directors and certain officers against costs and liabilities incurredin actions or threatened actions brought against such individual because suchindividuals acted in the capacity of director and /or officer of the Company. Inaddition, the Company has contracts with certain clients pursuant to which the Company has agreed to indemnify the client for certain specified and limitedclaims. These indemnification obligations are in the ordinary course of businessand, in many cases, do not include a limit on a maximum potential futurepayments. As of December 31, 2004, the Company has not recorded a liability forany obligations arising as a result of these indemnifications. Liens-In connection with the procurement of tax incentives at one of thecompany's foreign subsidiaries, the foreign zoning authority was granted a firstlien on the subsidiary's property and equipment. As of December 31, 2004, suchequipment had a book value of $670,000.5. RETIREMENT PLANS The Company has a defined contribution plan qualified under Section 401(k)of the Internal Revenue Code. Substantially all of its U.S. employees areeligible to participate after completing three months of service. II-26Participants may elect to contribute a portion of their compensation to theplan. Under the plan, the Company has the discretion to match a portion ofparticipants' contributions. The Company intends to match approximately $75,000to the plan for the fiscal year ended December 31, 2004. For the fiscal yearsended December 31, 2003 and 2002, the Company's matching contributions wereapproximately $48,000 and $50,000 respectively. Most of the Company's foreign subsidiaries maintain unfunded retirementplans consistent with local practices and requirements. Retirement-relatedexpenses for foreign subsidiaries totaled approximately $205,000, $124,000 and$38,000 for the three years ended December 31, 2004, 2003 and 2002,respectively. As of December 31, 2004, accrued retirement costs for foreignsubsidiaries totaled approximately $470,000.6. CAPITAL STOCK The Company is authorized to issue 75,000,000 shares of common stock and5,000,000 shares of preferred stock. Each share of common stock has one vote.The Board of Directors is authorized to fix the terms, rights, preferences andlimitations of the preferred stock and to issue the preferred stock in serieswhich differ as to their relative terms, rights, preferences and limitations. Stockholder Rights Plan-On December 16, 2002, the Board of Directorsadopted a Stockholder Rights Plan ("Rights Plan") in which one right ("Right")was declared as a dividend for each share of the Company's common stockoutstanding. The purpose of the plan is to deter a hostile takeover of theCompany. Each Right entitles its holders to purchase, under certain conditions,one one-thousandth of a share of newly authorized Series C ParticipatingPreferred Stock ("Preferred Stock"), with one one-thousandth of a share ofPreferred Stock intended to be the economic and voting equivalent of one shareof the Company's common stock. Rights will be exercisable only if a person orgroup acquires beneficial ownership of 15% (25% in the case of specifiedexecutive officers of the Company) or more of the Company's common stock orcommences a tender or exchange offer, upon the consummation of which such personor group would beneficially own such percentage of the common stock. Upon suchan event, the Rights enable dilution of the acquiring person's or group'sinterest by providing that other holders of the Company's common stock maypurchase, at an exercise price of $4.00, the Company's common stock having amarket value of $8.00 based on the then market price of the Company's commonstock, or at the discretion of the Board of Directors, Preferred Stock, havingdouble the value of such exercise price. The Company will be entitled to redeemthe Rights at $.001 per right under certain circumstances set forth in theRights Plan. The Rights themselves have no voting power and will expire onDecember 26, 2012, unless earlier exercised, redeemed or exchanged. Common Stock Reserved-As of December 31, 2004, the Company had reservedfor issuance approximately 8,450,000 shares of common stock pursuant to theCompany's stock option plans (including an aggregate of 1,015,164 options issuedto the Company's Chairman which were not granted pursuant to stockholderapproved stock option plans). Treasury Stock-During the year ended December 31, 2002, the Companyrepurchased 340,000 shares of its common stock at a cost of $360,000. In 2004,the Company retired 584,000 shares of its treasury stock. In August 2002, the Board of Directors authorized the repurchase of up to$1.5 million of the Company's common stock, of which approximately $1,140,000remains available for repurchase under the program at December 31, 2004.7. STOCK OPTIONS The Company adopted, with stockholder approval, 1995, 1996, 1998, 2001,and 2002 Stock Option Plans (the "1995 Plan," "1996 Plan," "1998 Plan," "2001Plan," and "2002 Plan") which provide for the granting of options to purchasenot more than an aggregate of 2,400,000, 1,999,992, 3,600,000, 900,000, and950,000 shares of common stock, respectively, subject to adjustment undercertain circumstances. Such options may be incentive stock options ("ISOs")within the meaning of the Internal Revenue Code of 1986, as amended, or optionsthat do not qualify as ISOs ("Non-Qualified Options"). II-27 The option exercise price per share may not be less than the fair marketvalue per share of common stock on the date of grant (110% of such fair marketvalue for an ISO, if the grantee owns stock possessing more than 10% of thecombined voting power of all classes of the Company's stock). Options may begranted under the Stock Option Plan to all officers, directors, and employees ofthe Company and, in addition, Non-Qualified Options may be granted to otherparties who perform services for the Company. No options may be granted underthe 1995 Plan after May 16, 2005; under the 1996 Plan after July 8, 2006; underthe 1998 Plan after July 8, 2008; under the 2001 Plan after May 31, 2011; andunder the 2002 Plan after June 30, 2012. The Plans may be amended from time to time by the Board of Directors ofthe Company. However, the Board of Directors may not, without stockholderapproval, amend the Plans to increase the number of shares of common stock whichmay be issued under the Plans (except upon changes in capitalization asspecified in the Plans), decrease the minimum exercise price provided in thePlans or change the class of persons eligible to participate in the Plans. The fair value of options at date of grant was estimated using theBlack-Scholes pricing model with the following weighted average assumptions:expected lives ranging between four to four and one-half years for optionsgranted in 2004, six years for options granted in 2003 and four years foroptions granted in 2002; risk free interest rate of 3.19% in 2004, 4.2% in 2003and 3.5% in 2002; expected volatility of 114% in 2004, 140% in 2003 and 119% in2002; and a zero dividend rate in each of the three years ended December 31,2004. The following table presents information related to stock options for2004, 2003 and 2002. Weighted Weighted Average Average Number Exercise Number Exercise Outstanding Price Exercisable Price ----------- ----- ----------- -----Balance 1/1/02 7,851,292 $ 1.84 4,795,880 $ 0.88 ======== =========== ======== Cancelled (489,482) $ 1.29 Granted 220,750 $ 3.64 Exercised (317,676) $ 0.35 --------- --------Balance 12/31/02 7,264,884 $ 1.99 5,402,457 $ 1.53 ======== =========== ======== Cancelled (127,176) $ 2.42 Granted 1,002,000 $ 3.40 Exercised (550,328) $ 1.14 --------- --------Balance 12/31/03 7,589,380 $ 2.34 5,780,204 $ 1.83 ======== =========== ======== Cancelled (49,174) $ 1.55 Granted 214,000 $ 3.74 Exercised (728,274) $ 1.48 --------- --------Balance 12/31/04 7,025,932 $ 2.36 5,985,748 $ 2.14 ========= ======== =========== ======== II-28 Weighted Per Share Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price ------ ----------- ---- ----- ----------- ----- Balance 12/31/04 $0.25 - 0.47 445,668 7 $ 0.41 445,668 $ 0.41 $0.50 - 0.75 1,625,061 7 $ 0.57 1,625,061 $ 0.57 $1.29 - 1.56 1,401,342 1 $ 1.48 1,401,342 $ 1.48 $2.00 - 2.50 1,021,911 2 $ 2.24 1,021,911 $ 2.24 $3.00 - 4.60 1,393,750 8 $ 3.53 422,050 $ 3.58 $5.43 - 5.89 1,130,200 1 $ 5.45 1,062,300 $ 5.45 $6.00 - 6.57 8,000 1 $ 6.24 7,416 $ 6.24 --------- --------- --------- -------- 7,025,932 $ 2.36 5,985,748 $ 2.14 ========= ========= ========= ======== Options granted prior to 2003 vest over a four year period and have a fiveyear life. In 2004, substantially all options granted vest over a four yearperiod and have a ten year life. The weighted average fair value of theunderlying common stock as of the date of grant for options granted in 2004,2003 and 2002 is $3.74, $3.21 and $3.62, respectively. In 2003, the Company extended the expiration date of options granted tocertain officers, directors and employees, substantially all of which werevested, to purchase 315,000, 566,000, 522,000 and 133,000 shares of its commonstock at $.47, $.50, $.67 and $2.00, respectively. In connection with theextension, the option holders agreed not to sell shares of stock acquired uponexercise of the extended options for designated periods of time ending betweenJune 2004 to March 2005. In connection with this transaction, compensationexpense of approximately $650,000 was recorded in the second quarter of 2003based upon the difference between the exercise price and the market price of theunderlying common stock on the date the options were extended. Compensationexpense is included as a component of selling and administrative expenses. In 2002, the Company extended the expiration date of options to the ChiefExecutive Officer to purchase 6,672, 248,496, 360,000, 399,996 and 123,996shares of its common stock at $.42, $.50, $.58, $1.29 and $.25, per share,respectively. In connection with this transaction, compensation expense ofapproximately $513,000 was recorded in the third quarter as selling andadministrative expenses. In addition, the Company issued 11,587 shares of itscommon stock pursuant to an employment agreement with an officer of the Company.Compensation expense of approximately $10,000 was recorded in the third quarterof 2002 as selling and administrative expenses.8. SEGMENT REPORTING AND CONCENTRATIONS The Company's operations are classified into two reporting segments: (1)outsourced content services and (2) IT professional services. The outsourcedcontent services segment focuses on fabrication services and knowledge services.Fabrication services include digitization and data conversion services, contentcreation and XML services. Knowledge services include content enhancement,hyperlinking, indexing and general editorial services. The IT professionalservices segment focuses on the design, implementation, integration anddeployment of systems used to author, manage and distribute content. TheCompany's outsourced content services revenues are generated principally fromits production facilities located in the Philippines, India and Sri Lanka. TheCompany does not depend on revenues from sources internal to the countries inwhich the Company operates; nevertheless, the Company is subject to certainadverse economic and political risks relating to overseas economies in general,such as inflation, currency fluctuations and regulatory burdens. Commencing October 1, 2003, the Company unified its selling and relatedactivities for its content and professional services segments. As such, sellingand corporate administrative costs are not segregated by, nor are they allocatedto, operating segments. The income (loss) before income taxes, by operatingsegment has been reclassified for comparative purposes. II-29 2004 2003 2002 ---- ---- ---- (in thousands)Revenues: Outsourced content services $ 43,701 $ 29,977 $ 33,089 IT Professional services 10,248 6,737 3,296 -------- -------- -------- Total consolidated $ 53,949 $ 36,714 $ 36,385 ======== ======== ========Depreciation and amortization: Outsourced client services $ 3,547 $ 4,157 $ 4,892 IT Professional services 92 79 78 Selling and corporate administration 285 292 258 -------- -------- -------- Total consolidated $ 3,924 $ 4,528 $ 5,228 ======== ======== ========Income (loss) before income taxes: Outsourced content services $ 16,116 $ 6,576 $ 5,037 IT Professional services 4,671 2,778 (655) Selling and corporate administration (9,693) (8,546) (10,224) -------- -------- -------- Total consolidated $ 11,094 $ 808 $ (5,842) ======== ======== ======== December 31, ------------ 2004 2003 ---- ---- (in thousands)Total assets Outsourced content services $15,937 $12,330 IT Professional services 2,033 3,533 Corporate (includes corporate cash) 19,241 9,283 ------- -------Total consolidated $37,211 $25,146 ======= ======= Long-lived assets: Long-lived assets as of December 31, 2004 and 2003, respectively bygeographic region are comprised of: 2004 2003 ---- ---- (in thousands)United States $1,756 $1,739 ------ ------Foreign countries:Philippines 2,626 3,430India 827 1,134Sri Lanka 180 202 ------ ------Total foreign 3,633 4,766 ------ ------ $5,389 $6,505 ====== ====== One client accounted for 23%, 33% and 17% of the Company's revenues forthe years ended December 31, 2004, 2003 and 2002, respectively. One other clientaccounted for 31% and 30% of the Company's revenues for the year ended December 31, 2004 and 2002, respectively. No other client accounted for 10% or more ofrevenues during these periods. Further, in the years ended December 31, 2004,2003 and 2002, revenues to non-US clients accounted for 30%, 47%, and 23%,respectively, of the Company's revenues. II-30 Revenues for the three years ended December 31, 2004, 2003 and 2002 bygeographic region are as follows: 2004 2003 2002 ---- ---- ---- (in thousands)United States $37,842 $19,582 $28,142The Netherlands 12,648 12,147 5,767Other - principally Europe 3,459 4,985 2,476 ------- ------- ------- $53,949 $36,714 $36,385 ======= ======= ======= A significant amount of the Company's revenues are derived from clients inthe publishing industry. Accordingly, the Company's accounts receivablegenerally include significant amounts due from such clients. In addition, as ofDecember 31, 2004, approximately 27% of the Company's accounts receivable wasfrom foreign (principally European) clients and 69% of accounts receivable wasdue from two clients.9. INCOME (LOSS) PER SHARE 2004 2003 2002 ---- ---- ---- (in thousands, except per share amounts) Net income (loss) $ 7,857 $ 475 $ (5,165) ======== ======== ========Weighted average common shares outstanding 22,288 21,570 21,489Dilutive effect of outstanding options 2,529 1,396 -- -------- -------- --------Adjusted for dilutive computation 24,817 22,966 21,489 ======== ======== ========Basic income (loss) per share $ .35 $ .02 $ (.24) ======== ======== ========Diluted income (loss) per share $ .32 $ .02 $ (.24) ======== ======== ======== Basic income (loss) per share is based on the weighted average number ofcommon shares outstanding without consideration of potential common stock.Diluted income (loss) per share is based on the weighted average number ofcommon and potential common shares outstanding. The difference between weightedaverage common shares outstanding and adjusted dilutive shares outstandingrepresents the dilutive effect of outstanding options. Options to purchase1,337,000 shares of common stock at December 31, 2003 were outstanding but notincluded in the computation of diluted earnings per share because the options'exercise price was greater than the average market price of the common sharesand therefore, the effect would have been antidilutive. Such shares excluded atDecember 31, 2004 were insignificant. In addition, diluted net loss per share in2002 does not include potential common shares derived from stock options becausethey are antidilutive. The number of antidilutive securities excluded from thedilutable loss per share calculation were 1,542,000 for the year ended December31, 2002.10. RESTRUCTURING COSTS AND ASSET IMPAIRMENT During the fourth quarter 2001, the Company commenced certain actions toreduce production operations at a wholly owned Asian subsidiary that wasoperating at a loss and to reduce overall excess capacity in Asia. Suchactivities, which culminated in the cessation and closure of all operations at such subsidiary and included employee layoffs, were completed in 2002. Inaddition, during 2002 the Company closed a second facility, resulting in thewrite-off of property and equipment associated with the closed facility totalingapproximately $244,000. Such write-off of equipment has been classified asRestructuring Costs and Asset Impairment for the year ended December 31, 2002. II-3111. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share amounts)2004Revenues $ 12,157 $ 12,354 $ 15,927 $ 13,511Net income 2,080 1,577 3,103 1,097Net income per share $ .09 $ .07 $ .14 $ .05Diluted net income per share $ .08 $ .06 $ .13 $ .042003Revenues $ 6,653 $ 8,056 $ 11,184 $ 10,821Net income (loss) (1,113) (636) 1,490 734Net income (loss) per share $ (.05) $ (.03) $ .07 $ .03Diluted net income (loss) per share $ (.05) $ (.03) $ .06 $ .0312. OTHER For the year ended December 31, 2001, the Company provided an allowancefor doubtful accounts of approximately $2.6 million representing the remainingbalance due at December 31, 2001 from a client that accounted for 30% of its2001 revenues because the client has reported an inability to raise furtheroperating funds required to make payment. In January 2004, the Company reached asettlement with this client to pay $1,000,000 cash as full satisfaction of theoutstanding balance due to the Company. The $1,000,000 receipt, net of $37,000in recovery costs is reflected as bad debt recovery income for the year endedDecember 31, 2004. The Company announced its intent to raise funds and filed a registrationstatement on Form S-3 to register 4,250,000 shares of its common stock, plus3,250,000 shares of common stock currently held by certain directors andofficers of the Company. On March 23, 2005, the Company terminated the offeringand, as such, in the fourth quarter 2004, expensed approximately $625,000 ofoffering costs. II-32Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. NoneItem 9A. Controls and Procedures. An evaluation has been carried out under the supervision and with theparticipation of our management, including our Chief Executive Officer andPrincipal Financial Officer, of the effectiveness of the design and theoperation of our "disclosure controls and procedures" (as such term is definedin Rules 13a-15(e) under the Securities Exchange Act of 1934) as of December 31,2004 ("Evaluation Date"). Based on such evaluation, our Chief Executive Officerand Chief Financial Officer have concluded that, as of the Evaluation Date, thedisclosure controls and procedures are reasonably designed and effective toensure that (i) information required to be disclosed by us in the reports wefile or submit under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC's rules andforms, and (ii) such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Principal FinancialOfficer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in our internal controls over financial reporting inconnection with the evaluation required by paragraph (d) of Rules 13a-15 or15d-15 under the Exchange Act that occurred during our last fiscal quarter that materially affected or are reasonably likely to materially affect the internalcontrols over financial reporting. II-33 PART IIIItem 10. Directors, Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act. The information called for by Item 10 is incorporated by reference fromthe Company's definitive proxy statement for the 2005 Annual Meeting ofStockholders to be filed pursuant to Regulation 14A under the Exchange Act nolater than 120 days after the end of the Company's 2004 fiscal year. The information concerning the Company's Executive Officers required bythis Item is incorporated by reference to the Company's proxy statement underthe heading "Executive Officers". The information concerning the Company'sDirectors required by this Item is incorporated by reference to the Company'sproxy statement under the heading "Election of Directors". Informationconcerning compliance by the Company's officers, Directors and 10% stockholderswith Section 16(a) of the Securities Exchange Act of 1934 is incorporated byreference to the information contained in the Company's Proxy Statement underthe heading "Compliance with Section 16(a) of the Exchange Act." Informationregarding the presence of an audit committee financial expert required by thisItem is incorporated by reference to the Company's Proxy Statement under theheading "Committees of the Board of Directors." The Company has a code of ethics that applies to all of its employees,officers, and directors, including its principal executive officer, principalfinancial and accounting officer, and controller. The text of the Company's codeof ethics is posted on its website at www.innodata-isogen.com. The Companyintends to disclose future amendments to, or waivers from, certain provisions ofthe code of ethics for executive officers and directors in accordance withapplicable NASDAQ and SEC requirements.Item 11. Executive Compensation.Executive Compensation The information called for by Item 11 is incorporated by reference fromthe Company's definitive proxy statement for the 2005 Annual Meeting ofStockholders to be filed pursuant to Regulation 14A under the Exchange Act nolater than 120 days after the end of the Company's 2004 fiscal year. Informationappearing under the captions "Compensation Committee Report on ExecutiveCompensation"; "Report of the Audit Committee" and "Stock Performance Graph" tobe included in the Company's 2005 Proxy Statement is not incorporated herein bythis reference.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information called for by Item 12 is incorporated by reference fromthe Company's definitive proxy statement for the 2005 Annual Meeting ofStockholders to be filed pursuant to Regulation 14A under the Exchange Act nolater than 120 days after the end of the Company's 2004 fiscal year.Item 13. Certain Relationships and Related Transactions. The information called for by Item 13 is incorporated by reference fromthe Company's definitive proxy statement for the 2005 Annual Meeting ofStockholders to be filed pursuant to Regulation 14A under the Exchange Act nolater than 120 days after the end of the Company's 2004 fiscal year. III-1Item 14. Principal Accountant Fees and Services. The information called for by Item 14 is incorporated by reference fromthe Company's definitive proxy statement for the 2005 Annual Meeting ofStockholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company's 2004 fiscal year. III-2 PART IVItem 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.(a) 1. Financial Statements. See Item 8. Index to Financial Statements. 2. Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts 3. Exhibits Exhibits which are indicated as being included in previous filings areincorporated herein by reference.Exhibit Description Filed as Exhibit------- ----------- ---------------- 3.1 (a) Restated Certificate of Incorporation filed Filed as Exhibit 3.1(a) to our Form 10-K for the year ended on April 29, 1993 December 31, 20033.1 (b) Certificate of Amendment of Certificate of Filed as Exhibit 3.1(b) to our Form 10-K for the year ended Incorporation of Innodata Corporation filed December 31, 2003 on March 1, 20013.1 (c) Certificate of Amendment of Certificate of Filed as Exhibit 3.1(c) to our Form 10-K for the year ended Incorporation of Innodata Corporation December 31, 2003 Filed on November 14, 20033.2 Form of Amended and Restated By-Laws Exhibit 3.1 to Form 8-K dated December 16, 20023.3 Form of Certificate of Designation of Filed as Exhibit A to Exhibit 4.1 to Form 8-K dated Series C Participating Preferred Stock December 16, 20024.2 Specimen of Common Stock certificate Exhibit 4.2 to Form SB-2 Registration Statement No. 33-620124.3 Form of Rights Agreement, dated as of Exhibit 4.1 to Form 8-K dated December 16, 2002 December 16, 2002 between Innodata Corporation and American Stock Transfer & Trust Co., as Rights Agent10.1 1994 Stock Option Plan Exhibit A to Definitive Proxy dated August 9, 199410.2 1993 Stock Option Plan Exhibit 10.4 to Form SB-2 Registration Statement No. 33-6201210.3 Form of Indemnification Agreement Filed as Exhibit 10.3 to Form 10-K dated December 31, 2002 Between us and our directors and one of our officers10.4 1994 Disinterested Directors Stock Option Exhibit B to Definitive Proxy dated August 9, 1994 Plan10.5 1995 Stock Option Plan Exhibit A to Definitive Proxy dated August 10, 199510.6 1996 Stock Option Plan Exhibit A to Definitive Proxy dated November 7, 199610.7 1998 Stock Option Plan Exhibit A to Definitive Proxy dated November 5, 199810.8 2001 Stock Option Plan Exhibit A to Definitive Proxy dated June 29, 200110.9 2002 Stock Option Plan Exhibit A to Definitive Proxy dated September 3, 200210.10 Employment Agreement dated as of Filed as Exhibit 10.10 to our Form 10-K for the year ended January 1, 2004 with George Kondrach December 31, 200310.11 Letter Agreement dated as of August 9, 2004, Filed as Exhibit 10.2 to Form S-3 Registration statement by and between us and The Bank of New York No. 333-12184421 Significant subsidiaries of the registrant Filed herewith IV-1Exhibit Description Filed as Exhibit------- ----------- ----------------23 Consent of Grant Thornton LLP Filed herewith31.1 Certificate of Chief Executive Officer and Filed herewith Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section Filed herewith 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2 Certification Pursuant to 18 U.S.C. Section Filed herewith 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1 Schedule II Valuation and Qualifying Accounts Filed herewith IV-2 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereunto dulyauthorized. INNODATA ISOGEN, INC. By Jack Abuhoff ------------------------------------------- Jack Abuhoff Chairman of the Board of Directors, Chief Executive Officer and President In accordance with the Exchange Act, this report has been signed below bythe following persons on behalf of the registrant and in the capacities and onthe dates indicated.Signature Title Date--------- ----- ---- Jack Abuhoff Chairman of the Board of Directors, March 25, 2005---------------------------------------- Chief Executive Officer and PresidentJack Abuhoff Todd Solomon Vice Chairman of the Board of March 25, 2005---------------------------------------- Directors and ConsultantTodd Solomon Stephen Agress Vice President - Finance March 25, 2005---------------------------------------- Chief Accounting Officer (PrincipalStephen Agress Accounting and Financial Officer) Haig S. Bagerdjian Director March 25, 2005----------------------------------------Haig S. Bagerdjian Louise C. Forlenza Director March 25, 2005----------------------------------------Louise C. Forlenza Charles F. Goldfarb Director March 25, 2005----------------------------------------Dr. Charles F. Goldfarb John R. Marozsan Director March 25, 2005----------------------------------------John R. Marozsan Exhibit 21 Significant Subsidiaries Name under State or other which subsidiary jurisdiction of conducts Name of Subsidiary incorporation business ------------------ ------------- --------Isogen International, LLC Delaware SameInnodata India (Private) Limited India SameInnodata XML Content Factory, Inc. Philippines SameESS Manufacturing Company, Inc. Philippines SameContent Online Services, Inc. Philippines SameInnodata Asia Holdings, Limited Bermuda SameInnodata Lanka (Private) Limited Sri Lanka Same Exhibit 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe have issued our report dated March 9, 2005 accompanying the consolidatedfinancial statements and schedules included in the Annual Report of InnodataIsogen, Inc. and subsidiaries on Form 10-K for the year ended December 31, 2004.We hereby consent to the incorporation by reference of said report in theRegistration Statements of Innodata Isogen, Inc. on Form S-8 (Registration No.33-85530, dated October 21, 1994, Registration No. 333-3464, dated April 18,1996, Registration No. 33-63085, dated September 9, 1998 and Registration No.333-82185, dated July 2, 1999, and Registration No. 333-118506, dated August 24,2004) and on Form S-3 (Registration No. 33-62012, dated April 11, 1996,Registration No. 333-91649, dated January 6, 2000 and Registration No.333-51400, dated January 2, 2001).Grant Thornton LLPEdison, New JerseyMarch 9, 2005 Exhibit 31.1 CERTIFICATIONSI, Jack Abuhoff, certify that:1. I have reviewed this annual report on Form 10-K of Innodata Isogen, Inc.;2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.Dated: March 25, 2005 Jack Abuhoff ------------------------------------- Jack Abuhoff Chairman of the Board, Chief Executive Officer and PresidentI, Stephen Agress, certify that:1. I have reviewed this annual report on Form 10-K of Innodata Isogen, Inc.;2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.Dated: March 25, 2005 Stephen Agress ------------------------------------ Stephen Agress Vice President, Finance and Chief Accounting Officer Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Innodata Isogen, Inc. (the"Company") on Form 10-K for the year ended December 31, 2004 as filed with theSecurities and Exchange Commission on the date hereof (the "Report"), I, JackAbuhoff, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C.ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, thatto the best of my knowledge: 1. the Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Jack Abuhoff ------------------------------------- Jack Abuhoff Chairman of the Board, Chief Executive Officer and President March 25, 2005 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Innodata Isogen, Inc. (the"Company") on Form 10-K for the year ended December 31, 2004 as filed with theSecurities and Exchange Commission on the date hereof (the "Report"), I, StephenAgress, Principal Financial Officer of the Company, certify, pursuant to 18U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002,that to the best of my knowledge: 1. the Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Stephen Agress ------------------------------- Stephen Agress Vice President, Finance and Chief Accounting Officer March 25, 2005 INNODATA ISOGEN, INC. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (Dollars in Thousands)Activity in the Company's allowance for doubtful accounts for the years endedDecember 31, 2004, 2003 and 2002 was as follows: Additions ----------------------------------- Balance at Charged to Charged to Balance atPeriod Beginning of Period Costs and Expenses Other Accounts Deductions End of Period------ ------------------- ------------------ -------------- ---------- ------------- 2004 $1,219 $ 25 $ -- (1,109) $ 135 2003 $1,254 $ -- $ -- $ (35) $ 1,219 2002 $1,853 $ -- $ -- $ (599) $ 1,254