Information Services Group, Inc.
Q1 2018 Earnings Call Transcript

Published: 13 May 2018

[Operator:]

Good day, and welcome to the Information Services Group 2018 First Quarter Investor 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.

[Barry Holt:]

Thank you, operator. Hello, and good morning. My name is Barry Holt. I'm a 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 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 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 ended December 31, 2017, and any other relevant documents, including any amendments or supplements to these documents filed with the SEC. You will 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?

[Michael Connors:]

Thank you, Barry, and good morning, everyone. Today, we will review our record first quarter revenues and strong cash generation. We'll brief you on our key operating and client highlights and reaffirm our full year guidance for revenue and adjusted EBITDA. We reported our largest-revenue quarter ever with revenues of $69 million. 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 Services, and clearly, Robotic Process Automation, or RPA, generated more than 40% of our revenue in the quarter. Recurring revenues reached $22 million, our best quarter ever, and up 10% from the prior year. This despite softness in the US multiyear public sector contract market. Globally for ISG, strong demand in the insurance, manufacturing and technology verticals, and for our managed services, research and automation services, helped drive growth for the quarter. During the quarter, we served 377 clients, including 39 that were new to ISG. With our continued strategic focus on recurring revenues, ISG won three significant managed services engagements within the last 60 days

[David Berger:]

Thanks, Mike, and good morning, everyone. First quarter revenues were $68.9 million compared with $66.6 million in the prior year, which was an increase of 3% on a reported basis and a decline of 1% in constant currency. Currency positively impacted reported revenues by 4% or $3 million. Reported revenues were $21.8 million in Europe, up 8% from the same period in 2017; $41.7 million in the Americas, which was up 1%; and $5.4 million in Asia Pacific, up 4% from the prior year. As Mike mentioned, recurring revenues of $22 million were up 10% versus the prior year. First quarter 2018 adjusted EBITDA was $5.8 million versus $7 million in the prior year, and was impacted, most notably, by the delay in a few network advisory service engagements that we expect to complete over the next two quarters. We reported first quarter operating income of $1.8 million compared with operating income of $1.2 million in the first quarter of 2017, up 49%. Our net income for the quarter was $200,000, which compared with a net loss of $600,000 in the prior year. Our reported fully diluted earnings per share was $0.00 compared with a fully diluted loss per share of $0.01 for the same period in 2017. Adjusted net income for the first quarter was $2.5 million or $0.05 per share on a diluted basis compared with an adjusted net income of $2.7 million or earnings of $0.06 per share on a diluted basis in the prior year's first quarter. As we discussed previously, ISG adopted the new revenue standard, ASC topic 606, on a modified retrospective basis, such that the new standard was applied to transactions as of January 1, 2018. You will find further details in our 10-Q that will be filed later today. Adopting the new standard will not have a material effect on our financial results for the year. We also discussed with you last quarter the so-called donut hole, which means that the cumulative effect of adopting the new standard resulted in a reduction in deferred revenues of approximately $3.9 million. This adjustment, net of taxes, was reflected as a net cumulative catch-up adjustment of $2 million to retained earnings as of January 1, 2018. This revenue and earnings will not be recorded to the P&L. Utilization for the quarter was approximately 65%. Quarter-end headcount was 1,324 versus 1,248 at year end, with more than 90% of the additions hired in India to support the continued growth of our RPA and managed services business. Our balance sheet continues to have the strength and flexibility to support our businesses over the long term. Net cash provided by operations for the quarter was $9.5 million, which was a new record for a first quarter, versus $2.3 million in the prior year. We invested $3 million in capital expenditures, partially related to our automation initiatives and our headquarters move in Stamford, Connecticut. And we repurchased $900,000 in shares. On the balance sheet, we ended the year with $31.1 million in cash, up 9% from $28.4 million at year end. Total debt outstanding was $114.4 million after paying down $2.3 million during the quarter. Our average borrowing rate for the quarter was about 5%, and we had 44.3 million shares outstanding as of April 27. Mike will now share concluding remarks before we go to Q&A.

[Michael Connors:]

Thank you, David. Overall, we are pleased with our operating momentum as we move through the first half, and we remain optimistic on the full year. To summarize, we reported the largest revenue quarter ever with revenues of $69 million. Digital services continues to be a strong growth engine, representing over 40% of our revenue for the quarter. We had our largest quarter ever for recurring revenues, with $22 million, up 10%, and representing more than 30% of our total revenue. Our cash balance was strong at $31 million, and we generated $9.5 million in cash flow from operations, our best cash inflow for a first quarter ever. And we have reaffirmed our full year guidance for revenues and adjusted EBITDA. As always, we are focused on creating shareholder value for the long term and are steadfast in our mission to deliver operational excellence to our clients. Overall, our foundation is solid, recurring revenues, digital, including automation services, a Who's Who list of blue-chip clients and a talented global team of 1,300 professionals on the ground in the middle of the digital revolution. Thanks very much for calling in this morning. And now let me turn the session over to the operator for questions.

[Operator:]

[Operator Instructions] We'll take our first question from Sarkis Sherbetchyan with B. Riley FBR.

[Sarkis Sherbetchyan:]

So you spoke about the timing of the network advisory engagements moving into the next two quarters here. Can you maybe remind us what the margin profile is of that slice of the business? And would that delay mean that the gross margin profile over the next, call it, two quarters or so, would be materially higher compared to what we saw this quarter?

[David Berger:]

Yes, that is the case. The network services has a higher margin than our average. And so it's a profitable - very profitable part of our business.

[Sarkis Sherbetchyan:]

That's helpful. And it did seem like you're reaffirming the revenue and adjusted EBITDA guidance here. And you give us some color as to the reasoning behind that. And I think on the last quarter's conference call, you mentioned you'd revisit that guidance range in the midpoint of the year. What in the current environment would cause you to maybe take that guidance up, given the growth you're seeing in both the recurring engagements as well as some of the other digital initiatives?

[Michael Connors:]

Look, I think part of it, Sarkis, is simply on timing and pace, and that's why we said we would look at this at the midyear mark. We'll just have to see how the pace of the work is going. The demand is high, as you can see. Digital is over 40% of the revenue. Recurring revenues, we had a great quarter. And as I mentioned, by the way, it'll be a little uneven during the course of the year because of the new subscriptions and because you take them in the quarter in which you sell them, if you will. So just watch that as we go through the year. But we expect that to be double-digit growth, as stated - as we have stated, on our way to the $100 million level there. So we'll see where we are at midyear. That's why we only do it once a year, which is in the middle of the year. And we'll take a look at where we are, what the pace is and our estimate as to when that work would be completed, whether it would all be done in 2018 or not.

[Sarkis Sherbetchyan:]

No, thanks for that update. And just if I can circle back to when you acquired Alsbridge. I think there were plenty of potential cross-selling opportunities to create some revenue synergies from that acquisition. Can you maybe help us understand if you've seen some of that thought process materialize here, given what you're working on with regards to post-integration of that business?

[Michael Connors:]

Yes. No, look, good question. The cross-selling is working extremely well. I think I gave a few examples in the US of some client work that all have $1 million price tag on it. We're selling multiple services to a very large fast food business, where we've taken our network, we're taking our managed services, our outsourcing, our change management. So we now have our teams trained up. We have advanced our digital training to our people around the world. And we are very pleased with the level of multiple services we're able to sell in. And of course, RPA is of interest to a lot of people. We're over 100 clients installed now. So that has also been a big benefit as a "additional add-on service" to some of our client base as well. So we are quite pleased with the progress on kind of selling multiple services into our client base.

[Operator:]

And we'll take our next question from Marco Rodriguez with Stonegate Capital Markets.

[Marco Rodriguez:]

I was wondering if, maybe circling back on the network services contracts, is there a way that you might be able to quantify the impact to the revenue side and to the EBITDA side.

[Michael Connors:]

Well, I think we said that we think that estimated about $1 million on the earnings side. And so it's a bit more on the revenue side. But that will all be picked up during the year.

[Marco Rodriguez:]

Got you. And was this just a function of not having the right person to sign a contract? Or can you kind of talk a little bit about as far as what the timing delays were?

[Michael Connors:]

It was - the pace of the clients, the slowdown. You do these things in different milestones. And as you achieve certain milestones, you move to the next step. And it's just, the pace of it was slower than we would have anticipated. But we have to go by the client pace.

[Marco Rodriguez:]

Understood. Okay. And then if maybe you could talk a little bit about the investments that you've made here the last 12 months. And then also what you might be expecting in terms of additional investments in fiscal '18 and maybe fiscal '19 to kind of support the growth you're anticipating.

[Michael Connors:]

So our investments are focused primarily in two areas. One is digital and the second is all things recurring, if you will. And our kind of normalized investments as we go forward for the balance of this year and next year will be concentrated in both of those areas. And what we try to do is we try to align the investment with the revenue levels. It's a bit of a subjective call for us, but we try not to get out ahead of the revenue. We've stated this before that we try to stay kind of center of the fairway and not get out ahead. We could get out ahead and you could drive a little bit, top line, more revenue, but then it also has an impact on a full year EBITDA level, and we're not prepared to do that. So we try to pace it, we try to make the best judgments that we can. And the investments, Marco, though will remain around recurring revenues and around All Things Digital.

[Marco Rodriguez:]

Got you. And if maybe you could talk a little bit more about the digital business for you guys. I know that in the past, you've called out a lot of the automation, the RPA business as being fairly in high demand, especially in the financial services, insurance. And I believe last quarter, you talked about the retail industry kind of looking at that as far as solutions were concerned. Maybe if you can talk a little bit about any other industries that are outside of that. What sort of demand are you kind of seeing there? And maybe if you can talk about certain types of applications they might be looking to use.

[Michael Connors:]

So we're seeing this now in multiple industry segments. So on the car, we're very heavily involved in the connected car and all things, the technology that go inside of that, around the selection, the identification, the selection of technology providers for a multitude of automakers. I think I gave you an example of a very large elevator company. They are looking to digitize more the elevator business. We can't go into a lot of detail. Very, very interesting concepts. We're helping them understand some emerging companies that have technologies, and this was where our Plug and Play partnership has come into play. Looking at some of the new emerging technologies from these startups is helping us with the elevator company. We're very excited about this going to a fully digital bank that we're working with in Europe. And then we also are working, as another kind of industry segment, Marco, is in the health care area. We're working on putting together what is called the fit-for-future digital strategy, which helps them do some digitization of the medical care processing areas. They want us also to help them with their workplace of the future. So when I look at things like manufacturing, such as an elevator company getting smart elevators and using Internet of Things and using a strategy around that, around an agile enterprise, when you look at the auto industry around moving to connected cars, or IoT sensors or digital transformation or cloud migration, those areas are all very, very hot. So it's becoming much broader in different industry segments, but I would say automotive; manufacturing; health care; and certainly, financial services, are all participating at a more enhanced and rapid speed there. And those are some of the examples of work we're doing with them.

[Operator:]

It appears there are no further questions at this time. Mr. Holt, I'd like to turn the conference back to you for any additional or closing remarks.

[Michael Connors:]

Okay. So this is Mike. Let me just close by saying thank you to all of our 1,300 professionals around the world. I think it's your ability to help our clients achieve operational excellence and faster growth, especially through digital transformation, that continues to be the reason why we're able to perform at the levels we are. Thanks to all of you on the call today for your continued support and confidence in our firm, and have a great day.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect.