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Information Services Group, Inc. (NASDAQ:III)

Q3 2013 Results Earnings Call

November 8, 2013 9:00 AM ET

Executives

Barry Holt - Communications Executive, ISG

Michael Connors - Chairman and CEO

David Berger - Executive Vice President and CFO

Analysts

Vincent Colicchio - Noble Financial

Justin Ruiss - Sidoti

Operator

Please standby, we are about to begin. Good day. And welcome to the Information Services Group Third Quarter Results Conference Call. Today's conference is being recorded and a replay will be available on ISG's website within 24 hours.

At this time for opening remarks and introduction, I would like to turn the conference over to Mr. Barry Holt. Please go ahead, sir.

Barry Holt

Thank you, Operator. Hello and good morning. My name is Barry Holt. I'm a Communications Executive at ISG. I'd like to welcome everyone to ISG's 2013 third quarter results 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 the 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 that was furnished yesterday to the SEC and the Risk Factor 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, 2012 and any other relevant documents, including any amendments or supplements to these documents filed with the SEC when they become available.

You'll be able to obtain free copies of any of ISG's SEC filings on either ISG website at www.isg-one.com or the SEC's website at www.sec.gov. ISG undertakes no obligation to update or revise any forward-looking statement to reflect subsequent events or circumstances.

Non-GAAP measures are provided as additional information and should not be 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 submitted yesterday.

And now I’d like to turn the call over to Michael Connors, who will be followed by David Berger. Mike?

Michael Connors

Thank you, Barry, and good morning, everyone. Today David and I will review our record third quarter and September year-to-date results and financial highlights, update you on some of our business highlights and conclude with our full year guidance for both revenues and adjusted EBITDA for 2013.

Our momentum continues, despite a mixed global economic environment we continue to see robust demand which illustrates both the value we provide to our clients and the market opportunity for our services. We are pleased to report another solid quarter with record revenues for the third quarter and record revenues for the September year-to-date results.

Revenues for the quarter totaled $51.4 million up 11% versus the prior year. Year-to-date revenues through September totaled $157.5 million up 10% versus the prior year. In addition, we generated almost $7 million in free cash flow during the quarter, strengthening the balance sheet and lowering our leverage ratio further below three times EBITDA.

We continue to witness broad-based demand extending the favorable revenue trends recorded during the first half of the year. The record revenue results were driven by another strong quarter in Europe up 19% year-on-year. Our return to growth in Asia-Pacific which was up 10% and 6% growth in the Americas which was the 10th straight quarter of growth there.

Our recurring revenue streams of managed services, research in our U.S. public sector grew 34% over prior year to $11 million in the third quarter and $31 million year-to-date, up 28%. Additionally, recurring revenue streams now account for almost 20% of ISG’s total revenues, well on our way toward our target of 25% in 2015.

The continued strong growth in Europe was driven by the energy in the U.K. public sector verticals. In the U.K. public sector, in addition to our previously announced contract win with the U.K. Ministry of Defense, we are doing work with the home office, the Department for Work and Pensions, the Vehicle and Operator Services Agency, now the Skills Funding Agency, the National Employment Savings Trust as well as the Post Office in BBC.

As I stated earlier, the Americas posted a 10-straight quarter growth. Their increase was driven by managed services and growth in multiple industry segments, including the U.S. public sector, technology, retail and the energy verticals. Asia-Pacific returned growth this quarter despite challenges in Australia where elections were held on September 7.

The incumbent government was defeated by the center-right Liberal national coalition. We believe these election results will spur demand for our services next year, as the new government seeks to lower cost and improve efficiency. Globally, our Blue Chip client wins for the quarter included such as National Grid, PHOENIX Pharma in Germany, Federal Express, Volkswagen, Northeast Utilities, Siemens, Goodyear, Silverleaf Resorts, BNP Paribas and Allied Irish Bank.

From a year-to-date perspective, recorded revenues were recorded totaling nearly $158 million, up 10% versus the prior year. This was supported by double-digit growth through first night months in Europe and the Americas, offering -- offsetting the anticipated decline in Asia-Pacific. We served 384 clients in the first nine months and revenue from our top 50 clients was up over 20% versus the prior year.

Turning to Managed Services, as we indicated previously in June, we signed a five-year contract with Marriott for over $14 million. Net revenue began soon. We will manage contract, performance, financial and relationship management for our client’s application data and maintenance, datacenter, network and service debt sourcing agreements.

I’d like to conclude my remarks with an update to our full-year revenue and adjusted EBITDA guidance for this year and comment on the recent performance of our III stock. We are reaffirming our previously raised full-year guidance with revenues between $205 million and $212 million and adjusted EBITDA between $21 million and $23 million.

We remain optimistic about full-year 2013 and our ability to continue to advance our long-term strategy. Our full-year guidance is based on a number of factors, including the strong year-to-date performance and our outlook for the balance of the year. The momentum we have experienced year-to-date with revenues up 10%, including this quarter’s double-digit growth in Europe.

Our recurring revenue streams of managed services research in the U.S. public sector, up 28% year-to-date. Year-to-date, EBITDA growth of 25% coupled with the current business trends and lead activity in our sales pipeline. With an expected offset in the fourth quarter by fewer billable hours and an unusually larger build up of employee vacation days in the U.S., due to the market demands in the first nine months.

Looking beyond 2013, our senior management team met at our Annual Strategic Retreat Weekend to review our key growth initiatives. We reaffirm that our strategy is working and are pleased with the year-to-date results. As reflected in both our revenue and EBITDA growth as well as the 20% growth in our top 50 clients. As a team, we continue to set an internal goal to organically with EBITDA of $30 million in 2015.

We remain focused on broadening our client relationships. We’ve expanded our focus from a transactional approach, driven by outsourcing to a broader strategic discussion, driven by the impact of emerging technologies and the need for operational efficiencies across the entire client enterprise.

We continue to focus on shareholder value by reducing the risk to our equity holder by further deleveraging the company. We retired $4.4 million of debt year-to-date. Strengthening our balance sheet with our new credit agreement and extending its maturity to May 2018 at very attractive interest rates.

Repurchasing $3 million in ISG shares and finally continue to meet with perspective new investors, a number of whom are now shareholders of ISG. We are managing the company for long-term growth. Our investors are recognizing our performance and potential, with III stock up nearly 300% for the year.

So with that, now let me turn the call over to David Berger who will summarize our financial results.

David Berger

Thanks, Mike and good morning everyone. Before I discuss our financial results, I would like to reiterate that ISG has presented GAAP financial results as well as certain non-GAAP financial information in our earning release.

During this call, I will discuss certain non-GAAP financial measures, which ISG believes improves the comparability of the company's financial results between periods, and provides for greater transparency of key measures used to evaluate the company’s performance.

Non-GAAP measures, which I will touch on today, include adjusted EBITDA, adjusted net earnings and the presentation of selected financial data on a constant currency basis. A complete reconciliation of non-GAAP financial measures is included in our earnings release, which was furnished to the SEC on Form 8-K yesterday.

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.

As Mike stated, ISG recorded record revenues in the quarter and record revenues on a year-to-date basis. Third quarter revenues totaled $51.4 million, up 11% versus the prior year in constant currency and on a reported basis. Revenues increased by 19% in Europe to $17.6 million, 10% in Asia-Pacific to $5.3 million and 6% in the Americas to $28.5 million, growth rates are in constant currency.

Operating income totaled $1.8 million for the third quarter of 2013 versus $2.4 million in the prior year period. The third quarter results included $2.1 million in stock-based compensation, which was recorded to selling, general and administrative expense on the P&L versus $700,000 in the prior year, driven by the vesting of performance-based restricted stock units, which was triggered by ISG share price, which was up 115% for the quarter.

Fully diluted earnings per share for the quarter was $0.01, compared to $0.01 for the same period in 2012, diluted adjusted earnings per share increased by 46% from $0.05 to $0.07.

Adjusted EBITDA of $5.8 million was up 9% on a reported basis and 7% in constant currency, compared with $5.3 million reported in the third quarter of 2012. The 2013 third quarter results included the charge totaling $100,000 for performance-based liability tied to the STA Consulting earn-out that is reasonably likely to be paid in the future.

The 2012 third quarter results included the release of our performance-based liability tied to the STA Consulting earn-out of $1.9 million. Excluding the performance-based liability accruals from both years, adjusted EBITDA was up 68% for the quarter driven by revenue gains and cost productivity.

