Fair Isaac Corporation F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

| About: Fair Isaac (FIC)

Fair Isaac Corporation (FIC) F1Q09 Earnings Call January 28, 2009 5:00 PM ET


John D. Emerick, Jr. - Vice President, Corporate Development and Treasurer

Dr. Mark N. Greene - Chief Executive Officer

Charles M. Osborne - Executive Vice President and Chief Financial Officer

Michael H. Campbell – Chief Operating Officer


Michael Nemeroff – Wedbush Morgan Securities

Carter Malloy – Stephens Inc.


At this time I would like to welcome everyone to the Fair Isaac first quarter 2009 earnings conference call. (Operator Instructions)

John D. Emerick, Jr.

Good afternoon everyone. This is John Emerick of Fair Isaac and I thank you for joining us for a review of our fiscal first quarter 2009 results. A replay of this call will be available on our website through February 28, 2009.

The forward-looking statements made on this call and in the news release distributed today should be viewed with caution. These statements represent our guidance and outlook as of today and are subject to risk and uncertainties, which could cause actual results to differ materially. These statements may include statements concerning our business strategies and reengineering plan and the actual expense, revenue and net income impact associated therewith. We assume no obligation to update the forward-looking statements included on this call and our news release whether as a result of new developments or otherwise. Fair Isaac’s product roadmaps and similar marketing materials should also be considered forward-looking and subject to change. You may obtain additional information concerning various factors and risks that could cause actual results to differ materially from today’s forward-looking statements by referring to our annual report on Form 10-K for the year ended September 30, 2008, which is filed with the Securities and Exchange Commission, and in other reports we file from time to time with the commission. Please refer to those sections in our Form 10-K and Form 10-Q reports entitled forward-looking statements and risk factors. These reports are available www.sec.gov and on www.fairisaac.com.

Now, I’ll turn the call over to Mark Greene, our Chief Executive Officer.

Dr. Mark N. Greene

We will proceed today in three parts. First, I will present the results of our fiscal first quarter and assess our business in view of current market conditions. Then our CFO, Chuck Osborne will provide further financial details. Finally, I will discuss our strategy and business outlook for the balance of the fiscal year. As always, we will then be happy to take your questions.

Starting with the results for our fiscal first quarter, ended December 31, 2008, revenue was $163.0 million, a decrease of 8% from the prior quarter and 14% from the same period a year ago.

GAAP earnings per diluted share were $0.25. When adjusted for restructuring charges of $0.12, this equates to $0.37 of non-GAAP earnings per diluted share. These results reflect the very difficult markets in which we operate.

Let me comment on this performance in terms of the four segments of our decision management portfolio, namely: analytics, which are the scores used to assess the risk of various transactions or entities; applications, which use these analytics to help businesses make smarter decisions throughout a customer life cycle; tools, such as our rules engine on which applications are based; and finally, the services segment, consisting of consulting and system integration work around our products.

Starting with analytics, analytics revenue fell by $3.0 million, or 8%, from the prior quarter, mainly due to fewer scores consumed at credit bureaus. We saw score volumes fall dramatically in September and then stabilize during this quarter.

Given the high margins of the analytics business, this fall-off contributed significantly to the decline in earnings. In recent weeks we have seen a slight recovery in scoring due to mortgage rate financing activity but this has not been enough to offset continued weakness in the credit card segment.

Turning to applications, application revenue fell by $7.0 million, or 7%, from the prior quarter. Two factors are at work here. On the one hand, the recession causes clients to conserve cash restricting investments in large technology projects and subjecting business cases to greater scrutiny. This lengthens our sales cycle.

On the other hand, the same economic forces lead clients to a greater appreciation of our decision management strategy since it provides a way for them to manage customer relationships more profitably across multiple product lines and channels.

As a result we are seeing a growing number of enterprise-wide RFPs for applications to originate and manage customer accounts, improve collections, and prevent fraud. The net is significant pressure on our applications revenue in the near term, but good prospects longer term for revenue growth once clients resume their technology investments.

Turning to tools, tools revenue grew by $1.0 million, or 5%, over the prior quarter. We see many clients, especially banks, using tools such as our blaze rules engine and model builder products for quick-hit, do-it-yourself decision management projects. We are helped in this segment by the fact that Blaze remains the leading rules management product, both in market share and functionality.

Finally, services revenue decreased by $5.0 million, or 16%, over the prior quarter. This is partially results of several clients requesting that we slow down previously contracted implementation engagements in order to lighten their operating expenses. The decline was also partly caused by our strategic decision to stop pursuing low margin consulting projects.

Now let me turn the call over to chuck for further financial details, after which I will return to discuss our strategy going forward.

Charles M. Osborne

As Mark reported, revenue from continuing operations in the quarter was $163.0 million, an 8% decrease from the prior quarter. While it is disappointing to see revenues slip, we think this is a respectable result given the significant pressure that our clients are under. Indeed, these results underscore the resilience of our business model which benefits from a higher percentage of recurring revenue.

Our transaction, or recurring, revenue for the quarter represented 77% of total revenues, an increase from the 75% for the same period of the prior year. Consulting and implementation revenues decreased to 17% of total revenues this quarter, from 19% for the same period last year. Finally, one-time, or license revenues, were 6% of total revenue, essentially flat from the same period last year.

This quarter 31% of total revenue came from outside the United States, compared with 32% for last year during the same period. Since we report in U.S. dollars our yearly revenues suffered a loss of roughly $6.0 million on a constant exchange rate basis. Adjusting for the currency exchange, the percentage of revenues from international actually rose by 1% to 27%.

Looking at bookings, bookings from continuing operations for the fourth quarter were $53.0 million from which we generated roughly $15.0 million of current period revenue, producing a 28% yield. This quarter’s bookings decreased by 43% compared to bookings from the same the period last year of $93.0 million. We experienced reduced levels of bookings as financial institutions slowed their investments in new projects.

Looking at expenses, our total operating expenses in the quarter were $143.0 million, a decrease of 8% against the year-ago period. Our management team has worked diligently over the past year to reduce operating expenses. Under our ongoing cost re-engineering program we booked severance and facilities’ closing charges of $8.0 million in the quarter to reflect the actions announced on January 7, which will reduce annual operating expenses by $40.0 million.

Excluding restructuring charges operating expenses declined by 13% versus the prior year. Together with prior cost initiatives introduced last year, this means we are reducing annual operating expenses, excluding restructuring charges, from $612.0 million in fiscal 2008 to approximately $535.0 million in fiscal 2009, or $77.0 million.

These savings cut across all of our major expense categories. Cost of revenues was $59.0 million for the quarter, compared to $67.0 million in the same quarter last year.

Research and development costs were $18.1 million for the quarter compared to $19.5 million in the same quarter last year.

Selling, general, and administrative costs were $54.8 million for the first quarter compared to $56.8 million for the same quarter last year.

And amortization expenses were $3.3 million in the first quarter compared to $3.1 million for the same period last year. This 6% increase is attributed to the acquisition of Dash.

Net income from continuing operations in the quarter was $12.1 million, a 49% decrease from last quarter, and a $9.0 million, or 42%, decrease from the same period last year. The first quarter net income from continuing operating was impacted by the $8.0 million, or $5.7 million after-tax, restructuring charge.

The effective tax rate this quarter was helped by a $700,000 discrete net benefit primarily associated with the research tax credit.

Fully diluted GAAP earnings per share from continuing operations for the quarter were $0.25, a 39% decrease from the same period last year.

After adjusting for the $0.12 after-tax restructuring charge, our non-GAAP EPS was $0.37, or a decline of only 8% compared with the period a year ago. We think this is the tangible evidence of the significant efforts we have undertaken to deliver the highest possible profitability in this environment.

Furthermore, these cost reductions stem from re-engineering programs which will provide us with greater operating leverage when volumes and revenue rebound.

Looking at our free cash flow, we define free cash flow as cash flow from operations less capital expenditures and dividends paid. The free cash flow for the current quarter was $30.0 million, or 18% of revenue, compared to $40.0 million, or 21% of revenue in the same period last year.

We are very focused on maintaining strong cash flow and expect this figure to grow once overall market conditions improve.

One of Fair Isaac’s key financial strengths is our balance sheet. We are using our significant cash flow from operations to further bolster our cash on hand. This cash conservation approach reduces our net debt and positions us well for maximum flexibility.

A few points to highlight our good liquidity and ability to weather economic storms. We have $527.0 million in global liquidity, consisting of $287.0 million in cash and marketable securities, plus $240.0 million available against our revolving credit facility.

We have manageable indebtedness consisting of $295.0 million balance outstanding on our revolver, at 3% interest, and $275.0 million in outstanding notes at 6.5% interest. The ratio of our total net debt to EBITDA is now 1.8 times, comfortably below the covenant level of 3 times.

Thanks to refinancing work completed last year, we have no significant debts maturing until 2012.

In keeping with this conservative fiscal stance, we did not repurchase any shares in the open market last quarter. Our fully diluted share count is essentially unchanged at 48.5 million shares.

We remain committed to returning capital to shareholder through stock repurchases over the long term and have $148.0 million remaining under our existing share repurchase authorization.

Let me now turn the call back to Mark to discuss our strategy going forward.

Dr. Mark N. Greene

During the quarter we saw the recession spreading from North America and Europe to Latin America and Asia and cascading from mortgages to credit cards, auto loans and other financial products. This prompted a thorough review of our strategy and financial plans.

We began our strategy refresh by interviewing senior executives at 40 of our top clients. During the month of November we met with chief risk officers and other C-level executives at these firms seeking to understand their business prospects and strategies and the likely impact on our own business.

Several messages came through clearly from these interviews. First, our clients are beginning to get their hands around this financial crisis. They don’t expect it to end soon but they are beginning to be able to model and asses what they are dealing with. In the words of one client, the “fog” of war is beginning to lift, although the war itself will go on for some time.

Second, most of our clients expect this crisis to last throughout 2009 and believe that we have yet to reach the peak of mortgage foreclosures and car delinquencies. They do see a gradual recovery starting in early 2010 but not to the level of business activity seen prior to the recession.

Third, in response to this our clients expect to decrease their technology budgets this year by about 10% while increasing the proportion spent on the types of technology featured in our decision management portfolio, namely: solutions for managing risk, reducing fraud, and improving collections efficiency.

Finally, we heard that many clients are expressing a desire for precisely the kind of capabilities that we are building, an integrated set of applications that allow them to manage risk at the customer level not just per transaction. We were actually very reassured by this unprompted validation of our decision management strategy.

These findings led us to several conclusions. First, our three-prong strategy of decision management analytics, applications, and tools is very much on target with the market’s needs. Second, the opportunity for these offerings will be strong once the global economy recovers. But third, until that recovery occurs, we needed to tighten our belt by reducing expenses and pacing investment in the decision management product roadmap.

With these insights in hand we reassess our corporate strategy and financial posture to determine how best to deliver value to shareholders. In this review we sought to balance the desire to maximize cash flow and protect earnings in the near term with a need to sustain investment in decision management products for longer-term growth.

After carefully considering various alternatives, we have recommitted ourselves to our original three-pronged strategy but with sharper focus. We are still committed to providing best-in-class analytics, applications, and tools to help clients manage their financial relationships over customer life cycles, from marketing to originations, on to account management, collections, and fraud prevention.

But we also recognized need to pare our costs in the face of difficult market conditions so we announced on January 7 four ways in which we are narrowing our strategy. First, we are sharpening our focus on the banking and insurance industries. This is the financial segment where we have greatest expertise and enjoy the best momentum. We are reducing go-to-market efforts outside of these two industries and restructuring ourselves and professional services organizations to reflect the recent consolidation in U.S. financial services.

Second, we’re pruning our product portfolio. Legacy offerings with few customers or below average profit margins are being weeded out of our lineup. Products outside of our core financial services applications footprints will be sold off or otherwise eliminated as market conditions allow. Third, we are pacing our development work on decision management applications.

We are not changing the initial phases of our product time line, including the first two products to implement our new integrated architecture. Those are a new collections and recovery application known as Debt Manager 7, which shipped on schedule last month with very timely support for receivables management in the mortgage and home equity loan markets.

And secondly, a new fraud application known as Falcon 6, which is now in early release with general availability set for April. This is a particularly exciting application since it uses an innovative adopted analytics approach to help financial institutions spot and stem new forms of fraud in real time, much as modern anti-virus software products adapt to new PC viruses over time.

So those two parts of our application roadmap remain on track. But we are extending later phases of the roadmap to reflect delays in clients’ buying intentions. We are pushing out by several months the delivery of applications for new account origination and account management.

We believe that we will still be able to capture those markets when they become hot but we are slowing our development burn rate in the meantime. But make no mistake, we remain very focused on the entire decision management suite and still have over 200 developers building these next generation products.

Fourth and finally, we have reduced our corporate service functions, such as finance, legal, human resources, and marketing. We are fortunate to have done quite a bit of cost management engineering in recent months, having already trimmed our work force from 2,800 to 2,500 employees during the last year. The further actions announced earlier this month removed an additional 250 positions.

These reductions, together with careful management of expected attrition, will leave our work force at roughly 2,100 employees, or about 25% smaller than the year-ago level. We expect these reductions will have minimal impact on our current revenue run rate.

The net result of these latest actions is to pare $40.0 million from our annual operating expense run rate. They are painful measures to take since they mean separating scores of talented professionals, many of whom have given years of loyal service to the company. But we are blessed with an intelligent, creative work force, people who care deeply about decision management and our mission to help clients make smarter decisions. So it’s hard to say goodbye to so many of them.

Yet difficult as this is, it’s the right thing for us to do given the unprecedented market challenges we face. The measures we have taken will allow us to protect near-term profitability and cash flow while staying the course on our longer-term decision management growth strategy.

Let me turn now to our outlook for the balance of this fiscal year. Visibility into our future prospects is beginning to improve but it remains difficult in this financial climate to forecast revenue with any precision, so while we are not in a position today to provide quantitative revenue or earnings per share guidance, we have provided a point estimate of $535.0 million for operating expenses in fiscal 2009.

Let me conclude with several observations about our company. First, despite revenue erosion, Fair Isaac remains in sound financial condition. We continue to enjoy good margins, strong free cash flow and a healthy balance sheet. We will continue our disciplined and conservative approach to financial management, maintaining ample cash on hand and assuming only manageable levels of net debt.

Second, we are making good strategic progress in all elements of our decision management portfolio. In analytics our partnership with Equifax is proceeding well despite market pressures, with several new products planned in coming months. And our consumer scoring business enjoyed double-digit revenue growth with its MyFico.com website continuing to win industry accolades as a top site for financial education.

In applications, our next generation products are bringing significant innovations to the market place. As we deliver a growing number of these integrated decision management applications, clients will enjoy the benefits of connected decisions, allowing business decisions and insights to flow from one stage of a consumer life cycle to another.

We are confident that products such as Falcon, which has long been the market leader in fraud prevention, will continue to revolutionize this market, especially when the new version is delivered in April.

Likewise in tools, our Blaze rules engine continues to be the market leader. Thanks to ongoing innovation, Blaze remains the most effective solutions for organizations seeking to ensure consistent decision making across an enterprise.

We have recently added powerful rule visualization capabilities to make it much easier for business executives to manage complex rule sets. And we have integrated optimization capabilities obtained in last year’s acquisition of Dash optimization, a very successful acquisition that has made Fair Isaac a leader in mathematical and pricing optimization, strengthening the value proposition of our tools portfolio.

Third, I would observe that we have a strong management team with seasoned professionals instilling proper disciplines in ourselves, marketing, and development functions. We are making good progress in our search for a new CFO to replace Chuck Osborne, who announced last November his intention to retire by next August.

In addition, I am delighted to announce today the appointment of our newest executive, Ms. Deborah Kerr, who will join Fair Isaac on February 2 as our Executive Vice President and Chief Technology and Products Officer. Deborah will be responsible for leading both global product development and product management functions for our decision management offerings. She joins us from EDS and HP Company where she spent the past four years as Chief Technology Officer, most recently leading the integration of EDS into HP. We are very excited to welcome Deborah to the Fair Isaac executive team.

Finally, I am encouraged by what we have heard from our top clients during the recent market research interviews. They like our existing products and our new product road map. They understand the relevance and benefits of our solutions for making smarter decisions in managing customer relationships. And they intend to buy our decision management solutions as budget constraints allow. Most importantly, they increasingly view Fair Isaac as a trusted business partner, one whose support and expertise they seek as they navigate through these difficult times.

The punch line here is that although we to see pressure on our top line throughout fiscal 2009, we are positioning ourselves for solid growth once markets recover. In the meantime, we are focused on protecting profitability and cash flows.

Before I close, let me invite you to join us at the New York Sheraton for an analysts day at 3:00 pm Eastern on Tuesday, March 10 and to attend our Interact ’09 Conference which begins immediately afterward.

At the analysts day we will provide further updates on our strategy, delve deeper into our financial models, demonstrate several new decision management products, and provide client case studies showcasing the business benefits of smarter decisions.

The Interact Conference which follows will be a wonderful opportunity to learn about our products and services and to hear about the latest analytics approaches for effective risk management. It will feature three keynotes from industry leaders and 80 timely sessions covering topical issues for these turbulent times. We hope you can join us for both events starting on March 10.

John D. Emerick, Jr.

Thank you very much. We will now open up the lines for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Michael Nemeroff – Wedbush Morgan Securities.

Michael Nemeroff – Wedbush Morgan Securities

In your prepared remarks you had mentioned a point estimate of was that $535.0 million in operating expenses in fiscal 2009?

Dr. Mark N. Greene

That’s correct.

Michael Nemeroff – Wedbush Morgan Securities

You said that some clients are saying that the fog of war seems to be lifted. If that fog of war seems to lift a little bit and sales cycles start to begin in earnest, would you imagine that maybe you would see a bottom to the declines in the total revenue, maybe by the fourth quarter of this year and we would see more declines like we saw in the first fiscal quarter going on for the next couple of quarters? Is that fair to say?

Dr. Mark N. Greene

I think you’ve got the right logic. It’s difficult to get the timing right. We see puts and takes there. On the one hand, for instance, our scoring business shows some early signs of recovery. I think I mentioned a pick up in the mortgage re-Fair Isaac area as an indicator of good things possibly happening there.

On the other hand, when we talked to our customers in these interviews that we conducted a month or two ago, they don’t think we’ve hit bottom yet and they don’t think we will for a couple of months. So you put those factors together and we see our business sort of largely bumping around at current levels, plus or minus, and I’m not yet in a position to have the confidence to call a bottom.

But we know what a bottom will look like and we know what indicators will see in terms of a restoration of the credit card segments, a pickup in the mortgage segment, lending activity beginning to improve generally at banks. There are a couple of those macro phenomenon, that when you see them, will be good signs for our business. We were among the first types of businesses to get sick in this economic down cycle, we will probably be one of the early recoveries but we can’t time that yet.

Michael Nemeroff – Wedbush Morgan Securities

The cash flow during the quarter, down about 20% on the operating cash flow. Is that the magnitude of reduction you are trying to protect for the full year, relative to the last fiscal year?

Charles M. Osborne

No, I think that is a fair way of saying it. Our free cash flow is generally going to track along with the revenue impact and so similar with Mark’s comments, I think we feel like we may be operating at this level for a period of time. As Mark said, we haven’t yet called it the bottom so we can’t give you guidance but we think we are taking all the right steps to protect that cash flow.

Michael Nemeroff – Wedbush Morgan Securities

The scoring business, extremely weak this quarter, continued to be extremely weak. It looks to anniversary, the weakness of down 20% or so, seems to anniversary next quarter or two. Do you expect that kind of weakness to continue in the scoring business throughout the year?

