Information Services Group Inc (III) 2009 Q2 法說會逐字稿

Welcome to the ISG second quarter 2009 earnings results conference call. Today's conference is being recorded and a replay will be available on ISG website within 24 hours. At this time for opening remarks and introductions I would like to turn the conference over to Mr. Barry Holt. Please go ahead, sir.

Thank you. My name is Barry Holt. I'm the lead communications executive at ISG. I'd like to wish you a good afternoon and welcome everyone to ISGs second quarter 2009 earnings conference call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer and Frank Martell, Executive Vice President and Chief Financial Officer. Before we begin I would like to read a forward-looking statement. It is important to note that this communication may contain forward-looking statements which represent the current expectations and beliefs of the management of ISG concerning future events and their potential affects. These statements are not guarantees of future results and are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated.

For a more detailed listing of risks and other factors that could affect future results please refer to the forward-looking statement contained in our Form 8-K, (inaudible) to the SEC and the risk factors section in ISGs Form 10-K, covering fourth quarter and full year 2008 results, which was filed be the SEC on March 13, of this year. You should also read ISGs annual report on Form 10-K for the fiscal year ending December 31, 2008. And Form 10-Q for the first and second quarter of 2009. And any other relevant documents including any amendments or supplements to these documents filed with the SEC when they become available. You will be able to obtain free copies of any of ISGs SEC filings on the SEC website which is www.sec.gov.

ISG undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances for the reconciliation of all non-GAAP measures presented to the most closely applicable GAAP measure refer to our current report on Form 8-K submitted yesterday. You will have an opportunity at the end of this presentation to ask questions. Now I would like to turn the call over to Michael Connors who will be followed by Frank Martell.

Thank you Barry, and good afternoon everyone. Today Frank and I will recap ISGs second quarter 2009 results and outline for you the progress from both a business and a financial perspective that ISG is making. With the economy still in turmoil during the quarter most of our clients were focused on surviving the near term with some short-term tactical approaches to their business operations. They were busy reducing staff, furloughing, reducing pay and other quick hit like activities. We are now beginning to see a shift back to using sourcing strategies to optimize cost structures now that many completed most of the short-term cost actions.

To put ISG second quarter and first half results in to perspective I would like to update you briefly on the relevant trends we are seeing in the broader sourcing markets. To do this I'm going to quote from our recently issued second quarter 2009 TPI index. For the past 7 years the TPI index has been the authoritative voice on the sourcing industry overall developments and key trends. Our data shows that the downturn in the global economy continued to depress the level of overall sourcing activity during the second quarter. Although there are some potentially encouraging signs that appear to be emerging. Based on the results of our second quarter TPI index there were 135 commercial contract awards valued at $25 million or greater during the second quarter. This is close to the 141 contract awards that were announced during the first quarter.

The total contract value or TCV associated with deals closed in the second quarter was estimated about $20.5 billion. Which was up slightly from the first quarter totals of nearly $20 billion. The one regional bright spot was Asia Pacific which continued to deliver strong growth so far this year with TCV jumping more than 50% compared with the first half of 2008. From a year-over-year perspective second quarter TCV was down 23%. From a very robust $26.6 billion total recorded in the second quarter 2008. Year on year decline was fueled by a 69% drop in demand for BPO services globally. Dislocations in the financial services industry as well as the fact that a record number of ITO mega deals in Europe were recorded in the second quarter of last year and had no counterpart so far this year.

Despite these challenge markets ISG remains focused on relentlessly leveraging our industry leadership and achieving profitable revenue growth. With our objective emerging in the post recession economy next year a stronger Company. With regard to building our core franchise we continue to invest in new products and services, geographic expansion and selectively bringing in new talent. We continue with our expertise at cost productivity and achieving best in class operating metrics. All of these efforts are central to achieving our near term and longer term strategic plans.

