What changed in this filing

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Item 7. Management’s Discussion and Analysis

2024-03-08 compared with 2023-03-10 · 73 added, 72 removed, 234 unchanged (38% of the section changed)

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References to “we,” “our” and “us” in this MD&A are to the Company and its consolidated subsidiaries.

This MD&A provides an analysis of our consolidated financial results and cash flows for 2022 and 2021 under the headings “Results of Operations,” “Non-GAAP Financial Presentation and Measures,” and “Liquidity and Capital Resources.” For a similar detailed discussion comparing 2021 and 2020, refer to those headings under Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2021.

This MD&A provides an analysis of our consolidated financial results and cash flows for 2023 and 2022 under the headings “Results of Operations,” “Non-GAAP Financial Presentation,” “Non-GAAP Financial Measures,” and “Liquidity and Capital Resources.” For a similar detailed discussion comparing 2022 and 2021, refer to those headings under Item 7.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2022.

BUSINESS OVERVIEW

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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.

The firm specializes in digital transformation services, including automation, cloud and data analytics;

The Company specializes in digital transformation services, including automation, cloud and data analytics;

sourcing advisory;

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market intelligence and technology research and analysis.

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.

Founded in 2006, and based in Stamford, Connecticut, ISG employs over 1,500 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.

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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 client accounts or other significant client events.

Other areas that could impact the business would also include natural disasters, pandemics, such as COVID-19, legislative and regulatory changes and capital market disruptions.

Other areas that could impact the business would also include natural disasters, pandemics, wars, legislative and regulatory changes and capital market disruptions.

We principally derive revenues from fees for services generated on a project-by-project basis.

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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 our traditional transaction services.

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

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Inflation has not had a material effect on our business operations, financial performance and results of operations, other than its impact on the general economy.

Our exposure from changes to interest rates also has not had a material impact.

Our exposure from changes to interest rates has impacted our business operations, financial performance and results of operations, as our interest expense has increased from $3.2 million in 2022 to $6.2 million in 2023.

The Company continuously monitors these changes and evaluates any effect.

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EXECUTIVE SUMMARY

ISG delivered another record performance in 2022.

Coming off our best year ever, we elevated our results to new heights.

The Company’s 2022 success was built on our strong portfolio of services and solutions, our proven ISG NEXT operating model and our growing client base.

We exceeded 900 clients for the first time, continuing a trend that has seen our client base grow significantly over the past few years.

Nearly every one of our clients today is a digital business.

Each is using digital technology to redefine how they operate, how they engage with customers, employees and business partners, and how they create new revenue streams through connected products and services.

Our record revenue and profitability were the result of the operating efficiencies we derive from our ISG NEXT operating model, as well as our more profitable mix of products and services.

Our iFlex delivery model, part of ISG NEXT, is generating strong utilization across the firm, allowing us to effectively manage our resources across borders and time zones and deliver greater value to our clients, mostly on a virtual basis.

Our strong financial position and operating results allowed us to return $24 million of capital to our shareholders in the form of dividends and share repurchases in 2022.

It also allowed us to amend our existing $140 million credit agreement in early 2023, converting it to an all-revolver facility, with more favorable terms and an extended maturity date.

Looking ahead, we remain confident about our overall prospects for 2023 and beyond.

We are investing now for when the overall market rebounds and demand surges forward again during the next big wave of digitalization.

During 2022, we added more than 250 new professionals to the firm to support our future growth.

We also added new and important capabilities with our acquisitions of Change 4 Growth, an award-winning company specializing in transformational change for enterprises, and Agreemint, an automated contracting solution.

Change 4 Growth is a perfect complement to our existing ISG Enterprise Change business and makes ISG a global leader in change management.

This acquisition will expand the ISG Enterprise Change business by offering organizational change management (OCM), communications, training development and delivery, leadership development, mentoring, DEI programs, executive coaching and culture change.

Agreemint, meanwhile, complements our ISG GovernX business.

This AI-powered contract authorizing tool allows clients to negotiate better contracts and accelerate time to completion.

Our clients continue to be the lifeblood of our firm.

Our success requires our shared commitment to delivering value to them every day.

And by all measures, we are doing a very good job of that.

Environmental, Social and Governance (ESG) has become firmly entrenched in the culture of ISG.

We are delighted our people, through individual and group efforts, are helping to lead the charge for better communities, a better environment and better opportunities for all.

Throughout the pandemic years, we reinvented ISG and invested in our future.

That has resulted in two back-to-back years of record-breaking financial results and a continuously growing client base.

It also has created a solid foundation for the future.

With our ISG NEXT operating model and unmatched portfolio of solutions, advice, research and support, we are ready to take on all challenges and build on our momentum as a stronger, more valuable firm.

2023 was a largely successful year for ISG.

We delivered another year of record revenues, at $291 million.

A strong first nine months of the year was followed by a soft fourth quarter, due to lingering macro concerns that impacted demand for advisory services in the short term.

Given that the overall IT and business services industry was down 6 percent for the year, we consider our topline growth of 2 percent to be a solid performance.

Our investments in our recurring-revenue businesses continue to pay off.

For the year, we generated record recurring revenues of $125 million, up 16 percent, driven by our research and platforms businesses.

Recurring revenue now represents 43 percent of our overall revenue, up 500 basis points from the prior year.

This puts us on track to reach our previously announced target of $150 million in recurring revenues by the end of 2025.

Our profitability, as measured by adjusted EBITDA, was $38 million, down from the prior year.

Even as discretionary spending on advisory services slowed in toward the end of the year, we decided to retain much of our advisory team globally in anticipation of a rebound in 2024, while investing in training more than 1,200 of our employees in AI technology during the fourth quarter.

We continue to expand our business for current and future growth—organically in areas like Cybersecurity, Training-as-a-Service (TaaS), and most recently Enterprise AI Advisory—and through acquisition, with our October purchase of Ventana Research.

A leading technology research business covering the $800 billion global software industry, Ventana Research gives us unmatched analyst coverage of software vendors—adding an important new pillar to our ISG Research portfolio and a strong complement to our Software Advisory business.

With this addition, ISG is increasing its recurring revenue streams, while gaining more than 40 unique new clients and adding nearly two dozen talented research professionals to our roster of world-class technology analysts.

Our acquisition of Ventana Research came one year to the day after we acquired Change 4 Growth, a leading change management firm, in 2022.

C4G has proven to be an excellent complement to our existing Enterprise Change business, delivering double-digit growth in 2023.

ISG influences more than $200 billion in enterprise technology spending annually.

We are using this market influence to lay the groundwork for the next big thing in technology:

Artificial Intelligence, especially the most-talked-about technology development of our time—Generative AI.

Through our new Enterprise AI Advisory business, we are identifying use cases for this exciting new technology and demonstrating where the greatest opportunities lie for ROI.

That includes advising clients on performance improvements in their IT operations and business processes and how to design for, buy, build, run and govern AI products, infrastructure and services.

Beyond AI, we are leveraging our global leadership in sourcing advisory to launch a platform solution called ISG Tango™ that puts our sourcing playbooks and intellectual property, contract exhibits, provider intelligence and other tools at the fingertips of our enterprise and provider clients and our advisors, to make the overall sourcing process more efficient and interactive.

ISG Tango™, we believe, will enable us to capture more unadvised transaction activity among the world’s largest enterprises (the G2000), and penetrate the underserved middle market, which spends an estimated $130 billion annually on technology and business services.

RESULTS OF OPERATIONS

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Revenues increased by $4.8 million or approximately 2% in 2023.

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

The revenue in Europe was flat with an increase in our Automation and GovernX service lines, being offset by a decrease in our Advisory, Research and NaSa service lines.

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

The increase in revenue in the Americas was primarily attributable to an increase in our Consulting and Automation service lines.

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

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

The translation of foreign currency revenues into U.S.

dollars negatively impacted performance in Europe and Asia Pacific compared to the prior year by $12.7 million.

dollars was flat with a negative impact in Asia Pacific, being offset by a positive impact in Europe compared to the prior year.

Operating Expenses

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Total operating expenses

Total operating expenses increased by $4.2 million, or approximately 2%, for 2022.

The increase in operating expenses was due primarily to higher travel and entertainment expenses of $3.3 million, compensation expenses of $3.0 million, event-related expenses of $1.5 million, non-cash stock compensation of $1.0 million, professional fees of $0.6 million, bad debt expenses of $0.5 million, occupancy expenses of $0.4 million, subscriptions fees of $0.3 million and computer expenses of $0.3 million.

The cost increases were partially offset by lower contract labor of $4.2 million, changes in fair value of contingent consideration of $1.5 million, lower restructuring costs of $0.8 million and communication expenses of $0.4 million.

Total operating expenses increased by $19.7 million, or approximately 8%, in 2023.

The increase in operating expenses was due primarily to higher bad debt expense of $5.1 million (refer to Note 2 for details), license fees of $5.0 million, contract labor of $3.0 million, restructuring costs of $1.9 million, travel and entertainment expenses of $1.7 million, non-cash stock based compensation of $1.7 million, computer expenses of $1.0 million, professional fees of $0.7 million and conference expenses of $0.5 million.

The cost increases were partially offset by lower compensation expenses of $2.4 million.

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

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Depreciation and amortization expenses in 2023 and 2022 were $6.3 million and $5.4 million, respectively.

The increase of $0.9 million was primarily due to the acquisitions of Change 4 Growth and Ventana Research.

See Note 4—Acquisition in the Notes to Consolidated Financial Statements for more regarding these acquisitions.

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

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Foreign currency transaction gain

Total other income (expense), net

The total increase of $0.6 million was primarily the result of higher interest expense attributable to higher interest rates and higher borrowings outstanding.

Total other expense, net

The total increase of $3.1 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

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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.

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.

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.

NON-GAAP FINANCIAL MEASURES

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, tax indemnity receivables, accounts receivables reserve, 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, accounts receivables reserves, write-off of deferred financing cost 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.

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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These non-GAAP financial measures exclude non-cash and certain other special charges that many investors believe may obscure the user’s overall understanding of the Company’s current financial performance and the Company’s prospects for the future.

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.

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.

Years Ended December 31,

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Severance, integration and other expense

Foreign currency transaction gain

Account Receivables Reserves

Tax indemnity receivables

Foreign currency transaction loss (gain)

Non-cash stock compensation

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Acquisition-related costs (1)

Account Receivables Reserves

Severance, integration and other expense

Foreign currency transaction gain

Write-off of deferred financing costs

Foreign currency transaction loss (gain)

Tax effect (2)

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Acquisition-related costs (1)

Account Receivables Reserves

Severance, integration and other expense

Foreign currency transaction gain

Write-off of deferred financing costs

Foreign currency transaction loss (gain)

Tax effect (2)

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● our operating activities provided net cash of $12.3 million for the year ended December 31, 2023.

Net cash provided from operations was primarily attributable to our net income after adjustments for non-cash charges of approximately $34.1 million partially offset by $23.0 million use of working capital primarily attributable to a $14.0 million change in accounts receivables and contract assets, a $7.2 million change in accrued expenses and other liabilities, a $1.0 million change in prepaid expense and other assets, a $0.7 million change in accounts payables;

Net cash provided from operations was primarily attributable to our net income after adjustments for non-cash charges of approximately $25.5 million partially offset by $13.2 million use of working capital primarily attributable to a $6.7 million change in accounts receivables and contract assets, a $6.5 million change in prepaid expense and other assets, a $4.9 million change in accounts payables, partially offset by a $3.8 million change in accrued expenses and other liabilities;

and $1.1 million change in contract liabilities;

● treasury share repurchases of $3.5 million;

● repayment of outstanding debt of $84.2 million;

● payments related to tax withholding for stock-based compensation of $2.7 million;

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● proceeds from revolving facility of $84.2 million;

● principal payments on borrowings of $4.3 million;

● payment of contingent consideration of $1.5 million;

● payment for Change 4 Growth acquisition of $3.5 million:

● payment for Ventana acquisition of $1.0 million:

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

● capital expenditures for property, plant and equipment of $3.4 million;

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The Company’s current outstanding debt may limit our ability to fund general corporate requirements and obtain additional financing, impact our flexibility in responding to business opportunities and competitive developments and increase our vulnerability to adverse economic and industry conditions.

On March 10, 2020, the Company amended and restated the 2020 Credit Agreement to include a $86.0 million term facility and to increase the revolving commitments per the revolving facility 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”).

Capitalized terms used but not defined herein have the meanings ascribed to them in the 2023 Credit Agreement:

● The revolving credit facility has a maturity date of February 22, 2028.

● 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 or (ii) Eurodollar Rate (adjusted for maximum reserves) as determined by the Administrative Agent (as defined in the 2020 Credit Agreement), 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 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 proceeds from asset sales by the Company and its subsidiaries, (ii) 100% of the net proceeds from issuances of debt and equity by the Company and its subsidiaries and (iii) 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 dispositions 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 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 $79.2 million and $74.5 million as of December 31, 2022 and December 31, 2021, respectively, which are carried at amortized cost.

The Company’s financial statements include outstanding borrowings of $79.2 million both as of December 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.

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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 December 31, 2022 and December 31, 2021, there were $9.0 million and $0.0 million borrowings, respectively, under the revolver.

In the third quarter of 2023, the Company borrowed $5.0 million against the revolver and subsequently repaid $5.0 million during that quarter.

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.

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 maintain liquidity, we may seek to sell additional equity securities or to secure additional debt financing.

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The Company was in compliance with its financial covenants under the 2023 Credit Agreement as of December 31, 2023.

On February 22, 2023, the Company entered into a third amended and restated senior secured credit facility comprising a $140.0 million revolving credit facility, amending and restating the 2020 Credit Agreement.

Employee Retirement Plans

For both fiscal years ended December 31, 2022 and 2021, we contributed $2.1 million, respectively, to our 401(k) plan (the “Savings Plan”) on a fully discretionary basis.

For the fiscal years ended December 31, 2023 and 2022, we contributed $0.0 million and $2.1 million, respectively, to our 401(k) plan (the “Savings Plan”) on a fully discretionary basis.

These amounts were invested by the participants in a variety of investment options under an arrangement with a third-party asset manager.

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Historically, we have found the application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in “Note 2—Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements.” We have identified revenue recognition as a critical accounting estimate:

Our accounting policies are more fully described in Note 2—Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.

We have identified revenue recognition as a critical accounting estimate:

Revenue Recognition

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In addition, from time to time, we enter into agreements with clients that limit our right to enter into business relationships with specific competitors of that client for a specific time period.

These provisions typically

prohibit us from performing a defined range of services that we might otherwise be willing to perform for potential clients.

These provisions typically prohibit us from performing a defined range of services that we might otherwise be willing to perform for potential clients.

These provisions are generally limited to six to twelve months and usually apply only to specific employees or the specific project team.

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See Note 2 to our consolidated financial statements included elsewhere in this report.

Quantitative and Qualitative Disclosures About Market Risk

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

Financial Statements and Supplementary Data

Reference is made to our financial statements beginning on page F-1 of this report.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

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-K

Item 7. Management’s Discussion and Analysis