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IHS, Inc. (NYSE:IHS)

F3Q07 Earnings Call

September 20, 2007, 5:00 PM ET

Executives

Jane Okun - Sr. VP and Chief Customer Process Officer

Jerre L. Stead - CEO and Chairman

Michael Sullivan - EVP and CFO

Ron Mobed - President and COO, Energy Segment

Jeffrey R. Tarr - President and COO, Engineering Segment

Analysts

Peter Appert - Goldman Sachs

Anurag Rana - KeyBanc Capital Markets

Patrick Burton - Citigroup

Lisa Monaco - Morgan Stanley Dean Witter & Co

John Neff - William Blair & Company, LLC

Randy L. Hugen - Piper Jaffray

Presentation

Operator

Good day ladies and gentlemen and welcome to the Q3 2007 IHS Incorporated Earnings Conference Call. My name is Anthon and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [Operator Instructions].

I would now like to turn the call over to Jane Okun, Senior Vice President, Investor Relations and Corporate Communications. Please proceed ma'am.

Jane Okun - Senior Vice President and Chief Customer Process Officer

Thank you Anthon. Good afternoon everyone and thank you for joining us for the IHS fiscal third quarter 2007 earnings conference call. If you do not have a copy of the news release we issued today, you will find a copy on our website, at ihs.com.

Some of our comments and discussions on the quarter are based on non-GAAP measures. Our non-GAAP or adjusted numbers exclude non-cash items, gains and losses on sales of assets and other items which management does not utilize in assessing our operating performance. Our earnings release, include both our GAAP-based income statement and statement of cash flows and a reconciliation to the non-GAAP measures discussed during this call. The reconciliation schedule can also be found on our website, ihs.com.

Our non-GAAP results are a supplement to the financial statements based upon generally accepted accounting principles. IHS believes this non-GAAP presentation and the elimination of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance.

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

The agenda for today's call is as follows. Jerre Stead, our Chairman and CEO will provide an overview of our acquisitions to-date and an update on our special initiatives. Mike Sullivan, our Executive Vice President and CFO will cover the third quarter and year-to-date financial results, talk about the expanded credit facility and provide an update to our outlook for fiscal 2007. After formal comments, we will then open the call for Q&A, at which time we will be joined Jeff Tarr, President and COO of our Engineering segment and Ron Mobed, President and COO of our Energy segment.

Please keep in mind that this conference call, particularly the discussion of our outlook may contain statements about expected future events that are forward-looking and subject to risks and uncertainties. Factors that could cause actual results to differ and vary materially from expectations can be found in IHS' filings with the SEC and on the IHS website. With that, it is my pleasure to turn the call over to Jerre Stead, IHS Chairman and CEO. Jerre?

Jerre L. Stead - Chief Executive Officer and Chairman

Thank you, Jane. Let me start by giving a welcome to our investors and our IHS colleagues on this call or on the webcast.

The third quarter was a milestone quarter for IHS, there is so much that we want to share with you today. We not only tallied strong financial and operational results, we also closed on five acquisitions during the third quarter and we extended and expanded our credit facility. We continue to be focused on driving the business forward to achieve our vision of becoming the source for critical information and insight.

I'll start by touching upon the highlights of our third quarter results then move on acquisitions and finally, update you on our company's initiatives. First, our financial highlights. Revenue for the quarter was $183.4 million, up 31% over last year. Adjusted EBITDA increased 53% to $44.7 million versus third quarter of 2006, and adjusted EPS was $0.43, up 34% over last year. Mike will give you more details later.

In addition to continuing our organic growth, one of our key strategies for creating long-term value is through profitable acquisitions. We have and will continue to use targeted and strategic acquisitions to enhance our core capabilities and to supplement our organic growth objectives. Since our last call and subsequent to the GCS and Jane's acquisitions in June, we have completed three more acquisitions for approximately $65 million.

Let me recap those three acquisitions for you now and then update you on our progress at Jane's. In July, we acquired the assets of Strategic Decision Group Corporation's Oil & Gas Consulting Practice. A recognized leader in the strategy consulting space, STG has served many of the world's leading energy firms with comprehensive insights, including overall corporate strategy, portfolio management and merger acquisition and divestiture support. STG will be managed within CERA, enhancing IHS' CERA consulting services. STG will drive additional product pull-through, helping IHS to further develop relationships with the national oil companies, particularly in the Mid East and Far East regions.

In mid-August, we acquired J. S. Herold, an independent research firm that provides in-depth analysis and key financial in operation data on more than 400 global oil and gas companies. We believe that J. S. Herold's insight with our critical information is a powerful combination. We also like the access to the financial marketplace that J. S. Herold brings us. J. S. Herold's data and analysis will improve and broaden the IHS capabilities, by providing financial expertise and tools. Additionally, J. S. Herold research will be enhanced by having access to IHS oil and field level data to underpin company and project analysis, offering even more benefits to our clients.

In late August, we acquired the assets of PCNAlert, which delivers leading component event management solutions, including product change notifications and end of life notifications for the electronics components industry. This acquisition allows IHS to deliver an end to end engineering obsolescence management solution, while furthering our overall part strategy.

As promised back in June, I'd also like to provide a brief update on the progress at Jane's. Financial performance at Jane's including both revenue growth and margin expansion is on track with our acquisition plan.

During the quarter, we made a number of structural changes. As a result, the Jane's organization now has fewer levels, clear accountability and is better aligned with our strategy for the business. Our collective efforts have produced a number of early wins, including sub-sizable new business with the U. S. government. There are new Jane's products in the pipeline and an initiative is underway to leverage IHS capability to enable Jane's products along customers to see our data displayed on a map.

We've begun the work that will enable us to sell Jane's products through our telesales center and to leverage our global account management teams to sell Jane's information and insight to our largest customers. While we continue to work on the many good acquisition opportunities and our pipeline, our top priority will always be to ensure a smooth transition for the purchases we've already made.

The credit facility expansion that we announced last week and that Mike will discuss further, gives us additional capacity to take advantage of these opportunities. Now, let me give you an update on the programs and initiatives we spoke about last quarter. You'll require... recall that these programs are part of our ongoing investments and long-term in nature. We talked about these programs being in three broad categories; driving profitable revenue growth, expanding margins and improving our acquisition processes.

Starting with profitable revenue growth, we've spoken about three large projects; Asia, customer first and global account management. We continue to make progress in developing our business in Asia. Two weeks ago, IHS participated in the first ever meeting of the World Economic Forum in the east, which was held in Delhi and China. In conjunction with this event, IHS was named by the World Economic Forum as one of the 125 founding members of the Global Growth Company Community, signaling growing awareness in the global business and policy making community of IHS' influence and leadership.

In addition, we had some strong customer wins in this region. As an example, we saw notable improvements to the subscription base, including one national oil company in Asia, where we signed a $10 million three-year renewal with 34% uplift.

Our second initiative focuses on customer first and marketing excellence. Enabling customer success begins with listing to customers, understanding how we can better retain and grow our existing relationships, and use these successes to attract new customers. We completed our engagement with over 1000 clients across the globe, allowing us to understand the quality and value we deliver them everyday and the level of delight we generate in every interaction. We will be sharing the results of this significant market research with you during our upcoming investor day.

We are continuing to structure and execute marketing programs in ways that grow our effectiveness in engaging customers and building awareness and demand for our unique value.

With regard to our global account management initiative, successes in the quarter reached beyond sales, and extend to both customer relationship management and input to product research and development. Examples include uplift of our data subscription with customer, improved contracting with another and valuable customer input for the next enhancement of our suite of cost product.

We also continue to focus on the projects intended to improve our operating margins. Our move to a shared services model is on track. We are making significant progress on this front. In fact, we've evolved our data accumulation project from a one-time initiative to a global sharing service. We've named a senior level executive to head our data accumulation shared service. The senior Vice President was promoted from within our organization and now leads the effort and will drive the transformation of our various processes into a more centralized, higher quality, efficient shared services function.

Finally, with the sharp focus this past year on creating and implementing a world class acquisition process, we now have a high quality system for identifying, assessing and integrating strategic additions to our company. Although we consider this particular initiative to be complete, we will continue to look for ways to improve our acquisition and integration process.

In summary, I am very pleased with the performance this quarter. There continues to be so much opportunity in this business, and we are working hard for all of our stakeholders to capitalize on the potential. With that, let me hand the call over to Mike, who will talk to you about our financial results and our recent credit facility expansion.

Michael Sullivan - Executive Vice President and Chief Financial Officer

Thank you, Jerre. I'll begin with an overview of third quarter year-to-date results, discuss our expanded credit facility and then provide an update to our annual guidance.

Let's start with the highlights. As Jerre mentioned, we delivered top line growth of 31% with Engineering growing at 40% and Energy growing at 23%. Organic revenue growth was 15%, with Engineering growing at 13% and Energy growing at 16%. Engineering organic growth for the third quarter benefited from the once every three year release of the Boiler & Pressure Vessel Code, but the organic growth rate in the engineering subscription products continues to track above 6%.

Gross margins expanded by 70 basis points year-over-year to 54.7%. SG&A as a percent of revenue and exclusive of stock-based compensation expense improved to 170 basis points versus the prior year to 31.5%. The adjusted EBITDA was $44.7 million, up 53% versus a year ago. Although this figure did include a $2.8 million foreign exchange gain, which won't continue beyond Q3. Adjusted EBITDA margin was up 3.6 percentage points from the prior year to 24.4% and we draw free cash flow on the quarter of $19.5 million.

Now, let me provide some details relative to these results. Our revenue growth was again broad-based in nature as we delivered good growth across all of our product categories. Specifically, critical information grew by 35% over the same quarter last year and represented 70% of our total revenue. We also saw strong growth rates in our decision support tools category, which was up 20% over third quarter last year and represented 15% of total IHS revenue for the quarter. Our services offering delivered 25% growth versus last years third quarter.

With regard to segment profitability, Energy adjusted EBITDA increased to $34.0 million in the third quarter of 2007, up from $23.4 million in 2006. Engineering adjusted EBITDA was $18.9 million, up from $13.3 million in the third quarter of 2006.

