Good day, ladies and gentlemen, and thank you for standing by welcome to the Information Services Group Third Quarter 2017 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 everyone. My name is Barry Holt. I'm the Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's third quarter conference call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer; and David Berger, Executive Vice President and Chief Financial Officer.

Before we begin, I'd like to read a forward-looking statement. It is important to note that this communication may contain forward-looking statements, which represent the current expectations and beliefs of the management of ISG concerning future events and their potential effects.

These statements are not guarantees of future results, and are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated.

For a more detailed listing of the risks and other factors that could affect future results, please refer to the forward-looking statement contained in our Form 8-K, which was furnished last evening to the SEC, and the Risk Factors section in ISG's Form 10-K covering full year results.

You should also read ISG's annual report on Form 10-K for the fiscal year ending December 31, 2016, 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 a 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 in the most closely applicable GAAP measure, please refer to our current report on Form 8-K, which was filed last evening with the SEC. And now I'd like to turn the call over to Michael Connors, who will be followed by David Berger.

Mike?.

Thank you, Barry, and good morning, everyone. Today, we will review our third quarter and September year-to-date results, brief you on our key operating and client highlights and reaffirm our full year forecast. We continue to make great progress establishing ISG as a significant digital technology partner to enterprises globally.

We just delivered our best quarter ever, with record revenues and record adjusted EBITDA. Let me review some of the key metrics. Q3 revenues were a record $68.3 million, up 30% and our adjusted EBITDA was a record $9.6 million, up 46%. We served 442 unique clients in the quarter, up 20% from a year ago.

ISG recurring revenues were $19 million during Q3, up 17% from last year. We now expect to exceed our $70 million target for the year, and we continue to target $100 million of recurring revenues within the next 3 years. ISG Digital Solutions continues to expand to meet growing client demand. It represents more than 35% of our revenue and climbing.

This business continues to have good growth potential in the near term, based both on our building pipeline and industry expansion. Among our ISG Digital Solutions for clients, we see especially strong demand for our Robotic Process Automation, or RPA services, and industry segments such as banking, insurance and retail.

Business today is going more digital. Every company, no matter how they started or where they are heading, is going to be a technology company. Technology decisions are no longer being left to the IT organization.

Increasingly, business leaders are deciding how to employ technology to develop new products and services, which workloads to move to the cloud, which business functions need to be automated, where and how to deploy the Internet of Things, how to leverage data analytics and cognitive computing, how to integrate the work of humans and bots, and how to improve collaboration in an increasingly decentralized operating environment.

Every business is going to be run based on data, analytics, cognitive intelligence and enhancing customer experience through technology. That's going to require new levels of innovation, design thinking, automation and complete transformation of business models.

In addition to enterprise buyers, service providers are struggling to meet these changing dynamics. They have relied for a long time on the labor arbitrage model, providing human labor at lower cost.

Now they must make investments in automation, cognitive computing and digital strategy, while they struggle with margin pressure in mid-single-digit growth. And the largest of them face competition from a whole host of nimble, niche technology players.

They also face challenges from the likes of Google and Amazon, who offer cloud computing capabilities that power SaaS and infrastructure-as-a-service platforms. ISG is in a unique position to help its clients, both buyers and sellers of technology services, reimagine their businesses in the digital age.

With our clients focused on all things digital, you can certainly understand why we were investing so heavily in our digital capabilities, especially in the area of RPA. Our RPA business has been a big growth driver for us. As you know, we entered this market with the acquisition of Alsbridge.

From what was essentially a start-up at the beginning of last year, we now expect to exceed our $15 million run rate target for RPA revenue this year. In addition, we expect to finish the year with more than 100 RPA clients.

I would note that valuations of automation services companies currently exceed 3x revenues, and we are seeing equity investments being made in these early-stage RPA services firms. At that valuation, by the middle of next year, our RPA business itself will be worth more than what we paid for all of Alsbridge last December.

You can see why we are so bullish about this business. Meanwhile, ISG Events, our homegrown P&L business, is helping us shine an industry spot light on digital transformation. Our ISG-produced events not only generate profitable revenue growth. They also help build our digital brand and drive new business leads for our advisory and research business.

Last quarter, we hosted an ISG Automation Summit in the U.K. and our first ever ISG Future Workplace Summit in Australia. At the U.K. Automation Summit in London, ISG made history when we state what is believed to be the first ever head-to-head administrative processing battle between a software bot and a human in front of a live audience.

More than 150 participants watched as an RPA bot took on an ISG adviser in a race to complete a laborious data-intensive process that involved verifying the VAT numbers of 400 companies.

In a clear demonstration of the power of automation, the bot completed all 400 checks in just 56 minutes and 7 seconds, by which time its human competitor had only managed to finish 77. The battle clearly highlights the potential of automation to make businesses more efficient and productive.

In August, we hosted the inaugural ISG Future Workplace Summit in Sydney, Australia to showcase new innovations impacting the digital workplaces such as mobility, digital labor and cloud-enabled collaboration platforms.

More recently in October, we held our 2017 ISG Sourcing Industry Conference, known as the premier annual event for service and technology providers in the United States.

More than 250 industry leaders gathered in Austin, Texas, including several enterprise clients, like Harley-Davidson, InterBank, Norfolk Southern and all of the major providers, like IBM, DXC, Cognizant, Automation Anywhere and others, to participate in our largest SIC event in our history.

We also recently launched 2 new products into the market that will serve us well as we move into 2018. The first product is ISG FutureSource, our next-generation sourcing solution for clients.

ISG FutureSource helps enterprises evaluate their business requirements, identify desired outcomes, fast-track the provider identification and selection process, collaborate with providers on developing the right solution, get to a signed contract and transition operations faster than ever before.

ISG FutureSource, which combines the best features of our legacy ISG and Alsbridge Solutions, will help solidify our industry-leading position in sourcing advisory, evidenced by the nearly $15 billion of sourcing contracts that will flow through ISG in 2017.

The second product we launched in Q3 is ISG Provider Lens, which provides valuable insights to enterprise buyers on the strengths, competitive differentiators and unique selling points of leading service providers serving the U.S. market.

These evaluations are used to streamline the provider selection process within ISG FutureSource, and creates a stronger link between our research and sourcing advisory services. The beauty of this product is you build it once, syndicate it and sell it many times, exactly the kind of recurring revenue streams we want.

As I mentioned at the outset, our Q3 revenues were a record $68.3 million, up 30% versus the prior year at constant currency. For only the second time in 12 quarters, our reported revenues benefited from a positive impact from currency, though the impact was small at $1 million.

As is customary for ISG, I'll focus on constant currency growth during this call. We had strong revenue growth in the Americas, up 42%; and in EMEA, up 15%; and Asia Pacific, up 12%. Through 9 months, revenues of over $200 million were up 26%. Q3 adjusted EBITDA of $9.6 million was at an all-time quarterly high and up 46% versus last year.

September year-to-date EBITDA of $24.6 million was up 45%. Our cash balance at quarter-end was $22 million, up 16% from the prior year. During the quarter, we took advantage of our excess cash position, and voluntarily decreased our debt by an additional $3 million for a total of $4.4 million in debt repayments in the quarter.

Now turning to our regions in the Americas. Our 42% growth in the third quarter was fueled by strong demand for Digital Services, including RPA, along with managed services, network services and our growing recurring revenue services, including research.

In our Industry segments, we saw especially good growth during the quarter in manufacturing, energy, technology, banking and insurance verticals. Key client engagements in the quarter included McDonald's; Hanon Systems, which is an automotive parts manufacturer; CNO Services, the insurance company; Marriott; and Aon Hewitt.

In a great example of our work last quarter, we were engaged by a brand-new CPG client to establish a new IT operating model, develop a business case for the best approach to source it, including the development of a captive, introduce market solution such as cloud and automation, support organizational change management or OCM for our client, and supply digital project management oversight as this work proceeds.

This engagement will span into 2018, and should produce more than $2 million in revenues. In another example, you can see that enterprises are looking at digital transformation everywhere. ISG Enterprise Print Services, a new service line that came with the Alsbridge acquisition, is gaining momentum with our cross-selling efforts.

It was recently awarded engagements with 2 of our financial industry clients.

The first engagement calls for ISG to migrate the client to a robust integrated communications platform for omni-channel delivery, including assessing internal print and mail operations and analyzing end-to-end communications workflow, including digital assets and platforms.

The second engagement will support the client's implementation of a new cloud-based platform for ordering print and e-form materials. Now turning to Europe. Revenues were up 15% in the quarter, led by double-digit growth in the DACH region, with especially strong growth in Germany.

Our strategy during Q4 of last year to maintain most of our resources in the U.K. despite the Brexit slowdown has proven to be a strong operating decision for us, as our U.K. business generated revenue growth in the quarter of more than 50% over the prior year.

In our industry segments in Europe, we saw good growth in our insurance, manufacturing, technology, banking and financial services verticals. Key client engagements in Europe in the quarter included Commerzbank, Lloyd's, Volkswagen, Yara International, which is a Norwegian chemical company, and Allianz.

ISG Europe was recently awarded 3 client agreements that total close to $50 million. This included a 5-year $10 million agreement with a large international bank. We will be providing benchmarking as a subscription for their global IT organization. We also signed a 2-year nearly $3 million agreement to provide digital services to the U.K.

government with the aim of driving service innovation and cost savings for the government and U.K. tax payers.

And we signed a more than $2 million engagement with a Danish IT service provider to restructure their current IT ecosystem and optimize the retained organization, including digital, cloud services, brokerage, as well as automation and robotics.

As an example of our automation work in Europe, ISG has been awarded a global RPA engagement with a leading global payment solutions provider. The contract calls for ISG to deploy software installation teams in the U.K.

and the U.S., launch the client's RPA center of excellence, provide training on digital software, and configure and deploy client automations. Moving to Asia-Pacific. Our third quarter revenues were up 12%. I just returned from a trip to Australia where I met with enterprise and government clients.

There are a number of early-stage digital transformations being considered in both the enterprise and federal government areas. I expect to see quite a few study and small assessment engagements over the next 2 quarters, with prospects that this area will open up in Australia for ISG, beginning in the second quarter of next year.

In our industry segments in this region, we saw good growth in some of our traditional service offerings in technology, banking, insurance, financial and public sector verticals. Key clients in this region included Qantas, Transport of New South Wales, the Australian Department of Health and Caltex Petroleum, an energy company.

In an example of a digital engagement in this region, we're working with a top pharmaceutical company on a number of activities, including helping them source for innovations for smart factories.

In our continuing drive for recurring revenues, we generated $19 million of these more predictable revenue streams in the third quarter, up 17% over last year. Year-to-date through September, recurring revenues were up 25%, driven by research, managed services and new subscription-type services, like benchmarking as a subscription.

As previously mentioned, we will exceed our $70 million recurring revenue target this year, up from about $60 million a year ago. Now turning to our full year guidance. We remain optimistic about 2017 and our ability to continue to advance our long-term strategy.

We are reaffirming our full year guidance, a revenue growth in the range of 25% to 34% or $270 million to $290 million; and our full year guidance for adjusted EBITDA growth of 60% to 75% or $32 million to $35 million.

We are increasingly confident in our outlook, based on the revenue momentum we experienced in the first 9 months, with revenues up 41% in the Americas and 10% in Europe, the growing demand for our digital services and the growth of our recurring revenue streams.

Naturally, in reaffirming our guidance, we remain cognizant of the potential impacts of broader macroeconomic conditions on our business. So, with that, let me turn the call over to David Berger who will summarize our financial results..

Thanks, Mike, and good morning, everyone. Third quarter revenues were $68.3 million, which compared with $51.9 million in the prior year, an increase of 30% in constant currency and 32% on a reported basis, currently positively impacted reported revenues by 2% or $1.1 million.

Revenues were $41.5 million in the Americas, up 42% from the same period in 2016; $19.7 million in Europe, up 15%; and $7.1 million in Asia Pacific, up 12%, with growth rates in constant currency. We reported operating income of $3.5 million for the third quarter of 2017 compared with operating income of $2.6 million last year.

Included in the third quarter 2017 operating income was a $500,000 reversal of a tax indemnity receivable associated with the Alsbridge acquisition, which was offset by a reduction in our tax provision. Net income for the 2017 third quarter was $1.4 million compared with net income of $800,000 in the third quarter last year.

Reported fully diluted earnings per share was up 50% to $0.03 compared with fully diluted earnings per share of $0.02 for the same period in 2016.

Adjusted net income for the third quarter was $4.7 million, up 55% or $0.10 per share on a fully diluted basis, compared with adjusted net income of $3 million or $0.08 per share on a fully diluted basis in the prior year's third quarter. Third quarter of adjusted EBITDA was $9.6 million compared with $6.6 million last year, an increase of 46%.

Utilization for the quarter was approximately 64%, up 200 basis points versus the prior year, seasonally impacted by vacation timing of our clients in Europe and the hurricanes in the U.S. Quarter end headcount was 1,252, with significant increases in digital service employees, offset by reductions as part of our integration initiatives.

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 9 months was $3.3 million. Through September, we invested $2.3 million in capital expenditures and repurchased $2.9 million in shares.

On the balance sheet, we ended the quarter with $22.2 million in cash and total debt outstanding of $118.1 million after paying down $4.4 million during the quarter, including a voluntary repayment of $3 million due to our cash position.

Our average borrowing rate for the quarter was 4.75%, and we have 43.4 million shares outstanding as of October 27. Mike will now share concluding remarks before we go to Q&A..

Thank you, David. Now to summarize. We had our best quarter ever, record-setting revenues and adjusted EBITDA. We had 42% growth in our largest region, the Americas, and in Europe, we had 50%-plus growth in the U.K. Brexit clearly is behind us.

Our EBITDA margin was 14%, and we are on track to increase our EBITDA margin by nearly 300 basis points for the year. We continue to pivot and focus the firm on all things digital for clients, with digital services revenue accounting for more than 35% of our total.

Our cash balance is strong at $22 million, after a $3 million additional repayment of debt in the quarter. And the integration of Alsbridge and ISG was completed with the launch of ISG FutureSource, our new sourcing solution.

We have now met our synergy target of $7 million, which we are flowing through our P&L, and using to fund our growth initiatives, especially in digital, while delivering a step change in our 2017 financials. As always, we are focused on creating shareholder value for the long term.

I am optimistic about our prospects for 2018 and our ability to progress our long-term strategy. Thanks very much for calling in this morning, and now let me turn the session over to the operator for your questions..

[Operator Instructions]. And we'll go first to Vincent Colicchio with Barrington Research..

A couple of questions for you.

The digital and RPA work, can you talk about the margins on that versus the typical margins of the company?.

So, the Digital Solutions is somewhat firm-wide kind of margins, with the exception that we also have subscription revenue with our software.

So, when we're doing our robotics work with our clients, and we're also selling them software from places like Automation Anywhere or Blue Prison, for example, we also received a percentage of that software subscription in years 1, 2, and 3, depending on the number of years that they have.

That margin is upwards of 30% of EBITDA margin on the software. So, when we're doing both the advisory and providing subscription revenue, the margins are higher..

And then you're doing quite well in the recurring revenue side. I know you have some opportunities to build out subscription-type services with Alsbridge.

Have you fully built that out yet or is there more to come?.

Yes. So Alsbridge really brought very little recurring revenue with them. But what we've done is we have expanded our offerings in recurring revenue, such as the example I gave with the large bank in Europe where we get signed a 5-year $10 million contract, roughly $2 million a year, for what we call benchmarking-as-a-subscription.

So, we have expanded that. We've created some additional software that we had acquired from Alsbridge, and turning it into subscription-based revenue around certain pricing and data analytics. So that's why you're seeing the increase of the recurring revenue. We targeted $70 million for the year, you'll recall, up from around $60 million.

And we are now on a run rate that we would exceed that number by end of the year..

One more for me.

Are you gaining wallet share at clients that - where you had no overlap with Alsbridge?.

Yes. So, the cross selling efforts, I tried to give a couple of examples, even I would say that on the digital arena, I use the print example, when you think of kind of print negotiations, you wouldn't necessarily think digital, but everybody is moving digital. So, we are cross-selling our network. We're cross-selling our digital.

We're cross-selling our print. Everything we have, we are now penetrating into the client base that we have, and I think you're seeing that with the results..

So, would it be fair to say it's meeting your expectations?.

I think it's exceeding our expectations at this stage..

We'll go next to Allen Klee with Sidoti & Company..

For the Events business, can you give us a sense of the size there, profitability and the growth potential?.

Yes. Allen, as you know, we announced that we were launching an ISG Events business last year. We brought in a fantastic executive from the outside who was one of the original founders of developing the events business at Gartner, and she has done a terrific job for us.

You can see by some of the events that we are doing, we're tying it into kind of all things digital, if you will, around the world.

We don't give out the exact revenue level, but let's suffice it to say that we think this can be a 0 to $10 million revenue business for us over a 3-year period of time, and that the margins in the Event business is well north of 50% gross margin..

Okay.

Any comments on how you feel about your ability to recruit, retain good people and thoughts on goals of growing your consultants?.

Yes. So, Allen, we think is a terrific model for both recruiting and retention. Our model, as I think you know, is one where we allow people to essentially live wherever they like. And because they're on the road with our clients most of the time, that is a big attraction for our folks. We don't have them check in to an office.

We have a terrific knowledge management system built globally that connects everyone in our firm anywhere in the world at any time. Our recruiting capabilities, we think, are very strong. Our pipeline is strong. We have demand for our jobs.

Despite the unemployment rate moving where it is, we feel very good about our ability to attract and certainly, our retention rates here are among the lowest in the industry. And we factor the reason for that around our business model and around the kind of work that we have doing with our plans..

Okay, great. Previously, you've mentioned that there's some timing issues on recognizing Alsbridge revenue as the projects get completed.

How do you feel about that being on track?.

I'm sorry. I missed the end of your question..

It might have been a quarter or 2 ago, there was some timing issue of recognizing some of the revenues related to Alsbridge that would come later in the year.

Do you feel comfortable that that's on track?.

Yes. Alsbridge revenue is definitely on track, as Mike indicated. We had strong RPA revenue during the quarter. As we discussed, at the end of the year, there will be a transition amount that will be recorded directly to the balance sheet. But as far as the timing, there was no issue as a result of that revenue recognition..

Thank you.

My last question is the network services business that you picked up with Alsbridge, can you tell me quantitatively how that's going?.

Yes. The network business, it's really two parts. If you think about the network carriers out there, the AT&T, the Deutsche Telekoms, et cetera, that's one piece of the business. The second piece is what we call digital platforms and software, DP&S.

And that's where people have the Microsoft and the Salesforce.com licenses, et cetera, and we help them understand, negotiate, manage those assets. So, both of those are doing well for us. We're cross-selling into our client base. We should have more than $2 billion network carrier contract value come through our shop this year.

So, it's significant in the market. We are the key player in the market in this space, and we feel very good about that and the software side of that business. It is fully integrated, so you know. Our entire businesses is fully integrated, so there is no Alsbridge. We have combined our network employees with the legacy Alsbridge employees.

We go-to-market as ISG, etcetera. So, we are known in the market as ISG, Allen..

We'll go next to Sarkis Sherbetchyan with B. Riley and Co..

Just with regards to the gross margins for the quarter, obviously, stronger both sequentially and year-over-year.

What was the delta attributable to? And is this sustainable kind of on a go forward basis? Can you maybe give some thoughts around that?.

Yes. I mean, the gross margin for the quarter was impacted by the mix of business. It was a strong mix. It'd be slightly higher than other quarters due to that mix. But with Alsbridge, we did pick up some contingency-based business.

So, in a quarter where you're booking the contingency revenue, you get a high drop through impacting the margin for the quarter..

Understood.

And if we were to kind of think about Q4 here, is some of that contingency-based business going to kind of creep into Q4, and does have similar margin profiles? Or would it kind of be at your historical rate?.

I mean, it will be above the historical rate, but not at the level of September, I mean, the third quarter..

Got it. And then I think, last quarter, you specifically called out about $1 million in incremental digital services investment spend.

Are you engaged in any incremental digital services investments in kind of in this quarter and/or inside of Q4 that we should be aware of, which perhaps elevates the SG&A rate?.

Well, we continue to invest to increase the headcount. The difference between the second quarter and the third quarter is the increase in revenues in that space more than covered the investment. So last quarter, the $1 million impacted the bottom line. This quarter, the additional revenue growth more than offset the additional investment.

So, the investment is starting to pay off..

Got it. That's very helpful. And then you kind of talked about the RPA solutions exceeding a $15 million run rate target. Can you maybe give a flavor of what the growth profile looks like for that business, maybe on a go forward basis? Just kind of help us understand what that could mean for fiscal '18..

Yes. So Sarkis, we're still working through our plan. The best way I would describe this is that we are pouring gas onto our RPA business into the business. We think this business has a significant growth trajectory and profile. We're not prepared yet to kind of go through the specifics, but the growth rate is significant.

I would put it well above 25% a year. But in terms of exactly, we haven't gone public with that. But I think that is why I decided to kind of communicate what we are seeing in the market and the value of these kind of RPA service businesses, and why they are so hot and why they're so valuable is because of the growth trajectory.

So, as I mentioned, before, when we acquired Alsbridge, RPA was still in its very early stage of start-up phase. We've got terrific leadership in that group. We've decided to pour gas on that. We've decided to put more investment in that.

You pivot where the market goes, and we have been very successful as a firm to follow the market, follow the puck, if you will, and this is certainly a very strong market.

And importantly, the reputation of ISG's history has allowed us to go into some very large blue-chip companies and actually create some proof of concepts around robotics that have been very successful. And we envision that occurring further next year. And put it into perspective, we have 100 RPA clients in 2017, and ISG had 0 a year ago.

So, there is something here, clearly, that clients want and want more of..

I certainly appreciate that color.

And just to be clear, that run rate you spoke of for the RPA revenues, that is not included in the $19 million in recurring revenue you've kind of targeted, right?.

Only the software subscriptions that's recurring is included..

And is that a material chunk of that business or not?.

It's roughly 20%. So roughly, our RPA business is roughly 80%. Service is 20% subscription, roughly..

[Operator Instructions]. We'll go next to Marco Rodriguez of Stonegate Capital Markets..

I was wondering if maybe you could talk a little bit more about RPA. Obviously, doing very well for you guys.

Maybe you can talk about the kind of competitive landscape out there, maybe who the other entities that you see the most of? And then if you could perhaps talk about your competitive differentiations there?.

Okay, good. Look, the RPA market is growing rapidly. I think we've said it was a couple of hundred million dollar market drawing to $1 billion plus, come 2020. So, this is a very early stage market, if you will. Our competition out in the marketplace are typically the big 4.

There are some very small upstart RPA services companies that are popping up around the world. The sandbox, frankly, is quite big, so there's room for plenty of players. But our differentiation is our reputation and the trusted advisor status that we have with 700-plus clients. They know ISG. They know our reputation. They know our ROI.

They know our people. They know what we stand for and buy. And so, our differentiation is going to the trusted people that have been clients of ours for a lot of years because of repeat clients year after year. And that is our competitive advantage going into our client base. So, they start with trust. They start with an ROI history with ISG.

So, when we talk to them about robotics and how we can help their business in terms of cost, in terms of speed, in terms of freeing up people to move on to more value-added services, there is a large listening group in that particular area.

So, we believe our differentiation is the trusted advisor status and the fact that we were very early to this market.

We establish this ourselves, and we must be one of the fastest-growing components of this industry with the start-up phase that Alsbridge had 1 year ago, and the fuel that we put on top of this, starting in January, puts us in a very strong position..

Got you, very helpful.

And are there any other like special skill sets that the consultants might need to kind of push themselves into the RPA-type business? Or is it pretty self-explanatory, if you will? And then just also kind of wondering if there's any sort of industry or vertical expertise that the consultant might need when selling the RPA services?.

So, the additional skill sets, first, is we do train them in the software that is available in the market, places like Blue Prism, Automation Anywhere and others. So, we do train all of our people in our RPA. We get them, if you will, ISG-certified around software, so they do need to understand that. The industry vertical expertise, we have that.

We are in 21 different distinct verticals, so we have good knowledge of the industry, good knowledge of the verticals, so we have that going in.

And then we educate up and scale up our teams of people around the software and how you can actually take a set of business rules, and convert them into training the bot to do what the human can do, and convert human labor into digital labor. So that's how we go about our work.

So, and then we kind of wrap it around organizational change management for our clients. OCM is a key part because there's a lot of disruption that occurs, clearly, with automation. So, the OCM and the acquisition we did with TracePoint about 1.5 years ago that we've now converted into our OCM global practice is also growing very rapidly for us..

Got you. And one quick follow-up on the prior question on gross margins and the impact you saw there. Just want to make sure I'm understanding. Obviously, you guys are trying to do a bit more of the software recurring revenue aspects to your services.

So, it kind of sounds like, perhaps, when we're looking out and thinking fiscal '18, '19 and beyond that, that gross margin should probably start to go a little bit higher versus where your historical numbers have been at the low 40%? Am I understanding that correctly?.

Yes, that's correct. I mean, it will still be in the low 40%, but it was 40%. Now it will step up from there..

We'll go next to Mark Jordan with NOBLE Capital Markets..

First question about the European business in the quarter. It showed a seasonal downtick from the second quarter going from $21.5 million to $19.7 million. Obviously, the vacation season has an impact.

Could you quantify if you were to normalize sort of the vacation cycle, would that revenues for the third quarter be in the range of $2 million to $3 million higher than the $19.7 million reported or what would be sort of a normalized number there, if you could normalize vacations?.

Well, I mean, last year, in prior quarters, we always experienced a few million dollar tick down. We're at the mercy of our clients. Our client, particularly, like in France, in August, it's pretty quiet, and our clients asked us not to show up on the site. So, I mean, the growth for this quarter was significant.

That was driven by new business, by the slowdown that we saw in the past that impact the decision-making because of Brexit appears to be behind us. But we're going to continue in future years to have that few million dollar drop off quarter-to-quarter as a result of the seasonality in Europe..

The order of magnitude would be $2 million to $3 million for the quarter once it normalizes?.

Yes..

Back to the RPA discussion. You said about $15 million run rate. 100 clients, if you divide $15 million by 100, you get $150,000 per client average.

Is that the actual ballpark number? And the second related question is, over time, do you see the revenue base of each client growing and how much upside do you think you could get it by year 2, 3 from that current base of 100 clients?.

Yes. Mark, good question. First of all, you do the math right. But keep in mind that that's early stage engagement fees. So, we have some clients that start January 1. You have clients start in July. You have clients start in September. So, they are a client once you start them, but they maybe early stage in terms of the fees.

So, we would not expect it to be "only $150,000 per client". So, keep that in mind.

What was the second part of your question?.

How can the typical client, if you're with them, what might be a reasonable expectation for revenue growth at that client, say, year 2, year 3 versus the first full year?.

Okay. So, we're in year 1. So, it's hard to tell because we don't have any history with this, frankly, out in the market. But historically, what we have seen with our client base is that our clients continue to be continuous clients year-after-year, about 80% of our clients every year are buying services from us the next year.

So, we would anticipate that a number of our RPA clients this year would be our clients next year. Why is that? Because you tend to start with 1 process or 2 processes in a certain area. I might do both claims, processing and insurance company to start off and then I might move to the flood claims areas, and I might move into other areas.

So, the way you build on this is to build on the processes that you are going to automate. You start small, and you tend to build from there. Great example is we have a very large bank in New York City that started very small. Once you get proof of concept, you see that it works, then you get more confident. You add another process and another process.

So that's how the business, if you will, like a Pac-Man kind of eats up additional opportunities in a client. But we're literally in year 1 here. So, our history, there is none. But historically, that's how it's worked and that's what we're seeing in the early days..

Good. Final question for me. You were awarded some contracts last quarter with the U.K. DoD government.

How are those contracts ramping?.

Yes. So, we got a contract with the Ministry of Defence. And I would see it ramping up as we move into 2018. The MoD one really starts, I guess, now. We had another contract to had run out with a consortium, and we would see that ramp-up would be somewhat linear, I would say, in terms of its revenue flow..

Okay.

And this was government?.

And the Swiss would be, I would say similar.

David, you agree?.

Yes. It's about similar, Mark..

And it looks like there are no further questions in queue. I'd like to turn it back over to today's presenters for any additional or closing remarks..

Well, let me just close by saying thank you to our almost 1,300 professionals around the world. It is their ability to help our clients achieve operational excellence and faster growth, especially through our digital transformation efforts that continues to be the reason for our strong performance and step change in our financials this year.

And let me thank all of you on the call for your continued support and confidence in our firm. Thanks for joining us, and have a great day..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect..