Internet Capital Group, Inc. Q3 2008 Earnings Call Transcript

Executives

Karen Greene – VP, IR and Corporate Communications

Walter Buckley – Chairman, President and CEO

Kirk Morgan – CFO

Analysts

Jeff Van Rhee – Craig-Hallum

Scott Berg – ThinkEquity

Jason Stankowski – Castle Peak

Matthew Kempler – Potomac Capital

Francis Gemino – Henley & Company

Internet Capital Group, Inc. (ICGE) Q3 2008 Earnings Call Transcript October 30, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to third quarter 2008 Internet Capital Group earnings conference call. My name is Candice and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session after management remarks.

(Operator instructions) I would now like to turn the presentation over to your host for today’s conference, Vice President of Investor Relations, Ms. Greene. You may proceed.

Karen Greene

Thank you and good morning. This is Karen Greene with Investor Relations and I want to welcome you to Internet Capital Group’s third quarter conference call. I’d like to remind everyone that we’re going to use presentation slides to accompany our prepared remarks today. These slides can be found at our website at www.internetcapital.com. Just go to the investor information tab and you’ll see an icon for our third quarter conference call. The slides can be access through that icon. For those of you without immediate access to our website, the conference call and presentation slides will remain on our website and be available for future reference.

On the call this morning, we will be discussing certain non-GAAP financial measures. For additional information on this non-GAAP financial measures including a reconciliation of these measures to the most comparable GAAP measures please refer to the press release we put out this morning including the attachments to this press release. The press release is also available on our website which again is www.internetcapital.com. To access the press release on our website go to the ICG press release tab and select October 30 press release. The attachments to the release can be accessed by clicking on the PDF file contained within the release itself.

Before we begin, I’d like to briefly review our Safe Harbor language. The statements contained in our press release and those that we make in the conference call as well as the accompanying slide presentations that are not historical facts are forward looking statements that involve certain risks and uncertainties including but not limited to risks associated with the uncertainty of future performance of our partner companies, acquisitions or dispositions of interests in partner companies, the effect of economic conditions generally, capital spending by customers, development of the ecommerce and information technology market and other uncertainties detailed in the company’s filings with the Securities & Exchange Commission. These and other factors may cause actual results to differ materially from those projected.

Now, let me turn the call over to Walter Buckley, ICG’s Chairman and CEO.

Walter Buckley

Thanks, Karen. And welcome and thank you for joining us this morning. I’ll begin by providing you with an update on ICG and discuss the Q3 highlights. Kirk Morgan, our Chief Financial Officer will follow with ICG financial results and review our quarter performance for the third quarter.

The third quarter 2008 has been challenging in many regards. A struggling economy, turbulent capital markets and general lack of visibility to the impact of these conditions on the buying behavior of customers, however, instant [ph] backdrop we ended the quarter on a strong financial position and a group of partner companies that continue to demonstrate solid growth and financial stability.

Let’s turn in to slide four, the main takeaways from the quarter. Our eight core partner companies had aggregate revenue growth of 20% in the third quarter of 2008 versus third quarter of 2007. Channel Intelligence, Freeborders, and WhiteFence demonstrated strong revenue growth in the quarter. I’ll discuss this in a little more detail in just a minute.

We also completed the sale of Creditex to International Exchange or ICE, which substantially enhanced our balance sheet and resulted in a gain of approximately $35 million, a significant return on our initial investment on Creditex in November 2006. Further solidifying our strong financial position, we are taking proactive steps through these operating expenses of ICG and in the number of our partner companies, which we believe will yield significant savings starting in the fourth quarter.

Now, turning to slides five through nine, let me share some partner company highlights from the quarter starting with Channel Intelligence. Channel Intelligence, an industry leader in web-based solutions enters the third quarter 2008 with strong revenue growth. CI entered the social networking market in the quarter by providing services that help in optimizing online advertising for the world’s largest social networking site. In addition, the company added a number of new customers to its portfolio including Xerox, LogiTech, Super Warehouse and Charming Shoppes to name a few. CI also saw an increase in revenue through expansion from existing customers such as Stiegl [ph], Target, Best Buy, Teleflora and Circuit City.