The reported tax rate for the third quarter was 30.6% versus 29.8% in the prior year's third quarter. The tax rate in this quarter benefited from the release of evaluation allowance associated with our foreign tax credits.

Stock-based compensation expense increased by $4.7 million versus a year ago, to $9.1 million for the third quarter of 2007. The increase related to the effected employee equity grants made since the third quarter last year and it changed the estimate of the number of performance shares expected to vest. Recall that certain of our performance grants allow for incremental shares to be issued if stretched targets are met. For the fourth quarter of 2007, stock-based compensation expense growth decreased in comparison to Q3, as Q3 included catch up the amortization for the change in estimate.

Adjusted net income for the third quarter totaled $26.9 million, up 46% compared to $18.4 million in the prior year. Adjusted EPS increased 34% to $0.43 per share in the third quarter of 2007 from $0.32 in the same period last year.

Please note that our earnings release provide the per share figures for a number of items that we exclude in measuring operating performance on the schedule attached to the release. This schedule will show the detailed reconciliation of EPS to adjusted EPS.

Third quarter free cash flow is $19.5 million versus $26.7 million a year ago. Year-to-date free cash flow was $81.6 million, down from $86.1 million in the prior year. Substantially all of this year-on-year change is driven by the timing differences which will reverse in the fourth quarter. As we reexamine the cash generative attributes of our company, we remain confident in our long-term ability to deliver 75% or more of adjusted EBITDA to free cash flow at term growth rates.

Now, let me move to a few of the highlights on our balance sheet. We ended the quarter with cash and short-term investments of $149 million and virtually no debt. Deferred revenue at the end of the quarter was about $231 million, which represent the year-over-year change of roughly $53.2 million, or 30%. The organic growth rate inherent in this year-on-year change is approximately 11.8%, which is in line with our year-to-date or overall organic revenue growth rate of 12.5%.

Before I discuss year-to-date results, let me quickly brief you of the details of the recent credit facility expansion. On September 7th, we entered into an amended credit agreement which increased the size of the facility from a $125 million to $385 million and increase the term of the facility to five years. This expansion aligns well with our overall corporate strategy of responsibly deploying capital in the form of acquisitions to supplement our organic growth rates. The expansion also allowed us to secure funding for the next five years at favorable market terms.

With regard to pricing, the terms of this unsecured facility call for a commitment fee of 10 to 25 basis points on the unused portion of the facility, while outstanding borrowings will carry interest rates of LIBOR plus 50 to LIBOR plus 125 depending upon the current leverage ratio. In terms of financial covenants, the agreement provides for maximum debt to EBITDA leverage of three times and interest coverage, defined as EBITDA over interest expense of not less than three times.

Now let me touch upon our year-to-date results just briefly. Revenue through the third quarter of 2007 was up 22% from a year ago. Year-to-date adjusted EBITDA for 2007 was up 43% versus the prior year. And the resulting adjusted EBITDA margin increased from 20.3% last year to 23.8% through the first three quarters of 2007.

Adjusted net income totaled $70.6 million through August 31, 2007, equal to $1.18 per adjusted diluted share compared to $50.4 million or $0.89 per adjusted diluted share in the prior year.

Now let me discuss our revised outlook for the full year ending November 30, 2007. Our guidance is on an all-in basis and assumes constant currencies and the affect of acquisitions completed to-date in 2007. The new guidance reflects the fact that the first three quarters came in ahead of our internal expectations and includes the addition of three acquisitions we've completed since the Jane's acquisition. Therefore, we are bringing both our full year revenue profit guidance up for the full year.

We expect all-in, 2007 revenue growth to be in the range of 22% to 24%. We are expecting all-in adjusted EBITDA to grow 35% to 37% for fiscal 2007. We expect our full year tax rate to be 32.1%, our 2007 stock-based compensation expense to be $29 million to $30 million, and fully diluted shares to be approximately 60 million. This outlook assumes no additional acquisitions, currency movements, restructurings, stock grants or other unanticipated events.

To recap, during the third quarter of 2007, we continued to drive strong top and bottom line growth. We continue to invest in the important programs that will help to secure a successful future. We are increasing our acquisition activity, identifying and closing some excellent additions to the IHS portfolio. While our acquisition pipeline continues to be full, we continue to work on bringing some of those targets to closure; we are especially focused on smoothly integrating and our driving results in the acquisitions done to-date ensuring the financial performance we expect out of these additions.

Now let me turn the call back over to Jerre.

Jerre L. Stead - Chief Executive Officer and Chairman

Thanks Mike. Let me close by saying that although the IHS management team is very pleased with the performance this quarter and very excited about the recent transactions, we are still laser-focused on continuing to execute. We look forward speaking with you more in-depth about our business at our upcoming Investor Day on October 11th in New York. We will provide more detail about our future plan and the opportunity will be there for you to see some of our products. We will also be providing an overview for 2008.

Thank you for your time today. I look forward to seeing many of you in person on October 11. Mike, Jeff and Ron are with me now and we are ready to open up the call for Q&A.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Peter Appert with Goldman Sachs. Please proceed with your question.

Peter Appert - Goldman Sachs

Thank you and congrats on another great quarter Jerre. The... I am wondering in the context of the consistent out performance you've enjoyed this year in terms of margins. If you are rethinking longer term, what the margin targets for these businesses should be?

Jerre L. Stead - Chief Executive Officer and Chairman

Thanks for the comments Peter. We said as you remember that we are comparing ourselves to the peer group, we've got ourselves what the target that we shared with our every colleague throughout IHS moving to the mid point of 30% adjusted EBITDA as a percent of revenue sometime in the future. We also will be presenting our strategic plans in a couple of weeks to our Board of Directors and the question you asked is one that you could expect them asking too.

We feel very good about our progress. We will continue to move forward and I think you can be resting in comfort that our target gets closer to reality and at that point of time, we for sure will review our next steps, Peter.

Peter Appert - Goldman Sachs

Okay, well still have a ways to go I guess to get to the mid 30% level. If I've done this arithmetic, I am right, may be this, a question for Mike, in terms of the 37% call it, EBITDA growth. It would imply, I think, backing into the fourth quarter that the margin would be sort of flattish with the third quarter. Is there any specific reason for that?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Well Peter, you build the model all year, where we will have less year-over-year margin expansion in Q4 than in the prior three quarters, and then very much is what our guidance calls for. When you look at it sequentially, it's the same trend we've been seeing in the business for three years where the seasonality is being taken out of the business to a large degree based on some of the non-recurring streams of the early part of the year, a rough and share week is a good example in Q1.

If you look back at the relative contribution in Q4 over the last three years, we've gone from that representing about a third or more of our full year profit to embedded in this year's numbers is something probably just over a quarter. So, I think it's more of the unseasonling of our company's economic model, brought about in some part by the acquisitions as well.

Peter Appert - Goldman Sachs

Right

Michael Sullivan - Executive Vice President and Chief Financial Officer

Getting revised to the phenomenon on your questioning.

Peter Appert - Goldman Sachs

Right. Okay. fair enough and then Mike on that the... I assume that in aggregate, these acquisitions you've made all come with margins below what the company overall had been doing, excellence in transactions. Was that fair?

Michael Sullivan - Executive Vice President and Chief Financial Officer

I don't know if that's fair or kind of all seven, Peter. Certainly we comment Jane's was running the biggest one of 16%, which is inferior to our margins and we talked about the plan of speed to get it to our margins. Herold was disclosed as the business and an asset that was running at comparable profitability level to ours and with some of the smaller tuck-ins; it's expected that after we acquire the asset that we drive some margin expansion. Although, the size of those revenues and profits don't tend to move the needle a lot to our consolidated numbers, but they are carrying profit percentages at least as long as ours in the near term.

STG, a service business, little bit different model there, where we aim for our service business to... if they can run and hold us constant at 24%, 25% rate. That's what we expect out of those types of businesses.

Peter Appert - Goldman Sachs

Okay, fair enough. Thanks Mike. And then last thing, I'll let someone else speak. Jerre, the... you've been very busy obviously from an acquisitions standpoint this year. Do you need to take a little break here to integrate these assets or should we look for the pace to continue at this level in terms of dollar investment?

Jerre L. Stead - Chief Executive Officer and Chairman

Yes, that's an excellent question Peter. Two or three comments; three years ago at our strategic meeting and energy, we laid out a plan that would actually get us to where we are at today, completing the acquisition of CERA that would create a great insight business that would pull through for us, our critical information in ever better fashion. Actually two years ago, Ron and his team identified J. S. Herold as a critical acquisition for us and we've executed that. It was four years ago, we actually started thinking about CERA, and so that happened. You can be assured that in Energy and I am going to touch on Engineering in just a second, we continue to have those patience, strategic acquisitions in mind.

On Engineering, it's actually an amazing transformation that is now being completed. Jeff and his team two years ago, at there strategic meeting laid out, in fact that's when we first started talking about Jane's in seriousness, laid out a plan that would get us to the point where less than 50% of their revenue was royalty-based with the acquisition of Jane's and PCN and some of the others that is now a reality.

Just a quick comment, we also said at that point of time that we wanted to get our total company business to 20% or less of royalty-based revenue and that too will occur in 2008. I just give you those as examples of this as not been opportunistic acquisitions as much as strategic use. We have more of those employees, I feel very good about the process that we put in place. We now look hard before we make the acquisition with all the strategic and financial hurdles. We are in very good shape, when we make that acquisition and how it's going to be integrated. I'll just give you one example of the day we announced the acquisition of J. S. Herold's or Jane's or any of them. There was a letter from me representing our whole team that went to every one of our new colleagues. We covered what we were going to do, how we are going to get there. We've... same information went out to our customers. We have a step-by-step plan. Jane's is being executed exactly against that plan.

So I feel very good about our ability to not just make the acquisitions, but to do the integration. If we feel the need to slow down or take a deep breath, I'd be the first one to make that happen, because we are committed to providing ever improving returns to our share owners. At this point in time, our pipeline continues to be filled with good strategic acquisitions. If they fit our financial profile, we will continue to make them, but certainly as I said in my talk today, we will first and foremost continue to focus on making sure the integration of the ones we've done is executed world class.

Peter Appert - Goldman Sachs

Great, thank you, Jerre.

