Information Services Group Inc. Q1 FY2021 Earnings Call

Good day and welcome to the Information Services Group First Quarter 2021 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 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.

Thank you, Barry, and good morning everyone. This morning I will review our record first quarter results, provide guidance for the second quarter, and discuss our initiation of our first ever quarterly dividend. ISG is off to its strongest start ever. Last year, our clients were dealing with the crippling effects of the global pandemic. This year, while the pandemic is far from over, our clients across many industries are now increasing their digital investments, moving beyond their initial COVID cautiousness in anticipation of renewed growth. This rising demand for all things digital, coupled with the benefits of our new ISG NEXT operating model and our disciplined operating approach, is reflected in our record fee revenues and profitability in Q1. Our results across the board exceeded expectations.

Thanks, Mike. I sincerely appreciate your kind words. I, too, will miss working with you and the entire ISG team. It has been a tremendous ride with 9 of our 10 acquisitions completed during my tenure and with more still in the pipeline, as you heard. Looking at the quarter, we managed through a difficult operating environment to deliver record results in Q1. Revenues for the first quarter were $66.6 million, up 4% on a reported basis and up 1% in constant currency compared with the first quarter of last year. Currency positively impacted reported revenues by $2.4 million versus the prior year. Excluding reimbursable client travel costs at $1.5 million, which accounted for approximately a 240 basis point decline versus the prior year, revenues were up 7% versus last year. Reported revenues excluding T&E were $38.1 million in the Americas, up 7% versus the prior year, $22.7 million in Europe, up 4% versus the prior year, and $5.7 million in Asia Pacific, up 24% versus the prior year. Record first quarter 2021 adjusted EBITDA was $8.6 million, up 2.4 times from last year's first quarter. We reported record first quarter operating income up $5 million. There was an operating loss of $700,000 in the first quarter of 2020. Net income for the quarter was $3.4 million and fully diluted income per share was $0.07 per share compared with a net loss of $1.4 million and a fully diluted loss per share of $0.03 respectively in the prior year. First quarter adjusted net income of $5.5 million or $0.10 per share on a fully diluted basis compared with adjusted net income of $1.1 million or $0.02 per share on a fully diluted basis from the prior year’s first quarter. Total utilization for the first quarter was 75% versus 68% in the prior year, reflecting the impact of our new ISG NEXT operating model. Our balance sheet continues to have the strength and flexibility to support our business over the long term. Net cash provided by operations reached a first quarter record of $12.1 million, compared with $4.6 million in the prior year. We ended the quarter with $48.6 million of cash, up 2.8 times from $17.4 million in the prior year. We repaid $1.1 million of debt in the quarter, lowering our debt balance to $77.7 million and our net debt to EBITDA ratio to 0.9 times. We repurchased $3 million of ISG shares. Our average borrowing rate for the quarter was 2.5%, almost half of last year's rate, and we have 48 million shares outstanding as of April 30th.

Thank you, David. To summarize, we had a record-setting start to the year, revenue up 7% and EBITDA up 2.4 times with revenue, EBITDA, and EPS all meeting expectations. Our balance sheet has never been stronger, $48.6 million of cash, and net debt down to 0.9 times EBITDA. Our new operating model, ISG NEXT, is driving a more profitable enterprise with our Q1 margins of 13%, up from 6% the prior year. We see digital demand increasing as clients look to accelerate their digital transformations coming out of the pandemic. ISG's momentum is also accelerating. Our Q2 guidance is up significantly over the prior year, and we announced the initiation of a quarterly dividend to reward our shareholders. 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. Thank you very much for calling in this morning. Now let me turn the session over to the operator for your questions.

Thank you. We'll take our first question from Joe Gomes with Noble Capital.

Good morning and congrats on the quarter, fantastic.

Good morning Joe, thank you.

So just wanted to a couple of quick questions, broader for you, Michael. How is the state business unfolding here, especially as we see the headlines at least that the Federal Government is pumping significant amounts of money into the States? Do you see any positive impact on the business from your end?

Good question. First of all, our public sector business in the U.S. continues to be strong and steady. As you know, these are longer-term contracts that we have with the state and local governments. Yes, we have our eye on all of that money beginning to flow into the different states. There are some restrictions on how they use it, but no restrictions that we are aware of around the transformation that they could do with many of their old antiquated technology. So we are keeping an eye on it. Keep in mind, these things have long runways in terms of buying because they go through a whole process of RFP and so on. But we think it could be a net positive application for us over the next 18 months.

Okay, great. And then I was wondering if you could give us a little more color on the significant ISG automation win, how that all came about and who you're competing against for this. Do you see more of these significantly larger than normal potential deals out there?

So good question, Joe. This is a very large top five global entertainment company. They went through a significant merger during COVID, and as a result of that, they have things like reward cards, etc. that they are looking to fully integrate, and they would like to use automation to help them on their journey. So yes, we did compete with that. I think our independent third-party objective-agnostic approach was the winner, in addition to the talent and the large-scale deal that we have done in ISG over the years in and around this industry, securing this win. This is a win that's greater than $10 million. It could get even larger and that will flow through for us during the second half of 2021 and fully in 2022. You can see this over the next 18 months or so. That's number one. Number two, we are beginning to see that clients are starting to accelerate, moving from kind of center of excellence, let’s try a process or two. Many industry segments now with the pandemic are looking to accelerate their automation journey and move to a much more scaling of that. I think we will see that over the next couple of years. As you may know, UiPath just went public with $600 million in revenue and a 50 times revenue model. So the industry itself is picking up some steam, and our automation business is also contributing to that, and we are also seeing the benefit of clients scaling their automation. So yes, sure, we do see that increasing over the next 18 months or so.

Great, thanks for that. One last one for me and I'll jump back in queue. Obviously, last year for most of the year, as you mentioned even here in the first quarter, the live events have taken a hit due to COVID restrictions. Any kind of time frame for when you see the live event starting to come back and contribute again to the top line?

Good question. At the moment, we are planning in our financials for the year to have very little. However, what we are doing internally is anticipating potentially in the United States launching our first physical event of any size in September, so right at the end of Q3. Depending on how well the U.S. responds over the next couple of quarters and months, with vaccination penetration and interest level from clients, it's possible we will begin to see that at the very tail end of Q3. So that's what we're internally planning on at the moment.

Hey great. Thanks for that, Michael. And David, thank you for all your help in the past and have a great retirement.

I appreciate that Joe.

We will take our next question from Marco Rodriguez with Stonegate.

Good morning guys. Thank you for taking my questions.

Good morning Marco.

Hey Michael, I was wondering if you could maybe spend a little bit more time on some of your prepared remarks where you talked about this new wave of digital transformation. Obviously, I’m assuming that there aren’t people out there that you’re still needing to convince as far as all things digital is concerned. So are your comments more around just people starting to get comfortable or end customers getting comfortable with the economy and they're sort of losing their purse strings, if you will?

Well, so I would put it – we will talk about cloud for a minute. Clearly, people have moved workloads to the cloud for the last several years. However, the level, the speed, and the acceleration are all picking up as a result of the pandemic. Why? Because the way work was performed has changed dramatically during 2020. When we think about all things digital, particularly cloud, we're talking about accelerating the workloads to the cloud. Our work includes everything from cloud implementation strategy to cloud readiness within a firm, to helping develop an application portfolio that could migrate around some of those applications. It's about sourcing for cloud transformation, designing cloud governance, billing, and chargeback. There are numerous areas now that indicate an increased level of investments emerging from the pandemic, which is going to accelerate these digital transformations. Most companies and industries were at the starting point before the pandemic. They are now eager to push forward. That is kind of our sweet spot. That’s what we mean by the acceleration on the digital journeys or investments made by clients.

Understood, very helpful. Then, in terms of your competitive positioning, you sort of addressed this in a prior answer here to the question. I'm assuming that most people are seeing the digital transformations, the adoption curves are steepening, and you obviously have a strong position in terms of your independence and your research aspects. But how do you see your competitive positioning evolving? Are you seeing any sort of competitive responses given your positioning for this digital transformation for your clients?

Our competitive landscape essentially has not changed much. We see the big four accounting firms out there, service providers, especially in automation. They are motivated to automate because they have a massive number of employees that were doing the work. These contracts are beginning to terminate, and business models are changing to outcomes. It's in their interest to automate as fast as they can, but it's not independent or third-party. If I’m Cap Gemini or Accenture, for example, I want to retain the work I have with Enterprise X, and I’ll help automate. However, our positioning remains strong as an independent, objective third party with trusted advisory capabilities across all things digital.

Understood. Last question from me, around capital allocation with the new dividend being implemented. Does that affect your thoughts on any sort of pre-payment of debt? Obviously, I know that the interest rate is low, and where does M&A fit into everything as well?

Yeah, thank you. The dividend doesn’t preclude us from continuing to pay down debt when you have a requirement of $4 million, given the current interest rate environment. We don't really see the need to accelerate that at this point. However, with the cash generation we've experienced in the first quarter anticipated for this year, we can continue to provide the dividend, repurchase shares, and pursue opportunistic acquisitions.

And sorry for one more quick follow-up on the M&A environment. What kind of opportunities are you looking at from a high level? Can you discuss that and what do valuations look like?

In acquisitions, we continue to focus primarily on two areas: anything digital-related that can accelerate or add a channel into our distribution network at the C-suite level, and all recurring revenues that we could use to sell into our distribution channels. There will be other opportunities that arise opportunistically, but strategically, those are our two key areas. Relative to valuations, there's always a disparity between the buyer's and seller’s perspective on value. We'll continue to remain disciplined and only pursue acquisitions that add value to the firm.

Got it, understood. Congratulations David on your retirement, I hope you have a great time. Thank you guys for taking my questions. Appreciate the time.

Thanks, Marco.

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

Hello, Mike. Nice quarter. Very nice quarter. So, how did the sales pipeline change at the end of the last quarter to the end of this quarter? The point of the question is to get a sense of what the revenue trajectory may look like in the second half.

The sales pipeline is building nicely for 2021 and 2022. Some of these have a longer close cycle. The sales cycle is longer in Europe due to uncertainty about the pandemic. Nevertheless, as mentioned earlier, anything related digitally, the pipeline has increased significantly since the end of last year.

And the large automation deal that you won, what timeframe will that be delivered?

That will be delivered over 2021 and into 2022.

Okay. Clearly, the digital environment is a tailwind for your business. If we look back at 2019 to now, do you think the organic growth potential of the company is higher now than it was then? Would you like to provide an estimate of what kind of organic growth you think you can achieve over the next three to five years?

Our target remains high single digits on the revenue line, with EBITDA growing at about one and a half times revenue growth. While there may be years where we can achieve double-digit top-line growth, these markers are our overall goals.

Any thoughts on government activity in APAC? I didn't hear you talk about that this quarter. Should that come back later in the year?

The government business is nice and steady now in Australia. The government side is spending and it serves us well for the entire region, and it continues to grow steadily. Additionally, commercial enterprises in Australia have also picked up steam relative to digital, contributing to good growth in Asia Pacific this quarter. We believe the government business looks strong for this year in Australia and should serve us well for the region.

And congratulations to David. We'll miss you, buddy.

Thank you, Vince.

You're welcome, appreciate it.

We will take our next question from Marc Riddick with Sidoti.

Hi, good morning gentlemen.

Good morning Marc.

So first of all, David, I wanted to congratulate you and thank you for everything along the way. Hopefully, I’ll look forward to once you’re done, because you’re not completely done yet, but look forward to a very happy retirement there. Thank you for all your efforts.

I appreciate that Marc.

I wanted to touch a little bit on comments around the utilization and I think, so you're looking now at mid-70s. I was wondering if you could touch a little bit on maybe what you've seen there in the past as far as what the maximum level you’ve seen in the past, and what you think might be attainable now given the new business structure and kind of what you’re seeing out there now?

Yeah, thanks for that. We were able to leverage our experts globally, and with travel at near zero, that has also had the impact of increasing our productivity. Seventy-five percent is a good level, and we're striving to maintain it. You can see how that has improved our results with margins at 13% versus 6% last year.

Great. I was wondering if you could talk about some of the initial findings that you’re seeing with NEXT. Are there any surprises so far? Is it along the lines of what you thought it would be? I’d like to talk about that and the evolution you see going forward.

Marc, it's Mike. Yes, the ISG NEXT has performed exceedingly well, even better than our early expectations. The model is based on a couple of principles: that we can leverage our experts with any client worldwide and generate more revenue due to stronger competencies. The iFlex delivery network we’ve established enables flexibility, as our consultants aren't limited to travel time, making them available for multiple clients. This has helped us reach that 75% utilization rate. While client demand may influence our levels in the future, this new model resonates well with clients as we address needs in cybersecurity and beyond. We have an encouraging outlook for the next year and a half.

Okay, great. Lastly, I wanted to discuss the way the business has returned with the activity and the acceleration. I appreciate the commentary you've given us. How has it come back? Does that give you more or less visibility than you've historically had with potential upcoming engagements?

In terms of visibility, I don't believe it's achieved much change because of our project's nature. While visibility is somewhat similar with recurring revenues increasing, we are seeing an increase in investments in digital transformation across various industries. Even some industries hit hard by COVID, like the hospitality sector, are looking to engage us as they recover. For instance, the major entertainment company seeking to automate and merge after a significant crisis is one example of how clients are pushing forward. So, while visibility remains unchanged, the pipeline is increasing.

Yes, it's very encouraging to hear the level of engagement from those types of customers. Thank you very much.

Okay, Marc. Thank you.

That concludes today's question-and-answer session. At this time, I will turn the conference back to today's speakers for any additional or closing remarks.

Well, thank you. Let me close by saying thank you to all of our professionals worldwide for stepping up to the challenges presented by the coronavirus and delivering these terrific first quarter results. Even working remotely, there’s been no let-up in our passion for delivering the best advice and support to our clients. And allow me again, to extend my sincerest best wishes to David on his retirement and to Bert on assuming his new role at ISG. We're going to miss David’s contributions, and I’m going to miss his friendship, but we also look forward to Bert taking over without missing a beat. Finally, thanks to everyone on the call for your continued support and confidence in our firm. Stay well everybody, have a great day.

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