Information Services Group Inc (III) 2019 Q1 法說會逐字稿

Good day, and welcome to the Information Services Group First Quarter 2019 Results Conference Call. Today's conference is being recorded and a replay will be available on ISG's website within 24 hours. At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Barry Holt. Please go ahead sir.

Thank you, operator. Hello and good morning. My name is Barry Holt. I'm the Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's first quarter conference call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer; and David Berger, Executive Vice President and Chief Financial Officer.

Before we begin, I'd like to read the forward-looking statement. It is important to note that this communication may contain forward-looking statements, which represent the current expectations and beliefs of the management of ISG concerning future events and their potential effects. These statements are not guarantees of future results and are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated.

For a more detailed listing of the risks and other factors that could affect future results, please refer to the forward-looking statement contained in our Form 8-K, which was furnished last evening to the SEC, and the Risk Factors section in ISG's Form 10-K covering full-year results. You should also read ISG's Annual Report on Form 10-K for the fiscal year ending December 31, 2018, and any other relevant documents, including any amendments or supplements to these documents filed with the SEC. You should be able to obtain free copies of any of ISG's SEC filings on either ISG's website at www.isg-one.com or the SEC's website at www.sec.gov.

ISG undertakes no obligation to update or revise any forward-looking statement to reflect subsequent events or circumstances. During this call, we will discuss certain non-GAAP financial measures, which ISG believes improves the comparability of the company's financial results between periods and provides for greater transparency of key measures used to evaluate the company's performance.

The non-GAAP measures, which we will touch on today, include adjusted EBITDA, adjusted net earnings and the presentation of selected financial data on a constant currency basis. Non-GAAP measures are provided as additional information, and should not be considered in isolation or as a substitute for financial results prepared in accordance with GAAP. For the reconciliation of all non-GAAP measures presented to the most closely applicable GAAP measure, please refer to our current report on Form 8-K, which was filed last evening with the SEC.

And now, I'd like to turn the call over to Michael Connors, who will be followed by David Berger. Mike?

Thank you, Barry, and good morning, everyone. Today, we will review our first quarter results; brief you on our key operating and client highlights; and comment on our second quarter.

First, I'd like to welcome Marc Riddick from Sidoti to the call. Sidoti has recently picked up research coverage of ISG. ISG now has five analysts following the firm. Our strategic focus continues to be on all things digital and building our recurring revenue streams. Our first quarter results reflect our progress with this strategy. ISG Digital Solutions generated more than 40% of our revenue. ISG Automation was up more than 50% sequentially and our recurring revenues were $19 million, representing 29% of our total firm revenues.

Overall, our first quarter revenues were soft as we anticipated on our last call. This was driven by four items totaling about $5 million. Number one, FX negatively impacted our revenues by $2 million. Number two, we had a reduction in spending of around $1 million in the quarter from one of our large automotive clients in the Americas. This was consistent with an overall cost reduction program at this client and was not specifically targeted at ISG. Number three, we had a major ISG event scheduled for Q1 that was postponed in March based on client input. This is $1 million event that we will now plan to hold later in the year. And number four, Brexit. The U.K. was down about $1.5 million in the quarter due to Brexit noise slowing decision making.

You might recall we recovered quickly from Brexit issues in late 2016. We expect a similar rebound in 2019. We are seeing decision making picking up once again in the U.K. and we cautiously expect a return to double-digit growth there as early as second quarter. Our revenues for the quarter $65 million were down 3% in constant currency, 6% on a reported basis. We delivered strong constant currency revenue growth of 10% in Europe even with the previously discussed shortfall in the U.K.

In particular, we saw great strength in Germany and our South Europe markets both up over 20%. This performance was offset by the softness in the U.S., driven by the timing delays and reduction in spending on some U.S. engagements. Globally for ISG, we saw strong demand in our insurance, manufacturing, travel and retail industries and our digital strategy services in the quarter.

During the quarter, we served 399 clients including 31 that were new to ISG that was up 6% over last year. Our nearly $4 million of EBITDA for the quarter was down from the prior year due to the softness in revenues.

Moving beyond the first quarter of softness, we are quite bullish on the quarters ahead. Our sales pipeline is robust. The Americas is expected to have double-digit sequential growth in Q2. The U.K. should rebound to traditional growth levels. And the product and service mix in our pipeline is increasingly more profitable.

Now turning to a number of our growth initiatives in the quarter. Innovation continues to be a hallmark of our firm. We continue to build out our ISG platform of subscription services. During the quarter, we launched ISG InformX, our groundbreaking data as a service solution that delivers instant intelligence to our clients on how their enterprise's performance -– performing against its peers.

ISG InformX relies on our market leading IT performance data, the world's most robust validated source of such metrics. We have strong interest in ISG InformX from several significant clients, a number of whom are now in beta testing the platform.

In another use of our rich repository of data, we also launched the platform version of our contract knowledge base, which allows easy online access to our industry-leading market intelligence for our provider clients such as Cognizant, Atos, Hexaware and Softech. This valuable data allows these subscription clients to see, which enterprise contracts are coming up for renewal, a tremendous marketing and sales advantage for them.

During the first quarter, we released version 2.0 of ISG GovernX, our digital managed services solution. This platform surface leverages cognitive technology to automate key processes in the management of third-party supplier relationships. We now have clients such as McDonald's, Takeda, Carrier, LAX Airport and Adidas subscribing to this service.

Now, turning to our regions. In Europe, our 10% revenue growth was fueled by double-digit increases in Germany and South Europe offsetting the previously discussed decline in the U.K. In our industry segments, we saw good growth in our life sciences, insurance, technology and consumer industries. Key client engagements in Europe in the first quarter included Allianz, ITERGO, BNP Paribas, Fiat Chrysler; and KMD, an IT solutions company in Denmark.

A German railway recently selected ISG as its strategic partner for proactive benchmarking and IT lifecycle management. This is a multiyear, multimillion-dollar contract that combines ISG data and analytics, including ISG InformX, ISG Research and ISG Sourcing to deliver an end-to-end solution. ISG also has been awarded a $1 million network services extension by a German chemical company, bringing the total value of this 15-month engagement to nearly $5 million.

In the Americas, revenues declined a little over $3 million based on the factors mentioned earlier. The reduction in spending by our automotive clients, the ISG Event moved from March to later in the year and a few other engagements with delayed timing. We fully expect the U.S. to come roaring back in the second quarter, as all things digital continues to heat up. Our recurring revenues expand and especially with our ISG platform services continuing to resonate with clients.

During the quarter in the Americas, we saw double-digit growth in such areas as digital strategy, HR tech, automation and software advisory. Key client engagements in the quarter included CNO, Marriott, Intergy, Johnson Controls, Stanley Black & Decker and McCormick.

During the quarter, ISG Automation signed its largest RPA advisory engagement ever for about $3 million with a global health care provider. This engagement, which starts this quarter will help this client scale it's automation program worldwide and further its understanding of how to apply blockchain to improve operations.

ISG also has been awarded a competitive multimillion dollar digital workplace engagement and a major global financial services organization. ISG will design this company's next-generation work processes using technology to optimize collaboration and consistency for more than 20,000 users. This is a great example of our next generation of digital solutions at ISG and our ability to incrementally add services and grow revenue across client engagements.

Also, we are beginning to see a pick up in our public sector U.S. business with two recent wins that will begin later this quarter. A multiyear, multimillion-dollar engagement with the state of Missouri and a close to $1 million engagement with the state of Washington, both to provide technology advisory services.

Now finally our smallest region, Asia Pacific, represents about 7% of our global business, saw its revenues decline $1 million in the quarter. This was due to continued sluggishness in the Australian public sector. Key clients in the quarter included Rio Tinto, Westpac Banking and Toll Holdings with growth and energy in the manufacturing industries.

In keeping with our practice, we will formally update our full-year forecast when we report our second quarter results. As mentioned, our second quarter pipeline is very robust in the Americas and Europe and this momentum is expected to put us on track to achieve our full-year objectives.

So with that, let me turn the call over to David Berger, who will summarize our financial results.

Thanks, Mike, and good morning everyone. First quarter revenues were $64.8 million, compared with $68.9 million in the prior year, which was a decline of 3% in constant currency and 6% on a reported basis. Currency negatively impacted reported revenues by 3% or $2 million.

Reported revenues were $22.2 million in Europe, which was up 10% in constant currency from the same period in 2018 and up 2% on a reported basis; $38.2 million in the Americas, down 8%; and $4.4 million in Asia Pacific, down $1.1 million.

First quarter 2019 adjusted EBITDA was $3.6 million versus $5.8 million in the prior year. The 2019 results were impacted by the previously discussed decline in revenues. We reported a first quarter operating loss of $700,000, down from operating income of $1.8 million in the first quarter of 2018.

The net loss for the quarter was $900,000, compared with a net income of $200,000 in the prior year. Reported fully diluted loss per share was $0.02, compared with a fully diluted earnings per share of $0.00 for the same period in 2018.

Adjusted net income for the first quarter was $1.5 million or $0.03 per share on a diluted basis, compared with adjusted net income of $2.5 million or $0.05 per share in a diluted basis in the prior year's first quarter.

Utilization for the quarter was approximately 66%. Quarter end headcount was 1,307. Our balance sheet continues to have the strength and flexibility to support our business over the long-term. Net cash provided by operations for the quarter was $1.3 million. On the balance sheet, we ended the quarter with $13.6 million in cash, and our total debt outstanding was $95.6 million after paying down $3.6 million during the quarter and we bought back $1 3 million in stock.

We will continue to de-lever our balance sheet and expect to lower our gross debt to under $90 million by year-end. Our average borrowing rate for the quarter was 5.4% and we had 46.8 million shares outstanding as of April 30. Mike will now share concluding remarks before we go to Q&A.

Thank you, David. To summarize, our revenues were $65 million, driven by 10% growth in Europe, a number that would have been even higher if not for the spending delays in the U.K. due to Brexit. ISG Automation signed its largest advisory services engagement ever, close to $3 million. Our current pipeline is expected to resolve [in] significant sequential growth in the second quarter. And we continue to de-lever, paying down approximately $4 million of debt during the quarter.

As always, we are focused on creating shareholder value for the long-term and we are steadfast in our mission to deliver operational excellence to our clients. Thanks very much for calling in this morning and now let me turn this session over to the operator for questions.

Thank you. (Operator Instructions) We will take our first question from Marco Rodriguez, Stonegate Capital Markets.

I was wondering if you could talk a little bit more about the health insurance carrier, the engagement kind of give us a sense as far as the scope. If you can put aside a dollar figure that'd be great. And then just sort of timing and how long the engagement will last.

Okay. So this is one of the top healthcare providers in the country. And they are beginning their journey on automation. I'd say beginning, they've done some kind of proof-of-concepts, but they are now beginning to have us come in and begin the process of automating. And you can imagine what all could be automated in a healthcare company, in terms of claims, processing, et cetera.

This first piece of engagement is about $3 million. And the timing of that will be paced by the client, but we expect that to all occur at the moment during 2019.

And then maybe if you can talk a little bit more about the Europe and specifically the U.K. and Brexit delays. Obviously, it's a bit of an impact to everybody, but just wondering if you have a feel for the timing of when you think it comes back, your confidence level and then also maybe you can talk a bit about if it does become a hard Brexit, what sort of impact you might have?

Okay. Well, first, we saw with all -– I mean there was all the noise with the deadlines and so on during the month of -– during the first quarter. What we saw with our clients is they were all hunkering down in terms of kind of Brexit related activity. They kind of slowed down on the work that we do, which tends to be more transformational on work, in the type of work. And so that's why it slowed in the first quarter. But what we are seeing the pipeline in the U.K. looks very good at the moment, a lot around automation, around transformation, around digital. So our sense is at the moment cautiously, we think that Brexit could come back quite –- U.K. could come back quite strong in the second quarter that the noise levels settle down.

They have a Halloween. As you know, a Halloween date at the moment, so it's out a few months. It doesn't mean there won't be noise. But the level of noise in the first quarter was pretty intense. So we're cautious, we're quite confident that we should see a nice rebound starting in Q2 there.

I think the hard Brexit right now Marco, I'm not sure what that would mean, because I'm not sure what that really does mean. So I think I will defer that one for another quarter. Let's see what else we can learn and if we can see if there's any implications at all on that area.

Just circling back on America speak to, I guess the domestic market, I believe you mentioned that some of the government work has started.

Yes. On the government work, as you know it's been quite soft through all of 2018, we had all the governor changes and that slowed things down. We have had a pick up during the quarter on some RFPs. And we just learn that we won the state of Missouri, which is a multimillion dollar and multiyear assignment for us. And we also just won the state of Washington, both of which is scheduled to start during this quarter for us.

So our sense is that we've seen the bottom and we are now beginning to see the turn on the public sector.

We will take our next question from Sarkis Sherbetchyan with B. Riley.

So just I think you mentioned the recurring revenues bucket of the business was about $19 million. Can you maybe give us a sense for the rate of growth in that business going forward, and just kind of what you're seeing from the level of activity that your clients are willing to kind of give you?