Jerre L. Stead - Chief Executive Officer and Chairman

You bet, Peter. Thank you.

Operator

Your next question comes from the line of Anurag Rana with KeyBanc Capital Markets. Please proceed with your question.

Anurag Rana - KeyBanc Capital Markets

Right, good afternoon everyone. Just let me recollect, it seems with $0.43 that you have about approximately $0.02 to $0.03 of favorable foreign exchange movement and is it a similar amount for the amortization of intangibles?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Anurag, with reference to what?

Anurag Rana - KeyBanc Capital Markets

With the EPS of $0.43, because there is some purchase price accounting there that must have had a negative impact on the total EPS?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes. We are checking the actual model, I think the quick way to look at that is look at the level of amortization we report to the standalone quarter, compare that to the sequential second quarter Anurag, and a good rule of thumb would be that for every extra $1 million or so of amortization, that's about a penny. So we are running down the actual Q2 to Q3 amortization levels here if you want to hang on for couple of seconds, but couple of $0.03 probably sounds about right.

Anurag Rana - KeyBanc Capital Markets

Okay I just wanted to confirm to make sure I had my... it's about 2 million extra from the last quarter. I just want to make sure my numbers were accurate.

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, that's 1 to 2 to setup that way. And do keep in mind that when you look ahead, that reflected the Herold's acquisition, not for an entire quarter. So you'll have in Q4 that running out for an entire quarter, changed those with us for substantially all the quarters, all that about 15 days.

Anurag Rana - KeyBanc Capital Markets

Okay, thank you. And also would it be possible to get any idea about what was the revenue from Jane and how much margin improvement or what were the margins from that acquisitions?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, we're just not going to... other than breaking out our revenue line for U. S. we do in consolidated numbers, the organic effects and acquisition impacts, we are really not going to be commenting on the specific performance of anyone of the discrete acquisitions that we do, Anurag.

Jerre L. Stead - Chief Executive Officer and Chairman

Just add to that Anurag, if you remember on our Jane's call, we said the following. Jane's was about a $68 million revenue business. We believed in the next 15 to 18 months, we would bring that into our low double-digit revenue growth, about 1.2 as Mike mentioned a few minutes ago. And we said on that call, Jane's was operating at about a 16%, 16% plus adjusted EBITDA and our target which were right on schedule is to get it up to our current level of adjusted EBITDA for IHS, Inc. So as I said in my talk at the beginning, we feel very good that we're on target at this point against those guidelines.

Anurag Rana - KeyBanc Capital Markets

Great. And if I could get one more then, please any comments on price increases either in the Engineering or the Energy Group?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, there is, I will start with Ron and then ask Jeff to comment too but it's a great question.

Ron Mobed - President and Chief Operating Officer, Energy Segment

Yes thanks. We're continuing to be able to drive meaningful price improvements across all parts of our business. The global accounts program is allowing us to understand our custom needs increasing well and therefore we're able to deliver the right value to our customers and ask for the right level of price within them.

Jeffrey R. Tarr - President and Chief Operating Officer, Engineering Segment

And in the Engineering Segment we continue to drive price increases in line with what we've done in the past, what I feel really good about is the new version of our Specs and Standards product which has been renamed Standards Expert and is getting excellent customer reviews for the additional value add we're delivering to them and I am confident that will enable us to continue to sustain kind of price increases you've seen in the past.

Jerre L. Stead - Chief Executive Officer and Chairman

And as I mentioned in the talk when you're with us I hope all of you on October 11th we will give you in-depth insight from our customer surveys and you will see that in both cases, the critical information and insight are valued a great deal by our customers and they consider more than two out of three of our customer survey consider our information in both engineering and energy is inside of their own work streams and critical to them being able to be successful.

Anurag Rana - KeyBanc Capital Markets

Thank you and congratulations on a great quarter.

Jerre L. Stead - Chief Executive Officer and Chairman

Thank you.

Operator

Your next question comes from the line of Pat Burton with Citi. Please proceed with your question

Patrick Burton - Citigroup

Hi, congratulations as well and thanks for taking the call. I guess Mike, my question will be on the organic growth and the two components of the business, another very good quarter for organic growth. Could we just go through the factors driving that in terms of new clients, increased cross sales, new products etcetera?

Jerre L. Stead - Chief Executive Officer and Chairman

Yes, that's great question Pat. Again, I will start with Ron and have Jeff pick up on it. As a reminder, we look at it in basically three buckets. Price increase, increased wallet size and new customers, our products and expansion.

Ron Mobed - President and Chief Operating Officer, Energy Segment

Absolutely. So in Energy, we've been characterizing as exactly as Jerre mentioned. We see a split roughly at 40% coming from price rises, remaining 60%, above 40% coming from existing customers and the remaining coming from new customers that we are acquiring. Within that, the areas of growth in the... the new customer acquisition tends to be in the emerging market in Asia and other parts of the world. And also in our existing customers, we are able to drive increasing revenues both from new product and from cross-selling existing products by virtue of the connection between official information and our insight and again accelerated by the global accounts program.

Jeffrey R. Tarr - President and Chief Operating Officer, Engineering Segment

In the Engineering Segment, Pat, this is a somewhat different quarter because of the Boiler Pressure Vessel Code... the best way to think about the growth in the Engineering Segment in the quarter is think of it in terms of organic subscription revenue growth that has been at a sustained level in excess of 6% with... within that, parts growing faster, the Standards growing slower. Now obviously we've got a lift this quarter from the Boiler Pressure Vessel Code, which is transactional revenue, which was somewhat offset by other non-recurring revenue streams including the exit of some non-recurring non-core services that we talked about in the fourth quarter of last year and exited at that time

Jerre L. Stead - Chief Executive Officer and Chairman

and we will give you much more color on that, when we are together at the investor meeting with the sharing a lot of that customer survey input.

Patrick Burton - Citigroup

Thank you.

Operator

Your next question comes from the line of Lisa Monaco with Morgan Stanley. Please proceed with your question.

Lisa Monaco - Morgan Stanley Dean Witter & Co

Hi good afternoon. Two quick questions and then one more in-depth question. Mike, if you could just clarify in terms of your guidance change, how much of that was due to the impact of I think it's the three additional acquisitions. Secondly, could just elaborate on what the timing difference was in free cash flow that you mentioned. I think it was for the first half of the year relative to last year. And then my other question was just on Energy, when you look out to the opportunities that you are pursuing, what gets you most excited about the business. What are your customers doing and how do you size that opportunity? Thanks.

Jerre L. Stead - Chief Executive Officer and Chairman

So, Lisa if it's okay, this is Jerre, we'll have Ron start, that's a great question and then have Mike pick up okay?

Lisa Monaco - Morgan Stanley Dean Witter & Co

Okay, great.

Jerre L. Stead - Chief Executive Officer and Chairman

Thanks.

Ron Mobed - President and Chief Operating Officer, Energy Segment

Thanks, hello. As we can imagine everyday is a great day for us, when you think about the level of investment going in to the energy industry across the board, we are in an excellent position. You see the investments being needed to maintain traditional oil and gas production, the investments being needed to grow the generation of power in the traditional OECD economies but also in the emerging market economies, very substantial investments in both of those, recognition that the world is changing, that different factors are coming into play that has people wondering what decisions they should be making and what critical insights and information they need to make their decisions. So, as we play across whether it's from advising the traditional oil and gas companies of investment opportunities across the globe or helping power companies to make decisions or even helping other concerned parties, government regulators, investors, the financial community, clearly now together with IHS have a great set of products coming in through the acquisition of Herold's. And then the continuing discussion about the environmental concerns around CO2, and how those policy and other changes might influence investment decisions. All of those factors are being treated by our insight and information products.

Jerre L. Stead - Chief Executive Officer and Chairman

Mike you want to pick up the free cash flow first and then the... guidance.

Michael Sullivan - Executive Vice President and Chief Financial Officer

Then the guidance... sure. Two real issues driving the timing lease of the... the more significant of the two is that, there was an extra U. S. payroll in Q3. You pay every two weeks and the Friday ended on August 31. We get into Q4; there will be one fewer U. S. payrolls. The size of an average U. S. payroll is right around $4 million. The second relates to the timing of the procure... our purchase of the Boiler Pressure Vessel Code document and the timing of our receipt of the cash from the customers, we estimate that impact to be about 2.5. So, those two factors relate to about $6.5 million return as quickly as next quarter on us.

Jerre L. Stead - Chief Executive Officer and Chairman

Now, to the guidance, the three acquisitions we referenced that are not Jane's, and Herold's, represent a combined purchase price at about $26 million. So, if you start looking at market EBITDA multiples and then spread it out over four quarters, I think you will see that's a pretty small impact to the overall upward revision in our profit estimate. The vast majority of that revision comes from the strength, the Q3, the continued strength that we see in the profit engine of company.

Lisa Monaco - Morgan Stanley Dean Witter & Co

Okay and then just one last one. On the foreign exchange gain that you mentioned, I think it was just under $2.5 million in the quarter in terms of EBITDA impact. Can you break that out between the two segments of the corporate expense line?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, it's all the corporate expense line, it's $2.8 million. It was a one-off gain out of the inter-company debt arrangement that came with the Jane's acquisition. We hedged it immediately after it gave rise to the gain. We have taken a conscious decision to keep that in place, as it brings some nice tax attributes to the repatriation of capital. So, its all on corporate, it won't recur again. It's been hedged and it really underlying it is a nice opportunity to bring some capital back without taxing it up in the U. S.

Lisa Monaco - Morgan Stanley Dean Witter & Co

Great, thank you.

Jerre L. Stead - Chief Executive Officer and Chairman

Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of John Neff with William Blair. Please proceed with your question.

John Neff - William Blair & Company, LLC

Hi, thank you and congratulations.

Jerre L. Stead - Chief Executive Officer and Chairman

Thanks John.

John Neff - William Blair & Company, LLC

A couple of questions; one... two for Ron and two for Jeff. For Ron, I was just wondering, is the J. S. Herold acquisition, is that a prelude to offering some kind of an investor oriented data and analytics package. And then the other question I had for you was if you could give an example of how the global account teams, the insight that they are getting translates into increased price and wallet share increases?

Ron Mobed - President and Chief Operating Officer, Energy Segment

Yes, thanks John. Actually as you probably know, we've been working on delivering products into that financial sector for sometime and what Herold does is two things. First of all, it gives us most significant inroads into that community with product which are very much tailored to that community by people who have domain expertise in that business. That's very helpful for us. The benefit by having that domain expertise then allows us that expertise to help us to tailor the existing more technical parts of our product line to be relevant to that financial community and one of the synergy benefit then is to think about how we can use that expertise, the existing product lines that exist in Herold's and in the rest of our organization and to deliver better suited products to that community.

John Neff - William Blair & Company, LLC

Right.

Ron Mobed - President and Chief Operating Officer, Energy Segment

Second question I think was around the way in which the global account programs are helping to deliver this insight into new products and the development of those new products, I think one of the best examples of that today is how those insights from the global accounts are helping to lead additional development in the suite of products we have around cost and cost management. In the last 18 months, we've recognized a huge customer interest in what's happening to rising capital cost in the industry. And what we did by listening to customers, we developed a cost index and the suite of insight workshops and research products associated with that. What that then did it spread great interest in the underlying data products on cost around the world and the analytical tools that we built around them. And so during this year, we have seen significant uplift in the sales of those products and what our customers are telling us through the global accounts is helping them to design additional enhancements or additional extensions of the products going from for example, upstream developments to LNG products and now even into refining. Does that help?

John Neff - William Blair & Company, LLC

Yes, a little bit it does, that's interesting. So, literally by helping them a sort of I guess... you are increasing the transparency around cost of operations around the world and then that is obviously that's... that sort of then generating a greater reliance on your products and your work flow?

Ron Mobed - President and Chief Operating Officer, Energy Segment

That's absolutely right and the relationship that develop by the global accounts by understanding the totality of the customer needs and then translating those customer needs into a set of solutions built around the entire portfolio product and services that we offer is what give the customer the benefit he is looking for.

John Neff - William Blair & Company, LLC

Okay great, thank you. And then for Jeff, are you... a quick question PCNAlert kind of a rare tuck-in for your segment. I was just wondering if you could comment on what about that acquisition you like strategically because my understanding as you already have a certain amount of PCNAlert capability prior to that acquisition and then the other question for you is if you could just tell us what's new about the re-launch of Specs and Standards products?

Jeffrey R. Tarr - President and Chief Operating Officer, Engineering Segment

Sure, thanks John. So, PCNAlert is a great tuck-in acquisition that sets aside the acquisition we did approximately two years ago from IQ of the electronic database and toolset. So, it fits in nicely, they are the leader in that space of product change notification. They've got a large database and some very powerful tools and it's a great add-on sale for everyone of our customers, for that electronic service offering. Your second question is about what's different about Standards Expert and I can't wait to show that to you when we are in New York together at our Investor Day. It is a product that was designed based on listening closely to our customer, we did it we call listening labs with the third party, every... our whole team including myself watching customers behind the glass, using our product over an extended period of time and then redesigning and re-launching that product on our new common product architecture. The product has been fully deployed in NASA. They've... I think you will see their press release of that deployment couple of months ago, great response from NASA, very sophisticated customer and it's now being rolled out systematically using an agile development process to our entire customer base. And we will show that to you in New York and I think you'll be impressed with what we've done.

John Neff - William Blair & Company, LLC

Great and then if I could just one quick question for Mike. The deferred subscription cost on the balance sheet are actually down from year-end despite the very strong increase in deferred subscription revenue. Just wondering if you could just tell us what's going on there?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, that's a great... that's a great highlight John, into the fact that we are becoming much less reliant on royalty-based revenue streams as Jerre mentioned. As the relationship of that cost of the deferred revenue balance should shrink as we lessen the reliance and that's exactly what you see happening there.

John Neff - William Blair & Company, LLC

And again, I lied, I got one more quick one. Jerre, I think you would said Jerre that... I just want to make sure, I heard you correctly, that you were targeting getting royalty based revenue down to 20% of the total in 2008?

Jerre L. Stead - Chief Executive Officer and Chairman

That's correct and I think as you watch us perform starting in Q1, you will see that as a reality John and as I said that was, that's why I am so very proud of this team and the efforts because that was the strategic plan, goal that we laid out over two years ago. The other thing, I make a quick comment on, you are right that was one of the... I would not call it a rare tuck-in for Engineering; I call it the first, more good ones to come. As you think further now, our targets of ever increasing proprietary information and insight, and you should think about it in four domains. Actually we'll talk about it a lot more, excuse me we will talk about a lot more in New York. But if you thought of our traditional engineering business, it's really our life cycle business, PCNAlert happens to help us move towards that. So, you think about environmental business, environmental domain and security domain and energy all energy and has Ron did such a great job of describing, when we talk about energy we talk about everybody, including our alternative fuels etcetera in energy. And then security of course with Jane's now, so with those four domains, we'll see more tuck-ins that compliment each of those and most importantly where the four come together, we are going to see most of our customers at the opportunity to make use of all four of those domains in the future. So, Jeff and Todd and team are sitting here smiling today just like Ron and Mark here, because they are now on track and Mike smiles all the time about tuck-ins because if he could do one a month or better we do it because what we do think, 80% incremental with them.

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, very high rates of contribution money.

Jerre L. Stead - Chief Executive Officer and Chairman

So, hopefully you will see more of those in the future.

John Neff - William Blair & Company, LLC

Thank you very much.

Operator

Your next question comes from the line of Randy Hugen with Piper Jaffray. Please proceed with your question.

Randy L. Hugen - Piper Jaffray

Thanks and congratulations. I was just wondering given the changing seasonality in the business, how should we think about margin seasonality and sequential margin improvement going forward?

Jerre L. Stead - Chief Executive Officer and Chairman

Let me start with that and have Mike pick up on it. As we've consistently talked about this year we have a large number of initiatives underway. All of them will do a couple of things. One, focus on creating more profitable growth, by providing better quality responsiveness to our customers; and two, helping us to increase margins going forward. For example, I didn't mention today that quote to cash project that Jane is heading up force, we are going to see those kind of recoveries or data accumulation improvements in '09 and '010 with significant improvements in our adjusted EBITDA as percent of revenue. So if you think about it... when we have been on roadshows, Mike's consistently showed a chart, which says, if we can grow 8% to 10% organic, we will get natural drop through of 150 basis points of improvement each year. Part of the balancing act that we are doing is, I am very pleased with the team is exceeding that, because of more growth including acquisitions, investing a significant portion that we give you and all share owners in the future ever improving return with increasing adjusted EBITDA as we go forward. So Mike, pick up the seasonality one with that context.

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes Randy, I think that's very analogous to the question Peter asked earlier. We will begin to see that in Q4 over the... the margins are continuing to be strong. They will continue to be better than they were last year, but sequentially they won't be as much of a pop from Q3, as we've seen historically. I think the way I start thinking about it is the kind of the annual expansion Jerre referenced, and kind of a lack of movement from one quarter to the next, absolute [ph] fundamental discreet items like we have seen some sub-surface software sales in the first part of '07. That expanded margins for us. CERA was strong, and did a nice job of expanding Q1, but on a sort of a straight line expectation, I would start looking at it as a sequentially flat kind of a model.

Randy L. Hugen - Piper Jaffray

All right, and is that going to be true Q4 to Q1 as well?

Michael Sullivan - Executive Vice President and Chief Financial Officer

Yes, well Q1 you're starting to spread in the 2008. I guess I could see year-over-year go back to what Jerre referenced, we'll talk more about what kind of an annual tick up or increase we are expecting very soon on October 11 in fact, but we would go back to say I'm balanced. The sequential movement just won't be as pronounced up or down as we've seen historically.

Randy L. Hugen - Piper Jaffray

All right, thanks.

Operator

Your next question is a follow-up question from the line of Anurag Rana. Please proceed with your question.

Anurag Rana - KeyBanc Capital Markets

Hi guys, just a follow up. Just wanted to make sure I heard this correct. 20% of total '08 revenue royalty-based, is that accurate?

Jerre L. Stead - Chief Executive Officer and Chairman

That is accurate.

Anurag Rana - KeyBanc Capital Markets

So help me understand this, because if I go back before Jane's, in my mind I always thought that about 80% of engineering was royalty-based, is that accurate?

Jerre L. Stead - Chief Executive Officer and Chairman

It is not.

Anurag Rana - KeyBanc Capital Markets

Okay.

Jerre L. Stead - Chief Executive Officer and Chairman

I can give you before Jane's; it was running again with the lot of work. Don't forget the strategy that Jeff and team put in place two years ago of rolling the parts business much quicker. They also did a great job by the way of stabilizing the Standards Management business and then making investments that it's going to be good for the future. But you should be thinking about most prior to Jane's, we were running this year 65% to 68% quarter-by-quarter of revenue in engineering as a percent of -- sorry of royalty revenues as a percent of the their total on engineering and I'm happy to highlight that because that was a important strategics taken around that we've now put in place just as the stakes that I talked about with Ron and his team of creating a insight pull-through of our critical information with the acquisitions of CERA etcetera. Both of those are now implemented and that allows us to start looking forward to the domain discussion that I just opened up that you will get a lot more detail when you're with us on October 11.

Anurag Rana - KeyBanc Capital Markets

Thank you guys.

Jerre L. Stead - Chief Executive Officer and Chairman

Thank you.

Operator

There are no further questions at this time. I'd now like to turn the call back over Jane Okun.

Jane Okun - Senior Vice President and Chief Customer Process Officer

Thank you. We thank each of you very much for your interest in IHS. As Jerre mentioned, we will be holding our Annual Investor Day on Thursday, October 11th in New York City. If you would like more information or would like to register, please contact Andy Schulz at 303-397-2969. This call can be accessed via a replay at 1888-286-8010 or international dial-in 617-801-6888 passcode 95050623, beginning in about two hours and running through September 27th.

In addition, the webcast will be archived for one year on our website, ihs.com. As always, you can contact IHS Investor Relations with any follow up questions. We can be reached at 303-397-2969. Thank you, we appreciate your interest and your time. Good afternoon.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.

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