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Information Services Group, Inc. (NASDAQ:III)

Q2 2014 Earnings Call

August 8, 2014 09:00 AM ET

Executives

Barry Holt – Senior Communications Executive

Michael Connors – Chairman and Chief Executive Officer

David Berger – Executive Vice President and Chief Financial Officer

Analysts

Marco Rodriguez – Stonegate Securities

Vincent Colicchio – Noble Financial

Peter Heckmann – Avondale Partners

Operator

Good day, and welcome to the Information Services Group Second Quarter 2014 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'd 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 Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's 2014 second 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 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 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 through the SEC and the Risk Factors 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, 2013 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's website at www.isg-1.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. During this call, we will discuss certain non-GAAP financial measures which ISG's believes improves the comparability of the Company's financial results between periods and provides for greater transparency of key measures, used to evaluated the Company's performance. The non-GAAP which we will touch on today include adjusted EBITDA, adjusted net earnings and the presentation of selected financial data on a constant currency basis.

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 second quarter results. We will update you on some operating highlights and reaffirm our full year guidance. We indicated during our first quarter results call that we anticipated sequential strength in the second quarter and we are pleased to report that our second quarter revenues were up 14% and EBITDA more than double versus the first quarter.

We delivered sequential revenue growth in all regions, 13% in the Americas including nearly 50% growth in the US Public Sector, 44% in Asia Pacific and 8% in Europe. Our second quarter revenue were about $55 million and our EBITDA was $7 million. Our recurring revenues for the quarter were up 35% to almost $15 million versus the prior year, a strong indication that our strategy to grow recurring revenues continues to work.

In all, we serve 277 clients in the second quarter. Nearly 10% of which were new to ISG. Now turning to our regions, second quarter revenues in revenue grew by 8% versus the first quarter and 3% in constant currency versus the prior year. The continued growth in Europe was driven by our strong performances particularly in Germany and France. We also saw growth in our energy and BFSI verticals, which is our Banking Financial Services and Insurance Segment.

Key client engagements during the quarter included Volkswagen, the UK Ministry of Defense, KFW Bank, GDF SUEZ, HSBC and BNP Paribas. Last quarter we projected double-digit sequential revenue growth in the Americas for the second quarter and we delivered on that with revenues up 13%. As anticipated, we reported 8% decline in Americas revenues in the second quarter versus the prior year was driven primarily by a few large US clients that have moved from a higher spend level and to a steady-state spend mode this year.

Overall, we are pleased with the pace at which the Americas is rebuilding its sales and delivery pipeline. Key client engagements in the quarter included Thomson Reuters, Abbot Laboratories, Southwest Airlines, MetLife and SC Johnson.

In Canada, we reserved work in the second quarter on a client engagement that as we previously indicated to you was suspended in the first quarter due to a formal labor union objection of company cost saving proposals. We expect this work to continue during the second half of 2014.

The Americas public sector followed a strong first quarter with an even more robust second quarter recording double-digit revenue growth versus the prior year. During the quarter, we commenced work on a multi-year engagement with the State of Illinois, Tollway Authority and we were also awarded and began work late in Q2, with the Texas A&M University System assisting with the evaluation of new ERP solutions.

During the quarter, we also strengthened our leadership team, when we announced that industry veteran; Todd Lavieri was joining the firm as Partner and President of ISG, Americas. I'm thrilled to have Todd in the team, in the time when ISG is poised for significant growth. With this experience, that IBM and Deloitte especially. We believe, he will add tremendous value to the firm overtime in developing and executing our global growth initiatives in expanding our client relationships.

Now moving to Asia Pacific. In Asia Pacific, our revenues were up 44% sequentially and rose 7% versus the prior year with the return to growth in the public sector in Australia. Key client engagements in the quarter included the Australian Taxation Office, Qantas Airways and Origin Energy.

Looking to the second half, we expect year-over-year revenue growth to be driven primarily by Europe as we continue our pipeline elsewhere. As I have mentioned before, we are investing in the new growth area called Engineering Services Outsourcing or ESO. Which is an under advised market that offers a potentially solid opportunity for us.

We believe, ISG is uniquely positioned to create a market in this space and we are actively recruiting today for an Executive to head up this initiative. We will continue to update you on our progress later this year.

As we informed you, on our last quarter results call, during the second quarter. Our Board of Directors approved a new share repurchase authorization of up to $20 million. Expected to be executed overtime, the repurchase program reflects our continued confidence in ISG's future cash generation capabilities.