Dr. Mark N. Greene

We think we saw during the quarter the business sort of flatten out at the lower level that we achieved sort of in step function at the end of September. I think you know that at the end of September there was a big down step in the volumes that we saw in scoring. It appears to be operating more or less consistently at that lower level now, which means in the quarter just reported, the way the math works, there was a climb down quarter-over-quarter mathematically. We now think we are operating more or less in a horizontal trajectory there. So the bleed off will appear less the further out you go, mathematically.

But this is a situation you have to watch week by week because the variability here seems to be much greater than historically we have seen in the past.


Your next question comes from Carter Malloy – Stephens Inc.

Carter Malloy – Stephens Inc.

Within the scoring segment, can you give more detail around prescreening volumes? And also an update on the margin profile within that segment.

Dr. Mark N. Greene

I will refer this to our Chief Operating Officer, Mike Campbell, who is closest to the scoring segments.

Michael H. Campbell

We are still seeing very low prescore volumes. When you start seeing the credit card offers coming back in your mail box you are going to start to see that those numbers are improving. But that is still staying at a fairly low level.

There are a couple of companies now that are getting ahead of the curve and have recorded some overages to what we expected. But they are very isolated cases right now and certainly not a wave.

Carter Malloy – Stephens Inc.

What did you say, still down to 20% plus.

Michael H. Campbell


Carter Malloy – Stephens Inc.

Also, margin profile for the business.

Michael H. Campbell

The rate is about the same.

Carter Malloy – Stephens Inc.

I understand the need to maintain a healthy balance sheet but if the operating environment stays the same, do you have plans to resume buyback activity anytime soon? What is the target debt to EBITDA before you can get back out and buy back shares again?

Dr. Mark N. Greene

We talked about the fact that operating right now at about 1.8 times we are comfortably below the covenant, but the notion of liquidity for us is one of making sure that we are in a position to weather any further downturn in this economy so in maintaining healthy cash positions we are also remaining drawn on our lines. And then our notes to the insurance company that actually have penalties for prepayments, we wouldn’t want to prepay those at this time.

But if we saw this operating environment improve, yes we would be back in the market and looking at our stock. It is at a very low level. We think that would be a good use of our cash. Going forward, as results and the economy improve, and we do, as we indicated, have remaining authorization from our Board of up to almost another $150.0 million in share repurchase, so you would expect to see us back in the market.

Carter Malloy – Stephens Inc.

It’s safe to assume if the environment stays the same that I could expect not to see you in the market.

Dr. Mark N. Greene

Not currently.

Carter Malloy – Stephens Inc.

Can you give us an update on the competitive landscapes, specifically for Falcon and Blaze as it relates to [inaudible] fraud product and then if you have seen ILOG more now that they are a part of IBM.

Dr. Mark N. Greene

First of all, the part of the market that is comparatively hot is actually not those areas at the moment. The majority of the buying over the last quarter, and I think this is true for our competitors as well, has been in the collections recovery space, which is what you would guess given the kind of economic climate that we have.

But I would say that with respect to the Falcon product and fraud, we are holding our own. We do see competition out there for sure, but especially with the new version coming out in April which has been preleased now, some clients have their hands on it, they are testing it, we feel very good about our competitive positioning. And we do see in our pipeline a growing number of large scale RFPs, particularly in the fraud area. So we are optimistic going forward but also cautious because we are not sure the speed of which those opportunities will actually progress in the pipeline.

But in terms of feature function, we like our positioning versus the competition.

Carter Malloy – Stephens Inc.

On ILOG, have you seen them any more in the market now that they have become part of IBM?

Dr. Mark N. Greene

We certainly see ILOG, which as you know is now part of the IBM company, in the market place. Very near term, this has been modestly positive for our business as customers are trying to understand the ramifications of that acquisition and a few of them are disaffected by the owners, etc. so near term we have actually seen our Blaze fortunes slightly improved. Longer term we acknowledge that the sales power that IBM can bring to the market place will be a challenge for us and so our strategy there will be to reach out to a broader network of distributors and partners. But near term it has not been a negative.


There are no further questions in the queue.

John D. Emerick, Jr.

Thank you and hopefully we will get to see everybody in March.


This concludes today’s conference call.

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