Fair Isaac Corporation (FICO) Q3 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Kyle, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the FICO Third Quarter Earnings Conference Call. [Operator Instructions] Mr. Weber, you may begin your conference.

Thank you, Kyle. Good afternoon, and thank you for joining FICO's Third Quarter Earnings Call. I'm Steve Weber, Vice President of Investor Relations, and I'm joined today by our CEO, Will Lansing; and our CFO, Mike Pung. You'll find on the Investor Relations portion of the FICO website a copy of today's news release, our Regulation G disclosure schedule and our financial highlights. While our press release describes financial results compared to the prior year, today management will also discuss results in comparison to the prior quarter in order to facilitate understanding of the run rate of our business. Certain statements made in this presentation may be characterize as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve many uncertainties that could cause actual results to differ materially. Information concerning these uncertainties is contained in the company's filings with the SEC, in particular, in the Risk Factors and Forward-Looking Statements portions of such filings. Copies are available from the SEC, from the FICO website or from our Investor Relations team. In order to provide additional information to investors, we will use certain non-GAAP financial measures on this call. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, entitled Regulation G Disclosure, is available on the Investor page of our website under the Presentations tab. A replay of this webcast will be available through August 25, 2012. And with that, I'll turn the call over to Will Lansing.

Thanks, Steve. Today, we announced the results of our third quarter of fiscal 2012. I'll briefly summarize those results and then discuss some of the exciting things we've been working on and what they mean for the growth of the business. I'm pleased to report we had a solid third quarter. Our revenue of $160 million was an increase of 7% over the same period last year. We delivered $21 million of net income and earnings of $0.59 per share versus $0.58 last year. I'm also pleased to report that we are increasing our full year guidance, which we'll detail later. As we've stated in prior discussions, we're continually weighing share repurchases against the possibility of acquisitions in order to achieve the greatest long-term return on capital. This quarter, we managed to do both. Mike will provide details on the share repurchases in a few minutes, but I'd like to talk about our acquisition this quarter of Entiera, which gives FICO a SaaS-based next-generation marketing automation platform. This is especially important in today's environment where marketing executives spend nearly as much on technology as CIOs as they struggle to keep up with rapidly evolving digital, social, mobile and interactive technologies and exploding volumes of structured and unstructured data. Since completing the acquisition in May, we've already made significant progress on integrating the Entiera platform with FICO's existing marketing decision management technologies. In fact, the acquisition has accelerated FICO's Marketing solutions product roadmap significantly. Soon, FICO will usher in a new era of analytically driven, big data multichannel campaign management, providing a combination unmatched in the industry today. In concert with the product integration, we've already begun migrating a number of large existing FICO customers to the new platform. This will enable these clients to benefit from a more functionally rich, efficient and high-performance campaign management solution. This acquisition will also serve as the vehicle for FICO to expand the reach of our marketing solutions into new industry verticals. The software-as-a-service delivery model we've acquired will also provide the means to deliver FICO's proven high-end marketing analytics products to mid-market clients in a highly competitive manner. As I said last quarter, we set the bar high as we evaluate potential acquisitions. I think Entiera provides a good illustration of what we look for. First, it's important that whatever we're acquiring must be able to be integrated quickly and efficiently with our existing product base, enhancing the functionality of our core products. Second, we look for opportunities to leverage our global sales force and extensive customer base. If we can find companies with products that provide our customers with additional capabilities that are closely adjacent to those of our current companies, we believe such an acquisition will help us take additional market share. Third, we look for products that are growing in terms of revenue and market share and have room for further growth. Finally, we keep a keen eye on valuation. And again, this is where we constantly weigh the value of acquisitions against investing in our own business, either through share buybacks or through internal development and operations. As I said last quarter, I'm convinced we're in a great position to capitalize on opportunities inherent in big data. You might not know it from the hype, but the real value in big data is not going to come from relaxing constraints on data storage and processing. The real value in big data lies in the ability to extract value from incremental data sets of increasingly marginal utility and ultimately make smarter business decisions. Nobody knows how to do that better than FICO, and we're moving quickly to seize the opportunity. So with that, I'll now pass the call to Mike for further financial details.

Thanks, Will, and good afternoon, everyone. Today, I'll emphasize 3 points in my prepared comments. First, we had a solid third quarter, delivering $160 million of revenue, a 7% increase over the same period last year. And although we remain concerned about events in Europe, these concerns are balanced by continuing improvement in the U.S. scores business while our software pipeline is strengthening worldwide. Second, we've now delivered $71 million of net income year-to-date, about as much as what we delivered in all of fiscal 2011. And with the repurchases this quarter, we've now retired more than 5 million shares this fiscal year. Finally, we are increasing our annual guidance today. Even with lingering uncertainty in Europe, we believe we have sufficient visibility to be confident in increasing our revenue and net income and EPS ranges. So for the quarter, revenue was $160 million, a $10 million increase over the prior-year period and a $1 million increase over the prior quarter. I'll break down the revenue into our 3 reporting segments. The first segment, Decision Management applications. Revenue from these applications was $98 million, up 2% from last quarter and up 7% versus the same period last year. While we saw strength across most of the portfolio, we achieved particularly strong results in our TRIAD and IFM products, driven from software license sales and the related implementation services. Moving on to Scores. Overall, our scores revenue was $42 million, flat with the prior year and down 6% from the prior quarter. We trap -- we track the subsegments here by B2B, which are scores sold to financial institutions, and B2C, which are scores sold directly to consumers. The B2B scores subsegment performed very well, up 4% from the same quarter last year as we continue to see health in the business improve. Year-to-date, our B2B scores business is up 7% over the last year. Couple of highlights include our Originations have continued to steadily trend upward. This quarter, Originations revenue was up 13% over the prior year. This is driven primarily from auto and mortgage originations which were particularly strong. We continue to work with customers on the adoption of FICO 8, which is now being used by more than 8,300 lenders. And from an innovation standpoint, we recently introduced 2 products into the market: The newest FICO Score version in Canada, which was developed using recent Equifax credit data and includes mortgage data for the first time. It's based on the FICO 8 score blueprint, and shows up to 6x more lift than that offered by a typical score redevelopment. We also introduced a new high-performance consumer credit risk score, FICO Mortgage Score powered by CoreLogic, that is expected to improve the quality of lending decisions and increase the number of mortgage loans lenders make by evaluating traditional credit data from the national credit data repositories along with unique supplemental consumer credit data contained by CoreLogic in the core score. Finally, Decision Management tools. Revenue in this segment was $20 million, up 20% versus the prior year and an increase of 7% versus the prior quarter, making it the highest-revenue quarter for tools in more than 3 years. The increase was driven primarily from several large deals for FICO Blaze Advisor and our optimization products. Looking at our revenue by region, this quarter 75% of total revenue was derived from our Americas region, the same as the prior quarter. Our EMEA region generated 18% in both this and the prior quarter, and the remaining 77% was from Asia-Pacific. In terms of by revenue type, recurring revenue derived from transactional and maintenance sources for the quarter represented 71% of total revenues versus 72% in the prior quarter; consulting and implementation revenues were 20% of total versus 19% in the prior quarter; and license revenues were 9% of total revenue, the same as last quarter. Now turning to bookings. We generated $17 million of current-period revenue on bookings of about $58 million at 29% yield. This compares with $18 million of revenue on bookings of $78 million, a 24% yield on the