Given our strong balance sheet and outlook, this program is a measured way to maintain ample financial capability, reinvest in our businesses for growth and deliver attractive returns to our shareholders.

During the second quarter, we repurchased $1.8 million in ISG stock. Also during the quarter, ISG was added to the Russell 2000 Index. Based on our strong operating performance and the resulting increase in our market capitalization. We look forward to the higher profile; our shares may have along with the opportunity to attract the broader audience of investors.

Finally, turning to guidance. We are reaffirming our guidance for 2014, targeting revenues between $215 million and $225 million, an adjusted EBITDA of $23 million to $26 million. This guidance is based on our improved second quarter performance and our progress in building our recurring revenue streams. Offset somewhat by an expected decrease in billable hours in the third quarter, due to summer vacations.

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. Second quarter revenues were $54.9 million an increase of 14% from the first quarter. Year-over-year second quarter revenues were down slightly by 1% on a reported basis and 3% in constant currency from $55.6 million in the second quarter of 2013.

Revenues were $21.4 million in Europe up 3% from the same period in 2013; $27.7 million in the Americas down 8% and $5.8 million in Asia Pacific up 7% with growth rate in constant currency.

Our operating income was $4.5 million for the second quarter of 2014. This compares to operating income of $4.3 million in the second quarter of 2013. Net income for the second quarter $3.1 million up 27% from $2.4 million in the prior year. Reported fully diluted earnings per share was $0.08 compared with $0.06 per share from the same period in 2013.

Adjusted net income for the second quarter $4.3 million with adjusted EPS of $0.11 per share on a diluted basis, up 22% from the prior year. This compared with adjusted net income of $3.5 million or $0.09 per share on a diluted basis in the prior year's second quarter.

Second quarter 2014 adjusted EBITDA non-GAAP measure was $7 million, which was up 8% on a reported basis and up 6% on a constant currency basis from $6.5 million in the second quarter of 2013.

The 2014 and 2013 second quarter results included charges totaling $300,000 and $500,000 respectively for a performance based liability tied to STA Consulting that was reasonably likely to be paid in the future. The 2014 second quarter also included $200,000 in deal related costs. Utilization for the quarter was 70%; total headcount of 891 was up 39 positions from Q1 with the added positions associated with the previously announced acquisitions and to support the growth in managed services.

We continue to maintain the strong liquidity position to support the implementation of our business plan. Cash and cash equivalents including restricted cash totaled $17.1 million at the end of the quarter a net decrease of $9.3 million from the year end.

The seasonal decline in cash provided by operations for the quarter was $4 million and capital spending was $456,000 during the quarter. During the first quarter, we repaid $844,000 of debt and repurchased $1 million of stock and paid $2.6 million in acquisition related cost.

Our total outstanding debt at June 31, 2014 was $55.1 million, which compared with $55.9 million at March 31, 2013. Our gross debt to adjusted EBITDA leverage ratio was 2.6 times and our net debt leverage ratio, which is net of our cash balance was 1.8 times at June 30, 2014. Our average borrowing rate for the quarter was 3%.

We anticipate that the convertible loan note will convert to equity at some point this year. The additional shares are already included in our fully diluted share count. This conversion would further decrease our debt by $3.4 million. Our accounts receivables balance as of June 30 was $50.8 million and our DSO's were 74 days.

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

Michael Connors

Thank you, David and in closing. Let me just summarize our highlights. Second quarter revenues grew by 14% versus the first quarter and EBITDA more than doubled. As expected, the Americas had double-digit sequential revenue growth and Asia Pacific grew sequentially 44%.

Our recurring revenue streams were up 35% in the quarter versus the prior year. We closed on the CCI acquisition strengthening our position in research and benchmarking. We have reaffirmed our full year guidance for 2014, which strengthened our management team with the hiring of an industry veteran as President of the Americas and we were added to the Russell 2000 in the quarter.

We continue to focus on sustainable long-term growth, margin expansion and free cash flow generation, with a view to strengthening our balance sheet and our long-term fundamentals and delivering attractive returns to our shareholders.

We believe that the fundamentals of our business in the industry overall remains strong and that our markets will continue to provide attractive growth opportunities for ISG. Thanks very much for calling in this morning and now let me turn the session over to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) we will go first to Marco Rodriguez with Stonegate Securities.

Marco Rodriguez – Stonegate Securities

Just a couple real quick housekeeping items. In terms of the 891 headcount, you had in the quarter. how of many of those were billable?

