Fair Isaac Corporation (FICO) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Fair Isaac Corporation Quarterly Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, January 25, 2018. And now, I’d like to turn the conference over to Steve Weber. Please go ahead.

Thank you. 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; 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 also includes 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 the 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 25, 2019. And 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’m pleased with the results and I’m happy to see we have good momentum as we look at the year ahead. In our first quarter, we reported revenues of $235 million, an increase of 7% over the same period last year. We delivered $27 million of GAAP net income and GAAP earnings of $0.86 per share. Our GAAP earnings and EPS include the charge of $12 million or $0.37 per share associated with the recent enactment of tax reform. We delivered $41 million of non-GAAP net income and non-GAAP EPS of $1.30 per share, up 23% and 27%, respectively from the same period last year. Mike will talk more about the impacts of tax reform but it is certainly a net positive for us going forward. We believe the reduced ongoing tax rate will have a positive impact in fiscal 2018 of nearly $14 million and today are updating our guidance to reflect that. In light of tax reform, we also announced to our employees today that we’ll be issuing a special grant of 10 restricted stock units to every FICO employee, making each employee an owner to share in our long-term success. On the software side of our business, we continue to build through our recurring revenue base as we sell more cloud-based deals. Our applications segment was up 5% over last year and recurring revenue was up 10%. We had particularly good quarters with our compliance, Customer Communications Services, collections and recovery and originations solutions. These products are innovative, relatively new cloud-based products and they’re now getting to a size where their growth can move the needle for the Company. In our decision management software, revenues were down about $1.5 million or 6% due to less upfront license sales. Our emphasis is on cloud deals in DMS, meaning more recurring revenue. However, those revenues were up 13%. Overall, our cloud based revenues were up 13% and our cloud based bookings were up 34% over the same period last year. In the Scores business, we continue to drive significant growth. Revenues this quarter were $70 million, up 18% from the same period last year. On the B2C side, revenues were up 27% over the previous year as we had new partners and seek growth from our existing partners. Today’s consumers are more focused than ever on their personal financial information and their credit worthiness. We’ve been focused on educating consumers first to our Open Access program and then with partners to provide additional content around the Scores with information like simulators, score ingredients, summary reports and monitoring. We are constantly looking for ways to expand offerings to consumers and provide more value to our partners to work together to give consumers best possible view how lenders assess them. On the B2B side, revenues were up 13% over the previous year as we continue to see increases in both volume and price. The current credit climate remains very strong and we expect to drive growth on the B2B side throughout this fiscal year. I’d like to take a minute to update you on our Financial Inclusion Initiatives that we’ve been talking about over the last several quarters. As you know FICO is an independent data analytics company, not a credit bureau. FICO’s role in the lending system is to harness the credit bureau’s data to produce FICO Scores, which are predictive of consumers’ credit risk. In order to produce the credit score that is reliable and predictive, we rely on quality data standards that are refined over decades and we know what’s at stake. The consumer’s ability to get a car loan or mortgage hinges on the lender’s ability to accurately assess risk. Our data standards play an important role in ensuring the robustness and accuracy of our credit scoring system and by extension the stability and soundness of millions of lending decisions every day. We are responsibly using new and regulatory compliant alternative data sources that allow us to give reliable FICO Scores to people who cannot be scored using credit bureau data alone. Our approach ensures that the integrity of our scoring standards as well as the expansion of credit scoring to a broader, more inclusive and more diverse group than ever before. I’ll share some summary thoughts later but now I would like to turn the call over to Mike for further financial details.

Thanks, Will Good afternoon, everyone. Today, I’ll emphasize three points in my prepared comments. First, we delivered $235 million of revenue, an increase of $16 million or 7% year-over-year. Recurring revenue grew 14% over last year, double-digit growth in all three segments and at a $175 million accounted for nearly 3/4 of the quarter’s revenue. Second, we delivered $27 million of GAAP net income, which included some charges associated with the tax reform act. Our ongoing recurring tax rate will decline over the remainder of the year, resulting in an estimated savings of $14 million or $0.44 per share. Finally, we generated $25 million of free cash flow this quarter and we used $50 million to repurchase shares in quarter one and an additional $50 million for repurchases in January. I’ll begin by breaking the revenue down into our three reported segments. Starting with the applications, revenues were a $141 million, up 5% versus the same period last year. Recurring revenue grew 10% over last year, partially offset by a decline in license revenue. We had a very strong quarter in our Customer Communications Services product where volumes pushed revenues up 18% from last year. We also had a strong quarter in collections and recovery, up 14% and in originations, up 13%. Our applications bookings of $62 million were flat with the prior year. In the Decision Management Software segment, revenues were $24 million, down 6% versus the last year due to fewer upfront license sales. That was partially offset by an increase of 13% in recurring revenue. Bookings of $12 million were also down, following last quarter’s record bookings. As we continue to transition to more SaaS based deals, we will likely see less upfront revenue but more recurring. And finally, in our Scores segment, revenues were $70 million, up 18% from last year. On the B2B side, we’re up 13% versus last year and are continuing to see positive trends. The B2C revenues were up 27% from the same quarter last year. As Will noted, we expect Scores growth to continue to accelerate throughout the year. Looking at revenues by region, this quarter’s 74% of total revenues were derived from the Americas; our EMEA region generated 18%; and the remaining 8% was from Asia Pacific. Recurring revenues derived from transactional and maintenance sources continued to trend up, this quarter representing 74% of total revenue. Consulting and implementation revenue were 18% and license revenues were 8% of total. Bookings this quarter were $82 million, down 15% from the prior year quarter. Total bookings for the trailing four quarters is $450 million. We generated $15 million of current period revenues on those bookings for a yield of 19%. The weighted average term for our bookings was 27 months this quarter. And this quarter we had 9 deals over a $1 million including 4 deals over $3 million. Operating expenses totaled to $195 million this quarter compared to $192 million in the fourth quarter. The increase is primarily related to our annual salary increase. And as you can see in our Reg G schedule, our non-GAAP operating margin was 25% for the first quarter. We expect that operating margin to be between 26.5% and 28.5% for the full year. GAAP net income this quarter was $27 million and included a charge to income tax expense of $12 million or $0.37 per share associated with the Tax Cuts and Job Act. The charge encompasses several elements, including a tax on accumulated overseas earnings and profits, and the re-measurement of deferred income taxes. We also had a reduction to income tax expense of $11.5 million, or $0.36 per share associated with the excess tax benefits from shareholders. Including all these items, the effective tax rate was about 20% this quarter. We anticipate a reduction in our tax rate will result in a savings in our fiscal 2018 of about $14 million. We are still evaluating the long-term impact of the tax reform but expect our tax rate to be in the low to mid-20s over the remainder of 2018. Free cash flow for the quarter was $25 million versus $28 million in the prior year. Turning to the balance sheet, we had $94 million of cash on hand at the end of the quarter. Our total debt is $664 million with a weighted average interest rate of 4%. The ratio of net debt to adjusted EBITDA this quarter is 2.2 times, below the covenant level of three times. During the quarter, we returned $50 million in excess cash to our investors, repurchasing 335,000 shares at an average price of around $148. We repurchased another 313,000 shares in January at an average price of about $160. We have about $187 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 technologies and products that advance our strategy or strengthen our portfolio and competitive position. And finally, we are updating our previously provided guidance to adjust for the impact of the tax reform legislation and the reduction in our share count. We are now guiding the full fiscal year as follows. Revenues remain unchanged at $990 million, GAAP net income previously guided at $139 million is now adjusted by the tax charges, and the ongoing rate benefit to $136 million, GAAP earnings-per-share is now approximately $4.34, non-GAAP net income previously guided at a $171 million is now revised to $191 million, making non-GAAP earnings per share an increase from $5.32 to $6.09 per share. With that I’ll turn it over to Will for some final comments.

Thanks, Mike. As I said in my opening remarks, I believe we have remarkable momentum and are just beginning to reap the benefits of our strategic initiatives. Our Scores business continues to lead the way. It’s really a unique franchise business at the heart of the U.S. credit markets. And we continue to find new opportunities to make the most of that valuable IP. On the software side, the product innovation we have invested in over the last several years is opening new markets and allowing us to serve entirely new sets of customers. At the same time, we are making a gradual but steady transition to our recurring SaaS revenue model that will deliver predictable profitable revenue. It’s truly an exciting time to be at FICO. I’ll now turn over 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 line.

[Operator Instructions] And we have a question from the line of Manav Patnaik with Barclays. Please proceed. Sorry Mr. Patnaik your line is open. We also have a question from the line of Brett Huff with Stephens Incorporated, please proceed.

Thank you. Good afternoon, guys. Couple of quick questions. Definitely, I want to hear a little bit more about the B2C growth. I know that’s one of the big focuses that we hear from investors. It sounds like it was driven kind of across the board by your current partners continuing to kind of penetrate some of their programs and they’re pushing it, and then also some new partners. Are those new partners -- do they look like the old one, like with Experian or like maybe with Discover or are they new and different and any detail on that would be helpful?

Yes, Brett. I mean, a great deal of it was driven from our expanded relationship with Experian which we announced last year in January along with the Discover deal. Recently, we booked some new transactions for an Affinity deal and several other educational programs, and those deals are starting to go live and we’re starting to see revenue flow from that. And I should also add that our myFICO business had a very nice quarter as well growing in the mid single digits. So, it’s a combination of a lot of small things beginning to add up.

Can you talk a little bit about kind of the relative economics on any of those? I don’t know how much you guys have talked about how much more beneficial maybe selling for a consumer application, FICO Scores for consumer application versus a B2B. But have you maybe dimensionalized that for folks at all?

No. I mean, we have I guess to some degree. We’ve talked certainly about the broader relationship with Experian and the way that the pricing dynamic works there, as they grow, we grow; and as they decline, we decline. So, we’re very much tied on a percent of success or failure. For each of the other deals, they’re very independently negotiated and they tend to be based upon the amount of technology or the amount of IP scoring technology they’re using in the systems that they’re implementing, and also based upon the size of the market they’re addressing. And so, we would literally have to go into each deal individually which of course we can’t do for confidentiality reasons.

Okay. And then, one last question, on the 13% B2B growth that’s also really nice acceleration, I think you mentioned just kind of generally good place where we’re in the credit cycle and consumer and economic activity and things like that. Anything from a share shift point of view vis-à-vis the Equifax breach that you saw between potentially different distribution partners?

No, but we don’t see any share shift, it’s just strength in the market and we don’t see any of that.

One last one if I can. An update on which products we have SaaSified? I know that the communication, the origination manager, collections I think are all pure SaaS at this point. Where are we kind of innings wise on getting the Falcon and TRIAD products more that way? I believe last quarter you sold maybe what your first of one of those two in the SaaS version?

Yes. Great question. It’s actually easier to ask the question which ones haven’t made the full transition yet. And you mentioned Falcon and TRIAD. What I would say is with respect to TRIAD, we actually have the TRIAD successor product called Strategy Director which is available in the cloud. And we also can offer Falcon in the in the cloud although it doesn’t -- it’s not as fully featured as we intend for it to be in the long run. So, there is more work to be done on falcon. But virtually, all of our major franchise offerings are available on the cloud now?

We have a question from Manav Patnaik with Barclays. Please proceed.

So, the first question was just obviously with the nice tax benefit, it looks you are giving employees those RSUs. But broadly, should we expect any change to capital allocation here, pick-up buybacks or maybe just do more M&A, just some thoughts there?

No. I think the answer to that is no. I think our business continues to go along the direction it’s been on. The level of buyback is a function of our free cash flow and also kind of what we consider to be optimal leverage. And so, you’ll see our buybacks drift upward and downward to maintain the level of leverage that we think is efficient for our balance sheet. So, we’re -- as we mentioned, we are at 2.2 times, which is a little bit low for us. And so there is room for us to potentially increase the buyback a little bit, but I think the way to think about it as business as usual.

Okay. And then, I was just wondering on the mortgage market side of things, the two-part question. One, what are the trends you are seeing there, within that 13% B2B, like is that all mainly credit card? And then, I guess, obviously, there is a the whole debate on the FICO Score within the mortgage market, if you have any thoughts there?

I can take the trends part. This is Mike. The quantities of B2B FICO Scores pull this quarter were up across the board, across all of the lifecycles that we service, marketing, originations and account management. As it relates to specific areas, we saw tremendous amount of strength in credit cards and have for the last number of quarters. But credit cards was a very big driver this quarter. We also saw a lot of strength in our marketing of auto loans and origination of auto loans and mortgage was little bit up from last year, flat to up slightly.

And just I guess thoughts just on the scoring debate out there in the market?

Well, yes. As you know, there is some pressure on the GSEs to reconsider the scores that they use to put on the paper. And today, FICO was very much the standard there. And we continue to believe that makes sense for FICO to remain the standard there. There is an RFI out and we are responding to that with our [indiscernible] and up to date offerings. And we think that system that we have today works well and there is -- from a policy standpoint it is really wrapped around safety and soundness. So, we would anticipate -- we hope that that system won’t change.

And then just last one for me on the DMS side of things, good to obviously see the recurring piece be up, but the license down. I mean, is that a trend we should continue to see? I was just hoping you could give us some more color there, maybe where we are in that transition, like what the mix looks like?

Well, I think what we saw this quarter is a continuation of what we have seen in the last couple of quarters. And that is upfront license revenue was starting to trend downwards on DMS as we are growing our recurring revenue business. It will continue to be lumpy depending upon the timing of when a deal is booked and revenue was claimed. Obviously, this quarter, we had very light bookings, not only in DMS but frankly across the whole Company, which isn’t too surprising to us coming off of the record we had in the fourth quarter. The decline in the license revenue is more than offset in general in the business by the recurring revenue. So, it’s just the continued advancement of the business model to more recurring revenue coming from the cloud products.

We have a question from Katelyn Young with William Blair. please proceed.

I was wondering if you could spend some time talking about the bookings in the quarter. Obviously, I understand you are coming off some really strong quarters over the last year. So, I was wondering if you could please just compare and contrast the bookings this quarter with perhaps a year ago in terms of product mix or client mix and if it is anything that was noticeably weaker in the quarter, any trends you are seeing there?

Yes. I wouldn’t call it a trend. I can explain a little bit about this quarter versus maybe prior quarters. Last years in total, we reported over $90 million each quarter bookings, with the last quarter of the year being been a very large record high. And we fell below that 90 million this quarter which internally was a disappointment to us. Fortunately, it was just due to some timing of some deals that we have in the pipeline and being we are in the first quarter, we are not too concerned that there’s any underlying trend there. It’s just simply the timing of when deals get signed and done. I would say that in the mix of the deals we have this quarter, many of them relate to our new cloud business including from a previous question we had another TRIAD cloud deal that we sign that was in one of our top 10 deals this quarter. So, there’s some very strong business that’s out there, unfortunately we didn’t get it all done by the end of December. But, we anticipate that we will catch itself up before the end of the fiscal year. So, beyond that, I wouldn’t say there is any other important trends to think of.

And then on the B2B growth side, are the XD relationships -- from the international work you guys are doing, is that a material contributor to revenue growth year-over-year yet or is that still kind of building out?

Not yet, it is pretty much in build mode.

And we also have a question from the line of Bill Warmington with Wells Fargo. Please proceed.

So, first question for you on the pipeline in the B2C Scores business. So, it sounds like you’ve got the two education clients are ramping. The Affinity client, it looked like American Express under Experian went live in early January. So, congratulations on that. And then, on the lead gen side, you mentioned Experian and their group of banks and as well as Discover. I wanted to ask if there have been any new players added to those three buckets, and then, also, if there was a pipeline of potential new deals in each of those three buckets.

Bill, there is a pipeline of potential opportunities in those buckets, and we added no new players in terms of new deals of any size that I can think of in quarter one. So, hopefully, we’ll have more to speak about in the next quarter or two on that.

Okay. And then, very strong performance on the B2B side. The question I had there is, is your guidance still assuming zero percent growth for that for the year?

Well, inherently, it’s the same as what we guided at the end of last year, because we have not updated our revenue guidance. So, from that regard, yes, that is true. We obviously had a stronger first quarter than we anticipated. We have a lot of license revenue to sign to hit the 990. And based upon a lighter first quarter in that it made sense to just let the guidance ride as is. But, I would say it’s safe to say, we feel better and better as we continue to see strength in all aspects of our Scores business.

Okay. And then, on the DMS side, I just wanted to ask, you had mentioned that -- it sounded like there were some deals that were close to closing that may have closed after the end of December. How are bookings trending so far in the March quarter?

Well, we’re not into March yet, Bill. Remember, we’re in January. I know out in Boston, you kind of wish it was the March timeframe. I’ll let you know. So, I would say, most of our deals frankly are loaded to the backend of any given quarter, usually comes in the third month of the quarter. And so, giving you much more guidance on January really probably won’t do a whole lot.

Okay. And then, another question on the tax reform. You’ve given us some guidance in terms of the actual rate impact and EPS impact. What’s the cash flow benefit do you expect on an annualized basis?

Well, if our cash expense is going down $14 million, which is what we stated, that’s dollar for dollar cash. So, we should see that -- this claim for the timing of when the cash payments go out or estimated cash payments go out. But, over the course of time we should see at least $14 million starting to come back through our cash flow statement, at least based on the way we see it today.

Got it. And then, the only other question I had for you was on the -- housekeeping question, the impact of the grants that you are giving out on the share count going forward, how do you think about that?

Yes. That’ll just be several million dollars this year, for the remainder of this fiscal year and they’ll might be a couple of million that’ll spill into next year but it’s a pretty inconsequential amount compared to our overall numbers.

Got it. One final one. You had mentioned the strength in the B2B volumes, which again, given the consumer credit tailwinds is not a surprise but you also mentioned better price there. Maybe you can talk a little bit about what’s going on there to drive better pricing?

We adjust our prices for our score, all of our scores typically annually. And so, every year we evaluate kind of where we are and we make modest adjustments and this year is no different. And so, yes, there is a little bit of pricing impact, but every year, we have little bit pricing impact.

Yes. What you are seeing in this quarter is the pricing impact that took effect basically January 1 of last year, just as an FYI.

And there are no further questions registered at this time.

All right, thank you. Thank you all for joining today’s call. This concludes our call and we will be back to update you next quarter. Thank you.