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Information Services Group, Inc. (III)

Q3 2012 Earnings Call· Fri, Nov 9, 2012

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Transcript

Operator

Operator

Good day and welcome to the Information Systems (sic) [Services] Group Third Quarter Results Conference Call. Today’s conference is being recorded and a replay will be available on ISG’s website within 24 hours. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Barry Holt. Please go ahead.

Barry Holt

Management

Thank you, operator. Hello and good morning. My name is Barry Holt. I am a Senior Communications Executive at ISG. I’d like to welcome everyone to ISG’s 2012 Third Quarter Results Conference Call. I am joined today by Michael Connors, Chairman and Chief Executive Officer; and David Berger, Executive Vice President and Chief Financial Officer. Before we begin, I would like to read a forward-looking statement. It is important to note that this communication may contain forward-looking statements, which represent the current expectations and beliefs of the management of ISG concerning future events and their potential effects. These statements however are not guarantees of future results and are subject to certain risks and uncertainties that could cause actual result to differ materially from those anticipated. For a more detailed listing of the risks and other factors that could affect future results, please refer to the forward-looking statement contained in our Form 8-K that was furnished yesterday to the SEC and the risk factors sections in ISG’s Form 10-K covering full year 2011 results. You should also read ISG’s Annual Report on Form 10-K for the fiscal year ending December 31, 2011 and any other relevant documents including any amendments or supplements to these documents filed with the SEC when they become available. You will be able to obtain free copies of any ISG’s SEC filings on either ISG’s website at www. isg-one.com or the SEC’s website at www.sec.gov. ISG undertakes no obligation to update or revise any forward-looking statement to reflect subsequent events or circumstances. Non-GAAP measures are provided as additional information and should not be consider in isolation or as a substitute for financial results prepared in accordance with GAAP. For the reconciliation of all non-GAAP measures presented to the most closely applicable GAAP measure, please refer to our current report on Form 8-K, which was submitted yesterday. And now I would like to turn the call over to Michael Connors, who will be followed by David Burger. Mike?

Michael Connors

Management

Thank you, Barry and good morning everyone. Today David and I will review the third quarter business highlights and financial results. Our report on the success we have had in growing our recurring revenue streams concluded with some comments on our guidance for revenue and adjusted EBITDA for the full year 2012 and talk briefly about 2013. Our third quarter revenues were nearly $47 million bringing our September year-to-date revenues to over $143 million, up 5%. Our third quarter adjusted EBITDA was $5.3 million and in the quarter we continued to return free cash flow to our stakeholders, deleveraging the balance sheet by repaying another $1.75 million of debt. During the quarter, we continued to invest in pursuing recurring revenue streams and are seeing significant success in Managed Services with revenues up 82% and new multiyear contract signings in quarter of $10 million. This is on the heels of our previous best quarter of $8 million in sales last quarter. The Americas continued to grow in double digits for the sixth consecutive quarter, offset by the increasingly challenging financial environment in Europe. Even though our full year results will be lowered by Europe, we are positioning the firm for strength in 2013 in that market. We have invested this year in the pursuit of U.K. public sector work, which, if successful, would have significant upside for us next year. We are riding out the European storm and believe our broad geographic reach and the diversity of our service offerings ensure that our strategy will continue to be embraced by the marketplace. As I indicated on our last call, the challenging macroeconomic climate in Europe, and recently in Australia, might negatively affect our results as clients defer decision making and postpone engagements. While this turned out to be the case as…

David Berger

Management

Thanks, Mike and good morning everyone. Before I discuss our financial results, I would like to reiterate that ISG has presented GAAP financial results, as well as certain non-GAAP financial information, in our earnings release. During this call, I will discuss certain non-GAAP financial measures, which ISG believes improves the comparability of the company’s financial results between periods and provides for greater transparency of key measures used to evaluate the company’s performance. The non-GAAP measures which I will touch on today include adjusted EBITDA, adjusted net earnings and the presentation of selected financial data on a constant currency basis. A complete reconciliation of non-GAAP financial measures is included in our earnings release, which was furnished to the SEC on Form 8-K. Non-GAAP measures are provided as additional information and should not be considered in isolation or as a substitute for financial results prepared in accordance with GAAP. ISG reported third quarter revenues of $46.5 million, down 2% versus the prior year in constant currency and down 5% on a reported basis. The strengthening dollar negatively impacted revenues by $1.3 million in the quarter compared to the prior year. Revenues increased by 12% in the Americas to $26.8 million, our sixth straight quarter of double-digit growth, offset by a 15% decline in Europe to $14.2 million and a 17% decline in Asia Pacific to $5.4 million; growth rates are in constant currency. ISG reported operating income of $2.4 million for the third quarter of 2012. This compares to operating income of $1.8 million in the third quarter of 2011. Reported diluted earnings per share was $0.01 per share and compares to a loss of $0.07 per share in the prior year. Adjusted net income was $1.8 million, or $0.05 per share on a diluted basis, compared with an adjusted net loss…

Michael Connors

Management

Great. Thanks, David. We are pleased with our September year-to-date performance with revenues up 5%. A challenging macroeconomic climate in Europe and most recently in Australia have negatively affected our results during this quarter as clients deferred some decision making and postponed some engagements. However, our geographic diversity has helped partially offset the slowdown we experienced abroad as our Americas operations recorded double-digit growth rates. We continue to focus our efforts for ensuring our thought leadership by hiring and retaining the most insightful advisers and analysts and reinvesting in client driven solutions like Managed Services, which has grown 82% in the quarter and as mentioned earlier signing $10 million of multi-year contracts. The market downturn in some ways is a catalysts for clients to improve operational excellence and take advantage of our broader range of products and services. We are seeing that with the aggressive growth in the Americas. We continue to monitor the macroeconomic environment especially in Europe. We are optimistic of winning a large U.K. public sector engagement which would add approximately 10% to this year’s revenue run rates in Europe for next year. I remain optimistic about our 2013 prospects and our ability to progress our long-term strategy. We have the pieces in place to achieve our vision to create an industry leading high growth information-based services company. We've focused our 800 professionals on a single mission: delivering operational excellence to our clients. We have taken measures to further deleverage our balance sheet through debt repayments. Thank you very much again for calling in this morning and now let me turn the session over to the operator.

Operator

Operator

[Operator Instructions] And we will take our first question from Marco Rodriguez with Stonegate Securities.

Marco Rodriguez

Analyst

I was wondering if you could talk a little bit more about the revenue distribution and some of the impacts that you saw there in the quarter. Maybe we can start with the Asia Pacific region; I know you mentioned the Australian negative impact there. Can you kind of quantify how much that impacted sales sequentially?

Michael Connors

Management

What you mean by sales sequentially? Sorry.

Marco Rodriguez

Analyst

Well, your sales in Asia Pacific were roughly $7 million last quarter of Q2 and they are $5.5 million this quarter…

Michael Connors

Management

Right.

Marco Rodriguez

Analyst

Q3, so about $1.5 million decline.

Michael Connors

Management

Yes, it’s -- as I mentioned earlier, it’s driven and I mentioned this on the last call we -- the Australian government in particular slowed down some projects that we expect that will pick up right toward the end of this year that will pick up that revenue level again in 2013. And then in the financial services some of the banking clients that we have there also slowed down on some of the projects that we are working on with them. That was the cause of the third quarter and we think it will spill a bit into the fourth quarter but we see that picking back up in 2013 especially with the government work.

Marco Rodriguez

Analyst

Okay. And so with the Asia Pacific area, I mean, so the sequential decline is that all because of Australia or is there weakness in other areas?

Michael Connors

Management

No, it’s basically all Australia. The Asian market continues to grow especially our northern Asian areas there. But no, it’s all driven by Australia.

Marco Rodriguez

Analyst

Okay. That’s helpful. And then in terms of the hurricane impact, can you quantify the amount of revenue that was lost in the quarter because of that?

Michael Connors

Management

Yes. We think we are going to lose about a $1 million based on that, and it's primarily driven around our inability to bill our clients because we were not able to work at our client premises and a lot of our work is on-site through the Eastern quarter. And then secondly some of our Eastern located consultants were unable to fly to other clients that were unaffected by the storm but they weren’t able to get out. So we are estimating it could run up to about $1 million and that’s why we factored that into our guidance.

Marco Rodriguez

Analyst

Okay. And I think you mentioned in the call that you are probably not going to be able to make that up in this calendar year.

Michael Connors

Management

Right.

Marco Rodriguez

Analyst

Is that just that some of the projects are that long in terms of nature or can you help me understand that?

Michael Connors

Management

Yes. These projects that we are working on are multiple months and because in fact some of our clients are still shutdown, have not reengaged in the work, that we anticipate are not being able to kind of double up if you will because of the Thanksgiving holiday, Christmas holidays. So that that work will come through we will complete those projects clearly but it will be end of 2013 before they are done.

Marco Rodriguez

Analyst

Got it. That’s helpful. And talking about Europe, you understand obviously the macroeconomic situation. I was wondering if you could perhaps provide a little bit more color on your movement in here to the U.K. public sector. What sort of gives you confidence that you can penetrate that market and can you discuss a little bit the competitive landscape there?

Michael Connors

Management

Yes. It’s very competitive, I will start with that. We have not penetrated the U.K. public sector in the past. But we made a conscious decision to invest with a team of people this year and spend time to see if we couldn’t focus and penetrate into the U.K. government. Our view there is that they are going through some major austerity programs, cost reductions in the 20% to 25% range over the course of the next 3 to 4 years. We felt that it was right in our sweet spot around operational excellence. So we made a conscious decision despite, I would say, a pretty soft environment in the U.K. to put some money and people back into the U.K. government penetration. We’ve gotten about $1 million worth of revenue out of the U.K. government this year, which is a breakthrough for us in some smaller government agencies. But in particular there is one agency which we have penetrated that we expect a formal announcement on during the latter part of this quarter. We expected it earlier. But based on the insights that we have and the work that we have done, we think that we will win that piece of work and as I said it, it would represent about a 10% increase in our European revenue run rate if we did win it going into 2013. Our confidence level is, it’s just the fact that we have been working it, penetrating it, building the relationships. We think we have a fantastic proposition in front of them. We’ve been given positive indications and we expect to hear something on that soon.

Marco Rodriguez

Analyst

Okay. That’s helpful. And then kind of shifting over to the employee count. Can you give us a sense as far as what your plans offer additional hires this year and then how should we be thinking about that going into next year?

David Berger

Management

Yes. I mean, we continue to -- headcount is always driven by our projections and the growth of our business. We keep a close eyes so we don’t get out ahead of ourselves. So as we go out, this quarter we hired 45 people during the quarter and last quarter it was around 35 people. So it probably would be something in that range as we continue out next few quarters.

Marco Rodriguez

Analyst

Okay. And now I understand that obviously with all the new hirings, some of your metrics, your revenue per employee have been coming down because you are -- I am assuming some of your consultants are not up to speed on getting all the training. Can you give us a sense when you might see that kind of reverse?

David Berger

Management

Well, realize, a lot of the headcount that we are adding is in the Managed Service area, a lot of these individuals are in our Indian operations and it supports our Managed Services. So the revenue per headcount is little different in that area than the overall consulting.

Marco Rodriguez

Analyst

Can you then give us…

David Berger

Management

It does take time before a new consultant hire-in becomes fully effective. But again because the heavy weight on the employees we are bringing in is in the Managed Service area. It does have an impact on the overall revenue per head.

Michael Connors

Management

So Marco, just as an example, of the 45 people we brought in the quarter I believe it was 36. 36 of those folks are part of our Managed Services operations and not all of them but on average that’s compensation levels are kind of $50,000 or less because of the base of operation for many of them will be in India. So just to kind of put it into perspective, that’s the kind of level. It’s not the $150,000 or $250,000 kind of senior consultant level. These are analyst type folks that we use for managing our governance services, our supplier contracts et cetera. So the -- and that total's now, I think it’s roughly around 200 of our 800 people ballpark of those kinds of folks that are managing our Managed Services area.

Marco Rodriguez

Analyst

Got it. That’s very helpful. And then lastly, the SG&A line declined pretty dramatically here sequentially in year-over-year. Is that a function of that $1.9 million reversal for earnout?

David Berger

Management

The -- yes, it’s driven by that. It’s been driven by the -- we did target some reductions in some of the noncompensation, like travel and entertainment, did reduce that line also.

Operator

Operator

And we will take our next question from Justin Ruiss with Sidoti & Company.

Justin Ruiss

Analyst · Sidoti & Company.

I just had a quick question. I know -- I don’t know what the exposure is towards the election. If you guys have any exposure towards the election but with a dust settled, does that give you any kind of opportunity to capture any kind of public sector business that’s out there?

Michael Connors

Management

Good question. So our public sector business, we are doing some work with one of the states today around health exchanges as part of the Obamacare, the Affordable Care Act kind of work. Now that things have settled down a little bit I wouldn’t necessary say the elections have changed it too much. Our U.S. public sector in terms of revenue standpoint is pretty robust right now. As we enter 2013, there seems to be funds that are freeing up to work on kind of system change out. I think I mentioned before, primarily these are because of the systems were old and lot of people that operated them are somewhat older even. And so the need to change that out to get much more efficient even in a tax-reduced type environment in some of these states has put pressure on them for more operational excellence type of work. And that is what’s driving our public sector growth areas. So I would say both here, we are working with the government in China, I just came back from China with the change over, we expect the government work in China to be increased. We talked about the U.K. government. But I don’t think there is anything related to the public sector here that we're not already own either pre-election or post-election that would change it. But it is pretty robust at the moment.

Justin Ruiss

Analyst · Sidoti & Company.

Got you. And then just another question on just at the U.K. front with the whole entering into the public sector there. Does that give you kind of foothold to I guess migrate to other nations out there to try and get into the public sector. I don’t really know if they kind of mirror each other. But you probably can catch what I'm saying.

Michael Connors

Management

Yes. It’s a good question. We have decided, we decided to focus and invest in the U.K. We focus in the U.S. with our STA acquisition and are growing that business. We focused it over on the Australian government because we've gotten a good foothold there. Our next target was the U.K. It’s taken a while and one of the reasons we stuck with it is because we think it can be quite lucrative. But it also means that you have to invest and you have to stick with people for a while because it takes a while to develop that business. So we don’t have a plan at the moment to move further in the European theater on the public sector until we get a good strong foothold in the U.K. and then we will take another look at it. But we kind of attacked the 3 we thought would be the 3 biggest markets for us: here, the U.K. and Australia. We got 2 of them in good shape and we think we are pretty close on breaking into the U.K. and we probably work through 2013 there before we would think about going elsewhere. But we -- if we can breakthrough with this big contract then we will be a good shape I think over in the U.K. to have us think about what might be next after 2013.

Operator

Operator

[Operator Instructions]

Michael Connors

Management

Okay, operator, with that I think I will wrap it up and thank all of our ISG’s over 800 professionals worldwide for your continued passion and dedication for your performance through the first 9 months of this year. We are working through the European storm, the Americas are really pretty robust, the public sector terrific, Managed Services is growing rapidly and we appreciate your efforts there. We think we are poised to continue to build on our market leadership and most of all we want to thank all of you on the call for your continued support and confidence. With that have a terrific weekend.

Operator

Operator

And that does conclude today’s conference. Thank you for your participation.