What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-09 compared with 2022-11-04 · 62 added, 130 removed, 150 unchanged (56% of the section changed)

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BUSINESS OVERVIEW

ISG (Information Services Group) (Nasdaq:

III) is a leading global technology research and advisory firm.

Information Services Group, Inc.

III) (the “Company,” “ISG,” “we,” “us” or “our”) is a leading global technology research and advisory firm.

A trusted business partner to over 900 clients, including more than 75 of the top 100 enterprises in our markets, ISG is committed to helping corporations, public sector organizations and service and technology providers achieve operational excellence and faster growth.

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market intelligence and technology research and analysis.

Founded in 2006, and based in Stamford, Conn., ISG employs more than 1,300 digital-ready professionals operating in more than 20 countries—a global team known for its innovative thinking, market influence, deep industry and technology expertise, and world-class research and analytical capabilities based on the industry’s most comprehensive marketplace data.

Founded in 2006, and based in Stamford, Connecticut, ISG employs approximately 1,600 digital-ready professionals operating in more than 20 countries—a global team known for its innovative thinking, market influence, deep industry and technology expertise and world-class research and analytical capabilities based on the industry’s most comprehensive marketplace data.

For more information, visit www.isg-one.com.

The information on or accessible through our website is not part of and is not incorporated by reference into this Quarterly Report on Form 10-Q, and the inclusion of our website address in this Quarterly Report on Form 10-Q is only for reference.

Our strategy is to strengthen our existing market position and develop new services and products to support future growth plans.

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These offerings are characterized by subscriptions (i.e., renewal centric as opposed to project centric revenue streams) or, in some instances, multi-year contracts.

Our digital services now span a volume of offerings and have become

embedded as part of even our traditional transaction services.

Our digital services now span a volume of offerings

and have become embedded as part of even our traditional transaction services.

Digital enablement provides capabilities, digital insights and better engagement with clients and partners.

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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, 2022 AND SEPTEMBER 30, 2021

Geographical revenue information for the segment is as follows:

Three Months Ended September 30,

Geographic Area

(in thousands)

Total revenues

Revenues decreased $2.3 million for the third quarter of 2022.

The decrease in revenue in the Americas was primarily attributable to a decrease in our Automation service line, partially offset by an increase in our Network & Software Advisory Services (NaSa), Advisory, Research, and GovernX service lines.

The decrease in revenue in Europe was primarily attributable to a decrease in our Automation and Research service lines, partially offset by an increase in our GovernX and NaSa service lines.

The decrease in revenue in Asia Pacific was primarily attributable to a decrease in our Advisory service line, partially offset by an increase in our GovernX and NaSa service lines.

The translation of foreign currency revenues into U.S.

dollars negatively impacted performance in Europe and Asia Pacific compared to the prior year by $4.0 million.

Operating Expenses

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

Three Months Ended September 30,

Operating Expenses

(in thousands)

Direct costs and expenses for advisors

Selling, general and administrative

Depreciation and amortization

Total operating expenses

Total operating expenses decreased $2.4 million, or approximately 4%, for the third quarter of 2022.

The decrease in operating expenses was primarily due to lower:

contract labor of $2.7 million and license fees of $1.5 million.

were partially offset by higher:

travel and entertainment expense of $0.9 million, non-cash stock compensation of $0.5 million, and professional fees of $0.4 million.

Compensation costs consist of a mix of fixed and variable salaries, annual bonuses, benefits and profit sharing 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 profit sharing 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 ISG 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 or work remotely, all occupancy expenses are recorded as general and administrative.

Depreciation and amortization expense in the third quarter of 2022 and 2021 was $1.3 million, respectively.

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 certain 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 and interim impairment tests, if triggering events are identified.

Other Income (Expense), Net

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

Three Months Ended September 30,

Other income (expense), net

(in thousands)

Interest income

Interest expense

Foreign currency transaction gain

Total other income (expense), net

The total increase of $0.2 million, or approximately 39%, was primarily the result of higher interest expense attributable to higher interest rates, partially offset by higher foreign currency transaction gains.

