Internet Capital Group Q3 2006 Earnings Call Transcript

Internet Capital Group (ICGE)
Q3 2006 Earnings Call
November 2, 2006 10:00 am ET

Executives

Karen Greene - VP of IR
Walter Buckley - Chairman and CEO
Kirk Morgan - CFO

Analysts

Jeff Van Rhee - Craig-Hallum
Derek Fisher - Emerald Asset Management

Presentation

Operator

Greetings, ladies and gentlemen, and welcome to the Internet Capital Group Incorporated Third Quarter Results 2006 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Ms. Karen Greene, Vice-president of Investor Relations. Thank you, Ms. Greene, you may begin.

Karen Greene

Thank you, 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 would like to remind everyone that we are going to use presentation slides to accompany our prepared remarks today. These slides can be found on our website at internetcapital.com. Go to the Investor Information tab and you'll see an icon for our third quarter conference call. The slides can be accessed through that icon. For those of you without immediate access to our website, the conference call and the 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 these 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 attachment to the press release. The press release is also available on our website which, again, is Internetcapital.com. To access the press release on our website, go to the ICG press release tab and select the November 2 press release. The attachments to release can be accessed by clicking on the PDF file contained within the release itself.

Please also note that upon the closing of the CreditTrade/Creditex merger, ICG will acquire an ownership interest of less than 20% in the parent company, Creditex Group. Because our ownership interest in Creditex Group will be accounted for under the cost method of accounting, we have removed CreditTrade from our Core category. Therefore, we are presenting pro-forma information relating to ICG's current eight private Core companies, Freeborders, ICG Commerce, Investor Force, Marketron, Metastorm, StarCite, Vcommerce and WhiteFence. Our ownership positions in these eight companies averages 51%.

Finally, 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 presentation 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 e-commerce and information technology markets, and other uncertainties detailed in the Company's filings with the Securities and Exchange Commission. These and other factors may cause actual results to differ materially from those projected.

Now let me turn it 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 Q3 highlights. Kirk Morgan, our Chief Financial Officer will follow with ICG's financial results and review our partner companies performance for the third quarter.

The third quarter of 2006 was extremely productive at both the partner company level as well as within ICG. We continue to demonstrate good progress against our strategic objectives and goals. This morning I will provide details of this progress and how it translates into long-term value creation for ICG and the stockholders.

I'd like to begin today by stating our mission which is to be a leader in the on-demand internet software and services space by owning leading stakes -- major stakes in leading on-demand software companies. Our actions are guided by this mission and we continue to be excited about the compelling opportunities we are seeing in this space. I will provide additional color on the market later in my remarks, but first let me review the highlights of the third quarter which are listed on slides 4 and 5.

Our eight Core partner companies had aggregate revenue growth of 29% and EBITDA improvement of 41% in the third quarter of 2006 versus 2005. ICG Commerce, StarCite, Freeborders and Metastorm all had very good quarter they all had excellent revenue growth and saw substantial pipeline increases as well which bodes well for 2007.

ICG Commerce, StarCite, Marketron and Metastorm were EBITDA positive from an operating perspective for the third consecutive quarter. Vcommerce and WhiteFence, our recent acquisitions, continue to build-out their infrastructure and sales and marketing resources, and Freeborders and Investor Force continue to engage in price development initiatives which should wind down in the first half of 2007.

We have been actively looking at new deals this quarter as our pipeline of opportunities continues to expand. M&A activity at our partner companies also continue to grow, and both CreditTrade and StarCite announced pending mergers. The CreditTrade transaction is expected to close within the next few weeks and we expect StarCite to close shortly after year-end. We are enthusiastic about both transactions and I will talk more about this in just a few minutes.

Finally, we recruited outstanding executives into ICG Commerce and WhiteFence and believe both companies are well positioned to grow and achieve leadership positions in their respective markets.

Now to give you a sense of the progress our partner companies have seen in the past quarter, let me share some highlights of our Core companies which you'll find on slides 6 through 9. Now turning to slide 6, I'll start with ICG Commerce.

ICG Commerce is the leading procurement services provider and continued to experience strong revenue growth this quarter. Revenue growth for the third quarter increased over 30% versus Q3 2005 and the pipeline of new customers continue to increase as well. New customer relationships include Global Crossing, a large national retailer and a global industrial manufacturer. The company also expanded relationships with several key customers including Alcan, Comair, and a large software company.

Finally, earlier in the quarter, ICG Commerce announced Carl Guarino as President and CEO. We're very pleased to have Carl onboard and believe that the wealth of experience he brings with him, as builder of businesses, and most recently at SCI will help build upon a strong momentum that we're seeing at ICG Commerce today.

StarCite, a provider of on-demand global meeting solution, had another quarter of strong revenue growth and a large number of new customer acquisitions, including Allergan, American Financial Group, Scotts Miracle-Gro, and several other Fortune 500 pharmaceutical & technology companies. StarCite also expanded services with a number of its major clients in the financial industry, adding registration services in India, and implementing additional product offerings with Fidelity Investments. In addition, StarCite's solidified its presence in Europe, with the opening of its European headquarters in Dusseldorf, Germany.

Metastorm, a leading provider of business process management software, achieved healthy revenue growth in the third quarter and signed a number of new customers including the FBI, a large New York-based bank and the U.K. Department of Finance. The company was also selected by Deloitte as one of the fastest growing technology company in its region.

And finally, Gartner Group Cited Metastorm as being one of the top 10 BPM software providers in terms of 2005 worldwide market share.

And finally, WhiteFence the online comparison shopping marketplace for home service and utilities recently announced the appointment of Eric -- of CEO, Eric Danzinger. Eric comes to WhiteFence from ziprealty.com and prior to that was President and CEO of Starwood Hotels. Eric has already built out a very strong management team, which is well positioned to pursue a number of strategic growth initiatives. In the third quarter, WhiteFence launched 55 new service providers and 10 new channel partners. The company also successfully renegotiated its commission structure with a number of top service providers and this is expected to generate substantial revenue growth for WhiteFence going forward.

Turning now to two important M&A events that occurred in the third quarter, I'll begin with CreditTrade. We announced the pending merger between CreditTrade and Creditex from the last quarter recall and spoke of the significant opportunity this merger represents for both companies. Lets go on slide 10, in this review of the merger highlights, the credit derivative market is growing rapidly, over 100% annually, according to industry analyst; therefore we believe this is a market with a great deal of opportunity ahead of it, and with the potential to deliver significant returns to leading players. Bringing CreditTrade and Creditex together, two companies with complementary offerings, geographies, and strengths; will significantly enhance the market presence of the combined company, positioning it to be an industry leader.

On a pro forma basis, the combined company will be net income positive, and since January 2004, we have shown an annualized revenue growth rate of over 50% a year, with revenues well over $100 million for 2006. ICG will continue to participate in the combined company through a meaningful but less than 20% interest in the company going forward. Doug Alexander will hold a Board seat and we view this transaction as an opportunity to have an ownership stake in one of the premier companies in the credit derivatives market. It will be creating significantly values over the next several years.

Now, turning to slide 11, let me review the StarCite, OnVantage merger and why we're so excited about this transaction as well. Bringing this together StarCite with its largest competitor in the market creates a clear leader with very strong growth potential. The combined company, which will now have a global presence, is projecting the following: Pro forma revenues will be in excess of $40 million for 2006, and a growth rate in excess of 40%. $5 billion of projected revenue opportunities will be brought to suppliers in 2006 up over 50% in 2005. $2.5 million projected attendee registrations will occur in 2006 also up over 50% in 2005; and note, as far as I get paid between $3 to $5 per registrant.

And finally, strong ROI, with average customer savings between 10% and 15%. We believe the pending mergers between CreditTrade and Creditex, and StarCite, and OnVantage are great example on the combining forces with the competitor, increasing functionality, scalability, and market share to emerging a stronger, more valuable entity. We see this as an opportunity at a number of our companies and will continue drive them to enhance their value and market position through merger activity. Ultimately, we believe this type of M&A activity will result in real value creation for ICG and its stockholders. In terms of new acquisitions, the level of deals will continue to grow considerably, as we broaden the ICG footprints in the on-demand sector. In addition, we've established relationships with number of M&A [votees] and venture funds in the on-demand space, which has opened up a new channel of deal growth for us. At this point in time, we're actively working on several very interesting transactions with a number of good opportunities in the backlog. Now, in terms of the market overview, research analysts at JMP Securities and IDC recently reported that the on-demand sector is expected to grow at least 20% a year over the next five years, with operating margins of 30% or greater.

Slide 12 hits the finer points on why this space is so compelling to the customer, to the vendor, and ultimately to the investor. We're seeking new acquisitions in the on-demand sector primarily because of the predictability, the visibility, sustainability and high margin characteristics of these business models. And while not all our companies fit this model today, a majority of our companies do. And our goal is to continue to move in this direction and be known as a leader in this space. ICG has deep experience in building these types of businesses as we've demonstrated over the last several years with companies like Blackboard, LinkShare, StarCite, ICG Commerce and others. And based upon our experience, our capabilities and the momentum we've seen over the last few quarters, we think that ICG and our companies are well positioned to capitalize in this emerging market. Finally, it is important to note that while we're enthusiastic about the growth and the success we're seeing today in this market, we believe the lion share of the opportunity is still in front of us.

Now in summary, this quarter we experience strong revenue growth and EBITDA improvement at our core companies, we're excited about the pending mergers at StarCite and CreditTrade and continue to pursue a robust pipeline of deals. We are satisfied with this progress and believe the remainder of 2006 and early 2007 will be exciting time for our companies and for ICG. With that, I'll turn it over to Kirk.

Kirk Morgan

Thanks, Walt, and good morning. Let me begin with our third quarter of 2006 consolidated income statement as prepared under General Accepted Accounting Principles. As a reminder, Investor Force's database division was sold in August of 2006 and has been reflected as a discontinued operation.

Turning to slide 14, revenues of our three consolidated companies ICG Commerce, StarCite and Investor Force totaled $16.6 million, compared with $14.6 million for last year's third quarter and our consolidated companies included ICG Commerce, Investor Force, StarCite and CommerceQuest. The increase is due to the strong revenue growth at ICG Commerce and StarCite tempered a bit by the fact that CommerceQuest is included in the 2005 period, while is not consolidated in the 2006 period. ICG reported consolidated net income of $13.4 million or $0.34 per diluted share for the third quarter 2006 as compared with net income of $87.3 million or $1.97 per diluted share for the third quarter 2005. Results for the 2006 quarter include $21.1 million in net after-tax gains primarily due to the release of LinkShare escrow and the Investor Force database division sale compared to $100.4 million in net after-tax gains in the prior year which were primarily related to the LinkShare sale. Additionally, results for the quarter include $1.9 million of stock-based compensation expense compared to $2.2 million in the 2005 quarter.

Let me next review our Core company results on slide 15. As Karen stated at the beginning of the call, we are presenting pro-forma financial information assuming the pending CreditTrade sale and Creditex transaction occurred on January 1, 2005. The information I'm about to share with you relates to ICG's eight Core companies in which we have an average ownership of 51%. All of the following pro-forma information is on an apples-to-apples comparative basis.

Aggregate revenue of our Core companies was $42.2 million during the third quarter of 2006 which is an increase of 29% from last year's third quarter of $32.6 million. ICG Commerce and StarCite continue to contribute significantly to this aggregate increase as their markets and businesses continue to mature. Additionally, Freeborders and Metastorm are also demonstrating solid progress.

Our Core companies reported an aggregate $4 million EBITDA loss during the quarter versus an EBITDA loss of $6.8million last year. ICG Commerce, Marketron and Metastorm continue to EBITDA positive while StarCite was break-even EBITDA for the quarter. StarCite would have been solidly EBITDA positive for the quarter except for some costs directly associated with the OnVantage merger. I would estimate that on an aggregate EBITDA basis the 2006 quarter was negatively impacted by approximately $700,000 of one-time items including the StarCite cost which I just referred to.

Now moving to the bottom line, the aggregate net loss for our Core companies was $6.2 million down from $9.4 million last year.

Slide 16 presents the movement of cash at the parent company level during the third quarter and our total liquidity at September 30th. We funded $500,000 to partner companies, received $4.3 million which was principally from the Investor Force database division sale and we had operating costs of $2.6 million net of interest. So therefore, we ended the quarter with $108.6 million of cash at the parent company which excludes the $14.3 million of LinkShare escrow proceeds which were received on October 2nd of 2006. Additionally, the value of our public company holdings Blackboard, GoIndustry and Traffic was $85.1 million, resulting in approximately $194 million of total liquidity.

Now lastly, let me provide a high-level view of the company on slide 17. For illustration purposes, I'll continue to summarize the information as of September 30th of 2006. Using our closing stock price of $9.45 on September 30th, our market cap after considering the possible conversion of our convertible notes was $398 million. Our cash, marketable securities and escrows as of September 30th totaled $212 million which includes the GoIndustry Industry contingent shares, the LinkShare escrow which was received on October 2nd and historical carrying value of CreditTrade at September 30th which is very low.

By deduction, an implied value of our share of our Core companies was $186 million representing a multiple on our trailing 12-month proportional revenue of 2.3 times. Additionally, these companies had net cash balances that aggregated $28 million. So, as we look forward to the rest of 2006, we expect that our Core companies will grow aggregate revenues at least 25% for the year, we also expect continued improvement in the core company EBITDA results while supporting growth and developing their technology platforms.

On the monetization front, we're actively working on a number of transactions, but the exact timing of which is difficult to predict.

In summary, we're very pleased with our overall quarterly performance, and we're on track to meet our goals for the year.

With that, I'll turn this back over to Buck.

Walter Buckley

Thanks, Kirk and now we'd like to open it up to Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is coming from Jeff Van Rhee with Craig-Hallum. Please proceed with your question.

Jeff Van Rhee - Craig-Hallum

Great, thanks. Hi guys. Kirk, if you could the previous guidance had been for growth in the Core companies of 20% plus and now we're kind of reshuffling with CreditTrade pending merger taking it out of there. What would growth had it been had it been in the mix?

Kirk Morgan

Jeff, I mean -- we're -- we're not specifically disclosing that, what that would have been. We're focusing more on the current eight Core companies.

Jeff Van Rhee - Craig-Hallum

Okay. Would you be revising your guided growth range higher if it was still in there, because now you're saying 25% or better growth?

Kirk Morgan

Yeah, I think really what we are trying to do is just focus on the eight Core that we currently have Jeff.

Jeff Van Rhee - Craig-Hallum

Yeah, right. So am I. So, I'm wondering if your expectations for those eight have increased.

Kirk Morgan

Right.

Jeff Van Rhee - Craig-Hallum

So have your expectations for those eight increased?

Kirk Morgan

Yes, they have.

Jeff Van Rhee - Craig-Hallum

Okay. Of the businesses that you have in that core mix, which ones are seeing the greatest acceleration in growth rate? I mean, clearly you've got some rapid, rapid growers in on-demand models in there, but which ones are seeing the accelerated rates of growth over the last several quarters?

Walter Buckley

Hi Jeff, this is Buck.

Jeff Van Rhee - Craig-Hallum

Hi Buck.

Walter Buckley

You know, I think we always to temper these -- you know, the answer in a sense is that these models are very steady and predictable and you enter the year with 70, 75% of your revenues booked. So, it's hard to significantly impact revenue growth. That said, I think StarCite, ICG Commerce, Freeborders are the three that are probably experiencing the most rapid acceleration. That said, you know, there is only so much you can accelerate in a year when you're going in with most of it already baked.

Jeff Van Rhee - Craig-Hallum

Understood. What is in then with the CreditTrade-Creditex merger, the post deal ownership stake will be what percent?

Kirk Morgan

What we've said is significant, but less than 20%.

Jeff Van Rhee - Craig-Hallum

Okay. And that significant -- so less than 20, and is that less than 20 just as a factor of the dilution without any incremental investment or does that assume some incremental investment?

Kirk Morgan

That assumes some incremental investment.

Jeff Van Rhee - Craig-Hallum

Okay.

Kirk Morgan

You know, had we just -- we'll announce this all this when the deal closes in a press release.

Jeff Van Rhee - Craig-Hallum

Okay.

Kirk Morgan

But had we just taken our pro-rata share, our ownership would have been less than what it is today, and it is important for us to acquire as large a stake in the combined company as we could going forward.

Jeff Van Rhee - Craig-Hallum

Right, absolutely. And then on the monetization front for fiscal '07, understanding you're not going to give us specific names and kind of a hard and fast number because you have to play market conditions as they come, but what's your general sense of how many monetizations we could see in a fiscal '07 timeframe?

Walter Buckley

Yeah Jeff, I would think that we would probably have around 2, I think is probably a pretty good gauge based on the past history.

Jeff Van Rhee - Craig-Hallum

Okay. Great, I'll jump back in line. Thanks, guys.

Kirk Morgan

Thanks, Jeff.

Operator

Our next question is coming from Derek Fisher with Emerald Asset Management. Please proceed with your question.

Derek Fisher - Emerald Asset Management

Hi good morning. My question was in new pipeline you have in terms of deal activity, can you talk at all about the size of deal that you're looking at or what stage companies you're looking at potentially reinvest some of the money (inaudible) you're selling off.

Walter Buckley

Certainly. You are just hitting on deal flow, and I'll sort of answer it in a two part way. Deal flow in general has picked up considerably over the last nine months both in terms of quantity and more importantly in quality. I think as we broaden our footprint nationally, and I think the results are beginning to pay dividends, we're establishing very good relationships with some investment banks that focus on the on-demand space, working closely with several venture funds who primarily invest in the on-demand space and creating a whole new set of deal flow for us. The kinds of companies we're focused on, obviously on-demand companies, for us sweet spot of our company is generating between north of five but between $10 and $25 million of revenues who are near EBITDA breakeven or maybe cash flow positive but I think valuations increase significantly once they're cash flow positive, and where we can take significant stakes, and so these are mature companies who are demonstrating good progress and are emerging as leaders in their markets and not only do they like us from an experience and focus factor they also view us as an ability to help them consolidate their respective markets. And I think that's something we are improving with CreditTrade and StarCite and as we look at new acquisitions it's certainly a very important criteria.

Derek Fisher - Emerald Asset Management

Do you have any kind of guidance as to where you are in terms of stage of these deals, was there something we expect in near term or--?

Walter Buckley

Well, we're very active in discussions with two companies today. And so, these kinds of transactions it's impossible to predict but I would expect that one of the transactions closes in next 90, maybe 120 days.

Derek Fisher - Emerald Asset Management

Okay. And second question with regards to this being end of the year is there any update at all on the loan to corporate officers?

Kirk Morgan

Sure. No, we expect these loans to be fully satisfied in early December 2006. And just as a reminder, these primarily non-cash loans were entered into in '99 and 2000, which were relating to some cash stock-option exercises, that the recourse balance is $2.7 million and will be repaid in cash with some portion possibly coming from stock sales and the balance of these loans are secured by approximately 450,000 shares of ICG stock and under terms of the loans the company will essentially take back those shares. Now, currently the company has these shares in a collateral accounts primarily for Buck, Doug Alexander and me, and as these shares come back to the company, it will reflected a share repurchases in our 2006 financials and will reduce our shares outstanding to approximately 38.6 million shares. And then lastly, in connection with all of this, appropriate Form 4's will be filed in early December of 2006.

Derek Fisher - Emerald Asset Management

Okay, thank you.

Walter Buckley

Any other questions?

Operator

Gentlemen, there are no further questions at this time. I'll turn the floor back over to you, Mr. Buckley.

Walter Buckley

I'd like to thank all of you for joining us this morning, and we look forward to reporting to you early in 2007. Thanks.

Operator

Thank you. This does conclude today's conference. We appreciate your participation, and you may disconnect your lines at this time.

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