Fair Isaac Corporation (FICO) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fair Isaac Corporation quarterly earnings conference call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Steve Weber. Mr. Weber, you may begin.

Thank you. Good afternoon, and thank you for joining FICO'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 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 April 27, 2018. Now I'll turn the call over to Will Lansing.

Thanks Steve, and thank you, everyone, for joining us for our second quarter earnings call. We're now halfway through our fiscal year, and I'm happy to report that we're driving growth in each of our three segments. In our second quarter, we reported revenues of 228 million, an increase of 10% over the same period last year. We delivered 25 million of GAAP net income and GAAP earnings of $0.78 per share. We delivered 34 million of non-GAAP net income and non-GAAP EPS of $1.05. And again this quarter, we're delivering balanced growth throughout our business. Our Scores segment was up 7% over the same period last year. Our Applications segment was up 10%, and our Decision Management Software was up 21%. In Applications, revenues were up 10% over the prior year. This is particularly notable as this segment includes many of our more mature products, but we're continuing to drive growth with our Fraud Solutions. And the investments we've made to cloud-enable our other products, like Originations Solutions, have opened new markets, leading to growth. We've also been able to drive growth from acquisitions like Adeptra and TONBELLER. These products are growing 16% and 32%, respectively, year-to-date. In our Decision Management Software, the investments we've made continue to pay dividends. Revenues were up 21% versus the prior year, with particularly good results in our Blaze Advisor and Decision Optimizer products. Bookings this quarter were up 67% over last year. We have a strong pipeline of opportunities in this space and are excited about growth prospects. In the Scores business, it was another quarter of good growth, and we also had some important developments. Revenues were up 7% versus the prior year, with B2C revenues up 16%. As we've been saying, we have a lot going on in this space and we expect revenue growth, particularly on the consumer side, to continue to accelerate as a number of initiatives go live later this year. The expanded agreement announced last quarter with Experian is still in early stages, and we expect to begin seeing its impact as the program rolls out. We also signed some new consumer agreements in second quarter, including an affinity deal for a major card issuer. While these deals will take time to go live and will have little impact on fiscal '17, they will be contributors to fiscal '18 growth, and we are doing exciting things to promote financial inclusion throughout the world. We're working on initiatives in places like China, Peru, India, the Philippines and Russia to help 850 million consumers who are currently credit invisible. These efforts parallel what we're doing in the U.S., leveraging new alternative data sources to help unbanked consumers find a path to access credit. These initiatives will not have an immediate impact on Scores revenue, but they're important in solidifying the brand globally and then laying the groundwork for possible future growth. On the B2B side, we continue to see positive signs. Year-to-date revenues are up 5% from the previous year, and the current economic conditions bode well for moderate sustained growth. And we remain focused on driving shareholder value. We've repurchased nearly 75 million in shares halfway through our fiscal year. And we actively manage our business to efficiently allocate resources, expand margins and continue to accelerate free cash flows. I'll share some summary thoughts later, but now I'd like to turn the call back over to Mike for further financial details.

Thanks, Will, and good afternoon, everyone. Today, I'll emphasize 3 points in my comments. First, we delivered $228 million of revenue, an increase of $22 million or 10% year-over-year. Our cloud revenue was $50 million, up 9% from last year. Second, we delivered $25 million of GAAP net income, up 9% year-over-year. And finally, we had $61 million of free cash flow this quarter, and we used $44 million of it to repurchase shares. I'll begin by breaking the revenue down into our 3 reporting segments. Starting with Applications. Revenues were $134 million, up 10% versus the same period last year. We had a strong quarter in Fraud Solutions, Originations and in our Customer Communication Services product lines. Our application bookings of $49 million is down from last year, when we had a record quarter, but still represent a solid quarter, and we continue to have a strong pipeline of potential deals. In the Decision Management Software segment, revenues were $29 million, up 21% versus the prior year. The increase this quarter was driven by Services revenues and Decision Optimization and Blaze Advisor sales. Bookings continue to be strong in this segment at $23 million, representing a 67% increase over the same period last year. Year-to-date, revenues in this segment are up 14% and bookings are up 46%. We continue to build transactional volumes which will give us predictable recurring revenue streams. And finally, in our Scores segment, revenues were $65 million, up 7% from the same period last year. On the B2B side, we're up 2% versus last year, which included a true-up of under-reported royalties. The B2C revenues were up 16% from the same quarter last year. We expect continued growth from both B2B and B2C in the back half of the year based on current trends and as new opportunities go online. Looking at revenues by region. This quarter's 75% of total revenues were derived from the Americans. Our EMEA region generated 18% and the remaining 7% from Asia Pacific. Recurring revenues derived from transactional and maintenance sources for the quarter represented 71% of total revenue. Consulting and implementation revenues were 18%, and license revenues were 11% of total. Bookings this quarter were $91 million, down 31% from the prior year quarter, when we had a record booking quarter. We generated $21 million of current period revenues on those bookings for a yield of 23%. The weighted average term for our bookings was 26 months this quarter. We continue to book more large deals. This quarter, we had 13 deals over $1 million, and we booked six deals over 3 million. In fact, in the first two quarters, we booked 13 deals over 3 million, more than the 10 we booked all of last year. Operating expenses totaled 188 million this quarter compared to 185 million in the first quarter. We expect to maintain our current cost run rate over the back half of the year, while actively allocating our resources to our highest strategic priorities. As you can see in our Reg G schedule, our non-GAAP operating margin was 25% for the second quarter and 25% year-to-date. We expect some margin expansion in the back half of the year, and that the full year operating margin will be 26% to 28%. GAAP net income this quarter was $25 million and included a reduction to income tax expense of about $4 million or $0.11 a share associated with the adoption of FASB standard number 2016-09. Adjusting for that impact, the effective tax rate was about 35% due to increased profits and higher tax jurisdictions. Non-GAAP net income was 34% for the quarter, down 3% from the same quarter last year. We expect the unaffected or normal tax rate to be about 30% for the full year before any impact of the stock-based comp change. The free cash flow for the quarter was $61 million, which included the impact from the new accounting standard. On a comparable basis, free cash flow was 38 million in the prior year. For the trailing 12 months, free cash flow was $191 million. Turning to the balance sheet. We had 116 million in cash on the balance sheet at the end of the quarter. Our total debt is 626 million, with a weighted average interest rate of about 4.2%. The ratio of our total net debt to adjusted EBITDA this quarter is 2.1 times, below the covenant level of 3. During the quarter, we returned $44 million in excess cash to our investors, repurchasing 348,000 shares at an average price of $126.97. We have about 155 million remaining on the latest 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 and competitive position. Finally, we're updating our previously provided guidance to adjust for the second quarter impact of the new accounting standard on share-based comp. We are not including any impact in future quarters until they are known. We are now guiding the full fiscal 2017 as follows: revenues remain at approximately 925 million; GAAP net income, previously guided at 126 million, is now adjusted to the new total of approximately 130 million; GAAP earnings per share is now approximately $4.03; non-GAAP net income remains unchanged at 158 million; and non-GAAP earnings per share is unchanged at $4.92 per share. With that, I'll turn it back over to Will.

Thanks, Mike. Halfway through our fiscal year, I'm very pleased with our progress. We have a very strong team in place, which is solidly executing on our strategy. We're driving sustainable balance growth throughout our portfolio and building a backlog of recurring transactional revenue. And we're seeing evidence that there's demand for the new products we've been investing in. At the same time, we're focused on expense management and margin expansion as we continue to deliver increasingly strong cash flows. I'll now turn the call back to Steve for Q&A.

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

[Operator Instructions] And our first question comes from Brett Huff from Stephens.

Just a quick follow-up on the bookings, it sounds like you had a good Applications quarter. Can you just give us any detail on the kind of win it was? Was it a renewal with expansions? Was it a new logo? It sounds like it was a larger fraud deal. Just any detail on that would be helpful.

Yes, Brett, in our Applications business, we had strong bookings, really, across the board. I wouldn't say there was any one particular product line that stood out over any others. We typically see larger bookings numbers in areas like fraud banking, which is where we have Falcon, and in our Originations business, where we are seeing a lot of demand for the new Originations manager product we've released.

Okay, that's helpful. And then any update on the DMS? I know we've got a big telco under our belt. How is that implementation going? I think it went live recently. Any update from that customer? And then in terms of pipeline, you mentioned that a couple of times, any thoughts or insight on the DMS part of that pipeline that you can tell us about?

So on the telco deal, it's going smoothly, and we're really happy with the progress to date. And DMS pipeline continues to improve every day, a little bit stronger than the day before.

And our next question comes from the line of Manav Patnaik from Barclays.

I just wanted to hash out the performance in the Scores business a little bit more. So first on the B2B side, I think you said 2% growth. Can you just explain that? I thought that could have been better than that. And then on the B2C side, maybe you could you give us a little bit more color between myFICO.com and the different pieces of Experian there?

Sure, Manav. So on the B2B side, we did report 2% growth. You got to realize, last year, we had a true-up of an underpaid royalty that affected last year's number. So if I would pull that out and set it off to the side on an apples-and-apples basis, without that number, the growth rate on the B2B side was between 8% and 9%. In terms of B2C, we had a very strong quarter, 16% growth. Much of it coming through our indirect partner channel. If I look back and take a quick look at our myFICO business, it grew mid-single digits, with the rest of it coming through new products that are starting to go online in our relationship with Experian.

And that relationship with Experian, you had the legacy piece of it and then the new lead gen piece of it. Is that something you guys can parse out and see the growth from the different areas? And has the -- would you say a lot of that 16% came from the newer side of things?

No, the rollout of the lead gen side is just getting underway. The deal was announced on our last call at the end of January, and so very little impact has been reflected in our numbers so far for that, which means the rest of it by default would come from the legacy agreement we had with them on the consumer side.

Okay, and then, Will, just broadly, I mean, we've talked before about how you guys need to invest in the infrastructure or whether that sale, support services or cloud offerings and so forth for all the different things you guys are working on, particularly DMS. Maybe just any color there. Is it more of the same? There's still a lot left to go? Just some thoughts there.

There's definitely investments still left to go. I think that what we're seeing is that the market appetite in and outside of the financial services sector for cloud offerings is increasing, and it's increasing very rapidly. So I would say that we're happy that we've invested as much as we have to date in terms of getting our products cloud ready and hardening our cloud infrastructure, but we're not finished. And if anything, I think we're accelerating our plans in terms of being cloud-ready for whatever the market demands. So we're not at a point where those investments are tapering off and you can expect margin expansion, at least not yet.

Okay. And then just last one for me. I guess, we've just seen a bit of PR from you, but is the cybersecurity score something to talk about now or is it just early?

In terms of revenue dollars and material contribution to FICO's revenue and profit profile, it's definitely early. In terms of opportunity, it's quite interesting. We have couple of things to work with. One is the IP surrounding what we bring to the cybersecurity game. And the second is our brand for Scores. I mean, FICO as a brand stands for respected, trusted, neutral, science-based evaluation of risk. And applied to the enterprise equity space, we had a great opportunity. That market is still wide open. As you know, we made an acquisition in that space recently, and we're pleased with it so far. We're doing additional development and efforts around it right now. But in terms of accounting to dollars, it's very early.

[Operator Instructions] Our next question comes from the line of Bill Warmington from Wells Fargo. Your line is open.

So congratulations on the Affinity win. I had a couple of questions about it. You mentioned it was a credit card issuer. So I wanted to ask whether this was what would be called like a traditional Affinity deal? Meaning that you're going to do monthly credit card, credit report, credit score, credit file monitoring or whether this was more of an educational program type deal?

This is more the former than the latter. I hesitate to call it the traditional Affinity business. But it's the Affinity business that we originally envisioned where through major partner players, we bring the FICO scores part of monthly monitoring by subscription kind of an offering out to the market. And so it has been a long time in coming, but there's a major player and we're quite excited about the prospects.

Now is this going to be done on a white-label basis or will we actually see you guys as the implementer?

You -- well, it's a combination of us and others. But you will certainly see our brand there in a very prominent way.

Okay. And then I wanted to ask about the demand you're seeing from credit card issuers in general. It seems like you're basically providing a couple of different solutions on the Score side in terms of providing for lead gen solutions and also retention solutions. And the credit card banks have come out with some reasonably aggressive goals for 2017 in terms of their credit card unit growth. So I wanted to ask whether you're seeing that demand remain pretty stable, whether you're seeing it pick up or slow down versus maybe where it was three months ago.

I would say, stable to up. I think that what you're seeing is absolutely right, which is there's a lot of activity in the marketplace. And I think that increasingly issuers are recognizing that the FICO brand and FICO Credit Score and the things wrapped around it are a differentiator and are valued by the market. So we're more involved than ever in efforts to win new customers and to retain old ones.

Okay. And then on the DMS side, last year was a year of investment in terms of growing the sales force. I think it had gone from around 10 or so in the early part of the year up to about 50. I wanted to ask, where that sales force was now? How the productivity was? And whether you feel like you've started to see the acceleration in the bookings there that you were hoping for?

So there are few things going on in our DMS business. One is, when we talked about DMS-dedicated sales, it really takes kind of two forms. One is, most of our sales force is organized around reaching business leaders, Credit Risk Officers, Business Unit Heads. Basically, the business owner. And the idea with some of the dedicated DMS sales was that we would also go after the IT shop and after the CIO, kind of demonstrating the value and extensibility of the DMS platform. As this thing has evolved, we've decided -- we continue to obviously serve the CIO and the IT side, but we've decided to broaden the DMS effort so that it's not just the people focus and specialize on DMS, but our generalized sales force is increasingly becoming equipped to explain the value -- the DMS value proposition to customers and obviously they can bring in specialized sales people, presales people as needed. But our ability to take DMS to market, we're now in an effort to broaden it and have it go to our broader sales force and not just specialized DMS sales people.

And so what are we looking in terms of headcount for sales approximately these days?

I think you have to think of it as unchanged. We are adding heads as fast as we can to get the qualified people that we can. But we're not -- I don't feel like we're at a tremendous deficit. I think we're in a constant mode of renewal, we're adding new people and cutting lower performers. And I think you'll see gradual, very gradual incremental increase over time. But we don't feel like we're at a big deficit and we're not in a giant growth push on headcount.

Okay, and then I wanted to ask, in terms of -- the revenue growth came in strong for the quarter, the margins were down year-over-year. I wanted to just double-check, you've addressed some of the issues, but I wanted to double back on that in terms of is it a function of mix? Is it a function on the revenue side? Is it a function of investments that you're making in the cloud preparation? What's the dynamic there?

Yes, Bill, I think the dynamic you're seeing is there was a step function in investment, mainly in sales and distribution that happened last year in our third quarter. That's when we really begin to step up the additional sales heads that we were adding. And, obviously, those sales heads weren't there in our second quarter last year, and you'll see them in our SG&A numbers in this year's second quarter. On top of that or beside that, but to a lesser degree, we put some money into our operations team that we had budgeted and planned for and spoke about at the beginning of the year. So the run rate, if you go back and look from probably quarter three last year, has been pretty stable in terms of expense. The step-up function happened between quarter two and three last year.

Got it. Makes sense. And then final question for me was just to touch on the free cash flow; that seemed particularly strong in this quarter. And just wanted to understand what the component to that were?

Yes, the big source of cash this quarter is our DSO. A drop from what's kind of traditionally been 65 days down to somewhere around 56 or 57 days. And those eight or nine days, if you think about it, one day in a DSO is $2.5 million. And if you have pickup eight or nine days, that's $20-plus million of cash flow. We just had very strong collections across virtually every part of the world we operate in, and that spiked the number quite a bit.

You're starting to use your own collections product in-house with Adeptra?

Hey, you got it.

And our next question comes from the line of Adam Klauber from William Blair. Your line is open.

Just one or two. Applications, you had some good wins. Are those a combination of existing and new clients? And if I remember, last quarter, you were having some success internationally there, did that continue to follow in this quarter?

Yes, Adam. So it is a combination. We we've had some very nice wins in our Fraud business, especially in Latin America, over the last couple of quarters. We had a large renewal this quarter in Fraud, which helped the Applications business as well. And we're also seeing a host of new customers that bought Origination Manager from us in the cloud, starting to go online and we're starting to see the revenue flowing through from that. Those are two probably the strongest areas. And beyond that, on the upside, our CCS business, which is the old Adeptra business we acquired a few years back. We're starting to see more and more customers come online on that across the world as well, with particular strength in Asia and North America. So it's a mixed group, but it's across a couple of pretty important product lines for us.

Okay. And then a sort of similar question on the Tools side but more core of financial vertical versus nonfinancials, I guess. How is the mix of sales going there?

Yes. This quarter, we had a couple of strong license deals that were outside of financial services that drove a nice increase in revenue. And then we had kind of the typical deals, especially on the optimization side. One of the real successes so far for us internally here is our optimization practice. We signed an incredibly large mortgage optimization deal this quarter. It's not upfront license, but it's a lot of services and some ongoing licenses. We signed that one down in Asia-Pacific. And we've also, over the course of the year, signed several credit line optimization deals, which are just very nice big and important deals for the banks and nice margin deals for the company. So those have been kind of highlight areas, as I would call them.

Okay, okay. And then on B2C on Scores, obviously, a good quarter. You have some of the deals ramping up towards the end of the year. So is this growth level in the range sustainable? Or is for some reason was 2Q just a little too high in B2C?

Quarter 2 on the B2C side is always a little bit higher than others. It's seasonally high. Not materially, but seasonally high. And I would say, we're starting to see some of the deals we signed earlier ongoing online a little bit heavier, and that's why there was a nice quarter-over-quarter step-up. We would expect the numbers to continue to grow but maybe not on the same step function we saw quarter 1 to quarter 2, but we still see the back half of the year being stronger than the front half of the year.

And our next question comes from the line of Matthew Galinko from Sidoti.

So appreciate you breaking out TONBELLER growth rate. Just curious how sustainable that is as we move forward?

Yes, the -- year-to-date, our TONBELLER product is up about 30%. Remember, this was about a $20 million product line, overall. So it's a high percentage on a lower dollar amount. The TONBELLER team are continuing to sell a lot of, I'll call them, legacy deals that they were selling prior to the acquisition. Since the acquisition, we've signed a couple of very large deals that were probably out of the reach of them as a standalone company, and we're working on several others. The deals are more ratable revenue-oriented. They're not big upfront license sales like you typically see in some of our other lines of business. And so we're just kind of grinding away and trying to build a bigger book of business with the AML software we bought. And so far, we're happy with where we're headed.

Got it. And then maybe just a follow-up on your large telco wins from last year. I'm wondering if you're finding that to be repeatable or is that go-live is having any influence on other deals in the pipeline that might be with other telcos?

I think it is repeatable. The time line for that is uncertain. So there's -- obviously, the experience we're having with that large one is letting us kind of harden the product and understand scalability challenges and so on. The appetite in the marketplace is there, and so we work on it and it's anybody's guess as to when we'll see more in that vertical. But I think it is likely in our future.

And I'm not showing any questions in queue at this time.

Thanks, operator. This concludes our call today. Thank you all for joining, and have a good day.