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 quarter ended September 30, 2022 was 18.0% compared to 34.9% for the quarter ended September 30, 2021.

The difference for the quarter ended September 30, 2022 was primarily due to the impact of earnings and losses in certain foreign jurisdictions and the impact of vesting of restricted stock units.

The Company’s effective tax rate for the quarter ended September 30, 2022 was lower than the statutory rate primarily due to the impact of vesting of restricted stock units.

There were no significant changes in uncertain tax position reserves or valuation allowances during the quarter ended September 30, 2022.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2022 AND SEPTEMBER 30, 2021

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2023 AND MARCH 31, 2022

Geographical revenue information for the segment is as follows:

Nine Months Ended September 30,

Three Months Ended March 31,

Geographic Area

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Total revenues

Revenues increased $3.8 million, or approximately 2%, for the nine months of 2022.

The increase in revenue in the Americas was primarily attributable to an increase in our Research, GovernX and NaSa service lines, partially offset by a decrease in our Automation service line.

The decrease in revenue in Europe was primarily attributable to a decrease in our NaSa service line, partially offset by an increase in our GovernX service line.

The increase in revenue in Asia Pacific was primarily attributable to an increase in our Advisory and NaSa service lines.

Revenues increased $5.9 million, or approximately 8%, for the first quarter of 2023.

The increase in revenue for the Americas was primarily attributable to an increase in our Advisory, Network & Software Advisory Services (NaSa) and GovernX service lines.

The decrease in revenue in Europe was primarily attributable to a decrease in our Advisory service line, partially offset by an increase in our GovernX and Research service lines.

The decrease in revenue in Asia Pacific was primarily attributable to a decrease in our Advisory service line, partially offset by an increase in our NaSa service line.

The translation of foreign currency revenues into U.S.

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

Nine Months Ended September 30,

Three Months Ended March 31,

Operating Expenses

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Total operating expenses

Total operating expenses decreased $0.4 million for the nine months of 2022.

The decrease in operating expenses were primarily due to lower:

contract labor of $4.6 million, license fees of $1.7 million, change in fair value of contingent consideration of $1.4 million, and severance, and integration and other expense of $0.9 million.

These costs were partially offset by higher:

travel and entertainment expense of $2.6 million, compensation costs of $2.1 million, event related expenses of $1.1 million, professional fees of $0.7 million, bad debt expense of $0.5 million, computer expenses of $0.5 million and non-cash stock compensation of $0.4 million.

Total operating expenses increased $6.6 million, or approximately 10%, for the first quarter of 2023.

The increase in operating expenses was primarily due to higher contract labor expense of $2.7 million, license fees of $1.6 million, travel and entertainment of $1.2 million, non-cash stock compensation of $0.5 million and professional fees of $0.5 million.

These costs were partially offset by lower compensation expense of $1.1 million and the prior year Neuralify earnout adjustment of $1.4 million.

Compensation costs consist of a mix of fixed and variable salaries, annual bonuses, benefits and profit sharing plan contributions.

Bonus compensation is determined based on achievement against Company financial targets and is accrued monthly throughout the year based on management’s estimates of target achievement.

Statutory and elective profit sharing plans are offered to employees as appropriate.

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Because our billable personnel operate primarily on client premises or work remotely, all occupancy expenses are recorded as general and administrative.

Depreciation and amortization expense in the nine months of 2022 and 2021 was $3.9 million and $4.0 million, respectively.

Depreciation and amortization expense in the first quarter of 2023 and 2022 was $1.6 million and $1.3 million, respectively.

The increase of $0.3 million was primarily due to the acquisition of Change 4 Growth.

Our fixed assets consist of furniture, fixtures, equipment (mainly personal computers) and leasehold improvements.

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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.

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 and interim impairment tests, if triggering events are identified.

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

Nine Months Ended September 30,

Three Months Ended March 31,

Other income (expense), net

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Interest expense

Foreign currency transaction gain (loss)

Foreign currency transaction (loss) gain

Total other income (expense), net

The total increase of approximately 1%, was primarily the result of higher interest expense attributable to higher interest rates, partially offset by higher foreign currency transaction gains.

The total increase of $1.4 million was primarily the result of higher interest expense attributable to higher interest rates, our higher debt balance and $0.4 million associated with the write-off of deferred financing costs.

Income Tax Expense

Our effective tax rate for the nine months ended September 30, 2022 was 25.4% compared to 27.7% for the nine months ended September 30, 2021.

The difference for the nine months ended September 30, 2022 was primarily due to the impact of earnings and losses in certain foreign jurisdictions and the impact of vesting of restricted stock units.

The Company’s effective tax rate for the nine months ended September 30, 2022 was higher than the statutory rate primarily due to the impact of foreign operations.

There were no significant changes in uncertain tax position reserves or valuation allowances during the quarter ended September 30, 2022.

Our effective tax rate for the quarter ended March 31, 2023 was 32.9% compared to 31.9% for the quarter ended March 31, 2022.

The difference for the quarter ended March 31, 2023 was primarily due to the impact of earnings and losses in certain foreign jurisdictions and the impact of vesting of restricted stock units.

The Company’s effective tax rate for the quarter ended March 31, 2023 was higher than the statutory rate primarily due to non-deductible expenses and the impact of earnings in foreign jurisdictions.

There were no significant changes in uncertain tax position reserves or valuation allowances during the quarter ended March 31, 2023.

NON-GAAP FINANCIAL PRESENTATION

This management’s discussion and analysis presents supplemental measures of our performance that are derived from our consolidated financial information but are not presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted EBITDA, adjusted net income, and adjusted earnings per diluted share, each as defined below.

We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted EBITDA, adjusted net income and adjusted net income per diluted share, each as defined below.

See “Non-GAAP Financial Measures” below for information about our use of these non-GAAP financial measures, including our reasons for including these measures and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.

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We use non-GAAP financial measures to supplement the financial information presented on a GAAP basis.

We provide adjusted EBITDA (defined as net income, plus interest, taxes, depreciation and amortization, foreign currency transaction gains/losses, non-cash stock compensation, interest accretion associated with contingent consideration, acquisition-related costs, and severance, integration and other expense), adjusted net income (defined as net income, plus amortization of intangible assets, non-cash stock compensation, foreign currency transaction gains/losses, interest accretion associated with contingent consideration, acquisition-related costs, and severance, integration and other expense on a tax-adjusted basis) and adjusted net income per diluted share, excluding the net of tax effect of the items set forth in the table below.

We provide adjusted EBITDA (defined as net income, plus interest, taxes, depreciation and amortization, foreign currency transaction gains/losses, non-cash stock compensation, interest accretion associated with contingent consideration, acquisition-related costs, and severance, integration and other expense), adjusted net income (defined as net income, plus amortization of intangible assets, non-cash stock compensation, foreign currency transaction gains/losses, interest accretion associated with contingent consideration, acquisition-related costs, severance, integration and other expense and write-off of deferred financing costs, on a tax-adjusted basis) and adjusted net income per diluted share, excluding the net of tax effect of the items set forth in the table below.

These are non-GAAP measures that the Company believes provide useful information to both management and investors by excluding certain expenses and financial implications of foreign currency translations that management believes are not indicative of ISG’s core operations.

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We believe that these non-GAAP measures provide useful information to investors because they improve the comparability of the financial results between periods and provide for greater transparency of key measures used to evaluate the Company’s performance.

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

(in thousands)

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Severance, integration and other expense

Foreign currency transaction (gain) loss

Foreign currency transaction loss (gain)

Non-cash stock compensation

Adjusted EBITDA

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

(in thousands)

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Severance, integration and other expense

Foreign currency transaction (gain) loss

Write-off of deferred financing costs

Foreign currency transaction loss (gain)

Tax effect (1)

Adjusted net income

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

Net income per diluted share

4 unchanged sentences

Severance, integration and other expense

Foreign currency transaction (gain) loss

Write-off of deferred financing costs

Foreign currency transaction loss (gain)

Tax effect (1)

Adjusted net income per diluted share

_________________________________

(1) Consists of expenses from acquisition-related costs and non-cash fair value adjustments on pre-acquisition contract liabilities.

(1) Marginal tax rate of 32%, reflecting U.S.

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The volume of billings and timing of collections and payments affect these account balances.

As of September 30, 2022, our cash, cash equivalents and restricted cash were $19.8 million, a net decrease of $27.8 million from December 31, 2021, which was primarily attributable to the following:

● net cash provided by operating activities of $4.6 million;

● treasury shares repurchased of $12.1 million;

As of March 31, 2023, our cash, cash equivalents and restricted cash were $23.8 million compared to $30.7 million as of December 31, 2022, a net decrease of $6.9 million which was primarily attributable to the following:

● repayment of outstanding debt of $79.2 million;

● net cash used in operating activities of $3.4 million;

● cash dividends paid to shareholders of $2.0 million;

● negative effects of exchange rate changes of $5.0 million;

● principal payments on borrowings of $3.2 million;

● payments related to debt financing costs of $0.8 million;

● purchase of furniture, fixtures and equipment of $0.5 million;

● treasury shares repurchased of $0.3 million;

● payments related to tax withholding for stock-based compensation of $0.3 million;

● proceeds from revolving facility of $79.2 million;

● proceeds from issuance of employees stock purchase plan shares of $0.2 million.

Capital Resources

On March 10, 2020, the Company amended and restated its senior secured credit facility to include a $86.0 million term facility and to increase the revolving commitments per the revolving facility (as amended by that certain First Amendment to Credit Agreement, dated as of June 1, 2022, the “2020 Credit Agreement”) from $30.0 million to $54.0 million.

On February 22, 2023, the Company amended and restated its senior secured credit facility to increase the revolving commitments per the revolving facility (the “2023 Credit Agreement”) from $54.0 million to $140.0 million and eliminate its term loan.

The material terms under the 2023 Credit Agreement are as follows:

● Each of the term loan facility and revolving credit facility has a maturity date of March 10, 2025 (the “Maturity Date”).

● The revolving credit facility has a maturity date of February 22, 2028 (the “Maturity Date”).

● The credit facility is secured by all of the equity interests owned by the Company, and its direct and indirect domestic subsidiaries and, subject to agreed exceptions, the Company’s direct and indirect “first-tier” foreign subsidiaries and a perfected first priority security interest in all of the Company’s and its direct and indirect domestic subsidiaries’ tangible and intangible assets.

● The Company’s direct and indirect existing and future wholly owned domestic subsidiaries serve as guarantors to the Company’s obligations under the senior secured facility.

● At the Company’s option, the credit facility bears interest at a rate per annum equal to either (i) the “Base Rate” (which is the highest of (a) the rate publicly announced from time to time by the administrative agent as its “prime rate”, (b) the Federal Funds Rate plus 0.5% per annum and (c) the Eurodollar Rate, plus 1.0%), plus the applicable margin (as defined below) or (ii) Eurodollar Rate (adjusted for maximum reserves) as determined by the Administrative Agent, plus the applicable margin.

The applicable margin is adjusted quarterly based upon the Company’s quarterly leverage ratio.

● The term loan is repayable in nineteen consecutive quarterly installments of $1,075,000 each that commenced on June 30, 2020 and a final payment of the outstanding principal amount of the term loan on the Maturity Date.

● Mandatory repayments of term loans shall be required from (subject to agreed exceptions) (i) 100% of the net proceeds from issuances of debt and equity by the Company and its subsidiaries and (ii) 100% of the net proceeds from insurance recovery and condemnation events of the Company and its subsidiaries.

● The senior secured credit facility 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), transactions 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.

In addition, the Company is required to comply with a total leverage ratio and fixed charge coverage ratio.

● At the Company’s option, the credit facility bears interest at a rate per annum equal to either (i) the “Base Rate” (which is the highest of (a) the rate publicly announced from time to time by the administrative agent as its “prime rate”, (b) the Federal Funds Rate plus 0.5% per annum and (c) Term SOFR, plus 1.0%), plus the applicable margin (as defined below) or (ii) Term SOFR (which is the Term SOFR screen rate for the relevant interest period plus a credit spread adjustment of 0.10%) as determined by the Administrative Agent, plus the applicable margin.

The applicable margin is adjusted quarterly based upon the Company’s consolidated leverage ratio.

Prior to the end of the first quarter-end following the closing of the credit facility, the applicable margin shall be a percentage per annum equal to 0.50 % for the revolving loans maintained as Base Rate loans or 1.50% for the revolving loans maintained as Term SOFR loans.

● The senior secured credit facility 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.

In addition, the Company is required to comply with a consolidated leverage ratio and consolidated interest coverage ratio.

● The senior secured credit facility contains customary events of default, including cross-default to other material agreements, judgment default and change of control.

The Company’s financial statements include outstanding borrowings of $71.3 million at September 30, 2022 and $74.5 million at December 31, 2021, which are carried at amortized cost.

The Company’s financial statements include outstanding borrowings of $79.2 million at both March 31, 2023 and December 31, 2022, which are carried at amortized cost.

The fair value of debt is classified within Level 3 of the fair value hierarchy.

The fair value of the Company's outstanding borrowings is approximately $69.1 million and $73.6 million at September 30, 2022 and December 31, 2021, respectively.

The fair value of the Company's outstanding borrowings was approximately $79.8 million and $76.5 million as of March 31, 2023 and December 31, 2022, respectively.

The fair values of debt have been estimated using a discounted cash flow analysis based on the Company's incremental borrowing rate for similar borrowing arrangements.

The incremental borrowing rate used to discount future cash flows is 5.3% and 2.0% at September 30, 2022 and December 31, 2021, respectively.

The Company also considered recent transactions of peer group companies for similar instruments with comparable terms and maturities as well as an analysis of current market conditions and interest rates.

As of September 30, 2022 and December 31, 2021, there were no outstanding borrowings under the revolver.

The incremental borrowing rate used to discount future cash flows was 6.5% and 6.3% as of March 31, 2023 and December 31, 2022, respectively.

The Company also considered recent transactions of peer group companies for similar instruments

with comparable terms and maturities as well as an analysis of current market conditions and interest rates.

The Company is currently in compliance with its financial covenants.

We anticipate that our current cash and the ongoing cash flows from our operations will be adequate to meet our working capital, capital expenditure and debt financing needs for at least the next twelve months.

The anticipated cash needs of our business could change significantly if we pursue and complete additional business acquisitions, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business, including the potential impacts of the COVID-19 pandemic and the severity of the related economic downturn and length of time of an economic recovery.

If we require additional capital resources to grow our business, either internally or through acquisition, or maintain liquidity, we may seek to sell additional equity securities or to secure additional debt financing.

The anticipated cash needs of our business could change significantly if we pursue and complete additional business acquisitions, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business.

If we require additional capital resources to grow our business, either internally or through acquisition, or to maintain liquidity, we may seek to sell additional equity securities or to secure additional debt financing.

The sale of additional equity securities or certain forms of debt financing could result in additional dilution to our stockholders.

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The Company expects to pay a total cash dividend of $0.18 per share for the four quarters ending March 31, 2024.

On November 1, 2022, the Board of Directors approved the fourth-quarter dividend of $0.04 per share, payable December 19, 2022, to shareholders of record as of December 5, 2022.

On May 8, 2023, the Board of Directors (the “Board”) approved the second-quarter dividend of $0.045 per share, payable June 30, 2023, to shareholders of record as of June 7, 2023.

The dividends are accounted for as a decrease to Stockholders’ Equity.

All future dividends will be subject to Board approval.

All future dividends will be subject to the Board’s approval.

Off-Balance Sheet Arrangements

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We base our estimates on historical experience, available information and various other assumptions we believe to be reasonable under the circumstances.

On an on-going basis, we evaluate our estimates;

On an ongoing basis, we evaluate our estimates;

however, actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes or developments in our evaluation of the accounting estimates and the underlying assumptions or methodologies that we believe to be Critical Accounting Policies and Estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As a smaller reporting company, we are not required to provide the information required by this item.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis