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Information Services Group Inc  (NASDAQ:III)
Q2 2019 Earnings Call
Aug. 05, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Information Services Group's Second Quarter 2019 Results Conference Call. [Operator Instructions].

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 -- Senior Communications Executive

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 second 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 this morning 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 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 upon 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 this morning 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 P. Connors -- Chairman and Chief Executive Officer

Thank you, Barry, and good morning, everyone. Today, we will review our progress and growing momentum as a firm. We continue to build our business with a focus on clients, operational discipline and innovation. That's reflected in the good progress we are making with Q2 EBITDA more than double Q1 and our revenues up sequentially in the Americas, and Europe.

We are seeing progress in our US public sector business, which added $9 million in new multi-year contracts in the second quarter. Together with Australia and Europe, we signed government contracts worth more than $13 million this quarter, a record high for the firm. We should see this revenue begin during the second half of the year.

Our Go Digital strategy continues to be a success, with digital solutions now representing nearly 45% of our business and climbing. Among our digital solutions, our ISG Automation business continues to grow at a double-digit pace and should top $30 million in run rate revenues heading into 2020. In our quest for $100 million of annual recurring revenues, we are building our ISG platform of software driven services while launching an exciting new network solutions offering. And we continue to de-lever our balance sheet, lowering our debt over the last 12 months by 12%. All of this, combined with a strong pipeline of new business in the second half, adds to our growing confidence that ISG remains on track to achieve its full year objectives.

After a soft first quarter, ISG built its momentum and delivered 4% sequential growth in Q2 and more than doubled its adjusted EBITDA. Our revenues for the quarter exceeded $67 million and we generated more than $8 million of EBITDA. Globally, we saw growth in our consumer, energy, life sciences and healthcare verticals. We also saw growth in our Business Advisory, Organizational Change Management, Automation and Network Advisory service lines. During the first half, we served 508 clients, including 66 brand new clients overall and a record 310 clients in the Americas.

Now, turning to a number of our growth initiatives, last week, we announced a new network services offering called ISG Network Select. The service, powered by a partnership with AVANT Communications, allows us to offer more vendor and technology options to clients, better pricing and accelerated speed to solution to meet our clients' next generation networking needs. Among our clients, about 90% have tested software-defined networking, but only 15% have adopted it. This is a great opportunity gap ISG can fill by offering our clients a broader range of solutions from 5G to SD-WAN that are crucial for successful digital transformation.

ISG Network Select represents a new recurring revenue stream that likely will begin in 2020. This offering will allow us to generate monthly recurring revenues from our clients' consumption of network services over the life of their contracts. We see this as a real win-win for ISG and our clients.

Meanwhile, ISG Automation continues to be in high demand among our clients while garnering high interest in the marketplace. Last month, we staged our extremely popular ISG Automation Summit in New York, the last of three such sold out industry events this year. At the Summit, we revealed preliminary findings from our latest automation maturity study, which show the number of enterprises that have established an automation center of excellence and are experimenting with cognitive technology, has more than doubled in the last year. We call this stage, Bot 2.0, and about half of the companies we surveyed are now at this level. Only about 10% are at about Bot 3.0, or the most mature state of enterprise automation capability.

We see a tremendous opportunity to help our clients advance to Bot 3.0 by scaling RPA across the enterprise, and moving to the next level of cognitive technology and artificial intelligence. Apparently, judging from the market valuations of automation software providers and RPA advisors, investors see a great opportunity in this space as well. Indeed, we think our ISG Automation business is undervalued. As I mentioned at the outset, we should be at nearly $30 million of run rate revenues from this business as we move into 2020, as our double-digit growth continues.

As an aside, you may recently have seen ISG being interviewed on Fox Business Network by host, Stuart Varney on the topic of automation and advanced robotics. So there's a lot of interest about this in the business world.

In terms of other growth initiatives, our ISG platform of software-based services continues to grow in importance with our clients. After the successful launch late last year of ISG GovernX, our managed services platform, we have launched ISG InformX this year, a new platform service that leverages the world's most robust, validated IT data repository to deliver instant intelligence on how an enterprise is performing against its peers. We are working on additional enhancements to ISG InformX that we will roll out in September. Overall, we are excited about the opportunities we have to deliver more value to our clients and build recurring revenues through platform services.

We are now seeing a pickup in our government sector, which has been sluggish following the 2018 election cycle. We recently signed $9 million of US multi-year public sector contracts, including with the states of Idaho and Louisiana. And we also signed $4 million of new engagements in Australia and Europe. In all, the $13 million in new government contracts we signed in the second quarter, was a new quarterly record for ISG.

Turning to our regions, Europe had sequential revenue growth of 3%, with revenues flat versus the prior year. As anticipated and discussed at the last call, the UK rebounded nicely with revenues up 11% versus the first quarter. Germany was up 1% for the quarter on a tough compare with a very strong Q2 last year.

In our industry segments, we saw good growth in our life sciences, insurance and technology industries and the Automation and Business Advisory service lines. Key client engagements in Europe in the second quarter included Fresenius, IT ERGO, Lowe Financial , AXA and BASF. In Germany, ISG has expanded its relationship with one of the world's leading healthcare companies, adding more than $3 million in incremental revenues to this multi-million dollar client. Also, in Germany, ISG has grown its relationship with a large chemical company, another major multi-million dollar client. New engagements with this client total more than $1 million in new revenue.

In the Americas, revenues grew sequentially by 5%. During the quarter, we saw good industry growth in our banking and financial services, and consumer verticals, and in our Business Advisory Services, HR Tech, and OCM service lines. The public sector held back growth in Q2, but we see that curve changing in Q3 as our newest contracts begin to take hold in the US. Key client engagements in the quarter included, Nutrien, Westpac, Refinitiv, CNA Financial, Messer Industries, Humana and the International Monetary Fund.

The Americas region also is projecting strong second half revenue growth as our pipeline increases and our utilization, which reached a high of 83%in Q2, continues to accelerate. Among recent wins, ISG has been awarded a multi-million dollar multi-year engagement with a Canadian energy company to provide a digital target operating model and digital sourcing strategy.We also have been awarded a new multi-million dollar series of engagements with a large Mexico-based bakery products company.

Finally, our smallest region, Asia Pacific, representing about 6% of our global business, was essentially flat on a sequential basis. This was due primarily to continued sluggishness in the Australian public sector. The federal election in May slowed decision making, but we have just recently landed significant new engagements with the Australian Department of Defence, the Australian Taxation Office, the Department of Home Affairs and the Department of Human Services and expect to see a bounce back in growth in the months ahead. Key clients in the quarter included Rio Tinto, Westpac Banking and Toll Holdings.

Now turning to our guidance, with momentum building and a strong second half pipeline ahead of us, we are targeting to achieve our full year revenue and adjusted EBITDA guidance. We base our guidance on continued strong demand for our digital services and promising dynamics in the commercial markets, and a recent series of wins in our government sector. We will, of course, keep an eye on the macro environment and watch for any changes in client decision making.

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

David E. Berger -- Executive Vice President and Chief Financial Officer

Thanks, Mike, and good morning, everyone. Revenues for the second quarter were $67.3 million, compared with $71 million in the prior year, a decrease of 3% in constant currency and 5% on a reported basis. Revenues were $40.2 million in the Americas, up 5% sequentially and essentially flat versus the prior year; $22.8 million in Europe, up 3% sequentially, flat versus the prior year in constant currency and down 5% on a reported basis; and $4.3 million in Asia Pacific, down 2% sequentially, 26% versus prior year in constant currency and down 31% on a reported basis. Currency negatively impacted reported revenues by $1.5 million versus the prior year.

Second quarter 2019 adjusted EBITDA was $8.1 million, up more than two times the first quarter and down $1.8 million versus the prior year. We reported second quarter operating income of $3.3 million, down from operating income of $4.2 million in the second quarter of 2018. Our net income for the quarter was $400,000 compared with net income of $2.4 million in the prior year.

Reported fully diluted income per share was $0.01 compared with fully diluted earnings per share of $0.05 for the same period in 2018. Adjusted net income for the first quarter was $3.2 million, or $0.07 per share on a diluted basis, compared with adjusted net income of $5.7 million, or $0.12 per share on a diluted bases in the prior years first quarter.

Consulting utilization for the quarter was 69%, up 700 basis point versus the prior year. Quarter-end headcount was 1,285, down slightly from last year and year end, as we automated some of our functions.

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 first half was $600,000. On the balance sheet, we ended the quarter with $10.4 million in cash and our total debt outstanding was $97 million after paying down $2.1 million during the first half. We have now reduced our debt by $13 million, or 12% over the last 12 months. We have also bought back $3 million in stock for the first half. Our average borrowing rate for the first quarter was 5.8% and we had 47.4 million shares outstanding as of July 31.

Mike will now share concluding remarks before we go to Q&A.

Michael P. Connors -- Chairman and Chief Executive Officer

Thank you, David. To summarize, we are building momentum in our business and we are on an upward growth trajectory. Our sales pipeline is strong and should accelerate our revenue growth in the second half. Our growth initiatives overall are taking hold and recurring revenues will get a boost starting later in Q3 with the uptick in our multi-year public sector business.

Our digital revenues have grown to nearly 45% of our total revenue and we expect double digit growth in our ISG Automation business for the remainder of the year. Taken together, our growing momentum gives us confidence in reaching our full year objectives. 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 the session over to the operator for questions.

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] We go first to Mark Riddick with Sidoti.

Marc Riddick -- Sidoti & Company, LLC -- Analyst

Hey. Good morning.

Michael P. Connors -- Chairman and Chief Executive Officer

Good morning, Marc.

Marc Riddick -- Sidoti & Company, LLC -- Analyst

So, I just want to go over a couple of quick questions before I get into more the revenue drivers and the details of second half acceleration. Wanted to see where we finished on -- where we're looking on employee count at the end of the quarter and where that might go with some of the opportunities you have going forward and where utilization shook off for the second quarter?

Michael P. Connors -- Chairman and Chief Executive Officer

David?

David E. Berger -- Executive Vice President and Chief Financial Officer

Yeah. So, the headcount, as I mentioned, in the quarter was 1,285. So, that's where we ended the quarter. Utilization for the quarter -- consulting utilization was 69%. We don't think there'll be significant adds to headcount for the balance of the year.

Marc Riddick -- Sidoti & Company, LLC -- Analyst

Okay. And then, maybe we can sort of touch a little bit on the strength of the public sector activity. You had mentioned a couple of the contracts that had been signed during the quarter and you had also mentioned some when you did your first quarter call. Just wanted to get a general sense of maybe what you feel like the funding environment is like out there and what the opportunities are now within the public sector in particular?

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. Good question. So we did sign a series of contracts late in the quarter. The market is picking up the activity that had been, I would say, somewhat dormant based on the election cycle and the change. I think we've talked about this before. There was a significant number of governor elections that were up and that stalled decision making, that's all now been freed up. So we're seeing a much more -- I wouldn't call it, robust yet, but much more opportunity in a lot of the state governments in terms of spending. So, we're getting our share certainly during this past quarter and we see it with things like Idaho, Louisiana.

I think we mentioned the State of Missouri, which was at the end of Q1, which has now started late Q2. And so we're kind of a bit bullish now on the public sector. We also had good government signings outside the US, especially down in Australia, which had been really pretty sluggish for a year or so, but we have opened up the floodgates there with the ATO, the Ministry of Defence and so on. So we'll continue to keep an eye on this. We'll see how the states in the US react to all that's going on in the macro environment, but at the moment, spending has opened up a bit.

Marc Riddick -- Sidoti & Company, LLC -- Analyst

Okay. Great. And then, so moving to new products and services, as far as the ability to add a recurring revenue, that certainly sounds very encouraging. I wonder if you could touch a little bit on maybe how that pricing dynamic works or because I think you mentioned monthly? Is this like a monthly renewal for the new service or how should we think about how clients then receive that and process that and what type of visibility that then gives you going forward as those contracts come about?

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. So, let me comment on our new Network Select, which is really what you're referencing. So let me give you a little context. So the large telecom providers, think Verizon, AT&T, you see it in the international players as well, Deutsche Telekom and others, British Telecom, also just announced, they are all refocusing and focusing on their most large accounts. And that is leaving accounts, pick it, going after a client, 800 or so out in the market to essentially look for other channels for their services. And this is where Network Select where we're going to try to fill a bit of a gap here.

Let me give you a client example to explain it. So a client needs as they're looking for their own digital transformation in their network, they need software, they need hardware, they need voice, they need data, they need video. Today, they will go to a series of providers to get all of that work done. What we are offering under Network Select is an opportunity for a bundled set of services, hardware, software, voice, data, and video, using AVANT Communications as our partner, who has relationships with a lot of software and hardware providers, servers, et cetera. And so, take a client that may have 100,000 seats, they might have a 1,000 locations. What we will do is work with them on their total requirements, what providers will best suit for them, we will help them down select, we will help them make recommendations, and once this provider network is selected, we will negotiate the contracts and the customer will sign a contract. Normally, these contracts are three years and we will stay as the client relationship over those three years. And there'll be a bill that goes out every month.

Let's assume in this particular example, the bill is a $150,000 a month and we will get approximately 10% of that on a recurring revenue basis. So, call it $15,000 a month. So this particular client is worth about $550,000 dollars. That's how it will work. And so we will continue to do our network advisory services that we do today with the larger clients, but the second tier of clients, now that the large telecom providers are moving, and allowing other channels to take, that's where ISG will step in and try to take some of that work in that channel. So the recurring revenue will be, we will get a monthly flow of that revenue, the consumption of the client services over the term of the contract. That's how it will work.

Marc Riddick -- Sidoti & Company, LLC -- Analyst

Okay. That's great. Thank you for the color on that. That's very helpful. Thanks.

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. Thanks, Marc.

Operator

We will go next to Vincent Colicchio with Barrington Research.

Vincent Colicchio -- Barrington Research -- Analyst

On the network product you mentioned, Mike, what does the competitive landscape look like, are there a number of competitors there ahead of you or no?

Michael P. Connors -- Chairman and Chief Executive Officer

So, Vince, good morning. Good question. This is new. So think about Verizon, AT&T, British Telecom, they went after all of these clients. They are now refocusing. You've seen significant reduction in force announcements from the largest carriers. So this is a new opportunity, new white space for folks like ISG to tackle. So it's too early to call, but there will be a number of competitors we expect in this space to try to fill the vacuum. But too early to call, so I will defer that for a couple of quarters and let you know what we are seeing in the market at that point in time. But it is very new.

Vincent Colicchio -- Barrington Research -- Analyst

Okay. And you had mentioned that you'll keep an eye on the macro in the US markets and there was some slowing in Europe. Just curious what your thoughts on the macro economy are? Are you seeing a slowing in the US market as one of the issues that I'd like you to address if you can?

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. So, we are not seeing a slowing. We are watching it, especially with the tariffs. We're watching the consumer and the industrial players who have kind of slowed down their decision making, but they're not moving quickly. So if you think about chemical companies that have tariffs slapped on, some of the consumer manufacturing companies where the parts coming out of China are being slapped with tariff, they have not moved yet in the most part to try to reduce expense and reduce work forces as they looked at this as a temporary situation. We're going to watch it carefully. We think that there may be upside for us that if, in fact, this goes on for longer periods of time, then some of these players may want to respond and react quick. And we'll also watch things like Brexit and so on that will slow down decision making.

So we're kind of watching it for the US in particular. I don't see it yet, but we're going to watch it carefully depending on how much longer this tariff situation lasts. Brexit, we know it's a Halloween date. We're watching it carefully. We had a nice spring back at 11% growth during the quarter. We see a pretty good robust third quarter, but we'll continue to watch that. And of course, the exports coming out of Germany, et cetera, with the auto industry, we'll keep an eye on that. But right now, the pipeline looks quite robust, but we'll watch it to see if there's any changes or slowdown in decisioning.

Vincent Colicchio -- Barrington Research -- Analyst

Okay. Thank you, Mike.

Michael P. Connors -- Chairman and Chief Executive Officer

Thanks, Vince.

Operator

Operator Instructions] We go next to Joe Gomes with NOBLE Capital.

Joe Gomes -- NOBLE Capital Markets -- Analyst

Good morning.

Michael P. Connors -- Chairman and Chief Executive Officer

Good morning, Joe.

Joe Gomes -- NOBLE Capital Markets -- Analyst

Mike, I was wondering if you can give us a little more detail, little more granularity. You were talking about, on the RPA, some of the software vendors and some of the service providers. Their valuations give you confidence that your RPA businesses is being undervalued. I was wondering if you can give us a some more color there, as to why you think it's undervalued?

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. So, look, I think, we've seen on the software providers themselves UiPath, $8 billion valuation with $100 million of revenue. Blue Prism, very large valuation with revenue under $100 million. So the software providers AA, Automation Anywhere, which likely is going to get another infusion here, but the last number they had was around $4 billion or $5 billion for a $100,000 in value. Thoughtonomy, which is one of our partners, was just bought by Blue Prism. Their revenue number is quite thin. Call it less than $10 million. They were about at $100 million. We've indicated before that the advisors like us, there's a public company called Symphony that was traded at about 3.5 times their revenue. And we're sitting here, we believe as we enter 2020, we'll be in and around the $30 million run rate standpoint. And we think the value of that assets $100 million by itself. So that's how we look at it in the market. So we know that value is not in our stock today, but we're going to continue to build our assets and we expect that the market hopefully will pick up and follow what we have or we'll assess how we can unleash that value at some point.

Joe Gomes -- NOBLE Capital Markets -- Analyst

Okay. Great. Thanks on that. And in the first quarter call you mentioned that you thought the Americas would see double-digit sequential growth. We saw 5%, which is great, but if you can just kind of bridge that gap as to why you didn't hit the double-digit growth?

Michael P. Connors -- Chairman and Chief Executive Officer

Yeah. Well, the 300 basis points that we weren't able to capture with our big auto client in Q2 that we thought we may be able with the kind of an ad hoc project that did not materialize there. So that actually cost us about 300 basis points. And I would say timing was just the rounding on the other bet, Joe.

Joe Gomes -- NOBLE Capital Markets -- Analyst

Okay. Great. And also, in the first quarter call, you had mentioned one of your events that had been postponed, pushed out from Q1, what is the status of that event?

Michael P. Connors -- Chairman and Chief Executive Officer

That's now scheduled for October. So, we should see that in the fourth quarter.

Joe Gomes -- NOBLE Capital Markets -- Analyst

That's great. Okay. Thank you much. Appreciate it.

Michael P. Connors -- Chairman and Chief Executive Officer

Thanks very much, Joe.

Operator

At this time, there are no further questions in queue. I'd like to turn it back to management for any additional or closing remarks.

Michael P. Connors -- Chairman and Chief Executive Officer

Thank you very much. Let me close by saying, I am energized by the enthusiasm our employees are showing for our clients and our future. As I travel around meeting with our clients and employees, I get a real sense of the forward momentum that we have in our firm and the excitement of our people for being part of the whole digital revolution. It's exciting to help our clients transform and help them achieve operational excellence and faster growth.

Let me thank all of our professionals around the world for their contributions to our success. And let me thank all of you on the call today for your continued support and confidence in ISG. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Barry Holt -- Senior Communications Executive

Michael P. Connors -- Chairman and Chief Executive Officer

David E. Berger -- Executive Vice President and Chief Financial Officer

Marc Riddick -- Sidoti & Company, LLC -- Analyst

Vincent Colicchio -- Barrington Research -- Analyst

Joe Gomes -- NOBLE Capital Markets -- Analyst

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