Fair Isaac Corporation (FICO) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Sherlyn, 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. All lines have been placed to mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Mr. Steve Weber. Please go ahead sir.

Thank you, Sherlyn. Good afternoon and thank you for joining today's second 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 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 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 Web site 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 Web site at fico.com or on the SEC's Web site at sec.gov. A replay of this webcast will be available through April 23, 2016. And with that, I'll turn the call over to Will Lansing.

Thanks Steve and thank you everyone for joining us for our second quarter earnings call. Today, I will briefly summarize our financial results for this quarter, and then I will talk about where we stand half-way through our fiscal year, and why we are so confident about our strategy and our execution of it. In our second quarter, we reported revenues of $207 million, an increase of 12% over the same period last year. We delivered $19 million of GAAP net income and GAAP earnings at $0.58 per share. We delivered $30 million of non-GAAP net income up 3% from last year and non-GAAP EPS of $0.91 per share an increase of 12% from the same period last year. Our application segment was up 16% over the same period last year. The results included our TONBELLER acquisition, but we also drove growth across our portfolio specifically in fraud solutions, marketing solutions and customer communications solutions. The margins in applications were negatively affected this quarter by a non-recurring charge that Mike will explain in a few minutes. Year-to-date applications revenues are up 10% over the previous year. Our tool segment was up 4% over last year driven primarily by recurring transactional and maintenance increases. Year-to-date tools revenues are up 12% over last year. Our score segment was up 4% compared to last year. Our B2C business was up 24%, our B2B business was down 2% versus last year, but after adjusting out a royalty true-up in the prior period our B2B revenues were up 7% because of our increases in originations. I'm pleased with the revenue growth we are now driving across our business. We believe we can continue and even accelerate that growth while managing our expenses and expanding our margins. We are doing this by carefully executing the strategies we have outlined in each of our segments. In our application segment, we have invested over the past 18 months to deliver cloud-based versions of our solutions. We have had early success selling our originations and collections from recovery product. Just last week, we introduced TRIAD cloud addition. This new offering give smaller and specialty lenders the ability to use advanced customer focused analytics and strategies to increase revenue, share wallet and customer satisfaction. The addition of TONBELLER in January gives us entry into the financial crime and compliance solutions space, and combined with our strong fraud management franchise makes our offerings more valuable to financial institutions as they view risks across their enterprise. In our tools business, we have been working on ways to expand our distribution to a much larger market. In a world that's increasingly looking for ways to extract value through analytics, we have IP and expertise to help make better decisions. When we introduced our decision management suite last year, we put that IP in the cloud and greatly expanded our addressable market. The pipeline analytic cloud now includes all the building blocks needed to build, deploy and manage predictive analytics for growth profitability and competitive advantage. It's beginning to open eyes in the analytics community and while we are still early, we believe we can become a significant growth driver in the years to come. In our score segment, we are now beginning to see the results of the strategic initiatives we have been working on for the last two years. We had a good quarter. In fact, the highest revenue quarter since Q4 of 2008. But more importantly we are positioned to drive significant revenue and earnings growth well into the future. The FICO Score Open Access program continues to expand. This program is good for consumers, good for financial institutions, and addresses consumer confusion between educational scores and FICO scores. This week we announced the expansion of the program to provide FICO scores to approximately 1 million consumers annually who are in need of credit and financial guidance through qualified non-profit credit counselors and participating government entities. In B2B scores, we are beginning to see increased volumes particularly in originations, which will provide a nice tailwind if the trend continues. Finally, our consumers' scores business is on a strong growth trajectory that we believe will continue. We are driving growth at myfico.com. Also this quarter, we have started to see the impact of our partnership with Experian, which has been migrating subscribers to products with the FICO score. That conversion will continue over the next few months and we expect the subscriber base to grow as more and more consumers look to Experian for genuine FICO scores. As I said before, we are particularly pleased to partner with Experian to provide a premier financial monitoring product to American consumers. And we believe that as we continue our efforts to inform consumers, they will ultimately choose products that include the same analytic overwhelmingly used by financial institutions, the FICO score. We are proud of our latest innovations which came out of several different areas of the business. We recently announced the launch of a FICO score based on alternative data to identify creditworthy Americans who are not able to be scored with traditional credit bureau data alone. FICO on partnership with Equifax and LexisNexis Risk Solutions has launched a pilot program with 12 of the largest credit card issuers. The new FICO score has been well-received by the media, consumer advocacy groups, regulators and large and small lenders. This quarter we released an enhancement on myfico.com, which for the first time provides consumers with a 19 most widely used FICO scores. Continuing our efforts to provide an unprecedented level of transparency and help consumers navigate a complex credit environment in which lenders use different versions of the FICO score for different types of lending decisions. Last month, we announced that 11 of China's leading alternative lending companies have signed on to the new FICO alternative lending platform as part of industry-wide efforts to upgrade risk management across China's booming peer-to-peer and micro loan sector. The 11 companies represent an estimated $10 billion in P2P and micro loans. By using the FICO platform, these lenders will be more stable, viable and profitable than ever before. In February, we announced the availability of the FICO data management integration platform as streaming analytics and real-time distributed processing platform that ingests, normalizes, correlates and distills Big Data as it is being generated. The platform collects filters and aggregates batch and streaming data from hundreds of sources and analysis it on the fly providing applications with greater agility and responsiveness to deliver high impact decisions. We also rolled out the FICO Big Data Analyzer, a purpose built analytics environment for a new generation of data professionals. Big Data Analyzer empowers a broad range of users to collaboratively explore data and discover new insights from any type and size of data on Hadoop. Built-on technology acquired from Karmasphere last year, Big Data Analyzer equips teams of business users and analyst and data scientists with access to their organizations new frontier of competitiveness, data and analytics. Finally, shortly before participating in the White House summit on Cyber Security, we announced the availability of the FICO Cyber Security Analytics Solution. This solution leverages decades of research and streaming analytics technologies as well as new advances in self-learning models to detect emerging and evolving cyber threats in real-time. As the leading provider of fraud detection solutions for financial institutions world-wide, we see first hand how today's cyber security breaches becomes tomorrows payment card fraud and account compromise headlines. We have adopted our real-time streaming analytics technologies to provide the unique analytic layer of event detection and monitoring. Our solution can help organizations of all kinds, protect their data assets and stop damaging data breaches and theft attempts in their tracks. These innovations are just the latest examples of ways in which we are unlocking the value of our core IP, developed from decades of analytics research and development to efficiently and effectively meet the burgeoning market demand for better decisions through analytics. At the same time, we continue to carefully evaluate uses of cash, in our second quarter we repurchased 540,000 shares. In April, we repurchased another 327,000 shares bringing our total to around 1.7 million shares repurchased so far this fiscal year. We remain confident in our strategic business model focused on growth and profitability while giving shareholders an even greater return by reducing shares outstanding. I will share some final thoughts later, but now I will turn the call over to Mike for further financial details.

Thanks Will. Good afternoon everyone. Today I will emphasize three points in my prepared comments. First, we delivered $207 million of revenue up 12% from the same period last year with growth in all three segments. This quarter includes initial revenue generated from our Experian partnership. We expect revenue from this partnership to ramp up as the program is rolled out across the various Experian platforms. Second, we delivered $19 million of net income, which was negatively impacted by a non-recurring pre-tax charge related to a loss contract and the TONBELLER acquisition costs both of which totaled $4 million in the aggregate. Finally, we funded the acquisition of TONBELLER, and also repurchased 540,000 shares in quarter two and another 327,000 shares in April. I will begin by breaking the revenue down into our three reporting segments. Starting with applications, revenues were $134 million up 16% versus the same period last year. This included about $3 million in revenues from our TONBELLER acquisition. The biggest gains came in our fraud and marketing solutions. License revenue was particularly strong at $23 million this quarter more than doubled the prior year. In the tool segment, revenues were $23 million up 4% versus the prior year. The growth this quarter was driven by our optimization products and our data management platform. And finally, in our score segment revenues were $50 million up 4% from the same period last year which included a royalty true-up. Adjusting for that true-up B2B was up about 7% primarily due to increased originations. Sequentially B2B is up 5%. The B2C revenues were up 24% from the same quarter last year and 40% sequentially due to increased sales at myfico.com and to the first revenues from the Experian partnership. We expect B2C revenues will continue to grow this year while Experian converts its existing subscribers to the FICO score and with new subscribers being added through the ongoing marketing efforts. Looking at our revenues by region, this quarter's 73% of total revenues were derived from our Americas region, our EMEA region generated 20% and the remaining 7% was from Asia-Pacific. Recurring revenues derived from transactional and maintenance sources for the quarter represented 67% of total revenues consulting and implementation revenues were 18% of total; and license revenues were 15% of total revenue. We generated $24 million of current period revenues on bookings of $80 million up 30% yield. The weighted average term for our bookings was 22 months this quarter. Our operating expenses totaled $173 million this quarter compared to $165 million in the prior quarter or up $8 million. This was higher than the $165 million to $170 million we guided last quarter due to a non-recurring $3.2 million charge from a cost overrun on a large implementation project and about $500,000 in legal and tax charges related to the TONBELLER acquisition. For quarter three and quarter four, we expect our operating expenses to be approximately $170 million per quarter including amortization expense. As you can see in our Reg G schedule, our non-GAAP operating margin was 24% for the quarter, we expect the full year that operating margin will be between 26% to 28%. GAAP net income this quarter was $19 million down 9% from the prior quarter but non-GAAP net income was $30 million for the quarter up 3% from the same quarter last year. The effective tax rate was about 28% this quarter. We expect the effective tax rate to be about 29% to 30% for the full year fiscal 2015 slightly lower than we previously estimated. Free cash flow for the quarter was $37 million compared to $44 million in the prior year. Moving on to the balance sheet, we add $87 million in cash on the balance sheet at the end of the quarter. This was down $8 million from last quarter due to the purchase of TONBELLER and repurchases of our shares partially offset by cash generated from operations and draws on our revolving line of credit. Our total debt is $658 million with a weighted average interest rate of 4.6%. The ratio of our total net debt to adjusted EBITDA is 2.8x, which is below the covenant level of 3x. During the quarter we returned $40 million in cash to our investors repurchasing 540,000 shares at an average price of $74.30. Additionally, we repurchased 327,000 shares in April. We still have $119 million remaining on the latest Board authorization and continue to view share repurchases as an attractive use of our cash. We also continue to actively evaluate opportunities to acquire relevant technologies and products that advance our strategy, our strength in our portfolio and competitive position. Finally, we are reiterating our previously provided guidance for the fiscal year. With that, I will turn the call back to Will for some final comments.

Thanks Mike. As I said, last quarter, it's a special time in the history of FICO. After refining our strategy and investing in our future, we are now beginning to see signs of sustainable growth returning to the business. Our score segment is poised to unlock the value that's been built over 25 years of leadership in the financial services system. Our applications remain industry leaders and we have the opportunity to reach new markets by offering these solutions in the cloud. And our decision management suite takes the proven value of IP we built and delivers it to markets that are just now looking to use data to make better decisions. We need to remain focused on execution. We will invest carefully in opportunities for growth and ensure that we deliver a high-quality products and technology on-time. And we will continually look for ways to monetize our IP and expertise and to provide value to our shareholders. I will now turn the call back to Steve for Q&A.

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

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

Yes. Greg calling on our Manav. So the B2B score looks like it came in pretty strong at the 7% and you talked about some mixed benefits from origination scores. I was wondering if you could just touch on which markets you are seeing that strength whether it would be in a mortgage, credit cards et cetera.

Yes. Greg, it was virtually across the board this quarter on the origination side led by cards and followed by mortgage and auto, which were both strong as well.

Okay. And then looking at B2C, I was wondering if you could to the extent that you can help us parse out, how much of that growth is coming from the core myfico versus the Experian deal and even if there is anything coming from the indirect market which you guys have talked about a little bit?

Yes. Greg, so we saw growth as we mentioned both across myfico and across Experian coming from the experian.com rollout that happened on December 29. We are not going to break down the numbers further between one or the other, we are just saying that overall we are starting to see some of the acceleration on the consumer side that we have been talking about here since November.

Okay. And the indirect I guess at this point, you guys are attacking that but haven't seen anything flow through to revenues.

Yes.

Okay. And then, I guess one more from me just on the kind of under banked FICO score, just wondering, how you guys are thinking about that, is it more of a public goodwill initiative, or is it really something that you think could start to generate revenue and what your strategies there?

I would say its both. I mean there is a pretty large group of customers that are been found no file and hard to score with traditional bureau data. And in a world where we can start to use the other kinds of data to make these decisions, it makes all the sense in the world to produce scores on it. And we have been working with Equifax and LexisNexis for some time on putting this thing together. We are really pleased with the results. It took a while to bring it to market because we wanted to maintain the integrity of what the score represents. And so we feel pretty good about the decision makers wrapped around these new scores. Is it, do we think we are generating goodwill with that? I hope so. And we are hoping to open up credit markets for the under banked. How bigger market will this be? Time will tell. I think that there is definitely an appetite from lenders to reach these consumers and we will just see how long it takes. But I think there is definitely a business there.

Okay. It makes sense. Thank you, guys.

Your next question comes from Bill Warmington with Wells Fargo.

Good afternoon, everyone.

Hi, Bill.

So a question for you on the B2B score side. You did about 11 billion scores last year, if I remember correctly. What's the run rate currently based on this quarter?

Yes. Bill, the overall volumes are up modestly. They are up higher on originations and a little bit lower on acquisition scores primarily due to a large client or two that have paired back on some of their marketing activities. But overall, we are running up about 3% or 4% in volume wise.

Got it. And then the – I wanted to ask about the – on the application side, and the SaaS offerings there. If you will give us a sense for about how much revenue was actually being generated on a SaaS basis, and then also a sense for your success selling into the small and mid-size clients in the U.S., and then also internationally?

Yes. So I don't have the exact number on the SaaS revenue this quarter, but I will tell you our SaaS business, the revenue that we are claiming is growing at around 5% clip. So mid-single digits. The backlog is growing at a rate slightly faster than that. In terms of kind of market penetration and market acceptance. We are continuing to work pipeline opportunities. We are seeing a lot of larger opportunities as well as smaller market opportunities come across our plate. But it's kind of slow as you go in terms of being able to get those deals in place, get them signed and then obviously convert them over to revenue.

Okay. And then jump back to the scores business, on the B2C side, with the Experian implementation on the direct subscribers, I wanted to ask what inning are we in, in terms of that process currently?

Well, for the quarter we just ended, our quarter two the revenue that is a component of our B2C from Experian came exclusively off of experian.com, which was launched on the 26 of December. Since the end of the quarter, other properties are becoming to convert over. And its – Experian game, they haven't reported any of those crossover numbers subscriber numbers to us yet that reporting will start coming across probably in about a month from now. But just for the knowledge here, we reported the numbers exclusively from experian.com.

Got it. Okay. And then, as you look down the road, I know that currently the arrangement is for solely the FICO score, is there – what do you think about the opportunity of being able to sell other products into that subscriber base over time things like the multiple scores that you had mentioned or maybe the score simulator or maybe something else that you are in the process of developing?

Yes. Bill, I think those are all good examples. We very much have the intension of continuing to enrich the offering to the consumer and those are all good candidates. With the multiple scores we have them up on myfico.com today; I guess that would put us in the forefront of sharing multiple scores with consumers. But, we are certainly willing and happy to have other partners share multiple scores with the consumers and from our standpoint we hope the market goes there. It would be a great thing. In terms of the simulator absolutely that's another natural and we have also talked about consumer card control as a potential offering. So there is a handful of things that are in the works.

Got it. And then one housekeeping item, on the buybacks you mentioned the – for the April buyback what was the actual dollar amount on that?

It was $30 million that was [certainly down] [ph] there, shares we brought back in April.

Okay. All right. I will see if anybody up – go back in the queue. Thank you.

Thanks Bill.

[Operator Instructions] Your next question comes from Brett Huff with Stephens Inc.

Good afternoon.

Hi, Brett.

Wanted to ask, a nice work on the apps growth that was obviously a really strong number, can you – I think you mentioned last quarter that you expected some renewals to happen maybe in the back half of the year and you talked sort of how the margin might go up as a result of some of those renewals in the back half, I think is how you described it. Is that still going to happen in the back half is – was the app strength to this quarter related to that or was this something from the pipeline, just kind of give us a sense of kind of what was the nature of the app win this quarter?

No. We had in terms of the win this quarter, we had one renewal that happened this quarter and then we had several other pretty healthy deals that we signed. That renewal happened in the second quarter and we had anticipated that in our guidance. The renewals we talked about in the back half of the year are still scheduled. And we expect them to come through as a component in the guidance that we have given for the full year.

Okay. And then question on the B2C direct to consumer agreement with Experian, it sounds like that's potentially really nice channel, what is the pipeline look for you all in terms of other outlooks where other partners you might be able to distribute through or work with in similar nature?

I can't speak to partnership discussions that are in the works. But, I will say that its our fervent hope that the entire industry adopts FICO scores instead of education scores because as you know FICO scores are the scores that lenders use and so many of the education scores that are being given to consumers are really not being used for credit decisioning purposes. So our goal is to see FICO scores, wherever consumers interested in and how their credit worthiness is being evaluated, we want the FICO score shared with them. And we are exploring all channels to make that happen including the most successful one so far which is Open Access.

And then last one from me, I think somebody asked this about SaaS before, but and I'm not sure that this question was asked. The percentage of rev that is composed of SaaS products, if we get that number of percentage on – I forgot – I may have just missed that.

No. I didn't have the number directly in front of me. I said the SaaS revenue was growing about 5% year-over-year that's claimable revenue. In general, I would have to look at up at our SaaS revenue was roughly 20% of our overall total revenue on an annual basis.

Okay. That's it for me. Thank you.

That would include hosted and SaaS by the way.

Oh, hosted and SaaS, okay. Thank you.

Correct.

Your next question comes from Matthew Galinko with Sidoti.

Hey, thanks for taking my question. I guess – last quarter you talked about TONBELLER acquisition making a sort of the combination making FICO more strategic of vendors for compliance. I'm just curious where you are on technical integrations now around that acquisition and what the timeframe is, that we might see the benefits of becoming more strategic?

The technology that we acquired with the TONBELLER acquisition is being held in tact. We haven't done a lot of work to try to merge that with our products because it's not necessary. What we are doing is focusing on the sales and distribution piece. And what we have seen is that the way anti-money laundering products are increasingly being bought is in connection with the Chief Risk Officer with a broader view of the risk facing the financial institution. And so we are lining up our TONBELLER capabilities along with our Falcon Fraud capabilities and our Infoglide and so on to bring it to the same decision maker just really on the sales and distribution side more than on the technology integration.

Fair enough. And then I guess one other quick one, just curious how if you could talk a little bit more also about the go-to-market plan with the cyber security technology.

Good question. The interest thing that's going on with the cyber security and how we play in that market is that our – our cyber solutions, which are a directly across our Falcon Fraud capabilities addressed cyber issues in real-time, which is not typical for the industry. And are able to score degree of threaten away that's not typical for the industry, usually the alerts are binary. And so we think we have some fairly distinctive capabilities in cyber. What we do not have is a strong self and distribution built there. And so right now we are working on more of an OEM basis with some of the major players to bring our technology to market along side theirs. A decision for us remains in the future whether it makes any sense to go direct. But right now our plan is to go through partners and channels.

Got it. That's helpful. And do you have any kind of timeframe to just think about on when we might start seeing not necessarily meaningful, but any sort of revenue contribution from that.

Well, I think certainly not before next year.

That's great. All right. Thank you.

Next question is a follow-up question from Brett Huff with Stephens Inc.

Thanks. Just one quick follow-up, did you guys in your guidance it didn't change I know, have your perceptions, or your assumptions in your guidance changed since last quarter on the piece guidance in revenue that is Experian driven based on kind of the early returns, or is it kind of coming in as you guys expected it and it just kind of take some time to get these conversions done.

No. It's coming in as we expected. We didn't make any kind of resource all of our guidance based upon the first three months worth of activity from Experian.

Okay. And then in terms of the after-tax or the charge, I think you said was $4 million, you guys called out, did that end up being where just from how its taxed, is that about a $0.08 hit to the reported numbers is that about, right?

Yes. It's between $0.08 and $0.09 a share and it related to the two pieces, the contract write-off and then just the cost of the acquisition at TONBELLER.

And the contract write-off that -- just describe that again for me, I know you mentioned it, but I'm not sure understand kind of what that is?

Yes. We are working on a large program outside the U.S. with a customer of ours, who are consolidating a number of legacy platforms and systems into a FICO platform. And the complexity of the project is driving some cost overruns and the accounts requires us to take any loss on – any estimated loss on a program like that when we know about it and that's why we booked this quarter.

Got you. Okay. That's it for me. Thank you.

You are welcome.

At this time there are no further questions.

Thank you. This concludes our call. Thank you all for joining.