Fair Isaac Corporation Q1 2010 Earnings Call Transcript

Jan.27.10 | About: Fair Isaac (FIC)

Fair Isaac Corporation (FIC) Q1 2010 Earnings Conference Call January 27, 2010 5:00 PM ET

Executives

Mike Pung - VP, Finance & IR

Mark Greene - CEO

Tom Bradley - EVP & CFO

Mark Scadina - EVP, General Counsel & Secretary

Analysts

Michael Nemeroff - Wedbush

Carter Malloy - Stephens

Mike Latimore - Northland Securities

Presentation

Operator

Good afternoon. My name is Courtney and I will be your conference operator today. At this time, I would like to welcome everyone to the FICO first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Mr. Mike Pung, you may begin your conference.

Mike Pung

Thank you, Courtney. Good afternoon and thank you for joining FICO's first quarter earnings call. This is Mike Pung, Vice President of Finance and Investor Relations. And I'm joined today by CEO Mark Greene and CFO Tom Bradley. You will fine on the Investor Relations portion of the FICO website, a copy of today's press release, our Reg G disclosure schedule, our financial highlights presentation and a schedule of historical revenue as reclassified for our new operating segment reporting.

A replay of this webcast will be available through February 27, 2010. 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 our filings with the SEC, in particular in the risk factors and forward-looking statements portions of those filings. Copies are available from the SEC, from the FICO website or from our Investor Relations team.

In order to provide additional information to investors, we will use certain non-GAAP financial measures on this call, including free cash flow, adjusted EBITDA and operating expenses excluding charges. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures entitled Reg G disclosure is available on the investor page of our website under the presentations tab.

Now, I will turn the call over to Mark Greene.

Mark Greene

Thanks, Mike and good afternoon. We'll proceed today in three parts, as usual. First, I'll summarize the quarterly results and assess our business in light of current market conditions. Then Tom Bradley will provide further financial details and finally, I'll discuss our strategy and business outlook for the remainder of the year before we take your questions.

Turning to first quarter 2010 results, revenue was $151 million, about flat with the prior quarter. Bookings, an indicator of future revenue, totaled $60 million, down from the prior quarter, but up 14% from the year ago period. We are starting to see signs of macro economic recovery in many of the markets we serve and stabilization in several of our key business segments. But since these encouraging signs are tentative, we remain very focused on controlling costs and protecting profits. These efforts continue to bear fruit, as we reported GAAP earnings per share of $0.37, up slightly from the prior quarter and up significantly from the year ago period.

I'd like to discuss the revenue results according to the three segments of our decision management portfolio; namely applications, which help businesses make smarter decisions over a customer life cycle; scores, which are the predictive analytics used in those applications to assess risk; and software tools, such as rules and optimization engines on which our applications are based.

Beginning with applications, applications revenue was $93 million this quarter. Down 2% from the prior quarter, but up 4% from the prior year period when adjusted for last year's sale of our telecommunications products. Two parts of our application portfolio deserve mention; namely marketing solutions, which our customers use to boost top line growth, and fraud management solutions which they use to bolster the bottom line.

Marketing solutions revenue grew 8% from the prior quarter, thanks to the rollout of our new Retail Action Manager product, or RAM. Best Buy signed a multi-year contract for RAM in the prior quarter and went live this quarter, less than 90 days after contract signature. Early results from Best Buy's RAM deployment are very positive. We're now preparing to launch the next version which are Action Manager 2.0 and we'll showcase its capabilities at major retail conferences this year. We are quite optimistic about the potential of this product.

Fraud management also showed continued strength with new bookings in the quarter totaling $24 million, consistent with the prior quarter. We continue to experience favorable market reaction to our two recent product launches in this area. Falcon 6.0 for Bank Fraud and insurance Fraud Manager 3.0 for insurance claims fraud. The combined pipeline for these fraud offerings remains well over $200 million with strength in all geographies. Our development and sales resources are heavily focused on these fraud offerings and we expect continued growth in bookings and revenue.

Turning to the next segment, Scores. Scores revenue was $42 million. Essentially flat against the prior quarter. The business-to-business portion of this, which is scores sold to financial institutions actually grew 1% from the prior quarter. This B2B scores business had been declining at double digit percentages during the recession. So we are gratified to see some stabilization here. We are cautious about near term prospects, given the signs of continued turbulence in US consumer credit markets.

But we do see three encouraging trends. First, several of our clients are now checking FICO scores more frequently to better monitor consumer financial health in the credit card, automotive, and home mortgage markets. For example, some credit card issuers are now pulling FICO scores every month, rather than just once a quarter. Second, we saw during this quarter renewed volume commitments for our prescore offering, which are scores that banks use to market, to acquire new clients. And third, we're seeing increased adoption of the latest version of our Score, FICO 8, with more than 800 lenders now using FICO 8 as the foundation for their risk management practices.

Now, turning now to the consumer portion of our scores business. Revenue from our myFICO service was down due to a decline in the average revenue per user. Even though traffic at our myFICO website remains strong, and our subscriber base continues to grow. ARPU, average revenue per user has been hurt by experienced withdrawal from the site last spring. In this challenging economy, we believe it's important for consumers to be able to know their FICO scores from all three credit reporting agencies. As they seek to manage their finances and be prudent users of credit.

I have two updates on this B2C or consumer scores business. First, we're diversifying our consumer services offerings. During the quarter, we launched a new identity theft service, and we expect to roll out other value-added offerings at myFICO.com in the months ahead. Second, we're pleased to be working now with Chase retail bank to launch in the near future a consumer education program for their customers that will link directly to the use of FICO scores and to the myFICO business.

Finally, the consumer scoring business. You'll be aware the last quarter we received an unfavorable ruling in our lawsuit against Vantage Score Solutions and two other credit reporting agencies. We continue to believe in the merits of our case, and we expect to move forward with an appeal of this ruling, but concurrent with this activity, we also continue to pursue mutually beneficial partnerships with all three credit reporting agencies, as part of our scores strategy.

Final segment to report on is our Tool segment, which consists of rules management, modeling and optimization products. We use these capabilities internally to build our own applications, and we also sell them directly to clients who want to build their systems internally. Revenue in this tool segment was $17 million during the quarter, an increase of 12% from the prior quarter. We signed $11 million in tools bookings during the quarter. And our pipeline remains strong, although market conditions and the competitive landscape remain challenging.

So to summarize the quarter, we see several signs that our business is stabilizing, and emerging from the downturn of the past two years. Applications revenue is firming up, thanks to growth in our marketing and fraud products. Scores revenue is likewise stabilizing, as the business-to-business portion shows modest positive growth. Bookings across all three of our segments grew by 14% from the prior year, and we once again delivered good bottom line results. In our discussions with clients, supports some level of cautious optimism for the second half of our fiscal year.

Let me now pass the call to Tom Bradley for further financial details.

Tom Bradley

Thank you, Mark. As we stated last quarter, effective October 1, we restructured our organization into three operating segments that are focused on four industries; banking, insurance, retail, and healthcare. We also organized our sales efforts into three regions, the Americas, EMEA, and Asia Pacific Japan. Mark has already discussed our revenue results by segment, so I will provide some additional comments as they relate to the other aspects of this structure.

Total revenue for the quarter was $151 million, flat when compared to the prior quarter. In the regional breakout this quarter, 76% of total revenue was derived from our Americas region, which includes North America, South America, and Central America. Our EMEA region generated 17% of our revenue and the remaining 7% was derived from APJ. All percentages are consistent with the prior quarter. By revenue type, recurring revenue derived from transactional and maintenance sources for the quarter represented 76% of total revenues, about the same as the prior quarter. Consulting and implementation revenues were 17% of total this quarter, compared to 16% in the prior quarter. Finally licensed revenues were 7% of total, versus 8% in the prior quarter.

Bookings of $60 million created $14 million of current period revenue, a 23% yield. As expected, our bookings declined from the prior quarter which included a very large agreement for retail action manager. Of the $60 million in bookings, almost 40% related to fraud products which came on top of a very strong booking number in the prior quarter. We expect to see some lift in revenue in the latter part of the year, as we complete the implementation of these bookings. We had 12 booking deals in excess of $1 million, of which two exceeded $3 million.

The first quarter saw continued benefit from our expense management efforts, with operating expenses equal to $120 million, up slightly from the prior quarter. As you can see in our Reg G schedule, non-GAAP operating margin before amortization and stock-based comp was 26% for the quarter, compared to 27% in the prior quarter. As we discussed on our last call, we expect operating expenses to grow modestly over the remainder of the fiscal year.

Moving to the bottom line, net income this quarter was $18 million, up 3% from the last quarter. The effective tax rate was about 33% for the quarter, higher than we anticipated due to the expiration of the federal research and development tax credit at the end of December. We would expect our rate to decline back down to around 31% if the R&D credit is reinstated by Congress.

We define free cash flow as cash flow from operations, less capital expenditures and dividends paid. The free cash flow for the quarter was $26 million or 17% of revenue, compared to $24 million or 16% of revenue in the prior quarter. Our ongoing cash flow continues to strengthen FICO's liquidity position. We have $371 million in cash and marketable securities on the balance sheet, plus $280 billion available against our revolving credit facility. This provides $651 million in available liquidity.

Our debt remains unchanged consisting of $295 million balance outstanding on our revolver with an all-in interest rate of 80 basis points and $275 million in outstanding notes. The ratio of our total net debt to adjusted EBITDA is now 1.5 times, well below the coveted level of three times. Our total fixed charge coverage ratio is 4.5 times, well above the covenant level of 2.5 times. We do not have any maturities of this debt until October of 2011. We are evaluating our debt structure in light of the current capital market conditions and we anticipate converting our revolver into longer term notes during the fiscal year.

During the first quarter, we repurchased 1,736,000 shares in the open market at a total cost of $33 million or an average cost of $19.24 per share bringing our share count outstanding at December 31st to 46.5 million shares. Since January 1, we have repurchased an additional 159,000 shares at a total cost of $3 million or $21.66 per share. As a result of these purchases, we have $93 million remaining on our existing share repurchase authorization. In light of the cash position on our balance sheet, and our ongoing ability to generate free cash flow, we expect to continue a disciplined repurchase of shares during the second quarter. We continue to evaluate how to best deploy accumulative cash to maximize shareholder value. I'll turn the call back to Mark.

Mark Greene

Thanks. In this concluding section, I'd like to discuss the health and prospects of each of our three business segments. Starting with applications. These are the applications that enable clients to connect decisions across the enterprise and across customer life cycles. Life cycle ranges from marketing to acquire new customers, to originating account relationships with those customers, and manages those relationships for profitability, collecting monies owed, and protecting against fraud.

Over the last year, we've made great progress in delivering next generation offerings for marketing, collections and fraud portions of that spectrum. And in the months ahead, we'll be releasing applications for the rest of the life cycle. Importantly, all of these applications are constructed on the same underlying tools, meaning that by the end of 2010, FICO will have the industry's first full suite of interoperable applications that really deliver on the promise of connected decisions. All built on an industry standard service-oriented architecture that makes our applications easy to adopt and implement. I'm very proud of the work being done here, and I'm excited by the favorable feedback from clients and analysts who understand the power of these solutions.

In our scores business, scores being the things which clients use at the core of their risk management practices. We expect to see a growing volume of FICO scores used as the level of lending activity picks up in the United States. Improved sales of autos and homes, along with renewed levels of credit card marketing activity by banks should translate directly into growth in our business-to-business scoring business.

One area we are tracking closely is the impact on our scores business of the new Card Act, which takes effect on February 22. We believe that near-term the Card Act will likely boost score volumes as credit card issuers seek to identify and retain their most profitable customers. The longer term picture is less clear, given concerns that the Card Act may render the credit card sector less profitable, prompting a reduction in the size of the sector.

Finally regarding our tools business. As we noted last quarter, we are making focused investments to accomplish two things in this space. First, we're ensuring that all of our applications make deep use of our tools to help fulfill the connected decisions vision. And second, we're strengthening and broadening our network of distribution partners, including OEMs, system integrators and resellers to drive sales of our decision management tools. In this regard, we recently expanded our reseller relationship with Software AG, a leading European software house to distribute FICO's tools with a particular emphasis on our Blaze Advisor (inaudible). This relationship resulted in three new sales in the quarter that we are reporting.

Now, to our outlook going forward. As I noted at the top of the call, we see tentative signs of stability and growing confidence in an economic recovery in most of our markets. In the US, financial results for large banks are improving but they are tempered by caution around consumer financial health in the face of continued high rates of unemployment and delinquencies in housing and credit cards.

Internationally, we see strength in Asia, especially in China where we are experiencing 10% growth and increasing market traction. We now work with eight top Chinese banks, including our newest client The Bank of Beijing. We recently appointed a Managing Director for China, Mr. Clifford [Mak] who comes with an extensive background of growing technology businesses in the region. And this month we also announced a strategic partnership in China with a long-top financial technologies, the financial IT market leader in China to further accelerate our market penetration.

Turning to EMEA, most of that region appears to be stabilizing or growing with the possible exception is United Kingdom. We're seeing significant opportunities in Germany and Eastern Europe, and have signed several large deals in this region during the quarter. We are now in the process of expanding our presence in the region, having opened an office in Munich and hiring additional staff. The unifying thought here is that market conditions and our own business are both stabilizing. Our opportunity and challenge now is to sustain the stabilization and move towards an era of growth.

In this regard, I was delighted to announce earlier this month, that Mr. Charlie (inaudible) will be joining the FICO executive team on February 1, as our new EVP of Sales and Marketing. Charlie is a highly qualified leader with a proven track record of growing revenue at successful organizations such as Avaya, DEA Systems and IBM. With Charlie's leadership, I look forward to placing FICO on the path to growth in the quarters ahead.

This brings us finally to guidance. We started the year off well, and remained confident in our ability to meet the guidance previously provided for fiscal '10, namely that we expect high single digit percentage growth, and GAAP earnings per share versus the prior fiscal year.

As I conclude, I'd like to note two important shifts that we are seeing in the market, both of which reaffirm our confidence in our long-term strategy. First is the growing interest in the business community in the use of analytics to improve business performance, exactly the sort of technology that's at the core of our company.

As the world emerges from recession, business leaders are progressing from fighting for survival, to once again seeking competitive advantage. This is particularly true in the four industries we serve, banking, insurance, retail, and healthcare. Leaders in these industries are increasingly asking how analytic tools and applications of the sort we provide can help them compete and win in this new reset economy. One can scarcely pick up the Wall Street Journal these days without seeing stories about the potential of analytics to solve critical business challenges.

Second phenomenon in our noting is the new found importance of risk management and with it the rise of risk professionals. Clearly one lesson from the recent downturn has been that risk management must be elevated from a tactical consideration, to a strategic business function. This bodes well for FICO, since chief risk officers are our customers.

Taken together, these two shifts, businesses focusing on analytics and risk managers growing in importance, mean that the business world is coming around to what has always been FICO's core strength. As the leader in decision management, FICO really can transform businesses by making every decision count. And we're working to parlay this into growth for our company. With that, I'll turn the call back over to Mike Pung for question-and-answer.

Mike Pung

Thanks, Mark. This concludes our prepared remarks and we are ready now to take your questions. Courtney, please open the line.

Question-and-Answer Session

Operator

(Operator Instructions). We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Michael Nemeroff from Wedbush. Your line is open.

Michael Nemeroff - Wedbush

I see the bookings was, the growth was 14%. If you could maybe tell us what the durations have been tracking like in that area, because without knowing the durations, the bookings are kind of almost a useless number.

Tom Bradley

Yes, the bookings for this quarter are actually even higher than last quarter. I believe the duration was…

Mark Greene

40 months.

Tom Bradley

40 months. Last quarter was 37 months.

Michael Nemeroff - Wedbush

Okay. And Mark, which products do you think are taking share? And which products do you think are not or may be losing share right now?

Mark Greene

I think in the application space, we feel very good about our market share experiencing fraud and in marketing. As we come out with other newer versions of the other products later this year, I expect that they will do well as well. We have good early intelligence about how those products will stack up versus competition, but at the moment, the winning spaces for us are fraud and marketing.

Michael Nemeroff - Wedbush

Okay. And then with the new revenue breakdowns, it appears and based on what I'm looking at with my model, that the applications revenue seems to be stabilized, as well as the tools revenue, and the scoring business might have some declines for the year. Is that the proper way of looking at it?

Mark Greene

I think that's right. I would encourage you to distinguish a little bit between the business-to-business portion and the business-to-consumer portion of scoring. The B2B portion, there's some tentative signs of stabilization there. The consumer portion remains in distress, but the rest of your analysis is right.

Michael Nemeroff - Wedbush

I'll gladly incorporate it into my model if you give us the numbers. And then the last question is, really on the tools business, you mentioned that there was a bookings number in tools. It's my understanding that the tools businesses is a straight pretty much an enterprise software business, just kind of want to understand where the bookings would come in. Wouldn't you just generate the license immediately up front?

Mark Greene

It's generally sold as a perpetual license, yes, with ongoing maintenance and services for implementation.

Tom Bradley

Good point.

Mark Greene

And so the three of those combined are booking over a shorter term period.

Tom Bradley

That's great. In contrast to applications, you are correct Michael that the tools bookings will flow very quickly to revenue, either current quarter or next quarter. Applications tend to be longer.

Operator

Your next question comes from the line of Carter Malloy at Stephens. Your line is open.

Carter Malloy - Stephens

Hey guys, thanks for taking the questions. First, I just want to talk about your cogs line there and it was down quite a bit relative to I think where myself and the rest of the street had been looking for. I'm just curious where you're continuing to find cost cuts within the business.

Tom Bradley

It's really in line with our overall expense cuts from a year ago. On a run rate basis, we're down practically $100 million and a lot of those costs are allocated to the cost of sales line. So I believe that's the major impact.

Carter Malloy - Stephens

But does that continue to come out of the headcount or are there other reductions you guys are finding and maybe what headcount currently stand at?

Tom Bradley

The headcount is just about flat from last quarter but it's down substantially from a year ago and headcount was the biggest driver of that expense reduction. We don't see that to continue to decrease. As a matter of fact, we expect modest increases in the expenses going forward.

Mark Greene

The headcount number these days is running just shy of 2100.

Carter Malloy - Stephens

Okay. And then on the scoring business, if we could get a little more granular there as you guys are saying the B2B portion in financial services or as a whole is actually flat or up sequentially.

Tom Bradley

As a whole, but as you'll note that’s largely financial services.

Carter Malloy - Stephens

Right. That would then imply myFICO revenues being down sub $9.5 million or so. That was down pretty big sequentially.

Tom Bradley

You are in the right ballpark, that's correct, year-over-year.

Carter Malloy - