Andy Schulz - VP, Investor Relations
Jerre Stead - Chairman & CEO
Scott Key - President & COO
Rich Walker - EVP & CFO
Manav Patnaik - Barclays Capital
Toni Kaplan - Morgan Stanley
Eric Boyer - Wells Fargo Securities
Kelly Flynn - Credit Suisse
Peter Appert - Piper Jaffray
Brian Karimzad - Goldman Sachs
Andrew Steinerman - JPMorgan
William Warmington - Raymond James
Dan Leben - Robert W. Baird
IHS Inc. (IHS) Q3 2012 Earnings Call September 20, 2012 8:00 AM ET
Good day ladies and gentlemen and welcome to the Q3 2012 IHS earnings conference call. My name is Alex and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.
I would now like to hand over to Andy Schulz, Vice President of Investor Relations. Go ahead please.
Thank you, Alex. Good morning and thank you joining us for the IHS third quarter 2012 earnings conference call. We issued our earnings release earlier this morning. If you do not have the release we issued earlier today, you will find a copy of it 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 for the non-GAAP measures discussed during this call. These reconciliation schedules can also be found on our website.
The non-GAAP results are 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 HIS’ 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 and good morning and welcome to all of our investors and to my IHS colleagues. After providing an overview of our performance for the quarter, I’ll give you an update on the multiple investments we continue to make in our business.
Regarding our financial results, revenues was up 14% in the third quarter including solid organic growth of 8% in subscription base and 5% overall. Adjusted EBITDA increased by 21% and our adjusted EBITDA margin was 31.4% an increase of 190 basis points over 2011. Scott Key, our President and Chief Operating Officer and Rich Walker our Executive VP and Chief Financial Officer will provide more detail shortly.
Our subscription business representing approximately 80% of revenue remained strong as it grew 8% organically for the seventh consecutive quarter. With existing customers, we continue to experience good price traction in renewal rates consistent with our plan. Yet, in late Q3, our non-subscription based business saw a rapid weakening in key markets as customers put capital decisions on hold in these uncertain environments.
This trend impacted Q3 performance and we anticipate that it will continue into Q4. Consequently, our Q3 non-subscription organic performance was significantly impacted by the abrupt slowing of customer decisions creating a disproportionate impact on our overall business and growth rates. We're seeing a slowing in economic growth globally as our economic forecasting teams continue to revise downward or outlooks with particular weakening in EMEA and APAC that is impacting supply chains of business spent.
The resolving impact on our growth is reflected in the Q3 performance we announced today and in our updated guidance for 2012. Overall, our growth remains well above economic growth rates in each of our end markets and our pipelines continue to grow. Scott will address the specifics of our growth and the key drivers and Rich will outline our updated guidance and full year outlook for 2012.
We continue to expand margins meaningfully and generate robust free cash flow. We added 190 basis point of margin versus a year ago. Our free cash flow conversation was 72% on a trailing 12 month basis. The result is adjusted EBITDA and free cash amounts at historic levels.
Let me switch now to an update on a few of our important focus areas. This quarter, we continued the significant implementation of new products, new platforms and new processes to position our company for long-term sustainable profitable growth. We continue to move quickly and deploy new systems and processes across every aspect of our business to capture scale efficiencies and to enhance the effectiveness of our global sales force. This is the largest transformation in value creation project in our history.
The third release of our Vanguard program was implemented in the first part of Q3; we now have approximately 60% of our revenue flowing through a common financial, sales and over through cash system. We are working to carefully and quickly convert our remaining business over the next three quarters. This transformation gives significant levers to provide future organic growth, margin expansion and delivery of increasing free cash flow as we realize these synergies over the next four quarters and into 2014.
We also continue to make very good progress on important customer colleague and sustainability corporate objectives. During the third quarter, our Customer Delight score increased to 66% from 62% in Q2. We are currently at our 2012 target with the final survey underway.
At a time when many customer satisfaction scores globally are flat or declining due to the difficult economic conditions, we continue to see consistent improvement in our customer interactions and value delivery. We also concluded our most recent colleague engagement survey with well over 90% of our colleagues providing input on how we can continue improving our business.
With regard to corporate sustainability, I am very pleased to announce that in the first year of having a formal corporate goal we entered a stretch target with the sustainability assessment score of 55. Some of the highlights are: we are scored in the 100th percentile for customer relationship management, the 93rd percentile for brand management and the 85th percentile for governments. I am also pleased to announce that IHS has been named to three MSCI flagship, Environmental, Social and Governments or ESG investment indices as a result of our company’s performance and increased transparency in ESG issues.
These best in class indices include companies with high ESG ratings relative to their sector peers across both global developed markets and the US market; being recognized by MSCI and independent global third-party in the investment community is further evidence that we are making measurable progress relative to our corporate sustainability objective.
Now let me turn the call over to Scott.
Thanks Jerre and good morning to all on this call and webcast. This morning, I am going to focus primarily on our growth and performance. Let me start by stating this quarter results were clearly below our expectations for acceleration in our growth in the second half of 2012. Simply put, based on the positive development of our sales pipelines in the first half and into Q3, we expected better performance. We expected our subscription growth rate to accelerate and our non-subscription business to perform better overall. Like many other businesses, we experienced an abrupt pause by our customers in their purchasing behaviors that became apparent as we finalized our Q3 close and developed our Q4 forecasts.
Although customers rely heavily on our information insight in uncertain economic environment, we're not immune to discretionary decision making in the face of rapidly slowing our uncertain markets that materially impact business spend.
Our customers’ reliance on our information insight is reflected in the continued stable 8% organic growth rate of our subscription base despite the market changes and the impact of fluctuations and discretionary decision making is reflected in the negative non-subscription growth rate for the quarter. As I have stated consistently over the past year or so, we're halfway through in eight quarter period of immense change management with historic levels of ongoing investment in our infrastructure, our sales force and our offerings, people, platforms, processes and products.
I am very proud of my fellow colleagues and their effort to deliver market leading performance and to realize the full potential of every area of our business. This is our focus every day at IHS.
I am going to review our growth and performance from many angles, by subscription and non-subscription, by geography and by broader end market trends. Before I do that, let me reinforce that the fundamentals of our business are modeled and our market opportunity have not changed. It is our commitment to these fundamentals that will drive continued long-term profitable growth and the achievement of the long-term aspirations we have articulated.
We have a significant number of long standing relationships with our core customer base and we’re building new relationships globally every single day. We remain focused on providing increased levels of value as we integrate offerings and capabilities to create new value for our customers. We’ve a deep and talented and highly engaged group of colleagues which includes some of the top experts in the world in our key vertical markets and across all areas of our capability.
The confidence we have in our ability to meet our long-term aspirations to create strong sustainable organic growth, expand margins and drive high levels of free cash flow remain unchanged.
Despite performance below our expectations, 80% of our aggregate business is doing very well. Our subscription base is represented by 76% of revenues in Q3 and we will manage this to a target of at least 80% of total revenue as we focused on expanding margins and increasing free cash flow.
Q3 subscription organic growth was 8% and this means we have sustained organic growth at 7% or higher for nine quarters in a row despite our unprecedented pace of transformation in sales systems, processes and operations amid uneven and generally poor economic conditions.
We continue to be focused on moving towards sustainable double-digit organic growth rate in our subscription business, but it is still very early in our new product introduction process and we are not yet complete with our transformational initiatives that will fully enable our sales force and maximize sales efficiency.
As we introduce each new product and as we implement each of our initiatives from now to 2013, we will build momentum towards our subscription organic growth potential. Having said that, the consistency of our subscription model and cash flows means that this growth is realized in a gradual manner and it takes a full year to sell new offerings into the existing subscription base and to begin to recognize the full value of new sales in the P&L.
I would like to give you some additional color on our subscription organic revenue growth of 8% and what unrealized this positive growth trend. Regarding value realization, we continue to see good traction in pricing and we are effectively managing discounting both of which continue to drive our positive subscription growth rates.
Regarding up-sell and cross sell, renewals rates remain [unplanned] as our offerings are must have in both uncertain markets and growth markets but we are not seeing the level of acceleration in new subscriptions we had expected at sale cycles lengthen in Q3 in many areas.
Regarding new customers, we see good moment in APAC as we remain a small part of a large market with continued doubled-digit growth but slower than expected levels in the Americas. We see good volume in our pipelines despite the lengthening sale cycles and here some key metrics from our global sale system.
The total values of single sales opportunities or SSOs in the pipeline grew from the close of Q2 to the close of Q3. Rising 15% by volume and 10% in value driven mostly by existing contract growth in upsell opportunities.
Regarding new business sales opportunities, we close $94 million in Q3 down slightly from $98 million Q2 and below the momentum we had anticipated.
What this tells us is the overall pipeline grew 10% but new business close remain flat as a result of lengthening sales cycles and customers putting some decisions on hold.
Non-subscription revenues were $91 million in the quarter representing a negative 5% organic growth rate and were relatively flat to Q2 after adjusting for seasonal events.
This follows a first half non-subscription organic growth rate of negative 3%. Within our non-subscription business we see slowing in key service lines as well as new license revenues as sales cycles extend for discretionary capital and expense items by customers.
From the pipelines building across these business lines, we had expected a Q3 non-subscription organic growth rate of 14%. And this represented 90% of the GAAP to our Q3 goals. We are analyzing every part of our non-subscription business critically examining performance as we drive to our goal of 80% subscription based revenues.
As we have done for the past year, we also continue to object the review the growth profile in each of our products in our portfolio and make decisions about whether are not they fit our future growth objectives.
Let’s look at regional organic performance. Americas’ organic revenue growth was 2% down 4% in Q2. Americas’ subscriptions grew organically at 7% continuing Q2 growth and non-subscriptions organic growth slowed to a negative 14% in Q3 reflecting significant increases in sales cycles and delays in customer decisions on key projects across software and services.
EMEA organic growth was 8% down 1% from Q2. We saw significant decline in EMEA organic subscription growth from a strong 9% in Q2 to 7% in Q3 reflecting the dramatically weakening market conditions in the region.
EMEA non-subscription organic growth offset some of the subscription weakening due to seasonal events in the region. APAC organic growth expanded to 11% in Q3 relative to 8% in Q2 with organic subscription growth at a strong 13% reflecting a good return on our investment in the region.
APAC non-subscription revenues grew at 6% and short of our expectations for the period as supply change in economic growth slowed in Japan and China, which will provide details and overall regional revenue growth as well as included FX impacts in a moment.
Let’s now look at our market and sector outlooks. We all continue to see increase in economic headwinds globally and more and more and high growth in emerging markets as we noted on our Q2 call.
Our economists, industry forecast teams continue to revise downward our near-term and 2013 growth expectations across the board. As you know, we have an award winning outlook and economic forecasting team and this is an important offering to our customers. Our guidance this month to our customers suggests that the weakness in the global economy is pervasive and we have just downgraded our outlook again.
The biggest growth downgrades have been for Europe, India, Japan and Brazil with emerging markets slowing more than predicted because of the weak export growth to the rest of the world and decelerating domestic demand.
IHS expects the Eurozone to remain in recession for much of the next year before the covering in 2014. Japan GDP growth slowed from 5.5% in the quarter to a mere 0.7% in Q2 with decelerations in domestic and external demand, exports to Europe fell by about 25%. China’s growth is softening but not collapsing, external demand is weakening and merchandize exports rose only 2.7% in August, sales to the European Union plummeting almost 13%.
Now turning to IHS performance in our key markets, despite these worsening global trends, we see continued solid growth in the number of our end markets along with weakness in [others]. Energy growth is robust worldwide with continued double digit organic growth across our offerings. Chemicals continue to do well and in North America where performance was strengthened by low energy and feedstock cost in the US.
Electronics growth had slowed to single-digits across most of our offerings as customers spend has declined with slowing of global supply chains. Transportation continues to perform well with single-digit to double-digit growth rates across autos and maritime markets as we continue to see growing market presence and market shares grow globally. Government defense and security continue to be challenged with single-digit growth rates as government spends remains under pressure globally and particularly in EMEA.
Before I conclude on revenue, just a quick update on our acquisitions and progress with SMT. We have successfully connected IHS Energy information to the Kingdom platform creating significant synergies for customers. We have also continued to rebuild and expand our technical sales and support capacity in high potential energy markets in EMEA and APAC. These elements will allow us to execute to the identified synergies and growth for this important acquisition. We also continue to integrate each of the acquired asset and colleagues and manage to well define integration and synergy plans and targets with good initial progress at [global spec] and invention machine.
In conclusion, we continue to invest and evolve IHS systems, products and operations to realize our long-term organic growth potential and the synergies we have yet to capture to a disciplined investment program targeting large capital intensive markets. We also continue to focus on the performance of our overall portfolio and make decisions that will optimize our growth potential.
Long-term, these changes will allow us to drive a higher level of revenue contribution from our subscription portfolio, creating even more stability in our business. We remain confident in the fundamentals of our business. We remain focused on execution to deliver our potential in any economic environment, ensuring IHS’ delivering performance and value well above market levels on a consistent basis.
Now let me hand the call over to Rich.
Thank you, Scott. Today I will brief you on some additional Q3 performance metrics, provide an update to our recently expanded financing capacity and give updated 2012 annual guidance.
Regarding the third quarter, let’s start with revenue. Third quarter 2012 revenue increased 14% to $386 million. The growth in revenue includes 5% organic growth, 11% growth from acquisitions offset by a 2% drag from FX relative to the same period last year.
Looking at regional performance, revenue growth was broad based as Americas revenue grew 13% all in with EMEA and APAC growing 13% and 21% respectively. Scott already touched on organic growth details, so I will move on to the rest of the P&L.
Now turning now to profit and margins; Q3 adjusted EBITDA totaled a $121 million, up 21% versus a year ago. Our adjusted EBITDA margin improved as expected and was 31.4% in the third quarter. This is a 190 basis point increase over last year and a 40 basis point improvement sequentially.
Given the trajectory of our revenue, we continue to aggressively manage our cost structure to ensure we are aligning resources to our highest growth and margin opportunities. This is why we continue to invest significantly in new products, new platforms and new processes to drive longer-term scale and efficiencies essential to long-term profitable growth.
We see the effectiveness of our cost focus as well as some of the initial efficiency gains from our infrastructure investments and the positive margin improvements in the third quarter. As a result, we continue to expand our margins and generate increasing from cash flow.
Moving down the P&L, adjusted EPS increased to $0.99 per diluted share in the third quarter representing $0.12 per share or 14% improvement. The adjusted tax rate for the third quarter was 22%. The reported GAAP tax rate for the third quarter of 2012 was 14% primarily due to discrete period tax adjustments including the impact of a tax rate reduction in the UK; the discrete period adjustments representing about $0.02 per diluted share in the third quarter. As a result, we expect full year tax rate to trend lower than prior years. The full year adjusted rate should be between 26% and 27% while the full year GAAP rate should be 20%.
Regarding segment profitability; Americas adjusted EBITDA increased 24% to [$96 million]; while EMEA’s adjusted EBITDA was up 32% to $31 million. APAC’s adjusted EBITDA was down 5% to $10 million as we continue to invest in our APAC Center of Excellence sales team and delivery capacity in this high growth region. Looking at the balance sheet; we ended the quarter with almost $300 million of cash resulting in the net debt position of $709 million.
Turning to financing; we recently increased our credit facility by $500 million in late August moving from $1.3 billion to $1.8 billion of total borrowing capacity. We elected to exercise the $250 million expansion feature under our existing facility consisting of $75 million increase in the revolver and $175 million in new term loan. We also entered into a new $250 million interest only term loan agreement which matures in 2.5 years. Proceeds from these term loans were used to pay down borrowings on the revolver. While these actions did not (inaudible) our outstanding debt, we have increased our current available borrowing capacity to $750 million to support continued acquisitions and strategic investment. Deferred revenue at the end of the third quarter was $516 million up 13% over the prior year.
Turning to cash flow; we continue to generate historic levels of free cash flow. In the third quarter, we generated $68 million of cash flow from operations and $50 million of free cash flow. On a trailing 12 month basis, our ratio of adjusted free cash flow to adjusted EBITDA was 72% after excluding one time deficit funding related to the pension change.
Cash flow remains the key metric to our value creation model. We delivered a record amount of free cash flow for the third quarter driven by a high level of recurring revenues and the early realization of the benefits derived from a common global financial system in process.
Capital expenditures expanded slightly as a percentage revenue to 4.5% due to continued focused on completion of our Vanguard implementation, investments in sales systems and new product platforms and our revised revenue outlook. As these measures suggest, we continue to build a strong cash generative business with strong EBITDA to free cash flow conversion despite investment at a historic rate.
Now let’s go to 2012 guidance. Our guidance is on an all-in basis and excludes further currency movements, mark-to-mark pension adjustments or unanticipated events. For 2012, we are revising our guidance and now expect all-in revenue in a range of $1.515 billion to 1.535 billion; all-in adjusted EBITDA in a range of $480 million to $490 million and adjusted EPS between $3.77 and $3.89 per diluted share.
At the mid-point, our revised guidance reflects our expectation in the subscription business will continue to grow at a high single digit rate of organic growth in the coming periods, just as it has for the past nine quarters. This also reflects the Q3 performance of our non-subscription business and the expectation they will perform similarly in the fourth quarter.
Important to note, FX has had a negative $10 million impact on results year to date. As we saw in the third quarter, we expect margins to continue to expand at approximately 200 basis points as we continue to realize the benefit of investment in systems and processes in the coming quarters. We also expect the positive pace of free cash flow conversion to continue as we drive to a higher level of subscription revenue.
With that let me turn the call back over to Jerre.
Thanks Rich. In summary, we see continued solid and consistent organic growth in our subscription base of 8% representing approximately 80% of the revenues in total. This was reflected in our Q3 growth and our full year outlook. We are now working on our 2013 plans and growth outlook and we see a continued consistent performance in our subscription base at approximately 8% for the next couple of quarters. We also expect to see margins expand as reflected in this quarter’s result and this will drive expanding free cash flow going forward. We will update you in early December as our fiscal 2012 comes to a close. As we continue to transform our business, the IHS executive team and every colleague are committed and focused to the delighting customers and creating long-term sustainable, profitable growth.
Scott, Rich and I are now ready to answer your questions. So let’s start the Q&A.
(Operator Instructions) The first question comes from the line of Manav Patnaik [Barclays Capital].
Manav Patnaik - Barclays Capital
I just wanted to dig a little deeper into the subscription side of the business. You know, you talked about expectations that should accelerate but it seem, some sort of I guess pull back or constrain there, just your outlook and if you can remind us again, the heavy subscription renewal months and how we should expect that to trend relative to your initial expectations?
Good question. I will start and Scott will pick up on it Manav. Like we said, solid 8% Q3 and in Scott’s script, he referred to the fact that from a renewal standpoint, from a pricing standpoint, from a cross selling standpoint, with the existing customers, we were right on the button. The shift was and Scott will give you color on this in just a second but the new customer organic growth we were expecting, we didn’t see on the (inaudible) so pick up from there Scott and then help because the second part of his question on how the renewal cycle goes with month-by-month.
So you have it right. What we had expected as we talk about our growth rate in the back half of the year was some increase and some momentum in the subscription base. So we saw a continued solid 8% as Jerre said, the foundation of that was good price realization, good cross sell and good upsell so those are all things as you know we don’t work in hard. What we would expected as we look at our the back half of our year and what we had talked about was probably the service space starting to rise to something like 9% so may be a point ticking up in the back of the year.
As you know, we continue to transform the business, create sales efficiencies, we have got products as we said that we started to launch this year. Really our goal is to complete all these change over the next three to four quarters and as we exit 2013 and head into 2014 we should see that subscription base begin to realize that benefits of all that work and through the renewal cycles see some list in the P&L.
So to that point, we start to have a heavier renewal cycle as we head into the back of the year usually last couple of months of the year and then into the first quarter as we have talked about in the past. So these will be important periods, so the next two to three quarters as Jerre said, important period for us to realize the sales efficiencies of new systems and begin to see momentum in our subscription base.
The next question comes from the line of Toni Kaplan [Morgan Stanley]. Go ahead please.
Toni Kaplan - Morgan Stanley
This is sort of similar to the last but the inclusion of S&P next quarter should benefit the subscription organic growth and the non-subscription since I think this was about 50-50 when you acquired them, and so within 8% guidance for organic growth, are you implying that the core subscription business is getting weaker and IHS Connect should also be in there. So I am just trying to reconcile how those positive sort of get you to 8% and not a little bit higher? Thank you.
Good question Toni. Scott, pick up on and then I’ll wrap up that because that's an important subject.
Yes, so appreciate it. So with regard to Connect of course as we've talk about that the platform for upsell or cross sell and of course we're seeing continued good momentum in upsell and cross sell. We also only have Connect we are very small portion of our sub space thus far. And we talk about energy of course where it is now and we are seeing next in the chemicals and then across each vertical over the next four quarters or so.
So that will be a continued source of upsell and cross sell growth. In terms of SMT you are right, in fact they move into organic as we get into the fourth quarter. We've made all the right moves to first part of the year connecting information with the platform as we said strengthening our teams in EMEA and APAC where we see good growth opportunity.
And we believe we'll deliver a positive quarter with SMT which would be good year-on-year growth realize in Q4 last year they had the best period in the history of that company as they joined IHS and we work to move them to our November 30 year end.
So we're continuing to work well with those teams, work well with customers and I think we should see some good momentum. And that would be reflected in the continued strength of our sub space.
And I just wrap up, Toni on the question. If you look at our supplemental revenue disclosures, you’ll see that the energy revenue actually grew about 25% all in Q3 and almost 29% on the year-to-date basis. So you see that very solid and I must say we're still more than delighted with the acquisitions we've made and particularly with SMT and what it’s bringing to us. Thanks Toni.
The next question comes from the line of Eric Boyer [Wells Fargo]. Please go ahead.
Eric Boyer - Wells Fargo Securities
So EMEA and APAC continue to perform relatively well compared to the Americas, but you saw the economic growth continuing the weak and mere across those regions. Can you just help us to better understand, how you are thinking about those markets going forward?
Yeah. Excellent question Eric. I will start with the color and Scott will pick up on it. As Scott said in his script, stayed very solid and Asia-Pacific continues to be our fastest growing region 11% solid organic growth, 13% year-to-date basis just saw really good business.
EMEA as we have talked about in Q2 actually was stronger from an organic base at 9% and we have expected in Scott’s script and I’ll him be specific with this in a second on EMEA. We do see softening and particularly if you look at what Scott talked about with the security and government.
So pick up on the color Scott.
And really our sub base of course is critical information across all these markets. So the overall sub performance is very consistent stable 8% easier than that of those areas and as Jerre said, energy remain strong with double-digit growth and what contributes to that is our strong energy subscription base and acquisitions we have made there. Chemicals remained strong, transportation remained strong, of course electronics, government defense securities where we are seeing some weakness in terms of the end markets and then you have to overlay that to the regions.
So EMEA of course we saw 200 basis points decline in their subscription organic growth rate from what was a very, very strong Q2 result down to the 7% level in their most recent period.
We did see in the Americas they continued 7% now within that is government defense and in some of those challenged markets but a good solid performance there. Of course Americas is mostly impacted by the non-recurring and a number of projects decisions made by customers as sales cycles lengthened a bit.
So in summary, APAC continues to do well. EMEA we believe we are going to continue to see headwinds in certain parts of those markets, Americas is pretty stable but a mix of performance across our end markets.
And just to wrap up on that Eric, Scott referred to our own economic forecasting teams and the softness in Japan and actually in China with recent events and reports. So we actually feel very good about the Asia-Pacific as compared to the uncertainty that is going on there. Thanks Eric.
The next question comes from the line of Kelly Flynn [Credit Suisse]. Go ahead please.
Kelly Flynn - Credit Suisse
Question about the near-term outlook for non-subscription, I know you said kind of expecting 8% for subscription. Did I hear you also say that you think the fourth quarter decline for non-subscription will be similar to the third quarters and if so how is it possible to similar when you stated that things sell off abruptly at the end of the third which would kind of imply that they might worsen in the fourth?
Thanks Kelly. Scott pick up and go back and help Kelly on that with the specifics and then Rich you wrap it up.
Thanks Kelly. So what we are clearly seeing as we’ve said is actually our pipelines continue to build as they did as we entered Q3 thought about the back half. So rising 15% our overall pipelines, sales pipelines in terms of opportunities rising 15% in volumes and 10% in value. So we see our pipelines expanding. What we didn’t see was new business close because of the lengthening of the opportunities in that pipeline.
So we talked about closing $94 million in Q3 which was down from $98 million in Q2. We would have anticipated about $20 million in growth over Q2 to get to our goals. Those opportunities are in our pipeline. It's our ability to close those with customers as they are very cautious about what they see around them. So we remain positive about what we have in our pipelines. The question will be the timing of closure and so what we’re reflecting is a lot of work over the last few days as we look at those expanding pipelines and what we believe we could close in Q4 and that’s what reflected in our guidance.
Kelly Flynn - Credit Suisse
But did you say that you think the non-subscription will be the same in the fourth quarter. That’s really my question?
So what we have hold you, given you an overall guidance range which we feel very confident in. We have told you we see consistent performance in our subscription trend and then we work in these expanding pipelines with customers to close in Q4 to reach the goals we’ve just outlined.
Kelly Flynn - Credit Suisse
Okay, got it. Did you gave out the deferred?
We did. Deferred revenue finished at 560 million Kelly. That was 13% overall growth inorganic, and the organic growth was 10%.
Kelly Flynn - Credit Suisse
Okay, great, so 10% versus 11% last quarter. So not off too much. Thank you.
Yeah, just a quick comment on that Kelly, very good for you, the impact of softening dollar actually, if it was a constant dollar, the deferred would have been the same in Q3, it was in Q2, 10.5% to 11%, so good for you, but we felt good about that. Thank you. Next question?
The next question comes from the line of Peter Appert [Piper Jaffray]. Go ahead please.
Peter Appert - Piper Jaffray
Thanks. So Jerre, it really seems like the non-subscription business has been the (inaudible) for IHS for the last couple of years; just in terms of the volatility you have seen there. So two questions here, one is strategically or structurally are there things you need to do or change to reduce that volatility; are there mix issues that perhaps should change or are there portions of the business that may be don’t fit as well with you, just strategically why are some of these businesses important to you in the context of this volatility? And then sub question two is, what gives you confidence it won’t continue to be volatile given the macro environment for another year or more?
Now those are excellent questions Peter, I’ll start and I will have Scott pick up on the second half of your question and then I’ll wrap up. The strategic question front end if you have heard Scott’s script, he said we would be and are working towards getting to a minimum of 80% of our total revenue being subscription based and it certainly includes looking at opportunities to I take away your word which is very good on volatility, in fact if we could get north of 80% we will do that and it’s a combination of things that we are working on and Scott I’ll have you give color on that and then I’ll come back with you on the second half because that’s a great question.
Yeah and you know we have worked as quite hard for a couple of years bringing in great leadership, great teams, great process and great structure and of course everything that’s non-subscription is here because it support our subscription value propositions and our core customer base. So those are the drivers, but we look at very part of the business. Just a little bit of colors, the pure consulting part of the business which is really not a significant part 6% or so of IHS overall in the first half grew at 9% year to date is about 6% organic growth.
So that’s a stable supporter of our subscription base. Where we've talked about some volatility is in some of our software and services and we're very mindful that as Jerre pointed out in our goal to move 80% how we'll get there is what we’ve said in the past and what we'll accelerate is the movement of some of our license and services to subscription basis and we’ll work to do that much more quickly particularly where its more lumpy than elsewhere and what you can expect here then is those core software and services that are tightly linked to our subscriptions then start to perform on a ratable basis as our subscriptions do. So that’s our goal and you’ll see us do that over the coming quarters.
And to pick up on the second part of your question Peter, equally important; two things, one as we move forward focusing on four vertical global markets and the adjacent markets structurally, strategically and organizationally. We've got a much better view of how those pieces will pull together in each of the regional markets on a global basis.
Point two, as Scott said, we actually with all the work our teams have done for putting sales force and all the mission in place have a much better understanding in a very current line of pipeline both with subscription base, but particularly with non-subscription base and as Scott said, Q3 was actually up 10% over the close of our pipelines of non-sub base. So we have got much better ability to track where we are going.
The other important comment here is, that as we look forward doing and making the moves that Scott just talked about and we will continue to, we have got the visibility to know which of the most likely non-sub based projects will complete, the only unknown that will continue is the pretty significant headwind that we are seeing on a pretty much a global basis right now, but a much better understanding and view of what’s on the pipeline; anything also in that Scott?
I think, I would said, you know we have core offerings, which some of we sold are not good in basis and particularly in licensees and software that’s critical to our information and you will see us move much more aggressively to move out to subscription model and that will take some of that lumpiness out and create greater consistency. None of these are sold independent of our information. It’s important to realize that although some lumpiness there in some decision making, what you see is good subscription base growth, consistent performance and we can bring that consistency to the other areas.
Your next question comes from the line of Brian Karimzad [Goldman Sachs]. Go ahead please.
Brian Karimzad - Goldman Sachs
Hey guys. First one, before a follow up is, can you tell us what percent of your revenue is from electronics and then that government defense security complex separately?
Well, the answer is no Brian. We will give you good color on it and Scott pick up on both electronics where its at, but the government and defense, what we can tell you on that is security revenue which we do report on and it is a pretty good indicator as long also macro forecast saying intersection revenue which would have government impact Brian those two were both down year-over-year in Q3 and basically flat for the year-to-date, so that gives you pretty good color of what we are seeing and pick up on.
As you know as we get to release for Vanguard our goal and we said it’s an investor and have all years to begin to give color why our vertical end markets and we are doing everything we can do that Brian so that you’ll have a good view of the business. What I would say to Jerre’s point is each of those sectors although we build capability and we’ve got great relationships there but less than 10% of overall sub space and we saw solid growth last year and we all see what’s happening with supply chains globally Intel and others and their outlooks, so the semiconductor side of that business of course is really thinking about the path ahead, but less than 10% and clearly offset regionally strong growth still as we expand our markets in APAC in each of those areas and then strong energy transportation and chemicals.
And just to wrap that, piece that Brian as Scott said in his script, the product offerings and services we sell into electronics did slow to a high single digits last quarter strong compared to market. Your follow-up?
Brian Karimzad - Goldman Sachs
The follow-up is I mean are you getting a sense of maybe some of the US defense complex is making some incremental adjustments as they get ready for next year or are you kind of still maintaining the view that they did most of that last year and then actually kind of curious that you zeroed in on software quite a bit as an area of weakness, certainly been an area where many of the recent acquisitions have been. Is there anything kind of tactically in terms of integration, maybe some pickups there that are happening?
So, I will get Scott to give follow-up number two [square] in just one second because that’s important on software. Scott, so do that one and then we will come back behind your follow-up number on US the [facts] but let’s get crystal clear on software.
So one thing that you should be clear on is 80% of our business revenue and aggregate is still growing at 10% and when we say that, that's a mixture of subscription and non-subscription. Right, so we have a subscription base, 76% growing at eight consistently. And we have 80% of our revenue growing at 10.
And that’s a mixture of subscription and non-subscription and some of those high growth areas are software. So we converge and very important for customer’s information, software tools and technology that’s the platform with research analytics on top and that is the value added combination we bring to customers that’s so critical.
So we got double-digit growth in many of those acquisitions and in our software and technology that enables our information. So, what we do have is some unevenness and some lumpiness in the larger software deals that have large implementation cost behind them, it can be as much as $100 million investment for customer, talk about that in the past.
Those sales cycles have lengthened and they are taking their times thinking about the implementation of that level of spend saw some lumpiness there but its still [quarter] our offering and solid growth in many, many areas in the company.
And sure we don’t want to mislead anybody. What Scott was talking about is where we can shift because as he said, it's an information based business all of our software. We will shift that to annual subscription base. We will do that going forward. So we have got more up front as you remember annual subscription base cash up front and move away from that lumpiness Scott was talking about then pick up on it.
So one more quick point for you. So when we say energy is growing at double-digits that’s information software services, when we say that chemicals is also growing strong high single double-digits transportation that’s the combination and that means we have got a great value proposition to those markets.
Brian Karimzad - Goldman Sachs
And then first part US defense aerospace ---
You know we invested once and they are all looking where the world headed right now. So part of that clause is I think many of them are trying to understand what’s the landscape is going to be a year from now and we could see some additional change. I think there is a lot of uncertainty there, a lot of initial moves made, the question is what further if anything needs to be done and that’s what they are reflecting on.
And I think Brian, what we will see because they are all looking at that cliff that everybody is talking about. Once we get through this election in November, December and Congress being very busy to hopefully do something about that potential [cliff] which would have a huge impact on defense as you know, we will have much better view on that but Scott says it will.
The next question comes from the line of Andrew Steinerman [JPMorgan]. Go ahead please.
Andrew Steinerman - JPMorgan
Could you talk about non-subscription revenues organic change in terms of consulting transaction revenues and other and what are driving each of them?
We will give you some color on that as you know, we move to where we are trying to get a good focus on 80% that is annual subscription base and a 20% non-sub. But we'll give you some color on the way those pieces are made up and then as Scott said a couple of minutes ago, we are eager as we get (inaudible) completed to be able to give you much better color on the vertical markets on a global basis that will give you really good visibility and that will include both sub base and non-sub base but give him a little color.
So we already talk about the peer consulting portion so year-to-date about 6% organic first half at about 9%. So that business relatively consistent with the overall business, transactions we've talk about in the past is in the $40 million to $50 million business that which is across the globe and it is the transactional selling of reports and insight and information to a very long-tail of customers and of course probably mostly impacted by discretionary spend, it’s a 1000s and 1000s of transaction across the world and then the rest of it is our services business that supports us in all kinds of ways and when customers decide to slow spend suddenly our goals in the businesses that we see decisions flowing.
So a good pipeline actually in each area they grew through the end through August to the end of Q3. We saw pipelines actually expand in each of those areas but just close to rate so lengthened. So that was really the negative impact on Q3 performance overall and the reason for the low subs non-recurring subscription number.
And the reason for the revision of the guidance on revenue.
The next question comes from the line of William Warmington [Raymond James]. Go ahead please.
William Warmington - Raymond James
Good morning, everyone. Jerre, a question for you on, you’ve talked about previously of moving to an organic revenue growth rate of 12% to 15% in the 2013 to 2015 timeframe. I just want to ask if you still feel comfortable with that level of growth and the timeframe. And then one housekeeping item on the EBITDA margin expansion for Rich, was that 200 basis points year-over-year or 200 basis points quarter-to-quarter?
Well, Rich, why don’t you pick up on that one first and then Bill we will be happy to respond on the organic question.
Perfect. The 31.4% margin in third quarter Bill was a year-over-year 190 basis points expansion. It was 40 basis points sequentially from the second quarter of this year.
William Warmington - Raymond James
And the 200 points you were talking about Rich?
200 points, we talked about think of more of a longer term progression in the coming quarters as we talked about the continuation and completion of the infrastructure and investment to drive the efficiency and productivity gains from those investments.
And one of the great things with the business model is indeed our ability to move expense levels relatively short period of time. Despite all the investments we are making so that when we see the global uncertainty; we will keep driving the organic growth which we will cover in just a second.
At the same time, you will see us drive strong EBITDA margins and continue to drive better free cash flow as a percent 12 month trailing of EBITDA, because we are blessed with the great business model that allows us to do that. So, do we still feel the same about 12% to 13% in the end of 2013 through 2015. I am going to have Scott read just the minute what we said on that subject which is yes we feel very strongly about our ability to do sustainable double-digit organic growth in the future as we make all of the investments we are making that gives us clear opportunity but Scott pick up on that so we are clear.
Yes thanks for the question for the question Bill. So as we’ve said, we expect now as we look at 2013 that we will see continued consistent performance of the subscription base at approximately 8% for the next few quarters. We then have talked about consistently about the seven quarters of delivery of 8% despite all the change and efficiencies in systems across IHS as we implement those in 2013 we start to see the benefit of that as we exit the year head into 2014.
We will also see the benefit of new products and all of those efforts. So that’s what we believe would take the subscription base then to the beginning point of that 9 to 15 range and then accelerate it from there.
So we feel good about the long-term potential, none of that has changed. We feel confident to model and we have work to do the next three to four quarters to prepare us for that future as we complete our transformation internally and then of course we are going to work expanding our presence in every single market as we monitor the external trends.
And just a quick wrap up and then we will move to the next question thanks Bill. Scott said a few minutes ago, that little better than 80% of the total revenues subscription base, non-subscription base is growing all double-digits today. Also we said, when we made the critical acquisitions that will complement our traditional engineering spec and standard business, that we thought when got into 2014 as we integrate all those with global spec etcetera that that will take us about 15% of our revenue from about mid-single 5%, 5.5% organic growth in to low organic growth over 11% to 12% and also be accretive into 2014 on our margins. So if you do all of that analysis, that says we’ve got very good visibility insight on what will get us 95% of the business into strong double-digits then doing what Scott just talked about as we finish all of the infrastructure systems we’ve had in place. So a good question though. Thank you. Next?
The next question comes from the line of Dan Leben [Robert W. Baird]. Go ahead please.
Dan Leben - Robert W. Baird
Just jumping back to the software side with the environmental business being down, is it fair to assume that EHS&S was kind of the culprit on that side this quarter. Just help us understand what the mix of kind of overall software is between that product, energy products etcetera, as well as the plans to move to a [SaaS model]. Is it something we’re going to see in the fourth quarter or is this 2013 type initiative?
Both pieces great questions, Scott?
One thing to realize about our EHS&S business, 80% of that is subscription base today. It is a combination of great information analytics and then tools for customers. We benchmark health safety issues, risk and compliance and we help take information, help them report. So the majority of that business actually is a great subscription information analytics and then tools business. So there is a portion of it which is software at enterprise level and of course those are very long deals as we discussed. We see the pipelines expand all year long because it’s critical for customers particularly water waste emissions reporting management in compliance and operating risk.
So it’s a fantastic business that ties directly with our customers. What we are saying to your point is about 20% of that business is enterprise software license sales. So we are going to look in next year, so 2013 as we actually said about four quarters ago that we would look to move that business to a fast model, we are going to look in that doing more aggressively because it’s probably the lumpiest part of our technology and software portfolio.
With that said the other parts energy probably 15% to 20% of our total energy business tightly bundled with information. There is no reason actually those aren’t large scale investments, they are instantaneous implementation for customers. So not large costs, so there is no reason we can’t move that one as we will renew subscriptions over the next year.
So to be really clear, we will start to see it in 2013 and we will start to take action there in different ways and that’s just to create some consistency for us.
A great question, Dan. So I think that wraps up the questions. I will have Andy pulls it off in just a second but thank you for the very thoughtful questions. I think we are pretty clear on where we feel we are at, where we are going to be and we look forward to as I said earlier getting back on the phone with you all in early December for our best shot at 2013 guidance. Andy?
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