Good day, and welcome to the Information Services Group 2018 Second Quarter Investor 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..

Thank you, operator. Hello, and good morning. My name is Barry Holt. I'm a Senior Communications Executive at ISG. I'd like to welcome everyone to ISG's Second Quarter Conference Call. I'm joined today by Michael Connors, Chairman and Chief Executive Officer; and David Berger, Executive Vice President and Chief Financial Officer.

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

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

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

You should also read ISG's annual report on Form 10-K for the fiscal year ending December 31, 2017, and any other relevant documents, including any amendments or supplements to these documents filed with the SEC.

You will be able to obtain free copies of any of ISG's SEC filings on either ISG's website at www.isg-one.com or the SEC's website at www.sec.gov. ISG undertakes no obligation to update or revise any forward-looking statement to reflect subsequent events or circumstances.

During this call, we will discuss certain non-GAAP financial measures, which ISG believes improves the comparability of the company's financial results between periods and provides for greater transparency of key measures used to evaluate the company's performance.

The non-GAAP measures which we will touch 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 this morning with the SEC. And now I'd like to turn the call over to Michael Connors, who will be followed by David Berger.

Mike?.

Thank you, Barry, and good morning, everyone. Today, we will review our record second quarter revenues and EBITDA, the highest levels ever achieved in any quarter by ISG. We'll brief you on our key operating and client highlights and reaffirm our full year guidance for revenues and adjusted EBITDA.

First as an overall comment, our strategy of go digital and building recurring revenue streams is working.

Together our expanded digital capabilities, growing recurring revenue services and disciplined management approach are delivering record-setting results, and we remain well positioned to continue driving profitable growth and delivering value for our clients and shareholders. Let me take a moment to review our progress.

We reported our largest-revenue quarter ever at $71 million. Our revenue would have been even higher, up 7% if not for the soft US public sector market. ISG Digital Services, including Robotic Process Automation, or RPA, generated more than 40% of our revenue in the quarter and for the first half represented over $55 million of ISG revenues.

Recurring revenues were at $18 million in Q2, and for the first half recurring revenues were $41 million. Our record revenue for the quarter and the mix of that revenue drove record quarterly EBITDA of $9.8 million, up 23% and our EBITDA margins for the quarter increased to 14%.

Network services bounced back nicely in Q2 and our managed services business secured three significant multiyear, multimillion dollar contracts with total contract value of more than $10.5 million.

This would be offset slightly by the loss in 2019 of a transportation client contract in Australia worth about $2 million since that client is moving much of its managed services back in-house next year. Globally we saw especially strong demand in the financial services, manufacturing and insurance verticals that helped drive growth for the quarter.

During the quarter, we served 418 clients, including 39 that were new to ISG. Members of our management team and I recently returned from visiting our business partner, Plug and Play, the world’s largest technology innovation accelerator platform.

During our visit to Silicon Valley, we were introduced to several of their incubator firms in areas like HR tech, insure tech, consumer tech and other areas. We believe ISG with our strong industry voice will help bring the best of these technologies to the commercial market with our clients.

Our business mix, being reshaped in part by demand for our digital services, including automation, continues to grow in value.

We are seeing strong market valuations in the M&A area for automation services and in automation software, such as the $1.8 billion valuation automation anywhere received during the quarter, which is one of our automation software vendors recently received with a $250 million Series A investment, and the [30 times] trailing revenue valuation of publicly traded Blue Prism, another of our software vendors equating to an enterprise value of over $1 billion.

Our RPA, or automation services, remain strong as reflected in our run rate revenues having increased from $50 million last year to $20 million early this year to now a new projected $25 million run rate in 2018.

In comparison with other RPA services and software players it certainly appears the valuation of our RPA business is not being fully recognized in ISG’s share price. Recently we hosted a sold out ISG automation summit event in New York. As we discussed at the event, many companies have accomplished [Bot 1.0].

They have assessed the need for and implemented their first wave of [Bots] and their initial investments are paying off. To become truly digital companies enterprises today will need to get to [Bot 3.0] and that is where the future value lies for ISG.

For a company to scale up its automation program it needs a high-level, multiyear plan for selecting, rolling out, configuring, deploying and maintaining the right automation technologies.

Companies need a digital platform with a framework that allows them to scale and coordinate automation initiatives across their enterprise and that is where we come in. ISG is uniquely positioned to help our enterprise clients turn automation vision into reality. Now turning to our regions.

