Fair Isaac Corporation (FICO) Q3 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Fair Isaac Corporation Quarterly Earnings Call. And 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 today Wednesday, July 31, 2019. I would now like to turn the conference over to Steve Weber, VP, Investor Relations and Treasurer. Please go ahead.

Thank you. Good afternoon, and thank you for joining FICO’s third quarter earnings call. I’m Steve Weber, 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 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 July 31, 2020. And with that, I’ll turn the call over to Will Lansing.

Thanks, Steve. Thank you, everyone for joining us on our third quarter earnings call. I’m pleased to report we delivered a record quarter with some remarkable results. We recorded our highest revenue quarter ever at $314 million, up 23% over last year. It was a good quarter for license sales but notably, it was also very good quarter for recurring revenue. All three segments drove double-digit recurring revenue growth, and total company recurring revenue was up 18% over last year. We continue to see the benefits of our business model shift to the cloud. We had another good bookings quarter at $109 million with many being recurring revenue deals. Year-to-date, our recurring revenue bookings are up 18%. We delivered $64 million of GAAP net income and GAAP earnings of $2.12 per share up 116% and 122% respectively. We delivered $76 million of non-GAAP net income and non-GAAP EPS of $2.50. Perhaps most impressive this quarter was the strength of results across our entire portfolio. In Applications, revenues were up 19% over the prior year. Much of this is due to some term license renewals. We also drove double digit growth in transactional volumes. This of course is key to our cloud strategy is our customers use our products across larger portions of their enterprise, we can drive sustainable recurring revenue growth. We had a particularly strong quarter in our banking fraud solutions business where we closed some large renewals and also signed some sizable new deals. We also had a good quarter in our customer communication solutions where we had nice transactional volume growth. In our Decision Management Software segment, we are seeing significant growth in both bookings and revenue. DMS revenues were record $33 million led by sales of our decisioning platform and Blaze. We also had $37 million of new DMS bookings, a record quarter and up 35% from the previous year. We signed a number of decision management platform deals steadily gaining more traction. Throughout our software business, we are selling more cloud deals. They accounted for more than 40% of our total bookings this quarter. In the Scores business, we had another record quarter at $115 million of revenue with both volumes and unit pricing up over last year. B2C revenues were up 8% this quarter and our B2B revenues were up 36% over the same period last year. The B2B growth was driven by increased originations and account management volumes as well as the continuing impact of the pricing initiatives we discussed last quarter. We see strength throughout the various verticals and life cycles in the Scores segment and expected to continue to perform well. We are also making progress on data decision cloud partnership with Equifax that we announced back in March. Our teams are working together to bring three products to market. First, connected platform integrating our decision management solution with Equifax as extensive data. Second, our suite of AML and KYC technology. We’ll use Equifax’ differentiated data to offer a full-service, best-in-class compliance offering. And third, Prescreen Central integrates FICO’s Marketing Solutions products with Equifax’ consumer data to deliver a direct marketing solution. We’ll keep you posted on the progress we’re making with this exciting partnership. Finally, we continue to deploy significant resources to our share repurchase program. In the third quarter, we spent $59 million and another $20 million in July for a total so far this fiscal year of $199 million. We exhausted the 2018 Board authorization and today we announced a new $250 million share repurchase authorization. I’ll share some summary thoughts later, but now I’d like to turn the call over to Mike to take you through our financial results.

Thanks, Will, and good afternoon, everyone. Today, I’ll emphasize three points in my prepared comments. First, we delivered $314 million of revenue, an increase of $59 million or 23% year-over-year. Recurring revenue was $226 million, up 18% from last year. Second, we delivered $64 million of GAAP net income, which is up 116% year-over-year. And finally, we had $61 million of free cash flow this quarter, and we spent $59 million of it on share repurchases. I’ll begin by breaking the revenue down into our three segments. Starting with Applications, where revenues were $166 million or up 19% versus the same period last year. We had a particularly strong quarter in fraud, which was up 80% in part due to some term license renewals. We also had a good quarter in our CCS business, which was up 13% compared to last year. And we also saw strong volumes throughout the portfolio with recurring revenues up 10%. We had another good quarter in our Decision Management Software segment, where revenues were at $33 million, up 31% versus the prior year, with strong platform and Blaze sales. Recurring revenue in DMS were up 14% from the previous year. Bookings were a record $37 million or up 35% from last year. And finally, of course, in our Scores segment, revenues were a record $115 million, up 27% from the same period last year and 10% over last quarter. On the B2B side, we are up 36% versus the same period a year ago, and B2C revenues were up 8% from the same quarter last year. Looking at revenue by region. This quarter 72% of total revenues were derived from the Americas. The EMEA region generated 21% and the remaining 7% was Asia Pacific. Recurring revenue derived from transactional and maintenance sources for the quarter represented 72% of total revenue. Consulting and implementation revenues were 14% of total revenue and license revenues were 14% of total revenue. Cloud revenues were $69 million this quarter, up 19% from last year. Bookings this quarter were $109 million, down about 9% from the prior year. We generated $16 million of current period revenues on those bookings for a yield of 15%, and the weighted average term of our bookings was 38 months this quarter. We had 19 deals over $1 million, four of which were over $300 million. Cloud bookings were $46 million this quarter and $119 million year-to-date, which is up 24% from last year. While we are pleased with the sixth straight quarter above $100 million in bookings. Year-to-date, we are still facing below our expectations, which is important as bookings generate future revenue. Operating expenses totaled $229 million this quarter compared to $230 million in the second quarter. We expect to maintain a similar run rate in the fourth quarter, while actively investing our resources in our highest strategic priorities. Our non-GAAP operating margin, as shown in our Reg G schedule was 34% for the quarter and 29% year-to-date. We expect the full year operating margin to be around that 29%. GAAP net income this quarter was $64 million or $2.12 a share and non-GAAP net income was $76 million or $2.50 a share, and the effective tax rate was about 18% for the quarter. We expect our annual tax rate to be about 14%. The free cash flow for the quarter was $61 million versus $72 million in the prior year. And for the trailing 12 months, our free cash flow was around $200 million. Now turning to the balance sheet, we had $79 million of cash at the end of the quarter. Our total debt is $828 million with a weighted average interest rate of about 4.7%. The ratio of our total debt – net debt to adjusted EBITDA this quarter is down to 2.3 times, which is well below our covenant level of three times During the quarter, we returned $59 million in excess cash to our investors, repurchasing 205,000 shares at an average price of about $289 a share. We also purchased an additional 20 million in July, which exhausted the Board authorization from last year. We have repurchased more than 840,000 shares this fiscal year at an average price of $237. We announced earlier today, the Board has approved a new $250 million authorization and continue to view share repurchases as an attractive use of our cash. And we also continue to actively evaluate opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio and competitive position. Now with one quarter remaining in our fiscal year, we are reconfirming our guidance that we updated last quarter, with revenue of $1.14 billion, GAAP net income of $173 million and GAAP EPS of $5.75. Of course non-GAAP net income is $214 million and non-GAAP EPS is $7.12. Finally, as you know, this is my 60th and last official earnings call. For those of you on the call that cover FICO, I’ve appreciated the time we spent discussing our company and getting to know each of you on a personal level. I’d also like to give my heartfelt thanks to all the members of our finance team, your hard work, dedication and commitment to operate with the highest standards has given me confidence in reporting our results over the years. And finally, I’d like to thank our investors for the trust and faith you have placed in me as a steward of these amazing assets. With that, I’ll turn the call back over to Will for some final comments.

Thanks, Mike. Next quarter, we’ll talk about our expectations for 2020. But for now, I’d like to review what we’ve been able to accomplish in 2019. In Scores, we continue to find new ways to extend the analytics in both the B2B and B2C markets, and we are working hard to make sure pricing is appropriate, given the massive value that the FICO Score adds in the financial markets. On the Software side, we are steadily growing our cloud business and our products are well positioned to serve customers looking to use analytics to make better decisions. As I’ve often said, these are exciting times at FICO, we have a very strong team helping our customers solve their most difficult problems and we continue to develop and market world-class technology you put advanced analytics into production to make better decisions. Finally, I would like to thank Mike, who is retiring after nearly 15 years with FICO, the last nine as Chief Financial Officer. During his career, FICO revenues grew from around $600 million in fiscal 2010 to this year’s guided $1.1 billion. Mike oversaw an ambitious long-term stock buyback program that increased value for shareholders, while enabling FICO to advance its innovations and analytics and solution development. Mike has been a great CFO. He distinguished himself with the Board and with our investors and guided us through the last recession, driving critical resource allocation decisions that gave FICO the runway to invest again in new products and services. We thank him and wish him well. I’d also like to welcome Mike McLaughlin to FICO as our new CFO. Mike will be joining us from Morgan Stanley, where he was a Managing Director and Head of Technology Corporate Finance. He brings us a wealth of leadership experience in both financial services and technology. He’d be starting next week and looks forward to meeting with many of you in the coming months. I’ll now turn the call back to Steve for Q&A.

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

Thank you very much. [Operator Instructions] Our first question comes from the line of Manav Patnaik from Barclays. Your line is over.

Thank you, good evening. And firstly congratulations and a big thank you to Mike as well. If I could just start with the bookings comments that you made about it being below expectations. And I was just wondering if you could help give a little bit more color on maybe how much below and why you think it is below the expectation?

I guess I would say, I wouldn’t put too much stock in it, that number does move around, how it is when deals push at the end of the quarter. We’ve pretty consistently shared with you that we don’t do unnatural acts to close deals at the end of the quarter. And so while we have an internal budget that has numbers for each quarter. I wouldn’t read too much into it.

Got it. And then maybe along the same lines, like you obviously had a pretty good quarter, and I guess I just wanted to get some sense on maybe why there wasn’t a guidance raise involved in there with only a quarter to go, presumably there’s enough visibility there?

That cuts both ways. Yes, there’s enough visibility, but at the same time, we’re one quarter away from closing out the year. I’m not sure what the point would be in raising guidance at this point.

Okay. And then maybe just one last one from me. We obviously heard Equifax talk about these products that you guys are putting out together. Just can you just help us with a little bit on, is it a revenue share model or who is going to do most of the heavy lifting on the sales front? Any other color there, please.

Sure. I mean it is a rev share model. We're in it together. We're trying to market the solution as a joint solution and make it easier for the customer to get the end-to-end solution on offer. The sales effort is on both sides, and it depends on who has which relationships and which product that – product and service we're working with. So I think that varies.

Okay, got it. Thank you guys.

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

Good afternoon everyone.

Hi Bill.

Hi Bill.

So the Scores revenue looked particularly strong this quarter accelerating from last quarter accelerating from last quarter. Is there any reason why that Scores volume should decline next quarter? It seems like it's pretty much a stairstep in terms of the price increases coming on.

Well Bill, so this quarter, we saw some of the additional feathering in of our auto scores that we described in the last call. We also saw a couple of residual customers start to roll in on the mortgage increase we did just over a year ago. And so beyond that, we had small audit settlement that's one-timer that was in these numbers. From time to time, we have global FICO Score deals that are license oriented, and we had a little bit of that this quarter. Those come and go on a variety of basis. And we saw volume increases in the mid-single-digit range and in a couple of cases on the origination side a little bit better than that. So with all that as a background, the revenue model could grow, assuming volumes continue to grow strongly over where it was last year in the fourth quarter, and that's probably the biggest variable that's uncertain at this point is how much of the volumes will look like in our fourth quarter and whether we have any other kind of onetimers that come along.

Okay. So now CCS, there've been some client departures last quarter, but this quarter, you guys signaled that one out as being particularly strong performance. I just wanted to ask about how that business was doing and what had happened with those clients who had left and whether you've been able to get new clients to replace them, just a little color on that.

Yes, I'd say that we have business coming and business going. Some of the business goes when big banks decide that they're going to try to achieve the same thing that our CCS offering does on their own by putting together with a fair bit of systems integration on their side the components of it. And while we have very large banks who are happy with CCS, there's also the ones that used to do it alone. We are adding business. We're adding business in Asia. We're adding business around the world, and so we're still very happy with the business.

So I noticed that the average term of the bookings this quarter went up to 38 months, and maybe you could talk a little bit about that occurrence. Is that a one-off event in terms of some of the deals that you signed? Or maybe you can give us a little quarter color on what's behind that increase.

It's been trending upward for years, and I think it's a reflection of the fact that the solutions that we're putting in place are more complex, more comprehensive and once installed, the customer has a desire to lock down longer term. And so we're seeing some of that. We don't have tremendous financial incentives for our salespeople to go push long terms. We really want to do just what the customer wants. And so I would say that the term length is really dictated by the customer, and I think it's largely because they put and our solutions, and they're not quick to take them up, and they feel more comfortable signing up the bigger deal.

And how's the rollout of Falcon X doing?

It's rolling. We're excited about the prospects we're getting in onto the marketplace. The early reception to what's coming has been extremely positive, and so we think we have the right – we have the right solution coming at the right time. We have a lot of people working on it right now.

And then the last question for me is on the UltraFICO Score. Experian has been running ads on their Boost product. I want to know it's actually generating revenue for yet? Or is it still pre-revenue?

With Boost, we actually participate in that. With UltraFICO not generating revenue, yes, we're in test mode still.

Got it. Before I go, I just wanted to say congratulations to Mike on a great run and happy trails.

Thanks, Bill. We'll come out and see you sometime.

Thanks Bill.

Pleased to do.

[Operator Instructions] Our next question comes from the line of Brett Huff with Stephens. Your line is open

Hey guys, congrats on a nice quarter and thanks for the detail as always. And Mike sorry to see you go, but I hope things go well in the next chapter.

I appreciate that Brad.

Well thanks for taking the questions as always. Can you guys – you guys talked a little bit about some of the SaaS products that you're developing and I know that we're midstream on those. Can you give us – I don't know if you mentioned TRIAD or the next-gen product that TRIAD is. I think it's a customer director if I'm remembering it right. Any update on how that's coming along?

Yes. Yes, it's actually called Strategy Director, which is the successor to TRIAD. Customer Management is what it does. It's going really well so there's absolutely uptake the market for it. And for us, Strategy Director is a lot of the TRIAD functionality but ported over to our Decision Management Platform business, and that's becoming increasingly important for us. I mean we're really focused on how to resolve our customers' needs with our platform solution. And although we still sell some things that are not on the platform, increasingly, the solutions are on the platform. And so Originations is on the platform, Strategy Director is now on the platform, Falcon X will be in the platform. And so this idea of getting to a unified kind of single code based platform with tremendous ease of use and ability to manipulate data across for different purposes, it's coming together very nicely. But with respect to Strategy Director, in particular, we're doing very well or selling it, and we're happy with it.

That's a nice segue to my next question. I know a lot of folks look at your business and think there is sort of margin in there to be realized over time. I know you're investing kind of in demand that you really see coming over the hill. Just kind of – you're mentioning sort of centralizing on a more common platform raises that question, maybe highlights that possibility for showing some more margin over time. Is that how we should think about? Is that sort of a gross margin focus once you get everything centralized? And how do you think about the tenor of that?

Yes, I would say that's a very astute question because that really is how you should think about it. Today, we have really broad portfolio software solutions with a lot of customization, and it's expensive – not expensive but it takes a lot of PS resources to install and to customize to our customers' satisfaction. And with the platform, that's going to be simplified. With the platform, there will be a lot much higher level of configuration, there will be returns to scale for us and there will be benefits for the customer from total cost of ownership. So as more and more of our new business winds up on the platform, yes, I think it's reasonable to expect that margins will go up. That's not guidance for next year, but that's just a reality that's in the economics of getting to a platform business.

That’s helpful. And then can you just remind us your view on total Scores through the cycle? If I recall I think it went from maybe $8 billion, or now at $11 billion, something like that. Is your sense – first, remind us if that's right. And then the second is we get a lot of questions, is the FICO Score less cyclical now than it was before? I think the answer is yes, but kind of give us your view on that and how – I won't say revenues will go for Scoring, but how the durability of the score usage might be this time around if we have a recession.

Sure. So the low point was right after the 2008 reset and we were about $9 billion scores then. The high point was 13.5 billion right before that. Today, we have not yet hit that $13.5 billion…

$14.5 billion

I'm sorry $14.5 billion today, so we've just surpassed that level. But the more important part of your question is right, which is how sensitive are we to economic cycles and what happens in the future? And I would say that we have a lot more scores than we used to have. I mean we have more breadth there. We're starting to sell scores internationally and so there's a little bit of high diversification there, and we have more flexibility in what we charge. So I think that the – well, obviously, we're not immune, we would suffer with volumes declining. I don't think it would be anything like what it once was.

Okay. And then last question from me, when we think about DMS and I think about Big Data and analytics. I think the Equifax partnership looks great. But it seems to me that DMS and Big Data are going to be, I'm not sure, is there a killer app for Big Data out there. I know you kind of had killer apps in Falcon and TRIAD, I know those are all kind of based on the same thing. But are you seeing emerging a use case that that we're not seeing yet that you're getting more excited about that might power more consistent DMS growth?

We definitely expect more consistent DMS growth and a lot more of it. I'm not sure that I would call it a single use case except it's a very high level. I think that the use case is digital transformation. I think what we have is a situation where financial services has run 7%, 8% of GDP for quite a long time. And over the coming 10 years, it will probably get cut into half as those products and services are provided through automation, through using lower cost means. And I think that our Decision Management Platform is aimed at providing data-driven decisioning to power those kinds of decisions. So I would say that as banks continue on their journey to – their digital transformation journey, as they continue to try to look at disparate data to have a more comprehensive view of a customer, the 360-degree view of the customer. As they seek to understand the customer journey better, all those things speak to the value of our Decision Management Platform as a solution. I don't think it's a single use case, I mean I think historically banks have had a need for a single use, for Originations for some area, for collections and recovery for some area, for fraud for some area. I think increasingly, we're going to see the lines blur there and banks will be seeking more comprehensive solutions, but the likes of which we have in decision management suite.

Great. Thanks for taking my questions and good luck, again, Mike.

Next question comes from the line of Adam Klauber with William Blair. Your line is open.

Good afternoon. Thanks. As far as price increases, you obviously got mortgage, auto. How is the dialogue now in credit cards? And if you could give us an idea, do you think that's likely or unlikely?

I think that all the scores beyond mortgage and auto is a bigger and more disparate group of scores, and so there is not a simple answer to that. I think that we always evaluate where there's opportunities. And it's not as clean as saying well here's the next thing that we're going to go do. But I think you can expect that we'll systematically look for opportunities.

Okay. And then on the Scores, what do you think is going to drive B2C revenues going forward – revenue growth going forward. Still growing at a decent pace, but somewhat slower than it was in the last year or two?

I would say, more of the same. It'll be some time before ultra FICO and things like that really make an impact. The volumes were more of a lagging indicator than a leading indicator. And so the volumes, you have greater visibility into what the volumes are likely to be than I would say we do, because we follow interest rates. So I think your guess is as good as ours on where it goes. We feel pretty good about things. But I think you should consult your own crystal ball.

Sure. Okay. And then as far as Falcon, I know you've had some sales internationally, I think South America. How is the pipeline for future Falcon sales?

Strong and South America has been really strong.

Okay. Is that…

Adam some of our biggest deals this quarter were Falcon and Falcon in the cloud. Two of our top 10, as an example, were deals that we signed down in Latin America in the last three months that were tied to Falcon. So despite the fact that we have a pretty big installed base, there are pockets of opportunity especially with the cloud that are coming along.

Okay. Thanks a lot guys.

And gentlemen, there are no further questions at this time. I'll turn the call back to yourselves. Please continue with your presentation or closing remarks.

Thank you very much. That concludes today's call . Thank you all for joining.

And that does conclude the call for today. We thank you for your participation. And I ask you please disconnect your line.