Jerre Stead- Chairman and CEO
Scott Key - President and COO
Richard Walker - EVP and CFO
Andy Schulz - IR
Eric Boyer - Wells Fargo
Brian Karimzad - Goldman Sachs
Bill Warmington - Raymond James
Toni - Morgan Stanley
Kelly Flynn - Credit Suisse
Bill Sutherland - Northland Capital Markets
Andrew Steinerman - JP Morgan
Manav Patnaik - Barclays Capital
IHS (IHS) F2Q12 Earnings Call June 18, 2012 5:00 PM ET
Good day ladies and gentlemen, and welcome to the second quarter 2012 IHS Incorporated earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host for today, Mr. Andy Schulz, vice president of investor relations. And you have the floor sir.
Thank you operator. Good afternoon and thank you for joining us for the IHS second quarter 2012 earnings conference call. We issued two news releases earlier this afternoon. In addition to announcing our second quarter earnings, we announced a secondary offering. If you do not have the releases we issued earlier today, you will find copies of them 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 stock-based compensation and other non-cash charges and other items. Our earnings release includes both our GAAP-based income statement and statement of cash flows and reconciliations to the non-GAAP measures discussed during this call. These reconciliation schedules can also be found on our website.
The non-GAAP results are a supplement to the GAAP financial statements. 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 and 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.
Please keep in mind that this conference call, especially 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's 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?
Thank you Andy. Good afternoon and welcome to our investors and to my IHS colleagues. After providing an overview of our performance highlights for the quarter, I will update you on the multiple investments we continue to make in our business, including the two acquisitions announced since investor day.
Before I brief you on the quarterly results, I want to quickly note the secondary offering we announced about an hour ago. This is a secondary offering for 8 million shares, plus a 1.2 million share [shoe]. As with the two secondary offerings we did shortly after our IPO, we are facilitating the organized sale of the shares of an existing share owner and IHS is not raising any primary funds.
Current share owners are not being diluted as a result of this offering, and we view this offering as a strong positive which will improve the liquidity of our stock. We’ll be happy to answer any questions you have on this offering.
Now, on to our financial results. Overall, we had a strong quarter, as expected. Revenue was up 20% in the second quarter, including solid organic growth of 8% in subscriptions and 7% overall. Adjusted EBITDA increased by 26%, and our adjusted EBITDA margin was 31%.
We are tracking to our updated guidance, which reflects our expectation of continued solid performance for the balance of the year. Scott Key, our president and chief operating officer, and Rich Walker, our executive VP and chief executive officer will provide more detail shortly.
This quarter we continued the implementation of new products, new platforms, and new processes to position IHS for long term profitable growth. When we think about our major investments and a scalable foundation, combined with a challenging situation in the broader global economy, our quarterly performance is especially notable. I want to thank all of my colleagues for their great work.
We continue to invest in our business at a historic rate, and we’re making great progress on our two major infrastructure projects, Vanguard and Newton. Vanguard is our platform to support business growth and drive business process simplification and standardization of all our financial, order to cash, and sales processes and systems. This is a very important enabler to all aspects of our business performance and growth.
On June 4, we reached another milestone in the Vanguard program, with the third release of the system. This release included the legacy legal entities of many of our largest acquisitions from the last five years, including IHS Jane’s, IHS Fairplay, IHS Global Insight, and our chemical assets.
Cross functional teams have been working diligently for months to ensure the effective launch and transition to Vanguard. I’m happy to report the release has gone according to our expectations and we are now commencing preparations for another significant release later this year.
We have created three regional centers of excellence for finance and customer care to support our growth worldwide. These centers are designed to create standard processes, maximize capacity and scalability, and continue to improve our customer’s experiences around the world. This represents an important investment in streamlining our operations, resulting in measurable progress and delighting our customers and contributing to the long term potential to expand margins and profitability. All of our teams are to be congratulated for their extraordinary efforts and great results produced to date.
We also continue to make excellent progress with project Newton, as we eliminate redundant activities and shut down legacy data centers. Acquisitions continue to be a key element in the strategic development of our business and our ability to deliver long term profitable growth.
The signing of a definitive agreement to acquire GlobalSpec for $135 million as announced last week represents the continued execution of our strategic plan. The GlobalSpec purchase price indicates the strategic importance of this asset and the synergies we anticipate as we transform our product design business over the next six to eight quarters. To this end, we have posted a supplemental deck to our website at IHS.com to further illustrate the key elements of this pending acquisition.
The purchase price for GlobalSpec represents a premium to IHS’s historic average multiples of revenue and EBITDA, and is in line with its strategic importance. The acquisition, once completed, will enable the transformation of that portion of our legacy PLC business, which represents approximately 15% of our total annual revenue.
GlobalSpec provides and engineering portal to over 7 million engineers globally. We believe it will be the catalyst for transformation of our product design portfolio, moving it from the current mid-single digit organic growth rate and dilutive margins to double digit organic growth at accretive margins.
We’re excited about the potential to elevate a significant portion of our business and achieve long term sustainable profitable growth. We’ve already given you a sense of its financial characteristics. Therefore, we will wait until GlobalSpec closes before updating our full year 2012 guidance for its impact.
Scott will tell you more about this important development to our business. I would also like to update you on XeDAR. XeDAR is an important addition to our energy technical offerings, and we’re looking forward to working with this very talented team to create even greater value for our global energy customers.
Now it’s my pleasure to turn this call over to Scott.
Thanks Jerre, and good afternoon to all on this call and webcast. This afternoon I want to offer some color on our growth and progress during Q2 and discuss the continued strategic development of the business as we focus on delivering sustainable long term profitable growth.
We made great progress toward achieving our 2012 goals during the second quarter, and we feel very good about our Q2 performance and momentum as we enter the remainder of the year. Results for Q2 were solid and in line with the anticipated step up from Q1. Further, we expect the second half of 2012 will be even stronger than the first half.
During the second quarter, subscription revenues expanded by $37 million in total to $287 million, representing 15% growth and 8% organic growth. This means we have sustained organic growth at 8% or higher for six quarters in a row, despite our unprecedented pace of integration and transformation amid uneven and generally sluggish economic conditions.
Nonsubscription revenues expanded by $27 million to $100 million in the quarter, representing 37% growth in total, including a 4% organic growth rate in Q2. This represents 16 points of sequential organic improvement over Q1 and the sequential momentum we expect as the year progresses. It is important to note that our consulting organic growth was a solid 17% in Q2 and 9% for the first half.
Let’s spend a moment looking at the core drivers of organic growth performance in Q2 and our areas of focus for the remainder of 2012. Our pace of product development and launch in 2012 is at the highest in our company’s history, and Q2 was no exception. These investments are a key component of our growth strategy, and we continue to make good progress.
Let’s take a closer look at our product introductions and enhancements. IHS Connect is a strategic product platform for which a series of vertical market releases will take place over the next 24 months to complete the integration of IHS capabilities for each of our target markets.
Our new offering, called IHS Connect for Oil and Gas, was launched in Q1 and the companion iPad app was launched in Q2 to continued positive customer reception, with nearly 1,000 IHS customers downloading it in the first six weeks since it appeared in the app store in early May.
IHS Connect will be a primary driver of upsell and cross-sell growth goals over the next eight quarters as customers can access all relevant IHS subscriptions from one easy to use workflow-based platform.
During the second quarter we also released key enhancements to our energy offerings, and saw continued strength in this important end market as we better connect our information to our key workflow platforms. Specifically, during Q2 we released an enhancement to Kingdom that seamlessly connects IHS Energy Information to key exploration workflows.
We released PETRA 4.0 with key new capability and significant performance enhancements. We released an upgrade to our primary energy web interface to over 16,000 geoscientists. We enhanced our map, graphical, or GIF interfaces with a new math services tool and we launched a significant upgrade to key energy interfaces and tools for Canadian customers.
We also had important enhancements and new releases in IHS Automotive and launched IHS Chemical, as we fully integrate and connect all capabilities to key customer workflows in each vertical market. We launched the extension of our coal API index in China and Australia, with the index now covering 90% of traded coal derivatives.
As we assist our customers with their big data issues in transforming operational data to critical digital information, we opened our first data transformation center in Houston. And lastly, we launched the IHS Unconventional Tight Oil Study, that is the first output of an integrated global team that is creating new analytics as we converge economic, geologic, and company information research and analysis.
We will see the benefit and value creation from each of these primarily subscription offerings in new revenue and enhanced upsell and cross-sell over the next two years as we renew and upsell the existing subscription base and see the full year benefit of these sales. We remain focused as well on sales force productivity, sales processes, and tools as we continue to upgrade and transform in each of these areas.
We remain on track with our deployment of our sales force automation system as part of Vanguard and the continuous improvement to our customer data and sales pipeline tools and management.
In the second quarter, the number of single sales opportunities, or SSOs, managed was approximately 18,000, up 88% in volume and 70% in value from Q2 2011, reflecting the growth of the company and our leverage of this system. Notably in Q2, we also renewed our EHS&S contract with the U.S. Armed Services with a three-year contract valued at over $48 million and representing an 18% uplift and expansion over the previous contract.
During the second quarter, we also continued to evolve our global sales leadership and structure for growth. We made strategic hires in EMEA and APAC sales leadership and established global sales strategy and global distance learning teams. All of these moves help us to fully realize the scale benefits of our systems investments and process enhancements. Importantly, the caliber of those interested in employment at IHS is arguably at an all-time high, while attrition rates are near all-time lows. This is not only true for the sales organization, but for IHS in total.
Let me spend a moment on our market outlook and sector outlooks. We all continue to see increasing economic headwinds globally and more and more in high-growth and emerging markets. Our analysts and economists are revising their outlooks downward for the balance of 2012 and for 2013 and uncertainty remains in outlooks on the full impacts in Europe and Asia.
While this represents increasing broad economic headwinds, this uncertainty builds demand for critical information and relevant insight by IHS customers as they navigate these markets. And we remain a small part of the large operating capital spend of our customers. This differential growth in the broader markets and economies is reflected in continued 8% organic expansion of our subscription base globally.
Let me spend a moment looking at growth in performance drivers in our key markets and core industries. By geography, organic growth was balanced. We see continued strength and expansion in EMEA, which grew 9% organically. We also see continued strong emerging market growth as APAC grew 8% organically and benefited from our focus and investment in our high-potential markets. And in the Americas, growth grew 6% organically.
By broader end-market trends, energy growth is robust worldwide with double digit organic subscription growth. Chemicals and transportation offerings also continue to grow at healthy rates. Manufacturing, government defense, and security continue to see market headwinds, with IHS organic subscription growth rates well above the overall market.
I want to touch now on our planned acquisition of GlobalSpec and our strategy for significant development and transformation of our product design offerings. We actively manage our entire portfolio for growth, and a fundamental requirement is the long term double digit growth potential for every IHS offering. Our product design workflow solutions represent roughly 15% of our annual revenue, and are composed primarily of the specs and standards portion of our legacy PLC business.
We have delivered solid mid-single digit growth for many years from these offerings, and while this represents the result of positive efforts by our teams, this is dilutive to our overall organic growth and well short of our long term growth aspirations. We have executed a disciplined investment strategy as we have transformed IHS to a customer workflow focus with positive results in energy technical, strategy planning and analysis, EHS&S, and supply chain, and we have a clear strategy we are now executing in the product design workflow as well.
The integration of GlobalSpec, and our additional investment and growth strategies will transform IHS’s capabilities and product design and create workflow solutions that seamlessly integrate information, insight, and productivity tools for an active global online community of over 7 million engineers.
This will enhance the value of current IHS and GlobalSpec offerings and provide the platform to bring additional IHS capabilities and solutions to this large global customer base. We also see immediate leverage of IHS global scale in sales and market presence to create large, strategic synergies as we elevate our total product design business to accretive growth rates and margins over the next six to eight quarters.
The acquisition, subject to customary regulatory review, and the integration of GlobalSpec, is a key step in our strategic development of a core part of IHS offerings and revenues, and we are excited to begin building new value for customers and enhancing the value we create and deliver with our many partners.
Before I conclude, just a quick update on our acquisition and progress with SMT. We continue to see the benefit of the strategic expansion of our business as we bring the right capabilities into IHS. We are delivering strong performance in assets acquired over the last four to six quarters where integration at all levels has been accompanied by double digit revenue growth during that time.
SMT continues to perform well as we integrate additional [ISS] information and workflow tools to Kingdom while delivering accretive profit margin. The sales pipeline is also building, as we have made strategic sales hires in the last few months and expanded sales and support capacity in EMEA and APAC to deliver continued growth.
In conclusion, we feel very good about our performance and our ability to deliver even better results in the back half of 2012 and thereafter. Continued investment in critical areas of our company only serves to improve our ability to execute in 2012 and positions us well for 2013 and beyond.
Now let me hand the call over to Rich.
Thank you Scott. I’ll provide an overview of our Q2 results and an update toward 2012 annual guidance. Let’s start with revenue. Second quarter 2012 revenue increased 20% to $387 million. The growth in revenue includes 7% organic growth and 14% growth from acquisitions. We saw limited impact from currency fluctuations for the quarter in total, but increasing impact as we exited the quarter. More on FX and its impact to our full year guidance in a moment.
The organic growth on subscriptions was 8% in the second quarter, six consecutive quarters of growth at 8% or higher, despite our unprecedented pace of integration and transformation against a backdrop of uncertain global economic conditions.
Subscriptions accounted for 74% of revenue during the quarter. Our nonsubscription revenue grew 4% organically in this quarter, representing a 16 percentage point sequential improvement from the first quarter. Our Q2 nonsubscription performance benefited from many items, including our best-ever IHS CERAWEEK event, our inaugural petrochemical conference, and 17% organic growth in our consulting and service offering. These elements are indicative of the momentum we expect to see as we drive to our full year outlook.
Looking at regional performance, revenue growth was broad based as the Americas grew 18% all in, with EMEA and APAC growing 19% and 31% respectively. We are pleased with our overall growth rates in these regions relative to the underlying volatile economic conditions in certain countries. It reiterates again that we remain focused on the right industries and workflows in the right markets.
Turning now to profit and margins, Q2 adjusted EBITDA totaled $120 million, 26% versus a year ago. Our adjusted EBITDA margin improved as expected, and was 31% in Q2. This is a 150 basis points increase over last year.
Looking at our organic business year over year, our total expense as a percentage of revenue declined by 800 basis points in the second quarter, while organic revenue increased by $23 million, representing a greater than 70% contribution margin on this growth. This is evidence of our continued disciplined and focused cost management, investing only where necessary to drive scale and growth in key industries and core markets.
Moving down the P&L, adjusted EPS increased to $0.97 per diluted share in the second quarter, representing a $0.14 per share, or 17%, improvement. The adjusted tax rate for Q2 was 25.6%, and the year to date rate remains in line with our annual guidance of 27-28%.
The reported GAAP tax rate for the second quarter of 2012 was 20.9%. Regarding segment profitability, Americas adjusted EBITDA increased 29% to $93 million, while EMEA’s adjusted EBITDA was up 26% to $32 million. APAC’s adjusted EBITDA grew 19% to $12 million as we continue to invest in our APAC center of excellence sales teams and delivery capacity in this high-growth region.
Looking at the balance sheet, we ended the quarter with $268 million of cash, resulting in a net debt position of $576 million. At the end of Q2, we have $420 million of capacity remaining on the revolver facility to support continued acquisitions and strategic investment. Deferred revenue at the end of Q2 was $544 million, up $63 million or 13%, of the prior year after excluding FX impacts.
Turning to cash flow, we generated $145 million of cash flow from operations and $127 million of free cash flow in the second quarter. On a trailing 12 month basis, our ratio of adjusted free cash flow to adjusted EBITDA was 73%, after excluding the one-time deficit funding related to the pension change.
Capital expenditures as a percentage of revenue are expected to remain below the 2011 rate of 4.1%. As these measures suggest, we continue to generate strong cash flow while we invest at a historic rate.
Now let’s go to 2012 guidance. Our guidance is on an all-in basis and excludes any expected impact from GlobalSpec or any other future acquisitions, further currency movements, mark-to-market pension adjustments, or unanticipated events. Based on exchange rates at the end of the second quarter, we estimate the potential negative exposure for 2012 to be approximately $11 million to revenue, and a minimal amount to adjusted EBITDA.
Importantly, while we are increasing our guidance because of our positive outlook for 2012, we would have increased it even further but for the headwinds resulting from the current FX environment.
For 2012, we are raising guidance and expect all-in revenue in the range of $1.53 billion to $1.58 billion, including 7-10% organic growth for the full year, all-in adjusted EBITDA in a range of $495-505 million, and adjusted EPS between $3.88 to $4.01 per diluted share. We also expect to depreciation and amortization expense to approximate $119 million, reflecting the impact of recently completed acquisitions.
In summary, Q2 was very much business as usual at IHS, with solid subscription based organic growth, continued margin expansion, and robust cash flow generation. With that, let me turn the call back over to Jerre.
Thank you Rich. 2012 represents the most important fiscal year in our company’s history. We’re pleased with our progress as we continue to invest in our future long term profitable growth, establishing the leadership, the capacity, and the critical infrastructure, systems, and processes that are the foundation of our performance for years to come.
The first half of 2012 is now in the books, and we look forward to delivering an even better second half. Scott, Rich, and I are now ready to answer your questions. So let’s start the Q&A.
[Operator instructions.] Our first question comes from the line of Eric Boyer with Wells Fargo. Please proceed.
Eric Boyer - Wells Fargo
It sounds like a little bit more concern on the global environment considering everything that’s going on. Scott, is your goal still 9% for organic growth? And then could you walk us through what you’re thinking about in terms of subscription and nonsubscription organic revenue growth ranges in the second half of the year to get to that 9%?
That’s a good question. I think just two things. I’ll let Scott answer the question in a minute on his personal goal, but if you do the math with the increased guidance we just gave you, and with the actual for the first half, you can see actually significant increase in both revenue for the second half to make the guidance for the year and EBITDA and those margins in the second half with current annual guidance would be 33.5% for the second half. What we tried to say is despite - not because, but despite - the uncertainty in the world, we feel good. In fact, we feel very good about what we’re doing. And as Scott said in his script, it clearly is giving us some revenue when uncertainty comes. So Scott, the 7-10 is what we continue to see. Scott, you said 8-9 the last time.
That’s right. And I think Eric several things. You understand the level of transformation and investment we’re making to position for future growth, and of course that’s a lot going on in IHS, and working quite well as Jerre said in our scripted materials.
We still continue to believe the range that we’ve outlined is the right range, and see a path to the aspiration I’ve laid out, which is really the baseline for the long term growth of the business. I would tell you this, as we’ve said in previous calls, over 80% of the business is growing today above 12%, and we talked about the 15%, which is the product design business and the importance of the GlobalSpec acquisition as a first grade step for us.
So we really see every piece of the business starting to move in the right direction, and I announced the long list of really important product releases that are about that future growth. So despite the headwinds we seem to be doing well. If there’s any caution on our part, it’s because we’re positioning so strongly for future growth. And I think thus far the results in this quarter show we’re weathering the headwinds pretty well.
Our next question comes from the line of Brian Karimzad with Goldman Sachs. Please proceed.
Brian Karimzad - Goldman Sachs
Scott, do you mind walking through some more color on the mechanics of the GlobalSpec business today, kind of what the mix of it is? And then how you see your execution there evolving over the next couple of years.
What’s exciting about this one is 7 million engineers across the globe. So GlobalSpec has more than half of those 7 million engineers coming from outside of IHS, coming to GlobalSpec every single day to answer critical questions. Our historical PLC business, as you might know, is 15% of revenues in total. It’s royalty-based, which means the margins are dilutive. And its growth rate, as we’ve said, has been solid, but not what we need across IHS for the long run.
So we had great opportunity. Our previous business really was not engaging engineers in workflow tools, and that prevented us from bringing the breadth of what we can do today already to those engineers every single day. So whether it’s environmental compliance on parts, or an extended view of the parts universe, whether it’s commodities and price or impacts on design from regulation, those are the things we [unintelligible] and we can’t do today.
So you’ll see us quickly do that with those engineers, bring them a broader array of high value information and insight, and then we’ll take those 7 million engineers - and you may know GlobalSpec has almost 100% of the revenue in the U.S., so they haven’t leveraged fully all global markets - and take them to IHS global markets very, very rapidly. So accelerate their existing business model, and then transform it to a great subscription model globally.
Our next question comes from the line of Bill Warmington with Raymond James. Please proceed.
Bill Warmington - Raymond James
A question for you following up on Scott’s comment about 80% of the business growing at 12% or better, whether you feel comfortable with a 12% type organic growth target for 2013. And then the second part of the question would be just to ask whether the 13% growth on the deferred revenue, whether that was the organic deferred revenue growth or just the reported? Or are they one and the same?
Rich, do you want to give the last part of the question please?
Absolutely. So you’re right, Bill. At the end of the second quarter deferred revenue was $544 million. The implied organic growth rate was 11%. When you look at this, there’s a number of factors that go into it: FX impact, seasonality, and the timing of the cash collections. Interestingly, for the last three years, the free cash flow in the second quarter has actually exceeded adjusted EBITDA, and it’s the same effect we see now. So great cash collection month. Again, normalizing for the seasonality FX impacts, and recurring seasonal cash collections, the trend in deferred revenue is actually in line with what we expected, and importantly, continuing at that 11% organic growth rate.
And Scott, pick up on the first part of Bill’s question, of what do we feel about 2013, 12% organic.
Bill, thanks for that question, because it’s really is our strategy. We have to have offerings that have that decade-long potential to be in the 9-15% range. And our goal, of course, is to be in the sweet spot of 9-15% organic growth for many years to come. And so you have it exactly right. What we’d expect to happen… we’re seeing our aspiration to the bottom half of that range, we’re seeing the bulk of our business right in the sweet spot of that range, and as we start to elevate all portions of the business… And you could think about us, all things being equal, right in the middle of that range as we come out of 2013, along this idea of six quarters or so to eight of elevation of product design. So that’s how it looks today, and we feel excited about getting to that path.
And just a little more color, as we move forward of how the new platforms will play late this year and early next year, IHS Connect being the first.
Yeah, we have major new releases, as you heard, in every single one of our workflow areas, so major new releases this year in Energy Technical Connect for strategy planning analysis, which you know is 30% of our business by revenue. Just starting on energy, oil and gas. We’ll see full energy toward the end of the year. Chemicals as we exit the year. Then into automotives. So 24 months from now that platform, Sphera and EHS&S, in Q4 this year. So we’re building momentum three years into reorganizing completely around workflows, and starting to see momentum with new offerings. Product design’s an important one for us to go at hard now, and we are.
Our next question comes from the line of Suzi Stein with Morgan Stanley Smith Barney. Please proceed.
Toni - Morgan Stanley Smith Barney
Hi, it’s Toni on for Suzi. Can you give any additional color on the secondary, the [trust] that’s basically selling over half its position and more with the [shoe]. Is there anything you can share about the timing?
Yes. For many of those of you on the call that I’ve talked to, you should know, as I’ve told you, that for the last three and a half years, I’ve talked consistently to TBG - [Heinie] Thyssen, the chairman of TBG - saying that over time, it would be great if we would have the opportunity to sell some of his shares. As you may know, he has sold none up to now. All of the other shares that were sold went as cash to his other siblings. And in fact, some of the shares also went to them, and those are pretty well behind us also.
So the timing was as straightforward as his board unanimously agreeing about four weeks ago to move forward with the sale. He’s happy to sign and has signed a one-year lockup, $5.5-6 million, depending on how the [shoe] plays out, for I believe many many years to come.
He’s very pleased with the performance and the 33% compound average share owner return over the last 6.5 years. And at the same time, as the board said, he has historically not been an investment company but indeed he has built organizations and companies, and I believe that’s eventually what he’ll do with these funds.
So it was as straightforward as that. What I kept saying to him was over time, if we could take the overhang of 22.4% of the top of our company, and were able to give certainty to the way we managed this particular secondary, I believed it would be helpful. I also believe - and I think we all do - that this will provide significant increase in liquidity in the shares that now are available for other share owners. So really that straightforward.
Our next question comes from the line of Kelly Flynn with Credit Suisse. Please proceed.
Kelly Flynn - Credit Suisse
Question related to the, I guess implied, organic growth guidance. Clearly you’ve said a number of times you expect it to accelerate in the back half. I was hoping you could just walk us through some mechanics there on what’s layering onto the growth rate, if you will, to help facilitate the acceleration? And maybe in particular touch on the impact of SMT, which rolls into the organic base, and the timing of any delayed projects. Last quarter, you touched, I think, Jerre, in the comments, on some delayed projects that you were hoping might materialize in Q2. Did those materialize? Or are those part of what’s forthcoming in the back half?
I’ll start backwards. What I said, or certainly meant to say, is that there are large potential orders that will come from EHS&S that are timing - we’re not quite sure whether it’s going to be first quarter, second quarter, third quarter - but have a significant impact on the other category, if you will. That still feels good to us. If you do the math, you can see a couple of things. And then I’ll ask Scott to add to that.
One is, as Rich just said, this quarter our free cash flow exceeded our EBITDA, and that tells you very clearly what’s coming on the organic growth on the subscription base. So that’s strong, and will continue to be strong, as we go through the balance of the year.
Other, as Scott said, was actually a couple of very good things. A record performance out of IHS CERAWEEK, 17% organic growth out of our consulting and services business. So very strong, with pretty darn good backlogs, pipelines, set up for the second half.
If you think about the mechanics of - Jerre kind of indicated it - continuing to elevate the subscription base with new offerings in new markets, Latin America, Asia-Pacific. Of course core to the business. So that’s part of what always gets us to our goals. The other is just good continued performance in the nonsubscription.
And if you look at last year, just to give you a sense of the mechanics, we exited Q4 last year with the nonrecurring at about just above 10% actually, and the company then as a result, at 9%. We see that momentum building from Q1 to what we just reported, Q2. And as Jerre said, good pipeline.
So at $100 million in nonrecurring in the quarter, what you see is, as those businesses build, of course it’s important to the overall performance. SMT is a part of that picture, as you suggest, and you’re exactly right. It goes to organic. And that’s why we’re clear to mention on every call, to talk about our progress. We talk about investments we’re making to continue to build and grow that business. So we’re giving you an outlook for the year that shows us continue to improve, and each of the pieces performing as we see them do every year.
And with, as Scott gave you some interesting statistics during his scripted part, on what we’re able to see with sales force automation going forward, higher degree of insight - no pun intended - than we’ve ever had. Rich?
Yeah, just real quick, Kelly, if you think 75-80% of the business, the subscription portion of the business, growing between 8% and 9%, and what that contributes on an annual organic growth basis, the 20%, or the nonsubscription, needs to contribute about 3-4% for the year to get to the guidance range of 7-10%.
And lastly, I might tell you, as we always have, how our year’s built, and we delivered exactly what we said we would. So when we release the supplemental information on the distribution through the year, both revenue and EBITDA, we talked about 24% in EBITDA. We actually delivered in Q2 24% of the guidance we just updated, an increase. And we delivered a full 25% of revenue where typically we’d be at 24%. So those are other ways to look at the mechanics.
Kelly Flynn - Credit Suisse
Could I just throw in a really quick one? The 7% organic growth, can you just clarify, is that constant currency? Or does that include the one-point hit from FX?
The hit from FX going forward is $11 million in the second half, with current rates, Kelly. The hit in Q2 was about $560,000 negative. That’s it.
Kelly Flynn - Credit Suisse
Was that reflected in the 7% organic?
Absolutely. And as Rich said, we would have increased guidance more, except for the $11 million revenue headwind, because of FX. When we close GlobalSpec, we’ll do a call for updating guidance for 2012 and included in there will be our latest view of what’s going on from exchange rates too.
Kelly Flynn - Credit Suisse
So it would have been 8% without the FX impact basically. Is that right?
Actually, as you round, it would not quite have made it.
Our next question comes from the line of Bill Sutherland with Northland Capital Markets. Please proceed.
Bill Sutherland - Northland Capital Markets
Scott, I’m kind of curious about the sales force expansion. Is there a way that you can quantify kind of how much progress you’ve made. And I know it’s a combination of just heads and productivity, but if you can give us some feel there?
I’ll start and Scott will pick up. We started, actually, six quarters ago, adding sales force and support in Latin America and Asia-Pacific, and have continued to do that. You’re correct, it’s a combination of productivity coming forward as we finally are moving to the world of automation, which we’re so pleased to do. Scott, do you want to give them some good statistics on that?
Yeah, I sure will. We talked about - and that’s why I wanted to give you a sense of the volume running through the system. So there’s a roughly 90% from a year ago on volume of our SSOs, our opportunities being tracked through this global pipeline. So that tells you something about efficiency, but I will say this, and that’s why we started this year with a 7-10% organic growth outlook, is we were pretty pragmatic about all the change we were driving. You know, opening the three centers of excellence, ramping those up, additional releases of Vanguard. That gives us better customer data. Sales force automation and training.
And so all of these take time away from our sales force. So while they’re getting more efficient with better tools, we also are driving change through the system, and that’s, again, why we’ve been pragmatic. So we feel pretty good about the results. What I would say is our sales and our growth initiatives are garnering all of the net hiring. So IHS is an important net hirer through the first half of the year, but you’ll notice actually we are growing margin.
So we’re managing expense base well. I would say we’ve probably added 5% to our sales force over the first half of the year as we’re building, and we probably added 5-10% of their productivity. But some of the other changes are sapping some of that productivity gain. We’ll be through all of that change as we get into Q1 next year, and fully through it by this time. So those efficiency gains will start to calm more over the next two, three, four quarters.
Thank you Bill, and we’ll continue, as you asked so well, to add feet on the street in the rapidly growing regions of the world. So we feel very good about where we’re at with that to date.
Our next question comes from the line of Dan Leben with Robert W. Baird. Please proceed.
Daniel Leben - Robert W. Baird
Jerre, you kind of have a longstanding target of exiting 2012 with 35% margins. Given the 33.5% midpoint for the second half, is there something that’s changed that goal and potentially related to that, could you talk about SMT to the extent customers are requesting a SaaS model versus a license offer model?
If you do the math, again, and if you took what Scott talked about earlier, of the historical revenue that you can think through, and EBITDA, of how we deliver that proportionally by quarter, as Scott just said, we hit it right on the button, which is for Q2 after adjustment, after increasing our guidance.
You can see us, with a pretty clear route, to exit 2012 at the 35% EBITDA margins. It’s pretty straightforward if you think how it should play out. And I must say, it is a longstanding goal. It’s one that I actually put up in October of 2008, of $1.5 billion revenue and 35% EBITDA, and I’m really proud of the team, because I think the likelihood of being at or very near that is very, very high, and gets higher each day.
Your question on SMT is an excellent one. Scott?
Remember what we did, and what we announced this quarter, the big move thus far this half year with Kingdom, the SMT workflow tool, as well as the new release with Petra, is a [unintelligible] connecting our information seamlessly. So the great thing that happened in this quarter with Kingdom was doing what we did some years ago with Petra that accelerated its growth. But seamless connection of information. And of course that information is sold on a subscription basis, and the information is much more valuable and a larger part of the total offering.
So while we’re very interested in moving as many customers to a more subscription-based model on software, we’re very, very focused on the information subscriptions as the core. And we’re seeing some of that, Dan, but we’re also responsive to customers. And at the end of the day, IHS’s nonrecurring software licensing revenues that is nonsubscription is 5-8% of the company in total. So as we move that way, it will help us, but it’s still not usually material.
Our next question comes from the line of Andrew Steinerman with JP Morgan. Please proceed.
Andrew Steinerman - JP Morgan
You talked about enhanced growth in the second half of the year. Could you delineate that by domain? You definitely gave some good color on energy, double-digit growth right now on subscription. Could you give a sense by domain where we’ll see the second half for performance enhance?
That’s a good one. Pick it up, Scott, and give color on it.
What we’re trying to do, and of course we still give domain color, is give vertical market color, and increasingly workflow color, as we get systems up and are able to give you a bit more granular visibility into what’s driving our growth. So I’ll start there.
Strategy planning analysis from a workflow perspective and energy technical continued to do very well, and are leading our growth. We are continuing to build an EHS&S, a great business, as we get Sphera launched at the end of the year. So that’s important. Supply chain, again continuing to build and contribute it. And we talked about product design and its growth rates in the mid-single digits as we bring GlobalSpec in to accelerate those growth rates.
What we tend to see, as we talked about in end markets, is then that kind of following. Big potential, continued investment in growth in chemicals, resurgence in North America due to low gas prices of the manufacturing base and strength there. Energy on a global basis. Automotive, moving quite well on a global basis in transportation. So those are the things that will lead our growth. But interestingly, we announced in Q2 really nice uplift in the U.S. in the government sector, so that was a positive.
So I think that gives you a sense for where it comes from, and what drives it as you look at the back half of the year.
Andrew Steinerman - JP Morgan
And how does energy nonsubscription look? You mentioned double digit growth in subscription for energy.
If you look at our nonsubscription, nonrecurring parts of the business by the various pieces, by workflow, of course energy’s quite strong. We have a number of nonrecurring offerings, analysis, reports, as well as critical information that we sell. So that’s a leader there. Where there’s some laggards there is in, for example, the product design area, in terms of transactions as an example. So a mix there. But energy’s strong across the board.
And if you just think about the fact that we delivered 9% organic growth in EMEA, a good part of that, because of the huge uncertainty, was excellent consulting business around the energy questions that are raised by companies that are trying to figure out how to do things more productively, and gain more productivity. So it’s strong, and I think we’ll continue to be strong.
One other thing to realize is part of the nonrecurring is a transactions business. Not hugely material in aggregate to IHS. It’s a complement to what we do in some cases. We’ve got a great team now working that hard, as we’ve got great new marketing tools on IHS.com. But that’s a business also that’s not our core subscription offering, and so we’re going to manage that well as we do our other nonrecurring lines in terms of their size and magnitude.
Our next question comes from the line of Manav Patnaik with Barclays Capital. Please proceed.
Manav Patnaik - Barclays Capital
Congratulations on the quarter and also for finally getting [Heinie] to sell some shares.
[laughter] Thank you. Someday I’m going to write a book on that.
Manav Patnaik - Barclays Capital
The question I had was, subscription-based organic revenue growth has been 8% for six quarters now. Deferred revenue growth organically also seems to have been in that 10-11% range for a while. It seems like most of the intraquarter surprises have been the nonsubscription based due to the lumpy nature of the business. But given all these new product initiatives and platforms, etc., what sort of timeline or timeframe should we be thinking about to see that 8% number start going to 9%, 10% and double digits going forward?
It’s a good question. Andy has corrected me and told me I can’t use “lumpy” anymore, so I’m now required to use “uneven” quarter by quarter. But it’s still lumpy. Because of the backlog insight that we have today in the pipeline insight, I think we feel very good about that piece and what’s going to happen in the second half. Pick up, though, Scott, because Manav’s question is so good on the rest.
I think you’re right to the point of why we announced the GlobalSpec acquisition and why it drives value for us. So the biggest part of the business is where we want it to be, toward the sweet spot of that 9-15%, right in the middle of that. So above 12% organic. The nonrecurring builds through the year, and we see that every year. So that sequential improvement is what we need to see.
Then, the last thing we’re doing, which we’re relentlessly focused on, organic growth of all pieces of the business. And we’re not going to rest until every part of the business has got the double digit potential.
And so now you’re looking at us take 15% of IHS by revenue, that’s growing at 5-6%, and really supporting our partners in that current business. And then the engineers that rely on it, with great new tools. And that’s going to be the piece now that starts to elevate us over the next few quarters, while we get sales force efficiency from the new tools we’re deploying. Such I think it’s that combination of things as we look at the next two, four, six quarters, that you’ll see take the full subscription base to the potential that the 80% of it is already realizing.
Manav Patnaik - Barclays Capital
There’s one final add-on to that, just on the APAC region. I guess it has solid double-digit growth, organically in the last year. What’s going on there where that’s in that single digits, and when should that start returning?
Two quick things. Also, as Rich pointed out, with our heavy investments there, which are sales people primarily, the growth in EBITDA was the lightest of each of the regions. That’s intentional, because that’s leading to very strong organic growth balance of 2012. You might talk, Scott, on the comps there for first half.
Yeah, and I would say that’s why we talk about full year guidance. We have strong performance in APAC, they’re delivering to our goals and our plans for the year. We’re investing differentially and the quarter to quarter unevenness is just that. We see solid performance in the subscription base there, exactly what we expect in a great double digit growth region.
And that team is really humming. Doing a great job. Very proud of them, as is true of the whole company.
Since there are no further questions, that concludes the Q&A portion of our call. I’d now like to turn the presentation over to Mr. Andy Schulz.
Just before Andy wraps it up, I just want to make a couple of comments. We come out of Q2 the strongest I’ve ever seen our company. It’s amazing the change that we continue to execute through. And amazing the uncertainty in the world we live in. And feel better about accomplishments and better about where we’re at and where we’re going with the future than I’ve ever felt in the 10-plus years that Scott and I have been working together now. So feel very good about what we got done. Much more excited about what we will get done.
Last quick comment, and Scott hit it hard. Being able to move that last 15%. And for those of you who have followed us since we went public in November of 2005, the time we went public, that was 52% of our revenue. Today it’s 15%, growing at 5-6%. We’ll make that, as Scott said so well, double digit growth and bring it to accretive multiples in the year ahead. So we’ve now nailed 95% of our total revenue of a very clear path to 11-12% organic in the future.
So I thank you all very much and look forward to reporting Q3 and Q4. In the meantime, talking to many of you on our secondary. Andy?
Thank you very much for your interest in IHS. This call can be accessed via replay at 888-286-8010, or international dialing 617-801-6888, passcode 44550273, beginning in approximately two hours and running through July 2. In addition, the webcast will be archived for one year on our website at IHS.com. And 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 time.
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