Yes. So for recurring revenues for the quarter is around $19 million. The first quarter tends to be a little higher. We get a little peek in Q1 on recurring, because a lot of our licenses, our software licenses are renewed in that quarter. And as you know with the change last year January of '18 you record your license revenue all in the month in which you have the licenses so first quarter tends to be a bit higher than Q2. So licenses helped us for that first quarter, but overall recurring revenues, we're pushing this. So this is why we're building out our platform.

These things take a little bit of time. Most of it is subscription. So you get kind of the 1/12 on those. So you'll get a little bit each month. So that will build up and we expect that to continue to build during 2019, to service well for 2020. We still remain on our goals that we would like by the end -– by going into 2021, that in the year 2021 we'd have $100 million of recurring revenue and we're in kind of the mid-70s, if you will, coming out of last year. So we would like to see that number have an 8 in front of it by the end of the year on our way to the $100 million target.

And would you anticipate maybe doing some tuck-in acquisitions to bolster that piece of the business?

Yes. We're always -- the hunt, really our focus on acquisitions, on the bolt-ons are either in the recurring revenue stream or in the automation space. That's where we're focusing all of our time.

And kind of a tangent to that, I mean, if I look at the utilization ratios of the business, it seems like you're kind of bouncing around in the mid-to-high 60% range. I guess over time if you build a recurring revenues component, call at the $100 million markets achieved. Would you anticipate on kind of rightsizing the headcount or just kind of, how do you bring the utilization ratios maybe to the mid-70s?

Yes. Well, first I think for us, and keep in mind, we use 2080 hours as the denominator, so you have to be a little careful on the comparisons. But so we use the full 2080 when we do our math for that, we don't break it down to 1850, which a lot do, backing off vacations and training. But our number target is 70. So we've got, we think at least 400 basis points to move. The balance between that for us is really bringing on new people on the digital side of things and you ramp them up. So of course, that has a little bit of utilization effect.

But certainly the recurring revenue should help us over time. So that grows, then you have a little less volatility that the client says you want to start on Monday and then decide to start on Thursday, so you get a little bit of leakage. And that's really where the utilization leakage occurs. Between that and kind of the ramp-up of kind of some of our digital workers that's kind of the delta we see between the 70 and the 66 at the moment.

We will take our next question from Vincent Colicchio with Barrington Research.

Yes. Mike, you had mentioned that the event business, in fact of the quarter, can you give us more color on why it was moved? Was it based on –- what was it based on?

Yes. So this one is, what we call the digital innovation tour. And this is clients, enterprise clients going to around a lot of the providers, innovation centers, et cetera. So this event, which we hold a couple of times here was originally set for March. The actual innovators, if you will, asked us if we could move it to Q2, which we have done. And so that came out of Q1 and we'll see it in Q2.

And then, could you give us a bit more color on -- aside from the auto client, what caused delays in the U.S. market?

So the U.S. market, yes. So look U.S. market, I think we still had, we have no growth at the moment in Q1 slightly dip on public sector, that is turning. I think we've hit bottom on that one. I think the second one as we talked about was the automation client and frankly just some other client engagements. Nothing in any particular. But I will comment on network because we've talked about it before. I think we have terrific network pipeline. And we should see that flow through into Q2, which also kind of bodes why we believe Q2 and we move forward is quite bullish. And we expect significant double-digit growth sequentially in the network business as well. And then of course, the digital business is really what's humming globally, but also in the U.S. So those are the key areas.

And then Australia -– the Australian government it seems to be a headwind for some time. Do you remain, what are your thoughts in that business in the longer-term?

Yes, so we didn't comment on this, but we did just win a pretty good piece of business with the Department of Defense. So I would expect, first of all, sequentially in Q2, it should be up double-digit and then we should see year-over-year growth in that market starting in the second half.

And as those that goes the APAC market overall or what?

Yes, I think so, because it represents about a third. So I think as long as there's a bit of spending there. Then I think that group will be able to show kind of their normal growth patterns. And I would expect that to begin during the second half and we would see good sequential growth there Q1 to Q2 with some of the activity that is going on as we speak.

And then lastly, overall are you seeing any regions would -– where you're seeing a pricing pressure impacting margin?

No, our pricing holds up pretty well. I would say, we have a little bit of pricing power in the German market, because we have a good command of that particular market. Digital is moving there especially with a lot of the automotive clients. We have some specialty around the autonomous driving. So we won some work with BMW, we just recently won work with FCA, which is Fiat Chrysler. They recognize our expertise to help them with this. It's a hot area. So we'd get a little bit more pricing power, if you will there. Other than that, I would say the pricing is holding pretty good for us.

We'll take our next question from Marc Riddick with Sidoti.

I wanted to touch a little bit on, you mentioned with the pipeline. I think, if I heard you correctly, you mentioned that you thought that was more profitable. I was wondering if you could delve into that a little bit of that, a function of business based on what you're seeing in the pipeline or how we should think about that.

Right. So I think what we're seeing there is the digital business for us can be a little more profitable because our rates can be a little stronger, number one. Number two, just the product mix that we have relative to a little bit of gain sharing that we have with our network business that looks quite strong, you add that component in. And thirdly, we're able to leverage on a number of engagements we have, some of our work in India that helps us from a margin standpoint. So when we look at that pipeline, that's why we think the current pipe for Q2 will benefit off from a margin standpoint.

And then I was wondering if you could talk a little bit about the, I think you did, you mentioned around the last quarter or maybe the quarter before around the potential for pace of share repurchase activity and what we might see there (inaudible) there was the more of that pay down during the first quarter.

Yes, we purchased $1.3 million during the first quarter and any acceleration would happen towards the back half of the year.

And then maybe if you could touch a little bit about around the -– some of the commentary around the margins. And maybe that's the kind of feedback that you're getting from that, which I guess, you had a certain amount of clients that were part of the beta test and maybe some large clients that were part of that with InformX and then just wondering if there were any sort of guidance and feedback that we got from there that you thought were helpful in moving forward. And how we should think about how the fact that (inaudible) the patient will match compared to your initial expectations.

So there's really two. One is InformX. The other is what we call GovernX 2.0. InformX just out into the market, it's still in beta test with a number of very big brand named companies. It's very powerful tool, essentially what we do is we load the clients' data into our InformX. We then take our benchmarking and assessment data, the market intelligence, which we think is the most powerful in the industry, because of our market position and sourcing. We compare theirs and they can compare it online, real time and do what else. For example, if they say: Hey look, I've got 1,150 apps that I'm using to support one of my divisions at company x. And it's costing me $250 million for those. And I go in and I compare that to a set of peer groups that I as the client chooses online with our tool. And then I see that others are averaging $175 million for similar like apps. I then identify: Hey look, I've got a spending pattern here, a much greater than my peer group. So then I can do what apps would set it up. So what if I were to take my costs down in certain apps, what would that mean? How would I go about it? And then our consulting would pick up from there. So it's – the timing of it has been quite –- the receptivity of this has been quite powerful. So we'll see how that unfolds.

The second one is GovernX. GovernX is out of beta into the market. I named a number of clients, McDonald's, Takeda and some others that have selected our tool, again, quite powerful where we add software plus our services out of India to support and manage a number of these large supplier contracts that enterprises have. So we've added this technology or software piece as part of our platform for clients and it is being well received and you can see some of the big brands that have picked it up already.

So again, this is platform, those are subscriptions. So therefore, it's going to be 1/12 along those lines, different than the software licenses that we have in automation, where you take it in the month in which you sell it. So this should build up during 2019 and service well from a revenue standpoint in 2020. That's our plan.

We'll take our next question from Joe Gomes with Noble Capital.

Most of questions have been asked already. But I just was wondering if you're still looking at that goal of 15% EBITDA margins and maybe you could walk us through how you guys think you can get there.

Okay. Good. So look, that's our –- we think that's kind of where we could settle in as a firm. It's going to require the higher recurring revenue streams and the mix of our services evolving and changing over time, which we've discussed. And we would hope that we would certainly get to the 14% level during this planning period. So the idea is change the mix, increase the recurring revenues, keep pushing on the digital services, which is a bit higher margin for us. And you add it all together depending on what clients want. That should lead us to the higher margin level. And we continue to leverage our center of excellence in India, where we have about 400 plus employees.

(Operator Instructions)

Okay. I think with that, let me close by saying, I am really energized by the great enthusiasm of our employees -- are showing for the future. As I travel around meeting with our employees and our clients, I get a real sense of the forward momentum we are building as a firm. And the excitement our people have for being a part of the digital revolution. That's really transforming the world's top enterprises for operational excellence and faster growth. And I want to thank all of our professionals around the world for their contributions to our success. And I want to thank all of you on the phone call today for your continued support and confidence in ISG. Have a great day.

Ladies and gentlemen, thank you for joining today's conference call. The call has now concluded. Please disconnect your lines and have a great day.