Freeborders, a leading provider of technology solutions and IT outsourcing, which continues to win new deals and have a healthy pipeline as we move in to the fourth quarter of 2008. Freeborders expanded business with ETI, Ticketmaster, and AirBill [ph] during the quarter. And despite challenging times to the sector, the company’s financial services business continues strong growth in Q3. With additional business closed at BNP Paribas, Cigna, Citibank, Credit Suisse, Deustche Bank, HSBC, and State Street. This further validates the value proposition of Freeborders to delivering to these customers.

ICG Commerce, a leading procurement outsource provider continue to demonstrate its ability to help companies substantially reduce expenditures, an increasingly important capability given the current economic conditions. Most notably, the company recently signed a significant eight-figure BPO deal with a fortune 1,000 companies, and we will begin the results of that starting in Q4. In addition, a long standing US-based customer in a global oil and gas industry signed a multi-million dollar contract amendment to include the management that extends across all of Europe. ICG Commerce also extended its relationship with two other existing customers, a global industrial packaging company and a national retailer, who were both seeking to capture savings through outsourcing a larger range of procurement categories.

Finally, in order to help companies thrive even greater savings across their global operations, ICG Commerce further expanded outsourcing procurement centers in Europe and in Asia, adding experts in London, England and Shenzen, China.

Turning to MetaStorm. MetaStorm had a good third quarter. Their platform and product offering continue to be well-received in the market as reflected by follow-on purchases from existing customers as well as new license deals with organizations around the world. New customers acquired in the quarter include: Johnson Controls, TSCU Financial Services, Rompetrol, Family Works, Top Markets, and US Department of Transportation and Security Administration. MetaStorm was recently named a leader by Garda Research, placing the company in the upper right hand or magic quadrant for the business process analysis market. The company is also recognized by Deloitte’s Fast 50 from Maryland. By list of the 50 fastest growing technology companies in the region and by Inc. 5000 as one of the fastest growing privately held company in the United States.

And finally, StarCite, a provider of on demand global meetings solutions. The company saves significant headwinds in the transaction portion of its business in Q3 as a result of the effects of the company on corporate travel. That said, the company continue to expand its corporate client based across all industry sectors turning one of the largest fast food chains, and oil and natural gas producer and corporations, and healthcare services, technology, financial services, and industrial products. StarCite also wrote out new marketing initiatives targeting mid-size organizations for meeting management solutions and sign a number of new customers in this year including Spencer Stuart, US Motivation, Potential [ph] Event, Event Strategy Group, and McDermott Will and Emery. The company also added to its growing roster of suppliers signing at Ritz Carlton and several other luxury brands, as well as the number of individual brand properties. Other product expansions include the roll out of an expanded business intelligent offering for both corporate buyers and suppliers.

Now, while the growths that are part of the company is slower than we originally projected, these companies continue to grow and deliver proven ROI to their customers. We’re working closely with our partner companies in this tough environment helping them weigh prudent investment for growth against importance of financial stability and profitability.

In light of the current macro trends, we believe that our focus should be on managing our liquidity and protecting the integrity of our balance sheet and our partner companies’ balance sheet. We simply put cash is king [ph] with profitability as a driving goal. As a result, we have taken and we’ll continue to take aggressive measures to reduce operating expenses at most of our partner companies, as well as at ICG. Leveraging the hard lessons learned in the last market downturn, we believe profitability is vital for our company right now, and can mean the difference between the last man standing and the victim of the times with our partner companies’ respective industries.

With a very conservative outlook on customer spending for the balance of 2008 and 2009, we want our partner companies to be well-positioned to weather this downturn and emerges leader in their markets. For ICG, our strong financial position is further enhanced by various strict cash management that will allow us to be agile and opportunistic in an environment we believe will be filled with string acquisition potential for both our companies and new targets.

From a broader perspective, we continue to be very enthusiastic about potential to create significant value by acquiring and building leading SAS [ph] companies. Garda Research recently predicted that 30% of all software revenue will come from SAS over the next three to five years versus just 10% today. The reasons are simple: Lower cost, use of use, and most importantly SAS and significant savings.

