Information Services Group Inc. Q2 FY2025 Earnings Call

Good morning, and welcome, everyone, to the Information Services Group Second Quarter 2025 Conference Call. This call is being recorded, and a replay will be available on ISG's website within 24 hours. Now I'd like to turn the call over to Mr. Barry Holt for his opening remarks and introductions. Mr. Holt, please go ahead.

Thank you, operator. Hello, and good morning. My name is Barry Holt. I'm the Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's second quarter conference call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer; and Michael Sherrick, Executive Vice President and Chief Financial Officer. Before we begin, I'd like to read a forward-looking statement. It's 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 that was furnished last night to the SEC and the Risk Factors section in our Form 10-K covering full year results and our Form 10-Q covering first quarter 2025 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'll 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 statements to reflect subsequent events or circumstances. During this call, we will discuss certain non-GAAP financial measures, which ISG believes improve 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 night with the SEC. And now I'd like to turn the call over to Michael Connors, who will be followed by Michael Sherrick. Mike?

Thank you, Barry, and good morning, everyone. Today, we will review our outstanding Q2 results accelerated by our pivot to AI, our acquisition of Martino & Partners in Italy, our view of the current market and our outlook for Q3. Our team executed extremely well, and ISG delivered an excellent second quarter, demonstrating our ongoing momentum with clients and our solid fundamentals. We delivered Q2 revenues of about $62 million, up 7%, excluding results from our previously divested automation unit. Growth was led by our largest revenue region, the Americas, up 16%. Our adjusted EBITDA was up 17% to $8.3 million, with our adjusted EBITDA margin up 240 basis points to 13.5%. Our enhanced profitability is a result of our improved business mix, disciplined operating approach and sound execution of our strategy. We also had an excellent cash quarter, producing nearly $12 million of cash, one of our best quarters ever for cash generation. Recurring revenues continue to be an important pillar of our success. In Q2, they reached $28 million, up 7% sequentially and represented 45% of our overall revenue. Our AI-centered approach is resonating with our clients. In Q2, our AI-related revenue was 2.5 times higher than it was a year ago. And in both the second quarter and first half, nearly 20% of our total revenue was AI related. We served more than 350 clients with AI-centered engagements in the second quarter, and that's up 50% from Q1. Further demonstrating the market's interest in AI, we produced two sold-out AI Impact Summit events in Q2, one in Boston and the other in Frankfurt, Germany, and we have three more slated for the second half. We also published our state of agentic AI market report, which has become our most downloaded research report ever. These autonomous AI systems are taking the market by storm and are now a significant aspect of most of our client engagements. We continue to leverage AI to expand the capabilities of our groundbreaking sourcing solution, ISG Tango. More than $11 billion of total contract value now flows through the platform, and that's up 20% from Q1. As expected, ISG Tango has opened up the mid-market to us, increasing our total addressable market. Over the years, ISG has grown through our enduring and trusted client relationships, our innovation and our commitment to excellence. We have also grown by expanding our capabilities and geographic reach through a series of tuck-in acquisitions. As noted in our earnings release, we have signed a definitive agreement for our latest acquisition, Martino & Partners, a highly respected advisory firm based out of Milan, Italy, focused on recurring revenue streams in the public sector. This transaction represents a further investment in our European business, and we expect it to close in early September. Italy has emerging growth potential, fueled by EU-funded programs aimed at technology modernization and a focus on AI and cost optimization. With the acquisition of Martino & Partners, we will add more than 20 new clients, expand our public sector reach beyond the central government to serve municipal entities with recurring revenue contracts and gain a stronger presence in Northern Italy where many leading commercial enterprises are located. We also add to our leadership bench with Co-Founder, Andrea Martino, slated to become CEO of our combined ISG Italy business. Overall, our momentum continues even as Europe remains a bit cautious. Uncertainty has become the norm, but enterprises are adjusting and moving forward. Two market factors are driving our performance. One, clients are riding the AI wave and investing aggressively in modernizing their technology operations and infrastructure to support it. This includes enhancing their data management capabilities as they prepare for broad-scale adoption of AI across their businesses. We prepared for this last year and are seizing the moment. Two, to fund these investments, clients remain focused on cost optimization. They continue to look to us to help them manage their cloud, infrastructure and software costs by tapping into our broad ecosystem expertise in our growing software research and advisory capabilities. Our towering strength is helping clients optimize their use of technology to drive greater efficiency. Combined with our all-out effort on AI, it is a powerful one-two punch. So we are well positioned, and we look forward to continuing our success in the second half. With that, let me turn to our regions. The year-over-year comparisons I cite here exclude revenues of about $7 million from our divested automation unit in last year's second quarter. Our Americas region delivered another excellent quarter. Revenues were up 16% to $39 million, driven by double-digit growth in our technology advisory, network, software, research, and GovernX businesses and in our consumer, energy, utilities, health sciences, and public sector industry verticals. Key client engagements during the second quarter included TreeHouse Foods, who is a significant mid-market client, along with Centene and PSE&G. During the quarter, ISG expanded its work with a large U.S.-based national health care company, generating additional revenues of $1 million. We are providing a range of services, including GovernX software and network to rationalize the client's tech spend and drive cost savings as part of an acquisition and divestiture of two businesses. In the energy sector, we continue to expand our business with a long-time client, a leading electric and gas utility company. During the quarter, we added $1.2 million of revenue supporting the client's SAP implementation, conducting a software assessment and developing a data center and network strategy. Turning to Europe. This market is showing early signs of a rebound with revenues up 21% sequentially from Q1 to $16.6 million. For Q2, Europe delivered double-digit revenue growth in our banking and health sciences industry verticals. Key client engagements in Europe in the second quarter included Allianz, Volkswagen, and BASF. During the quarter, we continued to expand our work with a leading multinational health care company. We are helping the client select a systems integrator for their adoption of SAP S/4HANA as part of a comprehensive business transformation program. For another client, a leading beverage company, we are supporting a complete restructuring of their applications estate and vendor ecosystem to enhance their AI capabilities. This includes selecting a data transformation partner to support this client's long-term AI strategy. Now turning to Asia Pacific. Our Q2 revenues of $5 million were essentially flat from the prior year. Key clients in the quarter included IEMO, Endeavour Group, and Standard Chartered Group. Among our Q2 engagements, we are supporting a leading Australia-based engineering services firm and selecting a finance and accounting provider while developing a broader tech, change management, and payroll services strategy. Now a few words on the overall market from our perspective. The outlook for tech services spending is somewhat mixed with strong demand in the U.S. and an improving outlook in Europe. To date, inflation does not appear to be as bad as originally feared and tariff risks seem to be manageable. Indeed, if anything, uncertainty is breeding stronger demand for technology-led cost and supply chain optimization services, and that plays to our strengths. Looking ahead, we see interest rate cuts stimulating further tech spending in the next 12 months with AI remaining the dominant long-term growth driver for the industry. So with that, let me turn to guidance. We expect current demand trends to continue in Q3, driven by cloud, AI, data analytics, and infrastructure modernization spending. Clients, for the most part, are not standing still. They are determined to stay ahead of the curve. For the third quarter, which includes the slower summer months in Europe, we are targeting revenues of between $60.5 million and $61.5 million and adjusted EBITDA between $7.5 million and $8.5 million, which will continue our year-over-year growth and margin acceleration. Now let me turn the call over to Michael Sherrick, who will summarize our financial results. Michael?

Thank you, Mike, and good morning, everyone. As Mike stated earlier, our revenue comparison with the second quarter of 2024 excludes our divested automation unit, which contributed about $7 million a year ago. This provides a more accurate view of our go-forward business. Revenue for the second quarter was $61.6 million, up a solid 7% versus the prior year. For the quarter, currency had an $800,000 positive impact on revenue. Americas revenue was $39.5 million, up 16%. Europe revenue was $16.6 million, down 7% and Asia Pacific revenue was $5.4 million, flat with the prior year. Second quarter adjusted EBITDA was $8.3 million, up 17% from the year-ago period and resulting in an EBITDA margin of 13.5%, up more than 240 basis points year-on-year. For the quarter, ISG delivered operating income of $4.7 million, up 28% compared with operating income of $3.7 million in the prior year. Our reported net income for the quarter was $2.2 million or $0.04 per fully diluted share compared with a net income of $2 million or $0.04 per fully diluted share in the prior year. Second quarter adjusted net income was $4.1 million or $0.08 per share on a fully diluted basis compared with adjusted net income of $3.8 million or $0.08 per fully diluted share in the prior-year second quarter. I do want to point out that last year, both GAAP and adjusted EPS benefited from a reported tax rate of 12% versus this year's more normal 39% tax rate. Headcount as of June 30, 2025, was 1,311, essentially flat with Q1. For the quarter, consulting utilization was a solid 76%. That compares with our average second quarter utilization of 74% and 79% in the year-ago quarter. We ended the quarter with cash of $25.2 million, up over $5 million from $20.1 million at the end of the first quarter. A key driver of the increase was strong operating cash flow. For the quarter, net cash provided by operations was $11.9 million, fueled by solid operating performance and strong cash collections. During the quarter, we paid dividends of $2.4 million and repurchased $4 million of stock. Our next quarterly dividend will be paid September 26 to shareholders of record as of September 5. Fully diluted shares outstanding for the quarter were 50.1 million, down 500,000 from year-end 2024. At quarter's end, we had approximately $11 million remaining on our share repurchase authorization. Our quarter end gross debt-to-EBITDA ratio was 2.0x, down from 2.4x at December 31, 2024, and at the bottom of our 2x to 2.5x target range. At quarter's end, our debt was unchanged. And for the quarter, our average borrowing rate was 6.2%, down from 7.3% in the year-ago period. Overall, our balance sheet is solid and continues to improve, providing us with a strong foundation to both operate and invest in the business. Mike will now share concluding remarks before we go to Q&A. Mike?

Thank you, Michael. To summarize, ISG delivered an excellent second quarter, continuing our momentum. Our revenues of $62 million exceeded expectations, led by another double-digit growth quarter in the Americas and accelerated by our all-in focus on AI. We grew our adjusted EBITDA by 17% and our margins by 240 basis points. And we had one of our strongest cash quarters ever, generating about $12 million in cash. Looking to the future, we signed a definitive agreement to acquire Martino & Partners and strengthen our position in Italy, a market with emerging growth potential. Our expanding AI capabilities and long-term focus on operational excellence, we believe, positions us well for continued year-over-year growth and margin expansion. 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 the operator for any questions.

The first question comes from David Storms with Stonegate.

Just wanted to start with the strong cash generation in the quarter. I know you mentioned that there was strong cash collection and solid operating performance. Could you give us a sense of how sustainable that is? Is that cash collection a new initiative? Or was that the impact of maybe one large outstanding balance?

David, it's Michael. I appreciate the question. I guess a couple of things. One, if you remember last quarter, I said that our Q1 operating cash flow was impacted to some extent on timing. And so we saw some of that. And that's really reflected if you look at the days sales outstanding, that's down about 10 days quarter-on-quarter. So we saw very strong collections from invoicing and due dates. I think that I wouldn't expect this level to repeat quarterly in the second half, but we would expect to continue to see strong operating cash flow as we look at the second half, but not at the levels that we just experienced.

Understood. That's very helpful. And then in the prepared remarks, you mentioned that you're seeing customers not standing still. This seems to be a bit of a reversal from maybe the elongated sales cycles you're seeing earlier in the year. Could you just maybe give us a sense of what your pipeline looks like right now around timing and maybe some of the interest that you're seeing?

Yes. Dave, look, I think it definitely has accelerated in many areas, primarily driven by a number of industry verticals, energy, utilities, banking, pharma, and health care are all up double digits for us. Part of it is the optimization push to garner some additional incremental savings so that can be used to put through on AI initiatives and other growth initiatives in these large firms. So we have had a bit of an acceleration of 'can you move fast?' And I'll give you one example. We have a very large cosmetics company who reached out to us via relationships that we had, asked us if we could come in and take a look at their entire portfolio, which is more than $1 billion, it's closer to $2 billion of spend around services and software and asked us if we could do a quick assessment, create the art of the possible. And then if we find potential big savings, could we help them execute it before the end of the year? That all happened in about a six-week period of time. Last year, when things were plotting along a bit, clients were taking much longer to make decisions, it would never have happened in that kind of timeframe. That's an example. We have several of those. So the pipeline is full. There are some elongated periods, but there are also some very quicker spurts that are happening, partly because there is a little more certainty around the tariffs. And clearly, that moves from day to day, but there's at least a sizing of what those are and what kind of products in particular, are being tariff. And they are then responding and reacting and trying to either get ahead of it or to help mitigate some of that. And so we're right in the middle of it. We kind of planned for this last year, as you know, and it's serving us quite well. But that's the change in the pipeline acceleration, if you will.

The next question comes from the line of Marc Riddick with Sidoti.

I wanted to begin by asking if you could share your observations regarding the various industry verticals and if there are any that are particularly leading the way in AI-driven activities. Additionally, I'd like to hear your insights on your exposure to state and local governments and what you're noticing from them, especially in relation to any shifting responsibilities from the federal government.

Thank you, Marc. Let me start with the state and local sector, which is experiencing growth for us, around 30% in the U.S. this quarter compared to last year. This growth is partly due to several Republican states accelerating their efforts to leverage AI for increased productivity and efficiency. It's worth noting that we have no exposure to DOGE or federal contracts, but state and local governments are using this opportunity to optimize their services, contributing to double-digit growth in our public sector business in the U.S. On the commercial side, we see a diverse range of industries, including aerospace, energy, and utilities. For instance, utilities are increasingly feeling the demand due to the AI acceleration and are looking to enhance their growth while needing financial resources to do so. Consequently, our work with the utility sector increased by 28% this quarter. The healthcare industry is also under pressure here in the U.S. and has seen significant double-digit growth, as they explore ways to utilize AI to change their cost structures and implement effective strategies. In summary, energy, utilities, banking, pharmaceuticals, healthcare, and the public sector are currently driving much of our demand.

That's very helpful. I appreciate it, Mike. I have a quick question as a follow-up. I wanted to touch a little on the acquisition announcement. Could you discuss how Martino & Partners came to be and share your thoughts on the potential pipeline moving forward? How are you feeling about the opportunities you're seeing in front of you?

Yes. So first on Martino & Partners, we're very, very excited about this. It's a small acquisition, but an important strategic one for our firm. We wanted to beef up our Italian capabilities because we expect over the next couple of years an expansion of spending by the Italian government, in particular, around transformation, around digital, around AI, and we wanted to be well positioned there. And we identified a number of targets. And we closed in on Martino & Partners really for a couple of reasons. One, they serve a little bit of the central government, which we do, but they also serve, if you will, the equivalent of the state and local in the Italian market, and we did not. So that immediately expanded our client base to a further reach around the municipal kind of government entities, which have recurring longer-term contracts and ones that get renewed fairly quickly. The second thing is we felt that combining that business with our current Italian business would give us more capabilities in terms of numbers of clients, the reach and certainly the number of professionals as we'll double roughly the number of people that we have in Italy, and they bring about 20-some-odd people to the party. And then importantly, from a leadership standpoint, we were very impressed with the two leaders of this business, one by the name of Andrea Martino, who we are going to make the CEO of all of our Italian businesses and his co-founder, Claudia De Roma. And between them and our teams, we think we have a strong leadership team. So that's why we kind of pursued Martino & Partners. In terms of the broader M&A environment, yes, we continue to look as we always have, to expand our capabilities, expand our recurring revenue streams, expand our transformation and AI capabilities. And for us, we've always been very surgical about our acquisition approach. We do have certain targets in mind that we think can enhance the value and create more value for our clients and our shareholders. And we think the market is good, and we've always been disciplined in our approach there. So maybe more to come on that as we move forward. I hope that answers that, Marc.

The next question comes from the line of Vincent Colicchio with Barrington Research.

Yes. Great quarter, Mike. We all understand the significance of data in AI. I’m curious about how far we’ve come in enhancing our infrastructure with the data necessary to support AI. What stage are we at in this process?

Well, first of all, I think we're still in the early stages of the market. It's very early in the development of AI, and some industries are progressing faster than others. In our work, we focus on helping clients identify AI sourcing strategies, advising them on the necessary cognitive infrastructure to scale their AI efforts, and creating information and data architectures that support AI models. We also assist in developing cybersecurity strategies for AI and data. There are several areas where we provide support to our clients. Many are looking to secure funding for AI initiatives, exploring ways to optimize costs to create financial resources for this purpose. They are interested in increasing productivity with AI and seeking cost-effective scaling solutions while aligning their delivery models with AI assistance. This outlines the sequence of inquiries we receive from clients regarding our guidance and research.

That's very helpful, and it does appear to be a sweet spot that will continue. Yes. I'm curious about the labor aspect. Are you turning away any business because of a shortage of labor related to AI?

No, I think we are in a good position. We are selectively hiring certain talent while also automating and utilizing AI internally. Additionally, we are developing our own AI agents to assist our consultants. As you may have noticed, our headcount is relatively unchanged from the previous quarter, which is largely due to our automation and AI efforts, as well as our work with consultants. We feel optimistic about this. We have also trained over 1,100 of our colleagues in AI skills, and importantly, the number of active engagements is growing. One example of this is ISG Tango, which has seen a significant acceleration and encompasses about 80 clients and around $11 billion in contract value, most of which include an AI component in their engagements with us. We're confident in our skill sets and while we can always benefit from more talent, I would say we have enough resources to meet the current market demand.

And one last question. So how do you see the geos playing out in the second half? Will Americas continue to lead? And will Europe continue to grow sequentially?

Yes. So good questions. So we continue to believe, as we started back kind of in the fourth quarter, we expect the U.S. to continue to lead the growth, and we are feeling that the second half will be quite strong for the Americas. We also, as you saw in Europe, a bit of sequential growth. Now I think we’ll be focusing on the year-over-year growth in Europe. And I believe we should see that, if not in the third quarter, will be pretty close, but I think we’ll see the year-over-year growth return to Europe starting in the third quarter, if not just a tad after that. So we see that turning. The pipeline there is stronger. There is still a little bit more uncertainty in the European theater with all that is going on there, geopolitical, etc. So they will be slower to respond. But as we kind of forecasted back in the fourth quarter, the U.S. would lead it, Europe would follow it, and we are seeing that now, and we were encouraged, frankly, with the quarter-over-quarter growth in Europe, it came a tad earlier than we anticipated, but we expect year-over-year growth to return in Europe in the second half year.

Next question comes from the line of Gowshi Sri with Singular Research.

Can you hear me?

Yes.

Congratulations on the quarter. On the question of your commentary about, it seems that the clients are now shifting towards end-to-end transformation deals on the AI and the more gradual modular engagements. How does that impact the margins going forward?

Thank you for the question, Gowshi. We are observing both trends. We're witnessing an acceleration in end-to-end solutions, as I previously mentioned. Additionally, clients are taking a more focused approach, choosing to concentrate on infrastructure or applications, for example. I would emphasize that anything related to AI is priced well due to high demand in that area. We're confident about our margins in this context, and our margin expansion from 2024 to 2025 is progressing. We're aiming for about a 300 basis point improvement compared to a year ago, which is evident in our performance. Strong pricing is a factor, but crucially, the demand and our execution are successfully capitalizing on that demand as it flows through the pipeline.

And on the client side, the struggle is, what are the kind of hesitation or hurdles in scaling AI initiatives are there?

It's primarily about cost. What we're noticing is that the situation isn't that different from when cloud technology was emerging. If you visualize a barbell, on one end you have the leaders who are eager to stay ahead. They are willing to take on significant change management to achieve their goals and they move quickly, as we see in industries like banking. On the opposite end, there are those who recognize the need to invest to accelerate their use of AI, but they face obstacles such as inadequate data management. It's crucial to have strong, clean data management to facilitate this progress. Essentially, it comes down to whether they are ready to invest, if the current volatility is deterring them, and whether their data management practices are up to standard. There are essentially two extremes on that spectrum.

Got you. Some of the AI solution vendors are vendor-driven and kind of sales heavy. How are you guys able to maybe respond to maybe provide a value proposition to the client or maybe by being vendor-agnostic frameworks? Can you talk a little bit about?

Yes. I mean, our bread and butter is that we are an independent, objective third-party respected researcher and adviser. And because of that, our clients trust us. That's why 85% of them are our same clients year after year. And they trust us to be able to come to them and talk to them about what that ecosystem looks like right now and as it is emerging. And we have relationships, Gowshi, as you know, with hundreds of the technology providers in the market, whether that’s services or software. And our clients trust us that we lay out for them what we believe their credentials and capabilities are and ask them to kind of look at that list. We call it kind of a Candidate Provider Qualification, CPQ for short, and our clients trust us to look at that. And then we have that ecosystem come in and our clients get a chance to see them in action and understand their capabilities. So that’s how we have positioned ourselves in both our research capability and our advisory capability. And it serves us, I think, pretty well.

And just my last question. Given that there is a boost in cash generation, what is the thoughts on capital allocation strategy? Any priority towards M&A in more M&A in Europe or invest internally to accelerate the AI tech capabilities?

Gowshi, it's Michael. I think, look, I mean, I think we've had a pretty steady and consistent capital allocation plan, right? So it remains same as before, which is dividend, share buyback, investing in the business, M&A, etc. Really no change whether we've got the higher level or lower level. It’s the same discipline. It’s a return on investment analysis that we do.

I'll take the rest offline. The next question comes from Joe Gomes with NOBLE Capital.

It's Jacob Mutchler on for Joe Gomes. I just had a quick follow-up question on the last question that was asked. As far as potential M&A activity, are there any areas that appear attractive or any operating activities that would be a nice addition to your current portfolio?

Our focus in M&A is centered on how we can enhance value for our clients and shareholders. Currently, we are exploring areas related to recurring revenue, transformation, digital technology, and AI, as these can significantly benefit the channels we access within our clients' C-suites. We have a loyal following among large enterprise clients, and we believe that if we could introduce additional capabilities through our channels, our clients would trust in the quality of our offerings and be receptive to these new solutions. Therefore, we are committed to increasing overall value by growing our recurring revenue streams and enhancing the capabilities we have developed over the past 19 years.

That's all I had. All my other questions were answered. And I'm showing no further questions. I'll turn the call back to Mike Connors for his closing remarks.

Well, thank you, and let me close by saying thank you to all our professionals worldwide for our continuing progress and for their collaboration and unwavering dedication to our clients and driving our long-term success. Our people have a passion for delivering the best advice and support to our clients as they continue their AI-powered transformations, and I could not be prouder of them. So thank you all for on the call today, for joining us and for your continued support and confidence in our firm. Have a great day.

This concludes today's teleconference. You may disconnect at any time.