Fair Isaac Corporation (FICO) Q1 2014 Earnings Report, Transcript and Summary

Good morning. My name is Jeremy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Quarterly Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Steve Weber. You may begin.

Thank you, Jeremy. Good morning, thank you for joining FICO's First 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. Yesterday, we issued a press release that describes financial results compared to the prior year. On this call, management will also discuss results in comparison to the prior quarter in order to facilitate an understanding of the run rate 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 for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measure. 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 February 23, 2014. Now I'll turn the call over to Will Lansing.

Thanks, Steve. First, I'd like to thank everyone for joining us this morning. We're holding our call this morning due to travel schedules. We do expect to conduct our call next quarter at our typical time of 5:00 p.m. Eastern. Today, we announced the results for our first quarter and fiscal 2014. I'll briefly recap those results and then talk about some of the exciting things we've been working on, and how we're measuring our progress. In our first quarter, we reported revenue of $184 million, a decrease of 3% over the same period last year. On a GAAP basis, we delivered $17 million of net income and earnings of $0.47 per share for the quarter versus $23 million and $0.66 per share from the same period last year. We delivered $26 million of non-GAAP net income and non-GAAP EPS of $0.73 per share, decreases of 18% and 17%, respectively, from the same period last year. These results were in line with our expectations as we had an exceptionally strong comparison with our fiscal 2013 fourth quarter. Mike will provide more detail on the numbers. But first, I'd like to update you on the progress we're making in the number of areas. We made significant progress with our cloud initiatives in the last quarter. The first part of our cloud efforts has been focused on making our applications available on a SaaS basis. We now have new software-as-a-service versions of our key products. This quarter, we sold our first 2 Origination Managers SaaS deals and a large debt manager SaaS deal. While SaaS deals don't generate upfront revenue in the quarter they are signed, they had recurring revenue in the future periods. Importantly, these deals did not cannibalize our legacy products. They were new customers that require SaaS delivery, providing early validation of our strategy of growth by exploiting new delivery channels. Mobility has become an important component of our SaaS applications and represents a growth opportunity beyond our core applications. Our Mobility offerings built around our Adeptra acquisition have expanded the utility of both on-premise and new cloud offerings. We have deployed new SaaS delivery infrastructure domestically and internationally, and we'll add to our infrastructure as demanded by the market. The second thrust in our cloud effort is to make our analytics IP available on a Platform as a Service. Where traditionally our analytic tools were available only for on-premise use, today, we can offer the most sophisticated analytic tools in the cloud environment. We call this the Decision Management platform which includes, among other things, components for developing analytic models, optimization algorithms and decision services. We also sold our first Retail Fraud Manager solution. Retail Fraud Managers are new FICO application that we developed in-house. It's targeted at retailers and key outsourcers for the retail industry, protecting them from the costly problems of returns, fraud, waste and abuse. I'm also happy to report on several developments in our Scores business. First, we announced in November a renewed multiyear agreement with Equifax, which will continue reselling FICO Scores and provide FICO access to its consumer data so we can develop and market new analytics. As part of the new agreement, FICO will now be able to sell FICO Scores directly to lenders and third party resellers. Consumers will continue to have access to their FICO Score based on Equifax credit data at myfico.com and on Equifax's consumer site. FICO Scores based on Equifax credit data will now also be made available to consumers through third parties. We also introduced our FICO Open Access program, which allows any lender to share the FICO Score with their consumers at no additional score fee, the same FICO Scores used by participating banks to manage their accounts. In addition to their FICO Score, the standard measure of U.S. consumer credit risk, these customers will see the 2 most important factors affecting their score, as well as FICO educational materials, to help them better understand credit scoring and what behavior impacts their FICO Score. Currently, we have commitments from Barclaycard US, First National Bank of Omaha, Discover and others to roll the program out to more than 35 million U.S. consumers, and we expect more banks to follow in the coming months. The program has been widely praised by consumer advocacy groups and regulators as a means to offer transparency to consumers looking to understand their credit situation. Participating banks have viewed it as a significant value add to the consumer. The FICO Score is being used to drive higher consumer engagement, higher perceived value in the banking relationship and perhaps even better consumer management behavior. We believe consumers benefit first by better understanding how lenders perceive them and second, through the extensive educational materials available to them through the Open Access program. We think consumers also benefit by understanding how the FICO Score, the score that lenders use, differs from education scores that sometimes appear on the market. We expect all of our initiatives to bear fruit as we move through 2014. We're laying the framework with these long-term programs for FICO to grow and flourish in the years ahead. We will continue to update you in the coming quarters and we'll be reporting new metrics to measure our progress, particularly as we see more SaaS customers coming on board. I'll now turn the call over to Mike for further financial details.

Thanks, Will, and good morning, everyone. Today, I'll emphasize 3 points in my prepared comments. First, our revenue this quarter was $184 million, a 3% decrease from last year. Our Scores business grew 9% and our Tools business, where we signed several large license deals that slipped from our fourth quarter, grew 15% from the prior year. Second, we delivered $17 million of GAAP net income this quarter and $26 million of non-GAAP net income. Our free cash flow was $26 million for the quarter. Finally, we repurchased about $25 million of stock this quarter, and ended the quarter with $96 million of cash with ample liquidity to pursue our investment strategy. Now I'll break the revenue down into our 3 reporting segments. And starting with Applications, revenue was $112 million, down 10% versus the same period last year. Much of our Applications growth was due to the acquisition of Adeptra, which grew 23% from last year, and CR Software, which grew 4% from last year. Declines in our Marketing Solutions business where we experienced some customer attrition earlier in fiscal 2013 and in customer management and fraud banking which had some large license sales in the previous year, offset the increase from our acquisitions. Finally, we signed several license deals that slipped in our fourth quarter with several other large deals from that period still in play. In our second segment, Tools, revenue was $25 million, up 15% versus the prior year and flat with the prior quarter. This segment continues to be an area of strength for us, which grew at double-digit rate in 2013. And finally, in our Scores segment. Revenue was $47 million, up 9% from the same period last year and up 2% from last quarter. On the B2C side, we're up 22% versus the same period a year ago, and down 3% versus last quarter. The B2B revenues were up 5% from the same quarter last year and up 4% compared with last quarter. The increase was primarily due to a global FICO Score deal we signed with a large customer in Latin America. Looking at our revenue by region. This quarter, 74% of total revenue was derived from our Americas region. Our EMEA region generated 19%, and the remaining 7% was from Asia Pacific. Recurring revenue derived from transactional and maintenance sources for quarter, represented 70% of total revenues. Consulting and implementation revenues were 19% of total revenue and license revenues were 11% of total revenue. Turning now to bookings. We generated $20 million of current period revenue on bookings of $84 million, a 24% yield. The weighted average term for our bookings was 23 months this quarter. Of the $84 million in booking, 15% relates to collections and recovery, 14% to originations solutions, and 11% to banking fraud solutions. We had 16 deals in excess of $1 million, 4 of which exceeded $3 million. Transactional and maintenance bookings were 29% of total this quarter. Professional service bookings were 55% this quarter. And finally, license bookings were 16% in the quarter. Turning to expenses. Operating expenses totaled $149 million this quarter compared to $140 million in the prior quarter, or up $9 million. The increase relates to our performance-based incentives. We also incurred a restructuring charge this quarter related to eliminating some headcount, focused on lower priority areas and plan to reinvest the savings towards higher priority investments during the year. We expect operating expenses to increase modestly over the next several quarters. As you can see in our Reg G schedule, non-GAAP operating margin was 27% for the first quarter versus 28% in the fiscal 2013. GAAP net income this quarter was $17 million versus $29 million in the prior quarter, and non-GAAP net income was $26 million versus $35 million in the prior quarter. The effective tax rate was about 37.5% this quarter, higher than the 31% we guided due to the expiration of the R&D credit, a onetime state audit adjustment, and a onetime tax adjustment related to our foreign operations. We expect the effective rate to be in about the 33% to 34% for the full year, unless the R&D credit is reinstated before the end of our fiscal year. Free cash flow for the quarter was $26 million or 14% of revenue, compared to $19 million or 10% of revenue in the prior year. Moving to the balance sheet. We have $96 million in cash on the balance sheet. This is up $13 million from last quarter due to increases in cash generated from our operations, as well as proceeds from options that were exercised, somewhat offset by share repurchases. Our total debt is $478 million, with the weighted average interest rate of 5.8%. We now have a $23 million balance on our $200 million revolving credit facility. The ratio of our total net debt to adjusted EBITDA is at 2x, which is below the covenant level of 3x. Our total fixed charge coverage ratio is at 4.7x, which is well above the covenant level of 2.5x. During the quarter, we returned $25 million in excess cash to our investors by repurchasing about 440,000 shares at an average price of $57.06 per share. We still have about $40 million remaining on our current board authorization, and continue to view share repurchases as an attractive use of our cash. We also evaluate the opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio in competitive position. Finally, we are reiterating our previous guidance as follows: revenue range from $763 million to $773 million, GAAP net income of $91 million to $94 million and corresponding non-GAAP net income of $125 million to $128 million, GAAP EPS of $2.50 to $2.60 per share and corresponding non-GAAP EPS of $3.46 to $3.56 per share. With that, I'll turn the call back to Steve for questions and answer.

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

[Operator Instructions] Your first question comes from the line of Manav Patnaik from Barclays.

This is actually Greg calling on for Manav. I'd like to start with the Scores, which you saw a nice quarter and you said a lot came from the large Lat Am contract. Can you just talk to the momentum you've seen in credit cards and if your expectations have changed for the rest of 2014?

Yes. Thanks, Greg, and good morning. We did have a large deal in Latin America. The first in the country that we signed a deal in. As it relates to the ongoing flow of the business, we had a strong pre-screen or acquisition score quarter, almost across the board compared to the prior quarter. So we're continuing to see momentum now on acquisition scores that are being used for marketing purposes. That was somewhat offset by our higher valued online Originations score where fewer accounts were originated during the quarter. And as a result, the ongoing momentum of the business was down slightly from the prior quarter.

Okay. And maybe a little bit on the M&A environment here, and I know you're about a year into integrating both CR Software and Adeptra, and what you're seeing and if there's any particular niches of interest that you're focusing on?

Yes. So first, with respect to the acquisitions that we made, those are all fully integrated and running very smoothly and we're happy with all of them, have retained the management from those companies, and are really pleased about the way that goes on. In terms of M&A going forward, we're always evaluating M&A opportunity. We would love to complement our organic growth efforts with acquired growth. That said, we continue to be value conscious. Markets are -- frothy's probably too strong a word, but valuations are high. And so we remain very disciplined in the way we evaluate these things. But we're absolutely active in evaluating. The strategy has not changed. We focus on tuck-ins that extend our current core franchises. We're always open to adding a franchise if we can get it at the right value and with the right kind of growth prospects. And until that -- those are the kind of strengths that we use. Occasionally, we'll do a technology tuck-in like the Infoglide acquisition that we did. But in general, we're pretty happy with our organic technology efforts. We really have a very, very strong development team, strong engineering team and I just have an absolute factory of innovation going on here. So that winds up not being quite as much a focus for M&A.

That make sense. And maybe along those lines, as you're expanding your SaaS offerings and building up the analytic cloud, how much more investing do you think needs to be done there? And are there specific areas where there's additional focus that needs to be made?

We will continue to focus there. I mean, we have been focusing there, you see it in the fact that our net income is not growing as fast as it has in prior years because we're taking that money and redeploying it into investment in our business. That's almost entirely a function of the opportunity set that we got. We like investing in stock buyback, but when we see the opportunities that we have in developing products and services organically, they're really attractive. And so we continue to invest there. I don't see that stopping in the near future. At the same time, we don't see it ramping up dramatically. I think that we're trying to strike a balance between continuing the stock repurchase, a lot of fiscal discipline, some level of investment in the business. Could we invest more in the business than we do today? We could. We could. But it would be at the expense of net income. And it would have a P&L impact that we're not happy about. So we don't do that. We're disciplined about how much we invest. But it's not going to stop either. This isn't a onetime shot and then we're done. You can expect continued investment. I mean we're building a business for the long haul here.

Your next question comes from the line of Brett Huff from Stephens Inc.

This is John Campbell, in for Brett Huff. Just for the EPS guide, are you guys going with a particular tax rate, or does the low end of that range assume that 44% tax rate and then just the high end assume that 33%?

No. We're using about -- right down in the middle of it, between 33% and 34% now that the R&D credit was not renewed by the Congress.

Okay. And then, are you guys able to break out what percent of rev currently is categorized as SaaS, and then maybe if you could just talk about how that trends over time?

Yes. So we typically haven't broken out what percent is SaaS, but let me give you little order of context around our business. So over the years, we've had lines of business that we have offered on a hosted basis for our customers. And we are now supplementing those hosted long-term deals with new cloud offerings. So if you lump both our hosted business and our cloud business together, on an annual basis last year, we had just over $150 million of revenue of that nature. And it's concentrated in a couple of areas, particularly in our Marketing Solutions business where we host for almost all of our customers and in our Adeptra business which, of course, is a SaaS offering for all of our customers. Outside of those 2, then we have several smaller product lines where we host or provide a SaaS offering. Kind of outside of our environment, of course, we have long had the national processors host and run our TRIAD and broad products for us. And there's another $80-or-so million of business that's being hosted in a cloud, not by FICO for our customers, but by our partners, the processors. So we have a fairly extensive experience in this area through our legacy hosted businesses.

Okay, great. And then just last one for us. The CapEx kind of came in, I guess, relatively light this quarter. Is that anything to read into the rest of the year?

No, not really. Our CapEx is typically around $20 million to $25 million a year. And it ebbs and flows with the investments that we make internally in the technology. And we would anticipate our full year CapEx to be pretty similar to what it was last year. It's more of the timing.

[Operator Instructions] Your next question comes from the line of Kevin O'Keefe from Brown Advisory.

Just to follow up on the SaaS point that the previous caller was making, is there any way you can quantify what the dollar impact you had anticipated going forward from the deals that you signed this quarter?

Yes. So Kevin, thanks for calling in. This is Mike. So we haven't been, right now, quantifying our SaaS deal separately. This is the first quarter we signed deals both on the Originations side and the Debt Manager side. They basically are compiled as part of the bookings right now and rolled forward in the guidance that we provided. The size of these deals are in the $1 million plus range over a multiyear period of time. And so we don't expect this to have a material impact -- these 3 deals to have a material impact for us. We would anticipate as we start to grow the book of business that is SaaS, as the market starts to migrate for us into that direction, that we'll be providing more specific information on the legacy business in comparison to the SaaS business. But right now, it's not large enough for us to break out and not meaningful enough for the investors to trend forward.

Got you. And we all appreciate that additional break out. The reason I ask is -- on the application side, 2 of your 3 businesses did outstanding this quarter. But the upside, I feel like we've been waiting a few quarters for a large number of deferred contract revenue. I think following the CR and the Adeptra acquisitions, we would have expected higher rouse flowing through on the upside. And since your guidance is unchanged. It seems like it's still kind of in the cards, but I'd love to hear if -- kind of what's driving lower revs right now and what the outlook is moving forward?

I think that it still is in the cards. I think it's safe to assume that Applications business will look a little bit stronger. But the deals on that side, their license deals, they tend to be lumpier. The timing is a little bit trickier. The sales cycle is long, and so I wouldn't read too much into one quarter.

So you anticipate the deals that have been on hold dating to the last summer still in the pipeline, it's not that they haven't closed and -- or they have closed and other business deteriorated, they just had the sales cycles been extended?

Yes. I would -- I think that's a fair summary.

Okay. And just one more if you don't mind, we're really pleased to see you guys back in the market buying your stock back. And I think prior indications have been, in the absence of acquisitions, your preference is to use cash flow to buy in your stock. I'm just curious, how much capacity you have if you did happen to see an acquisition that you found attractive. Could you do it? Or would you -- do you need to replenish your cash on your balance sheet before you think about other acquisitions?

We could do it. We have capacity with our line and with cash on hand and with cash from operations to do a reasonably significant acquisition. And I would say never say never if using paper, although it's -- you know how we feel about it. We value it so much. We're busy buying it in. So it would have to be something reasonably remarkable for us to issue paper to do. But we have the capacity without -- to do a pretty meaningful acquisition without issuing any stock.

That's great to hear. And so -- if I think about your thoughts on capital management, is it safe to say that you think about free cash flow as the engine to purchase in stock, and then you have the flexibility at this point to do a deal and lever up modestly if you have to?

That's exactly right.

[Operator Instructions] Your next question comes from the line of Matthew Galinko from Sidoti. Matthew Galinko - Sidoti & Company, LLC: So I'm just curious if you could show anymore color around the cloud bookings in terms of the duration of those. Is it -- can you say if it's greater than sort of the overall bookings term or less?

Slightly greater, Matthew. The overall booking term was about 2 years. This is -- the SaaS offerings in here were slightly longer than that. Matthew Galinko - Sidoti & Company, LLC: Okay. And can we sort of read into that being moving up then in the future or not necessarily the case?

Well, our objective is we're taking these products to market, is to line up a multiyear deal, much like we do with our other on-premise products. And be able to build in a ratable revenue streams that are -- that come along with these product lines. Customers may react differently but because of the nature of a lot of our products, we don't believe it'll be unusual for many of them to have multiyear periods. Though I'm quite certain there'll be customers who will go by year-to-year. So the market will begin to dictate that for us as we further penetrate it. Matthew Galinko - Sidoti & Company, LLC: Okay. And then, another question is around the Open Access move. How do you sort of view that in terms of opportunity versus cannibalization of the B2C Scores business?

We see it as -- we have not seen any cannibalization. We don't anticipate cannibalization there. We think there's a lot of opportunity. Obviously, it raises consumer awareness of the FICO Score. As you all know, there are a lot of non-FICO Scores with similar score ranges that are being sold out in marketplace that are most typically not the scores being used by lenders to make their credit decisions. It causes confusion. And frankly it's not great for the FICO brand. And so, the Open Access program lets us really put the FICO brand front and center, in front of the consumer. It lets -- the banks use the same score that they're using to make a better decision. It lets them disclose that with no additional cost to the consumer. And we think that raising that awareness has long-term benefits for us. One, it keeps the banks happier with using FICO Scores, but that's kind of the obvious one. Well, we also think that in the long run, it's going to create opportunities for us in our consumer Scores business. And so we do hope over time to capitalize on the broader consumer awareness.

And we have no further questions at this time. I would like to turn the call back over to Mr. Weber.

Thanks, Jeremy. This concludes our call today. Thank you all for joining.