**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





**FORM
      10-K**




(Mark
      One)




þ  ANNUAL
      REPORT UNDER SECTION13
      OR
      15(d)OF THE
      SECURITIES EXCHANGE ACT OF1934




**For
      the fiscal year ended** **December
      31, 2006**





o  TRANSITION
      REPORT UNDER SECTION13
      OR
      15(d)OF THE
      SECURITIES EXCHANGE ACT OF1934





**Commission
      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:Title
                of Each Class
            
            Name
                of Each Exchange of Which RegisteredCommon
                Stock $.01 par value
            
            NASDAQ
                Global Market





Securities
      registered under Section 12(g) of the Exchange Act:   **None**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes o No **þ**





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange Act. Yes o No **þ**





Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      past twelve months (or for such shorter period that the Registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes **þ** No o





Indicate
      by check mark if disclosure of delinquent filers in response to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of Registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. **þ**





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.  See
      definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
      the Exchange Act.




Large
      accelerated filer o  Accelerated
      filer o  Non-accelerated
      filer **þ**





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes o No **þ**





State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      last sold, or the average bid and asked price of such common equity, as of
      the
      last business day of the registrant's most recently completed second fiscal
      quarter **$60,000,000**





State
      the
      number of shares outstanding of each of the issuer's classes of common equity,
      as of the latest practicable date.





**23,905,541
      shares of common stock, $.01 par value, as of February 28,
      2007.**





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, economic performance, and
      financial condition. These forward-looking statements are made pursuant to
      the
      safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
      The words “estimate,” “believe,” “expect,” and “anticipate” and other similar
      expressions generally identify forward-looking statements, which speak only
      as
      of their dates.*





*These
      forward-looking statements are based largely on our current expectations, and
      are subject to a number of risks and uncertainties, including without
      limitation, 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 clients
      and prospective clients to execute business plans which give rise to
      requirements for digital content and professional services in knowledge
      processing, difficulty in integrating and deriving synergies from acquisitions,
      potential undiscovered liabilities of companies that we acquire, changes in
      our
      business or growth strategy, the emergence of new or growing competitors,
      various other competitive and technological factors, and other risks and
      uncertainties set forth under “Risk Factors.”*





*Our
      actual results could differ materially from the results referred to in the
      forward-looking statements. In light of these risks and uncertainties, there
      can
      be no assurance that the results referred to in the forward-looking statements
      contained in this release will occur.*





*We
      undertake no obligation to update or review any guidance or other
      forward-looking information, whether as a result of new information, future
      developments or otherwise.*




**Item
      1. Description of Business.**




**General**





We provide
      business services that help companies create and manage information more
      effectively and economically.





Our
      offerings encompass content-related business process outsourcing (BPO) services
      and information technology (IT) professional services, which constitute separate
      reporting segments. Our BPO offerings consist of fabrication services for
      digitization, imaging, data conversion and composition, XML and other mark-ups,
      translation and localization; and knowledge services for creating or adding
      value to a client's content. Our IT professional offerings focus on the design,
      implementation, integration and deployment of digital systems used to author,
      manage and distribute content.





Content-related
      BPO services represented 89%, 87% and 81%, and IT professional services
      represented 11%, 13% and 19% of total revenue in each of the three years in
      the
      period ended December 31, 2006. Content-related BPO services for business
      processes that we anticipate a client will require for an indefinite period
      generate what we regard as recurring revenues. Approximately 61% and 58% of
      our
      revenues were recurring in the years ended December 31, 2006 and 2005,
      respectively. A substantial majority of our IT professional services is
      provided on a project basis that generates non-recurring revenues.





In
      2006,
      we provided our services to approximately 130 clients primarily in four
      content-intensive sectors.




·
            Publishing,
                media and information services, including EBSCO and Reed Elsevier;





·
            Defense
                and aerospace, including Hamilton Sundstrand and Lockheed Martin;





·
            Government
                and regulation, including the Defense Intelligence Agency and the
                Financial Accounting Standards
                Board




I-1




·
            Education
                and culture, including the American Psychological Association and
                Cornell
                University





We
      work
      directly with existing and prospective clients to identify and refine their
      objectives, and to design, implement, integrate and deploy new and improved
      solutions to satisfy those objectives. We believe we provide high quality,
      value-added services to our clients on a timely basis and have developed a
      close
      relationship with them as a result. To enhance those relationships, we provide
      project support 24 hours a day, seven days a week, through our Asia-based
      customer service center, and we maintain sales, service and strategic support
      in
      North America and Europe in proximity to the operations of most of our clients.





Three
      clients accounted for 28%, 12% and 10% of the Company’s revenues for each of the
      three years in the period ended December 31, 2006. Two clients accounted
      for 27% and 12% of the Company’s revenues in the year ended December 31, 2005
      and 31% and 24% in the year ended December 31, 2004. No other client accounted
      for 10% or more of our total revenues during these periods. Revenues from
      clients located in foreign countries (principally in Europe) accounted for
      37%,
      35% and 30% of our total revenues for each of the three years in the period
      ended December 31, 2006.





A
      substantial portion of the services we provide to our clients is subject to
      our
      clients' needs. Our agreements with clients are in most cases terminable on
      30
      to 90 days' notice and are typically subject to client
      requirements.





We
      are
      headquartered in Hackensack, New Jersey, just outside New York City. We have
      two
      additional solutions centers in North America, seven production facilities
      in
      Asia (the Philippines, India and Sri Lanka) and a technology and tools
      development center in India. We were incorporated in Delaware in 1988.





**Innodata
      Isogen's Services**





**BPO
      SERVICES-** We
      group
      our content-related BPO services into two categories: fabrication services
      and
      knowledge services.





*Fabrication
      Services.* Our
      fabrication services include digitization, imaging, data conversion and
      composition services, XML and mark-up services, as well as translation and
      localization services. We use leading-edge technologies to capture our clients'
      relevant content and convert it into XML and other related mark-up standards.
      These technologies include high-speed scanning; a variety of commercial and
      proprietary optical/intelligent character recognition, or OCR/ICR, applications;
      structured workflow processes; and proprietary applications and tools designed
      to create meaningful, accurate and consistent data.





To
      convert the captured content to XML, tags are inserted within the content to
      provide a marker that computers can process. Our proprietary technology includes
      production-grade, auto-tagging applications that utilize pattern recognition
      algorithms based on comprehensive rule sets and related heuristics. This
      technology enables the mass creation or conversion of XML content from complex,
      unstructured data or content.





We
      price
      our digitization, content conversion and composition services based on the
      quantity delivered or resources utilized.





As
      an
      example, we built, for a secondary publisher, a searchable online archive that
      contains the back runs of three historical newspaper publications *.* The
      archive shows each newspaper page as a high-resolution image that can be
      magnified over 200% of its normal size. Each issue is digitally reproduced
      from
      cover to cover, including news stories and editorials, graphics and
      advertisements that bring history to life. Using the latest technology, we
      imaged the backfile and saved each page as a high-resolution, bi-tonal TIFF
      image. We captured the text of every headline, byline and story on every page
      using OCR, tagged the key information in XML and saved the text and image files
      for storage in an XML repository.





I-2





*Knowledge
      Services.* Our
      knowledge services add value to a client's content. These services include
      content creation and enhancement, taxonomy and controlled vocabulary
      development, hyperlinking, indexing, abstracting, technical writing and editing,
      copyediting and general editorial services, including the provision of synopses
      and annotations. We also provide editorial and research services that cover
      a
      wide spectrum of expertise, including medicine, law, engineering, management,
      finance, science and the humanities. To provide these services, we have
      organized knowledge teams that consist of a number of educated and highly
      trained people with expertise in the relevant subject. We typically price our
      knowledge services based on the quantity delivered or resources utilized.





As
      an
      example, a major publisher of scientific, technical and medical information
      sought to build one of the world's largest databases of scientific journal
      citations and references. We created records of nearly 15,000 journal titles
      going back almost 13 years, encoded in a way that supported integrated web
      searches and seamless linking. Under a long-term engagement, we maintain the
      database with daily updates, managing on behalf of our client a production
      process in which we aggregate, digitize, convert and enhance data.





**IT
      PROFESSIONAL SERVICES-** Clients
      who use our IT professional services typically require publishing, performance
      support or process automation systems that enable multiple authors to
      collaborate on content and enable multiple products to be generated from
      single-source XML repositories. Projects vary in size and duration. Our IT
      professional services are typically provided on a project basis that involves
      a
      defined task that, upon completion, does not generate any significant amount
      of
      continuing revenues. We frequently work on-site at clients to develop
      specifications and define requirements and to interact with end-users of the
      application. Detailed design, implementation and testing are generally performed
      at our offices in Dallas and Austin, Texas, as well as offshore at our office
      in
      Gurgaon, India.





Our
      IT
      professional services focus on the design, implementation, integration and
      deployment of systems used to author, manage and distribute content. We group
      these services into four categories: consulting; systems integration; custom
      application development; and other IT professional services, including
      applications maintenance, support, evaluation, implementation and training.





*Consulting.* We offer
      consulting services that focus on evaluating, advising, creating, overseeing
      or
      reviewing processes and/or technology designs that are necessary for a client
      to
      improve its management, use or distribution of information. We assist our
      clients by first understanding their business objectives and then analyzing
      and
      recommending the appropriate hardware and software specifications, as well
      as
      the process and engineering changes that will fulfill these objectives. Our
      consultants have a broad mix of functional and industry expertise. Our highly
      skilled process analysts, workflow architects and project managers enable
      clients to outsource to us their entire content operations, and thereby enhance
      the client's ability to manage, use and distribute the content.





As
      an
      example, a major defense contractor was awarded a multi-billion dollar military
      contract to build a new war plane. The military required that the technical
      documentation be delivered in electronic format and be useable by field
      technicians using handheld PDAs, as well as by pilots in the cockpit. The
      defense contractor hired us to recommend an XML-based publishing approach.
      Over
      several months, our team made several recommendations and redesigned the
      client's core business processes and systems architecture to achieve its
      objectives, including the ability to support high-volume, link-intensive data.
      We were then engaged by the client to develop the system. The completed system
      provided an end-to-end workflow that included link management, support for
      complex graphics, customized backend databases to support fast search and
      retrieval and customized user interfaces.





*Systems
      Integration.* Our
      systems integration services include the integration of disparate authoring
      tools, content and knowledge management systems and composition tools into
      an
      overall IT infrastructure, and also include the development of software that
      enhances the compatibility among various components of the overall IT
      infrastructure. We also undertake the management of programs and vendors during
      this process. Many of our systems integration projects involve organizations
      that are migrating to XML and other standards-based publishing systems or are
      seeking to integrate disparate data sources into a common environment. Our
      IT
      projects often include content analysis and the development of information
      architectures.




I-3





For
      example, one of the world's most successful IT equipment manufacturers was
      faced
      with the challenge of producing increasingly complex technical documentation
      faster, in more languages and across multiple platforms, as well as in print.
      This was necessary because of shortening product life cycles and the desire
      to
      market products in remote global markets. Over a 12-month period, our team
      of
      information architects and developers provided strategy and process consulting,
      product evaluation and information engineering services. We addressed complex
      content authoring, translation and localization and document rendition
      requirements. The result was a completely re-engineered standards-based product
      documentation system that enabled our client to easily revise and re-use content
      and translate that content into 35 languages seamlessly. We improved our
      client's time-to-market by significantly reducing the turnaround time for
      documentation and revisions, and substantially reduced overall product
      documentation costs.





*Custom
      Application Development.* Our
      custom application development services help our clients create new applications
      and enhance the functionalities of our clients' existing software applications.
      We design systems, develop software and run pilots.





Our
      application development services span the entire range of client server and
      Internet technologies. Our IT professional services staff is expert in XML
      and
      related information standards, as well as in emerging computing platforms.
      Our
      programmers are skilled in a range of programming languages and in a diverse
      set
      of application program interfaces, applications servers and database
      technologies.





As
      an
      example, a client in the information services industry needed to build an
      enterprise-scale publishing platform for a new online information service using
      the latest knowledge processing technologies. Our team of onshore and offshore
      technologists designed and built the platform over a period of 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 product pilot. Our single
      program manager coordinated the efforts of our IT professional services team,
      our outsourced content services team and other vendors on-site at the client’s
      location.





*Other
      IT Professional Services.* We
      assist our clients in the evaluation and implementation of software packages
      developed by third party vendors. We specialize in enterprise content management
      systems developed by several vendors, including: Documentum, XHive Corporation
      and Vasont Systems; and document authoring systems developed by vendors
      including PTC and Blast Radius; publishing tools developed by vendors including
      TopLeaf, Antenna House and FrameMaker; as well as various content analysis
      and
      extraction tools.





We
      provide support for our clients’ content-related applications, ensuring that
      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 provide a range
      of
      support services to our clients.




Refer
      to
      the notes to financial statements for a discussion of revenue, (loss) income
      before income taxes, and total assets for each of our content related BPO and
      IT
      professional services segments.





**Sales
      and Marketing**





We
      have
      three executive-level business development professionals and 12 full-time sales
      personnel. Historically, our sales efforts depended heavily on senior
      management. We are transitioning to a more structured direct sales model in
      which we implement additional sales infrastructure and maintain both dedicated
      sales support personnel and, when appropriate, hire additional sales persons.
      In
      this model, our executive-level business development professionals will continue
      to manage key client relationships through targeted interaction with our
      clients' senior management, while sales professionals will be responsible for
      identifying prospective clients and executing day-to-day sales strategies.




I-4





Our
      sales
      organization is responsible for qualifying and otherwise pursuing prospects,
      securing direct personal access to decision makers at existing and prospective
      clients and obtaining orders for our services and solutions. Our sales
      professionals work directly with clients to identify their requirements and
      with
      our engineering teams to define the solutions that best fit our clients'
      specific needs.





Sales
      activities include the design and generation of presentations and proposals,
      account and client relationship management and the organization of account
      activities.





Consulting
      personnel from our project analysis group and our engineering services group
      closely support our direct sales effort. These individuals assist the sales
      force in understanding the technical needs of clients and providing responses
      to
      these needs, including demonstrations, prototypes, pricing quotations and time
      estimates. In addition, account managers from our customer service group support
      our direct sales effort by providing ongoing project-level, post-sale support
      to
      our clients.





We
      constantly seek to expand the nature and scope of our engagements with existing
      clients by increasing the volume of our business and extending the breadth
      and
      value of services offered.





Our
      marketing organization is responsible for developing and increasing the
      visibility and awareness of our brand and our service offerings; defining and
      communicating our value proposition; and generating qualified, early-stage
      leads
      and furnishing effective sales support tools.





Primary
      marketing outreach activities include event marketing (including exhibiting
      at
      trade shows, conferences and seminars); direct and database marketing; public
      and media relations (including speaking engagements and active participation
      in
      industry and technical standard bodies); and web marketing (including search
      engine optimization, search engine marketing and the maintenance and continued
      development of external web sites).





**Research
      and Development**





In
      2006
      and 2005, we spent approximately $922,000 and $770,000, respectively, on
      research and development. We did not spend any significant amounts for research
      and development in 2004.





**Competition**





The
      market for content-related BPO services is highly competitive, fragmented and
      intense. Several of our major competitors are SPI Technologies, Apex CoVantage,
      Aptara and Cadmus Communications Corporation. However, we are not aware of
      any
      single competitor that provides the same comprehensive range of outsourced
      content services as we do. We believe that we also compete successfully by
      offering high quality services and favorable pricing by leveraging our technical
      skills, IT infrastructure, process knowledge, offshore model and economies
      of
      scale. Our competitive advantages are especially attractive to clients for
      undertakings that are technically sophisticated, sizable in scope or scale,
      or
      that require a highly fail-safe environment with technology redundancy. We
      also
      believe that the timeliness with which we provide our services enables our
      clients to reduce the time it takes for them to release their products to the
      market, thereby providing a competitive advantage to the client.





A
      sizeable number of large and mid-sized technology and business consulting
      practices compete with our IT professional services by offering content-related
      integration and consulting services as part of their broad and generalized
      offerings. Major companies such as IBM, EDS, Bearing Point, Accenture, Booz
      Allen and others compete for entire content supply chain dollars, and Thomas
      Technology Solutions, Jouve and RivCom are also engaged in this business.
      However, there are fewer firms that can so readily supplement their IT
      professional services offerings with relevant content services.





As
      a
      provider of BPO services and IT professional services, we also compete at times
      with in-house personnel at existing or prospective clients who may attempt
      to
      duplicate our services in-house.




I-5





Some
      of
      our competitors have longer operating histories, significantly greater
      financial, human, technical and other resources and greater name recognition
      than we do, and we cannot assure you that we will continue to compete
      effectively with them.





There
      are
      relatively few barriers preventing companies from competing with us. We do
      not
      own any patented technology that would preclude or inhibit others from entering
      our market.





**Employees**





As
      of
      December 31, 2006, we employed 76 persons in the United States and Europe and
      approximately 5,400 persons in five production facilities in the Philippines,
      one production facility in Sri Lanka, one production facility in India and
      a
      technology and tools development center in India. Most of our employees have
      graduated from at least a two-year college program. Many of our employees hold
      advanced degrees in law, business, technology, medicine and social sciences.
      No
      employees are currently represented by a labor union, and we believe that our
      relations with our employees are satisfactory.





**Item
      1A. Risk Factors.**





**We
      have historically relied on a very limited number of clients that have accounted
      for a significant portion of our revenues and our results of operations could
      be
      adversely affected if we lose one or more of these significant
      clients.**





We
      have
      historically relied on a very limited number of clients that have accounted
      for
      a significant portion of our revenues. Three clients accounted for 28%, 12%
      and
      10% of our revenues in the year ended December 31, 2006. Two clients accounted
      for 27% and 12% of our revenues in the year ended December 31, 2005 and 31%
      and
      24% in the year ended December 31, 2004. We may lose any of these or our other
      major clients as a result of our failure to meet or satisfy our clients’
requirements, the completion or termination of a project or engagement, or
      the
      selection of another service provider.





In
      addition, the revenues we generate from our major clients may decline or grow
      at
      a slower rate in future periods than in the past. If we lose any of our
      significant clients, our revenues and results of operations could be adversely
      affected and we may incur a loss from operations. Our services are typically
      subject to client requirements, and in most cases are terminable upon 30 to
      90
      days’ notice.





**A
      significant portion of our services is provided on a non-recurring basis for
      specific projects, and our inability to replace large projects when they are
      completed has adversely affected, and could in the future adversely affect,
      our
      revenues and results of operations.**





We
      provide a portion of our services for specific projects that generate revenues
      that terminate on completion of a defined task and we regard these revenues
      as
      non-recurring. Non-recurring revenues derived from these project-based
      arrangements accounted for approximately 39% of our total revenues for the
      year
      ended December 31, 2006 and approximately 42% of our total revenues for the
      year ended December 31, 2005. While we seek wherever possible to
      counterbalance periodic declines in revenues on completion of large projects
      with new arrangements to provide services to the same client or others, we
      were
      not able in 2006 and 2005 to avoid declines in revenues when large projects
      were
      completed. Our inability to obtain sufficient new projects to counterbalance
      any
      decreases in such work adversely affected our revenues and results of operations
      in 2006 and 2005 and may adversely affect our future revenues and results of
      operations.





I-6




**A
      large portion of our accounts receivable is payable by a limited number of
      clients; the inability of any of these clients to pay its accounts receivable
      would adversely affect our results of operations.**





Several
      significant clients account for a large percentage of our accounts receivable.
      As of December 31, 2006, 21%, or $1.4 million, of our accounts
      receivable was due from one client. If any of these clients were unable, or
      refuse, for any reason, to pay our accounts receivable, our results of
      operations would be adversely affected.





**Quarterly
      fluctuations in our results of operations could make financial forecasting
      difficult and could negatively affect our stock price.**





We
      have
      experienced, and expect to continue to experience, significant fluctuations
      in
      our quarterly revenues and results of operations. During the past eight
      quarters, our net income ranged from a loss of approximately $3.0 million
      to a profit of approximately $300,000.





Our
      quarterly operating results are also subject to certain seasonal fluctuations.
      Our fourth and first quarters include the months of December and January, when
      billable services activity by professional staff, as well as engagement
      decisions by clients, may be reduced due to client budget planning cycles.
      Demand for our services generally may be lower in the fourth quarter due to
      reduced activity during the holiday season and fewer working days for our
      Philippines-based staff during this period. These and other seasonal factors
      may
      contribute to fluctuations in our results of operations from quarter to quarter.





**We
      compete in highly competitive markets that have low barriers to
      entry.**





The
      markets for our services are highly competitive and fragmented. We may not
      be
      able to compete successfully against our competitors in the future. Some of
      our
      competitors have longer operating histories, significantly greater financial,
      human, technical and other resources and greater name recognition than we do.
      If
      we fail to be competitive with these companies in the future, we may lose market
      share, which could adversely affect our revenues and results of operations.





There
      are
      relatively few barriers preventing companies from competing with us. We do
      not
      own any patented technology that would preclude or inhibit others from entering
      our market. As a result, new market entrants also pose a threat to our business.
      We also compete with in-house personnel at current and prospective clients,
      who
      may attempt to duplicate our services using in-house personnel. We cannot assure
      you that our clients will outsource more of their needs to us in the future,
      or
      that they will not choose to provide internally the services that they currently
      obtain from us. If we are not able to compete effectively, our revenues and
      results of operations could be adversely affected.





**We
      are the subject of continuing litigation, including litigation by certain of
      our
      former employees.**





We
      are
      subject to various legal proceedings and claims which arise in the ordinary
      course of business. In addition, in connection with the cessation of all
      operations at certain of our foreign subsidiaries, certain former employees
      have
      filed various actions against one of our Philippine subsidiaries and have
      purported also to sue us and certain of our officers and directors. An
      unfavorable ruling in any of these proceedings could adversely affect our
      financial condition and results of operations. See “Legal Proceedings."





**Our
      international operations subject us to risks inherent in doing business on
      an
      international level, any of which could increase our costs and hinder our
      growth.**





The
      major
      part of our operations is carried on in the Philippines, India and Sri Lanka,
      while our headquarters are in the United States and our clients are primarily
      located in North America and Europe. While we do not depend on revenues from
      sources internal to the countries in which we operate, we are nevertheless
      subject to certain adverse economic factors relating to overseas economies
      generally, including inflation, external debt, a negative balance of trade
      and
      underemployment. Other risks associated with our international business
      activities include:




·  difficulties
      in staffing international projects and managing international operations,
      including overcoming logistical and communications challenges;




I-7





·
      local competition, particularly in the
      Philippines, India and Sri Lanka;





·
      imposition of public sector controls;





·
      trade and tariff restrictions;





·
      price or exchange controls;





·
      currency control regulations;





·
      foreign tax consequences;





·
      labor disputes and related litigation and
      liability;





·
      limitations on repatriation of earnings;
      and





·
      the burdens of complying with a wide
      variety of foreign laws and regulations.





One
      or
      more of these factors could adversely affect our business and results of
      operations.





**Our
      international operations subject us to currency exchange fluctuations, which
      could adversely affect our results of operations.**





To
      date,
      most of our revenues have been denominated in U.S. dollars, while a significant
      portion of our expenses, primarily labor expenses in the Philippines, India
      and
      Sri Lanka, is incurred in the local currencies of countries in which we operate.
      For financial reporting purposes, we translate all non-United States denominated
      transactions into dollars in accordance with accounting principles generally
      accepted in the United States. As a result, we are exposed to the risk that
      fluctuations in the value of these currencies relative to the dollar could
      increase the dollar cost of our operations and therefore adversely affect our
      results of operations.





The
      Philippines has historically experienced high rates of inflation and major
      fluctuations in the exchange rate between the Philippine peso and the U.S.
      dollar. Continuing inflation without a corresponding devaluation of the peso
      against the dollar, or any other increase in the value of the peso relative
      to
      the dollar, could adversely affect our results of operations. Since 1997, we
      have not purchased foreign currency futures contracts for pesos, but we may
      choose to do so in the future.





**New
      regulation of the Internal Revenue Service may impose significant U.S. income
      taxes on our subsidiaries in the Philippines.**





Our
      subsidiaries incorporated in the Philippines were domesticated in Delaware
      as
      limited liability companies. In August 2004, the Internal Revenue Service
      promulgated regulations, effective August 12, 2004, that treat certain
      companies incorporated in foreign jurisdictions and also domesticated as
      Delaware limited liability companies as U.S. corporations for U.S. federal
      income tax purposes. We have effected certain filings with the Secretary of
      State of the State of Delaware to ensure that these subsidiaries are no longer
      domesticated in Delaware. As a result, commencing January 1, 2005,
      these subsidiaries are not treated as U.S. corporations for U.S. federal income
      tax purposes under the regulations and are not subject to U.S. federal income
      taxes commencing as of such date.




I-8





In
      the
      preamble to such regulations, the IRS expressed its view that dual registered
      companies described in the preceding sentence are also treated as U.S.
      corporations for U.S. federal income tax purposes for periods prior to August
      12, 2004. In 2006, the IRS issued its final regulations, stating that neither
      the temporary regulations nor these final regulations are retroactive. Further,
      additional guidance was released by the IRS which clarified that the regulations
      upon which we relied were not binding on pre-existing entities until May 2006.
      For periods prior to this date these final regulations apply (i.e., prior to
      August 12, 2004), the classification of dually chartered entities is governed
      by
      the pre-existing regulations. As such, we believe that our historic treatment
      of
      these subsidiaries as not having been required to pay taxes in the United States
      for the period prior to August 12, 2004 is correct, and we have made no
      provision for U.S. taxes in its financial statements for these entities for
      the
      periods prior to August 12, 2004.





However,
      we cannot assure you that the Internal Revenue Service will not assert other
      positions with respect to the foregoing matters, including positions with
      respect to our treatment of the tax consequences of the termination of the
      status of our Philippine subsidiaries as Delaware limited liability companies,
      that, if successful, could increase materially our liability for U.S. federal
      income taxes.





**If
      certain tax authorities in North America and Europe challenge the manner in
      which we allocate our profits, our net income will
      decrease.**





Substantially
      all of the services provided by our Asian subsidiaries are performed on behalf
      of clients based in North America and Europe. We believe that profits from
      our
      Asian operations are not sufficiently connected to jurisdictions in North
      America or Europe to give rise to income taxation in those jurisdictions. Tax
      authorities in any of our jurisdictions could, however, challenge the manner
      in
      which we allocate our profits among our subsidiaries, and we may not prevail
      in
      this type of challenge. If such a challenge were successful, our worldwide
      effective tax rate could increase, thereby decreasing our net income.





**An
      expiration or termination of our current tax holidays could adversely affect
      our
      results of operations.**





We
      currently benefit from income tax holiday incentives in the Philippines, India
      and Sri Lanka which provide that we pay reduced income taxes in those
      jurisdictions for a fixed period of time that varies depending on the
      jurisdiction. An expiration or termination of our current tax holidays could
      substantially increase our worldwide effective tax rate, thereby decreasing
      our
      net income and adversely affecting our results of operations. The income tax
      holiday of one of our Indian subsidiaries will expire in March
      2007.





**Regional
      instability in the Philippines, India and Sri Lanka could adversely affect
      business conditions in those regions, which could disrupt our operations and
      adversely affect our business and results of operations.**





We
      conduct a majority of our operations in the Philippines, India and Sri Lanka.
      These operations remain vulnerable to political unrest. Political instability
      could adversely affect the legal environment for our business activities in
      those regions.





In
      particular, the Philippines has experienced ongoing problems with insurgents.
      The Abu Sayyaf group of kidnappers, which is purported to have ties to the
      Al
      Qaeda terrorist organization, is concentrated on Basilan Island. While Basilan
      Island is not near our facilities and the government of the Philippines has
      taken action to eradicate this group, we cannot assure you that these efforts
      will be successful or that the Abu Sayyaf group will not attempt to disrupt
      activities or commit terrorist acts in other areas of the Philippines or South
      Asia.





In
      recent
      years there have been military confrontations between India and Pakistan that
      have occurred in the region of Kashmir and along the India-Pakistan border.
      In
      addition, in recent years there has been civil unrest in Sri Lanka.




I-9





Further
      political tensions and an escalation in these hostilities could adversely affect
      our operations based in India, the Philippines and Sri Lanka and therefore
      adversely affect our revenues and results of operations.





**Terrorist
      attacks or a war could adversely affect our results of
      operations.**





Terrorist
      attacks, such as the attacks of September 11, 2001 in the United States,
      and other acts of violence or war, such as the conflict in Iraq, could affect
      us
      or our clients by disrupting normal business practices for extended periods
      of
      time and reducing business confidence. In addition, these attacks may make
      travel more difficult and may effectively curtail our ability to serve our
      clients' needs, any of which could adversely affect our results of operations.





**It
      is unlikely that we will pay dividends.**





We
      have
      not paid any cash dividends since our inception and do not anticipate paying
      any
      cash dividends in the foreseeable future. We expect that our earnings, if any,
      will be used to finance our growth.





**Item
      2. Description of Property.**





Our
      services are primarily performed from our Hackensack, New Jersey headquarters,
      our Dallas and Austin, Texas offices, and seven overseas facilities, all of
      which are leased. In addition, we have a technology and tools development
      facility in Gurgaon, India, which is also leased. The square footage of all
      our
      leased properties is approximately 450,000. Rental payments on property leases
      were approximately $2.0 million in 2006.





**Item
      3. Legal Proceedings.**





The
      Innodata Employees Association (IDEA), Jomarie Deles and other complainants
      have
      sued one of our Philippines subsidiaries, and have purported also to sue us
      and
      certain of our officers and directors, in *Innodata
      Philippines Employees Association (IDEA) v Innodata
      Philippines, Inc.* (filed
      July 27, 2001 at the National Conciliation and Mediation Board of the
      Philippine Department of Labor and Employment in Manila); Innodata Employees
      Association (IDEA), *Jomarie
      Deles, et al v. Innodata Philippines, Inc.* (filed
      July 1, 2002 in the National Labor Relations Commission of the Republic of
      the Philippines in Manila); and in related cases and proceedings filed in the
      Philippines Supreme Court, the Philippine Court of Appeals and the Philippines
      Department of Labor and Employment. Complainants seek to require reinstatement
      of employment and to recover back wages for an allegedly illegal facility
      closing on June 7, 2002 based on the terms of a collective bargaining
      agreement with this subsidiary. If complainants' claims had merit they could
      be
      entitled to back wages and benefits of up to approximately $5.3 million,
      based upon exchange rates as of December 31, 2006, and consistent with
      prevailing jurisprudence. Based on consultation with legal counsel, we believe
      that the complainants' claims are without merit and continue to defend against
      them vigorously.





In
      addition, we are subject to various legal proceedings and claims which arise
      in
      the ordinary course of business. While we currently believe that the ultimate
      outcome of these proceedings will not have a material adverse affect on our
      financial condition or results of operations, litigation is subject to inherent
      uncertainties. Were an unfavorable ruling to occur, it could have a material
      adverse effect on our financial condition and results of operations.





**Item
      4. Submission of Matters to a Vote of Security
      Holders-None.**




I-10




**PART
      II**




**Item
      5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities.**





Innodata
      Isogen, Inc. (the “Company”) Common Stock is quoted on the Nasdaq National
      Market System under the symbol “INOD.” On February 28, 2007, there were 112
      stockholders of record of the Company’s Common Stock based on information
      provided by the Company's transfer agent. Virtually all of the Company’s
      publicly held shares are held in “street name” and the Company believes the
      actual number of beneficial holders of its Common Stock to be approximately
      4,000.





The
      following table sets forth the high and low sales prices on a quarterly basis
      for the Company's Common Stock, as reported on Nasdaq, for the two years ended
      December 31, 2006.




**Common
                Stock****Sale
                Prices****2005**
            
            **High**
            
            **Low**First
                Quarter
            
            $
            10.07
            
            $
            2.98Second
                Quarter
            
            
            3.96
            
            
            2.30Third
                Quarter
            
            
            3.73
            
            
            2.25Fourth
                Quarter
            
            
            3.63
            
            
            2.25**2006**
            
            **High**
            
            **Low**First
                Quarter
            
            $
            4.05
            
            $
            2.35Second
                Quarter
            
            
            3.06
            
            
            2.06Third
                Quarter
            
            
            2.48
            
            
            1.53Fourth
                Quarter
            
            
            2.41
            
            
            1.61





**Dividends**





The
      Company has never paid cash dividends on its Common Stock and does not
      anticipate that it will do so in the foreseeable future. The future payment
      of
      dividends, if any, on the Common Stock is within the discretion of the Board
      of
      Directors and will depend on the Company's earnings, its capital requirements
      and financial condition and other relevant factors.




II-1




**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      following table sets forth the aggregate information for the Company's equity
      compensation plans in effect as of December 31, 2006:




**Plan
                Category**
            
            **Number
                        of Securities to be Issued Upon Exercise of Outstanding Options,Warrants
                        and Rights**
            
            **Weighted-Average**
                    **Exercise
                      Price of**
                    **Outstanding
                      Options,**
                    **Warrants
                      and Rights**
            
            **Number
                      of Securities**
                      **Remaining
                        Available For**
                      **Future
                        Issuance Under**
                      **Equity
                        Compensation Plans****(a)**
            
            **(b)**
            
            **(c)**Equity
                compensation plansapproved
                by security holders
            
            
            3,534,000
            
            $
            2.51
            
            
            2,431,000Equity
                compensation plansnot
                approved by security holders
            
            
            1,015,000
            (1)
            $
            0.84
            
            
            -Total
            
            
            4,549,000
            
            $
            2.14
            
            
            2,431,000





(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.





**Treasury
      Stock**





In
      August, 2006, the Board of Directors authorized the repurchase of up to $1.0
      million of its common stock of which approximately $681,000 remains available
      for repurchase under the program as of December 31, 2006. During the quarter
      ended December 31, 2006, the Company repurchased 11,300 shares of its common
      stock at a cost of $21,000.





**Issuer
      Purchases of Equity Securities.**





(a)
                Total Number of Shares (or Units) Purchased
            
            (b)
                Average Price Paid per Share (or Unit)
            
            (c)
                Total Number of Shares (or Units) Purchased as Part of Publicly Announced
                Plans or Programs
            
            (d)
                Maximum Number (or Approximate Dollar Value) of Shares (or Units)
                that May
                Yet Be Purchased Under the Plans or ProgramsMonth
                #1 (October 1-31, 2006)
            
            
            11,300
            
            $
            1.86
            
            
            11,300
            
            $
            681,000Month
                #2 (November 1-30, 2006)
            
            
            -
            
            
            -
            
            
            -
            
            $
            681,000Month
                #3 (December 1-31, 2006)
            
            
            -
            
            
            -
            
            
            -
            
            $
            681,000Total
            
            
            11,300
            
            $
            1.86
            
            
            11,300
            
            $
            681,000





Note:
      On
      August 23, 2006, the Company announced that the Board of Directors authorized
      the repurchase of up to $1.0 million of its common stock. There is no expiration
      date associated with the program.


II-2





**Item
      6. Selected Financial Data (In thousands, except per share
      amounts).**





**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands, except per share data)****STATEMENT
                OF OPERATIONS DATA:**REVENUES
            
            $
            40,953
            
            $
            42,052
            
            $
            53,949
            
            $
            36,714
            
            $
            36,385OPERATING
                COSTS AND EXPENSES:Direct
                operating expenses
            
            
            34,141
            
            
            30,920
            
            
            33,050
            
            
            27,029
            
            
            32,005Selling
                and administrative expenses
            
            
            14,284
            
            
            13,684
            
            
            10,205
            
            
            8,898
            
            
            10,038Restructuring
                costs and asset impairment
            
            
            604
            
            
            -
            
            
            -
            
            
            -
            
            
            24449,029
            
            
            44,604
            
            
            43,255
            
            
            35,927
            
            
            42,287(LOSS)
                INCOME BEFORE OTHER(INCOME)
                EXPENSE
            
            
            (8,076
            )
            
            (2,552
            )
            
            10,694
            
            
            787
            
            
            (5,902
            )OTHER
                (INCOME) AND EXPENSESTerminated
                offering costs
            
            
            -
            
            
            -
            
            
            625
            
            
            -
            
            
            -Bad
                debt recovery, net
            
            
            -
            
            
            -
            
            
            (963
            )
            
            -
            
            
            -Interest
                expense
            
            
            7
            
            
            18
            
            
            25
            
            
            9
            
            
            29Interest
                income
            
            
            (683
            )
            
            (457
            )
            
            (87
            )
            
            (30
            )
            
            (89
            )(LOSS)
                INCOME BEFORE(BENEFIT
                FROM) PROVISION FORINCOME
                TAXES
            
            
            (7,400
            )
            
            (2,113
            )
            
            11,094
            
            
            808
            
            
            (5,842
            )(BENEFIT
                FROM) PROVISION FORINCOME
                TAXES
            
            
            (77
            )
            
            (462
            )
            
            3,237
            
            
            333
            
            
            (677
            )NET
                (LOSS) INCOME
            
            $
            (7,323
            )
            $
            (1,651
            )
            $
            7,857
            
            $
            475
            
            $
            (5,165
            )(LOSS)
                INCOME PER SHARE:Basic
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .35
            
            $
            .02
            
            $
            (.24
            )Diluted
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .32
            
            $
            .02
            
            $
            (.24
            )Cash
                dividends per share
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -




******December
                31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands)****BALANCE
                SHEET DATA:**WORKING
                CAPITAL
            
            $
            13,632
            
            $
            21,432
            
            $
            22,209
            
            $
            11,983
            
            $
            8,570TOTAL
                ASSETS
            
            $
            30,329
            
            $
            37,611
            
            $
            37,211
            
            $
            25,146
            
            $
            22,697LONG
                TERM OBLIGATIONS
            
            $
            904
            
            $
            548
            
            $
            150
            
            $
            272
            
            
            -STOCKHOLDERS’
                EQUITY
            
            $
            19,009
            
            $
            26,814
            
            $
            26,737
            
            $
            17,404
            
            $
            15,569




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 content-related BPO services. These services
      consist of fabrication and knowledge services. Services that are provided for
      a
      specific project generate revenues that terminate on completion of a defined
      task and we regard these revenues as non-recurring. We also provide
      content-related BPO services for business processes that we anticipate will
      continue for an indefinite period and therefore generate what we regard as
      recurring revenues. We price our content-related BPO services based on the
      quantity delivered or resources utilized. Revenues for content-related BPO
      services are recognized in the period in which the services are performed and
      delivered.





We
      also
      derive a portion of our revenues from IT professional services.
      A substantial majority of our IT professional services is provided on a
      project basis that generates non-recurring revenues. These services consist
      of
      consulting, systems integration, custom application development and other
      professional services. We price our professional services on an hourly basis
      for
      actual time and expense incurred, or on a fixed-fee turn-key basis. Revenues
      for
      contracts billed on a time and materials basis are recognized as services are
      performed. Revenues under fixed-fee contracts are recognized on the percentage
      of completion method of accounting as services are performed or milestones
      are
      achieved.





Recurring
      revenues consisted of 61% and 58% of total revenues for the years ended December
      31, 2006 and 2005, respectively. The substantial majority of our recurring
      revenues are derived from content -related BPO services. A small portion of
      our
      recurring revenues is derived from the application maintenance agreements
      related to our IT professional services. Non-recurring revenues vary depending
      on the size and completion dates of specific projects.





We
      have
      historically relied on a very limited number of clients that have accounted
      for
      a significant portion of our revenues. Three clients accounted for 28%, 12%
      and
      10% of our revenues in December 2006. Two clients accounted for 27% and 12%
      of
      our revenues in the year ended December 31, 2005 and 31% and 24% in the year
      ended December 31, 2004. We may lose any of these or our other major clients
      as
      a result of our failure to meet or satisfy our clients’ requirements, the
      completion or termination of a project or engagement, or the selection of
      another service provider.





In
      addition, the revenues we generate from our major clients may decline or grow
      at
      a slower rate in future periods than in the past. If we lose any of our
      significant clients, our revenues and results of operations could be adversely
      affected and we may incur a loss from operations. Our services are typically
      subject to client requirements, and in most cases are terminable upon 30 to
      90
      days’ notice.





See
“Risk
      Factors.”





*Direct
      Operating Costs*





Direct
      operating costs for both our content-related BPO services and IT professional
      services consist of direct payroll, occupancy costs, depreciation,
      telecommunications, computer services and supplies. We anticipate our cost
      of
      labor to increase in 2007 by approximately $300,000 per quarter as a result
      of
      general wage increases.





*Selling
      and Administrative Expenses*





Selling
      and administrative expenses for both our content-related BPO services and IT
      professional services consist of management and administrative salaries, sales
      and marketing costs, new services research and related software development,
      and
      administrative overhead.





II-4




**Results
      of Operations**





**Year
      Ended December 31, 2006 Compared to the Year Ended December 31,
      2005**





*Revenues*





Revenues
      were $41.0 million for the year ended December 31, 2006 compared to
      $42.1 million for the similar period in 2005, a decrease of 3%.





Three
      clients accounted for 28%, 12% and 10% of the Company’s revenues in the year
      ended December 31, 2006. Two clients accounted for 27% and 12% of the Company’s
      revenues in the year ended December 31, 2005. Further, for the years ended
      December 31, 2006 and 2005 revenues from clients located in foreign
      countries (principally in Europe) accounted for 37% and 35% of our total
      revenues, respectively.





Revenues
      from content-related BPO services decreased 1% to $36.3 million for the
      year ended December 31, 2006 from $36.7 million for the similar period
      in 2005.





Revenues
      from IT professional services decreased 13% to $4.7 million for the year
      ended December 31, 2006 from $5.4 million for the similar period
      in 2005. The decrease in revenue is primarily attributable to non-recurring
      projects that reached completion.





For
      the
      year ended December 31, 2006, approximately 61% of our revenue was recurring
      and
      the 39% balance was non-recurring, compared with 58% and 42%, respectively,
      for
      the year ended December 31, 2005.





*Direct
      Operating Costs*





Direct
      operating costs were $34.1 million and $30.9 million for the years
      ended December 31, 2006 and 2005, respectively, an increase of 10%. Direct
      operating costs as a percentage of revenues were 83% for the year ended
      December 31, 2006 and 73% for the year ended December 31, 2005.





Direct
      operating costs for content-related BPO services were $30.1 million and
      $26.6 million for the years ended December 31, 2006 and 2005,
      respectively, an increase of 13%. Direct operating costs of outsourced content
      services as a percentage of revenues from outsourced content services were
      83%
      and 72% for the years ended December 31, 2006 and 2005, respectively. The
      increase in direct operating costs of content-related BPO services, both in
      total dollar amount and as a percentage of revenues, is principally attributable
      to increases in pay rates for both management and production personnel, growth
      in our engineering technology department, and increases in various fixed
      expenses.





Direct
      operating costs for IT professional services were $4.0 million and $4.3
      million for the years ended December 31, 2006 and 2005 respectively, a
      decrease of 7%. Direct operating costs of IT professional services as a
      percentage of revenues from IT professional services were 85% and 80% for the
      years ended December 31, 2006 and 2005, respectively. The decrease in
      direct operating costs of IT professional services for the 2006 period was
      principally due to a reduction in labor costs, while the increase
      in direct operating costs of IT professional services as a percentage of revenue
      is primarily attributable to decreased revenues without a corresponding decrease
      in direct operating costs.





*Selling
      and Administrative Expenses*





Selling
      and administrative expenses were $14.3 million and $13.7 million for
      the years ended December 31, 2006 and 2005, respectively, an increase
      of 4%. Selling and administrative expenses as a percentage of revenues were
      35%
      and 33% for the years ended December 31, 2006 and 2005 respectively.
      Included as a reduction in selling and administrative expenses in 2006 is
      approximately $246,000 received as an inducement to terminate our Dallas office
      lease prior to its contractual expiration date. Selling and administrative
      expenses for the year ended December 31, 2006 also includes accrued severance
      costs of approximately $275,000 related to the termination of an executive’s
      employment. In addition, in the year ended December 31, 2006, we spent
      approximately $922,000 in new services research and development compared to
      $770,000 in the comparable 2005 period. The balance of the increase from 2005
      principally reflects general increases in administrative costs.




II-5





*Restructuring
      Costs*





As
      part
      of an overall cost reduction plan to reduce operating costs, in September 2006
      we announced a worldwide workforce reduction of slightly under 300 employees,
      the majority of whom were based in Asia. Most employees were terminated prior
      to
      September 30, and we substantially implemented the plan at end of
      2006.





As
      a
      result, we estimate that total charges to earnings associated with the
      restructuring plan approximates $615,000 of which $531,000 and $84,000 represent
      severance costs and costs to implement, respectively. As of December 31, 2006,
      approximately $604,000, which includes $60,000 non-cash consideration via stock
      option, has been charged to earnings, of which $102,000 has been accrued and
      included under the caption “Accrued Expenses” in the balance sheet as of the
      period then ending.





In
      connection with the restructuring, the Company paid cash of $442,000 and
      recognized costs amounting to $60,000 for a stock option modification and
      expects to pay the balance of $113,000 during the first two quarters of
      2007.





*Income
      Taxes*





For
      the
      year ended December 31, 2006, the benefit from income taxes as a percentage
      of loss before income taxes was 1%. The 2006 benefit from income taxes is lower
      than the U.S. Federal statutory rate, principally due to the U.S. net operating
      losses which were not recognized as a result of a valuation allowance. In
      addition, certain overseas income is neither subject to foreign income taxes
      because of tax holidays granted to us, nor subject to tax in the U.S. unless
      repatriated.





For
      the
      year ended December 31, 2005, the benefit from income taxes as a percentage
      of
      loss before income taxes was 22%. The 2005 benefit from income taxes is lower
      than the U.S. Federal statutory rate, principally due to a portion of the U.S.
      net operating losses which were not recognized, offset in part by certain
      overseas income which is neither subject to foreign income taxes because of
      tax
      holidays granted to us, nor subject to tax in the U.S. unless
      repatriated.





*Net
      Loss/Income*





We
      recorded a net loss of $7.3 million in 2006 compared with a net loss of
      $1.7 million in 2005. The principal reasons for the increase in net loss in
      2006
      were a decline in revenues, increases in operating costs and expenses and a
      $604,000 restructuring charge.





**Year
      Ended December 31, 2005 Compared to the Year Ended December 31,
      2004**





*Revenues*





Revenues
      were $42.1 million for the year ended December 31, 2005 compared to
      $53.9 million for the similar period in 2004.





One
      client accounted for 27% and 23% of our total revenues for the years ended
      December 31, 2005 and 2004, respectively. A second client accounted for 12%
      and 31% of our revenues for the year ended December 31, 2005 and 2004,
      respectively. No other client accounted for 10% or more of our total revenues
      for these periods. Further, for the years ended December 31, 2005 and 2004,
      revenues from clients located in foreign countries (principally in Europe)
      accounted for 35% and 30% of our total revenues, respectively.




II-6





Revenues
      from content-related BPO services decreased 16% to $36.7 million for the
      year ended December 31, 2005 from $43.7 million for the similar period
      in 2004. This decrease primarily reflects an $8 million decline in revenues
      from
      a major content services project that was terminated late in the first quarter
      of 2005. We did not obtain sufficient new projects to counterbalance the decline
      in revenues from the termination of this project.





Revenues
      from IT professional services decreased 47% to $5.4 million for the year ended
      December 31, 2005 from $10.2 million for the similar period in 2004.
      The results in the 2004 period reflect approximately $4.4 million of revenues
      from two projects that were completed in 2004.





For
      the
      year ended December 31, 2005, approximately 58% of our revenue was recurring
      and
      the 42% balance was non-recurring, compared with 47% and 53%, respectively,
      for
      the year ended December 31, 2004.





*Direct
      Operating Costs*





Direct
      operating costs were $30.9  million and $33.1 million for the years
      ended December 31, 2005 and 2004, respectively, a decrease of 7%. Direct
      operating costs as a percentage of revenues were 73% for the year ended
      December 31, 2005 and 61% for the year ended December 31, 2004.





Direct
      operating costs for content-related BPO services were $26.6 million and
      $27.5 million for the years ended December 31, 2005 and 2004,
      respectively, a decrease of 3%. Direct operating costs of content-related BPO
      services as a percentage of revenues from these services were 72% and 63% for
      the years ended December 31, 2005 and 2004, respectively. Fixed costs
      increased approximately 2%, principally resulting from growth in our engineering
      technology department. The overall increase in fixed costs was in part offset
      by
      a reduction in depreciation and amortization costs of approximately $800,000.
      The increase in direct operating costs of outsourced content services as a
      percentage of revenues from content-related BPO services principally results
      from a 2% percentage point increase in variable costs of production as a percent
      of revenues, and from decreased revenues in 2005 without a corresponding
      decrease to fixed costs.





Direct
      operating costs for IT professional services were $4.3 million and $5.6
      million for the years ended December 31, 2005 and 2004, respectively.
      Direct operating costs of IT professional services as a percentage of revenues
      from IT professional services were 80% and 55% for the years ended
      December 31, 2005 and 2004, respectively. The dollar decrease in direct
      operating costs of IT professional services for the 2005 period was due to
      a
      reduction in labor costs. The increase in direct operating costs of IT
      professional services as a percentage of revenues from IT professional services
      was primarily attributable to decreased revenues without a corresponding
      decrease in these costs.





*Selling
      and Administrative Expenses*





Selling
      and administrative expenses were $13.7 million and $10.2 million for
      the years ended December 31, 2005 and 2004, respectively, an increase
      of 34%. Selling and administrative expenses as a percentage of revenues were
      33%
      and 19% for the years ended December 31, 2005 and 2004 respectively.
      Selling and marketing expenses increased by approximately $1.8 million, partly
      as a result of increased costs from our continued efforts to enhance our
      business development infrastructure. In addition, in 2005 we spent approximately
      $0.8 million for new services research and related software development. The
      balance of the increase from 2004 principally reflects general increases in
      administrative costs.


II-7




*Other*





On
      January 5, 2005, we announced our intent to raise funds and filed a registration
      statement on Form   S-3 to register 4,250,000 shares of our
      common stock, plus 3,250,000 shares of common stock currently held by certain
      of
      our directors and officers. On March 23, 2005, we terminated the offering and
      as
      such, in the fourth quarter 2004, expensed approximately $625,000 of offering
      costs.





In
      January 2004, we reached a settlement agreement with and received
      $1.0 million in cash from a former client in full satisfaction of a
      $2.6 million outstanding 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 debt recovery for the year ended December 31, 2004.





*Income
      Taxes*





For
      the
      year ended December 31, 2005, the benefit from income taxes as a percentage
      of loss before income taxes was 22%. The 2005 benefit from income taxes is
      lower
      than the U.S. Federal statutory rate, principally due to a portion of the U.S.
      net operating losses which were not recognized, offset in part by certain
      overseas income which is neither subject to foreign income taxes because of
      tax
      holidays granted to us, nor subject to tax in the U.S. unless repatriated.





For
      the
      year ended December 31, 2004, the provision for income taxes as a
      percentage of income was 29%. The 2004 provision is lower than the U.S. Federal
      statutory rate, principally due to certain overseas income which is neither
      subject to foreign income taxes because of tax holidays granted to us, nor
      subject to tax in the U.S. unless repatriated.





In
      August
      2004, the IRS promulgated regulations, effective August 12, 2004, that had
      the
      effect of making certain of our overseas entities taxable in the United States
      for U.S. federal income tax purposes. As a result, in the fourth quarter 2004,
      we provided approximately $450,000 for U.S. income taxes attributable to these
      applicable overseas entities. In addition, in December 2004, we effected certain
      filings in Delaware to ensure that these subsidiaries will not be treated as
      U.S. corporations for U.S. federal income tax purposes as of the date of filing
      and as such, will not be subject to U.S. federal income taxes commencing January
      1, 2005.





*Net
      Loss/Income*





We
      recorded a net loss of $1.7 million in 2005 compared with net income of $7.9
      million in 2004. The principal reasons for the decrease in 2005 were a decline
      in revenues and an increase in selling and administrative expenses.





**Liquidity
      and Capital Resources**





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





**December
                31, 2006**
            
            **December
                31, 2005**Cash
                and Cash Equivalents
            
            $
            13,597
            
            $
            20,059Working
                Capital
            
            
            13,632
            
            
            21,432




II-8




*Net
      Cash Provided By (Used In) Operating Activities*





Net
      cash
      used in operating activities was $3.5 million for the year ended
      December 31, 2006 compared to $1.1 million provided by operating activities
      for the year ended December 31, 2005, a decrease of approximately
      $4.6 million. The $4.6 million
      increase in net cash used in operating activities is principally due to a
      $5.7 million increase in our net loss, offset in part by a $1.1 million
      increase as a result of changes in operating assets and liabilities .





Accounts
      receivable totaled $6.5 million at December 31, 2006, representing
      approximately 56 days of sales outstanding, compared to $7.2 million, or 55
      days, at December 31, 2005.





A
      significant amount of the Company's revenues are derived from clients in the
      publishing industry. Accordingly, the Company's accounts receivable generally
      include significant amounts due from such clients. In addition, as of
      December 31, 2006, approximately 28% of the Company's accounts receivable
      was from foreign (principally European) clients and 21% of accounts receivable
      was due from one client. As of December 31, 2005, approximately 36% of the
      Company's accounts receivable was from foreign (principally European) clients
      and 37% of accounts receivable was due from one client.





*Net
      Cash Used in Investing Activities*





For
      the
      years ended December 31, 2006 and 2005, we spent cash approximating $2.3 million
      for capital expenditures. Furthermore, during the year ended
      December 31, 2006, we financed the purchase of software licenses
      totaling approximately $164,000. Capital spending in 2006 and 2005 related
      principally to normal ongoing equipment upgrades, project requirement specific
      equipment, and improvements in infrastructure. During the next twelve months,
      we
      anticipate that capital expenditures for ongoing technology, hardware, equipment
      and infrastructure upgrades will approximate $4.5 million.





*Net
      Cash Provided by Financing Activities*





Proceeds
      from the exercise of stock options provided cash approximating $356,000 and
      $1,297,000 in 2006 and 2005, respectively. In addition, payments of long-term
      obligations approximated $716,000 and $702,000 in 2006 and 2005,
      respectively.





During
      the year ended December 31, 2005, we entered into an agreement with a
      vendor to acquire certain additional software licenses and to receive support
      and subsequent software upgrades on this and other currently owned software
      licenses through February 2008 for a total cost of approximately
      $1.6 million. This total obligation and associated cost totaling
      approximately $1.6 million is a non-cash investing and financing activity.
      Of
      the $1.6 million, approximately $528,000 was paid in 2006 and $528,000 was
      paid
      in 2005. The remaining balance of $528,000 will be paid as a financing activity
      in the next 12 months.





In
      2006
      additional software licenses amounting to $164,000 were acquired under staggered
      payment terms. Under these terms the total amount will be paid in eight equal
      quarterly installments until December 31, 2007. Total payments made on these
      purchases in 2006 amounted to $82,000 with the remaining balance payable in
      full
      by 2007.


II-9





*Availability
      of Funds*





We
      have a
      $5.0 million line of credit pursuant to which we may borrow up to 80% of
      eligible accounts receivable at the bank’s alternate base rate plus 1⁄2% or LIBOR
      plus 3%. The line, which expires in May, 2007, is secured by our accounts
      receivable. At December 31, 2006, approximately $3.7 million was available
      to
      borrow under this line based on eligible accounts receivable. The Company has
      not borrowed against its credit line in 2006.





We
      believe that existing cash and internally generated funds will be sufficient
      for
      our reasonably anticipated working capital and capital expenditure requirements
      during the next 12 months. We fund our foreign expenditures from our U.S.
      corporate headquarters on an as-needed basis.





**Contractual
      Obligations**





The
      table
      below reflects our contractual cash obligations, expressed in thousands, at
      December 31, 2006.





**Payments
                Due by Period****Contractual
                Obligations**
            
            **Total**
            
            **Less
                than**
              **1
                year**
            
            **1-3
                years**
            
            **4-5
                years**
            
            **After**
              **5
                years**Capital
                lease obligations
            
            $
            23
            
            $
            23
            
            $
            -
            
            $
            -
            
            $
            -Non-cancelable
                operating leases
            
            
            3,262
            
            
            1,010
            
            
            2,240
            
            
            12
            
            
            -Long-term
                vendor obligations
            
            
            609
            
            
            609
            
            
            -
            
            
            -
            
            
            -Total
                contractual cash obligations
            
            $
            3,894
            
            $
            1,642
            
            $
            2,240
            
            $
            12
            
            $
            -





Future
      expected obligations under the Company’s pension benefit plan have not been
      included in the contractual cash obligations table above.





**Inflation,
      Seasonality and Prevailing Economic Conditions**





To
      date,
      inflation has not had a significant impact on our operations. We generally
      perform work for our clients under project-specific contracts,
      requirements-based contracts or long-term contracts. Contracts are typically
      subject to numerous termination provisions.





Our
      quarterly operating results are subject to certain seasonal fluctuations. Our
      fourth and first quarters include the months of December and January, when
      billable services activity by professional staff, as well as engagement
      decisions by clients, may be reduced due to client budget planning cycles.
      Demand for our services generally may be lower in the fourth quarter due to
      reduced activity during the holiday season and fewer working days for our
      Philippines-based staff during this period. These and other seasonal factors
      may
      contribute to fluctuations in our operating results from quarter to quarter.


II-10





**Critical
      Accounting Policies and Estimates**





*Basis
      of Presentation and Use of Estimates*





Management’s
      discussion and analysis of its results of operations and financial condition
      is
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires management to make
      estimates and judgments that affect the reported amounts of assets, liabilities,
      revenues and expenses, and related disclosure of contingent assets and
      liabilities. On an on-going basis, we evaluate our estimates, including those
      related to accounts receivable. Management bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities that are not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions.





*Allowance
      for Doubtful Accounts*





We
      establish credit terms for new clients based upon management’s review of their
      credit information and project terms, and perform ongoing credit evaluations
      of
      our customers, adjusting credit terms when management believes appropriate
      based
      upon payment history and an assessment of their current credit worthiness.
      We
      record an allowance for doubtful accounts for estimated losses resulting from
      the inability of our clients to make required payments. We determine this
      allowance by considering a number of factors, including the length of time
      trade
      accounts receivable are past due, our previous loss history, our estimate of
      the
      client’s current ability to pay its obligation to us, and the condition of the
      general economy and the industry as a whole. While credit losses have generally
      been within expectations and the provisions established, we cannot guarantee
      that credit loss rates in the future will be consistent with those experienced
      in the past. In addition, we have credit exposure if the financial condition
      of
      one of our major clients were to deteriorate. In the event that the financial
      condition of our clients were to deteriorate, resulting in an impairment of
      their ability to make payments, additional allowances may be necessary.





*Revenue
      Recognition*





We
      recognize revenue for content-related BPO services in the period in which we
      perform services and deliver in accordance with Staff Accounting Bulletin 104.





We
      recognize IT professional services revenues from custom application and systems
      integration development which requires significant production, modification
      or
      customization of software in a manner similar to SOP No. 81-1 *“Accounting
      for Performance of Construction-Type and Certain Production-Type Contracts.”* We
      recognize revenue for such services billed under fixed fee arrangements using
      the percentage-of-completion method under contract accounting as we perform
      services or reach output milestones. We measure the percentage completed either
      by the percentage of labor hours incurred to date in relation to estimated
      total
      labor hours or in consideration of achievement of certain output milestones,
      depending on the specific nature of each contract. For arrangements in which
      percentage-of completion accounting is used, we record cash receipts from
      customers and billed amounts due from customers in excess of recognized revenue
      as billings in excess of revenues earned on contracts in progress (which is
      included in accounts receivable). Revenues from fixed-fee projects accounted
      for
      less than 10% of our total revenue for each of the three years in the period
      ended December 31, 2006. We recognize revenue billed on a time and
      materials basis as we perform the services.





*Long-lived
      Assets*





We
      account for long-lived assets under Statement of Financial Accounting Standards
      (“SFAS”) 144, Accounting for the Impairment or Disposal of Long Lived Assets. We
      assess the recoverability of our long-lived assets, which consist primarily
      of
      fixed assets and intangible assets with finite useful lives, whenever events
      or
      changes in circumstance indicate that the carrying value may not be recoverable.
      The following factors, if present, may trigger an impairment  review: 
(i)  significant  underperformance  relative  to 
expected historical  or  projected  future  operating 
results; (ii) significant negative industry  or  economic 
trends; (iii) significant decline in our stock price  for  a 
sustained  period;  and  (iv)  a  change  in our
      market capitalization relative to net book value. If the recoverability of
      these
      assets is unlikely because  of  the  existence  of one or
      more of the above-mentioned factors,  we perform an  impairment
      analysis using a projected discounted cash flow  method.  We must make
      assumptions regarding estimated future cash flows and other factors to determine
      the fair value of these respective assets. If these estimates or related
      assumptions change in the future, we may be required to record an impairment
      charge. Impairment charges would be included in  general  and 
administrative  expenses  in  our statements  of
      operations,  and  would result in reduced carrying amounts of the
      related assets on  our balance  sheets. We did not recognize an
      impairment in any of our long lived assets in each
      of
      the three years in the period ended December 31, 2006 .




II-11





*Income
      Taxes*





We
      determine our deferred taxes based on the difference between the financial
      statement and tax bases of assets and liabilities, using enacted tax rates,
      as
      well as any net operating loss or tax credit carryforwards expected to reduce
      taxes payable in future years. We provide a valuation allowance when it is
      more
      likely than not that some or all of a deferred tax asset will not be realized.
      We have provided a valuation allowance for net operating loss carryforwards
      which may not be realized and for deferred tax assets in foreign jurisdictions
      which may not be realized because of our current tax holidays. Unremitted
      earnings of foreign subsidiaries have been included in the consolidated
      financial statements without giving effect to the United States taxes that
      may
      be payable on distribution to the United States to the extent such earnings
      are
      not anticipated to be remitted to the United States. In addition we have
      provided for an accrual for potential tax obligations resulting from income
      tax
      audits and other potential tax obligations.





*Goodwill
      and Other Intangible Assets*





SFAS
      142
      requires that we test goodwill for impairment using a two-step fair value based
      test. The first step of the goodwill impairment test, used to identify potential
      impairment, compares the fair value of a reporting unit with its carrying
      amount, including goodwill. If the carrying amount of the reporting unit exceeds
      its fair value, the second step of the goodwill impairment test must be
      performed to measure the amount of the impairment loss, if any. If impairment
      is
      determined, we will recognize additional charges to operating expenses in the
      period in which they are identified, which would result in a reduction of
      operating results and a reduction in the amount of goodwill. Our most recent
      test for impairment was conducted as of September 30, 2006, in which the
      estimated fair values of the reporting unit exceeded its carrying amount,
      including goodwill. As such, no impairment was identified or
      recorded.





*Accounting
      for Stock-Based Compensation*





Effective
      January 1, 2006, we adopted the provisions of Statement of Financial Accounting
      Standards No. 123(R) (“SFAS 123(R)”), “Share-Based Payments,” which requires the
      measurement and recognition of compensation expense for all share-based payment
      awards to employees and directors based on estimated fair values. SFAS 123(R)
      supersedes our previous accounting methodology using the intrinsic value method
      under Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for
      Stock Issued to Employees.” Under the intrinsic value method, no share-based
      compensation expense had been recognized at the time stock option awards were
      granted, because the awards had an exercise price equal to or greater than
      the
      market value of our stock on the date of the grant. However, at times,
      compensation expense had been recognized upon the modifications of stock option
      grants.





We
      adopted SFAS 123(R) using the modified prospective transition method. Under
      this
      transition method, compensation expense recognized during the year ended
      December 31, 2006 included compensation expense for all share-based awards
      granted prior to, but not yet vested, as of December 31, 2005, based on the
      grant date fair value estimated in accordance with the original provisions
      of
      SFAS 123. There were no share-based payment awards granted during the year
      ended
      December 31, 2006. In accordance with the modified prospective transition
      method, our Consolidated Financial Statements for prior periods have not been
      restated to reflect the impact of SFAS 123(R). We recognized compensation
      expense of approximately $241,000 in the year ended December 31, 2006. There
      was
      no material impact as a result of adopting SFAS 123(R) on basic and diluted
      loss
      per share for the year ended December 31, 2006.




II-12





*Legal
      Proceedings*





We
      are
      involved in numerous legal proceedings and claims. Our legal reserves related
      to
      these proceedings and claims are based on a determination of whether or not
      the
      loss is either probable or reasonably possible. We review outstanding claims
      and
      proceedings with external counsel to assess probability and estimates of loss.
      The reserves are adjusted if necessary. If circumstances change, we may be
      required to record adjustments that could be material to its reported financial
      condition and results of operation.





*Pension*





The
      critical assumptions we used in measuring pension benefit obligations and
      related effects on operations are discount rate and demographic factors such
      as
      retirement age, mortality, compensation increase and turnover. We evaluate
      these
      critical assumptions annually on a plan and country specific basis. While we
      believe that the assumptions used are appropriate, differences in actual
      experience or changes in assumptions may affect our pension and postretirement
      obligations and future expense. (See Notes to Financial Statements #6 for
      discussion on pension obligation and key assumption used).




*Development
      Costs of Software*





We
      expense as research and development costs for the development of new software
      to
      be sold, leased, or otherwise marketed as a separate product or as part of
      a
      product or process, and substantial enhancements to such existing software
      products, until technological feasibility has been established, at which time
      any additional development costs are capitalized until the product is available
      for general release to customers.  We expense all other research and
      development costs as incurred.





We
      did
      not capitalize any software development costs during any of the three years
      in
      the period ended December 31, 2006.  Included in the selling and
      administrative expense are research and development costs totaling approximately
      $922,000 and $770,000 for the years ended December 31, 2006 and 2005,
      respectively.





*Significant
      New Accounting Pronouncements Not Yet Adopted*





In
      July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48)
“Accounting for Uncertainty in Income Taxes” which prescribes a recognition
      threshold and measurement process for recording in the financial statements
      uncertain tax positions taken or expected to be taken in a tax return.
      Furthermore, FIN 48 provides guidance on the recognition, classification,
      accounting in interim periods and disclosure requirements for uncertain tax
      positions. This interpretation is effective as of January 1, 2007.
      While we are currently evaluating the impact of adopting FIN 48, we do not
      expect adoption to have a material impact on our consolidated financial
      position, statements of operations or statements of cash flows.





**Item
      7A. Quantitative and Qualitative Disclosures About Market
      Risk.**





We
      are
      exposed to interest rate change market risk with respect to our credit line
      with
      a financial institution which is priced based on the bank’s alternate base rate
      (8.25% at December 31, 2006) plus 1⁄2% or LIBOR (5.375% at December 31, 2006) plus
      3%. We have not borrowed under this line in 2006. To the extent we utilize
      all
      or a portion of this line of credit, changes in the interest rate will have
      a
      positive or negative effect on our interest expense.




II-13





We
      have
      operations in foreign countries. While we are exposed to foreign currency
      fluctuations, we presently have no financial instruments in foreign currency,
      except for cash necessary for operations. As of December 31, 2006 our foreign
      locations held cash totaling approximately $1.1 million.




II-14




**Item
      8. Financial Statements.**





**INNODATA
      ISOGEN, INC. AND SUBSIDIARIES**


**INDEX
      TO FINANCIAL STATEMENTS**





**PAGE**Report
                of Independent Registered Public Accounting Firm
            II-16Consolidated
                Balance Sheets as of December 31, 2006 and 2005
            II-17Consolidated
                Statements of Operations for the three years ended
            II-18December
                31, 2006Consolidated
                Statement of Stockholders’ Equity for the three years ended
            II-19December
                31, 2006Consolidated
                Statements of Cash Flows for the three years ended
            II-20December
                31, 2006Notes
                to Consolidated Financial Statements
            II-21


II-15


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





Board
      of
      Directors and Stockholders of


Innodata
      Isogen, Inc.





We
      have
      audited the accompanying consolidated balance sheets of Innodata Isogen, Inc
      and
      subsidiaries as of December 31, 2006 and 2005, and the related consolidated
      statements of operations, stockholders' equity, and cash flows for each of
      the
      three years in the period ended December 31, 2006. ** These
      financial statements are the responsibility of the Company's
      management. ** Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). ** Those
      standards require that we plan and perform the audit to obtain reasonable
      assurance about whether the financial statements are free of material
      misstatement. ** The
      Company is not required to have, nor were we engaged to perform an audit of
      its
      internal control over financial reporting. ** Our
      audit
      included consideration of internal control over financial reporting as a basis
      for designing audit procedures that are appropriate in the circumstances, but
      not for the purpose of expressing an opinion on the effectiveness of the
      Company’s internal control over financial reporting. ** Accordingly,
      we express no such opinion. ** An
      audit
      also includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the financial statements, assessing the accounting principles
      used and significant estimates made by management, as well as evaluating the
      overall financial statement presentation. ** We
      believe that our audits provide a reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Innodata Isogen, Inc. and
      subsidiaries as of December 31, 2006 and 2005, and the results of their
      operations and their cash flows for each of the three years in the period ended
      December 31, 2006 in conformity with accounting principles generally accepted
      in
      the United States of America.





As
      discussed in Note 1 to the financial statements the Company has adopted
      Financial Accounting Standards Board Statement No. 123(R), Share-Based Payments,
      in 2006. Also, as discussed in Note 6 to the financial statements the Company
      has adopted Financial Accounting Standards Board Statement No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans, in
      2006.





Our
      audit
      was conducted for the purpose of forming an opinion on the basic financial
      statements taken as a whole. The Schedule II - *Valuation and Qualifying Accounts* is
      presented for purposes of additional analysis and is not a required part of
      the
      basic financial statements. This schedule has been subjected to the auditing
      procedures applied in the audit of the basic financial statements and, in our
      opinion, is fairly stated in all material respects in relation to the basic
      financial statements taken as a whole.








/s/
      GRANT
      THORNTON LLP





Edison,
      New Jersey


March
      22,
      2007




II-16


**INNODATA
      ISOGEN, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


**DECEMBER
      31, 2006 AND 2005**


**(Dollars
      in Thousands)**





**2006**
            
            **2005****ASSETS****CURRENT
                ASSETS:**Cash
                and cash equivalents
            
            $
            13,597
            
            $
            20,059Accounts
                receivable-net of allowance for doubtful accounts of $70 and $111
                at
                December 31, 2006 and 2005 respectively
            
            
            6,484
            
            
            7,169Prepaid
                expenses and other current assets
            
            
            1,589
            
            
            1,543Refundable
                income taxes
            
            
            1,062
            
            
            1,215Deferred
                income taxes
            
            
            190
            
            
            338**Total
                current assets**
            
            
            22,922
            
            
            30,324**PROPERTY
                AND EQUIPMENT-NET**
            
            
            4,564
            
            
            4,823**OTHER
                ASSETS**
            
            
            1,912
            
            
            1,789**DEFERRED
                INCOME TAXES**
            
            
            256
            
            
            -**GOODWILL**
            
            
            675
            
            
            675**TOTAL**
            
            $
            30,329
            
            $
            37,611**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****CURRENT
                LIABILITIES**:Accounts
                payable
            
            $
            987
            
            $
            1,529Accrued
                expenses
            
            
            2,117
            
            
            1,770Accrued
                salaries, wages and related benefits
            
            
            4,259
            
            
            3,567Income
                and other taxes
            
            
            1,295
            
            
            1,363Current
                portion of long term obligations
            
            
            632
            
            
            663**Total
                current liabilities**
            
            
            9,290
            
            
            8,892**DEFERRED
                INCOME TAXES**
            
            
            1,126
            
            
            1,357**LONG
                TERM OBLIGATIONS**
            
            
            904
            
            
            548**COMMITMENTS
                AND CONTINGENT LIABILITIES****STOCKHOLDERS’
                EQUITY**:Serial
                preferred stock; 5,000,000 shares authorized, none
                outstanding
            
            
            -
            
            
            -Common
                stock, $.01 par value; 75,000,000 shares authorized; 24,087,000 issuedand
                23,905,000 outstanding at December 31, 2006; and 23,669,000 shares
                issuedand
                outstanding at December 31, 2005
            
            
            241
            
            
            237Additional
                paid-in capital
            
            
            17,225
            
            
            16,632Retained
                earnings
            
            
            2,622
            
            
            9,945Accumulated
                other comprehensive income
            
            
            (760
            )
            
            -19,328
            
            
            26,814Less:
                treasury stock - at cost: 182,000 shares at December 31,
                2006
            
            
            (319
            )
            
            -**Total
                stockholders’ equity**
            
            
            19,009
            
            
            26,814**TOTAL**
            
            $
            30,329
            
            $
            37,611





See
      notes
      to consolidated financial statements


II-17


**INNODATA
      ISOGEN, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**YEARS
      ENDED DECEMBER 31, 2006, 2005 AND 2004**


**(In
      thousands, except per share amounts)**





**2006**
            
            **2005**
            
            **2004****REVENUES**
            
            $
            40,953
            
            $
            42,052
            
            $
            53,949**OPERATING
                COSTS AND EXPENSES**Direct
                operating costs
            
            
            34,141
            
            
            30,920
            
            
            33,050Selling
                and administrative expenses
            
            
            14,284
            
            
            13,684
            
            
            10,205Restructuring
                costs
            
            
            604
            
            
            -
            
            
            -49,029
            
            
            44,604
            
            
            43,255**(LOSS)
                INCOME BEFORE OTHER (INCOME) AND EXPENSE**
            
            
            (8,076
            )
            
            (2,552
            )
            
            10,694**OTHER
                (INCOME) AND EXPENSES**Terminated
                offering costs
            
            
            -
            
            
            -
            
            
            625Bad
                debt recovery - net
            
            
            -
            
            
            -
            
            
            (963
            )Interest
                expense
            
            
            7
            
            
            18
            
            
            25Interest
                income
            
            
            (683
            )
            
            (457
            )
            
            (87
            )**(LOSS)
                INCOME BEFORE (BENEFIT FROM) PROVISION****FOR
                INCOME TAXES**
            
            
            (7,400
            )
            
            (2,113
            )
            
            11,094**(BENEFIT
                FROM) PROVISION FOR INCOME TAXES**
            
            
            (77
            )
            
            (462
            )
            
            3,237**NET
                (LOSS) INCOME**
            
            $
            (7,323
            )
            $
            (1,651
            )
            $
            7,857**(LOSS)
                INCOME PER SHARE:**Basic:
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .35Diluted:
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .32**WEIGHTED
                AVERAGE SHARES OUTSTANDING:**Basic:
            
            
            24,021
            
            
            23,009
            
            
            22,288Diluted:
            
            
            24,021
            
            
            23,009
            
            
            24,817




See
      notes
      to consolidated financial statements


II-18


**INNODATA
      ISOGEN, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENT OF STOCKHOLDERS’ EQUITY**


**YEARS
      ENDED DECEMBER 31, 2006, 2005 AND 2004**


**(In
      thousands)**


**Additional**
                
                
                
                **Accumulated****Common
                    Stock**
                
                **Paid-in**
                
                **Retained**
                
                **Comprehensive**
                
                **Treasury****Shares**
                
                **Amount**
                
                **Capital**
                
                **Earnings**
                
                **Income**
                
                **Stock**
                
                **Total****January
                    1, 2004**
                
                
                22,535
                
                $
                226
                
                $
                15,413
                
                $
                3,739
                
                
                -
                
                $
                (1,974
                )
                $
                17,404Netincome
                
                
                -
                
                
                -
                
                
                -
                
                
                7,857
                
                
                -
                
                
                -
                
                
                7,857Issuance
                    of common stock upon exercise of stock options
                
                
                728
                
                
                7
                
                
                1,075
                
                
                -
                
                
                -
                
                
                -
                
                
                1,082Retirement
                    of treasury stock
                
                
                (584
                )
                
                (6
                )
                
                (1,968
                )
                
                -
                
                
                -
                
                
                1,974
                
                
                -Income
                    tax benefit from exercise of stock options
                
                
                -
                
                
                -
                
                
                358
                
                
                -
                
                
                -
                
                
                -
                
                
                358Non-cash
                    equity compensation
                
                
                -
                
                
                -
                
                
                36
                
                
                -
                
                
                -
                
                
                -
                
                
                36**December
                    31, 2004**
                
                
                22,679
                
                
                227
                
                
                14,914
                
                
                11,596
                
                
                -
                
                
                -0-
                
                
                26,737Netloss
                
                
                -
                
                
                -
                
                
                -
                
                
                (1,651
                )
                
                -
                
                
                -
                
                
                (1,651
                )Issuance
                    of common stock upon exercise of stock options
                
                
                990
                
                
                10
                
                
                1,287
                
                
                -
                
                
                -
                
                
                -
                
                
                1,297Income
                    tax benefit from exercise of stock options
                
                
                -
                
                
                -
                
                
                334
                
                
                -
                
                
                -
                
                
                -
                
                
                334Non-cash
                    equity compensation
                
                
                -
                
                
                -
                
                
                97
                
                
                -
                
                
                -
                
                
                -
                
                
                97**December
                    31, 2005**
                
                
                23,669
                
                
                237
                
                
                16,632
                
                
                9,945
                
                
                -
                
                
                -0-
                
                
                26,814Netloss
                
                
                -
                
                
                -
                
                
                -
                
                
                (7,323
                )
                
                -
                
                
                -
                
                
                (7,323
                )Issuance
                    of common stock upon exercise of stock options
                
                
                418
                
                
                4
                
                
                352
                
                
                -
                
                
                -
                
                
                -
                
                
                356Purchase
                    of treasury stock
                
                
                (182
                )
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (319
                )
                
                (319
                )Non-cash
                    equity compensation
                
                
                -
                
                
                -
                
                
                241
                
                
                -
                
                
                -
                
                
                -
                
                
                241Adjustment
                      to initially apply FASB Statement 158,net of tax
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (760
                )
                
                -
                
                
                (760
                )**December
                    31, 2006**
                
                
                23,905
                
                $
                241
                
                $
                17,225
                
                $
                2,622
                
                $
                (760
                )
                $
                (319
                )
                $
                19,009





See
      notes
      to consolidated financial statements


II-19


**INNODATA
      ISOGEN INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**YEARS
      ENDED DECEMBER 31, 2006, 2005 AND 2004**


**(In
      thousands)**





**2006**
            
            **2005**
            
            **2004****OPERATING
                ACTIVITIES:**Net
                (loss) income
            
            $
            (7,323
            )
            $
            (1,651
            )
            $
            7,857Adjustments
                to reconcile net (loss) income to net cash(used
                in) provided by operating activities:Depreciation
                and amortization
            
            
            3,437
            
            
            3,160
            
            
            3,924Non-cash
                compensation
            
            
            241
            
            
            97
            
            
            36Deferred
                income taxes
            
            
            (222
            )
            
            215
            
            
            815Changes
                in operating assets and liabilities, net of acquisition:Accounts
                receivable
            
            
            685
            
            
            850
            
            
            478Prepaid
                expenses and other current assets
            
            
            (665
            )
            
            167
            
            
            (1,495
            )Refundable
                income taxes
            
            
            153
            
            
            (1,215
            )
            
            1,075Other
                assets
            
            
            (189
            )
            
            (355
            )
            
            (160
            )Accounts
                payable
            
            
            (542
            )
            
            80
            
            
            150Accrued
                expenses
            
            
            347
            
            
            (193
            )
            
            811Accrued
                salaries and wages
            
            
            692
            
            
            (412
            )
            
            1,114Income
                and other taxes
            
            
            (68
            )
            
            393
            
            
            1,064Net
                cash (used in) provided by operating activities
            
            
            (3,454
            )
            
            1,136
            
            
            15,669**INVESTING
                ACTIVITIES:**Capital
                expenditures
            
            
            (2,329
            )
            
            (2,335
            )
            
            (2,051
            )Decrease
                in restricted cash
            
            
            -
            
            
            -
            
            
            1,000Net
                cash used in investing activities
            
            
            (2,329
            )
            
            (2,335
            )
            
            (1,051
            )**FINANCING
                ACTIVITIES:**Payment
                of long-term obligations
            
            
            (716
            )
            
            (702
            )
            
            (88
            )Proceeds
                from exercise of stock options
            
            
            356
            
            
            1,297
            
            
            1,082Purchase
                of treasury stock
            
            
            (319
            )
            
            -
            
            
            -Net
                cash (used in) provided by financing activities
            
            
            (679
            )
            
            595
            
            
            994**(DECREASE)
                INCREASE IN CASH AND CASH EQUIVALENTS**
            
            
            (6,462
            )
            
            (604
            )
            
            15,612**CASH
                AND CASH EQUIVALENTS, BEGINNING OF YEAR**
            
            
            20,059
            
            
            20,663
            
            
            5,051**CASH
                AND CASH EQUIVALENTS, END OF YEAR**
            
            $
            13,597
            
            $
            20,059
            
            $
            20,663**SUPPLEMENTAL
                DISCLOSURES OF CASH FLOW INFORMATION**Cash
                paid during the year for:Income
                taxes
            
            $
            340
            
            $
            504
            
            $
            1,237Interest
                expense
            
            $
            7
            
            $
            18
            
            $
            25**NON-CASH
                INVESTING AND FINANCING ACTIVITIES:**Acquisition
                of equipment utilizing capital leases
            
            $
            -
            
            $
            -
            
            $
            66Vendor
                financed software licenses acquired
            
            $
            164
            
            $
            1,583
            
            $
            -




See
      notes
      to consolidated financial statements


II-20


**INNODATA
      ISOGEN, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**YEARS
      ENDED DECEMBER 31, 2006, 2005 AND 2004**





**1.**
            **DESCRIPTION
                OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
                POLICIES**





**Description
      of Business-** Innodata
      Isogen, Inc. and subsidiaries (the “Company”), is a leading provider of
      business services that help organizations create, manage, use and distribute
      information more effectively and economically. The Company provides
      content-related BPO services and content-related information technology (IT)
      professional services. The Company’s content-related BPO services focus on
      fabrication services and knowledge services. Fabrication services include
      digitization and data conversion services, content creation and XML services.
      Knowledge services include content enhancement, hyperlinking, indexing and
      general editorial services. The Company’s IT professional services focus on the
      design, implementation, integration and deployment of systems used to author,
      manage and distribute content.





**Principles
      of Consolidation** -The
      consolidated financial statements include the accounts of Innodata Isogen,
      Inc.
      and its subsidiaries, all of which are wholly owned. All significant
      intercompany transactions and balances have been eliminated in consolidation.





**Use
      of Estimates** -In
      preparing financial statements in conformity with accounting principles
      generally accepted in the United States of America, management is required
      to
      make estimates and assumptions that affect the reported amounts of assets and
      liabilities, and the disclosure of contingent assets and liabilities at the
      date
      of the financial statements, and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those estimates.
      Significant estimates include deferred taxes and related valuation allowances,
      allowances for bad debts and billing adjustments, cash flows used in impairment
      analysis of long-lived assets, litigation accruals, post retirement benefits,
      and tax audits.





**Revenue
      Recognition** -Revenue
      for content-related BPO services is recognized in the period in which services
      are performed and delivery has occurred and when all the criteria of Staff
      Accounting Bulletin 104 have been met.





The
      Company recognizes its IT professional services revenues from custom application
      and systems integration development which requires significant production,
      modification or customization of software in a manner similar to SOP
      No. 81-1 *“Accounting
      for Performance of Construction-Type and Certain Production-Type Contracts.”* Revenue
      from such services billed under fixed fee arrangements is recognized using
      the
      percentage-of-completion method under contract accounting as services are
      performed or output milestones are reached. The percentage completed is measured
      either by the percentage of labor hours incurred to date in relation to
      estimated total labor hours or in consideration of achievement of certain output
      milestones, depending on the specific nature of each contract. For arrangements
      in which percentage-of completion accounting is used, the Company records cash
      receipts from customers and billed amounts due from customers in excess of
      recognized revenue as billings in excess of revenues earned on contracts in
      progress (which is included in accounts receivable). Revenues from fixed-fee
      projects accounted for less than 10% of our total revenue for each of the three
      years in the period ended December 31, 2006. Revenue billed on a time and
      materials basis is recognized as services are performed.





**Foreign
      Currency** -The
      functional currency for the Company’s production operations located in the
      Philippines, India and Sri Lanka is U.S. dollars. As such, transactions
      denominated in Philippine pesos, Indian and Sri Lanka rupees were translated
      to
      U.S. dollars at rates which approximate those in effect on transaction dates.
      Monetary assets and liabilities denominated in foreign currencies at
      December 31, 2006 and 2005 were translated at the exchange rate in effect
      as of those dates. Exchange gains and losses resulting from such transactions
      were not material in 2006, 2005 and 2004.





**Cash
      Equivalents-** For
      financial statement purposes (including cash flows), the Company considers
      all
      highly liquid debt instruments purchased with an original maturity of three
      months or less to be cash equivalents.




II-21


**Property
      and Equipment-** Property
      and equipment is stated at cost and is depreciated on the straight-line method
      over the estimated useful lives of the related assets, which is generally two
      to
      five years. Leasehold improvements are amortized on a straight-line basis over
      the shorter of their estimated useful lives or the lives of the
      leases.





**Long-lived
      Assets** -The
      Company accounts for long lived assets under Statement of Financial Accounting
      Standards (“SFAS”) 144, Accounting for the Impairment or Disposal of Long Lived
      Assets. Management assesses the recoverability of its long-lived assets, which
      consist primarily of fixed assets and intangible assets with finite useful
      lives, whenever events or changes in circumstance indicate that the carrying
      value may not be recoverable. The following factors, if present, may trigger
      an
      impairment  review:  (i)  significant 
underperformance  relative  to  expected historical 
or  projected  future  operating  results; (ii) significant
      negative industry  or  economic  trends; (iii) significant
      decline in the Company’s stock price  for  a  sustained 
period;  and  (iv)  a  change  in the Company’s market
      capitalization relative to net book value. If the recoverability of these assets
      is unlikely because of the existence of one or more of the
      above-mentioned factors, an  impairment analysis is performed initially
      using a projected undiscounted cash flow  method.  Management must
      make assumptions regarding estimated future cash flows and other factors to
      determine the fair value of these respective assets. If these estimates or
      related assumptions change in the future, the Company may be required to record
      an impairment charge. Impairment charges, which would be based on discounted
      cash flows, would be included in  general  and 
administrative  expenses  in  the  Company’s 
statements  of operations,  and  would result in reduced carrying
      amounts of the related assets on  the  Company’s  balance 
sheets. No impairment was identified or recorded in each
      of
      the three years in the period ended December 31, 2006 .





**Goodwill
      and Other Intangible Assets-** Goodwill
      represents the excess purchase price paid over the fair value of net assets
      acquired. Effective July 1, 2002, the Company adopted SFAS No. 142, “Goodwill
      and Other Intangible Assets.” Under SFAS 142, the Company tests its goodwill on
      an annual basis using a two-step fair value based test. The first step of the
      goodwill impairment test, used to identify potential impairment, compares the
      fair value of a reporting unit, with its carrying amount, including goodwill.
      If
      the carrying amount of the reporting unit exceeds its fair value, the second
      step of the goodwill impairment test must be performed to measure the amount
      of
      the impairment loss, if any. If impairment is determined, the Company will
      recognize additional charges to operating expenses in the period in which they
      are identified, which would result in a reduction of operating results and
      a
      reduction in the amount of goodwill. In the annual impairment test conducted
      by
      the Company on September 30, 2006, 2005 and 2004 the estimated fair values
      of
      the reporting unit exceeded its carrying amount, including goodwill. As such,
      no
      impairment was identified or recorded.





**Income
      Taxes** -Deferred
      taxes are determined based on the difference between the financial statement
      and
      tax bases of assets and liabilities, using enacted tax rates, as well as any
      net
      operating loss or tax credit carryforwards expected to reduce taxes payable
      in
      future years. A valuation allowance is provided when it is considered more
      likely than not that all of some portion of the deferred tax assets will not
      be
      realized. Unremitted earnings of foreign subsidiaries for each of the three
      years in the period ended December 31, 2006, have been included in the
      consolidated financial statements without giving effect to the United States
      taxes that may be payable on distribution to the United States to the extent
      such earnings are not anticipated to be remitted to the United States.





**Accounting
      for Stock-Based Compensation** - Effective
      January 1, 2006, the Company adopted the provisions of Statement of Financial
      Accounting Standards No. 123(R) (“SFAS 123(R)”), “Share-Based Payments,” which
      requires the measurement and recognition of compensation expense for all
      share-based payment awards including employees and directors, to be based on
      estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting
      methodology using the intrinsic value method under Accounting Principles Board
      Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.” Under the
      intrinsic value method, no share-based compensation expense had been recognized
      for employees and directors at the time stock option awards were granted,
      because the awards had an exercise price equal to or greater than the market
      value of the Company’s stock on the date of the grant. However, at times,
      compensation expense had been recognized upon the modifications of stock option
      grants.




II-22





The
      Company adopted SFAS 123(R) using the modified prospective transition method.
      Under this transition method, compensation expense recognized during the year
      ended December 31, 2006 included compensation expense for all share-based awards
      granted prior to, but not yet vested, as of December 31, 2005, based on the
      grant date fair value estimated in accordance with the original provisions
      of
      SFAS 123. There were no share-based payment awards granted during the year
      ended
      December 31, 2006. In accordance with the modified prospective transition
      method, the Company’s Consolidated Financial Statements for prior periods have
      not been restated to reflect the impact of SFAS 123(R). The Company recognized
      compensation expense of approximately $241,000 in the year ended December 31,
      2006, of which $171,000 related to the adoption of SFAS 123(R). There was
      no material impact as a result of adopting SFAS 123(R) on basic and diluted
      loss
      per share for the year ended December 31, 2006.





Because
      of the Company’s net operating loss carryforwards, no tax benefits resulting
      from the exercise of stock options have been recorded, thus there was no effect
      on cash flows from operating or financing activities.





For
      the
      year ended December 31, 2006, share-based compensation expense related to the
      Company’s various stock option plans was allocated as follows (in
      thousands):





**Year
                ended****December
                31, 2006**Cost
                of sales
            
            $
            80Selling
                and administrative expenses
            
            
            101Restructuring
                costs
            
            
            60Total
                share based compensation
            
            $
            241





The
      following table illustrates the effect on net (loss) income and (loss) income
      per share if the Company had applied the fair value recognition provisions
      of
      SFAS No. 123 to stock-based employee compensation using the assumptions
      described in note 8, “Stock Options.”





**Year
                Ended December 31,****2005**
            
            **2004****(in
                thousands,****except
                per share amounts)**Net
                (loss) income, as reported
            
            $
            (1,651
            )
            $
            7,857Deduct:
                Total stock-based employee compensationdetermined
                under fair value based method, net of relatedtax
                effects
            
            
            (6,731
            )
            
            (3,200
            )Add:
                Compensation expense included in the determinationof
                net (loss) income as reported, net of related tax effects,
                relatedto
                the extension of stock options
            
            
            79
            
            
            -Pro
                forma net (loss) income
            
            $
            (8,303
            )
            $
            4,657(Loss)
                income per share:Basic-as
                reported
            
            $
            (.07
            )
            $
            .35Basic-pro
                forma
            
            $
            (.36
            )
            $
            .21Diluted-as
                reported
            
            $
            (.07
            )
            $
            .32Diluted-pro
                forma
            
            $
            (.36
            )
            $
            .19




II-23





**Fair
      Value of Financial Instruments** - The
      carrying amounts of financial instruments, including cash and cash equivalents,
      accounts receivable and accounts payable approximated fair value as of December
      31, 2006 and 2005 because of the relative short maturity of these instruments.
      The carrying amounts of long term obligations approximated their fair value
      as
      of December 31, 2006 and 2005 based upon rates currently available to the
      Company.





**Accounts
      Receivable** -The
      majority of the Company’s accounts receivable are due from secondary publishers
      and information providers. The Company establishes credit terms for new clients
      based upon management’s review of their credit information and project terms,
      and performs ongoing credit evaluations of its customers, adjusting credit
      terms
      when management believes appropriate based upon payment history and an
      assessment of their current credit worthiness. The Company records an allowance
      for doubtful accounts for estimated losses resulting from the inability of
      its
      clients to make required payments. The Company determines its allowance by
      considering a number of factors, including the length of time trade accounts
      receivable are past due (accounts outstanding longer than the payment terms
      are
      considered past due), the Company’s previous loss history, the client’s current
      ability to pay its obligation to the Company, and the condition of the general
      economy and the industry as a whole. While credit losses have generally been
      within expectations and the provisions established, the Company cannot guarantee
      that credit loss rates in the future will be consistent with those experienced
      in the past. In addition, there is credit exposure if the financial condition
      of
      one of the Company’s major clients were to deteriorate. In the event that the
      financial condition of the Company’s clients were to deteriorate, resulting in
      an impairment of their ability to make payments, additional allowances may
      be
      necessary.





**Concentration
      of Credit Risk** -The
      Company maintains its cash with high quality financial i nstitutions,
      located primarily in the United States. To the extent that such cash exceeds
      the
      maximum insurance levels, the Company is uninsured. The Company has not
      experienced any losses in such accounts.





**Income
      (Loss) Per Share** - Basic
      earnings (loss) per share is computed by dividing income (loss) available to
      common shareholders by the weighted-average number of common shares outstanding
      during the period. Diluted earnings (loss) per share is computed by dividing
      income (loss) available to common shareholders by the weighted-average number
      of
      common shares outstanding during the period increased to include the number
      of
      additional common shares that would have been outstanding if the dilutive
      potential common shares had been issued. The dilutive effect of the outstanding
      options is reflected in diluted earnings (loss) per share by application of
      the
      treasury stock method. Diluted net loss per share for 2006 and 2005 does not
      include potential common shares derived from stock options because as a result
      of the Company incurring losses, their effect would have been
      antidilutive.





**Development
      Costs for Software-** C osts
      for
      the development of new software to be sold, leased, or otherwise marketed as
      a
      separate product or as part of a product or process, and substantial
      enhancements to such existing software products, are expensed as research and
      development costs as incurred until technological feasibility has been
      established, at which time any additional development costs are capitalized
      until the product is available for general release to customers.  All other
      research and development costs are expensed as incurred.





No
      software development costs were capitalized during each of the three years
      in
      the period ended December 31, 2006.  Included in the selling and
      administrative expense are research and development costs totaling approximately
      $922,000 and $770,000 for the years ended December 31, 2006 and December 31,
      2005. The research and development costs for the year ended December 31, 2004
      were immaterial.


II-24





**New
      Accounting Pronouncements:**





In
      July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48)
“Accounting for Uncertainty in Income Taxes” which prescribes a recognition
      threshold and measurement process for recording in the financial statements
      uncertain tax positions taken or expected to be taken in a tax return.
      Furthermore, FIN 48 provides guidance on the recognition, classification,
      accounting in interim periods and disclosure requirements for uncertain tax
      positions. This interpretation is effective as of January 1, 2007.
      While the Company is currently evaluating the impact of adopting FIN 48.,
      we do not expect adoption to have a material impact on our consolidated
      financial position, statements of operations or statements of cash
      flows.





**2.**
            **PROPERTY
                AND EQUIPMENT**





Property
      and equipment, stated at cost less accumulated depreciation and amortization
      (in
      thousands), consist of the following:





******December
                31,****2006**
            
            **2005**Equipment
            
            $
            14,475
            
            $
            14,350Software
            
            
            3,150
            
            
            2,856Furniture
                and office equipment
            
            
            1,328
            
            
            1,070Leasehold
                improvements
            
            
            3,317
            
            
            2,573Total
            
            
            22,270
            
            
            20,849Less
                accumulated depreciation and amortization
            
            
            (17,706
            )
            
            (16,026
            )$
            4,564
            
            $
            4,823




Depreciation
      expense was approximately $2,750,000, $2,561,000 and $3,120,000 for each of
      the
      three years in the period ended December 31, 2006.





At
      December 31, 2006 and 2005, equipment under capital leases had a net book value
      of approximately $35,000 and $209,000, respectively.


II-25





**3.**
            **INCOME
                TAXES**





The
      significant components of the provision for (benefit from) income taxes for
      each
      of the three years in the period ended December 31, 2006 are as follows:





**2006**
            
            **2005**
            
            **2004**Current
                income tax expense (benefit):Foreign
            
            $
            191
            
            $
            144
            
            $
            174Federal
            
            
            (35
            )
            
            (821
            )
            
            1,943State
                and local
            
            
            (11
            )
            
            -
            
            
            305145
            
            
            (677
            )
            
            2,422Deferred
                income tax expense (benefit) provisionForeign
            
            $
            (222
            )
            $
            (52
            )
            $
            4Federal
            
            
            -
            
            
            139
            
            
            693State
                and local
            
            
            -
            
            
            128
            
            
            118$
            (222
            )
            $
            215
            
            $
            815(Benefit
                from) provision for income taxes
            
            $
            (77
            )
            $
            (462
            )
            $
            3,237





The
      reconciliation of the U.S. statutory rate with the Company’s effective tax rate
      for each of the three years ended December 31,  is summarized as
      follows:





**2006**
            
            **2005**
            
            **2004**Federal
                statutory rate
            
            
            (34.0
            )%
            
            (34.0
            )%
            
            35.0
            %Effect
                of:State
                income taxes (net of federal tax benefit)
            
            
            -
            
            
            3.9
            
            
            2.5Foreign
                source losses for which no tax benefit is available
            
            
            .9
            
            
            2.2
            
            
            1.5Foreign
                entities subject to US federal income taxes
            
            
            -
            
            
            -
            
            
            4.3Effect
                of foreign tax holiday
            
            
            (6.1
            )
            
            (25.9
            )
            
            (12.3
            )Taxes
                on foreign income at rates that differ from USStatutory
                rate
            
            
            (1.2
            )
            
            (5.7
            )
            
            (1.4
            )Change
                in valuation allowance on deferred tax assets
            
            
            43.4
            
            
            33.4
            
            
            -Other
            
            
            (4.0
            )
            
            4.2
            
            
            (0.4
            )Effective
                rate
            
            
            (1.0
            )%
            
            (21.9
            )%
            
            29.2
            %





During
      each of the two years ended December 31, 2005 and 2004, tax benefits related
      to
      stock option exercises were $334,000 and $358,000, respectively. Such benefits
      were recorded as a reduction of income taxes payable and an increase in
      additional paid-in capital. No such benefit was recorded in the year ended
      December 31, 2006.


II-26





Deferred
      tax assets and liabilities are classified as current or non-current according
      to
      the classification of the related asset or liability. Significant components
      of
      the Company’s deferred tax assets and liabilities as of December 31, are as
      follows (in thousands):





**2006**
            
            **2005**Deferred
                income tax assets:Allowances
                not currently deductible
            
            $
            145
            
            $
            285Depreciation
                and amortization
            
            
            239
            
            
            155Equity
                compensation not currently deductible
            
            
            559
            
            
            382Net
                operating loss carryforward
            
            
            4,396
            
            
            1,006Expenses
                not deductible until paid
            
            
            302
            
            
            261Total
                gross deferred income tax assets before valuation
                allowance
            
            
            5,641
            
            
            2,089Valuation
                allowance
            
            
            (4,340
            )
            
            (1,127
            )Net
                deferred income tax assets
            
            
            1,301
            
            
            962Deferred
                income tax liabilities:Foreign
                source income, not taxable until repatriated
            
            
            (1,981
            )
            
            (1,981
            )Net
                deferred liability
            
            $
            (680
            )
            $
            (1,019
            )Net
                deferred income tax asset-current
            
            
            190
            
            
            338Net
                deferred income tax asset-long term
            
            
            256
            
            
            -Net
                deferred income tax liability-non-current
            
            
            (1,126
            )
            
            (1,357
            )Net
                deferred income tax liability
            
            $
            (680
            )
            $
            (1,019
            )





In
      assessing the realization of deferred tax assets, management considers whether
      it is more likely than not that all or some portion of the deferred tax assets
      will not be realizable. The ultimate realization of the deferred tax assets
      is
      dependent upon the generation of future taxable income during the periods in
      which temporary differences are deductible and net operating losses are
      utilized. Based on a consideration of these factors, the Company has established
      a valuation allowance of approximately $4,340,000 and $1,127,000 at
      December 31, 2006 and 2005, respectively. In the three years ended December
      31, 2006, the Company increased its U.S. valuation allowances by $3,633,000,
      $1,022,000 and $105,000. The 2006 and 2005 increases resulted primarily from
      net
      operating losses incurred for which realization is uncertain. The 2006 increase
      was offset by a reversal of a valuation allowance of approximately $420,000
      which has been recorded for one of the Company’s Indian subsidiaries.





United
      States and foreign components of (loss) income before income taxes for each
      of
      the three years ended December 31, (in thousands) are as follows:





**2006**
            
            **2005**
            
            **2004**United
                States
            
            $
            (9,707
            )
            $
            (4,019
            )
            $
            6,731Foreign
            
            
            2,307
            
            
            1,906
            
            
            4,363Total
            
            $
            (7,400
            )
            $
            (2,113
            )
            $
            11,094




II-27





Certain
      of the Company’s foreign subsidiaries are subject to tax holidays for various
      periods ranging from 2006 to 2014, pursuant to which the income tax rate for
      these subsidiaries is substantially reduced. Unless renewed, as the tax holidays
      expire, the Company’s overall effective tax rate will be negatively impacted.
      The tax benefit for tax holidays was approximately $450,000, $500,000 and
      $800,000 for each of the three years in the period ended December 31, 2006.
      The income tax holiday of one of the Indian subsidiaries will expire on March
      2007.





The
      Company has U.S. Federal net operating loss carryforwards available of
      approximately $13 million which will expire between 2025 and 2026.





In
      August
      2004, the Internal Revenue Service (“IRS”) promulgated regulations, effective
      August 12, 2004, that treated certain of the Company’s subsidiaries that are
      incorporated in foreign jurisdictions and also domesticated as Delaware limited
      liability companies as U.S. corporations for U.S. federal income tax purposes.
      In the preamble to such regulations, the IRS expressed its view that dual
      registered companies described in the preceding sentence are also treated as
      U.S. corporations for U.S. federal income tax purposes for periods prior to
      August 12, 2004. On January 30, 2006, the IRS issued its final regulations,
      stating that neither the temporary regulations nor these final regulations
      are
      retroactive. The earliest date that any entity is subject to these regulations
      is August 12, 2004. For periods prior to the date these final regulations apply
      (i.e., prior to August 12, 2004), the classification of dually chartered
      entities is governed by the pre-existing regulations. The Company believes
      that
      its historic treatment of these subsidiaries as not having been required to
      pay
      taxes in the United States for the period prior to August 12, 2004 is correct,
      and would vigorously defend its treatment if challenged. As such, the Company
      has made no provision for U.S. taxes in its financial statements for these
      entities for the periods prior to August 12, 2004. In December 2004,
      the Company effected certain filings in Delaware to ensure that these
      subsidiaries will not be treated as U.S. corporations for U.S. federal income
      tax purposes as of the date of filing and as such, were not subject to U.S.
      federal income taxes commencing January 1, 2005.





In
      2006,
      additional guidance was released by the IRS which clarified that the regulations
      upon which the Company relied were not binding on pre-existing entities until
      May 2006. Based on this guidance, the Company believes it may be entitled to
      a
      refund for taxes paid and intends to pursue this claim. However, given the
      uncertainty regarding the procedures and the IRS’ position regarding grant of
      such refunds, it does not believe it is appropriate to record a benefit and
      an
      income tax receivable at this time.





Pursuant
      to an income tax audit by the Indian bureau of taxation, on March 27, 2006
      one
      of the Company’s Indian subsidiaries has received a tax assessment approximating
      $350,000, including interest, for the fiscal tax year ended March 31, 2003.
      Management disagrees with the basis of the tax assessment, and has filed an
      appeal against the assessment, which it will fight vigorously. The Indian bureau
      of taxation has also completed an audit of the Company’s Indian subsidiary’s
      income tax return for the
      fiscal tax year ended March 31, 2004. The ultimate outcome was favorable,
      and there was no tax assessment imposed for the fiscal tax year ended March
      31,
      2004. On March 20, 2007, we received notice of assessment from the Indian bureau
      of taxation for the fiscal year ending 2005. We will submit the required
      documentation allowing them to commence their audit.





In
      addition, the Company’s U.S. federal income tax return for 2004 is currently undergoing audit
      by the IRS and the State of New Jersey is auditing its income and sales tax
      returns for various periods through 2006. The IRS has also indicated that it
      will review the Company’s 2005 tax return.





Furthermore,
      the Company is subject to various other tax audits and claims which arise in
      the
      ordinary course of business.


II-28




As
      a
      result of the above matters, included in income and other taxes payable account
      for the years ended December 31, 2006 and 2005 is an accrual for
      potential tax obligations of approximately $619,000 and $554,000, respectively. While
      management currently believes that the ultimate outcome of all these proceedings
      will not have a material adverse effect on the Company’s financial position or
      overall trends in results of operations, litigation is subject to inherent
      uncertainties. Were an unfavorable ruling to occur, there exists the possibility
      of a material adverse impact on the operating results of the period in which
      the
      ruling occurs. In addition, the estimate of potential impact on the Company’s
      financial position or overall results of operations for the above legal
      proceedings could change in the future.





**4.**
            **LONG
                TERM OBLIGATIONS**





In
      2005,
      the Company entered into an agreement with a vendor to acquire certain
      additional software licenses and to receive support and subsequent software
      upgrades on this and other currently owned software licenses through February
      2008. Pursuant to the agreement, the Company has paid a total of $528,000 in
      2006 and $528,000 in 2005. The remaining balance is payable in four payments
      of
      approximately $132,000 per quarter in 2007 and is presented under “Current
      portion of long-term obligations” below. The total cost (in thousands) was
      allocated to the following asset accounts in 2005:





Other
                current assets
            
            $
            487Other
                assets (long-term)
            
            
            608Property
                and equipment
            
            
            488Total
            
            $
            1,583




In
      2006
      additional software licenses amounting to $164,000 were acquired through
      financing. Under these terms the total amount shall be paid in eight equal
      quarterly installments until December 31, 2007. Total payments made on these
      purchases in 2006 amounted to $82,000, with the remaining balance payable in
      full by 2007. This balance is included in the amount presented under “Current
      portion of long-term obligations” below.





Total
      long-term obligation as of December 31, 2006 and 2005 consist of the
      following:





**2006**
            
            **2005**Vendor
                obligationsMicrosoft
                license
            
            $
            609
            
            $
            1,056Capital
                lease obligations
            
            
            23
            
            
            155Deferred
                lease payments
            
            
            27
            
            
            -Pension
                obligationsAccrued
                pension liability (see Note 6)
            
            
            877
            
            
            -$
            1,536
            
            $
            1,211Less:
                Current portion of long-term obligations
            
            
            632
            
            
            663Total
            
            $
            904
            
            $
            548





**5.**
            **COMMITMENTS
                AND CONTINGENT LIABILITIES**





**Line
      of Credit** -The
      Company has a $5 million line of credit pursuant to which it may borrow up
      to 80% of eligible accounts receivable at the bank’s alternate base rate plus 1⁄2%
      or LIBOR plus 3%. The line, which expires in May 2007, is secured by the
      Company’s accounts receivable. At December 31, 2006, approximately $3.7 million
      was available to borrow under this line based on eligible accounts receivable.
      The Company did not borrow against its credit line in 2006.


II-29





**Leases** -The
      Company is obligated under various operating lease agreements for office and
      production space. Certain agreements contain escalation clauses and requirements
      that the Company pay taxes, insurance and maintenance costs. Company leases
      that
      include escalated lease payments are straight-lined over the non-cancelable
      base
      lease period in accordance with SFAS 13.





Lease
      agreements for production space in most overseas facilities, which expire
      through 2030, contain provisions pursuant to which the Company may cancel the
      leases with a minimal notice period, generally subject to forfeiture of security
      deposit. The annual rental for the cancelable leased space in 2006 is
      approximately $1,285,000. For each of the three years in the period ended
      December 31, 2006, rent expense, principally for office and production
      space, totaled approximately $2,163,000, $1,956,000 and $1,725,000,
      respectively.





In
      addition, the Company leases certain equipment under short-term capital and
      operating lease agreements. For each of the three years in the period ended
      December 31, 2006, rent expense for equipment totaled approximately
      $45,000, $71,000 and $47,000, respectively.





At
      December 31, 2006, future minimum annual rental commitments on
      non-cancelable leases (excluding operating leases with terms less than one
      year)
      (in thousands) are as follows:





**Operating
                leases**2007
            
            $
            9292008
            
            
            9682009
            
            
            8222010
            
            
            3482011
            
            
            18$
            3,085





In
      connection with the relocation of the Company’s Dallas office, the lessor agreed
      to pay approximately $246,000 as incentive to terminate the lease prior to
      its
      contractual expiration date. In connection with this transaction, the Company
      recognized income of approximately $246,000 in 2006.





**Litigation** -In
      connection with the cessation of all operations at certain foreign subsidiaries,
      certain former employees have filed various actions against certain of the
      Company’s Philippine subsidiaries, and have purported to also sue the Company
      and certain of its officers and directors, seeking to require reinstatement
      of
      employment and to recover back wages for an allegedly illegal facility closing
      on June 7, 2002 based on the terms of a collective bargaining agreement with
      this subsidiary. If complainants' claims had merit they could be entitled to
      back wages and benefits of up to approximately $5.3 million, based upon
      exchange rates as of December 31, 2006, and consistent with prevailing
      jurisprudence. Based on consultation with legal counsel, we believe that the
      complainants' claims are without merit and continue to defend against them
      vigorously.





In
      addition, the Company is subject to various legal proceedings and claims which
      arise in the ordinary course of business.





While
      management currently believes that the ultimate outcome of all these proceedings
      will not have a material adverse effect on the Company’s financial position or
      overall trends in results of operations, litigation is subject to inherent
      uncertainties. Were an unfavorable ruling to occur, there exists the possibility
      of a material adverse impact on the operating results of the period in which
      the
      ruling occurs. In addition, the estimate of potential impact on the Company’s
      financial position or overall results of operations for the above legal
      proceedings could change in the future.


II-30





**Foreign
      Currency** -The
      Company’s production facilities are located in the Philippines, India and Sri
      Lanka. To the extent that the currencies of these countries fluctuate, the
      Company is subject to risks of changing costs of production after pricing is
      established for certain customer projects. However, most significant contracts
      contain provisions for price renegotiation.





**Employment
      Agreements**





In
      2006, the
      Company entered into a three year employment agreement with its Chief Executive
      Officer (“CEO”). The agreement, which has an effective date of February 1, 2006,
      provides for: annual base compensation of $369,000 subject to cost of living
      adjustments and annual discretionary increases as determined by the Company's
      Board of Directors; additional cash incentive or bonus compensation for each
      calendar year determined by the compensation committee of the Board of Directors
      in its discretion and conditioned on the attainment of certain quantitative
      objectives to be established by the compensation committee with a target bonus
      of not less than 50% of base salary for the year; and equity-based incentive
      compensation in such amounts as shall be determined by the compensation
      committee, which, if granted, shall have an exercise price equal to the fair
      market value of the shares at the time of the grant. The agreement also provides
      for insurance and other fringe benefits, and contains confidentiality and
      non-compete and non-interference provisions. In the event the CEO is terminated
      without cause (as defined) or, if upon expiration of the term of the agreement
      the Company does not offer to enter into a successor agreement on substantially
      similar terms, the CEO is entitled to receive payments in an amount equal to
      the
      greater of (i) his then base salary for 24 months or (ii) the number of months
      remaining in the term of the agreement; the continuation of his health, life,
      disability and non-qualified retirement plan benefits for the greater of (i)
      24
      months or (ii) the number of months remaining in the term of the agreement;
      twice the CEO’s then bonus target; and the removal of any vesting, transfer,
      lock up, performance or other restrictions or requirements on his stock options
      or other equity-based compensation. In the event the CEO resigns after the
      6-month anniversary of a change of control (as defined), the CEO is entitled
      to
      receive severance payments in an amount equal to the greater of (i) his then
      base salary for 36 months or (ii) the number of months remaining in the term
      of
      the agreement; the continuation of his health, life, disability and
      non-qualified retirement plan benefits for the greater of (i) 36 months or
      (ii)
      the number of months remaining in the term of the agreement; three times his
      then bonus target; and the removal of any vesting, transfer, lock up,
      performance or other restrictions or requirements on his stock options or other
      equity-based compensation. The agreement also  provides
      for potential tax gross-up payments in respect of income taxes and penalties
      that may be imposed on the CEO under Section 409A of the Internal Revenue Code,
      and in respect of excise taxes and penalties that may be imposed on the CEO
      under Section 4999 of the Internal Revenue Code.





In
      December 2005, the Company entered into a three year employment agreement with
      its Chief Financial Officer. The agreement provides for annual base compensation
      of $300,000, plus additional short term incentive compensation conditioned
      on
      the attainment of certain quantity and quality objectives to be established
      by
      the Compensation Committee of the Board of Directors. The agreement also
      provides for insurance and other fringe benefits, and contains confidentiality
      and non-compete and non-interference provisions. In addition, the Company
      granted 250,000 fully vested options to purchase 250,000 shares of the Company's
      common stock ("Option Shares") at an exercise price of $3.28 per share. The
      options expire on the earlier of (i) December 21, 2015, (ii) 60 days after
      employment ceases or (iii) 12 months following the termination of employment
      as
      a result of his death or disability. Furthermore, no Option Shares may be sold
      during the first year after the date of grant; no more than 25% of the Option
      Shares may be sold during the second year after the date of grant; no more
      than
      50% of the Option Shares may be sold during the second and third years after
      the
      date of grant, and no more than 75% of the Option Shares may be sold during
      the
      second, third and fourth years after the date of grant. No restrictions on
      sales
      apply after the fourth anniversary of the date of grant.


II-31





An
      executive vice president of the Company was provided a separation agreement
      in
      connection with the termination of his employment with the Company effective
      as
      of May 26, 2006. Pursuant to the separation agreement, the Company will continue
      to pay his base salary for a period of twelve months, as provided for in his
      employment agreement. Included in selling and administrative expenses for the
      year ended December 31, 2006 is accrued severance costs of approximately
      $275,000.





**Indemnifications** -The
      Company is obligated under certain circumstances to indemnify directors and
      certain officers against costs and liabilities incurred in actions or threatened
      actions brought against such individual because such individuals acted in the
      capacity of director and/or officer of the Company. In addition, the Company
      has
      contracts with certain clients pursuant to which the Company has agreed to
      indemnify the client for certain specified and limited claims. These
      indemnification obligations are in the ordinary course of business and, in
      many
      cases, do not include a limit on potential maximum future payments. As of
      December 31, 2006, the Company has not recorded a liability for any
      obligations arising as a result of these indemnifications.





**Liens** -In
      connection with the procurement of tax incentives at two of the Company’s
      foreign subsidiaries, the foreign zoning authority was granted a first lien
      on
      the subsidiary’s property and equipment. As of December 31, 2006, the
      net book value of the property and equipment were $508,000.





**6.**
            **PENSION
                BENEFITS******





**U.S.
      Defined Contribution Pension Plan -** The
      Company has a defined contribution plan qualified under Section 401(k) of
      the Internal Revenue Code, pursuant to which substantially all of
      its U.S. employees are eligible to participate after completing six months
      of
      service. Participants may elect to contribute a portion of their compensation
      to
      the plan. Under the plan, the Company has the discretion to match a portion
      of
      participants’  contributions.
      The Company intends to match approximately $66,000 to the plan for the year
      ended December 31, 2006.  For the years ended December 31, 2005 and 2004,
      the Company’s matching contributions were approximately $71,000 and $75,000
      respectively.




**Non-U.S.
      Pension benefits-** In
      September 2006, the FASB issued Statement No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans, an
      amendment of FASB Statements No. 87, 88, 106 and 132(R) (“FAS 158”). FAS
      158 requires an employer to recognize a net liability or asset and an offsetting
      adjustment to accumulated other comprehensive income to report the funded status
      of defined benefit pension and other postretirement benefit plans effective
      for
      the Company’s year ended December 31, 2006.




FAS
      158
      did not change the manner in which plan liabilities or periodic expense is
      measured. Changes in the funded status of the plans resulting from unrecognized
      prior service costs and credits and unrecognized actuarial gains and losses
      are
      recorded as a component of other comprehensive income within shareholders’
equity.





The
      objective of FAS 158 is to require that the funded status of defined benefit
      pension and other postretirement benefit plans (measured as the difference
      between the fair value of plan assets, if any and the benefit obligation) be
      recognized on the balance sheet as a net asset or net liability.





As
      required, the Company has adopted this statement and applied it prospectively
      beginning with the Company’s fiscal year-end December 31, 2006. While the
      adoption had no effect on the consolidated statements of operations,
      unrecognized actuarial amounts were reflected in the consolidated balance sheet
      as of December 31, 2006. The result of this was the recognition of
      additional pension liabilities of $877,000 representing the increase in
      actuarial liabilities for retirement benefits not previously recorded in the
      books of the Philippines subsidiaries. It was not necessary to recognize any
      additional pension liabilities for the Indian and Sri Lankan subsidiaries since
      all pension liabilities are recorded in full and are accounted for in accordance
      with FAS 112 Accounting for post-employment benefits.




II-32






The
      following table illustrates the incremental effect of applying FAS 158 on
      individual line items in the consolidated balance sheet as of December 31,
      2006 (in thousands).




**Beforeapplication
                ofStatement 158**
            
            **Adjustments**
            
            **After
                application of Statement 158**Deferred
                income tax receivable
            
            $
            139
            
            $
            117
            
            $
            256Liability
                for pension benefits
            
            
            703
            
            
            877
            
            
            1,580Total
                liabilities
            
            
            10,443
            
            
            877
            
            
            11,320Accumulated
                other comprehensive loss
            
            
            -
            
            
            (760
            )
            
            (760
            )Total
                stockholders' equity
            
            $
            19,769
            
            $
            (760
            )
            $
            19,009





All
      the
      non-U.S. subsidiaries provide for government mandated, defined pension benefits.
      For certain of these subsidiaries, vested eligible employees are provided a
      lump
      sum payment upon retiring from the Company at a defined age. The lump sum amount
      is based on the salary and tenure as of retirement date. Other non-U.S
      subsidiaries provide for a lump sum payment to vested employees on retirement,
      death, incapacitation or termination of employment, based upon the salary and
      tenure as of the date employment ceases. The liability for such defined benefit
      obligations is determined and provided on the basis of actuarial valuations
      as
      of December 31, 2006. Pension expenses for foreign subsidiaries totaled
      approximately $313,000, $251,000 and $228,000 for each
      of
      the three years in the period ended December 31, 2006 .





Included
      in accrued salaries, wages and related benefits as of December 31, 2006 and
      2005
      are accrued pension liabilities related to the above unfunded plans totaling
      approximately $703,000 and $493,000.





The
      following table sets out the status of the non-U.S pension benefits and the
      amounts (in thousands) recognized in the Company’s consolidated financial
      statements.




**Benefit
      Obligations:**


**Change
                  in the benefit obligation**
              
              **2006**
              
              **2005**
              
              **2004**Projected
                  benefit obligation at beginning of the year
              
              $
              493
              
              $
              327
              
              $
              154Service
                  cost
              
              
              176
              
              
              129
              
              
              83Interest
                  cost
              
              
              68
              
              
              34
              
              
              20Increase
                  (decrease) in liability
              
              
              -
              
              
              -
              
              
              50Foreign
                  currency exchange rate changes
              
              
              26
              
              
              -
              
              
              -Actuarial
                  loss (gain)
              
              
              903
              
              
              54
              
              
              44Benefits
                  paid
              
              
              (86
              )
              
              (51
              )
              
              (24
              )Projected
                  benefit obligation at end of year****
              
              $
              1,580
              
              $
              493
              
              $
              327





II-33





**Components
        of Net Periodic Pension Cost:**
 **2006**
              
              **2005**
              
              **2004**Service
                  cost
              
              $
              176
              
              $
              129
              
              $
              83Interest
                  cost
              
              
              68
              
              
              34
              
              
              20Amortization
                  for increase (decrease) in liability
              
              
              -
              
              
              -
              
              
              50Actuarial
                  loss (gain) recognized
              
              
              45
              
              
              54
              
              
              44Net
                  periodic pension cost
              
              $
              289
              
              $
              217
              
              $
              197
 
 **Unrecognized
        Actuarial Loss (Gain):**
 
 Experience
        gains and losses and effects of changes in actuarial assumptions are carried
        forward and amortized over a period no longer than the average future service
        of
        employees.
 
 The
        following table sets out the unrecognized actuarial gain (loss) (in thousands),
        as of December 31, 2006.
  Net
                  cumulative unrecognized actuarial gain (loss) - January 1,
                  2006
              
              **$**
              (170
              )Actuarial
                  (loss) for the year
              
              
              (748
              )Recognized
                  actuarial loss for the year
              
              
              45Net
                  cumulative unrecognized (loss) - December 31, 2006
              
              $
              (873
              )
 
 Actuarial
        assumptions for all non-U.S. plans are described below. The discount rates
        are
        used to measure the year end benefit obligations and the earnings effects
        for
        the subsequent year.


**2006**
            
            **2005**
            
            **2004**Discount
                rate
            
            
            6.5%-10
            %
            
            7.5%-14
            %
            
            7.5%-12
            %Rate
                of increase in compensation levels
            
            
            7%-10
            %
            
            7%-10
            %
            
            7%-10
            %




**Estimated
      Future Benefit Payments:**





The
      following benefit payments (in thousands), which reflect expected future
      service, as appropriate, are expected to be paid:





2007
            
            
            442008
            
            
            492009
            
            
            522010
            
            
            572011
            
            
            622012
                to 2016
            
            
            365




II-34




**7.**
            **RESTRUCTURING
                COST**





As
      part
      of an overall cost reduction plan to reduce operating costs, in September 2006
      the Company announced a worldwide workforce reduction of slightly under 300
      employees, the majority of whom were based in Asia. Most employees were
      terminated prior to September 30, and the plan was substantially implemented
      by
      the end of 2006.





As
      a
      result, management estimates that total charges to earnings associated with
      the
      restructuring plan is expected to approximate $615,000 of which $531,000 and
      $84,000 represent severance costs and costs to implement, respectively. As
      of
      December 31, 2006, approximately $604,000, which includes $60,000 non-cash
      consideration via a stock option modification, has been charged to earnings,
      of
      which $102,000 has been accrued and included under the caption “Accrued
      Expenses” on the accompanying Balance Sheet as of the period then
      ending.





In
      connection with the restructuring, the Company paid cash of $442,000 and
      recognized cost amounting to $60,000 for stock option modification and expects
      to pay the balance of $113,000 during the first two quarters of 2007.





Restructuring
      costs by segment (in thousands) are as follows:





Total
                expected costs
            
            Costs
                incurred as of December 31, 2006Outsourcedcontent-related
                BPOServices
            
            $
            165
            
            $
            154IT
                Professional Services
            
            
            21
            
            
            21Selling
                and Corporate Administrative
            
            
            429
            
            
            429Total
                Consolidated
            
            $
            615
            
            $
            604





Relative
      to the restructuring, the Company modified the expiration date of an option
      held
      by a departing officer to purchase 100,000 shares of the Company’s common stock
      at an exercise price of $2.59. The option, which was scheduled to expire at
      a
      rate of 20,000 shares per year commencing on May 31, 2009, was modified wherein
      20,000 shares continue to expire on May 31, 2009, 20,000 shares continue to
      expire on May 31, 2010 and the remaining 60,000 shares will also expire on
      May 31, 2010. The modification also provided that the option will survive the
      termination of the officer’s employment with the Company. The Company
      recognized, as part of the restructuring cost, $60,000 related to the stock
      option modification.





**CAPITAL
      STOCK**





T he Company is
      authorized to issue 75,000,000 shares of common stock and 5,000,000 shares
      of
      preferred stock. Each share of common stock has one vote. The
      Board
      of Directors is authorized to fix the terms, rights, preferences and limitations
      of the preferred stock and to issue the preferred stock in series which differ
      as to their relative terms, rights, preferences and limitations.





**Stockholder
      Rights Plan** -On
      December 16, 2002, the Board of Directors adopted a Stockholder Rights Plan
      (“Rights Plan”) in which one right (“Right”) was declared as a dividend for each
      share of the Company’s common stock outstanding. The purpose of the plan is to
      deter a hostile takeover of the Company. Each Right entitles its holders to
      purchase, under certain conditions, one one-thousandth of a share of newly
      authorized Series C Participating Preferred Stock (“Preferred Stock”), with
      one one-thousandth of a share of Preferred Stock intended to be the economic
      and
      voting equivalent of one share of the Company’s common stock. Rights will be
      exercisable only if a person or group acquires beneficial ownership of 15%
      (25%
      in the case of specified executive officers of the Company) or more of the
      Company’s common stock or commences a tender or exchange offer, upon the
      consummation of which such person or group would beneficially own such
      percentage of the common stock. Upon such an event, the Rights enable dilution
      of the acquiring person’s or group’s interest by providing that other holders of
      the Company’s common stock may purchase, at an exercise price of $4.00, the
      Company’s common stock having a market value of $8.00 based on the then market
      price of the Company’s common stock, or at the discretion of the Board of
      Directors, Preferred Stock, having double the value of such exercise price.
      The
      Company will be entitled to redeem the Rights at $.001 per Right under certain
      circumstances set forth in the Rights Plan. The Rights themselves have no voting
      power and will expire on December 26, 2012, unless earlier exercised,
      redeemed or exchanged.




II-35




**Common
      Stock Reserved** -As
      of
      December 31, 2006, the Company had reserved for issuance approximately
      6,980,000 shares of common stock pursuant to the Company’s stock option plans
      (including an aggregate of 1,015,164 options issued to the Company’s Chairman
      which were not granted pursuant to stockholder approved stock option plans).





**Treasury
      Stock**





In
      August, 2006, the Board of Directors authorized the repurchase of up to $1.0
      million of its common stock of which approximately $681,000 remains available
      for repurchase under the program as of December 31, 2006. During the year ended
      December 31, 2006, the Company repurchased 182,262 shares of its common stock
      at
      a cost of $319,000.





In
      2004,
      the Company retired 584,000 shares of its treasury stock.





**8.**
            **STOCK
                OPTIONS**





The
      Company adopted, with stockholder approval, 1998, 2001, and 2002 Stock Option
      Plans (the “1998 Plan,” “2001 Plan,” and “2002 Plan”) which provide for the
      granting of options to purchase not more than an aggregate of 3,600,000,
      900,000, and 950,000 shares of common stock, respectively, subject to adjustment
      under certain circumstances. Such options may be incentive stock options
      (“ISOs”) within the meaning of the Internal Revenue Code of 1986, as amended, or
      options that do not qualify as ISOs (“Non-Qualified Options”).





The
      option exercise price per share may not be less than the fair market value
      per
      share of common stock on the date of grant (110% of such fair market value
      for
      an ISO, if the grantee owns stock possessing more than 10% of the combined
      voting power of all classes of the Company’s stock). Options may be granted
      under the Stock Option Plan to all officers, directors, and employees of the
      Company and, in addition, Non-Qualified Options may be granted to other parties
      who perform services for the Company. No options may be granted under the 1998
      Plan after July 8, 2008; under the 2001 Plan after May 31, 2011; and
      under the 2002 Plan after June 30, 2012.





The
      Plans
      may be amended from time to time by the Board of Directors of the Company.
      However, the Board of Directors may not, without stockholder approval, amend
      the
      Plans to increase the number of shares of common stock which may be issued
      under
      the Plans (except upon changes in capitalization as specified in the Plans),
      decrease the minimum exercise price provided in the Plans or change the class
      of
      persons eligible to participate in the Plans.





The
      fair
      value of options at date of grant was estimated using the Black-Scholes pricing
      model with the following weighted average assumptions: eight years for options
      granted in 2005 and four to four and one-half years for options granted in
      2004;
      risk free interest rate of 4.39% in 2005 and 3.19% in 2004; expected volatility
      of 150% in 2005 and 114% in 2004, and a zero dividend rate in each of the two
      years ended December 31, 2005 and 2004. The weighted average grant date fair
      value of options granted in 2005, and 2004 was $3.28 and $2.89,
      respectively.




II-36





The
      following table presents information related to stock options for 2006, 2005
      and
      2004.


**Number**
                **Outstanding**
              
              **Weighted
                  Average Exercise****Price**
              
              **Number**
                **Exercisable**
              
              **Weighted
                  Average Exercise****Price**Balance
                  1/1/04
              
              
              7,589,380
              
              $
              2.34
              
              
              5,780,204
              
              $
              1.83Forfeit
              
              
              (32,774
              )
              $
              1.89Expired
              
              
              (16,400
              )
              $
              0.86Granted
              
              
              214,000
              
              $
              3.74Exercised
              
              
              (728,274
              )
              $
              1.48Balance
                  12/31/04
              
              
              7,025,932
              
              $
              2.36
              
              
              5,985,748
              
              $
              2.14Forfeit
              
              
              (214,000
              )
              $
              3.91Expired
              
              
              (35,267
              )
              $
              3.67Granted
              
              
              784,000
              
              $
              3.37Exercised
              
              
              (990,395
              )
              $
              1.74Balance
                  12/31/05
              
              
              6,570,270
              
              $
              2.72
              
              
              6,372,254
              
              $
              2.68Forfeit
              
              
              (494,700
              )
              $
              3.53Expired
              
              
              (1,108,200
              )
              $
              5.45Granted
              
              
              -
              
              
              -Exercised
              
              
              (418,420
              )
              $
              1.03Balance
                  12/31/06
              
              
              4,548,950
              
              $
              2.14
              
              
              4,478,167
              
              $
              2.12




**December
                31, 2006****Options
                Outstanding**
            
            **Options
                Exercisable****Per
                Share**
              **Range
                of**
              **Exercise
                Prices**
            
            **Number**
              **Outstanding**
            
            **Weighted**
              **Average**
              **Remaining**
              **Contractual**
              **Life**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Aggregate
                Intrinsic**
              **Value
                as of**
              **December
                31, 2006**
            
            **Number**
              **Exercisable**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Aggregate
                Intrinsic Value as of**
              **December
                31, 2006**$0.25
                - 0.42
            
            
            130,668
            
            
            1
            
            $
            0.26
            
            $
            64,084
            
            
            130,668
            
            $
            0.26
            
            $
            64,084$0.50
                - 0.67
            
            
            1,203,996
            
            
            4
            
            $
            0.57
            
            
            1,084,950
            
            
            1,203,996
            
            $
            0.57
            
            
            1,084,950$1.29
            
            
            399,996
            
            
            1
            
            $
            1.29
            
            
            448,916
            
            
            399,996
            
            $
            1.29
            
            
            448,916$2.00
            
            
            103,444
            
            
            8
            
            $
            2.00
            
            
            33,102
            
            
            103,444
            
            $
            2.00
            
            
            33,102$2.59
            
            
            1,214,346
            
            
            5
            
            $
            2.59
            
            
            -0-
            
            
            1,214,346
            
            $
            2.59
            
            
            -0-$3.00
                - 4.00
            
            
            1,496,500
            
            
            8
            
            $
            3.44
            
            
            -0-
            
            
            1,425,717
            
            $
            3.43
            
            
            -0-4,548,950
            
            
            
            
            
            
            
            $
            1,631,052
            
            
            4,478,167
            
            
            
            
            $
            1,631,052




II-37




The
      number and weighted-average grant-date fair value of non-vested stock options
      is
      as follows:





**Shares**
            
            **Weighted
                Average**
              **Grant-Date
                Fair Value**Non-vested
                January 1, 2006
            
            
            198,016
            
            $
            3.12Granted
                2006
            
            
            -
            
            
            -Forfeited
                2006
            
            
            (65,541
            )
            $
            3.57Vested
                2006
            
            
            (61,692
            )
            $
            2.86Non-vested
                December 31, 2006
            
            
            70,783
            
            $
            2.92





The
      total
      compensation cost related to non-vested stock options not yet recognized as
      of
      December 31, 2006 totaled approximately $173,000. The weighted-average
      period over which these costs will be recognized is two years.





The
      total
      intrinsic value of options exercised for each of the three years in the period
      ended December 31, 2006 was $1,131,000, $1,728,000 and $1,994,000,
      respectively. The total fair value of stock options vested during the year
      ended
      December 31, 2006 was $176,000.





Options
      granted prior to 2003 vest over a four year period and have a five year life.
      In
      2004, substantially all options granted vest over a four year period and have
      a
      ten year life. In
      2005,
      the Company granted to officers and directors, fully vested options to purchase
      760,000 shares of the Company's common stock ("Option Shares") at an exercise
      price of ranging between $3.00 and $3.46 per share. The options expire on the
      earlier of (i) ten years after date of grant, (ii) 60 days after employment
      ceases and (iii) 12 months following the termination of employment as a result
      of his or her death or disability. Furthermore, no Option Shares may be sold
      during the first year after the date of grant; no more than 25% of the Option
      Shares may be sold during the second year after the date of grant; no more
      than
      50% of the Option Shares may be sold during the second and third years after
      the
      date of grant, and no more than 75% of the Option Shares may be sold during
      the
      second, third and fourth years after the date of grant. No restrictions on
      sales
      apply after the fourth anniversary of the date of grant.





In
      May 2005, the Company and certain of its officers and directors agreed to
      change the initial exercise price and initial expiration date of vested options
      to purchase 1,390,346 shares of the Company’s common stock held by such officers
      to a new price of $2.59, and to new expiration dates as follows:





**Quantity**
            
            **Initial
                Price**
            
            **Initial
                Expiration Date**
            
            **New
                Price**
            
            **New
                Expiration Date**540,346
            
            $
            1.56
            
            
            May
                31, 2005
            
            $
            2.59
            
            
            108,000
                per year commencing May 31, 2009, remainder on May 31,
                2013810,000
            
            $
            2.25
            
            
            770,000
                on October, 8, 2005 and 40,000 on October 18, 2005
            
            $
            2.59
            
            
            162,000
                per year commencing September 30, 2009 until September 30, 2012,
                8,000 on
                September 30, 2013 and 154,000 on March 31, 201440,000
            
            $
            2.50
            
            
            October
                3, 2005
            
            $
            2.59
            
            
            October
                3, 2010




II-38




In
      connection with the extension, the option holders agreed not to sell, pledge
      or
      otherwise dispose of any of the shares of common stock received upon exercise
      of
      their respective option(s) referred to above until the earliest to occur of
      (i)
      May 16, 2007; (ii) the first day on which the closing market price for the
      Company’s stock is at least $5.00 per share for ten consecutive trading days; or
      (iii) the termination of employment or directorship (as applicable) with the
      Company either (A) by the Company, for reasons other than “for cause”; or (B) by
      the option holder, upon mutual agreement between the option holder and the
      Company.





In
      addition, the Chief Executive Officer further agreed to pay to the Company
      any
      pre-tax net profit earned from the sale of the shares of common stock received
      upon exercise of his options set forth above if he directly or indirectly
      competes with the Company or solicits Company customers or clients during the
      period from May 16, 2005 until the first anniversary of the termination of
      his
      employment for any reason.





No
      equity
      compensation expense was recognized because the exercise price of the modified
      options was equal to the price of the underlying common stock on the date the
      grants were modified. In addition, pursuant to Emerging Issues Task Force
      (“EITF”) 00-23, Issues Related to the Accounting for Stock Compensation under
      APB Opinion No. 25 and FASB Interpretation No. 44, the Company has determined
      that the modified grants continue to qualify for fixed accounting
      treatment.





In
      December 2005, the Company accelerated the vesting of options to purchase
      790,000 shares of Common Stock that were previously granted to the Chief
      Executive Officer and certain officers and directors. Pursuant to the
      modification agreement, the officers and directors agreed to not sell, pledge
      or
      otherwise dispose of more than a certain number of shares issued or issuable
      upon exercise of these options during the period of time that such option shares
      would otherwise have not vested. As a result of the accelerated vesting,
      approximately $1.3 million of future non-compensation charges will not be
      required effective January 1, 2006 because of the Company’s adoption of SFAS 123
      (R).





**9.**
            **ACCUMULATED
                COMPREHENSIVE INCOME**




The
      Company’s accumulated comprehensive income consists of accumulated comprehensive
      income from pension liability and deferred tax benefit on the pension
      liability.





**10.**
            **SEGMENT
                REPORTING AND
                CONCENTRATIONS**





The
      Company’s operations are classified into two reporting segments: (1)
      content-related BPO services and (2) IT professional services. The
      content-related BPO services segment focuses on fabrication services and
      knowledge services. Fabrication services include digitization and data
      conversion services, content creation and XML services. Knowledge services
      include content enhancement, hyperlinking, indexing and general editorial
      services. The IT professional services segment focuses on the design,
      implementation, integration and deployment of systems used to author, manage
      and
      distribute content. The Company’s content-related BPO services revenues are
      generated principally from its production facilities located in the Philippines,
      India and Sri Lanka. The Company does not depend on revenues from sources
      internal to the countries in which the Company operates; nevertheless, the
      Company is subject to certain adverse economic and political risks relating
      to
      overseas economies in general, such as inflation, currency fluctuations and
      regulatory burdens.




II-39





**2006**
            
            **2005**
            
            **2004****(in
                thousands)**Revenues:Content-related
                BPO services
            
            $
            36,277
            
            $
            36,655
            
            $
            43,701IT
                Professional services
            
            
            4,676
            
            
            5,397
            
            
            10,248Total
                consolidated
            
            $
            40,953
            
            $
            42,052
            
            $
            53,949Depreciation
                and amortization:Content-related
                BPO services
            
            $
            2,897
            
            $
            2,728
            
            $
            3,547IT
                Professional services
            
            
            127
            
            
            101
            
            
            92Selling
                and corporate administration
            
            
            413
            
            
            331
            
            
            285Total
                consolidated
            
            $
            3,437
            
            $
            3,160
            
            $
            3,924(Loss)
                income before income taxes:Content-related
                BPO services
            
            $
            4,105
            
            $
            9,204
            
            $
            16,116IT
                Professional services
            
            
            635
            
            
            1,052
            
            
            4,671Selling
                and corporate administration
            
            
            (12,140
            )
            
            (12,369
            )
            
            (9,693
            )Total
                consolidated
            
            $
            (7,400
            )
            $
            (2,113
            )
            $
            11,094




******December
                31,****2006**
            
            **2005****(in
                thousands)**Total
                assetsContent-related
                BPO services
            
            $
            13,057
            
            $
            15,436IT
                Professional services
            
            
            2,043
            
            
            3,140Corporate
                (includes corporate cash)
            
            
            15,229
            
            
            19,035Total
                consolidated
            
            $
            30,329
            
            $
            37,611





Long-lived
      assets as of December 31, 2006 and 2005, respectively by geographic region
      are
      comprised of:





**2006**
            
            **2005****(in
                thousands)**United
                States
            
            $
            1,928
            
            $
            2,022Foreign
                countries:Philippines
            
            
            2,250
            
            
            2,573India
            
            
            626
            
            
            848Sri
                Lanka
            
            
            456
            
            
            144Total
                foreign
            
            
            3,332
            
            
            3,565$
            5,260
            
            $
            5,587





Three
      clients accounted for 28%, 12% and 10% of the Company's revenues in the
      year ended December 31, 2006. Two clients accounted for 27% and 12% of
      the Company’s revenue in the year ended December 31, 2005 and 31% and 24% in the
      year ended December 31, 2004. No other client accounted for 10% or more of
      revenues during these periods. Further, in the years ended December 31,
      2006, 2005 and 2004, revenues to non-US clients accounted for 37%, 35%, and
      30%,
      respectively, of the Company's revenues.




II-40




Revenues
      for each of the three years in the period ended December 31, by geographic
      region (determined based upon customer’s domicile), are as follows:





**2006**
            
            **2005**
            
            **2004****(in
                thousands)**United
                States
            
            $
            25,951
            
            $
            27,243
            
            $
            37,842The
                Netherlands
            
            
            10,200
            
            
            10,819
            
            
            12,648Other
                - principally Europe
            
            
            4,802
            
            
            3,990
            
            
            3,459$
            40,953
            
            $
            42,052
            
            $
            53,949





A
      significant amount of the Company's revenues are derived from clients in the
      publishing industry. Accordingly, the Company's accounts receivable generally
      include significant amounts due from such clients. In addition, as of
      December 31, 2006, approximately 28% of the Company's accounts receivable
      was from foreign (principally European) clients and 21% of accounts receivable
      was due from one client. As of December 31, 2005, approximately 36% of the
      Company's accounts receivable was from foreign (principally European) clients
      and 37% of accounts receivable was due from one client.





**11.**
            **(LOSS)
                INCOME PER SHARE**




**2006**
            
            **2005**
            
            **2004****(in
                thousands, except per share amounts)**Net
                (loss) income
            
            $
            (7,323
            )
            $
            (1,651
            )
            $
            7,857Weighted
                average common shares outstanding
            
            
            24,021
            
            
            23,009
            
            
            22,288Dilutive
                effect of outstanding options
            
            
            -
            
            
            -
            
            
            2,529Adjusted
                for dilutive computation
            
            
            24,021
            
            
            23,009
            
            
            24,817Basic
                (loss) income per share
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .35Diluted
                (loss) income per share
            
            $
            (.30
            )
            $
            (.07
            )
            $
            .32





Basic
      income (loss) per share is computed by dividing income (loss) available to
      common shareholders by the weighted-average number of common shares outstanding
      during the period. Diluted income (loss) per share is computed by dividing
      income (loss) available to common shareholders by the weighted-average number
      of
      common shares outstanding during the period increased to include the number
      of
      additional common shares that would have been outstanding if the dilutive
      potential common shares had been issued. The dilutive effect of the outstanding
      options is reflected in diluted income (loss) per share by application of the
      treasury stock method. Options to purchase 2.8 million shares of common stock
      in
      2006 and 3.1 million shares of common stock in 2005 were outstanding but not
      included in the computation of diluted income per share because the options’
exercise price was greater than the average market price of the common shares
      and therefore, the effect would have been antidilutive. In addition, diluted
      net
      loss per share does not include 796,000 and 1,733,000 potential common shares
      derived from stock options for the years ended December 31, 2006 and 2005,
      respectively, because
      as a result of the Company incurring losses, their effect would have been
      antidilutive .




II-41





**12.**
            **QUARTERLY
                RESULTS OF OPERATIONS
                (UNAUDITED)**




**First**
              **Quarter**
            
            **Second**
              **Quarter**
            
            **Third**
              **Quarter**
            
            **Fourth**
              **Quarter****(in
                thousands, except per share amounts)****2006**Revenues
            
            $
            10,285
            
            $
            9,721
            
            $
            10,400
            
            $
            10,547Net
                loss
            
            $
            (1,346
            )
            
            ($2,952
            )
            
            ($2,196
            )
            
            ($829
            )Net
                loss per share
            
            
            ($.06
            )
            
            ($.12
            )
            
            ($.09
            )
            
            ($.03
            )Diluted
                net loss per share
            
            
            ($.06
            )
            
            ($.12
            )
            
            ($.09
            )
            
            ($.03
            )**2005**Revenues
            
            $
            11,190
            
            $
            10,110
            
            $
            9,647
            
            $
            11,105Net
                income (loss)
            
            $
            299
            
            
            ($517
            )
            
            ($875
            )
            
            ($558
            )Net
                income (loss) per share
            
            $
            .01
            
            
            ($.02
            )
            
            ($.04
            )
            
            ($.02
            )Diluted
                net income (loss) per share
            
            $
            .01
            
            
            ($.02
            )
            
            ($.04
            )
            
            ($.02
            )





**13.**
            **OTHER**





In
      January 2004, the Company reached a settlement agreement and received $1,000,000
      cash from a former client as full satisfaction of a $2.6 million dollar
      remaining outstanding balance that the Company had fully written off as a bad
      debt in 2001. The $1,000,000 receipt, net of $37,000 in recovery costs, is
      reflected as bad debt recovery income in the statement of operations for the
      year ended December 31, 2004.





In
      January 2005, the Company filed a registration statement on Form S-3 to register
      4,250,000 shares of its common stock, plus 3,250,000 shares of common stock
      held
      by certain directors and officers of the Company. On March 23, 2005, the Company
      terminated the offering and, as such, in the fourth quarter 2004, expensed
      approximately $625,000 of offering costs.




II-42




**Item
      9. Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure.**





None





**Item
      9A. Controls and Procedures.**





An
      evaluation has been carried out under the supervision and with the participation
      of our management, including our Chief Executive Officer and Chief Financial
      Officer, of the effectiveness of the design and the operation of our "disclosure
      controls and procedures" (as such term is defined in Rules 13a-15(e) under
      the
      Securities Exchange Act of 1934) as of December 31, 2006 (“Evaluation Date”).
      Based on such evaluation, our Chief Executive Officer and Chief Financial
      Officer have concluded that, as of the Evaluation Date, the disclosure controls
      and procedures are reasonably designed and effective to ensure that (i)
      information required to be disclosed by us in the reports we file 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 and forms, and
      (ii) such information is accumulated and communicated to our management,
      including our Chief Executive Officer and Chief Financial Officer, as
      appropriate to allow timely decisions regarding required
      disclosure.





There
      were no changes in our internal controls over financial reporting in connection
      with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under
      the Exchange Act that occurred during our last fiscal quarter that materially
      affected or are reasonably likely to materially affect the internal controls
      over financial reporting.




II-43


**PART
      III**





**Item
      10. Directors, Executive Officers and Corporate
      Governance.**





The
      information called for by Item 10 is incorporated by reference from the
      Company’s definitive proxy statement for the 2007 Annual Meeting of Stockholders
      to be filed pursuant to Regulation 14A under the Exchange Act no later than
      120
      days after the end of the Company’s 2006 fiscal year.





The
      Company has a code of ethics that applies to all of its employees, officers,
      and
      directors, including its principal executive officer, principal financial and
      accounting officer, and controller. The text of the Company’s code of ethics is
      posted on its website at www.innodata-isogen.com. The Company intends to
      disclose future amendments to, or waivers from, certain provisions of the code
      of ethics for executive officers and directors in accordance with applicable
      NASDAQ and SEC requirements.





**Item
      11. Executive Compensation.**





The
      information called for by Item 11 is incorporated by reference from the
      Company’s definitive proxy statement for the 2007 Annual Meeting of Stockholders
      to be filed pursuant to Regulation 14A under the Exchange Act no later than
      120
      days after the end of the Company’s 2006 fiscal year.





**Item
      12. Security Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.**





The
      information called for by Item 12 is incorporated by reference from the
      Company’s definitive proxy statement for the 2007 Annual Meeting of Stockholders
      to be filed pursuant to Regulation 14A under the Exchange Act no later than
      120
      days after the end of the Company’s 2006 fiscal year.





**Item
      13. Certain Relationships and Related Transactions, and Director
      Independence.**





The
      information called for by Item 13 is incorporated by reference from the
      Company’s definitive proxy statement for the 2007 Annual Meeting of Stockholders
      to be filed pursuant to Regulation 14A under the Exchange Act no later than
      120
      days after the end of the Company’s 2006 fiscal year.





**Item
      14. Principal Accountant Fees and Services.**





The
      information called for by Item 14 is incorporated by reference from the
      Company’s definitive proxy statement for the 2007 Annual Meeting of Stockholders
      to be filed pursuant to Regulation 14A under the Exchange Act no later than
      120
      days after the end of the Company’s 2006 fiscal year.





III-1


**PART
      IV**





**Item
      15. Exhibits, Financial Statement Schedules and Reports on Form
      8-K.**





(a) 1.
      Financial Statements. See Item 8. Index to Financial Statements.


2.
      Financial Statement Schedules. Schedule II - Valuation and Qualifying
      Accounts


3. **Exhibits**





Exhibits
      which are indicated as being included in previous filings are incorporated
      herein by reference.





**Exhibit**
            
            **Description**
            
            **Filed
                as Exhibit**3.1
                (a)
            
            Restated
                Certificate of Incorporation filed on
            
            Filed
                as Exhibit 3.1(a) to our Form 10-K for the year endedApril
                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 endedIncorporation
                of Innodata Corporation filed on
            
            December
                31, 2003March
                1, 20013.1
                (c)
            
            Certificate
                of Amendment of Certificate of
            
            Filed
                as Exhibit 3.1(c) to our Form 10-K for the year endedIncorporation
                of Innodata Corporation
            
            December
                31, 2003Filed
                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 datedSeries
                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 December
                16, 2002 between Innodata Corporation and
                American Stock Transfer & Trust Co., as Rights
                Agent
            
            Exhibit
                4.1 to Form 8-K dated December 16, 200210.1
            
            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, 2002Between
                us and our directors and one of ourofficers10.4
            
            1994
                Disinterested Directors Stock Option Plan
            
            Exhibit
                B to Definitive Proxy dated August 9, 199410.5
            
            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 endedJanuary 1, 2004
                with George Kondrach
            
            December
                31, 200310.11
            
            Letter
                Agreement dated as of August 9, 2004, by and
                between us and The Bank of New York
            
            Filed
                as Exhibit 10.2 to Form S-3 Registration statementNo.
                333-12184410.12
            
            Employment
                Agreement dated as of December 22, 2005, by
                and between us and Steven L. Ford
            
            Exhibit
                10.1 to Form 8-K dated December 28,
                2005




IV-1




**Exhibit**
            
            **Description**
            
            **Filed
                as Exhibit**10.13
            
            Form
                of 2001 Stock Option Plan Grant Letter,Dated
                December 22, 2005
            
            Filed
                as Exhibit 10.2 to Form 8-K dated December 28, 200510.14
            
            Form
                of 1995 Stock Option Agreement
            
            Exhibit
                10.4 to Form 8-K dated December 15, 200510.15
            
            Form
                of 1998 Stock Option Agreement for
            
            Exhibit
                10.5 to Form 8-K dated December 15, 2005Directors10.16
            
            Form
                of 1998 Stock Option Agreement for Officers
            
            Exhibit
                10.6 to Form 8-K dated December 15, 200510.17
            
            Form
                of 2001 Stock Option Agreement
            
            Exhibit
                10.7 to Form 8-K dated December 15, 200510.18
            
            Form
                of new vesting and lock-up agreement for  each
                of Haig Bagerdjian, Louise Forlenza, John
                Marozsan and Todd Solomon
            
            Exhibit
                10.8 to Form 8-K dated December 15, 200510.19
            
            Form
                of new vesting and lock-up agreement
            
            Exhibit
                10.9 to Form 8-K dated December 15, 2005for
                Jack Abuhoff10.20
            
            Form
                of new vesting and lock-up agreement for
                George Kondrach
            
            Exhibit
                10.10 to Form 8-K dated December 15, 200510.21
            
            Form
                of new vesting and lock-up agreement
            
            Exhibit
                10.11 to Form 8-K dated December 15, 2005for
                Stephen Agress10.22
            
            Form
                of 2001 Stock Option Plan Grant Letter, dated
                December 31, 2005, for Messrs. Abuhoff, Agress
                and Kondrach
            
            Exhibit
                10.2 to Form 8-K dated January 5, 200610.23
            
            Form
                of 2001 Stock Option Plan Grant Letter, dated
                December 31, 2005, for Messrs. Bagerdjian and
                Marozsan and Ms. Forlenza
            
            Exhibit
                10.3 to Form 8-K dated January 5, 200610.24
            
            Transition
                Agreement Dated as of September 29, 2006 2006
                with Stephen Agress
            
            Exhibit
                10.1 to Form 8-K dated October 3, 200610.25
            
            Form
                of Stock Option Modification Agreement with With
                Stephen Agress
            
            Exhibit
                10.2 to Form 8-K dated October 3, 200610.26
            
            Employment
                Agreement Dated as of February 1, 2006
                with Jack Abuhoff
            
            Exhibit
                10.2 to Form 8-K dated April 27, 200621
            
            Significant
                subsidiaries of the registrant
            
            Filed
                herewith23
            
            Consent
                of Grant Thornton LLP
            
            Filed
                herewith31.1
            
            Certificate
                of Chief Executive Officer
            
            Filed
                herewithpursuant
                to Section 302 of theSarbanes-Oxley
                Act of 200231.2
            
            Certificate
                of Chief Financial Officer
            
            Filed
                herewithpursuant
                to Section 302 of theSarbanes-Oxley
                Act of 2002.32.1
            
            Certification
                Pursuant to 18 U.S.C. Section  1350,
                as adopted pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002.
            
            Filed
                herewith32.2
            
            Certification
                Pursuant to 18 U.S.C. Section 1350,
                as adopted pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002.
            
            Filed
                herewith





IV-2




**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.


INNODATA
                ISOGEN, INC.By
            /s/ 
Jack
              AbuhoffJack
              AbuhoffChairman of the Board of Directors,Chief Executive Officer and
              President




In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.





Signature
            
            Title
            
            Date/s/
                Jack Abuhoff
                Jack
                  Abuhoff
            
            Chairman
                of the Board of Directors,
                Chief
                  Executive Officer and President
            
            March
                30, 2007/s/
                Steven L. Ford
                Steven
                  L. Ford
            
            Executive
                Vice President,
                Chief
                  Financial Officer
                  and
                    Principal Accounting Officer
            
            March
                30, 2007/s/
                Haig S. Bagerdjian
                Haig
                  S. Bagerdjian
            
            Director
            
            March
                30, 2007/s/
                Louise C. Forlenza
                Louise
                  C. Forlenza
            
            Director
            
            March
                30, 2007/s/
                John R. Marozsan
                John
                  R. Marozsan
            
            Director
            
            March
                30, 2007/s/
                Peter H. Woodward
                Peter
                  H. Woodward
            
            Director
            
            March
                30, 2007









**INNODATA
        ISOGEN, INC.**
 **SCHEDULE
        II**
 **VALUATION
        AND QUALIFYING ACCOUNTS**
 **(Dollars
        in Thousands)**
 
 Activity
        in the Company's allowance for doubtful accounts for the years ended December
        31, 2006, 2005 and 2004 was as follows:
  **Additions****Balance
                  at**
              
              **Charged
                  to**
              
              **Charged
                  to**
              
              
              
              **Balance
                  at****Period**
              
              **Beginning
                  of Period**
              
              **Costs
                  and Expenses**
              
              **Other
                  Accounts**
              
              **Deductions**
              
              **End
                  of Period**2006
              
              $
              111
              
              $
              (9
              )
              $
              -
              
              $
              (32
              )
              $
              702005
              
              $
              135
              
              $
              9
              
              $
              -
              
              $
              (33
              )
              $
              1112004
              
              $
              1,219
              
              $
              25
              
              $
              -
              
              
              (1,109
              )
              $
              135