Utilization for the quarter was 67%. Headcount increased by 19 in the quarter to 859 with most of the increase headcount in India to support growth in managed services.

ISG reported record September year-to-date 2013 revenues of $157.5 million, an increase of 10% in constant currency and on a reported basis, and was up $14.3 million from $143.2 million in the prior year.

Adjusted EBITDA for 2013 September year-to-date of $17.3 million, compared to $13.7 million of adjusted EBITDA for September year-to-date 2012, up 25% in constant currency, diluted adjusted earnings per share increased by 57% from $0.14 to $0.22.

We continue to maintain a strong liquidity position to support the implementation of our business plan. Cash and cash equivalence totaled $23.6 million at the end of the quarter, which was a net increase of $4.6 million from June 30th.

Free cash flow defined as cash provided by operating activity less capital expenditures are $6.4 million for the first nine months compared favorably to an outflow of $1.4 million for the same period in 2012. We repurchased $1.7 million worth of ISG shares during the quarter, $3 million year-to-date. We spent $1.6 million on CapEx in the first nine months consistent with last year.

During the quarter, we spend $800,000 to pay down debt. We have $59.3 million of total debt outstanding and our leverage ratio has declined to 2.7 x EBITDA at the end of the quarter. Due to the strong financial performance and focus on deleveraging, interest rate short is our term loan will be reduced by 50 basis points to LIBOR plus 3% in the fourth quarter.

Our accounts receivable balance as of September 30th was $46.8 million and our DSOs were 78 days.

Mike will now share concluding remarks before we go to Q&A.

Michael Connors

Thank you, David. We are pleased -- very pleased with our nine month results and remain optimistic about our outlook for the full year.

In summary, the third quarter was a record revenue quarter, up 11% versus the prior year and contributed to our record nine-month revenues. Our strategy is paying off. With our recurring revenue streams of research, managed services in the U.S. public sector of $31 million for the first nine months is up 28%.

September year-to-date revenue for our top 50 clients, up over 20%; Europe revenue through nine months, up 16%; year-to-date EBITDA, up 25%. We continue to pay down debt and de-lever our company. As such, our leverage ratio remains below three x EBITDA with our interest rate declining as David mentioned.

And finally, the market has begun to recognize our efforts with ISG shares up nearly 300% for the year. And even with this improvement, we feel our shares are undervalued.

Thanks very much for calling in this morning. And now let me turn the session over to our operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Vincent Colicchio with Noble Financial.

Vincent Colicchio - Noble Financial

Yes, good morning guys and congratulations for the nice quarter.

Michael Connors

Good morning, Vincent.

Vincent Colicchio - Noble Financial

Good morning. So in Europe, could you give us little more color in terms of, I know, there is a lot of stress in the U.K., are there any other geographies you are feeling good about and you named bunch of the agencies you’re doing work with, in the U.K. Are any of those that you mentioned new and what does the pipelines looks like for next year, if it is not too early?

Michael Connors

Yes, Vincent okay, first of all in terms of Europe, I would say there are probably three key contributing factors to our kind of turbo-charged growth there. One, we have very strong leadership in Europe. We have people that have been in the business, in the industry, understand it and understand what our client needs has been changing and emerging, so that’s one.

Two, we invested in the business you will recall last year to begin a new channel in the public sector in the U.K. I don’t have that list back in front of me but roughly half of those clients that I rattled off for the public sector are new, either towards the end of second quarter or end of third quarter. So that is also driving new revenue growth. Also, our German and French market, our French market in particular has picked up dramatically during 2013, so our three, kind of, four major hubs, U.K., France, Germany, are all growing. Our Nordics market, we are investing in the market there and we will see that growth towards the end of this year and end of 2014.

We’ve expanded in Denmark, Finland and in Sweden during the last three or four months. So our presence there has more than doubled, so we anticipate that being a growth engine sometime in 2014 and 2015. So those are the reasons we think Europe is growing. We’ve got good set of product and services now for our client base. They believe in our strategy and we are getting a larger share of their spending.

Vincent Colicchio - Noble Financial

Your top 50 continues to perform well. Anyhow, there’s obvious reasons, right, managed services is coming online and doing well. You’ve got more and you are cross-selling. Starting from the obvious, is there any new insight you may have on that because it looks like it’s actually improving versus the last quarter?

Michael Connors

Yeah, good point. I think, what we’re able to do now is just recall. We integrated all of our businesses under the ISG brand and that has enabled us to have a much broader discussion, not only with the CIO and the CFO, but we are also now penetrating into the Chief Marketing Officer, if you will to see suite in these organizations.

So, our four recall, ISG products and services wheel is working, everything from our benchmarking and analytics to our strategy work, to our transaction, to our managed services work. So it’s giving a larger share of their spending coming to ISG. Their spending is not increasing in totality of that much, so we’re taking some of the spending and share away from others that they may have provided in the past, so those are the real key reasons, Vince.

Vincent Colicchio - Noble Financial

And then, David looks that utilization or utilization rate dropped a bit sequentially, was that surprise and how do you see trending going forward?

David. Berger

Yeah, that’s not a surprise. It was pretty consistent with the prior year and you have the impact of the holidays, particularly in France and in Europe during that period. Mike did mentioned that in fourth quarter, we do have some because we are in a combination of clients taking holidays at the end of the year and some build up of holidays in the Americas that will impact that but overall the utilization is 70% through nine months.

Vincent Colicchio - Noble Financial

Okay. That sounds a good healthy number. And then just one more and I will go back in the queue, Asia Pacific, so it wasn’t really Australia, could you give us more color on what was driving the growth?

David. Berger

Yeah, in the quarter, they said I think Asia Pacific in terms of its year-over-year for the full year is not going to be that robust until the government comes back and we expect that next year. But third quarter, we had great penetration in Asia in places like Thailand, the Philippines and in Hong Kong. And in addition, we had a commercial client in China also expand our business with us. So, of the Asia component of our Asia Pacific had a strong quarter and that’s really what drove that growth.

Vincent Colicchio - Noble Financial

Okay. I will go back in the queue. Thanks, guys.

David Berger

Okay. Thank you, Vince.

Operator

(Operator Instructions) We’ll go next to Justin Ruiss of Sidoti.

Justin Ruiss - Sidoti

Good morning, Mike. Good morning, David.

Michael Connors

Good morning, Justin.

Justin Ruiss - Sidoti

I just had a quick question on the managed services side, I know, you have been adding to that team overseas. What's kind of the scope or is there any kind of guidance on how much are we building out that team or is there kind of level them out you’re looking for?

Michael Connors

So right now managed services, we have about -- between 150 and 200 people in India that around our managed services team. It depends on the size and complexity. So Marriot as an example we have two to three people on the ground everyday in Bethesda, Maryland and then we have another 20 somewhat people in India that’s managing that account. So, you saw the headcount increase not much during the quarter but almost all of that increase was for our managed services business and the Marriott account in India.

As we think about managed services over the next two or three years, I couldn’t vision that number increasing significantly because of our growth ambitions on the managed services side.

So it matches up to the contract. Once we know we’re going to have a contract. We began our hiring process, training process and that usually is two, three, four months ahead of when we get the revenue generated. That’s why our first year margins in that business are lower, but after year one once we have a normalized, it is margins that are much greater than the average in the firm. So that’s where we are today and our expectations over the next two to three years, is that Indian operation would grow significantly as result.

Justin Ruiss - Sidoti

Got you. And then maybe I might have missed it. I don’t know you had said it. But can you breakout how much percentage managed services of revenue?

Michael Connors

We only breakout our recurring revenue and our recurring revenue is managed services, research and public sector. David what…

David Berger

Yeah. We’ve recorded, my comment and in the script $11 million for the quarter, $31 million year-to-date.

Justin Ruiss - Sidoti

Okay. Perfect.

David Berger

Yeah. Up 34% for the quarter and 28% year-to-date.

Justin Ruiss - Sidoti

Perfect. Thank you very much.

Michael Connors

Thank you, Justin.

Operator

And now we’ll conclude our question-and-answer session for today. I’d like to turn the conference back to our speakers for any additional or closing remarks.

Michael Connors

Well, thank you, above all, I want to thank all of our ISG’s over 800 professionals worldwide for your continued passion and dedication to our clients for your strong performance for the first nine months. We are seeing the first of your efforts and leading the way as we continue to build our market leadership in the years ahead. And I want to thank all of you on the call today for your continued support and confidence in our firm. Thanks very much and have a terrific weekend.

Operator

This does conclude the conference. We thank you for your participation.

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