In the Americas, revenues were $41 million, that is up 2%, with continued strong demand for digital services, as well as network managed services and research. Our commercial Americas sector remained strong. Excluding the public sector, our Americas revenues were up 7% in the quarter.

As I mentioned last quarter, the US public sector market remained sluggish with the lack of enterprise-wide transformation engagements across states and will soften overall Americas reported revenue growth in the near-term.

We saw good growth during the quarter in the Americas at our manufacturing, energy, life sciences, healthcare and insurance verticals. Key client engagements in the quarter included John Hancock life insurance company, [indiscernible] Archer-Daniels-Midland, Southwest Gas and Stryker. Turning to a few of our notable client wins in the Americas.

We won a significant global engagement to design and implement a future IT agile operating model and sourcing strategy for a global auto manufacturer. Our global presence, strategy and design expertise and the value of our ISG future source solution launched last year were all major factors in winning this business.

ISG also won an IT digital sourcing engagement with an entire new client, a large US-based food and beverage company. ISG will support the rationalization of this client’s provider relationships while positioning the company to take advantage of modernized technology solutions, including digital and cloud.

For another new client, an internationally known clothing company, we will develop a comprehensive shared services and digital strategy, including HR, Finance, accounting, organizational change management or OCM, and RPA services.

And finally ISG has been awarded an infrastructure strategy and sourcing engagement with a large multistate utility company. The project will include a refreshed IT strategy and operating model design based on enterprise agility, again using our ISG future source approach and methodology.

We also recently expanded our HR tech US ecosystem by forming a partnership with Ultimate Software, a major provider of human capital management, SaaS solutions. Like our earlier announced partnership with Workday, this alliance gives us access to their client base for OCM and HR transformation work.

It will also give us a deep background in Ultimate Software’s capabilities so we can better advice our clients on the range of solutions available to them in the marketplace.

Turning to Europe, we reported our highest quarterly revenues in Europe, of $24 million, up 12% led by 23% growth in the UK, driven by our digital services and 39% growth in the Nordics. The UK continues to be a bright spot in Europe.

You will remember that at the end of 2016 we made the decision to bite the bullet, take some cost, but retain our team there and we believe we have weathered the Brexit storm. That decision has paid off with a strong business rebound.

With our full team in place, ready and able to serve the growing client demand for digital transformation and automation services we have now proved four consecutive quarters of significant double-digit revenue growth in the UK. Overall, we saw good growth during the second quarter in our insurance, technology, travel and retail verticals.

Key client engagements in Europe in the second quarter included Allianz, BASF, [Fresenius], KMD, which is a technology solutions provider to the Danish government, BNP Paribas, and BMW.

Among our significant wins during the quarter we won a large HR tech engagement with a European-based national transportation group, supporting a major transformation for 90,000 employees. Shifting to Asia Pacific, although our second quarter revenues were down slightly we saw good growth in Australia.

This performance offset a decline in Asia due to the completion of a large engagement last year. We saw good growth in this region from our banking, insurance and manufacturing verticals. Key clients in this region included Airservices Australia, Westpac, Insurance Australia Group, or IAG, and Telstra.

Now turning to our guidance, we are confident we will achieve our full year revenue and adjusted EBITDA guidance based on continued demand for our digital services growth and recurring revenues and promising market dynamics in the commercial markets of the Americas and Europe. We remain on track to what we believe will be another record year for ISG.

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

Thanks, Mike, and good morning, everyone. Second quarter revenues were $71 million. This compared with $68 million in the prior year, an increase of 4% on a reported basis and an increase of 2% in constant currency. Currency positively impacted reported revenues by 2% or $1.6 million.

Revenues were $24 million in Europe, up 12% from the same period in 2017; $40.8 million in the Americas, up 2%; and $6.1 million in Asia Pacific, down $400,000 from the prior year. Second quarter 2018 adjusted EBITDA was $9.8 million versus $8 million in the prior year, up 23%.

We reported second quarter operating income of $4.2 million, which was up almost 8 times, versus operating income of $500,000 in the second quarter of 2017. Our net income for the quarter was $2.4 million, compared with net loss of $300,000 in the prior year.

Our reported fully diluted earnings per share were $0.05 compared with fully diluted loss per share of $0.01 for the same period in 2017.

Adjusted net income for the second quarter was $5.7 million or $0.12 per share on a diluted basis, which was up over 60% compared with adjusted net income of $3.5 million or $0.08 per share on a diluted basis in the prior year's second quarter. Utilization for the quarter was approximately 68%.

Quarter-end headcount was 1,371 versus 1,324 in March, with the addition primarily to support growth in managed services and digital solutions. Our balance sheet continues to have the strength and flexibility to support our business over the long term. Net cash provided by operations for the first half was $7.1 million versus $1.7 million last year.

During the first half, we invested $3.4 million in capital expenditures, we repaid $6.5 million in debt, repurchased $2.5 million in shares and paid $1.2 million in contingency consideration associated with prior acquisitions. On the balance sheet, we ended the quarter with $19.4 million in cash, and $110.2 million of debt.

Our average borrowing rate for the quarter was 5.3%, and we had 45.1 million shares outstanding as of July 27. Mike will now share our concluding remarks before we go to Q&A..

Thank you, David. Overall, we are pleased with our operating momentum as we complete the first half, and remain optimistic about the full year. To summarize, in Q2 we delivered our highest revenue in EBITDA ever in any quarter for ISG with revenues of $71 million and EBITDA of almost $10 million.

That translated into an EBITDA margin of 14%, one of our best quarters ever. Digital services continues to be a strong growth engine representing over 40% of our revenue for the quarter. Our first half recurring revenues reached $41 million on our way to our three-year target of $100 million.

We generated $7.1 million in cash versus $1.7 million at this time last year, and we repaid $6.5 million in debt in the first half. And we have reaffirmed our full year guidance for revenues and adjusted EBITDA.

As always, we are focused on creating shareholder value for the long term and are steadfast in our mission to deliver operational excellence to our clients.

Overall, our foundation is solid, recurring revenues, digital, including automation services, a Who's Who list of blue-chip clients and a talented global team of 1,300 professionals on the ground in the middle of the digital revolution. Thanks very much for calling in this morning. And now let me turn this session over to the operator for questions..

[Operator Instructions] We'll take our first question from Vincent Colicchio from Barrington Research. Please go ahead..

Good morning Mike. Nice quarter..

Good morning Vince..

So on the US public sector side, will this weakness continue over the balance of the year? It sounds like it will from your comment, and what specifically is causing it? Can you give us more color?.

Yes, the public sector as I mentioned last quarter, is primarily driven by – it is all RPFs for the most part and the number of enterprise solutions being requested among the states is very, very soft. So these things kind of go in spurts and it has been quite soft during the first half of the year.

We don't see anything that shows that it is going to be dramatically different during the second half of the year, so we are managing [indiscernible] soft.

It is possible that it could pick up and, of course, that would help our overall reported growth rate, but you also keep in mind that we mentioned last year that West Virginia, which is a state that we had for seven years ended its run with us during the I think it was first part of April of last year.

So that is not continuing and that was roughly $4 million a year. So, all of those combined kind of leads us to what we see as the sluggishness Vince..

Okay, and then you had a nice few wins in managed services. Were those tied to network engagements? I know you had some network engagements delayed last quarter..

Yes. So, two different points. One is on the network. We did not have some completed network. We completed many of them in Q2. A few still are in Q3 as we mentioned in Q1, it would be Q2 and Q3 and that in fact did happen. So network flowed through as we thought it would and on managed services these are these multiyear, multimillion dollar agreements.

We have got three very, very large brand names in the market that we were able to secure and we will begin the revenue in those beginning in the third quarter of this year..

And then I mentioned the [percent] contribution from [digital] recurring in the quarter could you just repeat that please?.

Yes over 40%..

On the digital, right?.

Correct..

And the recurring?.

Revenue was 18 recurring was 18 million for the quarter 41 for the first half and that would compare first half last year reported of what David roughly..

The first half last year was 37 million..

Thanks guys. Next year..

Yes thank you..

We will take our next question from Sarkis Sherbetchyan from B. Riley & Company. Please go ahead..

Good morning and thanks for taking the question here..

Good morning Sarkis..

So obviously for 2Q it looks like you guys posted a pretty nice EBITDA margin percentage near 14%.

As we look to the back half of the year do you think that bad performance continues or would there be something from a lever either to the upside or downside that we should be thinking about?.

Well, for the full year we haven't changed our revenue guidance -- our revenue and EBITDA the guidance. We use that as a proxy for what we're looking at for the second half. Obviously in the first quarter our margins are usually below the year average. So from a full year we've given our full-year guidance..

Understood and I think you mentioned some of the network services work pulling third to 3Q and expect some additional it sounds like for 3Q and I believe those are a little bit more higher margin in nature.

So can you maybe comment on what you expect for that margin flow-through to materialize for the 3Q period?.

Well, this is Mike, Sarkis.

Let me maybe answer it this way our mean we have certain higher-margin network is higher recurring is higher and of course it depends on the total mix in any given quarter for the margin, but I would -- I think we're at 9% in Q1 14% with Q2, 14% is I think if you go back in our history we've only had a couple of quarters that look like that.

So it was a very good mix. We'll continuing to drive the mix but of course it has to be what the client's needs are in order to drive our solutions they're. So hard to forecast it but we feel very good about our network business for the balance of the year..

Got it. Thanks. One more for me with respect to the dollar index I mean obviously it's arising here more recently.

Do you expect that to either contribute positively or negatively as you are kind of looking towards the back up of the year?.

Yes. It has much less of an effect in the second half of the year; particularly in the third quarter it's going to probably have no impact on the reported versus the reported in the third quarter..

Thank you. That's all for me..

Thanks Sarkis..

We will now move to Marco Rodriguez from Stonegate Capital Markets..

Good morning guys, thank you for taking my questions..

Good morning Marco..

I was wondering if we maybe talk a little bit about Asia and kind of the drivers there. It's been some time since we've seen some decent year-over-year growth. I mean last year is pretty much flat and the first half of this year is kind of flat.

Can you just talk a little bit about what's kind of going on there? What sort of strategies might be in place to try and accelerate some growth or if it's just an end market macroeconomic issue that you guys really can't control?.

Well, first of all Australia actually had a very good quarter. I don't think we broke it out but it was somewhere around 7% or 8% growth in Australia.

Asia was down with a very large engagement last year in Asia that did not repeat this year, so that put a damper if you will on the overall region reported results I think it was down 400,000 or something all driven by Asia.

So outside of ANZ, AZ still had a very good first half second quarter I think with 7% or 8% on the revenue line primarily all around the commercial sector.

The federal government there we do work for both the federal government in Canberra and state governments in Australia and if the federal government isn't spending which it's kind of soft at the moment then it does hold back our overall growth rate because it's such a large chunk of that overall marketplace in Australia so that's all it is but I will say that Australia did have a very, very good quarter at 7% or 8% top-line growth for Q2, but I don't see back half of the year.

We don't see that government but I don't see back half of the year we don't see that government movement at least nothing that we can indicate to us that that's going to shake out much for growth rates for that region for the back half but we factor that in..

Perfect. And they're kind of circling back on the U.S. public sector market the state and local governments kind of being soft with their spend there.

I know I heard your comments last quarter and you repeated here and out of your expectation for the second half just kind of remain I guess kind of soft nothing really seeing; you're not really seeing much out there that's going to change that.

Is there a particular point in time on the calendar year where things will start to break or there's the potential to break where you could see increase in the spending there for the public sector?.

Well, I mean there is nothing we know what contracts are coming up but we also know that the government's are very strained if you will in terms of revenue that usually drives the spending yet to spend in order to save, I will say the republican-controlled states tend to move faster than the democratic-controlled states.

So if you think about that we have our eyes on all of those. We do have one state in particular that is not ready to be announced but we think there may be something coming that we can announce in Q3 that could help generate but keep in mind that West Virginia ran out on us.

So the year-over-year for 2018 is difficult as well but we have a couple of states that we're actively involved in right now that could turn and so we'll certainly report that in Q3 but that's kind of the state of the business at the moment.

So we're factoring that in and FYI the overall if you will report it but we're very-very bullish on the commercial markets and we like the public sector because it's good margin. It's recurring when you get it because they're multi-year agreements but we have to be patient with that particular market..

Got it. And last quick question here just kind of on the digital advisory services obviously done very well for you guys and it sounds like is it exceptionally well in Europe here this quarter.

Maybe if you can kind of compare/contrast the demand for digital advisory services by region kind of what are the sort of the main applications people are looking for in each region..

Sure, I would say that first the U.S.

is ahead of Europe and Europe is dramatically ahead of Asia-Pacific just in terms of the parts of the world but the services range from everything from moving more and more workloads to the cloud, moving more to mobility and the use of artificial intelligence, cognitive robotics process automation; most industry segments in the U.S.

have begun that process. In Europe we see all of that but I would say in Europe they're much, I would call it bigger bangs and three specific examples come to mind. One is around autonomous cars. We are involved in a number of autonomous driving we call it AD our AD practice with a number of automotive suppliers.

They are focusing around that in the automotive industry.

We have areas like elevators that are moving to smart elevators so we have the two largest elevator companies in the world that we're working with and also from a banking or financial services standpoint we're working with banks on the digitization of those banks and in one case with a very large Nordics Bank we're helping them create what they're calling a digital bank.

So in Europe I would say there's more of the Big Bang Theory approach on some of the digitization and the U.S. it's kind of the bread and the butter how do you automate our basic services, shared services, HR, finance, accounting, payables, receivables, IT shared services because the ROI on that is quite high and quite tremendous.

So those are the engagements. I think I also gave a few examples during my prepared remarks on some very specific examples with clients, with food industry, etc. But that's maybe how I would contrast those two regions. And then in Asia-Pacific much-much further behind in that regard very slow I would say to adapt..

Got it. Thanks a lot. I appreciate your time..

Thanks Marco..

We will take our next question from Ben Klieve from Noble Capital Markets. Please go ahead..

All right. Thank you. Few questions this morning on RPA growth and kind of what makes up various parts of this.

So curious as you seen the run rate growth from 15 to 20, [now 25] million; can you break that experience down between brand-new engagements with customers versus those who are kind of earlier adopters who are expanding the scope of the technology..

Ben, I do not have that breakdown but I think the way I would look at it is our ratio is roughly 85% existing clients, 15% new, it's probably a bit higher on the automation clients. So maybe 80/20 would be a good gauge for you to consider but the clients on the RPA so these are existing ISG clients.

As it relates to automation though a lot of those clients are automating for the first time. They're getting through what we call Bot 1.0, they're testing proof of concept oh wow this process can work.

I can actually automate my claims in certain areas or I can automate my mortgage processing area or what have you and now they're moving into a Bot 20.30 if you will and so each of them will evolve we think over the next few years. I don't know if that helps but that's the gauge. We don't really break it down precisely to say it's a client.

We've never had but about 85% of our clients are testing the digital arena as we speak..

Got you. And that is helpful. I was more curious not necessarily on their brand new clients to you but if they were -- if this was their first sticking their toe in the water to RPA technology versus universal expansion of services that they've already had in the RPA world..

Yes, I would estimate that, I don't have that precise number but I would estimate that to be at least kind of three quarters, their first four on a quarter that are now advancing to stage two..

Got it and then as you look at the evolution from 1.0 to 2.0 and then 3.0 can you talk about how the scale of the investment in the margin structure would work for you?.

So for us the licensing where we generate about, our recurring revenue where we generate about $0.30 on the dollar on those license agreements clearly as more Bots and licenses get embedded and installed that will increase the recurring and that will increase the depending on how fast others adopt, it may increase the mix between our services and our software.

Today I think it runs somewhere around 80:20, 80% services, 20% licensing last year was more like 85:15, I think over time the mix gets stronger. Of course it depends on how fast the services grow.

So I want to be careful that I think the mix would be what it is because if services grow faster for new entries then you won't have the mix I just described but as you mature if you will same store sales, if you want to look at it that way you're definitely going to have a mix that's closer to 75:25 or possibly 70:30 on services and software.

So that will increase over time..

Got it. That's perfect.

And then last kind of general question here on results from the RPA side and particularly aligns with Grant Thornton kind of comment on the value being realized from that relationship to date and then also if there's any kind of milestones you're looking for in the kind of second half of the year from that engagement that we can look forward though..

So that's been we love Grant Thornton because they have all kind of the [roughly] 2000 channel. We're not breaking that out as part of our agreement with Grant Thornton but it is one of several channels that we are using for our robotics process automation. So we're not just banking on Grant Thornton.

I would say it has not had any material impact on our growth if I could say it that way I think all of our total channels, the ISG channels using our partners our own partners as well as just brand new clients come into play is probably the driving force but we're certainly pleased that Grant Thornton is one of our channels but I would not say it's anything material for us..

Perfect. That's great. Thanks Mike. I'll get back in queue..

Okay Ben. Thanks very much..

[Operator Instructions] That concludes today's question-and-answer session. At this time I will turn the call back to today's speaker for any additional or closing remarks..

Thanks very much. Let me just close by saying thank you to my fellow 1,300 professionals around the world.

It is their ability to help our clients achieve operational excellence and faster growth for their client base especially through these digital transformation that continues to be the reason for our strong performance and let me thank all of you on the call today for your continued support and confidence in our firm.

With that everyone have a terrific and great day. Thanks very much..

That will conclude today's conference. Thank you for your participation and have a good day..