Information Services Group Inc. Q4 FY2022 Earnings Call

Hello, everyone and welcome to the ISG 2022 Fourth Quarter and Full Year Results Call. My name is Charlie and I will be coordinating the call today. This call is being recorded and a replay will be available on ISG’s website within 24 hours. I will now hand over to your host, Mr. Barry Holt for his opening introduction. Barry, please go ahead.

Thank you, operator. Hello and good morning. My name is Barry Holt. I am a Senior Communications Executive at ISG. I’d like to welcome everyone to ISG’s fourth quarter conference call. I am joined today by Michael Connors, Chairman and Chief Executive Officer and Bert Alfonso, Executive Vice President and Chief Financial Officer. Before we begin, I would like to read a forward-looking statement. It is important to note that this communication may contain forward-looking statements, which represent the current expectations and beliefs of the management of ISG concerning future events and their potential 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 on our Form 8-K that was furnished last night 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 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 the ISG’s SEC filings on either ISG’s website or the SEC’s website. ISG undertakes no obligation to update or revise any forward-looking statements 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 could 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. And now, I would like to turn the call over to Michael Connors who will be followed by Bert Alfonso. Mike?

Thank you, Barry and good morning everyone. Today, we will review our record results for the fourth quarter and full year, our continued recurring revenue growth, our new enhanced amended credit facility, and our outlook for the first quarter. ISG delivered our best quarterly and full year performance in our 17-year history. For the quarter, ISG delivered record revenues of $74 million, up 11% in constant currency, record net income of $4.3 million, up 20%, record earnings per share of $0.09, record adjusted earnings per share of $0.13, and record adjusted EBITDA of $11 million, up 9%. Our key metrics were equally impressive for the full year with record revenues of $286 million, up 8% in constant currency; record operating income of $29 million, up 17%; record net income of $20 million, up 27%; record adjusted net income of $27 million, up 18%; record earnings per share of $0.39; record adjusted earnings per share of $0.53; and record adjusted EBITDA of $43 million, up 11%. Our record fourth quarter and full year results were accomplished despite an uncertain macro environment and fewer working days in Q4, normally a seasonally lower quarter for ISG. But our diverse and valued suite of products and services from cost optimization to business transformation is making a difference in our performance. Looking at the fourth quarter, our top line growth was driven by double-digit operating growth in both the Americas and Europe as client demand for efficiency and optimization services escalates. We also saw strong growth for our subscription services in research and governance and in network and software advisory services during the quarter. Our recurring revenues in Q4 reached $30 million, up 26% over the prior year and represented 40% of our firm-wide revenues. For the year, we achieved $108 million in recurring revenue, surpassing the $100 million goal we set for ourselves back in 2020. Not surprisingly, FX continues to chip away at our reported results. For the quarter, the impact of revenue was 447 basis points or $3.2 million and $13 million for the full year. Overall, our more profitable mix of products and services, combined with the operating efficiencies we derived from our ISG NEXT operating model resulted in the highest full year EBITDA margin in our firm’s history at 15%. From a client perspective, we served 556 clients in Q4, up 6% and surpassed 900 clients for the year, a new high for our firm. Today, nearly every one of our clients is a digital business. Each is using digital technology to redefine how they operate, how they engage with customers, employees and business partners and how they create new revenue streams through connected products and services. Even in uncertain times, our clients remain committed to continuous digital transformation. Markets and technology are changing fast. There is really no time to hit pause. Every business needs to keep moving forward or be left behind. With intense market pressure to invest in cloud, analytics, customer experience, and AI, our clients are turning to ISG to help them optimize their costs, not only to get lean, but to free up resources to fund their digital ambitions. To meet this need, ISG introduced a wide ranging cost transformation service that builds upon our longstanding expertise in this area. Our offering focuses on the four key levers to optimize cost: the supplier ecosystem, technology investments, software asset management, and business operations. This approach delivers both short and long-term efficiencies and reduces the peaks and valleys of traditional linear spend models. As I mentioned, these continuous savings can be reinvested in our clients business, particularly for ongoing digital transformation. This is another example of how our 17-year history of being the largest sourcing advisor in the world is paying off. Revenues from our cost optimization services are growing by double-digits. Among our major engagements, we are helping a global healthcare solutions company reduce its $40 million of technology costs by 25% and an automotive supplier reduce its $140 million spend by 20%. There are many more such opportunities in progress and in our pipeline. Turning to our regions, the Americas delivered $44 million of revenue in the quarter, up 12% versus the prior year on the strength of our digital and cost optimization offerings. During the quarter, we saw double-digit growth in our media, health sciences, energy, and utilities industries. And among our services, network and software advisory, research, and GovernX were also up double-digits. Key client engagements during the fourth quarter included McKesson, Stryker, Exelon, and Pfizer. As I mentioned, demand for GovernX, our SaaS-based vendor compliance and risk management platform is soaring as clients seek to get the most value out of their supplier ecosystems. During the quarter, a global hospitality giant renewed its annual $1 million plus ISG GovernX subscription at a higher rate for 2023. This client is one of our longest-standing GovernX clients, generating more than $25 million in recurring revenue over the last 10 years. We also extended our ISG GovernX contract with one of the top three global tech giants in the world for a further 4 years with a significant increase in annual contract value. ISG also won a new multimillion dollar ISG GovernX engagement with a major U.S. healthcare company to provide our unique vendor management office as a service capability. Additionally, ISG Research has signed a large deal worth more than $1.5 million with a leading services tech provider for a range of go-to-market projects and ISG solutions, including a multiyear ISG ProBenchmark contract. Now turning to Europe, our Q4 revenues of $24 million were up 12% in constant currency over last year. For the quarter, Europe delivered double-digit revenue growth in our media, public sector, consumer services, and manufacturing industry verticals and in our GovernX and network and software advisory businesses. Key client engagements in Europe in the fourth quarter included Volkswagen, Deutsche Bonn, Allianz, and Nestle. During the quarter, a leading transportation company in Germany extended the digital labor and automation engagement ISG was awarded for an additional 2 years. ISG will continue as the client’s strategic automation advisor, delivering platform-as-a-service maintenance and licensing services. We also secured a major deal with a global chemicals and industrial solutions manufacturer in Germany to provide network advisory services. Additionally, ISG has been awarded a significant $1 million plus engagement with the Swiss Federal Office of Information Technology, Systems and Telecommunications. We are helping this client optimize their technology portfolio, restructure their underlying cost models, and redefine their organizational structure to ensure lasting improvement. Now turning to Asia-Pacific, our Q4 revenues of $7 million were up 5% in constant currency from last year, with double-digit growth in our network and software advisory business. Asia-Pacific has been a strong performer this year, with full year revenues up 16% in constant currency. In the latest quarter, we saw double-digit growth in our consumer and media industry verticals. Key clients in the quarter included the Australian Taxation Office, and the insurance company, Bupa. Turning now to another very positive development for ISG, we recently announced that we were able to successfully amend our $140 million credit agreement at more favorable terms. This was made possible by our strong financial position and operating results. The new agreement converts the previous term and revolving loan into an all revolving credit facility. It eliminates $4.3 million of mandatory annual principal payments under the former agreement and extends the maturity date by 3 years to February 2028. This is clearly an excellent outcome, especially during a time of increasing interest rates and a volatile debt market. Now, let me turn to guidance. Continuous digital transformation remains a business imperative and ISG is ideally positioned to meet that need. In addition, we see continuing strong demand for our services as we help our clients optimize their technology and business environments, design their future operating state, and leverage the technology and services that will help them realize their objectives. Looking ahead to 2023, our demand pipeline remains strong. Indeed, we hired additional employees in Q4 to meet future demand. We are also mindful of the economic factors that could impact the timing of client decision-making, including inflation, the possibility of recession, geopolitical concerns and talent shortages. In consideration of all of this for the first quarter, we are targeting revenues of between $73 million and $75 million including a negative FX impact of approximately 200 basis points in this range and adjusted EBITDA between $10 million and $11 million. So, with that, let me turn the call over to Bert, who will summarize our financial results. Bert?

Well, thank you Mike, and good morning everyone. As Mike mentioned, ISG continues to have momentum in the market, leading to a record-breaking quarter and year. Revenues for the fourth quarter were $74.2 million, up 7% on a reported basis, and up 11% on a constant currency basis compared with the fourth quarter last year. Currency negatively impacted reported revenues by $3.2 million versus the prior year. The Americas reported revenues of $43.6 million, up 12% versus the prior year. Europe revenues were $23.9 million, up 1% on a reported basis, and up 12% in constant currency. Asia Pacific revenues were $6.7 million, down 4% reported and up 5% in constant currency. Fourth quarter adjusted EBITDA was $11.1 million, up 9% from last year, resulting in an EBITDA margin of 15%, up 33 basis points compared with the prior year's fourth quarter. In constant currency, adjusted EBITDA was up 17% for the full year. Fourth quarter operating income increased slightly to $7.2 million, compared with $7.1 million in the prior year. Net income for the quarter was $4.3 million, or $0.09 per fully diluted share, up 20% over net income of $3.6 million, or $0.07 per fully diluted share in the prior year. Fourth quarter adjusted net income was $6.5 million or $0.13 per fully diluted share, up 27% from adjusted net income of $5.1 million or $0.10 per fully diluted share in the prior year’s fourth quarter. Headcount as of December 31, was 1,599, up 61 professionals or 4% from Q3. As Mike mentioned earlier, we added resources to gear up for future growth. Consulting utilization for the fourth quarter was 67%, impacted by our additional hiring and our full year utilization was 73%. Our balance sheet continues to have the strength and flexibility to support our business over the long term. For the quarter, net cash provided by operations was $6.6 million and $11.1 million for the full year. We ended the quarter with $30.6 million of cash, up from $19.7 million at the end of the third quarter. During the fourth quarter, ISG paid dividends totaling $2 million. Our next quarterly dividend will be payable on March 31 to shareholders of record on March 20. In addition, we paid $3.5 million related to the C4G acquisition, borrowing $9 million from our revolver to fund the acquisition and business operations. We also paid down $1.1 million of debt with a debt balance of $79.2 million. Our debt-to-EBITDA ratio was 1.8x, a record low for year-end. Our average borrowing rate for the quarter was 5.1%, up from 1.9% last year, and we ended the quarter with 48.3 million shares outstanding. Mike will now share some concluding remarks before we go to the Q&A. Back to you, Mike.

Thank you, Bert. To summarize, our portfolio of cost optimization sourcing and digital transformation services is in the sweet spot for enterprises in today's environment. As a result, ISG delivered our best quarter and full year ever, with record-breaking revenues and profits in each period. Our Q4 recurring revenues were up double-digits, enabling us to exceed our $100 million full year target set back in 2020. Recurring revenues were 40% of our firm-wide total in Q4. We navigated FX headwinds and other market uncertainties in the fourth quarter to deliver double-digit operating growth in Europe, the Americas, and Asia Pacific had an outstanding year. Our strong financial position and operating performance allowed us to successfully amend our $140 million credit agreement, giving us more flexibility to invest in the continued growth of our firm. And we see our momentum continuing with the potential of another record-setting first 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. So thank you very much for calling in this morning. And now let me turn the session over to our operator for your questions.

Thank you. Our first question comes from Vincent Colicchio of Barrington Research. Vincent, your line is open. Please go ahead.

Yes, thanks. Nice quarter, Mike.

Good morning, Vince. Thank you.

Couple for me. Good morning. So sounds like the strength in the quarter was somewhat similar to last quarter, cost optimization GovernX research. I think network advisory was sort of a new area of strength. Does that latter area have legs? And are there any other areas I am not mentioning that we are new source of strength this quarter versus last? And do they have legs as well?

Yes, good point. So cost optimization and on the digital transformation front continues, and definitely our network and software advisory business – reminding you that the software advisory or all the software that enterprises purchase, whether that is a Salesforce or an Oracle or a ServiceNow etcetera. We help them navigate the number of licenses, the value, the pricing etcetera. Clearly, that fits right into cost optimization. The network, which is a large spend sometimes the third largest tech spend in a lot of large enterprises around the network, around 5G, around data and voice etcetera, does have legs. We had an outstanding fourth quarter in network and software, and we see both of those fitting right into the current environment, both in Europe and in the U.S. So we see a lot of legs there, and our recurring revenue streams with our platform business like GX and our research, we see continued strength there as well. So, you couple that together with a pretty strong demand environment for the services and the suite of services that we currently have, and it is kind of pushing us to where we are in the early part of ‘23.

And what were the major margin improvement drivers? Was it the mix? And if so, will that mix also benefit you in ‘23?

Well, I would say the first thing is our recurring revenues were $30 million. We have never been at that level. And then Vince, you followed us for a while you will go back maybe 4 or 5 years, we might not have had $30 million of recurring revenue, so having in the quarter number one that our recurring revenues are clearly higher margin. So as that continues to expand, it is $100 million of our business now and that will continue to definitely grow. So I think that in the mix that we have with our kind of digital transformation, which we can still sell at good premium levels. I think our margins should continue to be healthy as we move forward.

Okay. And then, lastly, what are your thoughts on acquisitions currently and this pricing come in to make it a more attractive area to focus on capital this year?

Yes, as we did two last year with agreement and Change for Growth. We are on the hunt primarily around recurring revenue streams and around digital, and we are in the market. If we find something that is a win-win for us as well as the target, then we will execute that during 2023. We see the market; most of ours are sole-sourced. So it's a bit of a dance and it's both an economic as well as an emotional sale because all these teams tend to be owned or operated, the ones we are interested in. But we think the market is in pretty good shape out there. And we have our sight set.

Okay, thank you. I will go back into the queue. Nice job.

Thanks a lot, Vince.

Thank you. Our next question comes from Marc Riddick of Sidoti. Marc, your line is open. Please go ahead.

Hi, good morning.

Hi, Marc. Good morning, Marc.

So I wanted to touch on a couple of things and thank you for all the detail and congratulations on getting the agreement done, which is certainly encouraging. I was wondering if you could talk a little bit about clients looking for cost savings solutions and likewise how you are seeing that shift play out. Are there any particular industries that have been more at the forefront of that process than others?

Yes. Good question. Let me give you a couple of examples. One CIO from a very large top five insurance company called and asked us if they have $225 million of application expense. They wanted to know if that was the right number. If not, they were looking to cut at least 20% or $40 million plus out of that. So we said, let us come in; we will do a quick assessment for you and benchmark it against our data. Based on our assessment, we think we can take $50 million of cost out. This particular example wanted to take that money and move it over to digitizing a number of their processes in this insurance company. Another example is a large bank that does a lot of training on regulatory and compliance. We have a new service we launched last year called Training as a Service (TaaS), and we are planning to operate their Training as a Service on a fixed fee multiyear contract. This is because of the number of people, the turnover, and the costs associated with it. We could do it more efficiently for them. The industries that are hottest at the moment include health sciences, with about 20% plus growth, and manufacturing for efficiency and optimization reasons, also up 20%. The media and tech industry out west are up almost 40% driven by cost optimization. The private equity channel is also very, very strong for us. We help them do two things on their targets and also on their exits to spruce up their portfolios for exit preparation. Lastly, the public sector market globally is in good shape as well.

That is really helpful. Thank you. Regarding your comments on the hiring that took place during the fourth quarter, does that continue into the new year or is there a bit of a pause after that?

Yes, we hired about 60 people in the fourth quarter. We hired about 50 in the third quarter. We did hire in January and February, and we now think that at these levels we are, we will be around 1,600 employees. After January and February hiring that we did, we think this range of around 1,650 is right for the next few quarters. We are certainly open to hiring surgical personnel as needed for expected projects, but we think we will be stable for the next period unless we do win some larger bids.

Excellent. Thank you very much.

Yes.

Thank you. Our next question comes from David Storms of Stonegate Securities. David, your line is open. Please go ahead.

Thank you and good morning, appreciate you taking my call and congrats on the really strong quarter. Just wanted to start with the recurring revenue side of things, what are some of the key variables that are driving that number higher? And how are you thinking about continuing to grow that number now that you have hit that $100 million goal?

Yes, good question. First of all, what are the drivers behind our performance? The key components include our platform business around GovernX, ProBenchmark, and certainly our research, which is a subscription and kind of multi-year agreement model. What is driving that? The GovernX service revolves around regulatory and compliance, governing the ecosystem which has become much more complex post-pandemic as companies have worked to broaden their supplier community. The ProBenchmark platform is hot because many tech providers need insight into pricing capabilities in the market. Our research offerings are also in demand due to the complexity of emerging technologies. Between our research and platform business, we aim to continue growing our recurring revenue streams. We plan to provide guidance on our multi-year recurring revenue outlook during our May Q1 report.

That's very helpful. Thank you. And one more if I could. You had mentioned that you have signed a number of GovernX clients. Given the current macro environment, are you seeing any requests for terms in those contracts that might indicate companies trying to stay nimble?

Not in our GovernX contracts. I would say there might be a slight elongation in the process to finalize things, driven by needing a few extra approval layers compared to before. So the sales cycle can be a little longer, but these things don't really affect the terms of our agreements.

That's excellent. Thank you. I'll jump back in the queue.

Thank you, David.

Thank you. Our next question comes from Joe Gomes of Noble Capital Markets. Joe, your line is open. Please go ahead.

Hey. Good morning. This is Joshua Zoepfel just filling in for Joe Gomes. I want to congratulate you guys on the quarter as well as the year.

Thanks.

So, I just wanted to start off with, I know your revenues kind of came in slightly higher than you guys expected last quarter. Was this just a lower OpEx headwind or was there something a little bit more to that, maybe more recurring revenues?

Yes, I think it's two-fold. First, the demand for our cost optimization services is clearly increasing. Our platform services fit into the sweet spot for large enterprises managing complex ecosystems. Those factors are likely driving our performance.

Okay, perfect. Thank you. I didn’t notice anything regarding share purchases in the quarter. Was it just due to that Change 4 Growth acquisition? What are your guys’ plans for share repurchases going into this New Year?

We were focused on the acquisition during the quarter. We chose to use our cash proceeds for that. We think holding some cash serves us well in this environment. Our long-term strategy is to avoid dilution from stock compensation, but we don't have immediate plans for share repurchases.

Okay, perfect. Thank you. And just lastly, regarding your UK operations for the Change 4 Growth, is that something you guys are looking into moving forward?

I would say we are not setting up anything beyond what we have today. The Change 4 Growth business is U.S.-domestic. We have some resources on the ground and we see this as a way to expand our business more globally.

Okay, perfect. Yes, that clears everything up. Thank you guys so much. Congrats again.

Thank you.

Thank you. Our next question is from Michael Matheson of Singular Research. Michael, your line is open. Please go ahead.

Congratulations on those numbers, gentlemen. Great quarter. Great year. Regarding some of the longer sales cycle that you described yourself beginning to see, are there any particular industry verticals where you see more of that than others?

No, I would say that it’s not prevailing in any one industry. The sales cycle is a little longer due to needing additional layers of approval. However, that does not significantly impact the demand we are experiencing.

Okay, great. Thank you. One last question, you mentioned the new service training as a service. Is it something you can leverage to other banks or potentially other industries?

Yes. Training as a Service is a growing segment that we believe can extend beyond financial services. We are seeing traction in health sciences as well, so we think this could be a fast-growing segment for us over the next 2 to 3 years.

Good luck with that. Again, it’s a great idea. Thank you for taking my questions.

Yes. Thanks, Michael.

Thank you, Michael. I see we have a follow-up from David Storms with Stonegate Securities. David, your line is open. Please go ahead.

Hi, yes. Just one follow-up, do you guys have any thoughts on capital expenditures? If there is anything unusual we should be keeping an eye out for in 2023?

No, David, I would say overall, we are very lean on capital. We have very little real estate. Our capital tends to fluctuate between $2 million and $3 million, which was a little bit higher in ‘22. We upgraded our accounting and HR systems. But it’s been fairly consistent. It’s a low capital requirement business, which helps us in terms of cash flow.

That’s very helpful. Thank you and congrats again on a great year.

Thank you.

Thanks David.

At this stage, we currently have no further questions, so I will hand back over to the management team for any closing remarks.

Well, thank you and let me just close by saying thank you to all our professionals worldwide, for their dedication to our clients and for working together as a global team to achieve our record fourth quarter and full year results. Our people have a passion for delivering the best advice and support to our clients as they continue their digital journeys and I could not be prouder of them. And thanks to all of you on the call today for your continued support and confidence in our firm. Have a great rest of the day.

Ladies and gentlemen, this concludes today’s call. Thanks for joining. You may disconnect your lines.