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Executives

Steven P. Weber - Vice President of Investor Relations and Treasurer

William J. Lansing - Chief Executive Officer, President and Director

Michael J. Pung - Chief Financial Officer, Chief Investor Relations and Executive Vice President

Analysts

Carter Malloy - Stephens Inc., Research Division

Manav Patnaik - Barclays Capital, Research Division

Matthew Galinko - Sidoti & Company, LLC

Nandan Amladi - Deutsche Bank AG, Research Division

Fair Isaac (FICO) Q2 2013 Earnings Call April 24, 2013 5:00 PM ET

Operator

Good afternoon. My name is Charlene, I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. Mr. Steve Weber, you may begin your conference, sir.

Steven P. Weber

Thank you, Charlene. Good afternoon, and thank you for joining FICO's second quarter earnings call. And 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. Today, 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 the actual results to differ materially. Information concerning these uncertainties is contained in the company's filings with the SEC, in particular, 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 measures. The earnings release and Regulation G schedule are available on the Investor Relations page of the company's website at fico.com or on the SEC's website at sec.gov. A replay of this webcast will be available through May 24, 2013. Now I'll turn the call over to Will Lansing.

William J. Lansing

Thanks, Steve. Today, we announced the results for our second quarter of fiscal 2013. I'll briefly discuss those results, update you on our progress with the acquisitions we've made in the last year and discuss some of the internal investments we've been making to generate greater value from our product portfolio.

In our second quarter, we reported revenue of $179 million, an increase of 12% over the same period last year. We delivered $25 million of non-GAAP net income and non-GAAP EPS of $0.69 per share, an increase of 5% from the same period last year. On a GAAP basis, we delivered $18.5 million of net income and earnings of $0.51 per share for the quarter, down 8% and 7%, respectively, from the same period last year. The reduced margin is primarily due to soft license sales this quarter as well as implementation expenses as we ramp up applications to drive future recurring revenue. Mike will delve into the numbers in a few minutes and discuss how we expect to deliver the full year results we've guided. But first, let me tell you a bit about our acquisitions and internal investments we've undertaken that are advancing our growth strategy.

This quarter, we announced the acquisition of Infoglide, a leading provider of entity resolution and social network analytics. This tuck-in acquisition brings critical link analysis functionality that we've been licensing from them for our fraud prediction products. The technology is state-of-the-art at finding suspicious information in an insurance claim or financial transaction and then making links with other transactions to expose otherwise invisible patterns. And in this era of Big Data analytics, it has applications to other areas that interest our clients, social networks, for example, that extend well beyond fraud management. Watch the space for some exciting developments in the months ahead.

This is the first full quarter of results from our acquisition of CR Software. The added functionality from CR makes our debt collection and recovery solutions best-in-class and greatly expands our addressable market. Initial response from customers has been very encouraging. We have developed a significant pipeline and we're working hard to convert it into revenue in the coming quarters. With Entiera, we continue to migrate current clients onto that platform as they renew their contracts. The customer dialogue technology we obtained from this acquisition has quickly become a cornerstone of our marketing solutions.

I'm very pleased with the progress we're making with the Adeptra product that we acquired last year. We signed more than 10 deals this quarter, including 2 large deals in Asia, which will deliver significant recurring subscription revenue as they go live over the next few quarters. We are convinced that this customer engagement technology will increasingly become mission-critical infrastructure as companies strive to improve their customers' experience. We've had discussions with several large companies that are interested in partnering with us, to use FICO Adeptra customer engagement technology in their applications outside of the markets we currently serve. This product has excellent growth potential and it validates our strategy to invest in robust products with revenue opportunities beyond the financial services sector.

Finally, I'd like to talk about innovation. We've stepped up our development efforts in the area of enterprise fraud prevention, which is proving to be a significant growth driver for the business. We focused significant resources on the specific areas of application fraud, online fraud and merchant monitoring. This quarter, we introduced FICO application Fraud Manager, the first solution combining advanced decision management and investigated workflow capabilities with analytics for both first-party and third-party application fraud. The solution helps private companies and public agencies across multiple markets and sectors reduce losses while improving customer service. And this solution is addressing a significant problem, application fraud is estimated to cause credit grantors more than $6.7 billion a year in the U.S. alone and polished figures may not account for the full scope of the problem. That's because most reported application fraud is third-party fraud, which involves identity theft. Yet many industry experts believe the bigger problem is first-party fraud, in which the criminal is the customer, who obtains credit often by falsifying information without intending to pay it back. Historically, this kind of fraud has been difficult to detect and often the losses are characterized as bad debt rather than fraud. One industry analyst group estimates that first-party fraud in credit cards costs $18.5 billion worldwide in 2012 and will rise to $28.6 billion by 2016. It's this much larger problem that FICO is tackling and we think the potential for widespread adoption of our product is significant.

The strong response we've had to the FICO Adeptra product has led us to dedicate more resources to developing the next-generation of customer engagement capabilities and embedding them in multiple FICO applications that span our clients customer life cycles. We remain convinced that this customer engagement solution is solving a critical need for our customers and will remain a solid growth area for us for many years to come.

Lastly, we've been working on some exciting cloud-based technology initiatives that we believe will dramatically change the way businesses, large and small, develop and deploy analytics. We believe this innovation will be a game changer, allowing rapid development of solutions to problems that were previously thought to be unsolvable. We'll be announcing this innovation live to more than 600 of our customers at our FICO World Conference in Miami next week. FICO World is always among the high points of the year for us and for our clients. This year, we'll explore how banks, retailers and other businesses worldwide are using the latest Big Data analytics to better understand customer needs, pinpoint risk and improve the customer experience. The customer revolution continues to gain momentum with consumers demanding more from companies and raising the stakes of competition. This is FICO's home turf, helping businesses cut through the volume, velocity and variety of Big Data to un-lock its value and making smarter decisions.

We will continue to focus our resources on using analytic technology to extract value from the explosion of data that's becoming available. This is where we believe the real growth potential lies and the greatest opportunity for meaningful financial returns. With that, I'll turn the call over to Mike for further financial details.

Michael J. Pung

Thanks, Will, and good afternoon, everyone. Today, I'll emphasize 3 points in my prepared comments. First, our revenue this quarter was $179 million, a 12% increase over the same period last year and a 6% increase -- 6% decrease over the prior quarter. Our recurring revenue remained strong, representing 71% of total revenue while license revenue this quarter disappointed. Second, we delivered $18.5 million of GAAP net income and $0.51 of GAAP earnings per share, decreases over the same period last year. On a non-GAAP basis, both net income and EPS increased from the same period last year. Finally, we delevered our balance sheet over the past 2 quarters. Free cash flow was $31 million this quarter and our cash balance now stands at $131 million.

Turning to revenue. Revenue for the quarter of $179 million or a 12% increase over the prior year. Approximately 10% of the growth related to the Adeptra and CR Software acquisitions. I'll breakdown the revenue into our 3 reporting segments. The first segment is applications. Revenue from applications was $117 million, up $21 million or 22% versus the same period last year but down $7 million or 6% from last quarter when we had several large license deals. Much of the increase is due to the acquisition of Adeptra and CR Software, which accounted for about $17 million of revenue this quarter. The rest of the portfolio performed well, growing about 4% over the same period last year. The second segment is Scores. Overall Scores revenue was $44 million, essentially flat with the same quarter last year and up 1% from the prior quarter. The B2B revenue was flat with last year which has, a reminder, included a one-time Scores project. On the B2C side, the renewed focus we're putting into the business is beginning to pay off with growth this quarter at 13% versus the same period 1 year ago. We've continued to see strength in both areas of our Scores business and are encouraged by macro trends as well as steadily improving internal execution. The third segment is Tools. Revenue in this segment was $18 million, down 5% versus the prior year and 17% versus the prior quarter. While our second fiscal quarter is typically a weak period for Tools license sales, this quarter was even lighter than expected as we saw customer delays in purchasing. After several consecutive strong quarters in our Tools business, this was an area of disappointment for the quarter. Our pipeline for the business, however, remained strong and we are redoubling our focus on sales execution in the back half of the year to meet our plan. Looking at our revenue by region. This quarter, 72% of total revenue was derived from our Americas region, our EMEA region generated 20%, and the remaining 8% was from Asia Pacific. By type of revenue, recurring revenue, which is derived from transactional and maintenance sources, for the quarter represented 71% of total revenues versus 68% in the prior quarter; consulting and implementation revenues were 19% of total versus 17% in the prior quarter; and license revenues were 10% of total revenue versus 15% in the prior quarter.

During the quarter, we recorded $19 million of license revenue versus $28 million in quarter 1 with declines in both our Applications and Tools businesses. We had several large deals that pushed which we will continue to pursue. This mix shift had an impact on our margins which I'll detail shortly.

Turning now into bookings. We generated $16 million of current period revenue on bookings of $85 million or a 19% yield. This compares with $27 million of revenue on bookings of $82 million, which was a 33% yield in the prior quarter, meaning a greater percentage of our bookings will convert to revenue in future quarters.

The weighted average term of our bookings was 28 months this quarter compared to 24 months in the prior quarter. Of the $85 million in bookings, 26% relates to fraud solutions, 15% to our Adeptra mobility product line, 14% to customer management solutions, 11% to decision management Tools and 10% to collections and recovery solutions. We had 16 booking deals in excess of $1 million, 4 of which exceeded $3 million. Transactional and maintenance bookings were 46% of total this quarter versus 33% in the prior quarter. Professional services bookings were 44% this quarter versus 34% in the prior quarter. Finally, license bookings were 10% in this quarter versus 33% in the prior quarter.

As Will mentioned, we signed more than 10 Adeptra deals. We include the estimated future revenue from an Adeptra contract in our reported bookings when either the proof of concept is complete or there are minimum contractual commitments. Some of the deals signed this quarter have not completed the proof of concept and, therefore, are not reflected in the reported bookings number. These bookings backlog of signed deals will be reflected in a future booking.

Turning to expenses. Operating expenses totaled $146 million this quarter compared to $147 million in the prior quarter or down $1 million. The decrease was primarily due to nonrecurring restructuring charges we took last quarter. We expect operating expenses to increase modestly in the last 2 quarters of the year. As you can see on our Reg G schedule, non-GAAP operating margin was 24% for the second quarter versus 29% in the prior quarter. The decline in this quarter was due to the decrease in higher margin license sales and the resulting product mix shift. While margins associated with the acquired product lines are initially lower than historical FICO margins, we expect operating leverage to improve as we fully realize expense synergies and grow these businesses.

GAAP net income this quarter was $18.5 million versus $23 million in the prior quarter. Non-GAAP net income was $25 million versus $32 million in the prior quarter. The effective tax rate was about 27% this quarter and reflects the expected benefit from the reinstatement of the R&D tax credit. We expect the effective rate to be about 31% to 32% for the full year fiscal '13.

In terms of free cash flow, which we define as cash flow from operations less capital expenditures and dividends paid, was $31 million for the quarter or 18% of revenue compared to $19 million or 10% of revenue in the prior quarter.

Moving on to the balance sheet. We have $131 million in cash and marketable securities. This is up $40 million from last quarter, primarily due to increases from operations. Our total debt is $504 million with a weighted average interest rate of 6.1%. We have a $49 million principal payment that's due in May. The ratio of our total net debt to adjusted EBITDA is 2x, below the covenant level of 3x. And our total fixed charge coverage ratio is at 4.4x, well above the covenant level of 2.5x. We had no borrowings under our line of credit facility.

We did not repurchase any shares during our second quarter as we delevered our balance sheet after the current and recent acquisitions. We still have $150 million remaining on the current Board authorization and continue to view share repurchases as an attractive use of excess cash.

On the guidance. Finally, while we are running behind our plan due to this quarter's revenue shortfall, we have visibility into a significant pipeline of opportunities over the balance of the year. In particular, we expect accelerated growth from our Adeptra and CR Software acquisitions, from license opportunities within our Tools business and further growth associated with our core transactional revenue. We will continue to manage our expenses wisely while investing in our internal growth initiatives. Accordingly, we are reiterating our annual guidance today and, in addition, adding non-GAAP metrics to our guidance. As a reminder, our guidance for revenue is $760 million to $770 million and GAAP net income of $100 million or earnings per share of $2.80. On a non-GAAP basis, we expect to deliver $128 million of non-GAAP net income and $3.60 of non-GAAP EPS. This assumes amortization of approximately $13 million, restructuring- and acquisition-related expense of approximately $3 million and stock-based comp of approximately $25 million.

With that, I'll turn the call back to Steve for question-and-answer.

Steven P. Weber

Thanks, Mike. This concludes our prepared remarks. And we're ready now to take your questions. Operator, please open the line.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Carter Malloy from Stephens.

Carter Malloy - Stephens Inc., Research Division

So can you give us a little more around the license revenues' softness this quarter and really just more around your confidence going forward? Because looking at tax rate up and OpEx up, we're going to be leaning pretty heavily on that on the revenue growth to come through for the back half.

Michael J. Pung

Yes, absolutely, Carter. So at the beginning of the year, we had an annual guidance that had very aggressive license revenue. We saw a very good pipeline coming into the year across the existing businesses we have and since then, we had bought CR Software. And the pipeline of CR Software's -- came very large and is growing even more significantly now that we have a system of record embedded within our collections and recovery business. Coming into the end of this quarter, quarter #2, we had a handful of large transactions that we had line of sight on, that we didn't get the deals done on and didn't get them closed for a variety of reasons, purchasing decisions were delayed and some of the deals slipped forward. We've signed 1 or 2 small ones but we're still pursuing much of the large transactions. With that, we also believe that with the CR Software business and the ramp-up of the Adeptra business, we do have line of sight certainly to the bottom end of our guidance and enough pipeline to safely get us well within the guided range we have on revenue. As it related to OpEx, while we see some modest increases in OpEx over the balance of the year, we pretty much absorbed all the cost associated with the acquisitions. And now it's a matter of simply just running the business as efficiently as we believe we have in the past and we can. And so while we see some modest growth on the OpEx side, it isn't going to be very significant with respect to, certainly, what's been seen with the on-boarding of some of these transactions. As it relates to the tax rate, we've been guiding the full year all along at around 31% to 32%. So really, nothing's changed there but for the reinstatement of the R&D credit, which we assumed would happen within the numbers we provided at the beginning of the year.

Carter Malloy - Stephens Inc., Research Division

So that helps. And on -- so on the R&D expense line, do you expect it to stay down here as percent of revenue and not -- at last couple of calls or 2, 3 or 4 calls back, that was expected to go up. But since, it seems you guys have maybe capped that back off down here in the high single-digits.

Michael J. Pung

Yes. I mean we were expecting it to be around the 9% range. Actually the absolute dollar amount has gone up and part of that is just a redeployment of functions from other areas into R&D, so taking administrative cost out of our R&D team or our IT team and reinvesting it on the R&D line item. But the rate we're running at right now is probably the right absolute dollar amount.

Operator

Your next question comes from the line of Manav Patnaik from Barclays.

Manav Patnaik - Barclays Capital, Research Division

Well, just firstly, you talked a lot about the -- on -- in the innovation section, you ran through a bunch of different things which you sounded excited about. Could you just again just -- I sort of missed the last one you talked about, the one you're releasing in Miami, if you could just repeat that. And then just when should we start -- like what's sort of time frame should we expect seeing some sort of a benefit or meaningful contribution through revenue from these products that you talked about?

William J. Lansing

Sure. So if it sounded like we didn't give you a lot of detail around that last item, it was by design. It was because we're announcing it formally at FICO World in 1 week. But I'm happy to give you a little bit more, I don't think it will spoil the party. It -- we call it decision management platform and it's basically our analytics in the cloud, made available on the cloud, that it's very easy for customers to pull down our analytic tools and apply them to whatever it is they like and make better decisions with it. So that's -- we think that's going to have a lot of uptake. We think that's going to be a pretty good product offering, I should say, it's really a service. And so that's one. I'd say one that has more short-term impact is our Infoglide acquisition and how that ties to some of the internal fraud products that we've developed, particularly around application fraud. That is -- as I said earlier, it's a really big problem for the industry and we're now increasingly able to focus on it and help them with it. The -- in terms of time frame, we love all our children equally. We invest in all of our important franchises and we continue to make good progress with Falcon and good progress with our other major franchises. The collection recovery franchise has been challenging, I guess, is a way to put it, because we've been accelerating the migration from our legacy products over to our newly acquired Debt Manager 9 product and that resulted in some incremental expense this quarter, not that it wasn't anticipated but it's expense we don't anticipate recurring. And so I think that we're going to start to see a lot of benefit out of that transition. And particularly, when you look at our collections recovery franchise, not just from the standpoint of a core product in Titanium/DM9 but also the way it works with Adeptra and how those products tie together, I think we're going to see some really meaningful revenue and profit coming out of it. And that could -- that's just going to accelerate in the back half of the year and into next year.

Manav Patnaik - Barclays Capital, Research Division

Okay. Fair enough. And Mike, you talked about, in your commentary, that you were encouraged by the macro trends. Could you maybe expand a little more with some specifics on what you guys are seeing and what those data points for that were encouraging?

Michael J. Pung

Yes. In particular, Manav, we've been experiencing a long period of time, as you know, where our Scores business and the volumes underneath our Scores business on the Originations side have been going sideways. And we're starting to see some improvement on that end. It just so happens we had a tough comparable period for our B2B Scores business and that last year we had a large transaction that hit our revenue line item. But except for that line item, we're starting to see some nice growth on the B2B side. I wouldn't say we're off to the races and I am not trying to imply that. But certainly compared to what we've seen in the past, we're starting to see further progress on the macro side on the Scores business.

Manav Patnaik - Barclays Capital, Research Division

And I guess, in the balance sheet, you talked about the mix of your business here between credit card, mortgage and the rest. Can you provide any more color between those like anyone doing better than the other that's taking, I guess, the modest growth that you're referring to?

Michael J. Pung

Yes, I know. We're -- things haven't changed materially on any of the individual particular line items. We're seeing a little bit more out of credit cards but fundamentally, things haven't materially changed.

Operator

Our next question comes from the line of Matthew Galinko from Sidoti.

Matthew Galinko - Sidoti & Company, LLC

I saw CapEx seems to be trending a little bit higher through the first couple of quarters for the year. Just curious what's driving that and how do you expect it to close out back half of the year?

Michael J. Pung

Yes, that's a great question. CapEx, year-to-date, is probably twice what it was last year at this same time, Matt. And a big part of what is driving the growth was the opening up of 2 office facilities, one in Roseville, Minnesota and one here in expansion in San Jose where we've, in Minnesota, consolidated from 2 facilities to 1. And that included some build-out along with just equipping the facility, much of that hit in the first quarter. In the second quarter here, much of the driver behind the CapEx number was investment that we have made in -- on the Adeptra side to set up distribution opportunities outside the U.S. and Asia, in particular, where we signed a couple of very large deals along with simply the equipment in PCs and things of that nature that we have upgraded and put into the hands of the people in the companies that we bought. We'll probably end the year up with, in total, $25 million to $28 million of CapEx, which is quite a bit larger than we'd historically run. But we're investing in parts of the company that -- especially on the Adeptra side that does have revenue payback, it's just not overhead.

Matthew Galinko - Sidoti & Company, LLC

Got you. And I mean, how substantial are the investments in billing some hosted infrastructure as I think you talked about in some of the new products?

Michael J. Pung

Overall, they're not material in that an Adeptra data center, as an example, is not a significant full service data center, it's more of a telecom data center. And so the investments aren't that large individually. And in the aggregate, we're putting them in place in countries where we see the largest of opportunities. So in the grand scale, they're not really significant. For the rest of the business, we generally made our data center investments about 1.5 year ago and we still have enough capacity in the U.S. for, I'll call them, legacy FICO ramp-up.

Matthew Galinko - Sidoti & Company, LLC

And then can you just repeat what you saw on the B2C side of the Scores business?

Michael J. Pung

Yes. Our B2C side grew 13% on a year-over-year basis. We were very close to $11 million of revenue on the B2C side, something we haven't seen in several years. Much of it is driven from an increase, conscious increase, to grow our subscription side of that business as opposed to onetime Score polls. And as you compound enough of that backlog of subscription revenue, you begin to see some lift and, in fact, we're starting to see that along with the benefits of some of the infrastructure changes that we made 1 quarter ago.

Operator

Our next question comes from the line of Tom Ernst from Deutsche Bank.

Nandan Amladi - Deutsche Bank AG, Research Division

Nandan Amladi on behalf of Tom. Going back -- I have a 2-part question. On some of these new products, I know you sell subscriptions. Has the nature of the sales process changed at all as a result? And second part of the question is do you have enough sales capacity to address the stronger second half?

William J. Lansing

So the answer to the first question, yes, absolutely. There's a difference in the way you incent salespeople for SaaS business. And when we acquired Adeptra and Entiera both, I mean, there was -- we incorporated into our sales plans some of the sales incentive methodology that was in place there. As more and more of our business becomes available on a SaaS basis, we will be working through the implications of that for how we drive incentives through our sales force. To the second part of your question, the capacity -- we actually feel like our capacity is adequate. We feel pretty good about it. And we are always adding and subtracting salespeople on the margin. But we're -- I -- we feel comfortable about where we are.

Operator

[Operator Instructions] There are no further questions in queue at this time. I'll turn the call back over to the presenters.

Steven P. Weber

Thank you. This concludes our call today. Thank you all for joining.

Operator

This concludes today's conference call. You may now disconnect.

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