Fair Isaac Corporation (FICO) Q1 2015 Earnings Report, Transcript and Summary

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

Thank you, Mike. Good afternoon, and 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; our CFO Mike Pung; and our Executive Vice President of Scores, Jim Wehmann. Today 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 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 include 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 Statement 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 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 January 29, 2016. Now I'll turn the call over to Will Lansing.

Thanks, Steve, and thank you, everyone, for joining us for our first quarter earnings call. I'll briefly summarize our financial results for this quarter and then I'll discuss some of our strategic initiatives and their expected impact. In our first quarter, we reported revenues of $190 million, an increase of 3% over the same period last year. We delivered $14 million of GAAP net income and GAAP earnings of $0.43 per share, down 15% and 8%, respectively, from the prior year. We delivered $23 million of non-GAAP net income, down 14% from last year, and non-GAAP EPS of $0.68 per share, a decrease of 7% from the same period last year. Our Applications segment was up 3% over the same period last year and our Tools segment was up 19%. Our Scores segment was down 7% compared to last year when we had a large global FICO Score deal. These results were in line with our internal expectations coming off last quarter's record results. We continue to invest in areas where we see the greatest potential with the goal being to drive predictable, sustainable growth. Let me give you a few examples. First, we announced this month that we have acquired TONBELLER, an innovator in risk-based financial crime prevention and compliance. This acquisition combines FICO fraud detection and analytics leadership with TONBELLER's capabilities to address the rapidly growing demand for integrated enterprise-class financial crime and compliance solutions. Now on the face of it, this may appear to be a simple technology tuck-in, giving us better capability in the areas of anti-money-laundering and know-your-customer. In fact, this acquisition is much bigger than that. We believe it will enable FICO to leverage our fraud analytics and risk management expertise to vault ourselves into the increasingly important market for integrated financial crime and compliance solutions, also known in the industry by the acronym FCC. There are a couple of aspects to this market that we find particularly compelling. First, incumbent FCC solutions in the market today are rule-based. With our in acquisition of TONBELLER, we're in a position to offer a risk-based approach, which leading industry experts believe will be required as institutions struggle to anticipate and respond quickly to known and emerging risks across the enterprise. And second, the buyers of this solutions tend to be chief risk and compliance officers. Now many CROs know FICO for our risk management solutions, but they generally view our powerful product solutions as tactical point solutions. By integrating them within a robust FCC offering, FICO will move into a more strategic position within financial institutions, helping chief risk and compliance officers move quickly toward their goal of a common, unified view of the entire risk spectrum. So needless to say, we're very excited about the prospects of this acquisition to help even FICO's value within our customers' businesses. We continue to make progress with some of the innovation we've introduced in our Applications and Tools segments. We signed a new Turkish client for our applications fraud solution and it includes Identity Resolution, a product that we integrated from our Infoglide acquisition. We sold a few deals this quarter where we integrated the InfoCentricity technology that we acquired last year. And we're seeing validation of the Decision Management suite with new customers in banking and retail across North and South America and Europe. We also ran our first competition in partnership with Kaggle. There were 500 participants and more than 2,000 individual entries. More than 130 teams leveraged FICO's technology in their algorithms, and the winning entry was based on FICO's Xpress Optimization technology. This was a great first effort for our Kaggle collaboration. In our Scores business, we announced that the largest private credit reporting agency in Malaysia, CTOS Data, will offer FICO Scores to all its clients beginning in early 2015. The CTOS-FICO consumer credit score will be developed based on FICO's proven score modeling technology. The scoring model for CTOS is created by analyzing the information found in CTOS's comprehensive credit information database. Expanding our valuable FICO Score franchise internationally is an important component of our growth strategy, and agreements like this one in Malaysia represent meaningful progress. In addition, we continue to build momentum with the FICO Score Open Access program. Citi is rolling out the program to its customers right now, and Chase and Ally have committed to do so in 2015. Thanks to our program, American consumers now have a better view of how banks measure their creditworthiness. It's also a win for the banks who are providing valuable information to their customers. We've heard anecdotally that by doing so, they may be reducing their risk. Better informed consumers make better borrowers. Ultimately, this program helps differentiate FICO Scores from the numerous irrelevant scores available in the marketplace that are not used for actual lending decisions. Finally, our partnership with Experian was rolled out at the end of December, making FICO Scores available through Experian's considerable direct-to-consumer channels. As I said last quarter, we're particularly pleased to partner with Experian, a premier provider of financial monitoring products to consumers. The product launched 4 weeks ago, so we don't have results to report yet. But early signs have been positive and we're very excited about the prospects. More broadly, we believe that FICO Score provides substantial value to consumers, just as it does to financial institutions, and consumer credit products that include FICO Scores are differentiated in the crowded market of generic products. It's too early to discuss the impact of this partnership agreement, but we will provide updates beginning next quarter. We believe that it will become a significant driver of revenue and earnings by the end of our fiscal year and well into the future. We continue to carefully evaluate uses of cash. This quarter, we're happy to announce the strategic acquisition of TONBELLER, but we also deployed significant cash toward share repurchases. We retired more than 800,000 shares in the first quarter and approximately 500,000 shares in January. As we look toward the future, I'm more convinced than ever that FICO is well positioned to excel in each segment of our business. We continue to invest heavily in our R&D initiatives, and we remain extremely focused on execution to deliver superior products to our customers and sustainable value growth to our investors. I'll have some summary thoughts later, but now I'll turn the call over to Mike for further financial details.

Thanks, Will, and good afternoon, everyone. Today I will emphasize 3 points in my prepared comments. First off, we delivered $190 million of revenue, with $23 million of license revenue, the area where we historically experienced most of our lumpiness. While our Scores business was down compared to last year, our consumer offering is well positioned to drive meaningful growth going forward. Second, following last quarter's record free cash flow of $65 million, we actually had a negative cash flow of $5 million this quarter due to several large payments, mainly our annual incentive payment, which was made in November, and our estimated federal taxes. Finally, we refinanced our revolving line of credit, increasing our capacity from $200 million to $400 million. We used the revolver to repurchase our stock, retiring 844,000 shares in quarter 1 and approximately 500,000 shares in January, as well as to fund the TONBELLER acquisition in January. I'll begin by breaking the revenue down into our 3 reporting segments. Starting with applications. Revenues were $116 million, up 3% versus the same period last year. The biggest gains came in Collections and Recovery Solutions and Originations. In the Tools segment, revenues were $30 million, up 19% versus the prior year. The growth this quarter was driven by our Blaze Advisor rules product and our data management platform. And finally in our Scores segment, revenues were $44 million, down 7% from the same period last year, which had included a large global FICO Score license. Because of that, on the B2B side, we're down 8% versus the same period a year ago. Sequentially, B2B volumes increased 4%, and on a trailing 12-month basis, we sold about 11 billion Scores. The B2C revenues were down 5% from the same quarter last year, as the product mix continues to shift away from upfront sales to subscription products. We're at an inflection point in our Scores business and given the progress Will described earlier, we expect our B2C business to grow significantly moving forward. Looking at our revenues by region. This quarter's 72% of total revenues were derived from our Americas regions. Our EMEA region generated 20% and the remaining 8% was from Asia Pacific. Recurring revenues derived from transactional and maintenance sources for the quarter represented 69% of total revenues, consulting and implementation revenues were 19% of total revenue and license revenues were 12% of total. Now turning to bookings. We generated $23 million of current period revenue on bookings of $70 million, a 32% yield. The weighted average term for our bookings was 21 months this quarter. Our operating expenses totaled $165 million this quarter compared to $170 million in the prior quarter, down $5 million. And they were at the higher end of the range we provided last quarter. We remain committed to investing reasonably in our growth initiatives. As Will mentioned, we have invested heavily in R&D, with continued emphasis on our Collections and Recovery and bank fraud products, as well as our Decision Management suite. With the acquisition of TONBELLER, we expect our OpEx run rate to be approximately $165 million to $170 million over the next few quarters, including amortization expense. As you can see in our Reg G schedule, non-GAAP operating margin was 19% for the first quarter. We expect for the full year that operating margins will be between 26% to 28%. GAAP net income this quarter was $14 million, down 15% from the prior year. Non-GAAP net income was $23 million for the quarter, down 14% from the same quarter last year. The effective tax rate was about 21% this quarter and was positively impacted by a catch-up from the reinstatement of the R&D tax credit. We expect the effective tax rate to be about 30% to 31% for the full year. Free cash flow for the quarter was negative $5 million compared to $26 million in the prior year. While our first quarter is typically our lowest cash flow quarter, this year was particularly light due to the annual payments for incentives and some large estimated tax payments. For the trailing 12 months, cash flow was $129 million, which is more indicative of our annual expectations. Moving onto the balance sheet. We had $95 million in cash on the balance sheet at the end of the quarter. This is down $10 million from last quarter. The primary activity for the quarter was share purchases and draws off our revolving line of credit. Our total debt is $607 million, with a weighted average interest rate of 4.8%. During the quarter, we refinanced our revolving credit facility, which previously had a $200 million capacity. The new facility has a capacity of $400 million, and we now have $160 million balance on that credit facility. The ratio of our total net debt to adjusted EBITDA is 2.6x, below the covenant level of 3x, and our total fixed charge coverage is at 4.6x, well above the covenant level of 2.5x. During the quarter, we returned $61 million in excess cash to our investors, repurchasing 844,000 shares at an average price of $71.78. Additionally, we repurchased approximately 500,000 shares in January. We still have nearly $150 million remaining on the latest new board authorization and continue to view share repurchases as an attractive use of cash. We also continue to actively evaluate opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio in competitive position. Finally, today, we are updating our guidance to reflect the purchase of TONBELLER. We expect the acquisition to provide about $10 million of revenue this fiscal year and to roughly break even during that period. We now expect revenues to be between $830 million to $835 million. We're making no changes to our previously announced guidance ranges for net income and EPS. As a reminder, this EPS guidance assumes outstanding shares of about $33 million fully diluted shares, although ongoing repurchases will likely bring that number down. With that, I'll turn it back over to Will for final comments.

Thanks, Mike. It's now been 3 years since I became the CEO of FICO. At that time, I talked about the strong IP of the company and the exceptional talent the company has to help solve our customers' most difficult problems. My goal then was to find ways to unlock some of the potential that I believe was still untapped. I'm now convinced that we're beginning to see that promise realized. Our FICO Score brand, which was long thought to be a mature product pegged to the U.S. GDP, is once again poised to deliver meaningful growth for the business. The cloud versions of our applications opened up new markets and can provide a new source of recurring revenues. And our Decision Management suite has the opportunity to change the way businesses of all sizes and across all industries use analytics to make better decisions. It's a special time in the history of FICO. We're focused, as always, on execution, yet when we pause at times like this to review where we've been, where we are today and where we're headed, we realize that the future holds a lot of promise for FICO and for our shareholders. I'll turn the call now back to Steve for Q&A.

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

[Operator Instructions] The first question is from Manav Patnaik with Barclays.

The first question I have was sort of a big picture question around innovation of the company. I know you talked about a lot of recent partnerships and so forth, but I was wondering how you guys look at that internally in terms of a target, like a lot of software companies have with x business revenues coming from new products over the last 3 to 4 years, et cetera. Like do you guys have targets like that? And how many new products a year or so forth are you trying to target? Can you give us some color on that?

Well, as you know, we have large, mature franchises, and bringing up new products is not a super speedy thing. We have kind of a longer-term view of our investment horizon and when those products will fully mature. For example, Decision Management suite, which we started several years ago, is just now this year becoming really commercially interesting. And in the coming years, it will be a significant contributor. But right now, it's still not moving the needle dramatically. We don't have a specific metric around percentage of revenue that have to come from new products. But we continue to pour investment into developing those new products. Our R&D is up this quarter to -- up nearly 2 points versus the year-ago period, and you see that reflected in kind of the case of what's coming out of our product and technology organization. The other place where we're seeing it is in the speed of releases. We're releasing -- I hesitate to call them updates. We're releasing additional features and functionality to our existing products at an ever faster clip, and I think you have to put that in the category of innovation. And certainly we're putting a lot of our investment energy into improving our existing products and franchises.

Okay, fair enough. And then if I can just ask on the just relative to guidance. You gave us some good color on OpEx and I think R&D and so forth. Just wondering, I guess, obviously, licensing is lumpy. It seems like a little slow start, obviously, in this quarter. Like what are the other moving parts or onetime items in terms of comps versus last year that we should be looking out for in terms of modeling the rest of the quarters?

Well, Manav, I think that the numbers are going to be pretty straightforward along the most variable lines. I'd say the only maybe slight anomaly we also had this quarter that will normalize itself out was our cost of revenue line item on the PL was a little higher this quarter. And that's more attributed to a couple of very large projects where we're utilizing some pretty heavy outside fees and outside costs. And we expect that to average itself out a little bit and reduce itself over the course of time and over the course of the year. The only other, I guess, point to make is that with the acquisition of TONBELLER, their heavy quarter for them, usually in their revenue cycle, is the quarter ended December. And so if you take the $10 million of revenue that we're suggesting in our guidance revision coming from TONBELLER, probably a little more than 1/3 of it, because we have 3 quarters, will come in our September quarter and you can't just annualize that. It's more heavily weighted towards the December quarter, which of course won't be in our numbers. So you can kind of spread that out with a little bit more of that revenue and the related expenses in the September quarter.

Okay. Fair enough. And then the last one is just any FX impacts to note or how should we think about your exposure by currency?

Well, there was a little bit, as a result of some of the strengthening of the U.S. dollar. Nothing that large and, therefore, we didn't report it out. We denominate a lot of our contracts, especially the legacy ones in U.S. dollars, and so the impact for us when the exchange rate moves dramatically is maybe not quite as big as it is for others.

The next question is from Bill Warmington with Wells Fargo.

So I wanted to ask where you're seeing the greatest traction with your SaaS offering so far?

Yes. I think the place we're seeing most of the market opportunity is coming in 3 areas: Our Collections and Recovery offering, our Originations Manager offering and our Marketing offering. Those 3 or 2 of the 3 have historically been on-premise software, the first 2. And more and more of the discussions we're having with our customers are around offering that on the cloud. I would say in addition to that, we're starting to see accelerating interest in the Decision Management platform, which we, of course, offer both on-premise and in the cloud. And most of the deals this quarter on the DMP happened to be on-premise, but we're starting certainly to see more willing to consider a cloud version of that product also.

Interesting. Okay, and then on the Scores business. You mentioned the large global contract that distorted the year-over-year comps. If you excluded that from year ago base, what would the year-over-year growth in the Scores have look like?

Bill, if you took it out, we'd be roughly even for the quarter-over-quarter as opposed to down 7%.

Got it. Okay. And so maybe if you can comment a little bit about what's going on within the Credit Card business in terms of the level of solicitations that you're seeing.

Yes, I'd be happy to take that, Bill. So year-over-year, Will is right, we would be roughly flat in terms of dollar revenue. In terms of where the volumes are shifting, more of the volumes were shifting year-over-year towards prescreen or acquisition scores, as well as account management scores with a little bit less around originations. That's sequentially, I should say. Year-over-year, we saw a little bit higher origination Scores versus the prior year. And so when you look at the actual volumes, sequentially, they're up about 4% and pricing is down slightly because of the mix shift.

Got it. And then if you could talk a little bit about what's going on with bookings. I know that they touched down a little bit this quarter. Is it just a difficult comp that you're seeing there or -- is there anything that's going on in the environment or is it just sort of random timing of how deals are closing?

Yes, nothing is going on in the environment. I mean, bookings tends to be a function of how many large deals we've signed at any given quarter. And frankly, we had a big revenue and a big booking quarter in quarter 3 and 4 last year and it was fairly light this quarter because of the timing of transactions. And so we view that as lumpy, heavy and lumpy, much like we view license revenue as being lumpy.

Okay. And then you mentioned that the operating margin should improve significantly throughout the year going -- I think you mentioned 19% up to 26% -- 28% for the year. How do you get there? What's the bridge to that?

Yes. The bridge to that is quite simple. I mean, we had a very -- we had an average quarter, if you will, on license revenue, and we anticipate in the back half of the year license revenue to pick up by virtue of term licenses that are scheduled to renew and just new deals that we'll sign. And we expect Scores revenue to pick up, which of course is 100% royalty margins. And those tend to offset what is typically kind of lower margin services revenue. And this quarter, as I mentioned in particular, we had a couple of very large contracts that provided the headwind on the gross margins of the company.

Got it. And then one -- just a quick housekeeping item. What was the -- it sounds like you spent about $100 million of the $250 million authorization on repurchases. Is that right?

Yes, through January.

Through January. Then what was the actual share count exiting the December quarter, fully diluted? I was hoping to get some sort of a sense for where you are tracking so far this quarter.

Yes. We exited the quarter, so on December 31, with 31.7 million shares outstanding. And the diluted share count, which of course takes into account options in RSUs, was at about 33 -- slightly over 33 million shares. But our actual share counts 31.7 million and declined, of course, with the purchases we did in January.

Okay. So the January -- I wasn't sure. What was the January purchases?

We said about 0.5 million shares, slightly more than that.

0.5 million? Okay.

Yes.

[Operator Instructions] The next question is from Brett Huff with Stephens.

This is James Rutherford in for Brett, actually. Just a couple of questions here. First on SaaS. I know we touched on it earlier, but I was curious what the SaaS revenue growth was in the quarter and what you guys expect for the year there?

Yes. Our SaaS revenue quarter-over-quarter growth was about 6% across all our products.

Okay. And I guess just conceptually, what is the big driver of the significance of the SaaS? Is that enabling you to penetrate kind of different customers that you couldn't with the on-premise license option? What's the kind of the main driver there that's helping you guys on that?

I'd say that's part of it but it's not all of it. So when you think what our SaaS business, it falls into 3 categories. There's our applications available in the cloud, which definitely opens up new potential markets and new customers and faster implementation and sometimes lower pricing. So that's one kind. Another is our debt trust, CCS area, where it's really a pure SaaS offering that's growing very nicely. And sometimes, it's sold standalone and more often it's sold in conjunction with some of our other products. And then third is kind of the new stuff coming along with Decision Management platform, where our customers have a choice of buying it on-premise or in the cloud, and increasingly we're seeing interest in the cloud offering, the cloud version. So it's all 3.

Okay, that's helpful. About the Open Access, I know that that's not a direct driver of revenues near term. But I'm sort of curious, what is the link there between that and the myFICO business. Is there something going on in terms of customer acquisition that you're hoping will help drive adoption to myFICO product? And if so, is that marketing? what specifically is going on there? At this point, it's more of a brand enhancement type of activity?

It's really not designed to the customer acquisition program. I mean, our goal with Open Access was to create a lot of transparency. I mean, I think over the last several years, there has been some amount of confusion in the marketplace about FICO Scores versus, what, credit scores, and particularly versus credit scores that are not really used for lending decisions. And so our goal with Open Access was to make sure that consumers had access to the score on which the decision was being made. And fortunately, that program has come together and we have a lot of support from banks and it provides all this consumer transparency. Consumers can now see what's going on. And it's good for the banks, too. It was never really designed for customer acquisition. And I wouldn't even call it about brand building. It's more about cleaning up consumer confusion. Now we strongly believe that as the market recognizes where FICO Score is relative to other so-called education scores, other kinds of credit scores, we think that there'll be follow-on beneficial effects from that, and that goes to education programs and other kind of things that we can monetize. But monetization was definitely not the goal of Open Access. As it relates to myFICO -- I'll turn it over to Jim Wehmann and let him also speak to this. But as it relates to myFICO, myFICO is an industry-leading credit report monitoring offering. And to the extent there's some spillover effect, that's a terrific thing, but it's not -- I wouldn't call it meaningful. It's not what the intent was. Jim, I'll pass it to you and you might want to speak to some of those things.

Yes. I mean, I think with respect to the consumer business going forward, I think what's important to keep in mind is that we're not optimizing any one channel per se. We're going to be optimizing kind of the entire opportunity. So it's frankly a little less important to us whether we are growing myFICO to its fullest extent, or are we taking advantage of kind of the entire opportunity both directly and indirectly in the consumer space.

Okay, understood. That's helpful. And continuing on the Scores, I know there's not a lot you guys are saying yet on the Experian deal, which seems to be pretty good for you, guys. I was curious, if you could -- is there any expectations for the Experian deal in your current guidance? And then also, are you guys talking at all about the economics in terms of the royalties from that versus some of the other perhaps B2B scoring as it stands now?

There is. Our current guidance does include our views about the Experian deal. And so I don't expect incremental there. Do we expect more to come from the industry and from other players over time? Yes. And we think that -- we're really delighted to have started this program with the premier player in credit report monitoring business and to go out to the marketplace with real FICO Scores together with Experian. As the world, as consumers, as everyone is sensitized to the difference between FICO Scores and other scores, we think there'll be more interest in incorporating FICO Scores into these credit report monitoring products. And so there could be some benefits down the road that are not in our guidance, but those are further out.

Okay, great. And last question for me on the Tools business, we haven't talked about that yet. Excluding the Blaze Advisor true-up, what was growth there? And then can you just talk about the dynamics in that business and kind of where the things are shaping up in the current period as well?

Yes. We've been growing our Tools business roughly teens, low teens, over the past several years. There really was no true-up per se. We had several large deals that hit this quarter. So it's kind of hard to include or exclude any one deal and try to do a what-if. So we grew 19% and that's the number.

There are no further questions at this time. I will turn the call back over to the presenters.

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