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Information Services Group, Inc. (III)

Q4 2018 Earnings Call· Fri, Mar 15, 2019

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Transcript

Operator

Operator

Good day. And welcome to the Information Services Group Fourth Quarter and Year End 2018 Results Conference Call. Today's conference is being recorded and a replay will be available on ISG's Web site 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 sir.

Barry Holt

Management

Thank you, operator. Hello and good morning. My name is Barry Holt. I'm a Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's fourth quarter conference call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer and David Berger, Executive Vice President and Chief Financial Officer. Before we begin, I'd 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 are not guarantees of future results and are subject to certain risks and uncertainties that could cause actual results 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, which was furnished this evening to the SEC, and the Risk Factors section in ISG's Form 10-K covering full year results. You should also read ISG's annual report on Form 10-K for the fiscal year ending December 31, 2017, and any other relevant documents, including any amendments or supplements to these documents filed with the SEC. You will be able to obtain free copies of any of ISG's SEC filings on either ISG's Web site at www.isg-one.com or the SEC's Web site at www.sec.gov. ISG undertakes no obligation to update or revise any forward-looking statement to reflect subsequent events or circumstances. During this call, we 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 we will touch on today, include adjusted EBITDA, adjusted net earnings and the presentation of selected financial data on a constant currency basis. 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. 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 filed last evening with the SEC. And now, I'd like to turn the call over to Michael Connors, who will be followed by David Berger. Mike?

Michael Connors

Management

Thank you, Barry, and good morning, everyone. Today, we will review our record fourth quarter and full year revenues; brief you on our key operating and client highlights; discuss the increasing value of ISG automation; provide our guidance for 2019 revenues and EBITDA; and discuss our capital deployment plans. But let me get right to the headlines. We delivered record revenues of $68 million in the fourth quarter and record revenues of $276 million for the full year. Europe was a key driver. Reported revenues were up 18% in Q4 and 15% for the full year. Digital continues to be a growth engine for the firm. It accounted for 45% of our revenues in the fourth quarter and for the year surpassed $100 million for the first time. Automation is a key part of our digital business and continues to grow in value for our clients and our firm. We lowered our debt by $18 million in 2018 and delivered strong operating cash flow, $8 million in the fourth quarter and $19 million for the year, our best performance in five years. And we have a plan to return more of our cash to our shareholders in 2019. We have great momentum in our business and with strong demand for all things digital bright prospects for the long-term. There isn’t a client conversation now that doesn't include some element of digital and we are responding by building digital capability into each of our service lines. ISG FutureSource, our next generation digital sourcing solution is one example. Launched just over a year ago, ISG FutureSource reinvent our traditional sourcing services and addresses the need for speed, agility and mastering the increasing complexity of today's digital sourcing environment. We also see a future where we are able to deliver certain offerings using…

David Berger

Management

Thanks Mike and good morning everyone. Fourth quarter revenues were $67.9 million compared with $66.6 million in the prior year, which was an increase of 4% in constant currency and 2% on a reported basis. Currency negatively impacted reported revenues by 2% or $1.1 million in the quarter. Reported revenues were $25.3 million in Europe, up 21% in constant currency from the same period in 2017 and 18% on a reported basis; $38.1 million in the Americas, down 3% and $4.5 million in Asia Pacific, down $1.4 million. Fourth quarter 2018 adjusted EBITDA was $8.6 billion, which compares to $8.9 million in the prior year. We reported fourth quarter operating income of $3.3 million compared with operating income of $4 million in the fourth quarter of 2017. The net loss for the fourth quarter was $900,000 compared with a net loss of $2.7 million in the fourth quarter of 2017. Reported fully diluted loss per share was $0.02 compared with a fully diluted loss per share of $0.06 for the same period in 2017. Included in the net loss was $1.6 million and $2.1 million of income tax expense for the fourth quarters of 2018 and 2017 respectively related to changes in the U.S. federal tax code under the Tax Cuts and Jobs Act. Adjusted net income for the fourth quarter was $2.3 million or $0.05 per share on a diluted basis compared with adjusted net income of $100,000 or $0.01 per share in the prior year's fourth quarter. Utilization for the quarter was approximately 64% and 66% for the year. Quarter end headcount was 1,310. Our balance sheet continues to have the strength and flexibility to support our business over the long-term. Net cash provided by operations for the year was $19.1 million versus $11.4 million in the prior year and $8 million for the quarter. In 2018, we invested $4 million in capital expenditures, repurchased $3 million in shares and repaid $18 million in debt. On the balance sheet, we ended the year with $19 million in cash, which was up 38% from the $14 million in Q3. Total debt outstanding was $99.1 million after paying down $2.1 million during the quarter and $17.6 million for the full year. We plan to pay down an additional 8% to 10% of our debt in 2019. Our average borrowing rate for the quarter was 5.2% and we had $45.8 million shares outstanding as of March 1st. In terms of modeling for 2019, we are looking at interest expense between $6 million and $6.5 million, depreciation expense between $3 million and $3.5 million, intangible amortization of around $4 million, stock compensation of around $11 million, cash taxes between $5 million and $6 million, capital expenditures of approximately $4 million and an effective tax rate between 32% and 34%. Mike will now share concluding remarks before we go to Q&A.

Michael Connors

Management

Thank you, David. And let me summarize for us. We delivered record revenues of $276 million, including a record $68 million in the fourth quarter. We generated 18% revenue growth in Europe in the fourth quarter and 15% for the year. We continue to grow our digital services revenue, which accounted for more than 45% of our total for the fourth quarter and a record $100 million plus for the year. We delivered strong growth in ISG Automation and expect strong double-digit growth again this year as demand remains high and we explore avenues for creating further value in this business. We generated $19 million of cash from operations, our best result in the last five years. And our cash balance is at $19 million after paying down $18 million in debt and buying back $3 million in shares. We will look to return more of our cash to shareholders in 2019, including accelerating our share repurchase program. As always, we are focused on shareholder value for the long-term and we are steadfast in our mission to deliver operational excellence to our clients. Overall, our foundation is solid, recurring revenues, digital and automation services, subscription software, a growing list of blue chips clients and a talented global team of 1,300 professionals on the ground in the middle of the digital revolution. Thanks very much for calling in this morning. And now let me turn the session over to the operator for your questions.

Operator

Operator

[Operator Instructions] We will take our first question from Vincent Colicchio with Barrington Research.

Vincent Colicchio

Analyst

How large is the RPA practice today and could you remind us how margins compares to the company average?

Michael Connors

Management

First of all, we exited 2018 at greater than $20 million and our plan is that we would exit 2019 at greater than $30 million. And in terms of margins that is a business that’s a combination of both advisory and recurring revenues around software. So we have both the software and the services combined. So when you look at the two together, I would say it's just a bit greater than the overall firm average margins.

Vincent Colicchio

Analyst

And then on the government side of the business. I mean, you had some slippage versus expectations. I assume of course you knew that there will be some politics and some noise there. Is there anything else you think that's affecting that business?

Michael Connors

Management

I think there are two things. One, we expect closure on a few deals, and I will mention states of Michigan, states of Indiana, which have closed subsequently that did not close, we did not start work. There was also a higher education big university that closed, but not during when we thought it would in the fourth quarter. So that is really the issue. We see that work starting up now, but we will see the flow through for growth, we believe starting in the second quarter of this calendar year.

Operator

Operator

Your next question is from Sarkis Sherbetchyan with B. Riley FBR.

Sarkis Sherbetchyan

Analyst

Can you remind us what recurring revenues were for 4Q?

Michael Connors

Management

It was $17 million from 4Q, $76 million for the full year.

Sarkis Sherbetchyan

Analyst

And with regards to this layer of business, do you expect year-over-year growth for '19?

Michael Connors

Management

Which business, Sarkis?

Sarkis Sherbetchyan

Analyst

Just for the recurring revenue…

Michael Connors

Management

Yes. We think the recurring revenues will grow double-digits in '19.

Sarkis Sherbetchyan

Analyst

And if I recall correctly, your goal was to get to $100 million in recurring revenues in the next few years. Does your line of thinking change on that?

Michael Connors

Management

No, we think we’re still right on target to get there as we enter 2021. So we've got one year down, two to go. And based on what we’re seeing with our change of trying to push more into annuity streams with our ISG platform services, with more software offerings, we think we will get the target of $100 million on the timeline that we've described.

Sarkis Sherbetchyan

Analyst

And if I take the guidance for EBITDA, as well as revenues for the year it looks like you would expect essentially flat margins. Can you just give us the puts and takes on the reason why and also if you see weakness in certain areas of the business, which are offset by some big growth here, just try to give those drivers?

Michael Connors

Management

I think the way to look at it is first quarter is going to be flat and then you are going to see the growth and I think you will see margin change as we go through the year. So, I think we’re being as conservative as we can be at the moment, considering the other areas. But internally, we would like -- we are targeting that margin number to grow in '19 over '18. But at the moment, we put the investment in some people. We’re putting the investment in our ISG platform, all of which should service to get to the $100 million plus in recurring. So those factors are the ones that we factored in and we also are losing a million bucks a quarter with one of our top client. We added that all up and that’s how we ended up with our guidance.

Operator

Operator

We will take our next question from Marco Rodriguez with Stonegate Capital Markets.

Marco Rodriguez

Analyst · Stonegate Capital Markets.

I was wondering if you can maybe talk a little bit more about the RPA business. Your commentary on looking for I guess strategic alternative acquisitions, other activities that could help drive value there, vis-à-vis I guess where your software partners are getting much higher valuations. Can you just talk a little bit more about that and talk about, I suppose the valuation disconnect that you're seeing there?

Michael Connors

Management

So we know we’re building a very valuable asset with automation, it is a hot area. We know that valuations for the software, pure software players like Blue Prism, which is public like Automation Anywhere, UiPath, WorkFusion, they are all out there in the public domain, have some explosive values. We also know that firms that are emerging in the services and software space like our ISG Automation business are selling at around 3 times revenue, because we've been in the market. We've see some of the assets. There was a recent public sale through Sykes, which is a public company and others. So, when we look at all of that, we say, well, wait a minute, we don't think we're getting the value of our assets certainly reflecting at the moment in our share price. We also think that this business, through expansion, could become even more valuable. So we’re going to look at a number of areas created as a legal entity during the course of the year, and we'll see what the best options are for us.

Marco Rodriguez

Analyst · Stonegate Capital Markets.

And maybe if you can talk about, I guess acquisition landscapes for you guys in terms of the RPA business or anything else that maybe somewhat attracted to you. If you can maybe talk about opportunities that are out there, maybe numbers and what valuations might look like?

Michael Connors

Management

We’re always on the hunt on acquisitions. Our focus is around digital analytics and things that we can attach to our platform, as well as recurring revenues that we can put through, if you will, our distribution channel. That’s the focus of any bolt-on acquisition. I will put the Automation acquisitions aside for a second. But rest of them, we have always been disciplined in terms of the value that we would pay and its usually at the levels that sit, if you will, a bit below where we trade at. But we also have a pretty good model that we have I think well versed in, which is a combination of a little bit of cash, a little bit of stock and some earn-out. And that model does resonate with the candidates that we are looking out on the outside. So, I think the pipeline is good. I think the market is good. I think the ISG platform is well respected in the market. And we will continue to look at something and if something made sense then we would jump at it.

Marco Rodriguez

Analyst · Stonegate Capital Markets.

And last question and I will jump back in the queue. Just coming back to U.S. public sector and its impact in the Americas, I know we've talked about this last quarter. As far as some of that weakness there, I guess, it seems to be bleeding in here. And I think if I heard you correctly, your expectation is that Q2 '19, a lot of choppiness should abate. Just wondering what gives you confidence in this forecast there for the U.S. public sector.

Michael Connors

Management

So we have a good pipeline. The pipeline was turnspit. It turned back on kind of toward the beginning of the year as the new governor all took office, freeing up some RFPs, which the RFP traffic is higher than it was in the past. We've also won a few pieces of work in a couple of state in higher education. We also have a few things that are in the pipeline that we expect solutions on within 30 days. So you add all that together, we think that the public sector has hit its bottom and it will go back to some normalized, if I can say, in this political environment but a normalized spending pattern. And therefore, we envision public sector returning to growth in Q2. So that’s where we get our confidence level.

Operator

Operator

And your next question is from Joe Gomez with Noble Capital.

Joe Gomez

Analyst

Just wanted to circle back here about some of the uses of cash, you guys are talking about for this year; you're paying down debt; increasing the rate of buybacks; potential bolt-on acquisitions. Just trying to get a better feel or idea of how you guys think you’re going to be able to fund all of that?

David Berger

Management

Well, this year we generated -- in 2018, we generated $19 million of cash flow, which has similar cash characteristics in 2019. So that was funded. As you know our acquisition, we tend to fund through a combination of cash shares and earn out. So that enables us to spread the cash over a number of years. So that’s how we do the three items you mentioned.

Michael Connors

Management

One other factor, Joe, is that keep in mind that we paid back about $18 million of debt in 2018. And our projection is to spread the wealth, if you will, on the cash. And our debt, we would take down 8% to 10% during '19 and that of course frees up some additional cash to do the buybacks and other things, so keep that in mind.

Joe Gomez

Analyst

And I might have missed this and if I did, I apologize. But in the last quarter you were talking about some network revenues you're expecting to get about $2 million the quarter that had been shifted to the right. Did that occur?

Michael Connors

Management

Yes, we had very strong sequential network growth, call it in the 25% range for the quarter. And that did come to fruition. And we think our network business, just to add one of the components here. With the dramatic changes going on, which I’m sure we’ve all seen with AT&T, Verizon and others, who are essentially blowing up their current business model and changing it. We think that our network business, although, it’s a little choppy we think that the network business over the next couple years could be a new broader growth driver for us nothing more at the moment. But with those business models changing and with our expertise and data that we have, we think we could be even a large player in the network space. So we are working on some new initiatives during the first half of this year. And as we develop those, we'll be back in touch. But the network business, in our view, is a growth opportunities. Though, it is a little choppy quarter-to-quarter, it’s a little higher margin. And we think there's some uplift on the growth rates over the next couple of years to take advantage of the business models that are changing.

Operator

Operator

It appears there are no further questions at this time.

Michael Connors

Management

All right, thanks very much. Let me just close by saying thank you to all of our professionals around the world for their individual and collective contributions, and continuing to write the chapter in our growth story and for the strides that they are taking on behalf of the firm on our road ahead. And let me thank all of you on the call for your continued support and confidence in our firm. Thanks for joining us and have a great day.

Operator

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.