III

Business Context and Reporting Period

Company: Information Services Group, Inc. (ISG)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2011
Business Overview: ISG provides technology insights, market intelligence, and advisory services to private and public sector clients. The company operates through three brands: TPI, Compass, and STA Consulting. During the quarter, ISG completed two significant acquisitions: Compass (January 4, 2011) and STA Consulting (February 10, 2011), expanding its global footprint to 21 countries with nearly 700 professionals.

Key Financial Metrics

Note: Debt figures reflect the balance sheet as of March 31, 2011, including $4.75 million in current maturities and $68.3 million in long-term debt.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 17% ($5.8 million) year-over-year, driven primarily by the acquisitions of Compass and STA Consulting. Europe revenue grew 56% and Asia Pacific revenue grew 45%, while Americas revenue declined 7% due to lower volumes in sourcing engagements and reduced business from a large auto client.
• Profitability Decline: The company reported an operating loss of $5.2 million compared to operating income of $1.7 million in the prior year. This shift was caused by a 38% increase in operating expenses ($12.7 million), largely due to acquisition-related costs, higher direct advisor costs, and $1.1 million in restructuring charges.
• Cash Flow: Net cash used in operating activities increased significantly to $9.0 million from $2.5 million. Investing activities consumed $8.0 million, primarily due to $13.5 million in acquisition costs (net of cash acquired). Total cash and cash equivalents decreased by $19.4 million from the prior quarter.
• Debt Structure: The company amended its credit agreement in March 2011, requiring mandatory principal repayments of $3.0 million in Q1 and additional payments throughout the year. Additionally, $6.3 million in convertible notes were issued as part of the Compass acquisition consideration.

Guidance, Outlook, and Risks

• Management Commentary: Management attributes the revenue increase to successful acquisitions and higher sourcing activity in Asia Pacific. They anticipate that integration-related cost synergies from the Compass acquisition will be realized over the next 3 to 6 months.
• Restructuring: A restructuring program initiated with the Compass acquisition resulted in $1.1 million in costs (recorded in SG&A) focused on workforce reductions and real estate consolidation. Remaining actions are expected to be completed within 3 to 6 months.
• Forward-Looking Statements: The filing includes standard disclaimers regarding risks such as foreign currency fluctuations, client concentration (top 20 clients accounted for 45% of 2010 revenue), and the ability to integrate acquisitions successfully.
• Market Risks: The company faces interest rate risk (a 100 basis point change would impact pre-tax results by $0.7 million annually) and significant foreign currency exchange rate risk, as 42% of revenues are generated outside the Americas.

Investor Verification Checklist

• Acquisition Integration: Verify the timeline and cost savings associated with the Compass and STA Consulting integration and restructuring programs.
• Client Concentration: Monitor the stability of the top 20 clients, particularly the auto sector, which represented 15% of 2010 annual revenue.
• Debt Covenants: Review the amended credit agreement terms, specifically the mandatory quarterly principal repayments and leverage ratio requirements.
• Convertible Notes: Track the stock price relative to the $4.00 trigger event for the $6.3 million convertible notes issued to Compass shareholders.
• Geographic Mix: Assess the sustainability of revenue growth in Europe and Asia Pacific versus the decline in the Americas.