Michael Connors

678.

Marco Rodriguez – Stonegate Securities

678, you said?

Michael Connors

Yes.

Marco Rodriguez – Stonegate Securities

Got it and then, I'm wondering if you have the segment revenues broken out in thousands of the way, you report them in the queue.

David Berger

Yes, hold on just one second. The Americas was $12.665 million, Europe is $21.423 million and Asia Pacific is $5800.

Marco Rodriguez – Stonegate Securities

Got it. Appreciated that. then I was wondering, if you can kind of clarify some on the debt side. In the press release, I believe that it says you paid down $5.4 million of debt, but it looks like sequentially debt was pretty flat. Can you talk a little bit about that?

David Berger

Yes, that was paid down of non-operating cash flow, which includes the $1.8 million of debt. I mean, $1.8 million of stock repurchases, $2.6 million of acquisition related and we had $844,000 of debt repurchases.

Marco Rodriguez – Stonegate Securities

Okay, got it. And then, I was wondering, if you could talk a little bit about the competitive environment, you guys are seeing right now in the UK. Maybe if you can address, what you're seeing from a pricing standpoint a number of competitors I mean, entering any sort of additional color will be helpful?

Michael Connors

UK is still quite solid for us, we have two streams going in the UK, one is our commercial and the other is our public sector that we entered in to at the beginning of 2013. And clearly, it's very competitive market in the UK, always has been there is a lots of competitors, big guys, small guys.

Pricing wise it's the same, we have not seen any changing in our pricing mechanisms. So I don't think, we are under any different pricing pressure today, than we may have been a year or two ago. So we don't see any change in our pricing. We continue to focus both on the commercial side as well as on the public sector side.

We continue to generate revenues on several departments in the UK government and our commercial business continues to build with companies like Allied Irish Bank with nationwide and others that were over in the UK region.

Marco Rodriguez – Stonegate Securities

I see and are you seeing more strength on the public side versus the commercial side?

Michael Connors

I don't know, if I would say more strength, but I would say the public sector is strong in the UK. I don't know, I would give one over the other in terms of our revenues, but clearly the UK public market is the second largest sourcing market in the world, next to the United States. It's just in the public sector side and that's why we chose to invest in it, late 2012 and enter it in 2013 and it serving as quite well.

Right in the heart of what we do around operating excellence, as the UK Government continues to look for ways to streamline the government and their cost.

Marco Rodriguez – Stonegate Securities

Got it and I believe, Mike you mentioned in your prepared remarks that second half of the year. You're going to see some additional strength through the European market. Is that being driven primarily in the UK arena or there are other areas you're seeing strength?

Michael Connors

It's actually, throughout Europe for us. So second half, we see strength and in Germany, France, the Nordics which we also invested in during the part of last year and into the first quarter. we've added a number of new resources as that region begins to heat up as well for us. So, I think the big four the UK, France, Germany and the Nordics looks like they're all humming pretty well for us.

Marco Rodriguez – Stonegate Securities

Got it and last question, will jump back in queue. Can you provide some color on the tax rate, it seemed like, it was pretty low this quarter?

Michael Connors

It’s a mix of the foreign earnings distribution. So we had, some changes in the pre-tax income by jurisdiction, it was decreased tax liabilities from unremitted foreign earnings and this is partial with Russell reserves related to previously unrecognized tax benefits. So it's really change in the mix.

Marco Rodriguez – Stonegate Securities

Got it. All right, thanks a lot, guys.

Operator

(Operator Instructions) We will go next to Vincent Colicchio with Noble Financial.

Vincent Colicchio – Noble Financial

The recurring revenue number, I think that's the best number I've ever heard. I know, you did, you doing further well in the state, US State Government solid [ph], is managed services growing as fast as overall recurring revenue.

Michael Connors

Yes, so I mean our overall recurring revenue streams were up 35% and again that comprises managed services research in our US public sector all with contracts that are multiyear and yes our managed services business lea by Anubhav Saxena is doing extremely well. We have a good very solid pipeline there and we are very pleased with the progress that we are making in all of our recurring stream.

So it's working, I think we talked about this on a few calls over the last year or so and we had about $15 million in recurring revenue in the quarter. so it's jumping above that, 20% mark above revenues, this year.

Vincent Colicchio – Noble Financial

You think, it might be sort of word of point, when the course is selling [indiscernible] word is getting out, you know you're kind of creating a new market here and people hearing about this.

Michael Connors

We definitely are the first mover here, the first mover advantage. We have quite an advantage though, we believe the combination of services and software. We have an embedded Blue Chip client base, we've got now a track record over the last three years of some significant success. We had a great large Marriott [ph] contract signing last year, which led us to some additional clients.

It's a long sale cycle, but once you're in, you're in and we feel clearly there are some small emerging companies out there, that would like to get in on this, but we've got quite an advantage. We believe and in our services, our software capabilities in our embedded client base. So we don't take anything for granted, but we've got quite, the lead.

Vincent Colicchio – Noble Financial

In the second half, is the company working on any large contracts. Word is, there is a reasonable chance to win, that could provide applied to the numbers?

Michael Connors

I don't know that there is anything – what I would call, very large size that would change in material way, the second half guidance that we have given now.

Vincent Colicchio – Noble Financial

Okay and I know it's been tough to find out recurring revenue type of requisition upsize, where the valuation is reasonable. How is that working these days?

Michael Connors

We are, as you know part of our strategy is around Bolton acquisitions, we are focused on research, analytic, capability in particular that would give us some recurring revenue streams. We have a number of things in the pipeline, nothing to report at this stage, but we are active in the market.

Vincent Colicchio – Noble Financial

Thanks. I'll go back in the queue. Thanks.

Operator

We will go next to Peter Heckmann with Avondale Partners.

Peter Heckmann – Avondale Partners

A follow-up to the last question. Are you seeing an increase in the tax rate, on managed services? And can you give us an update of how many new managed services clients, you may have signed year-to-date?

Michael Connors

Pete, thanks, but welcome, good morning. We don't release primarily for competitive reasons, the client base in that area because we do believe, we've got a strategic advantage. I will say that, it is part of that 35% growth that we reported year-over-year in the quarter.

Managed services continues to be a great asset for us. Not only for the revenue growth, but what it does as most of it is multiyear and once we are in, we're in. and we look to continue to expand our scope, once we're in each of these clients.

So it is a component of that recurring revenue streams. We have grown the client base, but we don't release the clients date.

Peter Heckmann – Avondale Partners

And then, do you want to take the opportunity to discuss any kind of qualitative commentary about the third quarter and the fourth quarter. you confirmed your full year guidance, certainly the qualitative commentary has helped the first and second quarter, but given the patterns of utilization and potentially any one-time items that may have occurred in the second half flash, is there anything worth calling out, in terms of how we are thinking about the third and fourth quarter?

Michael Connors

Well, when we are looking at, as we look out at the demand. I mean, number one. I think we see the growth in the second half driven primarily by Europe because it is for us products and service offerings are, have really taken hold and the investments that we've made toward the end of the last year and into early this year, in places like the Nordics are now seeing the fruits of the labor.

I think on the Americas and Asia Pacific, those pipelines are growing, we're at the front end of those pipelines. So we are not calling out anything of significance in either of those two regions, but that should service well as we, also enter into 2015, but I think the key is for us in the second half, is I think the strength that we see and we expect double-digit growing, happening in Europe during the back half.

Peter Heckmann – Avondale Partners

Okay, great and then I was just trying to look through my notes and seeing and David and maybe we can follow-up offline, it seems to me like there was a couple one-time cost items, that you're comping [ph] against, it seemed like there was maybe a $1.5 million issue related to STA in the fourth quarter, it seems to be that was also recognized in the third quarter, does that ring the bell or should I go back and?

David Berger

Well in this quarter, we had, we put away $300,000 additional and that was up against $500,000 last year, we had $200,000 in deal cost, but yes we in the second half of the last year, we did accrue a lot for at STA.

Peter Heckmann – Avondale Partners

Okay and then at this time, you want to take the opportunity and provide any update specifically your preliminary on 2015?

Michael Connors

Pete, not yet. We plan to do that, at a later date. We normally we do, when we report our full year results, but we are not there yet.

Peter Heckmann – Avondale Partners

Got it. Appreciated.

Operator

(Operator Instructions) and we have no further questions at this time.

Michael Connors

Okay, thank you, operator. Let me close by saying, by thank you to the ISG's more than 850 professionals worldwide. We appreciate your consistent passion and dedication to providing client solutions and I also want to thank all of you on the call for your continued support and confidence in our firm. Have a great day and have a great weekend. Thanks very much.

Operator

That does conclude today's conference. We thank you for your participation. You may now disconnect.

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