Fair Isaac Corporation (FICO) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Latvia and I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac’s Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Steve Weber, you may begin your conference.

Thank you. Good afternoon and thank you for joining today’s FICO’s third quarter earnings call. I am Steve Weber, Vice President of Investor Relations, and I am 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 maybe characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements may involve 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 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 July 29, 2016. And with that, I will turn the call over to Will Lansing.

Thanks, Steve and thank you everyone for joining us for our third quarter earnings call. Today, I will brief you on our financial results for this quarter and how we are doing year-to-date. Then I will take a step back and reiterate our strategy overall and in each operating segment and how we are doing executing against that strategy. In our third quarter, we reported revenues of $209 million, an increase of 6% over the same period last year. Year-to-date, revenues were up 7%. This quarter, we delivered $20 million of GAAP net income and GAAP earnings of $0.62 per share. We delivered $32 million of non-GAAP net income, up 10% from last year. During the past year, we brought down our diluted shares from 35 million to 32 million, accelerating our non-GAAP EPS to $1 per share, an increase of 20% from the same period last year. Our applications revenues were down 2% over the same period last year due to lighter license sales this quarter. The segment has performed well this year, up 5% year-to-date. Our tools segment was up 18% over last year, driven primarily by increases in both recurring and license revenues. Growth has been steady in the tools segment and year-to-date tools revenues are up 14% over last year. Our scores segment continues to do very well. Total scores revenue was up 23% compared to last year. Our B2C business was up 73% and our B2B business was up 5% versus last year. Year-to-date, the scores business is up 7%. As we move through our fourth fiscal quarter, it’s a good time to review our strategy and our success in executing on that strategy. In our applications segment, we have invested heavily in order to increase the addressable market for our market-leading analytic applications. We have made available cloud-based versions of our solutions. We have built out additional functionality in our products and we have acquired additional capabilities through a number of acquisitions. In some cases, we have strengthened the motor under our market leading products. In fast-moving markets like fraud prevention, our acquisitions of Infoglide with its identity resolution engine and of TONBELLER with its financial crime and compliance technology have enabled us to offer a much broader, more responsive fraud prevention solution to our customers. We have improved our strong offerings in the customer account management, originations and collections in recovery spaces and have expanded the addressable markets by offering cloud-based versions of them. We believe that over time these investments will drive growth that we couldn’t achieve by simply selling to customers buying on-premise solutions. With a strong portfolio of products now in place, we are shifting our focus to distribution. In fact, this quarter, we had a small restructuring charge as we moved some expenses from building our products to distributing those products. We are working on refining our distribution and go-to-market for both the applications and tools segments. This includes significant sales training and increasing sales resources to reach new market segments. We are confident about our prospects, but also understand that our banking clients are operating in the constrained environment. So, even as our ability to compete and win is growing, it remains difficult to predict the timing of individual deals. In our tools business, we have also been working on ways to expand distribution to a much larger market. The challenge is similar to the one we faced in the applications business, but the approach is different. Essentially, we are actively pursuing ways to get our best-of-breed products into the hands of the disparate markets and disparate industries that are looking to use analytics to extract value from data. Furthermore, we are growing recurring revenue in our tools business as over time, we had more subscription-based cloud revenue. In our scores segment, we are beginning to realize the results of our strategic initiatives. The $56 million of revenue this quarter was the highest since Q4 of 2007. As we look ahead, we see opportunities to continue to grow. In B2B scores, we are seeing increased volumes, including another quarter of growth in origination activity. As this score used by lenders, we are well-positioned to benefit from a macro expansion of consumer lending. And our consumer scores business continues to deliver outstanding growth. In fact, this quarter that business is up 73% over last year. We are driving growth at myfico.com as consumers continue to receive a premium value in our FICO score-based products and services, including access to the most widely used FICO score versions across all three bureaus. And our partnership with Experian delivers a premier financial monitoring product, where Experian provides the FICO score with their data. Consumers are beginning to understand that the FICO score is the store that lenders use, and therefore, the score they need to know. We continue our efforts to educate and inform consumers with the expectation that they will ultimately choose products that include the same analytic used by the overwhelming majority of financial institutions, the FICO score. As we review our strategies, investments and results, we continue to carefully evaluate uses of cash. In our third quarter, we repurchased 327,000 shares. So far this fiscal year, we have repurchased around 1.7 million shares. As I said before, we are committed to a core 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.

Thinks, Will. Good afternoon, everyone. Today, I will emphasize three points in my comments. First, we delivered $209 million of revenue, up 6% from the same period last year. This quarter includes a 23% increase in scores segment and an 18% increase in tools. While our applications segment was down slightly, this segment is up 5% year-to-date. Second, we delivered $20 million in net income, which included restructuring and acquisition-related expenses of $2.3 million. While we continue to invest heavily in our growth initiatives, our emphasis is shifting from new product releases to refining our distribution capabilities. Finally, we delivered $34 million of free cash flow and repurchased 327,000 shares during the quarter. I will begin by breaking the revenue down into our three reporting segments. Starting with applications, revenues were $127 million, down 2% versus the same period last year due to lighter license sales this quarter in our marketing solutions and fraud management products. This was offset somewhat by our acquisition of TONBELLER. Year-to-date, our applications revenue are up 5% versus the same period last year. In the tools segment, revenues were $26 million, up 18% versus the prior year. The growth this quarter was driven by our rules and models products and our data management platform. Year-to-date, tools revenues are up 14%. And finally, in our scores segment, revenues were $56 million, up 23% from the same period last year. B2B was up 5% driven by another strong originations quarter and B2C revenues were up 73% from the same quarter last year. Revenue increase this quarter had a double-digit rate on myfico.com and our Experian partnership continues to evolve with virtually all their subscribers now receiving a FICO score as part of their bundled offering. Looking at our revenue by region, this quarter, 74% of total revenues were derived from our Americas region; our EMEA region generated 18%; 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 18% of total and license revenues were 13% of total revenue. We generated $16 million of current period revenues on bookings of $60 million, a 27% yield. The weighted average term for our bookings was 21 months this quarter. Year-to-date, our bookings are pacing below our expectations, which is important as bookings generate future revenue. Our operating expenses totaled $172 million this quarter, down slightly from the prior quarter. This was higher than the amount we got in last quarter due to the $2.3 million charge for restructuring and acquisition related expenses. The restructuring expense resulted from moving resources to distribution roles. As you can see in our Reg G schedule, non-GAAP operating margin was 26% for the quarter. We expect the full year that operating margins will be between 25% and 27%. GAAP net income this quarter was $20 million, down 3% from the prior year. Non-GAAP net income was $32 million for the quarter or up 10% from the same quarter last year. The effective tax rate was about 35% this quarter, higher than previous quarters due to higher U.S. based profits. And it’s 29% year-to-date, which approximates where we expect the effective tax rate to be for the full year 2015. Free cash flow for the quarter was $34 million compared to $25 million in the prior year. Now moving on to the balance sheet, we had $84 million in cash at the end of the quarter. This is down $2 million from last quarter due to repurchases of shares and some debt reduction, partially offset by cash generated from operations. Our total debt is $648 million with a weighted average interest rate of 4.2%. The ratio of our total net debt to adjusted EBITDA is 2.7 times, below the covenant level of 3 times. During the quarter, we returned $30 million in cash to our investors by repurchasing 327,000 shares at an average price of $91.72. We still have remaining $119 million on the latest Board authorization and continue to do 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 and competitive position. And finally, we are reiterating our previously provided guidance for the fiscal year. This implies quarter four revenues of between $224 million to $229 million and net income of $39 million to $42 million. This requires us to close at least $35 million of license revenue in quarter four compared to the record $46 million we delivered in quarter four of last year. We have several large deals and a strong pipeline of mid-sized opportunities in our pipeline for quarter four that supports our current forecast. With that, I will turn it back over to Will for some final comments.

Thanks Mike. With less than one quarter to go in our fiscal year, I am pleased with our progress towards our targets for the year. More importantly, I am pleased with how the company is positioned to deliver value to our shareholders now and in the future. We laid our first strategies through our business. For our software assets, we have invested to maintain our deeply embedded market leadership and to expand our IP assets under broader markets. We are beginning to see results, but there is much more yet to come. On the scores side we are just now seeing how we can take a brand that is so strong in financial services and create substantial value among consumers. Even as we operate in markets with significant stress and turbulence, I believe we have never been better positioned to make the most of our significant opportunities. We will have much more to say next quarter as we talk about our expectations for fiscal 2016. Rest assured we will remain focused on execution. And while 2015 was the year of innovation, 2016 will be a year where we expand our distribution to leverage that innovation. And all that we do will be with an eye towards providing value to our shareholders. I will now turn the call back over to Steve for Q&A.

Thanks Will. This concludes our prepared remarks and we are ready now to take any questions. Operator, please open the line.

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

Hi, this is actually Greg calling on for Manav. Just wanted to ask about myfico.com, nice to hear that it’s growing double-digits, I think that might be a step up from at least, anecdotally, what you were saying last quarter, just wondering what’s driving the strong growth there and what you are seeing, at least in the direct channel?

Well, in the direct channel, we are seeing a lot of volume coming through along with some of the enhanced packaging that we put together last year. We took and added several products, including identity theft product last year and we are seeing the benefits of that increased volume against the higher price point.

Okay, that makes sense. And then also just wanted to ask about the – you talked about the distribution for both applications and tools, when we think about the cost base, is that a shifting of costs from product development into that sales or are we going to see a step up from the added distribution?

I would say that you are going to see a little bit of both. So what we have is a situation where over the last several years, we have invested extremely heavily in our product portfolio both through organic development and also through acquisitions. And we are now in the fortunate position having a really robust set of products and services to offer. And our distribution doesn’t match the breadth of our product portfolio. We – I suppose I am not alone as CEO of a software company who feels like you can never have enough distribution for great product. But it is really very much the case with our company that our product portfolio exceeds the coverage that we have and the ability to distribute it. So we are taking some resource from the products side and shifting it in the direction of distribution – sales and distribution. And we will also be increasing the expenses associated with sales and distribution because we think it represents a pretty big opportunity.

Okay. And then maybe one more sort of on the same line, just an update on the integration of TONBELLER and where you are in the process of taking that outside of its core markets to some of the other European markets?

It’s very smooth. The integration is very smooth. We have retained all the personnel. We are really thrilled with the management team there. The growth is still being driven primarily and probably will for the foreseeable future, will be driven primarily by the TONBELLER’s sales and distribution arm selling their products. But we are starting to take it out to the FICO parent side of the house.

Okay. Thanks guys.

Your next question comes from the line of Bill Warmington with Wells Fargo.

Good afternoon, everyone.

Hi, Bill.

So, I was asked for a little additional color on the bookings numbers. And you saw it in terms of what are the headwinds that you guys faced this quarter that just passed and then also what gives you confidence that you can go ahead and – that you will be able to source new transactions and also, close the ones that are in the pipeline for this coming quarter?

Great question, Bill. So this is a couple of quarters in a row now where bookings is underperformed at least our internal targets. And as a reminder, bookings represent net new deals that are signed, new revenue associated with it, not standard renewals. Lighter bookings tends to create a headwind because we rely on deals that we signed to generate future revenue for us. And so with a headwind in the bookings numbers that provides or creates a situation where we have to go and get more net new revenue in order to fill that – to meet our objectives and our plans. The environment that we have been operating in, both in the U.S. and at least in the third quarter EMEA, have been what’s driven to the lighter amount of bookings. In other words, we have been dealing with this challenge in North America for some time. In the last quarter, we had a very light quarter in EMEA, which is quite unusual for the team there. And so, we are actively working towards getting some deals closed that we accounted on and planned for certainly within the fiscal year and in a certain case in the third quarter. Some of the work that we are doing to refine the sales organization includes some new blood that we have brought in over the past few months, including leaders in our fraud line of business and in our marketing line of business. And we are using all those efforts to close the gap here for this fiscal year and as we look at next year’s plan.

Got it. And then on the scores side of the business, on the B2C side, wanted to ask about what kind of activity you are seeing in the affinity market, that’s been a market that’s really been pretty quiet now for a number of years, what’s going on there and are you guys participating?

It’s good news. And we are participating, but I would also say it’s going slowly. So what we see is an increase in the number of RFPs out there. We find ourselves on the receiving end of the RFPs and we are definitely a player in the market and considered so by the people we are looking for affinity [ph] channel. I am very confident about our prospects in this space. That said, recognize that these are complex deals that take a long time to put together and they take even longer to implement. So the revenue impact of doing deals in the affinity space will be delayed, but the early signs are extremely promising.

Got it. Thank you very much.

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

Hi. This is James Rutherford in for Brett. Thanks for taking the question. Just got a couple here first, on scores, should we expect that kind of strong growth to continue in the fourth quarter and then how should we think about the tough mortgage comps in the fiscal fourth quarter to impact that growth? And then I have one more follow-up after that.

You can expect the growth to be continually strong in the fourth quarter. We are on a trajectory upward in the third quarter while the best quarter we had in a very long time, it’s not a one-off, its part of a trend and you can follow the dots. It’s a booming business and growing and the fourth quarter should be there in the third. Mortgage is not a big part of the story so I wouldn’t spend a lot of time talking about it.

Okay. On distribution, the new kind of strategy of shifting spend there, how should we think about the margin impact of those investments, given that I would assume some of the product spend was capital spending versus it sounds like more OpEx, is there an impact to the margin, how should we think about that?

No, I don’t think you should – I don’t think you should think that there will be a big margin impact, because in fact, our R&D spending expense is not capitalized. So moving the dollars from the product side of the house to the sales of side of the house is not going to have a big margin impact. And these are not dramatic changes that we are talking about. These are measured changes on the margin.

Got it. Okay. Thanks for the help.

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