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Information Services Group, Inc. (NASDAQ:III)

Q1 2010 Earnings Call

May 07, 2010 11:00 am ET

Executives

Barry Holt - Senior Advisor, Communications

Michael Connors - Chairman & CEO

David Berger - EVP & CFO

Analyst

David Parker- Lazard Capital Markets

Robert Riggs - William Blair & Company

Tim Fox - Deutsche Bank

Operator

Good day, everyone, and welcome to the Information Services Group first quarter 2010 earnings 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 introductions, I would like to turn the conference over to Mr. Barry Holt. Please go ahead.

Barry Holt

Thank you, operator. Hello, my name is Barry Holt. I am the Lead Communications Executive at ISG. I’d like to wish you a good morning and welcome everyone to ISG’s 2010 first quarter earnings conference call. I am joined today by Michael Connors, Chairman and Chief Executive Officer; and David Berger, Executive Vice President and Chief Financial Officer.

Before we begin, I would like to read a forward-looking statement. It is important to note that this communication may contain forward-looking statements which represent the current expectations and beliefs of the management of ISG concerning future events and their potential effects. These statements are not guarantees of future results and are subject to certain risks and uncertainties that could cause actual result to differ materially from those anticipated.

For a more detail listing of the risks and other factors that could effect future results, please refer to the forward-looking statement contained in our Form 8-K furnished to the SEC and the risk factors sections in ISG’s Form 10-K covering full year 2009 results, which was filed with the SEC on at March 8th of this year.

You should also read ISG’s Annual Report on Form 10-K for the fiscal year ending December 31, 2009 and any other related documents including any amendments or supplements to these documents filed with the SEC when they become available. You will able to obtain free copies of many ISG’s SEC filings on the SEC’s website 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 consider in isolation or is a substitute for financial results prepared in accordance with GAAP. For the reconciliation of our non-GAAP measures presented to the most closely applicable GAAP measure, please refer to our current report on Form 8-K submitted yesterday. You will have an opportunity at the end of the presentation to ask questions.

Now I would like to turn the call over to Michael Corners, who will be followed by David Burger. Mike?

Michael Corners

Thank you, Barry and good morning everyone. Today David and I will recap ISG’s 2010 first quarter results. In spite of the recent volatilities in Europe, we are beginning to see a gradual return of business confidence. In signs of a shift back to the use of sourcing strategy by clients to optimize cost structures, many companies have now completed many of their short-term cost reduction actions.

Clients continue to plan for increased strategic spending during this year. Clients have indicated us that they would start spending actions slowly in Q1 and they have and provided the markets continue to stabilize, pick up the pace of strategic spending actions over the second half of this year. So as the global economy recovers companies should shift from short-term action such as reductions in force to more permanent solutions to fundamentally reset their business model.

We think that the great recession as reinforced the clients the need for flexibility to expand and contract based upon market conditions and sourcing strategies assist in that effort. We are in an excellent position to support their initiatives from strategic assessments through contract negotiations and implementation and ultimately with our post contract management services and we continue to review our own cost structure to better position ourselves for growth going forward.

We believe that the pace of recovery in this market will be tied a return of confidence and a global economic recovery which we believe will continue to unfold as the year progresses. Now to put ISG’s first quarter results and perspective, I would like to update you briefly on the relevant trends we are seeing the broader sourcing markets. To do this I will quote from our recently issued first quarter 2010 TPI index.

The TPI index is the authoritative voice on the sourcing industry’s overall developments and key trends. Our first quarter data showed that total contract value or TCV for the global outsourcing market was $19.5 billion, up nearly 25% over the first quarter a year ago, though it was driven by four mega deals, each of these mega deals were in excess of $1 billion in TCV and I’m pleased to say that we were the sourcing advisor to clients on three of them.

The number of contracts in the first quarter was $109 down 21%, indicating what we believe will be a slow, but deliberate recovery this year in the industry. There was a significant amount of restructuring of contracts in the quarter and by restructuring, we mean that clients renew their agreements with their existing suppliers or they restructure their current contracts or they add or delete scope of an existing contract, that’s what we mean by restructuring.

There were 25 restructuring signed by clients in the first quarter, valued it around $8 billion, so $8 billion of the $19.5 billion or about 40%. Restructurings represented the highest share of the total market value in outsourcing history. Now by domain, the IT outsourcing segment of the market was up. The BPO market continued its decline from 2009. By industry sector, the overall industries two traditional leaders, financial services and manufacturing, financial services was down and manufacturing was up.

Now on past calls we told you that we continued to invest in our business and we expect to come out of this recession position to add even greater value to our clients. One of our key growth engines is the broadening and deepening of our global footprint. We significantly increased our presence in key geographies of the world, while sourcing strategies are being employed at a faster rate, including such areas of China, Southeast Asia and Nordics.

We signed in the quarter an extension of our agreement to help Huaqiao, become the hub of financial services outsourcing in China. This new contract runs through 2010 with possible extensions through 2012. We are working directly with the Chinese government today to prepare them with our direction to launch the first major China Sourcing Clients and Service Provider Conference that’s planning to be held next month.

Now client wins in the quarter for us included company such as Barclays, Cardinal Health, Deutsche Bank, E.On, The Hartford, Hilton Hotels, NetApp, Symcor, WIMS and Yahoo. And just last week we signed a five-year multi-million dollar agreement with a major drug chain to government outsourcing contracts as part of our continued focus to expand our recurring revenue streams in our governance services business.

We are now managing over $1.2 billion in client annual contract value as a result of this latest deal and we also just received ISO Certification for our governance services operation, which we believe assisted us in winning this latest contract. I am also very pleased to report that last month TPI was ranked No. 1 in the 2010 Global Outsourcing 100. The World's Best Outsourcing Advisor named by the independent International Association of Outsourcing Professionals, the IAOP with further recognition in its latest May 3 edition of FORTUNE Magazine.

In the categories of Customer References, Company Recognition and Executive Leadership, we’ve received the highest possible scores. We continue to demonstrate our leadership in the sourcing advisory industry and the outstanding value we deliver to our clients on premise everyday.

Now let me turn the call over to David Berger, who’ll summarize our financial results for the first quarter.

David Berger

Thank, 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 information in our earnings 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 a greater transparency of key measures used to evaluate the company’s performance.

The non-GAAP measures 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. 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.

ISG’s reported total revenues of $34.8 million during the first quarter of 2010, was an increase of 2% from the first quarter of 2009. Fee revenues before client reimbursable expenses aggregated $32.2 million during the first quarter of 2010, which was an increase of 1% year-on-year and down 4% before the impact of currency translations.

Revenues in the Americas increased 5% for the quarter compared to 2009; revenues from international operations decreased by 3%, which was a 12% decline on a constant currency basis from the first quarter of 2009 levels. The increase in revenues was primarily due to the higher levels of sourcing activities, particularly in the US and Asia Pacific attributable to increases in information technology, post contract governance services, and the favorable impact of foreign currency translation to US dollar on reported results, which offset declines in business processed outsourcing.

ISG reported operating income of $1.7 million for the three months ended March 31, 2010, compared with $2.1 million of operating income for the same 2009 period. First quarter 2010, adjusted Earnings Before Interest, Taxes, Depreciation, Amortization and non-cash stock compensation and impairment charges totaled $4.8 million, compared with $5.1 million in the first quarter 2009.

Excluding the impact of the currency translation, adjusted EBITDA declined $900,000 from first quarter 2009 levels. The decline in operating income and adjusted EBITDA was due to increased variable compensation expense, which partially offset by increased income associated with higher revenues.

Reported fully diluted earnings per share of $0.01, compared with $0.02 for the first quarter of 2009 and fully diluted adjusted earnings per share for the first quarter of 2010 of $0.07 was flat with the comparable EPS in the first quarter of 2009. ISG continues to maintain a strong liquidity position to support the implementation of our business plans.

Cash and cash equivalents aggregated $38 million at March 31, 2010, a decrease of $5 million from December 31, 2009. The decrease in cash balances from year-end 2009 was attributable to the $2.7 million of term loan interest principal payments and US tax payments. Total outstanding dead at March 31, 2010 was $69.8 million compared with $71.8 million at December 31, 2009.

Finally, Mike Connors, our Chairman and CEO purchased 50,000 shares in a private transaction yesterday for total purchased is up 465,457 shares in the last six months. With today's purchase Mike now owns 7.3% of ISG's outstanding shares.

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

Michael Connors

Thanks, David. Our vision remains the same. We are here to build a world class industry-leading information based services company. We’ve return to growth, we continue to invest in growing our industry verticals, expanding our CIO services including a push on strategy and [crown] computing and consulting, continuing to expand geographically, focusing on our recurring revenue businesses such as governance services, expanding our BPO service offerings and investing in our people.

In addition, we continue to pursue aggressively potential acquisitions that align with our vision. The team is focused and the energy levels are high and we are very pleased and have been ranking number one in the 2010 Global Outsourcing 100 as the world's Best Outsourcing Advisor.

Thanks very much for calling in this morning. Let me turn the session over to our operator for any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll hear first from David Parker with Lazard Capital Markets.

David Parker- Lazard Capital Markets

If you could provide some more color around that multi-year agreement that you’re able to sign and ability just to expand your recurring revenue stream, which I think is an attractive characteristic for your business, do you believe that going forward you’re going to be able to sign more of these?

Michael Corners

Let me just put this into context here. So about two years ago, we said to you that one of our objectives was to begin to getting mix of both our advisory business and recurring revenue streams. We launched what we called governance services, which is to go into clients and help them manage the actual contracts that they have with service providers. This recent signing which was with a major retailer was a five-year transaction multi-million dollars in scope where we will be providing assistance with them in managing their service agreements. We now have about $14 million of contract revenue under management, if you will.

Our revenue stream from this is around $8 million annualized, we’ve got about 14 under contract in growing. We’ve got about 1.2 billion now of service agreements that we’re managing on behalf of the clients. So, governance services remains a key part of our concurring revenue strategy so we are aggressively in the marketplace up-selling those services, David. So the answer is, we would hope that we would have more of those and we’re in the marketplace trying to do just that.

David Parker- Lazard Capital Markets

And then is there any upfront revenue that’s recognized or is this all streamlined over the five-year period?

Michael Corners

It’s streamlined over the period of services are provided.

David Parker- Lazard Capital Markets

Okay. And then if you could just also provide some color around your current headcount, you said that you’re still investing in personnel just what reasons are you investing in currently?

Michael Corners

So we will have a total billable headcount of 328 at the end of the quarter. And we continue to invest to try to upgrade the competencies of our staff. So there is just, we’ve selected hiring across the globe in the areas to help our positioning.

Operator

We’ll take our next question from Robert Riggs with William Blair & Company.

Robert Riggs - William Blair & Company

Mike to start with, you talked about the success that you’re having in China, what do you view as the most attractive international markets or kind of your priorities for expanding in those international markets. And is there any particular investment associated with that and then also what does the competitive environment look like?

Michael Corners

So first in the Asia, we think China and Southeast Asia are the hot beds for us, that’s where we’ve been putting our investment dollars and that’s around people and some IT. China, clearly takes awhile to unfold, but we are very pleased with the very early sings of work that we’re doing there. We’re also working in concert with the Chinese government to assist them as they are looking to create China as a financial services hub, if you will, a second India.

And we’re working with the Chinese government about how to go about doing that I think we are having some good success early on there. So the investments that we put in are on people on the development of IT and our view on both of those markets and the Asian market in general is that in the long run this will be a very, very lucrative market for us and we were getting in early and we’re putting the investments early and we’re getting some good success.

And over in Europe, we’ve expanded over in Nordics considerably and we believe that’s also another hot bed if you will and we’re getting some very good traction in that region as well. So that’s where we‘ve been putting a majority of our emphasis and investment dollars and time on these expansions in these international markets.

Robert Riggs - William Blair & Company

Compared to the US, is there any difference and I guess the products maybe that resonate with the clients, for example, is governance more important in any international markets, any difference there?

Michael Corners

The difference I would say in Asia is that first kind of [abortive] entry is around IT. So there is some, but very smaller amounts of work in the BPO space over in Asia, so the primary work that we do is around the IT around with the CIO, or the IT strategy area, or the kind of work that we’re doing to bring in processing in the China, so that is the difference between the US and Europe and that IT is the significantly dominant area of need in the Asian markets in the early days.

Robert Riggs - William Blair & Company

I appreciate the billable advisor headcount, what’s the utilization rate, I think you’ve given kind of a trailing 12 month number in the past.

David Berger

The utilization for the first quarter was 74%, up from prior year.

Operator

(Operator Instructions) We’ll go next to Tim Fox with Deutsche Bank

Tim Fox - Deutsche Bank

Mike, the first question I had was around the nature of the business right now from a restructuring perspective, I mean that was a big number in the first quarter. I’m wondering if you could just give us your perspective on what that means to the industry over the next two to three quarters, is this something that was just based on some renewals, do you think this is M&A related and is this net positive for your business as these contracts get restructured in some cases midway through the term of the deal?

Michael Connors

Yes, let me talk about the industry first and I’ll go right. First, clearly it was the big part of what was happening in the quarter was $8 billion of “restructuring”. The number of contracts that are up over the next 24 months is the largest number that had been up ever, so there is a lot of opportunities if you well, if clients so chose to restructure some of these agreements, and we think that will continue may be not at the significant phase that you saw in the first quarter, although there are some very, very large possible restructuring contracts that are due up this year and early next year that it could be drawn and we’ll show a very large number before this year is out depending on what the couple of those contracts do will determine the real dollar value associated with it.

From our standpoint, renegotiations was up dramatically for us during the quarter more than 2X what it was a year ago and we would expect that to continue for us, and what we typically are doing for clients is that they do want to restructure they ask us to come in give a good understanding of what the market is, take a look what their client contract is and what would be possible if they were to go back with their current service providers, and either expanse scope, take some scope away what does it look like on the pricing? What does it look like on quality performance and other kind of value added kinds of services? So for us, we think its good work, its great work and we would expect renegotiations to be pretty strong for the course of this year.

Tim Fox - Deutsche Bank

I just a follow-up on the BPO commentary you made, obviously as a whole it’s been struggling, certainly a deals larger than $25 million. You also mentioned that you’re expanding your BPO offering, so I’m wondering if you could talk a little bit about how you think that market is evolving and why you’re actually investing and expanding in the BPO in spite of what we’re seeing from an overall global perspective.

Michael Connors

So, first BPO market was down last year, significantly it’s down in the first quarter as you know, where we’re putting on investment dollars would be on everything but the O, if I could say it that way. We are looking at enterprise improvement where performance improvement if you will at the enterprise level for clients that may not necessarily include the O, meaning that outsourcing may not be the solution set for client. So we’re putting in and in fact have a bit of investment dollars in with a group of individuals to try to penetrate companies around what we are calling our enterprise improvement services.

Because our [POS] is that on the BPO side, that the opportunities in terms of growth there in the near term will not be there and the market is quite soft for all those reasons, so we’re looking at providing assistance if you will in a much broader way in terms of what we call enterprise improvements, so that’s where we’re putting our dollars associated with that.

I will say that the HR component of the BPO area started off very strong in the first quarter of this year, so one element of the BPO area, Human Resources was in pretty good shape during the quarter. But I would say the F&O area said are all which we kind of put aside last year during the big recession where CFOs were more interested in what they could do at the very moment in time in terms of cost reductions they put their own units if you will off to the side because there is a longer tale on them, we did not see that rushing back here anytime soon.

Tim Fox - Deutsche Bank

David, if you have these numbers at hand here, where you are looking for the absolute dollar, revenue dollars for Europe and Asia, and if possible what the local currency growth rates were for those two regions? Just remodel it out a little bit more.

David Berger

The Europe number was 10.3 million for the quarter and Asia-Pacific was 3.4, and in terms of the growth on a fee basis, Europe is down 12%, on a reported basis it’s 12% down in Europe and 18% up in Asia.

Tim Fox - Deutsche Bank

18 and do you have that on a local currency basis?

David Berger

Yeah, I’ll get back to you on that, okay?

Tim Fox - Deutsche Bank

Yes, I will get you offline, thank you.

Operator

Ladies and gentlemen, there are no further questions at this time. (Operator Instructions) And gentlemen, it appears we have no further questions from the phone audience, I will turn the conference back over to Mr. Connors for any final remarks.

Michael Connors

Thanks very much. I want to thank all of our nearly 450 professional world-wide for their passion and dedication that resulted in the number one ranking by the IAOP, that’s over the last couple of months. It is only through their efforts that we are now poised to build on our market leadership in the months ahead. And I’d like to close by also thanking all of you for your continued support and confidence and we look forward to talking with you again in the next quarter. Thanks very much and thanks for joining us this morning.

Operator

Ladies and gentlemen that does conclude today’s conference call. We’d like to thank you all for your participation.

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Source: Information Services Group, Inc. Q1 2010 Earnings Call Transcript
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