Our long standing experience in building market leaders like Blackboard, Link Share, Creditex and others combined with our solid financial foundation put up in a strong position to further capitalize on this opportunity. And really the most important take where I can leave with you today is that with a strong balance sheet and experienced management team and an excellent group of companies behinds us, ICG is committed to executing on this mission to build leading companies in the internet and software and services based. We believe these are unprecedented times that we require patience, discipline and flexibility. And we believe we have the fortitude and capabilities to emerge as leader in this market. With that I will turn it over to Kirk.

Kirk Morgan

Thanks, Walter, and good morning. I will begin in slide 11 with our third quarter 2008 consolidating income statement. During the quarter, ICG consolidated results with three partner companies, ICG Commerce, Investor Force and VCommerce. We consolidated two partner companies in a comparable 2007 period, ICG Commerce and Investor Force. Consolidated revenue in the third quarter 2008 totaled $17.1 million compared with $14.6 million for last years’ third quarter. This growth is primarily due to ICGs consolidation of VCommerce in 2008 quarter.

Moving to the bottom line, ICG reported consolidated net income of $22.5 million or $0.60 per diluted share for the third quarter 2008 as compared with a net loss of $4 million or $0.11 per diluted share for the third quarter 2007. Results for the 2008 quarter include $34 million in net gains primarily related to the gain on the sale of Creditex which I will discuss later versus $3.4 million net gains in the 2007 quarter.

Let me next review our core company result on slide 12. The information I’m about to share with you relates to ICG’s eight core companies, in which we had an average ownership interest of 47% as of September 30, 2008. Let me next review our core company results on Slide 12. The information I’m about to share with you relates to ICG’s eight core companies in which we had an average ownership interest of 47% as of June 30, 2008. Aggregate revenue of our eight core companies increased 20% to $69.6 million during the third quarter of 2008, up from $58 million in last year’s second quarter. The companies experiencing strong revenue growth during the third quarter were Freeboarders, Channel Intelligence and WhiteFence. This brings our year-to-date aggregate revenue growth in 2008 over the first nine months of 2007 to approximately 26%.

Regarding the third quarter, in light of the significant headwinds our companies are facing in the current economic environment, we believe 20% year-over-year growth is solid. It is also important to note that virtually all of this growth is organic, accelerating from 14% organic growth in the first half of 2008. With that said, given the current economic environment and the related lack of visibility affecting some of the industries in which our partner companies operate, we are adjusting our guidance for full year core company asset revenue growth to be in a range of 20% to 25% on a GAAP basis.

Now moving to EBITDA, our eight core companies reported an aggregate $6.9 million EBITDA loss during the quarter as oppose to an aggregate EBITDA loss of $6.4 million in last year’s comparable quarter. StarCite continues spending in the quarter in connection with the ongoing integration of the StarCite Advantage platforms, and this weigh down our performance again. We saw deceleration in spending this Q3 closed which is encouraging. ICG Commerce and MetaStorm continue to lead the way with solid positive EBITDA for the quarter and the third quarter is always WhiteFence’s strongest. Year-over-year we also saw solid EBITDA improvement of Freeborders, Channel Intelligence, VCommerce and Investor Force.

Let me now provide a little more color on our EBITDA performance. On the bottom of slide 12, a highlight of some elements including our EBITDA loss such as equity-based compensation, restructuring and integration cost. EBITDA would have improved from a loss of $5.2 million in the 2007 quarter to a loss of $2.7 million in the 2008 quarter if these items had been excluded. Again, this highlights a solid EBITDA performance of the companies I mentioned previously. And as you can see, the Q3 improvements are even more encouraging when you look at it relative to our year-to-date performance. I believe this is positioning these companies from more profitable growth in the future. Of course, keeping in mind the uncertain economic environment in which they operate. Lastly, any cost reductions some of our companies are undertaking as they look to Q4 and in to 2009 may result in some one-time charges that could impact their pure EBITDA results. I’ll be sure to highlight those charges if any on our next call.

Now, let’s move to slide 13, slide 13 presents the movement of cash of the parent company level during the quarter and total liquidity of September 30. We deployed a total of $3.8 million in the quarter primarily to investor portion of VCommerce, received $30.2 million in proceeds for the sale of a portion of our Intercontinental Exchange shares we received in the credited transaction, which I will discuss again in more detail later. We purchased $234,000 of our common stock and had net cash of operating cost of $3.3 million. We entered the quarter with $51.7 million of cash at the parent company. At September 30, the value of our Blackboard holdings including our hedges was $85 million. The value of our remaining free tradable ICE shares was $28.2 million. I’ll update you on our post quarter activity in a moment. And the value of our Go industry holdings was $18.2 million.

Let me now provide an update on our 20 million shares repurchase plan we announced in July. During the quarter, we deployed $234,000 to repurchase 30,000 shares. Subsequent to the quarter end, we repurchase 468,000 shares for $3 million. Today, we have spent an aggregate of $3.2 million to repurchase approximately 498,000 shares at an average price of approximately $6.45. Those shares repurchased during our quarterly trading blackout period were purchased to a broker pursuant to a trading plan meeting the requirements of Rule 10-B51 of the Exchange Act. Due to the market uncertainty at the time we entered the plan in the middle of September, and our ability to control purchases while the plan was in place, we limited the broker’s authority to the repurchase of $3 million of stock during the blackout period. As we emerged from the blackout period, we will continue to evaluate stock repurchases in light of the macroeconomic environment. Clearly, we want to be very prudent and measured all of our capital allocations decisions. Our stock repurchases are no different.

Now, turning to slide 14 where I have a summary of the Creditex transaction. On August 29, the acquisition of Creditex by ICE was consummated. We received 737,000 shares of ICE stock with a value of $64.9 million on a closing date just based on an ICE closing stock price of $88.03. At closing, 60,000 of these shares were placed in the escrow to satisfy potential identification claims. The remaining 677,000 shares with a closing date value of $59.6 million were transferred to ICG. Receipt of these shares was the basis for us recording an accounting gain of $34.8 million in the third quarter since the carrying value of Creditex was only $24.8 million. In September, we sold 327,000 shares at an average price of $92.32 realizing cash proceeds during the quarter of $30.2 million. In October, we sold an additional 175,000 shares at an average price of approximately $85.90 for cash proceeds of just over $15 million. So we currently hold a 175,000 of freely tradable shares and additional 60,000 shares that are held in escrow. Given our NOL position, there was no income tax impact for any of these transactions.

We look forward to reporting to you on our 2008 results and providing color for 2009 in February. Now, I’ll turn it over to Buck.

Walter Buckley

Thanks, Kirk. And now, we would like to open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from the line of Jeff Van Rhee of Craig-Hallum. Please proceed.

Jeff Van Rhee – Craig-Hallum

Thank you. Hey Buck, hey everyone. Just a couple of questions for you, Buck. Maybe just start with the EBITDA situation. How many of the unconsolidated core companies were EBITDA positive in the core and along those same lines although the environment is changing very quickly. Can you give us a little more color as they have evaluated their plan; they have evaluated their current cash balances and ability to reduce costs? Of those companies that are not EBITDA positive, your best guess at any cash needs in those companies, let say, in the next six months?

Walter Buckley

Yes Jeff. Two questions, I think first, there were two companies in that non-consolidated group that were EBITDA positive that internal late sense, as we look at the 2009 cash requirements, we really don’t think there would be anymore in – obviously this our best kept of the time of what we’ve traditionally done which is $10 million or so, plus or minus a little bit. But that’s what we would expect to see in 2009.

Jeff Van Rhee – Craig-Hallum

So just unclear – so for the remainder or for the entirety I guess of 2009, your best guess based on what they’re seeing right now is that your likely use of cash to fund existing would be around $10 million?

Walter Buckley

Yes.

Jeff Van Rhee – Craig-Hallum

And is that spread out or is that in one particular entity?

Walter Buckley

That’s just a couple.

Jeff Van Rhee – Craig-Hallum

A couple, okay. You had mentioned some cost, some steps you had taken at the corporate level to reign in expenses, do what you can to tighten up, can you help us get a little tighter sense of what that means? Quantify it if you would.

Walter Buckley

Jeff, we’re still working through all of that. I mean, everything is on the table right now. Headcount, compensation levels, all the other cost that go to the income statement – I mean, we’re looking at everything. We’re targeting, trying to get down from a $15 million run rate which is about where we are in 2008, down to about $12 million run rate to about a 20% reduction.

Jeff Van Rhee – Craig-Hallum

Okay. All right, that’s helpful. And then, ICGC you talked about several wins or expansions and seemingly very large one in there, you have given us some sense of backlog, can you give us another snapshot at backlog or another growth metric to get a sense of what’s going on there? In conjunction with that, the consolidated revenue number if I have it right on the adjusted basis here, you didn’t show much growth but seemingly I would think ICGC is growing nicely, so would you clarify that as well?

Walter Buckley

Sure. Just heading about – talking about ICGC initially, they had three big customers expansion in the quarter, and one of the reasons why you haven’t seen as much growth in a consolidated type, they have one of their midsize, smaller to midsize customers enter some financial issues and so we backed out some revenue that would otherwise they’ve had in the quarter. And so, that did have some effects on the company. With that said, they landed a very large BPO contract early in October, which I haven’t seen in that revenue as recognized in Q3. You’ll begin to see that in Q4. And the pipeline of opportunity behind this BPO transaction is significant. I would say their pipeline is probably stronger today than they’ve seen in a number of quarters. We’ll come out with a backlog metric at the end of the year which we traditionally do. Because of these large BPO win, their backlog is up significantly.

Jeff Van Rhee – Craig-Hallum

Okay. And the midsize customer that went away just to be clear, there was no competitive situation there, it’s not as they build one to another provider, they just had issues and backed away completely from an outsource procurement.

Walter Buckley

They’ve actually have their own serious financial issues, so it’s the viability of the company.

Jeff Van Rhee – Craig-Hallum

Okay.

Walter Buckley

They just – I can’t get to a lot more detail than that. But it’s their own financial viability.

Jeff Van Rhee – Craig-Hallum

Yes, okay. And then just one last one, Kirk, you mentioned the buyback numbers both pre-end of the quarter and post-end of the quarter number of shares prize. I missed a couple of those data points, could you just hit that again?

Kirk Morgan

Yes, during the quarter Jeff, we repurchased about 30,000 shares for about $234,000. And then after the quarter end, we repurchased about 468,000 shares for $3 million.

Jeff Van Rhee – Craig-Hallum

Okay, perfect. Thanks a lot.

Operator

Our next question will come from the line of Scott Berg of ThinkEquity. Please proceed.

Scott Berg – ThinkEquity

Good morning everyone and I hope all is well.

Walter Buckley

Good morning, Scott.

Scott Berg – ThinkEquity

Okay, just a couple of questions here for you. First of all, you have given the macro. Obviously, we all know what’s going on in the macro out there but how do you view the current macro? Is it more favorable or less favorable to some of the potential acquisitions or other companies that you guys are currently looking at? I’ll assume multiples have come down but you didn’t give the credit seat, their variables. Just how are you looking at that today?

Walter Buckley

Scott, good question, I’ll answer it on two dimensions: One, in terms of our partner companies, and two, on the acquisition side. From a partner company standpoint, obviously decision making slows significantly in the second half of September. But I think in the midterm, we feel that sect [ph] platforms in general are going to benefit, especially those who can deliver quantifiable and meaningful savings in the near term. And I think that that a number of our companies do that. Just about all of them. And so, I think, these companies, they’ve looked at their own headcount, they’ve looked to outsourcing labor and now really streamlining in automated business processes, I think the next big stage. And I think SAS, in general, are coming specifically well-positioned as companies continue to squeeze – they’re on cost structures.

From an acquisition standpoint, private companies’ valuations are coming down. They’ve not come down nearly as fast as public company, technology valuations – it is usually a lag of anywhere from 6-12 months, and probably halfway through that, so I think as we continue to go through this typical environment, you can see valuations come down and we do think that over the next 6-24 months there are going to be some great opportunities, and it something that we’re actively looking at today, but we just still think there are a better of a disconnect between the private and public sect side.

Scott Berg – ThinkEquity

All right, very good. I think that’s consistent will put you guys in the last two quarter. Would you consider later stage companies or early stage companies more or attractive now, if you were to look on acquisition?

Walter Buckley

Yes, we’ve actually – I would say, slightly changed our focus looking at later stage opportunities companies worth $15 million run rate or greater. We’ve been building SAS based businesses for 10 years and we understand what it takes, and we think that in this environment, being able to take – make investment at good valuations in later stage businesses is probably something that we didn’t exist for the last several years, and will exist. Our best guess is going forward, I mean, that is probably the best place for us to position ourselves. And so, you’ll see us looking at later stage transactions.

Scott Berg – ThinkEquity

I just have one more here. What would you say to these things behind Channel Intelligence were for the quarter? I know there’s a macro move to purchasing more items in line and using some of those services, but what would you attribute most of those things the last three months or two?

Walter Buckley

Yes. Channel is a unique, were we say, software companies these need to be successful for two way, they either is going to drive significant savings, quantifiable to the customers we’re going to help, or they’re going to help them sell more. And Channel helps their customers, both manufacturers, retailers and CSEs sell more product. And so, in this environment, and it is very quantifiable and so they work with the – all three constituents helping them drive revenues, and they have been very successful doing it especially with the launch of their new spend management product. So, we think they are well-positioned obviously in the retail industry that has got their own set of issues. But since they provide significant value on the top line, they are benefiting from that.

Scott Berg – ThinkEquity

Okay, very good. That’s all I have to say. Thank you.

Operator

Our next question will come from the line of Jason Stankowski of Castle Peak. Please proceed.

Jason Stankowski – Castle Peak

Hi guys. I’m just curious. As you look at acquisition and you’re saying that the private valuations haven’t come down. I’m happy to see you guys bought some stock subsequent to quarter end, but with light capital needs of the underlying businesses. How are you looking at the value of the company you can buy, which you’re buying on the open market now, and the idea of putting more capital towards – if my numbers are correct, basically, being able to buy the rest of your portfolio. The non-public party or portfolio for near free at these current levels in your stock price. And why wouldn’t a larger buyback is something that is very compelling to the company given the assets you’ve just monetized?

Walter Buckley

Absolutely, good question. I mean, as we think about it there are three areas for us to allocate our money. Certainly, stock buyback; follow on investment in our existing companies, taking larger ownership stakes and new acquisitions. And obviously, today, as we will look at the three pockets or areas, buying back our stock is attractive as any. And we allocated $3 million in the 10B515 program starting September. And obviously, the world change significantly from this September.

Jason Stankowski – Castle Peak

Right.

Walter Buckley

And once we’ve put that in place, we couldn’t do anything to change it. But if there’s something that we are actively evaluating in, I would say, it’s weighing it again making sure that we have the capital to weather the storm and be opportunistic. But certainly, it’s very attractive from a capital allocation perspective.

Jason Stankowski – Castle Peak

Am I looking at it incorrectly? I mean, you’re saying opportunistic and to me it looks like one of the most opportunistic things you could do in businesses you already know really well as opposed to the risk.

Walter Buckley

No, I mean, you’re absolutely looking at it correctly. I only say that there may be opportunist to buy out larger stakes in one of – I don’t want to say which company but very attractive valuations as well, so those are things we weigh again. But you’re absolutely right in terms of what we believe is a very, very attractive capital allocation.

Jason Stankowski – Castle Peak

Yes. Thou said many of the people want to get part of it near free but if those deals are out there that would be great as well. All right, thanks guys.

Operator

(Operator instructions) Our next question will come from the line of Matthew Kempler of Potomac Capital. Please proceed.