Now over the past three months and for the first half of this year ISG have experienced revenue compression as many of our current and perspective clients particularly in the United States and Western Europe continue to defer decisions or adopt a more tactical slow rolling approach to decision making relating to sources. Over the past two quarters unfavorable currency translation continued to put a significant drag on reported results. This current year environment compared with the record levels of activity in the sourcing industry during the first half of 2008 which translated into record revenues and profitability for ISG.

Now despite the short-term pressure, we continue to invest for long-term profitable growth and I am pleased to say that a number of these investments are generating growth for us this year. I'm particularly pleased with the progress made by post contract management or governance services business which we launched during the second half of 2008. With well over 27 active sourcing arrangements around the globe, post contract management and governance is expected to be an area of predictable revenue growth for ISG as we my in to 2010. One of our key competitive advantages is our geographic footprint.

We decided despite the economy to push ahead and invest this year in our geographic expansion plans in Asia, Latin America, additional parts of Europe and explore opportunities in the Middle East we are making good progress on this front, we are seeing business growth in the Nordics, Latin America and Asia, areas where we have invested.

We launched TPI in to China, and opened this quarter the TPI training and assessment center in Hungaria. We believe this venture to be the first of its kind in China and offers us the opportunities to assist Chinese firms to participate more aggressively in supplying and using sourcing services. Over the past few months we have continued to develop this business and believe that China will be a source of emerging demand for sourcing advisory services beginning in 2010.

In our view our new service offering such as TPI governance services as well as continued investments in our geographic expansion, coupled with our existing core business will support sustainable organic growth and further margin improvements. We believe ISGs global leadership and geographic footprint have positioned us to manage through this current economic downturn, and support our clients needs to drive improvements in the key technology and business operations. ISGs market leadership emanates from it world class and loyal blue chip clients.

We ended the second quarter with about 200 active client engagements, that's up slightly from the 193 at the end of the fist first of this year, and about the same number as the second quarter of a year ago. Approximately 75% of our year to date fee revenues were generated from existing or former clients. Again demonstrating a continued high level of client satisfaction and loyalty, to the TPI brand. And ISG has commenced engagements with 46 brand new clients, over the past 6 months.

We continue to build up our blue chip client base, for example, during the quarter, we worked with companies 3M, Abbott Labs, Starwood Resorts, Quest, Service Master, Eon, Nordaya, Zurich, Quantus Airlines, K-Bank, Loreal, and the Australian government to name a few. Importantly, despite the top line compression in currency translation impacts we were able to maintain double digit EBITDA margins and protect profitability levels during the first six months of 2009, with a continued aggressive drive for operating efficiencies. ISG benefited from the flow through of better than expected savings rates from our previously announced 2008 value creation plan. As well as additional productivity actions we've taken in 2009, all which have resulted in strong gross margins and enhanced the leverage of our billable resources. Our strong focus on cost productivity has allowed us to continue to increase on investment in marketing and business development activities, fund our development of new products and services, and our geographic expansion, which we believe will generate future profitable revenue growth streams for us.

As I outlined earlier many companies in the near term are continuing to defer decisions and adopt a more tactical approach to decision making related to sourcing. But ultimately as the level of global economic activity improves, we expect most companies will look to fundamentally reset or reduce costs, and improve their long-term competitiveness. We continue to believe many clients will eventually move ahead with decisions on major sourcing transaction because the ROI is just too compelling. When they do ISG will be in an excellent position to support their initiatives from strategic assessments to contract negotiations and implementation and ultimately with post contract management services and to do so on a global basis. Let me now turn the call over to Frank Martell who will summarize ISGs financial results for the second quarter.

Thanks Mike. Good afternoon to everyone. Before I dive in to the financial results, I need to confirm that in order to facilitate a full analysis of the Company's financial performance ISG has presented GAAP financial results as well as certain non-GAAP information in our earnings release.

During this call I will discuss certain non-GAAP financial measures which we believe and prove the comparability of ISGs financial results between periods, and provides greater transparency of key measures used to evaluate our performance. Non-GAAP measures I will touch on today include EBITDA, cash earnings per share, as well as the presentation of selected financial information on a constant currency basis. A complete definition of each of those non-GAAP measures and the reconciliation to the nearest GAAP measure is included in our earnings release which was published yesterday.

Non-GAAP measures are provided additional information and should be -- should not be considered in isolation or as a substitute for information prepared in accordance with US GAAP. Now, as Mike mentioned ISG continues to proactively navigate through unprecedented financial and economic turmoil. Our second quarter and first half revenue trends reflect the impact of the recession on sourcing industry activity as well as unfavorable foreign currency translation impacts on reported results. Having said that the Company has continued to aggressively reduce costs, and drive productivity in to everything we do in line with the marketplace realities.

ISG reported total revenues of $31.5 million during the second quarter of 2009, a decrease of 38%, in the second quarter of 2008. Reported revenues decreased 33%, before the impact of currency translation. Fee revenues which are revenues before client reimbursable expenses totaled $29.4 million during the second quarter, which is a decrease of 37% year-over-year. Excluding the impact of currency translation, fee revenues were down 32% for the quarter. Revenues in the Americas decreased 33% for the quarter, while international revenues declined 32% on a constant currency basis from record performance levels in the second quarter of last year. International revenues in the second quarter 2009 were down 44% if you include the impact of FX translation.

For the first half of 2009 ISG reported revenues at $65.8 million, which is a decrease of 32%, from the first half of 2008. Excluding the impact of currency translation on these reported results, first half revenues decreased 26%. Fee revenues of $61.3 million during the first half, were down 31% year-on-year, including currency translation impacts, and 25% on a constant currency basis. Revenues in the Americas for the first half declined 29%, while international revenues were down 20% on a constant currency basis.

Including currency translation international revenues were 35% lower year on year. The revenue compression experienced in both the second quarter and the first half of 2009 reflected the impact of the recession, on current clients and perspective clients, many of whom as Mike mentioned have deferred or canceled sourcing transactions in the face of the continuing downturn.

For the second quarter 2009 EBITDA, a non-GAAP measure totaled $3.8 million compared with a second quarter 2008 EBITDA total of $8.1 million. Excluding the impact of currency translation EBITDA decreased $3.2 million or 46% for the second quarter of last year. ISGs first half EBITDA totaled $8.2 million, which is a decrease of 46%, from the $15.1 million, delivered in the first half of 2008. EBITDA margins when they are expressed as a percentage of fee revenues, for the fist quarter, the first half of 2009, aggregated 12.8% and 13.3%, which compares with 17.4 and 17% respectively in 2008. Second quarter and first half EBITDA includes the impact of approximately $1.6 million, in one time severance charges offset partially by 600,000 in lower vacation related accruals which have no 2008 counterpart. Decreases in EBITDA for the second quarter and the first half of 2009 resulted primarily from lower revenues in the Americas and Western Europe.

To mitigate the impact of the lower revenues and fund development in the rollout of new products and services ISG implemented an ongoing cost reduction program over the past 18 months. As a result of this program, during the second quarter, our direct costs, as well as our selling and general administrative expenses were reduced by 38% and 29% respectively. When viewed across the entire first half of the year, direct costs and selling and general administrative expenses were reduced by 40% and 9% respectively. From a diluted earnings per share perspective for the second quarter, of 2008, that figure was flat versus $0.08 for the same 2008 period. Delude EPS for the first half of 2009 totaled $0.02 compared with $0.13 for the same 2008 period. Diluted cash earnings per share which is a non-GAAP measure, for the second quarter 2009 was $0.09 compared with $0.17 last year. Diluted cash eps for the first half of this year was $0.19 compared with $0.31 for the first half of last year. Decrease in both diluted EPS and cash EPS was driven primarily by lower revenues as well as severance costs offset partially by lower taxes and lower net interest expense.

Finally, from a financial perspective ISG continues to maintain a s strong liquidity position in order to implement and support our business plans. Our cash and cash equivalents aggregated $45.8 million at June 30, of this year, a net decrease of $15.3 million from year end of 2008, the decrease however was primarily attributable to two payments which totaled $22 million. These two payments related to voluntary principal, and interest payments on our term loan as well as payments related to the 2008 variable incentive plan, which were made in the March of this year. These payments were largely offset by positive operating cash flow. ISGs outstanding debt at June 30, 2009, totaled $81.8 million, which is down from $93.8 million at the end of March 2009.

To sum things up, face the reality of the recession driven revenue compression, ISG continues to focus on enhancing the fundamentals of the business, drive productivity programs and improve our liquidity and capital structure this year. With that I will thank you very much for your time and I will turn the program over to Mike who will share some concluding remarks before we go to Q&A.

Thanks, Frank. Our vision remains the same. That's to build a world class industry leading information based services company. Despite all of the challenges and the head winds, we believe ISG is executing against its goal to develop a more profitable and focused Company. Revenues will be back. We have been operating Company for just 18 months. Much of which has been in the middle of an economic tsunami yet we have made great progress, we've diversified our revenues into a greater number of industry verticals. We've launched several important new service offerings for the future. We're expanding our global footprint. We increased our margins and positioned ourselves to expand them further and achieve higher levels of liquidity.

Beyond our focus on organically building our TPI platform, we are also continuing to pursue potential acquisitions. Activity level in this area has increased in the second quarter, as we pursue possible opportunities to build our overall scale, add new data and research services and expand the capabilities of our existing advisory services. Acquisitions remain an integral part of ISGs long-term strategic growth plan.

ISG global leadership, data driven products and services and a robust geographic footprint have positioned us to manage through the current economic downturn and support our clients needs to lower their costs and drive business improvements in their key technology and business operations. We are navigating through the challenging global economic conditions by driving best in class cost productivity levels, investing in our future and expanding the global footprint. We have prepared ourselves we believe for the post recession economy. Thanks, very much, for calling in this afternoon and now let me turn the session over to our operator for any questions that you may have.

(Operator Instructions) We will go first to Brandon Dobell with William Blair.

Hi, guys.

Hey, Brandon. Want to focus on some of the quantitative aspects first, which would be given the continued environment, how do people feel these days, analysts, guys on the ground doing the work, do they feel comfortable with the organization, the direction, and order adding value, that kind of stuff, and have you made changes in response to any push back from your employees in terms of structure, compensation those kinds of things? Thanks for the question, Brandon. Our people are feeling this is a difficult selling environment because of the decision making of the clients. The great news is that we have a lot of loyal client following. They are asking us to come in to do assessments, strategy work and what I would call preparation work. That work tends to be taking longer periods of time because they're extending those periods of time, maybe a few less people on the ground and takes longer to get it done because they don't want to assume additional risks in their businesses in the short-term. I think our people are feeling very good about the kind of value that they're able to deliver to the clients, probably a bit frustrated that the declining decision making is as slow and as sluggish as it is.

Having said that I think our people are very juiced and energized around our direction, they like the new service and product offerings that are being introduced. They like the fact that the global footprint is being expanded because that's what our clients are looking for, and they like the fact that we are introducing new information products for the future that will help not any our clients but also the service providers provide a better service to our clients. So along all of those lines I think despite kind of the economy I think our people are feeling very good about the future and how we are getting ourselves positioned for the future. We have not changed our organization structure. It remains a go to market structure on both an industry vertical standpoint as well as service offerings like CIO services and CFO services et cetera. We feel that still remains the right approach to the marketplace. There is good horizontal integration among the teams.

Okay. Shifting gears a bit as you look over the last four months or so has there been any change in what you would characterize as momentum, either inbound interest, response time from outbound selling. Trying to gauge the relative momentum in the business as you work through the second quarter.

This is Frank, how are you doing?

Good.

I think in terms of the last couple of months I think there has been a level of activity that's picked up. In a number of areas which I think is good news. I think it's a bit different by vertical. The financial services vertical that was I think extremely distressed has gotten some legs underneath it again , there is some decision making that's happening. We are seeing a lot of clients that are buying, probably I would characterize it, buying in kind of bite sized chunks if you will versus committing to the whole deal from the get go. What's happened is particularly in the US as we see clients kind of piecemealing across the continuum of the transaction, they're doing the assessment and then signing up for the subsequent work and signing up for additional work, we are getting ultimately all the full engagement sizes that historically we have gotten but in bite sized chunks.

I think in the second quarter we did see a slow down in Western Europe, in particular as you know that was a growth engine for us across 2008. Now part of that obviously is we had a huge quarter last year that really wasn't repeatable this year, particularly in the environment. I think more broadly there was a slow down in Europe in the second quarter broadly speaking, I think that reflects the economic realities over there. And also just the fact that as you know that market was fueled by huge deals last year. And those have gone out of the market. I say it's -- I hate to use the word green shoots in some areas, certainly are -- having said that as Mike articulated in his -- broadly speaking, quite a challenge.

As we think about the quarterly progression, looking out the next couple of three quarters the performance in the second quarter you think that's set a bit of a bottom for most geographies, with the exception of Western Europe and let's just talk on constant currency before anything else or do you think you're going to see seasonal weakness that exacerbates what was a decent quarter or second quarter.

There is a seasonality in this business. We are right into the summer season particularly in Western Europe. That always impacts the revenue a bit in the the third quarter. Typically in Europe, the third quarter is a bit weaker than the fourth quarter. I don't think you will see a strong move either way in terms of revenue, totality of revenue stream in the third quarter. And fourth quarter, visibility becomes a bit more challenging.

Okay. As we think about molding our cash flows in the back of the year, or back half of the year, any major changes to how we think about capital spending or DSOs to mold our cash flow?

No. In fact, if you strip out the one time, we did have actually an operating cash flow in the second quarter that was well in excess of the EBITDA total which has been good news. We've consistently generated some pretty solid cash flows. Part of that is because we have stayed on the DSOs they stayed in the mid 50 day range. We don't see much of a change there certainly we don't have any significant past dues or any significant receivable issues at this juncture. I don't know, we are always looking at how to best deploy the capital structure. Things like normal operations CapEx and stuff are pretty de minimus really. But we do have an ongoing share repurchase program. We are looking at our debt level. We may do something there. Nothing certainly has been decided.

Okay.

(Operator Instructions) Next to [Fred Galago] with Lazard Capital Markets.

I'm wondering on the weakness in Western Europe, is that purely FX recessionary timing in tough comps or is there anything else going on there?

Yes, I think this is Frank, as I said earlier, pat of that is definitely the fact that last year the market was full of there were a lot of big ITO deals, Shell and BT, et cetera that are not in the market now. That obviously -- where we see our revenue growth. BPO market as I mentioned has also been soft. There is some softness in the underlying market and there is quite a material if you look material, currency and material kind of comp issue if you will, comparative issue but there is some I think market pressure in Europe.

And I wonder if you could just provide an update on TPI momentum and government services since we last talked any milestones or call out there?

On the government services front there is a lot of activity on governance service. It was fairly slow as the decision makers put that decision off during the first, I would say almost the first half of the year. We have a large pipeline of prospects that we are working on now and feel very good about the work effort, the Claude Moret and his team are doing on the government services side. No contracts to announce as yet but there is a lot of activity we will hope will come to some fruition beginning in the second half of this year. On TPI momentum we are launching our third information product, out of that group which has only been operating a little over a half a year. That should be going out during the third quarter. So there is some progress being made on the momentum side as well. We feel very good about both of those businesses going forward. They are both in the emerging stage of development. With governance services probably a bit father along because of the sales cycle, what we have been involved in there. Nothing to report other than good activity on both levels and we would expect some activity on governance services beginning in the second half of the year.

All right. Great. Expense controls look very strong and we will look out for the new product in the third quarter. Thanks a lot, guys.

(Operator Instructions) Tim Fox with Deutsche Bank.

Thanks, good afternoon, guys.

Hey, Tim.

My first question was around the overall cost structures, staffing levels, utilization rates, where do you stand today? Can you talk broadly about your advisory utilization rates and I think more meaningfully going forward when we do see revenues start to come back, you think you will need to staff up at all or are you in good shape from a utilization perspective where you'll start to see a lot of that drop right down to EBITDA?

This is Frank. Just on the utilization, I think the story is with the revenue compression, and significant we hope for better, but -- we have been watching very closely the advisory staff count and trying to keep it right sized. You can never do that perfectly, so utilization in the second quarter is a bit lower than we would like. It was about 64.5%. For the quarter. As we talked about last year we really ran pretty much red line last year in the second quarter, so that was about 78%. So you can see the differential there. We have been able to make a lot of that up, that creates pressure, we have been able to make that up through not only in keeping staff count right sized but also on the discretionary cost side as well. You can't make the whole thing up but obviously you can make up a lot of it, we have been able to do that. Year to date the utilization sits a bit over 65%. That compares to about 75.5%. Which is really more where we are targeting 75% plus.

The good news though as you look kind of, as we exited the second quarter, because of lag affect on the people side we have seen the bench our bench numbers drop significantly so we are coming into the third quarter, so we are coming into the third quarter with a, actually a fairly productive and efficient bench situation. You should see those utilization numbers trend in the right direction as we go forward. Certainly if there is a significant pick up we would look to, we have to look at the staff count in terms of total size but for right now we do have still come capacity in the organization and that's really by design because I think testament to respond a little bit to Brandon's earlier comment, the pipeline is active it's getting some of these decisions made and over the line and it won't take that many to stimulate some growth.

Second question was around, you have a large North American auto manufacturer as a customer, just wondering if there is any additional color you can provide on business there it's obviously dropped as a percentage of revenue but is there anything to comment on on business there?

So good question. First, we are fully paid up from anything as it relates to prebankruptcy so there is no outstanding bills there. That's number one. So that's good news. Number two, our kind of core business with them continues, so that's second piece of good news, and the third piece is that we are -- we think that there are some additional new opportunities to help them over the course of the next 12 to 18 months on some new work that we believe will be significant for us in the future. We are still working it. We think there could be some real opportunities for us there. But nothing to report today other than we see some new opportunities on the horizon.

My last question was around the competitive environment. Obviously still have a high percentage of your business coming from your existing customer base, which is encouraging. In those instances where you are competing I was just wondering how this environment has changed if at all the overall landscape, whether it be who you are seeing and pricing per se on the competitive front?

On the competitive front I would say again, it's roughly the same kind of breakdown roughly 25% of our business is competitive. Varies in terms of which country the competition is at in the US. Equitara, who it the number two player, Allsbridge the number three player and a few others as well as the big four as well as occasionally but not very often one of the strategy firms still remain one of the competitive set here. Over in Europe it tends to be a little bit of the same but a bit more localized with some more local regional firms in addition to the ones that I mentioned and the same case over in Asia Pacific.

As it relates to pricing and all of that I think our realization rate has held up exceedingly well. I think we believe that we have a premium brand in TPI. And we are able to price that accordingly. One of the disciplines that we've installed and that the management of TPI has installed, is that but the TPI brand does command a certain level of value. And that we are not going to even, despite a very difficult operating environment we are not going to dilute the value of that brand. Our pricing has held up remarkably well during this difficult environment and the competitive front is roughly the same as it relates to the competitors that we are operating with in each parts of the world.

Okay, encouraging on the pricing front, thanks very much.

(Operator Instructions) Gentlemen it does appear we have no fur phone questions in the queue.

Thank you. In closing let me first thank all of our 430 associates around the world for their continued dedication and relentless focus on our clients. That's the key to our success. It has been for now 20 years, and it will be going forward. I think we believe the sourcing strategies remain a very compelling business case for clients with a strong ROI and I think when corporate confidence and decision making returns we feel that with our market leading position that we provide a unique platform to be able to support our clients efforts to lower their costs and drive business improvements going forward. I would like to thank all of our investors for your continued support and confidence, we believe we are building a great Company and look forward to your continued support in the future. Thanks, everyone, for calling in today.