prior quarter. The weighted average term for our bookings was 16 months this quarter compared to 23 months in the prior quarter. Of the $58 million in bookings, 25% was related to tools, 22% was related to our origination solutions, 20% related to fraud and 12% related to customer management solutions. We had 8 booking deals in excess of $1 million, 2 of which exceeded $3 million. Transactional and maintenance bookings were 28% of total versus 37% in the prior quarter. Professional services bookings were 52% this quarter compared to 44% in the prior quarter. And finally, license bookings were 20% in this quarter versus 19% in the prior quarter. Operating expenses totaled $123 million this quarter, up $2 million from the prior quarter. Quarter 3 includes costs associated with the acquisition of Entiera, costs associated with increased personnel and a onetime true-up related to royalties paid to a third party. We expect operating costs in quarter 4 to be consistent with our third quarter as we absorb a full quarter for the acquisition and increased personnel expenses. As you can see in our Reg G schedule, non-GAAP operating margin before amortization and stock-based comp was 28% percent for the third quarter and is 38 -- and is 30% year-to-date, in line with our expectations. GAAP net income this quarter was $21 million, and the effective tax rate was about 31%. We expect the effective tax rate to be about 32% to 33% for the full fiscal year. In terms of free cash flow, we define it as cash flow from operations less capital expenditures and dividends paid. Free cash flow for the quarter was $16 million or 10% of revenue compared to $36 million or 23% of revenue in the prior quarter. Free cash flow this quarter was impacted by the timing of receipts of payments, including a large quarterly tax payment and an extra payroll pay period during the month of June. Now moving on to the balance sheet, we have $151 million in cash and marketable securities. This is down $40 million from last quarter due to share repurchases and the acquisition of Entiera. Our total debt is $504 million, with a weighted average interest rate of 6.1%, and the cost of our debt remains fairly fixed at about $8 million per quarter. The ratio of our total net debt to adjusted EBITDA is 2x, which is below the covenant level of 3x. Our total fixed charge coverage ratio is at 4.3x, all above the covenant level of 2.5x. We continue to have no borrowings under our line of credit facility. We repurchased 836,000 shares in the third quarter at a total cost of $34 million or $40.71 per share. Our basic shares outstanding were $33.7 million at the end of the quarter, down from $37.1 million at the beginning of the year. The repurchases this quarter exhaust the board authorization from last fall. We continually evaluate the best way to deploy excess cash to maximize shareholder value and consider our share repurchase plan a very attractive use of our cash flow. And as we previously stated, we also regularly evaluate and consider opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio and competitive position. Finally, we are increasing the guidance we gave today at the beginning of the year. Based on our results and the visibility into our baseline and new deals in the fourth quarter, our new guidance is as follows. Revenue guidance has been increased to $650 million to $655 million for the year, up from the previously guided $640 million to $645 million. Net income guidance increased to $90 million to $93 million on a GAAP basis, up from the previously guided $86 million to $89 million. And GAAP earnings per share guidance has increased to $2.50 up to $2.60, an increase from the $2.45 to $2.55 we previously guided. As you recall, the original guidance was based on 35 million shares outstanding. We now believe our average share count for the full fiscal year will be closer to 36 million, primarily due to the dilution related to in-the-money options. These additional shares, about 1 million in total, are added to the total diluted share count when we compute EPS. With that, I'll turn the call back to Steve for question-and-answer.

Thanks, Mike. This concludes our prepared remarks, and we're ready now to take your questions. Kyle, please open the line.

[Operator Instructions] Your first question comes from Manav Patnaik from Barclays Capital.

So firstly, on the scores, so clearly, I mean, based on the commentary, I mean, the B2B business was up, I guess, 4% is what you said. So I just wanted to get some color on how, I guess, poorly the B2C segment performed. Because given the easy comp you had from last quarter and if everything seems to be sort of getting better from the second quarter that you had, why the total performance wasn't as good?

What we're doing in the B2C business is essentially rebuilding it. We've rebuilt some of the team there. We've moved the location into the heart of Silicon Valley where we think we can pick up the kind of talent that we want for a consumer-facing business like this. And so we don't see the decline that we've seen this quarter continuing for long. What we see is a rebuild in that business.

So can you give us some numbers around how bad the decline was and relative to the last few quarters?

Yes, let me give you an idea, Manav. This quarter on the B2C side, we delivered about $9.3 million of revenue. That compares to about $9.6 million in the second quarter, and first quarter was $9 million. So we basically landed on around $9 million to $9.5 million. And that's been our run rate as of recent on the B2C business as we're investing back into the organization.

And how about for the same quarter last year?

Certainly, last quarter, third quarter B2C was at $10.3 million. So we're down about $1 million from same period last year.

And I guess just trying to understand the decline. Is that -- I mean, I guess, to some extent you said you're focused on, I guess, restructuring the business to some extent, but is most of that decline, I guess, retention-related, like people just not signing up for these things anymore?

Actually, our retention is improving but we've dramatically reduced our SEM efforts, our customer acquisition efforts, while we transition to a new platform and evaluate the strength and profitability of the programs. And so, as I said, I think we're in a rebuilding mode, meaning our analytics around it are getting better. We understand our programs better today than we did in the past. And we believe that we'll be in a position to ramp up our marketing spend and our customer acquisition efforts there in the future. Right now, we're running at a reasonably low customer acquisition SEM customer acquisition program and relying more on SCO.

Okay. And I guess what sort of timeline should we expect the refocus to start next year, next fiscal year or calendar year? Or how does that...

Well, I would say in the next fiscal year you can expect improvement.

And then on the M&A, I mean, clearly, Will, since you came in, I guess almost pretty quickly you made the first acquisition. I just wanted some color -- I guess 2 things. Firstly, what sort of timeline or goal should we be looking for in terms how well Entiera is being integrated and how that's helping, I guess, the marketing portfolio that you guys have? And the second part would be just sort of how would you describe the pipeline, whether it's the number of companies you have that you're looking at or just a general feel of what the opportunity looks like?

I think that probably the right way to evaluate it -- because what we're doing is we're integrating it very quickly. We're really going to market together. So the notion of kind of breaking out Entiera and looking at it separately is not a good way to look at this business. So I think the right way to evaluate the wisdom and successfulness of -- the success of this acquisition is to look a year from now at whether our marketing solutions business is stronger a year from now than it is today. Because that's how we think about it. And so we go to market together with them. If you think about what it is that we bought here, besides the terrific management team, we got really nice technology and a nice platform. We -- our solutions, our marketing solutions, are tremendous on the analytic side, but we -- I think we are best-in-class in if you want to think about it as segmentation of one and that kind of analytics. And what Entiera brings to the party is tremendous campaign management, the ability to have an interactive dialogue with the consumer that makes operational the analytics that we've put in place. And so taking those to market as a package, working with our clients together on that, we think is the right way to do it. We sell the products, our Retail Action Manager products, together with the Entiera Insight products. And we've actually -- we've only been owners of Entiera for a very short time, we've already sold our first deal together. So we are very bullish on the way this is going to work out.

Okay. And then just generally on the health of the pipeline, the acquisition pipeline.

So the health of the pipeline has been very good, before we bought Entiera and even now today of course. We have several large deals that we are working on with respect to our PMM and our marketing group. I'm not planning to break out any specific numbers at this point in time, but the pipeline and marketing is very strong, Manav, if that's what your question is.

Your next question comes from the line of Carter Malloy from Stephens.

So another quarter of sequential uptake in the tools business. Should we sustain this type of growth and lift it forward? Or are you looking for the acceleration to come more on the application side of business?

It's a fairly balanced pipeline we have, Carter, between tools and apps, and so I wouldn't take one or the other and accelerate it per se. Our tools business, as you know, can kind of bounce around and be lumpy based upon large deals that happened to get signed. And we signed a couple of very nice big deals this quarter and, in part, that's what pushed our revenue up to the $20 million. We also are in the midst of a lot of implementation work, and services revenue on the tool side has been very strong. So I think the guidance we laid out at the beginning of the year for all of our software companies is probably the right way to look at both of them.

Okay. And then going forward, and I asked this and you're probably going to say no anyways, but looking at 2013 or going forward for next 12 or 18 months, especially taking into account the lumpiness of the business like you said and the European exposure, do you guys anticipate that we can sustain these types growth rates for the software side of business?

Well, we'll be -- we're in the middle of doing our planning for next fiscal year. We feel pretty good about our fourth quarter and pipeline beyond that. And our intention in the long term remains the same as it was when we started the year out, which is the growth rates in the 5% to 7% being sustainable, and we don't have anything to change today with regards to that. And when we deliver our fourth quarter results here in a few months, we will update everybody on the guidance at that point.

Okay. And then one more model question for you, Mike. We've seen R&D normalizing back out a little bit. And as we think about that over the next year or 2, I think you've spoken publicly a little bit about this already, but should we be looking at R&D as a percent of revenue in the 9% or even 10% range or even higher than that going forward? Or should we hold it back, continue holding it back?

Yes, so good question. When we took the restructuring and drove -- 1.5 years ago and we drove some of the margin expansion, some of -- a couple of percentage points came out of the R&D line. At that point, we made the comment that we expected to invest some of that margin expansion back into the business modestly as opportunities arose. A little bit is coming back in right now. We are at about 9%. I still think over the near term, 9% to 10% is probably a good way to look at it from your modeled perspective.

[Operator Instructions] Your next question comes from Ty Lilja from Feltl and Company.

First, I was curious about the TRIAD upgrade announced last week. I was wondering if you could talk about the features of that and kind of what the outlook is for that product line.

Sure, Ty. This is Mike here. We had a great quarter at TRIAD. Sold several deals this quarter and had a very strong quarter. We recently released TRIAD 8.6. In simple terms, what 8.6 does is it provides our customers with the ability to do more advanced modeling and more detailed modeling around scenarios that underlie the strategies that they're trying to execute on. We increased the number of potential scenario opportunities tenfold, from literally 1,000 to 10,000 different scenarios, making the application itself more powerful and flexible to the banks. We also, in coordination with that, expanded some functionality that allows our clients to manage small business portfolios at a much more granular level than what the prior version of TRIAD did. So generally a right-of-dot release, but a very powerful release for those who are modeling many, many different types of scenarios as they are looking for ways to grow profitably.

Do you think the upgrade gives you the potential to generate some more revenue from that business? Or is it kind of holding on to what you have and waiting for transactions to pick up?

Well, I think it's a little of both. I mean, we obviously have a very big TRIAD installation base, and credit card growth will drive the volumes just organically within the base. This functionality provides some additional features that keeps us way ahead of the market in terms of any competition and hits the sweet spot of some of the banks who are looking at managing the profitability of their portfolios, which is increasingly a bigger and bigger priority.

Okay, sure. And also, I was wondering if you could just give an update on where you're at in the Falcon upgrade. I know it's been kind of an ongoing process.

Yes, we went through a couple of major upgrades with Falcon last year. That was the heavy Falcon upgrade year, if you will, for us. We continue to add functionality right of dot. I believe we're at 6.1.4, and we probably have a couple of other right-of-dot upgrades for the remaining part of this calendar year that are basic functionality that's building out this suite of products. But we don't really have any major upgrade that's on at least the near 6-month horizon.

Okay. And I was wondering too, could you just -- if there's any new news around your health insurance fraud product.

Sure. Our Insurance Fraud Manager product is performing very well. We had a very large sale this quarter through one of our processors, and we have several others that are in the works. And the product is performing very well. We're continuing to do again, right-of-dot upgrades and pushing the distribution channels. So we had a real good quarter in IFM.

[Operator Instructions] There are no further questions at this time.

Thanks, Kyle. This concludes today's conference call. Thank you all for joining.

Thank you.