IHS Inc. F3Q09 (Qtr End 08/31/09) Earnings Call Transcript

IHS Inc. (IHS)

F3Q09 Earnings Call

September 17, 2009 5:00 pm ET

Executives

Andy Schulz – Senior Director, Investor Relations

Jerre L. Stead - Chief Executive Officer

Michael J. Sullivan - Chief Financial Officer

Jeffrey R. Tarr – President and Chief Operating Officer

Analysts

Vincent Lin - Goldman Sachs

Brian Shipman - Jefferies & Co.

John Neff -William Blair & Company

Peter Appert - Piper Jaffray

William Sutherland - Boenning & Scattergood

Presentation

Operator

Welcome to the Q3 2009 IHS Inc. earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Andy Schulz, Senior Director of Investor Relations.

Andy Schulz

Thank you for joining us for the IHS third quarter 2009 earnings conference call. We issues two news releases about one hour ago. If you do not have the two news releases we issued today, you will find a copy on our Web site at www.IHS.com.

In addition to announcing our third quarter and year-to-date results, we also announced our acquisition of Environmental Support Solutions, or ESS, for approximately $59.0 million net of cash acquired. ESS is yet another important step in the development of our environment domain offerings and we will full discuss the details on this call.

Some of our comments and discussions on the quarter are based on non-GAAP measures. Our non-GAAP or adjusted numbers, exclude stock-based compensation and other non-cash charges, net pension income, gains and losses on sales of assets and other items. Our earnings release includes both our GAAP-based income statement and statement of cash flows and reconciliations to the non-GAAP measures discussed during this call. These reconciliation schedules can also be found on our Web site. The non-GAAP results are a supplement to the GAAP financial statements. IHS believes this non-GAAP presentation and the elimination of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance.

As a reminder, this conference call is being recorded and Web cast and is the copyright and property of IHS. Any rebroadcast of this information in whole or in part without the prior written consent of IHS is prohibited.

The agenda for today’s call is as follows: Jerre Stead, our Chairman & CEO, will provide highlights of the quarter, review our most recent acquisitions, including today's ESS announcement, and update some of our strategic initiatives. Mike Sullivan, our Executive Vice President and CFO, will review our third quarter and year-to-date results, update our outlook for fiscal 2009, and provide an initial sense for fiscal 2010 expectations. After formal comments, we’ll then open the call for Q&A, at which time we will be joined by Jeff Tarr, President and Chief Operating Officer of IHS.

Please keep in mind that this conference call, especially the discussion of our outlook, may contain statements about expected future events that are forward-looking and subject to risks and uncertainties. Factors that could cause actual results to differ and vary materially from expectations can be found in IHS’s filings with the SEC and on the IHS Web site.

With that, it is my pleasure to turn the call over to Jerre Stead, IHS chairman and CEO.

Jerre L. Stead

Good afternoon and welcome to all of our investors and IHS colleagues, including our new colleagues at both Log Tech and ESS who are joining us on this call or Web cast. Today, after briefly reviewing our performance for the quarter just ended, I will discuss our recent acquisitions, focusing primarily on today's ESS announcement. I will also update you on two other important endeavors: the ongoing global insight integration and our Vanguard initiative.

Our financial results for Q3 were as follows: revenue for the third quarter was $239.0 million, up 15% over last year. Adjusted EBITDA increased 24% to $71.0 million and our adjusted EBITDA margin was up 200 basis points. Adjusted earnings per diluted share were $0.66, an increase of 18% over last year, and we generated $48.0 million of free cash flow during the recently completed quarter. Mike will provide more details soon.

Again, I wish to salute all of my colleagues for their terrific execution in delivering strong performance this year, under very challenging conditions. Our team has done a great job.

We are focused on improving our leadership position in critical information and insight across four targeted information domains: energy, product life cycle; security; and environment, all supported by macroeconomics that cover 170 global vertical markets 200+ geographic regions. We are executing this strategy both organically and through acquisitions.

Our acquisitions add capability to IHS that are highly desired by our customers. Hopefully, you saw our news release earlier this month regarding the purchase of Log Tech, a classic energy tuck-in acquisition. Log Tech is a leader in the development of digital log information and cost-effective software solution. The acquisition of Log Tech allows IHS to increase our Canadian well log coverage and expand our well log management product offerings across all of our markets.

Now, let's turn to today's acquisition announcement. The acquisition of ESS is another step in our commitment to be the leader in global environment health and safety management solutions. This acquisition puts IHS at the forefront of innovation and sustainability and climate change management. We will integrate the capabilities of ESS into our existing solid position in environmental, health, and safety and combine it with our capabilities and chemical life cycle management reach, materials compliance, and hazardous materials management systems.

This is another strong addition to our IHS portfolio. Organizations around the world need sustainability solutions and insight to manage climate change and compliance risk and to identify operational efficiencies. IHS is unique in the marketplace in its ability to give companies the means to combine internal operational data with external information to support strategic decision making around sustainability and compliance solutions for environmental, health, and safety and climate change. The acquisition of ESS increases the IHS capabilities in this arena.

Let me tell you a little bit about the company. ESS is an established global player in the environmental, health, and safety information systems space. They bring over 100 colleagues in six locations. Their people, software and customer base strengthen and further differentiate the IHS portfolio. Like our existing business, it provides software that enables organizations to address environmental, health and safety, and crisis management challenges more efficiently, at lower costs, while improving the quality and accuracy of internal and external reporting. The combination of IHS and ESS environment information solutions, deep subject matter expertise, and proven technology give IHS premier offerings in the market.

ESS has many attractive characteristics. First, it is a growing, profitable, environmental business, one that has been in existence for over 15 years. Second, ESS immediately enhances the capabilities and scale of our environment business through its attractive customer base, mature worldwide operations, and skilled workforce.

ESS delivers to IHS one of the largest environmental, health, and safety customer bases in the world, with 3,500 customers from mid-tier to large enterprises, including more than half of the Fortune 500 and 75% of the Fortune 100. These enterprise customers strengthen our market-leading position in asset-intensive process industries, while simultaneously providing greater access to mid-market customers.

Additionally, ESS extends our environmental, health, and safety reach into a broader spectrum of industries, including education, food and beverage, health care, and construction. This provides IHS more scalability and growth opportunities around the world, including North America, the EU and, especially the APAC region by supporting pictorial-based languages in an established base of business.

ESS brings additional skilled people providing breadth and depth to our highly talented group of colleagues. For example, the addition of ESS's seasoned sales, marketing, and development teams will be combined with our existing IHS teams to support the IHS environment domain in our rapid growth plans.

Third, ESS is a strong cultural fit for IHS. In addition to its passion for the environmental, health, and safety space, ESS has a commitment to customer delight and colleague engagement, with a history of providing profitable top and bottom line growth. ESS's ongoing partnerships with its customers and being innovative have helped it obtain excellent customer satisfaction ratings over the last two years, according to an independent research firm.

So again, we welcome our new colleagues and I look forward to providing you with examples of our success in the coming quarters as we add ESS to our environment domain.

Our acquisition pipeline remains healthy and we continue to see a multitude of opportunities as we remain a patient and disciplined acquirer.

It's hard for us to believe that it's almost been a year since IHS acquired Global Insight. We continue to be very pleased with the integration efforts following the acquisition of IHS Global Insight. It was a critical acquisition for us. By overlapping all four of our information domains the acquisition puts us at the center of the most critical business decisions that our customers are making every day, and it places us in the unrivaled position of being able to develop comprehensive solutions for our customers around the world.

Regarding our progress, we remain on track relative to our integration plans and we are ahead of our margin goals. We ramped up to 18% EBITDA margins during Q3, more than doubling our margins since the time of acquisition.

With regards to our integration effort, here are the details. We have achieved targeted milestones on our shared services integration and have initiated four integrated and joint commercial offerings, one of which has already been launched to customers, that is our global scenarios product. Using our IHS CERA and IHS Global Insight capabilities, this offering was launched in June with a Web cast attended by over 900 attendees from 250 different companies, representing 12 different industries. We have had five workshops to date, including one in London last week and are very excited about its growth prospects across many industries.

In terms of sales performance, Q3 was the strongest sales quarter to date for new subscription sales and consulting services for IHS Global Insight. We have fully integrated our consulting offerings and teams across all of Insight, including IHS Global Insight, IHS CERA, IHS Jane's, and IHS Herold, and we are now managing our consulting opportunities from a single company-wide integrated pipeline.

Finally, the acquisition of Global Insight continues to serve as a catalyst for change at so many levels throughout our company. For example, we recently consolidated five separate stand-alone offices in the London area into a single integrated facility. This move has many benefits: cost containment; margin expansion; and increased productivity by providing new opportunities to collaborate across key Insight products and services.

Now, let's move on to Vanguard. We believe that it is critical that we continue to invest meaningfully in the future of our company. In addition to the acquisitions we have completed over the last three months, we continue to make several essential investments which will help us delight customers both now and in future years and which will improve our infrastructure, allowing us to continue to grow revenue profitably and expand margins in the future.

A great example of this is our multi-year Vanguard program. This program will replace all of our billing systems and general ledgers, cleanse our customer and product master data, and put a governing structure in place to manage all of this in a consistent manner globally.

On our last call I said we had selected SAP to be our partner. We signed a contract, purchased, and paid for the software in the third quarter and we continue to work very closely with SAP to ensure the success of our implementation. Although the software selection was an important decision, we are very focused on the fact that our choice of implementation partner and the way in which we structure and resource our implementation is an equally important success factor. We have made significant progress to this end during the last quarter, having completed an extensive evaluation of potential partners.

Now, we will chose one and negotiate a contract that will provide measureable performance metrics and then we will move forward into our global design phase.

In addition, we have continued to create the organizational structure for the project that will provide the level of leadership talent and subject matter expertise to ensure that we can implement swiftly and successfully. We have created a Vanguard implementation team and have named Tim Jefferies as Senior Vice President and Chief Business Transformation Officer to lead this team. Tim will report to me and will lead the full Vanguard implementation organization under the strategic guidance and oversight of the newly-formed Vanguard executive team.

The Vanguard executive team is chaired by Jane Okun and comprised of four other members of our leadership team, representing each of our most relevant functional areas. In addition, we are assembling a very high-level and experienced implementation team comprised of our very best talent. This project is a critical one for us and we have put ourselves in the best position to succeed.

Several months ago we began work on a sales force automation initiative. This project will enable better sales collaboration, cross-selling, and enhanced customer delight. Because of the significant interdependence between Vanguard sales force automation, we have moved SFA into the Vanguard program to maximize synergies and best practices between our global ERP and CRM implementations.

As we head into this fourth quarter of our 50^th year in business, we remain laser-focused on one objective above all else: delighting our customers at every opportunity. We look forward to wrapping up the year with strong performance while we continue investing in and building for an ever more profitable future growth.

Now it's my pleasure to turn the call the call over to Mike.

Michael J. Sullivan

I will provide an overview of our third quarter year-to-date results and then I'll also provide an update to our 2009 annual guidance, as well as introduce our fiscal 2010 expectations.

First, let's start with revenue. Third quarter 2009 revenue increased $32.0 million, or 15%, to $239.0 million. The 15% total growth in revenue includes 2% organic growth, 17% growth from acquisitions, and a 4% reduction in revenue stemming from downward FX pressure.

The 2% overall organic growth rate was driven by strength in our subscription-based business which, although down moderately since Q2, grew by 9% in the third quarter. This subscription-based growth was offset by continued declines at our consulting, transactional, and other revenue transaction types, in particular consulting, which generated about $13.0 million in third quarter revenue. It was down 32% organically year-over-year at Q3. Despite the continued softness in this part of the business, we do see an improving consulting pipeline and are optimistic that we will ultimately see a conversion of that pipeline into revenue. I will comment more on revenue by transaction type a bit later.

Our acquisitive growth stems from IHS Global Insight and Lloyd's Register-Fairplay. Recall that we lapped the one-year anniversary of our IHS Global Insight acquisition in October and hence while its revenue growth will now contribute to our overall rate of organic growth, it's revenue will no longer be purely incremental to our revenue. Despite the FX headwind, revenue growth was broad-based in nature with growth in all three regions. America's revenue grew 15%, EMEA revenue grew 12%, and APAC increased 39%. America's organic revenue growth was flat, EMEA was up 3%, and APAC grew 19%.

In terms of revenue performance by offering type, critical information represented 64% of total revenue, while insight grew 65%, primarily due to acquisitions and accounted for 36% of total revenue.

Regarding revenue by transaction type, our subscription-based revenue accounted for 80% of total revenue and grew 9% organically on an earned or reported basis.

Importantly, our level of cash-based or invoice sales of subscription products also remains up over prior-year levels. This figure represents a good leading indicator for our subscription business as it sees through the [inaudible] revenue and focuses on real-time sales performance. And while this growth is not as great as a 9% reported organic growth in the quarter, it remains encouraging to see this critical part of our business grow during a very tough economic period. I will provide a bit more insight regarding subscription-based sales when I discuss domains in a minute.

Our transactional business was down 12% organically in the third quarter and represented 7% of our overall revenue. Consistent with the prior quarters, we've been able to effectively insulate the impact of profit of this historically lower margin business. As I mentioned earlier, consulting accounted for 5% of third quarter revenue and was down 32% organically in Q3 versus the prior year.

Finally, other revenue accounted for 8% of revenue in Q3. It was off 15% organically, due in part to lower one-time energy software sales.

Remember that the organic growth rates of our non-subscription revenue streams—transaction, consulting, and other—have historically been more volatile from quarter to quarter and will likely continue to be that way in the future.

For the third quarter of 2009 revenue by domain was as follows. Energy was 46% of total revenue and grew 1% all in. Energy was up overall, in spite of the negative impacts from FX and the absorption of most of the reduction in consulting revenue.

On the subscription side of the portfolio, we continued to see uplift from many of our customers, partially offset by higher churn rate for our smaller companies.

Product life cycle was 32% of revenue and increased 6% all in, despite facing FX pressure.

Our subscription-based PLC business remains a stalwart performer. It's growth rates have remained virtually unchanged to date in 2009.

Security was 11% of revenue, up 35% all in since last year and helped by the inclusion of LRF. Our IHS Jane's and LRF offerings have been among some of our better performers this year, especially the subscription portions of the portfolio.

And environment was 3% of total revenue, down 9% all in since the prior year. Keep in mind that our environment revenue is more volatile since it has less dependence on subscription-based products and on a year-to-date basis it has grown 35% all in.

We see a lot of excitement and activity in the marketplace and a growing pipeline and are focused on converting that pipeline to revenue and building out our capabilities with internal investment and acquisitions.

The remaining 8% of overall revenue is the portion of IHS Global Insight Business that supports all four of our domains and therefore represents all three but the intermediate intersection of all these domains.

Beginning next month, we will include its growth as part of our organic rather than acquisitive revenue, as we complete the first year of our Global Insight acquisition.

Looking at the rest of the P&L, gross margins improved 150 basis points year-over-year to 57.5%.

SG&A as a percent of revenue, and exclusive of stock-based compensation expense, improved relative to last year and represented 28.0% of revenue.

Adjusted EBITDA totaled $70.8 million, up 24% versus a year ago and adjusted EBITDA margins improved by 200 basis points versus the prior year to 29.6%.

Adjusted EPS increased 18% to $0.66 per diluted share in the third quarter, up from $0.56 last year.

Regarding the 200 basis point improvement in our adjusted EBITDA margin, note the following details:

First, to understand our true performance better, we normalized for the inclusion of IHS Global Insight, which while profitable, has diluted our margins for the past year. Excluding IHS Global Insight, the adjusted EBITDA margin would have been up another 160 basis points.

As a footnote, this is the last quarter for which we will be providing IHS margins with and without the inclusion of IHS Global Insight since we are now about to lap the one-year anniversary of the acquisition.

Also of note, IHS Global Insight has continued to improve its own reported margins sequentially since the time of our acquisition in Q4 2008.

The second of two normalizing margin adjustments relates to the consolidation of Lloyd's Register-Fairplay since our current presentation dilutes our margin by approximately 60 basis points relative to the prior-year presentation.

After considering both of these factors, our normalized year-over-year margin improved 420 basis points. Consistent with quarters one and two, this is likely an unsustainable rate of margin improvement, particularly on just two points of overall organic growth.

Having said that, this quarter's margin improvement was driven by the following factors. First, the third quarter margin strength continues to reflect the fact that our revenue softness has occurred in our least profitable revenue streams—transaction and consulting—which has had a significant positive impact on reported margins.

Next, margins also have been helped the last four quarters by the Q3 2008 restructuring, which we have now lapped, and the stronger U.S. dollar that was evident throughout much of the year. It is particularly important to note our reliance on both sales mix and currency in driving our margins to date in 2009, as neither of these forces is expected to continue to contribute in fiscal 2010.

To be clear, our business model continues to harbor great margin potential, we just won't likely continue to see the boost from these two forces. However, despite the fact that we will be performing in an environment where some meaningful forces may be working against us, we still expect margin improvement in 2010.

Turning now to segment profitability, America's adjusted EBITDA increased 16% to $56.3 million in the third quarter, compared to $48.4 million in the prior-year period. This increase was driven primarily by continued growth in the energy and PLC subscription businesses, as well as acquisitions to a lesser extent.

EMEA's adjusted EBITDA was $18.8 million in the third quarter, up 4% from last year's $18.1 million. And APAC's adjusted EBITDA was $6.3 million in the current quarter, up 49% versus last year's third quarter. The increase here was primarily driven by growth in our international energy data.

The reported tax rate for the third quarter of this year was 24.6% compared to last year's 18.7%. Remember that last year's rate reflected the cumulative, year-to-date benefit from the implementation of an inter-company debt structure.

Adjusted EPS increased 18% to $0.66 per diluted share versus $0.56 per diluted share in the third quarter of 2008. Please note that our earnings release provides the per share figures for a number of items that we exclude in measuring operating performance, on the schedule attached to the release. This schedule will show you the detailed reconciliation of reported EPS to adjusted EPS.

Now let me touch on year-to-date results just briefly. Revenue through Q3 of 2009 was up 16% from a year ago and our organic growth rate was 4% year-to-date.

Year-to-date adjusted EBITDA for 2009 was up 24% versus the prior year and the resulting EBITDA margin increased 2% to 28.3% from 26.3% last year.

Let's move on to the balance sheet. We ended the quarter with $118.0 million of cash and $77.0 million of debt. Receivables are up 14% over the prior year, in line with our revenue growth.

Deferred revenue at the end of the third quarter was about $310.0 million, which a year-over-year change of $46.0 million. The organic growth rate inherent in this increase was 5%, more in line with our cash base subscription sales growth.

Turning to cash flow, we generated $48.0 million of free cash flow in Q3, up from $40.0 million in the prior year, despite funding a rather significant level of capex in the third quarter of 2009. On a year-to-date basis free cash flow was $155.0 million in 2009, up from a $130.0 million in 2008. On a trailing 12-month basis, our free cash flow now totals $200.0 million, or $3.15 per diluted share and represents 76% of adjusted EBITDA.

As mentioned a moment ago, this significant level of free cash flow was generated despite higher levels of capex, stemming from some recent lease build-outs and the funding of our ERP licenses.

Our internally-generated cash flow has put us into a net cash position of $41.0 million as of quarter end and before the ESS transaction, despite outlaying about $60.0 million just last quarter for the acquisition of the remaining 49.9% of Lloyd's Register-Fairplay.

Regarding our share repurchase program, our only third quarter 2009 repurchases relate to the vesting of employee shares. Year-to-date IHS withheld approximately 210,000 shares, or $9.5 million of treasury stock, under this program.

We continue to see our overall liquidity as a strategic asset during these turbulent times and continue to believe that this strong balance sheet position and cash-generative business will serve us well in the months and quarters to follow.

Now before I get to guidance, let me give you a brief overview of the financial characteristics of the ESS acquisition. We purchased ESS for approximately $59.0 million, net of cash acquired, which represents about 3x revenue. On a forward basis, we expect this represent a high-single-digit multiple of adjusted EBITDA.

Consideration was paid in all cash and since ESS was acquired subsequent to our quarter end, our third quarter results were not affected by the acquisition.

Now let's turn to 2009 guidance. Our guidance is on an all-in basis and includes all acquisitions to date, including ESS. Also, our guidance assumes no further currency movements, restructurings, unanticipated events, or additional acquisitions.

For 2009 we expect all-in revenue growth of 14% to 15% from a 2008 base of $844.0 million. All-in adjusted EBITDA growth of 22% to 24% from a 2008 base of $225.0 million. Net interest expense to be approximately $1.0 million to $2.0 million. Depreciation and amortization to be $50.0 million to $52.0 million. Stock-based compensation expense is expected to be in the range of $56.0 million to $58.0 million. Our tax rate to be approximately 28% to 29%, and we expect fully-diluted shares to be about 64.0 million in 2009.

Looking ahead to 2010, we wanted to give you an early sense of our expectations. Based on current FX rates and assuming no further restructurings, unanticipated events, or additional acquisitions, we expect 2010 all-in revenue in a range of $1.04 billion to $1.08 billion, and adjusted EBITDA in a range of $312.0 million to $324.0 million. IHS expects to provide full 2010 guidance in December 2009.

Last, there is one seasonal item we wish to call to your attention, specifically for 2010 the 29^th annual CERAWeek conference will fall in our second fiscal quarter as opposed to our traditional first quarter. CERAWeek 2010 will be held March 8-12 in Houston, Texas. Please go to CERAWeek.com to sign up.

In closing, while our top line growth has slowed, it feels good to be able to deliver growth and to meet our profit objectives as we've managed the business through this difficult cycle. We are encouraged that our free cash flow generation has held up so well. We continue to invest in the company's future and feel very good about the position we will be in once growth reaccelerates.

With that, let me turn the call back over to Jerry.

Jerre L. Stead

2009 has been an exciting year of progress for our company, during the most severe global economic downturn in over 50 years. We look forward to wrapping up a successful fourth quarter and delivering continued improvements in all areas of our company in 2010.

Thanks for your time today. Mike and Jeff and I are now ready to do the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Vincent Lin - Goldman Sachs.

Vincent Lin - Goldman Sachs

I wanted to get some color on two items. The consulting weakness and given the easier comparison this quarter, I was a little bit surprised by the decline this quarter. Are you starting to see things starting to turn a little bit there, just given some stabilization on the macro environment that we have seen recently.

And then secondly, looking at the organic growth of the deferred revenue balance, it looks like there is some more modest deceleration versus the 7% that you reported last quarter. Is there any seasonality in there or it's just a function of the environment and whether we should expect to see some modest pickup in the November quarter and going forward.

Jerre L. Stead

A couple of comments, just to put in perspective. The organic downturn that Mike talked about was on $12.7 million of revenue on consulting. It did not include the acquititive part, which was the Global Insight. They were actually flat year-over-year. That was not included.

As to point two, and Jeff will add color to this, our pipeline is a very good pipeline today from a consulting standpoint. And I think we feel quite good about what's coming in the future. Jeff will give you a little color, though, on how we've worked to get it to be a meaningful and profitable pipeline.

Jeffrey R. Tarr

Just a little context first of all, it's still a continued tough environment for the consulting business. Also we have been very busy rationalizing that product line, so we now have a much better product line, one that is tighter. It's integrated under a single leader, which creates an opportunity for scale that we didn't have before. And also to create some new and more compelling offerings for our customers.

We do feel good about the pipeline. It has continued to build in recent months. Not much more to share on that.

Jerre L. Stead

And as I mentioned in my part of the talk today, and as Jeff just said, we now have all pieces of consulting reporting in and I think we feel very good about where we'll be in the future.

Two other quick comments on that, we had said last year that we thought we would get consulting to be in the 5% to 9% of total revenue range. We are now there. As Mike mentioned, 80% of our revenue in Q3 was end of subscription based and 5% was consulting. And we now feel pretty good about that range of 5% to 9% profitable consulting going forward.

On your second part of the question on deferred, Mike.

Michael J. Sullivan

A couple of quarters ago we introduced this sales metric into our calls to really begin to see through the deferral of revenue on that subscription engine and I have commented now for a couple of quarters in a row we are encouraged, that even on a sales basis, we continue to see growth in the subscription portion of our business, just not at the levels that we're reporting, the 9% that we reported for earned subscription growth.

So when you look at the deferred revenue balance and the five points of organic change there, it's coming more in line with the real level of sales growth in the company, so it looks pretty reasonable to us. I'm not going to project what I think it is going to look like next quarter but I would tell one of the real values of focusing on this sales metric for us is it gives you all a chance to, with more immediacy, see the turn in that subscription business as the sales metric would likely begin to reaccelerate, obviously in advance of the deferred run out of the revenue.

So not to diminish the importance of the organic growth rate in the deferred revenue balance, but I think sales has now become an even better leading indicator for us to focus on.

Jerre L. Stead

That was part of the reason we chose to give the early guidance in both revenue and EBITDA for 2010. I think you will be able to see pretty clearly as you work through that, our expectations for the turnaround of all pieces of our business in 2010.

Operator

Your next question comes from Brian Shipman - Jefferies & Co.

Brian Shipman - Jefferies & Co.

I am assuming the 2010 guidance includes today's acquisition. Ex the acquisition, what is the organic revenue growth assumption embedded in the guidance that you're using. It appears you're remaining on the conservative side of things. Is that a fair characterization?

And then you mentioned reported margins were helped, I would assume over the last couple of quarters, as the more profitable parts of your business have become bigger contributors. If we see transaction and consulting businesses coming back meaningful, and you kind of alluded to the fact that you think they will, will that actually curtail the margin expansion or hurt margins? I think you kind of alluded to it, if you could expand on that a little more.

Jerre L. Stead

Again, I would encourage you to look at the guidance we just gave, and you're going to figure out real quickly that you'll see expanded margin improvement in 2010. Let Mike pick up on the rest of the questions. And great questions.

Michael J. Sullivan

We wanted to give you a sense of the dollars in a range of revenue for next year. I think you would appreciate it's pretty early. We would really rather not get into any of the piece parts of what comprises the year-over-year change, but you know we've got a few forces—organic, acquisitions, and FX. The only substantial acquisition I would say that's contributing next year, you're right, is ESS. And maybe you could look at the foreign currency environment. But I would rather not give you any adjectives on the degree of organic growth or how we feel about it.

Jerry's right on margin expectation. What I'm trying to do is to let people know that 420 basis points isn't a sustainable expectation and it's been driven in part by a couple of forces that probably won't continue. But as Jerry elegantly pointed out, the guidance we gave today has profit growing at higher clips than revenue and if you kind of run through those numbers, I think you will see margin improvement in the range we've historically committed to delivering on an all-in basis.

Jerre L. Stead

Let me just bold on that because I'm not sure Brian was back with us at the beginning. We said three-and-a-half years ago that an intermediate target for us on margin expansion was 30%. As a refresher, we were at 18.5% when we went public, not quite four years ago.

We said last year, at this time, when we acquired Global Insight, that Global Insight's low margins would cost us a year in reaching that intermediate target of 30%. We also said that we expected Global Insight to go out of 2009 into 20%+ level of margins. You heard me talk today, we're at 18%, actually ahead at the end of Q3 on that projection.

So if you thought about it, you'll see that we're very much on target as a 30% target that we laid out three-and-a-half years ago. And we would also say the same thing we did in May at our investment day when Mike and I and Jeff, in fact, all talked about there is no foreseeable limit to margin improvement going forward. Despite the fact that we are investing a great deal, and will continue to, in the kind of infrastructure things that we talked about, and new products, today.

Michael J. Sullivan

I think the other thing to point out on those transactions types, the targeted margins in these parts of the business, they're not necessarily dilutive to our overall margins. They can be somewhat dilutive to our growth when stacked up against parts of the business that contribute nearly 100% revenue to profits.

So I don't want to let this be taken the wrong way, we don't have loss leaders in the portfolio, it's just that when you focus on year-over-year improvement margins, that the mix of profitable products and services becomes very relevant.

Brian Shipman - Jefferies & Co.

How was the 2% organic revenue growth performance versus your own internal plans and do you feel like you're at the bottom with that number?

Michael J. Sullivan

I think I would just default to the guidance that we've given throughout the year. You saw us tighten our range and top line all-in from 12 to 16 to 14 to 15. That nudged the midpoint up just a little bit. We're picking up a little bit of revenue on this acquisition for the last 2.5 months or so of the year, so it will kind of spell out that we're operating pretty comfortably in the zone of expectations.

And like you all are doing, we are watching our pipelines and our sales metrics and the other leading indicators of free cash flow closely to pinpoint that point of reacceleration.

Jerre L. Stead

One additional comment because these are critical questions. In Mike's presentation he talked about the mix of small companies that have cancelled and the actually quite good uplifts that we have enjoyed from a value selling standpoint during 2009, on certainly energy, product life cycle, and security.

So I would say we feel quite good. That puts us a 4% year-to-date organic growth and you can probably do the math to see how this is going to play out for us.

Key point, as Mike made, Jeff wakes up every morning, Jerry wakes up, Mike does, and all the rest of us, thinking about organic growth and where we go in 2010.

Operator

Your next question comes from John Neff -William Blair & Company.

John Neff -William Blair & Company

The acquisition of ESS is one of the six other early leaders in the Groom study that was mentioned. Could you elaborate a little more on why ESS, what specifically they brought to the table. The press release makes some reference to some data that they have but most of the descriptions seem to describe them as a software company. This is a question I asked Jeff last quarter, but sort of the whole software-versus-data question as it relates to the long-term strategy, as you see sort of the environmental domain taking shape in the future, how that relates to this acquisition.

And then a couple of numeric-type questions. Thousands of customers but $20.0 million in revenue, roughly, and is there a deferred revenue write-down associated with that acquisition?

Jerre L. Stead

It's important that we remind everybody that we have a long and patient look at potential acquisitions. ESS is one we have highly valued for well over two years ago when we first started looking aggressively for acquisitions in the environment area. Jeff will give most of the details but I will tell you there are two things that come to mind.

ESS brings great colleagues and products and services to complement our current great colleagues and products and services in environment. They also give us a leg up in the Asia Pacific region that is of significance, complementing customers that we do a lot of business within our other domains. So that's a big peck.

Jeffrey R. Tarr

You hit the big ones, Jerry, on team, platform, customer base. One of the benefits we've had of being in this space now in the year since we acquired ESP, is we've gotten to see who we're competing against, who we're dealing with, who else has products inside our customers with adjacent functionality.

And time and time again we've been impressed with ESS, their capabilities and the extent to which it complements what we've been doing and it fills in some product gaps. We now feel we have a very complete offering with best-in-class capability across the board in this space. A strong presence in every major region that we operate and we're excited about that.

Looking forward and building on that, one of the things we liked about ESS is that it really did fill out that customer base. We now have a very large customer base. We believe the largest customer base in the space for this type of platform. What a great place to operate from as we add information and insight to the offering.

And I will just tell you an anecdote, I was with a customer not long ago who was sharing with me, and this is a customer of the IHS environmental management offering. First of all, she told me time and time again that she made the right decision. And when I asked her what can we do next, what can we do to further delight her, and what she said was help them model scenarios, because the world is changing, the regulatory environment is changing, they have some big decisions to make. How do they think about the ability of taking their carbon and CO2 and actually reusing that and possibly selling enhanced CO2 and how does that change their investment profile.

Well, that's what we're building. And that's a capability we're building, taking our information, our insight, and leveraging it across what is now the largest and best platform in the world.

Jerre L. Stead

And Jeff, just add to John's other point on software as compared to data.

Jeffrey R. Tarr

What I just described, that scenario, the modeling capability, is information and insight intensive. And that is in line with our existing business model.

Michael J. Sullivan

John, I love the sequence, kind of why ESS, software versus data, and then right to the deferred revenue write-down. But as you know, you've spent a lot of time here. We have deferred revenue write-downs on every acquisition we do and this is no exception. It's perhaps a funny way to ask and a funny way to say it, that yes, there is deferred revenue in this business. We will have deferred revenue on the opening balance sheet.

Expect that this fully embedded in our revenue guidance outlook that we just gave. And I would just close by saying when we look at the economics of a particular deal or acquisition, we do tend to look through some of the bookkeeping, like the deferred revenue haircut that we take on the opening balance sheets. And look at the real revenue growth potential and cash generation of the businesses, to get to the right valuation. So hopefully that suffices as an answer.

Operator

Your next question comes from Peter Appert - Piper Jaffray.

Peter Appert - Piper Jaffray

Mike, with regard to sort of trimming the higher end of the guidance, to the extent that FX is less negative in the fourth quarter and you've got the incremental contribution from the acquisition, I guess the implication you might read into that, is that there is some further slowing in the tone of the business. Can you comment on that?

Michael J. Sullivan

Yes, first of all, we tightened the range. We don't need four points of range this late in the year. We kind of look at that midpoint and how that moves is the directional way in which we feel the guidance has moved. And again, brought it up about a half point, largely to accommodate the revenue that we will see from this acquisition in the balance of the year.

FX, you're right that the force in fourth quarter will be less than third quarter but when you look at the full year guidance, it's relatively unchanged from the last time we spoke, three months ago. So that didn't move materially, we nudged the midpoint up a half point to accommodate the acquisition, and we tightened the range for you. That's how I think about what we did there.

Peter Appert - Piper Jaffray

And you sort of addressed this earlier, but any color on new sales trends in the quarter and sales activity? Is there feedback from the sales people in terms of tone of business currently?

Michael J. Sullivan

Yes, I think the tone of business feels like it's picking up. The leading indicators we watch, cash-based sales on the subscription engine still positive, and a little bit more positive than they were in Q2. The pipeline is building. We need to get more signatures on that pipeline and bring in some of that consulting and software business. And then our cash flow is another good indication, a leading indicator of the business, having a 20% year-over-year increase there despite pretty dramatic increased levels of capex. It feels good as well.

So come cautious optimism, I think we sense, and leading indicators that are starting to show marginal, but encouraging, improvement.

Jeffrey R. Tarr

Some of the terms I hear from sales people is I hear terms like thawing, the decision making is starting to free up. We have seen a number of projects continue to move forward. For example, in the environmental space. Continue to build a pipeline rack up verbal wins, that has been offset by decision making still staying quite high in organizations, which lengthens the sales cycles and sometimes causes some movement of a closing of a deal from one quarter to the next. And that is still a factor.

The other way that we look at this is by domain. And as you heard Mike say, the product life cycle domain has tended to perform very well and very consistently for quite a string of quarters. If we look at the other large driver of revenue growth, the other large domain being energy, certainly we will feel better when we start to see more of that consulting revenue come through the pipeline.

And then one of the other metrics we watch is what's going on with natural gas prices, which tends to affect the smaller companies. You heard Mike talk about churn amongst the smaller energy companies, particularly in the North American market, where gas is a big factor. But hopefully see some turnaround there.

And we should also next year cycle through that year of difficult market conditions.

Peter Appert - Piper Jaffray

Jerry, I think you had indicated in the past that the environmental segment was clearly the focus from and M&A standpoint. Is that still the case? Do you think there's more to come?

Jerre L. Stead

This was a big step. A good question, Peter. A big step for us. Our pipeline right now is very active and it actually touches each of the domains. Actually pretty well balanced. So we feel good about the things that will complement us in each of those domains. We've seen valuations get to a point that we are hopeful puts us in the opportunity to continue to make those strategic acquisitions.

But for sure we've got to focus on environment. Certainly as Jeff said a while ago, we now feel like we're in a significant leadership position here. And we will continue to complement that.

But suffice it say, I could think of potentially good acquisitions in each of the four domains right now.

Operator

Your next question comes from William Sutherland - Boenning & Scattergood.

William Sutherland - Boenning & Scattergood

Can I get some color on the pricing trends that you're seeing in the market?

Jerre L. Stead

I mentioned a few minutes ago, setting aside the cancels of the medium to small end, in energy particularly, we have been very pleased with the value increase uplift with our selling in that environment.

Jeffrey R. Tarr

To give some context to that, we've been talking about over the course of the last year what we've been doing to invest in the quality of our information and insight, and one of the attributes of quality means expanding. Our information collection is growing every year. And because of that, that enables us to command a fair and generally higher price each year for what is a larger and higher quality collection of information. We continue to be successful in that endeavor and especially with our core customers.

William Sutherland - Boenning & Scattergood

So I think you have had to obviously hold back on some of the pricing this year, is that feeling like that's going to loosen up in the coming quarters?

Jeffrey R. Tarr

I would say that we've been getting fair prices for improvement in quality across the board and I would say where we've seen pressure as we've talked about, is in the mid-to-small side of our market, smaller customers. And that's where if we've seen pressure, it's primarily been there. And that's been market conditions. But certainly continued strength because of our investments in quality.

William Sutherland - Boenning & Scattergood

In the environment, the lumpiness there, any additional color as far as that little downtick in the quarter?

Jerre L. Stead

These are large projects and starting with million dollar up projects in many cases. They take time for approvals and as they move up the organization, the good news is we're able to provide education to higher levels in the organization as we move upwards and so it takes time, therefore it does tend to be lumpy.

One of the things that we're pleased with, with the addition of ESS, is that we do have, because of our other domains, very good relationships at the C levels and we think that will help us with that addition.

And so when we say lumpy, you know, having run software businesses as I have over the years, this is far less lumpy than some of the big ones are, but we're going to see things bounce up and down on a quarter-to-quarter basis.

The pipeline, though, I would like Jeff to comment on.

Jeffrey R. Tarr

The pipeline has continued to grow. Certainly the summer is a tougher time in software businesses but the fact that we've had to move up organization, there is a great deal of C-level interest in environment and sustainability and in some cases board-level interest. And so what we have found, and in some places we've gotten verbals from the decision makers who themselves have been surprised at how high they've had to go up in the organization to get approval. That's another factor.

Another one is the fact that we've been very focused on the ESS acquisition over the last couple of months and that has taken time and effort. And also, we want to make sure that our customers make the right decision across a broader portfolio of offerings with which we're entering Q4.

And then finally, we've got our user group, both ESS and IHS, have our user-group conferences coming up over the next few weeks. Future years, there will be one, this year we have two. But this upcoming quarter is an important quarter for those events.

Operator

Your final question is a follow-up from John Neff -William Blair & Company.

John Neff -William Blair & Company

The lumpiness in the environment domain, is that because this is a predominantly licensed model, on the software side?

Jerre L. Stead

No, it's because it's a large sign-off decision. That in most companies never been signed off before. It's really important to understand that phenomena. Most companies have not bought the kind of product that is now needed to help them make their decisions from an environment standpoint before.

Jeff's comment was so important a minute ago, which is we've had—weeks ago—commitments from people that thought they were at the level of approval to find out they had to go up higher as the organization changes. And it's very important to recognize.

This is now a risk management subject at the board level of most companies, which is a good thing for IHS. So that's very good news for us, but it is a new and important change for most companies.

Jeffrey R. Tarr

Nothing to add there that we haven't already said, although if I think about what's coming up, as I mentioned, we have a couple of user conferences coming up. We have the end of year for IHS, what has historically been the end of year for ESS comes up in Q1 as well as in our Q1 the end of the calendar year for our customers, and for better or worse, those tend to be significant times for enterprise software.

Jerre L. Stead

So I think you will see as we move forward that the cycle, which is a longer cycle today, will get ever more sophisticated and move quicker in the future.

I think with that we're ready to wrap up. Just a quick comment again. We feel very good. I'm very proud of the team that has gone through this amazing year. As I said, we expect to wrap up a good fourth quarter and we gave you an early indication of what we think is going to be a very good year in 2010.

Andy Schulz

We thank each of you very much for your interest in IHS. This call can be access via a replay at 888-286-8010, or international dial-in, 617-801-6888, pass code 27763090, beginning in about two hours and running through September 24, 2009.

In addition, the Web cast will be archived for one year on our Web site at IHS.com. And as always, you can contact IHS Investor Relations with any follow-up questions. We can be reached at 303-397-2969.

Operator

This concludes today’s conference call.

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