Fair Isaac Corporation (FICO) Q3 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is Lita, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Third Quarter Earnings Call. [Operator Instructions] Thank you. Mr. Steve Weber, you may begin your conference now.

Thank you, Lita. 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. Today, we issued a press release that describes the financial results compared to the prior year. On this call, management will also discuss in comparison to the prior quarter in order to facilitate an understanding of the runway of our business. Certain statements made in this presentation may be characterized 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. This call will also include statements regarding certain non-GAAP financial measures. Please refer to the company's earnings release and Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measures. The earnings release and Regulation G schedule are available on the Investor Relations page of the company's website at fico.com or on the SEC's website at sec.gov. A replay of this webcast will be available through August 30, 2013. Now, I'll turn the call over to Will Lansing.

Thanks, Steve. Today, we announced the results for our third quarter of fiscal 2013. I'll briefly recap those results, talk about the performance of our different segments and give our view on the macro environment. In our third quarter, we reported revenue of $184 million, an increase of 15% over the same period last year. On a GAAP basis, we delivered $20 million of net income and earnings of $0.54 per share for the quarter, down 5% and 8%, respectively, from the same period last year. The GAAP results included a noncash tax charge of $0.07 per share. We delivered $29 million of non-GAAP net income and non-GAAP EPS of $0.80 per share, increases of 14% and 10%, respectively, from the same period last year. Recurring revenues throughout our business were strong again this quarter. We are pleased with the continued momentum we're seeing in our Scores business, which I'll discuss in a minute. One area of disappointment is the lengthening of the license sales cycle, particularly among North American banks. While we still feel the size and quality of our pipeline provides us with the ability to deliver against our previous guidance, we had expected to close more deals at this point in our fiscal year. As a result, we are adjusting our guidance down modestly. Mike will explain this when he reviews the financials, but first I'll discuss the results in each of our business segments. Our Application revenue this quarter was $115 million, up 17% from the same period last year. Most of the increase is attributable to the acquisitions of Adeptra and CR Software, but we continued to deliver very good results in fraud banking, which is up 14% year-over-year. As I said earlier, Applications is an area where we have seen delays in license sales. While we had a decent quarter, posting $13 million in license revenue, we had expected to close even more deals in Q3 but did not because of the lengthening sales cycle. Our Tools revenue was $22 million this quarter, up 7% from the same period last year. The increase was driven primarily by services revenue, as we work with our customers to implement and customize our Blaze and Xpress products. We are also seeing an increase in maintenance revenues as we reap the benefits of previous license sales and the high rate of maintenance contract renewals. Our final segment is Scores. We're very pleased with the results in this segment, and particularly with the momentum that we've seen in both the B2B and B2C portions of the business. As you know, this quarter we renewed our contract with Experian. While I won't go into details, I will say that I'm very happy that we extended our long-standing relationship serving U.S. financial services customers. I'm also thrilled that the new agreement allows us to offer U.S. consumers their FICO Scores based on Experian data. Our website, myFICO.com now offers consumer FICO Scores based on credit data from each of the 3 bureaus. Our B2C business was up 21% versus last year, including a modest benefit from the sale of Experian-based scores, which we began to offer in June. We will see a full quarter impact in the fourth quarter and expect to see continued momentum in our subscription business to consumers. On the B2B side, revenues increased 10% over the same period last year, due to increased volumes driven by stronger mortgage and auto lending. We've also seen modest improvements in the macro environment and are beginning to see other signs of growth in consumer lending, particularly as financial institutions seek to market their products and services to broader segments with consumers. Coming out of the recession, banks tended to offer credit primarily to consumers with high FICO Scores. Now as they begin to compete for the business with consumers with mid-range FICO Scores, we expect volumes to continue to improve. We've continued to move quickly to integrate the acquisitions we've made in the past year and expect them to make significant contributions to our revenue and margins in fiscal 2014, which we'll discuss next quarter. With that, I'll turn the call over to Mike for further financial details.

Thanks, Will, and good afternoon, everyone. Today, I'll emphasize 3 points in my prepared comments. First, our revenue this quarter was $184 million, a 15% increase over the same period last year and a 2% increase over the prior quarter. The increase from last year was primarily driven by our acquisitions, with about 1% of the growth coming organically. Second, we delivered $20 million of GAAP net income and free cash flow of $27 million. We repurchased about $48 million of stock this quarter, made a $49 million scheduled debt repayment and ended the quarter with $93 million of cash. Finally, we are revising our guidance today, moving the revenue range down slightly and adjusting net income to reflect this revenue change, as well as the noncash tax charge we took this quarter. Now I'll break revenue down into our 3 reporting segments. Starting with Applications, revenue was $115 million, up 17% versus the same period last year but down 2% from last quarter. Much of the increase from the prior year was due to the acquisitions of Adeptra and CR Software, which accounted for about $20 million of revenue in this quarter. In the second segment, Tools, revenue was $22 million, up 7% versus the prior year and up 20% versus the prior quarter. The year-over-year increase was primarily due to growth in services and maintenance revenue. License sales were flat with the same period last year but up 80% over last quarter. And third, in our Scores segment, revenue was $47 million, up 12% from the same period last year and up 7% from the prior quarter. As Will noted, we delivered very solid results in both B2B and in B2C. B2B was up 10% compared to the same period last year and 8% compared to last quarter. On the B2C side, we're continuing to see good growth, up 21% versus the same period a year ago and 4% versus last quarter. This quarter, our consumer business benefited modestly from the Experian agreement. And next quarter, we will see the full benefit. As we said last quarter, we see macro trends continue to improve steadily, although not dramatically. Looking at our revenue by region. This quarter's 72% of total revenue was derived from our Americas region, our EMEA region generated 19% and the remaining 9% was from Asia Pacific. Recurring revenue, derived from transactional and maintenance sources for the quarter, represented 70% of total revenues, consulting and implementation revenues were 18% of total and license revenues were 12% of total revenue. During the quarter, we recorded $22 million of license revenue versus $19 million in the prior quarter, with the increase driven by the Applications business. We are continuing to see delays in purchasing decisions by our customers, particularly among North American banks. We are still confident we will close these deals, but the delays may push some license revenue into our first quarter of 2014. Turning now to bookings. We generated $20 million of current period revenue on bookings of $70 million, a 28% yield, and the weighted average term for our bookings was 23 months this quarter. Of this $70 million in bookings, 22% relates to fraud solutions, 22% to decision management tools and 13% to collections and recovery solutions. We had 17 booking deals in excess of $1 million, 2 of which exceeded $3 million. Transactional and maintenance bookings were 28% of total this quarter; professional service bookings were 43% this quarter; and finally, license bookings were 29% this quarter. Turning to expenses. Operating expenses totaled $149 million this quarter compared to $146 million in the prior quarter or up $3 million. We expect the operating expenses to increase modestly next quarter with increased revenue. As you can see on our Reg G schedule, our non-GAAP operating margin was 25% for the third quarter versus 24% in the prior quarter. The initial margins associated with the acquired product lines are lower than historical FICO margins, and we expect operating leverage to improve as we fully realize expense synergies and grow these businesses. GAAP net income this quarter was $20 million versus $18 million in the prior quarter. Non-GAAP net income was $29 million versus $25 million in the prior quarter. The effective tax rate was about 31% this quarter, but includes a noncash tax valuation allowance charge of $2.5 million or $0.07 per share, associated with tax law changes in one of the larger states where we do business. We expect the effective tax rate to be about 31% for the full year. The free cash flow for the quarter was $27 million or 15% of revenue compared to $31 million or 18% of revenue in the prior quarter. Year-to-date, our free cash flow is $78 million. We have $93 million in cash and marketable securities on the balance sheet. This is down $38 million from last quarter, primarily due to our share repurchases and the debt retirement, offset by increases in cash generated from operations. Our total debt is $485 million with a weighted average interest rate of 5.7%. We made a $49 million principal payment in May on our notes and now have a $30 million balance on our $200 million revolving credit facility. The ratio of our total net debt to adjusted EBITDA is 2.1x, below the covenant level of 3x. And our total fixed charge coverage ratio is at 4.5x, well above the covenant level of 2.5x. During the quarter, we returned $48 million in excess cash to our investors through our stock repurchase plan. We repurchased approximately 1 million shares at an average price of $48.51. We still have $102 million remaining on the current board authorization and continue to view share repurchases as an attractive use of excess cash. We also evaluate opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio and competitive position. Now on the guidance. When we've provided guidance at the beginning of the year, we anticipated revenue to grow from our acquisitions, from the recurring revenue associated with our installation base and from new license sales generated from our products. While we are performing at or above our expectations on the first 2 areas, we expected more growth in license revenue than we've seen so far this year. We continue to pursue many pipeline opportunities, some of which are substantial. But because we are seeing delays in purchasing decisions, we are revising our annual guidance down modestly to reflect this uncertainty around the timing of these deals. We now believe our total revenue for the fiscal year will fall between $755 million and $765 million compared to our previous guidance of $760 million to $770 million. And GAAP net income will be $94 million to $97 million versus the previous guidance of $100 million. This change includes the impacts of the $2.5 million tax charge. New GAAP EPS guidance is $2.61 to $2.70 versus our previous guidance of $2.80. This new guidance reflects an annual diluted share count of approximately 36 million shares. On a non-GAAP basis, we now expect to deliver $125 million to $128 million of non-GAAP net income compared to the previous guidance of $128 million, and non-GAAP EPS of $3.48 to $3.57 a share compared to the previous guidance of $3.60 a share. As always, we continue to manage our expenses wisely, while investing in our internal growth initiatives. I'll now turn the call back to Steve for question-and-answer. Steve?

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

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

Gentlemen, the first -- just the details, in terms of the $20 million, I think you said contribution from acquisitions, how did that split between Adeptra and CR Software?

Manav, Adeptra was roughly 70% of that $20 million. There was roughly another $5 million from CR and the rest from the other 2 small deals.

Okay. All right. Fair enough. Now on the Scores side, you talked, obviously, this quarter you had some nice benefit from mortgage and auto. And I guess going forward, you're seeing some modest improvement in the consumer side. Now with the mortgage headwind for the second half of the year, is there -- like how should we read in terms of the -- either the sequential or year-over-year growth on the B2B side, at least? I understand B2C will see that benefit from the Experian deal.

Yes. On the B2B side, we're continuing to see modest growth, and I would expect our fourth quarter on the B2B side to be somewhat flat or potentially down depending upon the timing of the slowdown in some of the mortgage refinancing. We're not seeing that rapidly in the near term, but there is a possibility we see some flat or downtick on the B2B side for that region.

Okay, fair enough. And I guess, last question. Nice to see you guys back in the buyback market. Just curious on is that sort of an indication that the M&A activity will slow down or pause for now? Or is it just that there aren't that many deals in the horizon? Anything to read into that?

Manav, the answer to that is it's -- is the same as the answer we've had, which is we look at acquisitions on a somewhat opportunistic basis, and we can't completely control the timing of when the right deal comes along. And so where we have the cash available and we don't have the deal, we're in buyback mode. And now and then, the buybacks are going to be suspended when we need to use the cash for acquisition. So I would not read too much into the fact that we bought a bunch of stock this quarter. That could be different next quarter or we could buy a bunch more. I mean, I really can't say.

Your next question comes from Carter Malloy.

This is Lauren Slabaugh in for Carter. Quick question on what you mentioned about the lengthening of the license sale cycle. Could you just give a little more color on what's going on behind the scenes at some of the big banks to cause this?

I think that is a combination of 2 things. It's a combination of the environment that our customers are operating in, and we all know that environment. And so there's a little more complexity to their side of the equation. And I think the other part of it is the way we're going at our deals. We're looking at larger deals, and they naturally take longer to get done. And so it's a combination of both factors.

Okay. That's helpful. And then moving over to the Scores business. Could you just go a little bit about the health of the prescreen and marketing business there?

Yes. On the prescreen side, we've seen some modest growth over the last 3 quarters in a row on volumes that are being pulled for acquisition and marketing purposes. This quarter, we saw 8% growth over last year on volume acquisitions. And year-to-date, we're up modestly, about 4% on a year-to-date basis. We have seen more of the actual revenue growth, though, coming on the origination side, and that's been tied more to the mortgage and the autos. So I would say modest improvement, nothing eye-popping and off the charts, but several quarters in a row of continued growth is well accepted here.

[Operator Instructions] There are no further questions at this time. This concludes today's conference. You may now disconnect.

Thank you.