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III > SEC Filings for III > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for INFORMATION SERVICES GROUP INC.

Form 10-Q for INFORMATION SERVICES GROUP INC.


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risks and uncertainties. We have based these forward-looking statements on our current expectations and assumptions about future events. In some cases, you can identify forward-looking statements by terminology, such as "may," "should," "could," "predict," "potential," "continue," "expect," "anticipate," "future," "intend," "plan," "believe," "estimate," "forecast" and similar expressions (or the negative of such expressions.) Forward-looking statements include statements concerning 2012 revenue growth rates and capital expenditures. Forward-looking statements are based on our beliefs as well as assumptions based on information currently available to us, including financial and operational information, the volatility of our stock price, and current competitive conditions. As a result, these statements are subject to various risks and uncertainties. For a discussion of material risks and uncertainties that the Company faces, see the discussion in our 2011 Form 10-K titled "Risk Factors."

BUSINESS OVERVIEW

Information Services Group, Inc. (ISG) (NASDAQ: III) is a leading technology insights, market intelligence and advisory services company serving more than 500 clients around the world to help them achieve operational excellence. We support private and public sector organizations to transform and optimize their operational environments through research, benchmarking, consulting and managed services with a focus on information technology, business process transformation, program management services and enterprise resource planning. Clients look to us for unique insights and innovative solutions for leveraging technology, our deep data source, and more than five decades of experience of global leadership in information and advisory services. Based in Stamford, Connecticut, we have over 800 employees and operate in 21 countries.

Our strategy is to strengthen our existing market position and develop new services and products to support future growth plans. As a result, we are focused on growing our existing service model, expanding geographically, developing new industry sectors, productizing market data assets, expanding our managed services offering and growing via acquisition. Although we do not expect any adverse conditions that will impact our ability to execute against our strategy over the next twelve months, the more significant factors that could limit our ability to grow in these areas include global macro-economic conditions and the impact on the overall sourcing market, competition, our ability to retain advisors and reductions in discretionary spending with our top strategic accounts or other significant client events. Other areas that could impact the business would also include natural disasters, legislative and regulatory changes and capital market disruptions.

We derive our revenues from fees and reimbursable expenses for professional services. A majority of our revenues are generated under hourly or daily rates billed on a time and expense basis. Clients are typically invoiced on a monthly basis, with revenue recognized as the services are provided. There are also client engagements in which we are paid a fixed amount for our services, often referred to as fixed fee billings. This may be one single amount covering the whole engagement or several amounts for various phases or functions. From time to time, we earn incremental revenues, in addition to hourly or fixed fee billings, which are contingent on the attainment of certain contractual milestones or objectives. Such revenues may cause unusual variations in quarterly revenues and operating results.

Our results are impacted principally by our full-time consultants' utilization rate, the number of business days in each quarter and the number of our revenue-generating professionals who are available to work. Our utilization rate can be negatively affected by increased hiring because there is generally a transition period for new professionals that result in a temporary drop in our utilization rate. Our utilization rate can also be affected by seasonal variations in the demand for our services from our clients. The number of business work days is also affected by the number of vacation days taken by our consultants and holidays in each quarter. We typically have fewer business work days available in the fourth quarter of the year, which can impact revenues during that period. Time-and-expense engagements do not provide us with a high degree of predictability as to performance in future periods. Unexpected changes in the demand for our services can result in significant variations in utilization and revenues and present a challenge to optimal hiring and staffing. The volume of work performed for any particular client can vary widely from period to period.


RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 AND
SEPTEMBER 30, 2011

On January 4, 2011, ISG completed the acquisition of Compass. Compass is an independent global provider of business and information technology benchmarking, performance improvement, data and analytics services. Compass uses benchmarking to support fact-based decision making, analysis to optimize cost reduction, and tools and techniques to manage business performance.

On February 10, 2011 ISG completed the acquisition of STA Consulting (Salvaggio, Teal & Associates) an independent information technology advisor serving the public sector. STA Consulting advises clients on information technology strategic planning and the acquisition and implementation of new Enterprise Resource Planning (ERP) and other enterprise administration and management systems.

Revenues

Revenues are generally derived from engagements priced on a time and materials basis as well as various fixed fee projects, and are recorded based on actual time worked and are recognized as the services are performed. Revenues related to materials (mainly out-of-pocket expenses such as airfare, lodging and meals) required during an engagement generally do not include a profit mark-up and can be charged and reimbursed discretely or as part of the overall fee structure. Invoices are issued to clients at least monthly.

We operate in one segment, fact-based sourcing advisory services. We operate principally in the Americas, Europe, and Asia Pacific. Our foreign operations are subject to local government regulations and to the uncertainties of the economic and political conditions of those areas.

Geographical revenue information for the segment is as follows:

Three Months Ended September 30,

(in thousands)

                                                    Percent
                                                    Change
Geographic Area     2012        2011      Change       %
Americas          $  26,842   $ 24,006   $  2,836        12
Europe               14,240     18,341     (4,101 )     (22 )
Asia Pacific          5,387      6,554     (1,167 )     (18 )
Total revenues    $  46,469   $ 48,901   $ (2,432 )      (5 )

The net decrease in revenues of $2.4 million in 2012 was attributable principally to a 22% decrease in Europe to $14.2 million and an 18% decrease in Asia Pacific revenues to $5.4 million. The decrease in revenues is primarily due to lower volumes in sourcing related engagements in Europe and Asia Pacific regions. These decreases were offset by a 12% increase in Americas primarily due to an increase in managed services revenue. The translation of foreign currency into US dollars also had a negative impact on performance compared to the prior year.

Operating Expenses



The following table presents a breakdown of our operating expenses by category:



                                             Three Months Ended September 30,
                                                      (in thousands)
                                                                           Percent
                                                                           Change
Operating Expenses                         2012        2011      Change       %
Direct costs and expenses for advisors   $  27,876   $ 28,005   $   (129 )       -
Selling, general and administrative         13,957     16,237     (2,280 )     (14 )
Depreciation and amortization                2,224      2,882       (658 )     (23 )
Total operating expenses                 $  44,057   $ 47,124   $ (3,067 )      (7 )

Total operating expenses decreased $3.1 million or 7% for the quarter with decreases in selling, general and administrative ("SG&A") (14%) and depreciation and amortization (23%) expenses. Lower expenses were driven by reduced travel, conferences and occupancy expenses. We did not record any restructuring or deal costs during the third


quarter of 2012 compared to $0.6 million recorded in the third quarter of 2011. These cost decreases were partially offset by higher compensation, computer and bad debt expenses. Lower SG&A levels were mostly driven by a $1.9 million reduction in the contingent liability related to the STA Consulting earn out based on future projected profit levels. The impact of foreign currency translation into US dollars also drove costs lower compared to the same prior 2011 period.

Compensation costs consist of a mix of fixed and variable salaries, annual bonuses, benefits and pension plan contributions. A portion of compensation expenses for certain billable employees are allocated between direct costs and selling, general and administrative costs based on relative time spent between billable and non-billable activities. Bonus compensation is determined based on achievement against Company financial and individual targets, and is accrued monthly throughout the year based on management's estimates of target achievement. Statutory and elective pension plans are offered to employees as appropriate. Direct costs also include employee taxes, health insurance, workers compensation and disability insurance.

Sales and marketing costs consist principally of compensation expense related to business development, proposal preparation and delivery and negotiation of new client contracts. Costs also include travel expenses relating to the pursuit of sales opportunities, expenses for hosting periodic client conferences, public relations activities, participation in industry conferences, industry relations, website maintenance and business intelligence activities. The Company maintains a dedicated global marketing function responsible for developing and managing sales campaigns, brand promotion, the TPI Index and assembling proposals.

We maintain a comprehensive program for training and professional development. Related expenses include product training, updates on new service offerings or methodologies and development of project management skills. Also included in training and professional development are expenses associated with the development, enhancement and maintenance of our proprietary methodologies and tools and the systems that support them.

General and administrative expenses consist principally of executive management compensation, allocations of billable employee compensation related to general management activities, IT infrastructure, and costs for the finance, accounting, information technology and human resource functions. General and administrative costs also reflect continued investment associated with implementing and operating client and employee management systems. Because our billable personnel operate primarily on client premises, all occupancy expenses are recorded as general and administrative.

Depreciation and amortization expense in the third quarter of 2012 and 2011 was $2.2 million and $2.9 million, respectively. The decrease of $0.7 million in depreciation and amortization expense was primarily due to decrease in amortization as a result of intangible assets that were fully amortized in 2011. Our fixed assets consist of furniture, fixtures, equipment (mainly personal computers) and leasehold improvements. Depreciation expense is generally computed by applying the straight-line method over the estimated useful lives of assets. We also capitalize some costs associated with the purchase and development of internal-use software, system conversions and website development costs. These costs are amortized over the estimated useful life of the software or system.

We amortize our intangible assets (e.g. client relationships and databases) over their estimated useful lives. Goodwill related to acquisitions is not amortized but is subject to annual impairment testing. As of November 1, 2011, trademark and trade names acquired in our acquisitions were reclassified from indefinite to definite lived assets and are being amortized over their estimated useful lives.

Other (Expense), Net



The following table presents a breakdown of other (expense), net:



                                 Three Months Ended September 30,
                                          (in thousands)
                                                                Percent
                                                                Change
                             2012         2011        Change       %
Interest income            $      11    $      23    $    (12 )     (52 )
Interest expense                (790 )       (812 )        22         3
Foreign currency loss            (76 )       (191 )       115        60
Total other expense, net   $    (855 )  $    (980 )  $    125        13

Income Tax Expense

Our quarterly effective tax rate varies from period to period based on the mix of earnings among the various state and foreign tax jurisdictions in which business is conducted and the level of non-deductible expenses projected to be incurred during the current fiscal year. Our effective tax rate for the three months ended September 30, 2012 was 86.5% compared to


425% for the three months ended September 30, 2011. Our effective tax rate is higher than the statutory rate primarily due to the reversal of deferred tax assets associated with vested restricted stock units of $0.1 million and an increase in the valuation allowance of $0.6 million related to the foreign tax credits. Our operations resulted in pre-tax income of $1.6 million and a tax provision of $1.4 million at the 86.5% effective tax rate for the three months ended September 30, 2012.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND SEPTEMBER
30, 2011

The results for the nine months ended September 30, 2011 discussed below include the operations of Compass from January 4, 2011 to September 30, 2011 and STA Consulting from February 10, 2011 to September 30, 2011.

Revenues



Geographical revenue information for the segment is as follows:



                       Nine Months Ended September 30,
                                (in thousands)
                                                     Percent
                                                     Change
Geographic Area     2012        2011       Change       %
Americas          $  77,927   $  66,006   $ 11,921        18
Europe               46,008      56,298    (10,290 )     (18 )
Asia Pacific         19,290      17,508      1,782        10
Total revenues    $ 143,225   $ 139,812   $  3,413         2

The net increase in revenues of $3.4 million or 2% in 2012 was attributable principally to an 18% increase in Americas revenues to $77.9 million and a 10% increase in Asia Pacific revenues to $19.3 million. The increase in revenues is primarily due to higher levels of sourcing activity in Americas and Asia Pacific region, attributable to increases in managed services revenue. These increases were offset by an 18% reduction in Europe primarily due to lower volumes in sourcing related engagements. The translation of foreign currency into US dollars also negatively impacted performance compared to prior year.

Operating Expenses



The following table presents a breakdown of our operating expenses by category:



                                              Nine Months Ended September 30,
                                                       (in thousands)
                                                                            Percent
                                                                            Change
Operating Expenses                         2012        2011       Change       %
Direct costs and expenses for advisors   $  84,672   $  79,953   $  4,719         6
Selling, general and administrative         47,052      52,304     (5,252 )     (10 )
Depreciation and amortization                6,637       8,452     (1,815 )     (21 )
Total operating expenses                 $ 138,361   $ 140,709   $ (2,348 )      (2 )

Total operating expenses decreased $2.3 million or 2% for the first nine months of 2012 with decreases in SG&A expenses (10%) offset by increases in direct expenses (6%). Lower costs were driven by lower travel, occupancy, conference, bad debt and marketing expenses. We did not record any restructuring or deal costs during the first nine months of 2012 compared to $3.1 million recorded in the first nine months of 2011. These cost decreases were partially offset by higher outside professional services, compensation and benefits, contract labor, and computer expenses. Lower SG&A levels were mostly driven by a $1.9 million reduction in the contingent liability related to the STA Consulting earn out based on latest estimates of future profit levels. The impact of foreign currency translation into US dollars also drove costs lower compared to the same prior 2011 period.

Depreciation and amortization expense in the first nine months of 2012 and 2011 was $6.6 million and $8.4 million, respectively. The decrease of $1.8 million in depreciation and amortization expense was primarily due to decrease in amortization as a result of intangible assets that were fully amortized in 2011.


Other (Expense), Net



The following table presents a breakdown of other (expense), net:



                                    Nine Months Ended September 30,
                                            (in thousands)
                                                                 Percent
                                                                 Change
                                  2012        2011     Change       %
Interest income                $       37   $     58   $   (21 )     (36 )
Interest expense                   (2,501 )   (2,487 )     (14 )      (1 )
Foreign currency (loss) gain          (69 )        9       (78 )    (867 )
Total other expense, net       $   (2,533 ) $ (2,420 ) $  (113 )      (5 )

Income Tax Expense

Our effective tax rate for the nine months ended September 30, 2012 was 80.5% compared to (19.1)% for the nine months ended September 30, 2011. Our effective tax rate is higher than the statutory rate primarily due to the reversal of deferred tax assets associated with vested restricted stock units of $0.2 million and an increase in the valuation allowance of $0.6 million related to the foreign tax credits. Our operations resulted in a pre-tax income of $2.3 million and a tax provision of $1.9 million at the 80.5% effective tax rate for the nine months ended September 30, 2012.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our primary sources of liquidity are cash flows from operations, existing cash and cash equivalents and our revolving credit facility. Operating assets and liabilities consist primarily of receivables from billed and unbilled services, accounts payable, accrued expenses, and accrued payroll and related benefits. The volume of billings and timing of collections and payments affect these account balances.

As of September 30, 2012, our cash and cash equivalents were $15.0 million, a net decrease of $9.5 million from December 31, 2011, which was primarily attributable to the following:

net cash provided by from operating activities of $0.1 million;

payments of principal amounts due on the debt of $5.3 million.

payment of STA Consulting contingent consideration of $2.0 million.

capital expenditures for furniture, fixtures and equipment of $1.5 million; and

equity repurchases of $1.2 million;

Capital Resources

We have outstanding a substantial amount of debt, which may limit our ability to fund general corporate requirements and obtain additional financing, limit our flexibility in responding to business opportunities and competitive developments and increase our vulnerability to adverse economic and industry conditions.

We incurred a substantial amount of indebtedness to finance the acquisition of TPI, including transaction costs and deferred underwriting fees. On November 16, 2007, our wholly-owned subsidiary International Consulting Acquisition Corp. ("ICAC") entered into a senior secured credit facility comprised of a $95.0 million term loan facility and a $10.0 million revolving credit facility. On November 16, 2007, ICAC borrowed $95.0 million under the term loan facility to finance the purchase price for our acquisition of TPI and to pay transaction costs. As a result of the substantial fixed costs associated with the debt obligations, we expect that:

a decrease in revenues will result in a disproportionately greater percentage decrease in earnings;

we may not have sufficient liquidity to fund all of these fixed costs if our revenues decline or costs increase;

we may have to use our working capital to fund these fixed costs instead of funding general corporate requirements, including capital expenditures;

we may not have sufficient liquidity to respond to business opportunities, competitive developments and adverse economic conditions; and


our results of operations will be adversely affected if interest rates increase because, based on our current outstanding term loan borrowings in the amount of $58.6 million, a 1% increase in interest rates would result in a pre-tax impact on earnings of approximately $0.6 million per year.

These debt obligations may also impair our ability to obtain additional financing, if needed, and our flexibility in the conduct of our business. Our indebtedness under the senior secured revolving credit facility is secured by substantially all of our assets, leaving us with limited collateral for additional financing. Moreover, the terms of our indebtedness under the senior secured revolving credit facility restrict our ability to take certain actions, including the incurrence of additional indebtedness, mergers and acquisitions, investments and asset sales. Our ability to pay the fixed costs associated with our debt obligations will depend on our operating performance and cash flow, which in turn depend on general economic conditions and the advisory services market. A failure to pay interest or indebtedness when due could result in a variety of adverse consequences, including the acceleration of our indebtedness. In such a situation, it is unlikely that we would be able to fulfill our obligations under or repay the accelerated indebtedness or otherwise cover our fixed costs.

The 2007 Credit Agreement contains a number of covenants that, among other things, place restrictions on matters customarily restricted in senior secured credit facilities, including restrictions on indebtedness (including guarantee obligations), liens, fundamental changes, sales or disposition of property or assets, investments (including loans, advances, guarantees and acquisitions), transaction with affiliates, dividends and other payments in respect of capital stock, optional payments and modifications of other material debt instruments, negative pledges and agreements restricting subsidiary distributions and changes in line of business. The 2007 Credit Agreement contains customary events of default, including cross-default to other material agreements, judgment default and change of control.

We are required to comply with a total leverage ratio as defined in the 2007 Credit Agreement. The total leverage ratio is defined as the ratio of consolidated indebtedness to consolidated earnings before interest, taxes, depreciation and amortization, subject to certain exclusions. The 2007 Credit Agreement includes quarterly financial covenants that require us to maintain a maximum total leverage ratio (as defined in the 2007 Credit Agreement). As of September 30, 2012, our maximum total leverage ratio was 3.00 to 1.00 and we were in compliance with all covenants contained in the 2007 Credit Agreement. The maximum total leverage ratio will continue to decline over the life of the 2007 Credit Agreement. The maximum total leverage ratio is 3.00 for the quarter ended September 30, 2012 and through the period ending December 31, 2012 and will continue to decline thereafter. We currently expect to be in compliance with the covenants contained within the 2007 Credit Agreement. In the event we are unable to remain in compliance with the debt covenants associated with the 2007 Credit Agreement we have alternative options available to us including, but not limited to, the ability to make a prepayment on our debt without penalty to bring the actual leverage ratio into compliance. Our available cash balances and liquidity will be negatively impacted should such prepayment be necessary. In addition, should our revenues not meet our forecast, we have the ability to reduce various expenditures to minimize the impact to the leverage ratio. Such actions may include reductions to headcount, variable compensation, marketing expenses, conferences and non-billable travel.

On January 4, 2011, as part of the consideration for the acquisition of Compass, we issued an aggregate of $6.3 million in convertible notes to Compass (the "Notes"). The Notes mature on January 4, 2018 and interest is payable on the outstanding principal amount, computed daily, at the rate of 3.875% per annum on January 31 of each calendar year and on the seventh anniversary of the date of the Notes. The Notes are subject to transfer restrictions until January 31, 2013. If the price of our common stock on the Nasdaq Global Market exceeds $4 per share for 60 consecutive trading days (the "Trigger Event"), the holder of the Notes may convert all (but not less than all) of the outstanding principal amount of the Notes into shares of our common stock at the rate of 1 share for every $4 in principal amount outstanding. After the Trigger event, we may prepay all or any portion of the outstanding principal amount of the Notes by giving the holder 30 days written notice.

On March 13, 2012, our lenders agreed to allow ICAC to include the results of operations of Compass in the calculation of our leverage ratio. ICAC also received approval to increase the annual cash dividend payable to ISG to $2.0 million.

We anticipate that our current cash and the ongoing cash flows from our operations will be adequate to meet our working capital and capital expenditure . . .

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