Fair Isaac Corporation (FICO) Q2 2019 Earnings Report, Transcript and Summary

Greetings and 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. It's Tuesday, April 30th, 2019. I would now like to turn the conference over to Steve Weber. Please go ahead.

Thank you, Eric. 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 the Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measure 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 April 30th, 2020. And now I'll turn the call over to Will Lansing.

Thank you, Steve and thank you everyone for joining us for our second quarter earnings call. We delivered another solid quarter as we continue to see traction in our software business and amazing opportunities in our Scores business. Because of the increased visibility into our growth, today, we are raising our full year guidance. In our second quarter, we reported revenues of $278 million, an increase of 9% over the same period last year. We delivered $33 million of GAAP net income and GAAP earnings of $1.10 per share. We delivered $47 million of non-GAAP net income and non-GAAP EPS of $1.56. We had another good bookings quarter, with more than $100 million in bookings for the fifth consecutive quarter. And we continue to book a lot of new cloud deals. In fact, year-to-date, our cloud bookings are up 43% versus the first half of last year. Our software revenue was up a modest 3% this quarter. Applications were down 3% as we had less upfront license sales and services revenue than last year, while our decision management software was up 41%. Some of the decision management increase was due to licenses, but we're also seeing the benefit of services and transactional revenues from deals we've signed in previous quarters. As we have said, we're happy with the strategic investments we've made, and our innovative technology has been recognized by the industry. In fact, a recent Chartis report named FICO a category leader in AI for financial services and pointed to completeness of offerings and market potential. It's another data point that increases our confidence in investing in technology that helps banks meet ever more sophisticated requirements. As you know, last month, we announced a partnership with Equifax to provide a connected platform experience combining Equifax data with our FICO decision management platform. Since then, we've met with a number of customers who are intrigued with the potential of the turnkey cloud applications we are rolling out. We'll continue to keep you posted on our progress. I view this as an important initiative for FICO and I believe it will greatly expand the footprint of our decision management platform. In the Scores business, we had another great quarter as we saw stable volumes and the partial effects of price increases that began to take effect in our second quarter. Total revenues were up 20% versus the prior year and totaled $104 million. On the B2B side, revenues were up 27% over the same period as last year. This was primarily due to targeted price increases as well as some new product innovations. We implemented some price adjustments in January, and they have been phasing in the last few months. B2C revenues were up 5% this quarter and 7% year-to-date. We're pursuing a number of potential deals and still see many opportunities in this space. And we remain focused on driving shareholder value. We've repurchased $120 million in shares halfway through our fiscal year, and we worked diligently to efficiently allocate resources, accelerate free cash flow, and improve margins while still investing for the future. I'll share some summary thoughts later, but now I'd 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 remarks. First, we delivered $278 million of revenue. That's an increase of $22 million or 9% year-over-year. Our recurring revenue was $212 million, which is up 10% from last year driven by the strength in our Scores business. Second, we delivered $33 million of GAAP net income, up 7% year-over-year, and EPS of $1.10 per share, up 10%. Finally, we are raising our guidance to reflect the momentum we are seeing in our Scores business. I'll begin by breaking down revenue into our three reported segments, starting with applications, where revenues were $142 million, which is down 3% versus the same period last year and is due to reductions in upfront license sales and services. Our applications bookings of $63 million is down 9% from last year. We do expect license revenue to expand over the remainder of the year due to several large term license renewals. In the decision management software segment, revenues were $32 million, which is up 41% versus the prior year due primarily to increased services revenues as we implement new installations and deploy analytic models. Recurring revenue in DMS were up 4% from the previous year. Bookings were $28 million, which is up 41% from last year. And finally, in the Scores segment, revenues were $104 million, which is up 20% from last year. On the B2B side, we were up 27% due primarily to some targeted price increases that began to feather in during the quarter. The B2C revenues were up 5% from the same quarter last year. We expect continued growth, particularly from B2B, as the pricing increases continue to ramp up. Looking at revenues by region. This quarter, 78% of total revenues were derived in the Americas. Our EMEA region generated 15%. And the remaining 7% was from Asia-Pacific. Recurring revenues derived from transactional and maintenance sources for the quarter represented 76% of total revenue. Consulting and implementation revenues were 18% and license revenues were just 6% of total revenues. Cloud revenues were $67 million this quarter, which is up 6% from last year. The growth rate was lower this quarter due to some customer churn on our CCS product. Year-to-date cloud revenues are $130 million, which is up 9% from last year. Bookings this quarter were $106 million, up 4% from the prior year. We generated $15 million of current period revenue on those bookings for a yield of 14%. The weighted average term for the bookings was 32 months this quarter. This quarter, we had 12 deals between $1 million and $3 million, and we booked an additional seven deals over $3 million. In addition, cloud bookings were $29 million this quarter, down slightly from last year due to the timing of signed deals. Operating expenses totaled $230 million this quarter compared to $213 million in our first quarter. The increase relates primarily to variable expenses associated with increased revenue and employee incentive costs. We expect to maintain our current cost run rate over the back half of the year while actively investing our resources in our highest strategic priorities. As you can see in our Reg G schedule, our non-GAAP operating margin was 25% in the second quarter, and it is 26% year-to-date. We expect that operating margins will be between 26.5% to 28.5% for the full year. GAAP net income was $33 million or $1.10 per share, and non-GAAP net income was $47 million or $1.56 per share. The effective tax rate was about 16% this quarter, and we expect our tax rate to be about 14% for the fiscal year. The free cash flow for the quarter was $44 million versus $42 million in the prior year, with a trailing 12-month free cash flow of $211 million. Now, looking at the balance sheet, we had $77 million of cash on hand at the end of the quarter. Our total debt is $828 million, with a weighted average interest rate of 4.8%. And the ratio of our total net debt to adjusted EBITDA this quarter is 2.6 times, which is below the covenant level of three. Depending on marketing conditions, we may be refinancing some of our fixed debt that will be maturing over the next 16 months. During the quarter, we returned $37 million of excess cash to our investors, repurchasing 150,000 shares at an average price of $247. Through the first two quarters of the year, we've repurchased 575,000 shares at an average price of $208. We still have about $80 million remaining on the 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. And finally, as Will mentioned, we are raising our previously provided guidance. Our new guidance for the full fiscal year 2019 is as follows; we expect revenue to be approximately $1.14 billion, up from the previously guided $1.125 billion. GAAP net income is now expected to be approximately $173 million and GAAP earnings per share is now approximately $5.75 per share. Non-GAAP net income is now expected to be $214 million or $7.12 per share. With that, I'll turn it back over to Will for final comments.

Thanks Mike. We're halfway through another fiscal year and we're very well-positioned for the future. Our customers are increasingly seeking better, more advanced analytics and technology to optimize their most difficult decisions and we are ready and able to help them. As a result, our pipeline is very robust. We have more and bigger deals in our pipeline than ever before. We have a great team in place, and we're effectively executing on our cloud strategy to drive profitable recurring revenue and earnings growth. I'll now turn the call back to Steve for Q&A.

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

Thank you. [Operator Instructions] And our first question comes from the line of Manav Patnaik with Barclays. Please go ahead.

Thank you. Good evening guys. Just on the guidance raise. So most of the raise that was shared was because of the price increases that are going into effect on the B2B Scores side. And then does that mean you still expect that kind of 9% growth from the software this year as well?

Partially, Manav. So, yes, in fact, the increase in the revenue guidance is driven from the Scores pricing, which we have some visibility now to the back half of the year. That's a bit offset by our growth in the software business. As you remember, last quarter, we fell short of our revenue growth on professional services. We made a little bit of it back here in the second quarter, but we expect, for the full year, we'll likely fall short, putting our software growth somewhere around 7%-ish, plus or minus. So, we're bringing that number back slightly and it's being replaced by the Scores item.

Got it. And then just on the B2C Scores, the 5% growth feels a little light, was there any in comps that are pioneering, or anything going on there?

No, nothing really going on there. It's growth that's coming through our partner pipeline, mainly through Experian.

Got it. And then just lastly, Will, maybe some broad color on the cloud transition, the SaaS transition, how you think about that progress so far?

We're pleased with our progress and we still have plenty of work ahead. We are now at the point where all of our major franchises are available on the cloud. We have Falcon X coming out, which is our cloud version of Falcon, coming out this year and that's positioning us even more strongly in the cloud. But we still have work to do in terms of simplifying the product and consolidating the code base. And so I would say that there's more work ahead, but we're really feeling good about it. The infrastructure is really solid. The reliability is there. The geographic reach is there. We have great network ops and operational control of it. So, we're pretty happy about that.

Okay, got it. Thanks guys.

Our next question comes from the line of Bill Warmington with Wells Fargo. Please go ahead.

Good afternoon everyone. So, an initial question for you on this -- on the special price increase in auto, and maybe it would help if you compare and contrast that one with the mortgage price increase from last year. You guys referenced a couple of terms in terms of the increase being partial and feathering in. So is there something that's different about the structure of the auto industry that -- where the price increase is going through a little more slowly than it did for mortgage?

Yes, that's exactly right, Bill. It's slightly different, and we have some lagging price coming in. And so that it's as simple as that. I mean it's still quite a major move in auto.

I would add one other thing, Bill and that is we've, both with mortgage and auto, we've always said we will grandfather in any committed dates that exists with our resellers, the three bureaus. And in the case of auto, there are some committed dates that extend out, and so that's why it feathers in a little bit slower. And also, the timing by which the credit bureaus implement their rate card with the end customers is different than it is for mortgage. And so those are a little bit in nuanced discussions that, I guess, add on to what Will said.

Got it, that's helpful. And then on the bookings detail, it looked like the transaction and maintenance bookings went from about 55% of total bookings in the December quarter to about 35% of total bookings in the March quarter. I just wanted to ask what was going on behind that.

Really nothing. You are right, those are correct numbers. And in the first quarter as in some prior quarters, we had a heavier percentage of deals that we signed that were transactional or license-oriented. This quarter happened to be one that was very heavy PS-oriented. I think roughly 60% or something close to 60% of our bookings this quarter are PS, which will burn off here probably in the next six to nine months. So, there really is nothing to it other than the mix of the deals that we signed this quarter than in the past several.

Okay. And then on the timing of the cloud bookings for the quarter, the $29 million, that was below the last couple of quarters. When you reference timing, do you mean there were some deals that potentially were going to book in the March quarter that are going to book in the June quarter? Or -- I just want to ask a little more detail on that.

Yes, that's exactly right. I mean we obviously are sensitive to the customers who want to sign deals by the end of the quarter, but we don't go the extra mile in terms of trying to get something signed by the end of March as compared to something in April or May. And practically speaking, these cloud deals are all ratable revenue anyway, and so it's simply a timing of one quarter to the next. And frankly, that's all it was this quarter. We were happy with over $100 million, and it certainly could have been a much larger number. And hopefully, we'll make some of that up in the back half of the year.

Yes. And you guys have referenced the transition from the upfront license fee model to the SaaS cloud delivery model as being a headwind to revenue and margins in the past. I just want to know if you could help us quantify how much of a headwind that is currently or if you want to talk about it in terms of the current quarter or in terms of the guidance.

Yes. So, under the old accounting rules, Bill, 605, it was a headwind. I think as I mentioned last quarter when we first had to implement the new revenue rule, 606, there was a strange little component to that rule for on-premise software, which is whenever there is a renewal or a new license deal signed on-premise, if there are guaranteed minimums in the contract, those guaranteed minimums are required to be recognized upfront under the old rule rather than ratably under the old rules.

Under the new rule.

I'm sorry, under the new rule.

Upfront.

And they're recognized upfront now. And we do have Falcon renewals from time to time that carry guaranteed minimums in there, and so that's actually created some license revenue that we are claiming this year, including in quarter two that we didn't claim in the past. So, what we are finding this year with these renewals is that we have more license revenue than we built into our plan and that's offsetting some of the softness in the recurring revenue that we're seeing from some churn on a couple of customers in CCS.

Okay. And then final question for you. It looked like most of the expense increase on a year-over-year basis was in the personnel department. So, I just wanted to ask for a little color on that. Is most of that going into R&D personnel? Or is that for implementation of the bookings? I just wanted to get a little -- see if we could get a little color there.

Yes. I call it two broad things. So, the first is we have continued to add headcount in the organization. And the headcount is primarily being added in R&D and operations, so that hits a combination of cost of goods and a combination of the R&D line item. That's where the heads are being added in. Also, as we've added in some heads for the existing employee base, we did as we typically do our annual compensation increase, which took effect in December. So, the January through March is the first full quarter in which we have a 3% salary increase in effect for the remainder of the employees. So, between the headcount added and the annual increase, that's the category that is driving the biggest part of the increase. The rest of the increase is frankly tied to variable incentive comp, commissions and incentive comp for the rest of the organization. And as a result of raising the guidance, it also affects that incentive comp line item, and we, as a result, have to increase our accruals to catch up not only for the first quarter, but the second quarter. So, those are really the two things that are driving the cost increase. That's why we believe it's going to level out over the rest of the year.

Got it. Well, thank you very much.

[Operator Instructions] Our next question comes from the line of Brett Huff with Stephens Inc. Please go ahead.

Yes, hi guys. This is Joel [Indiscernible] on for Brett Huff. I just want to ask on the M&A comment, what kind of assets would you guys be looking at? And for the right deal, is that something that you would lever up? Are these going to be more tuck-in acquisitions that you'd be looking at going forward? Thank you.

So, I think we've discussed this in the past, but it is probably worth reiterating. We are always looking for interesting acquisition opportunities. We have a very active corporate development arm. And the challenge for us -- and we do -- as you noted, we do from, time-to-time, do small tuck-in acquisitions for talent or little pieces of technology that we think would extend our franchises nicely. The more interesting question that we wrestle with is there are a lot of businesses out there that were we to merge or acquire them would result in accretion. And the problem is that we don't like their businesses as much as we like our own business. And so every time it comes down to do you want to get bigger by acquisition, our bar is we have to like their business as much as we like our own business, and that is a very, very high bar. And so I would never say never, and under the right circumstances, yes, we would lever up to do it. But we've been -- I've been CEO of FICO for seven years, looking for the last five, and I haven't come across the one that makes financial sense and is as attractive a business as our own. So, we just take the money and we buy back FICO stock with it and give it back to our owners.

All right. And Mr. Weber, we have no further questions from the phone lines. I'll turn it back to you.

All right. Thank you. This concludes today's call. Thank you all for joining us.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and you may now disconnect your lines.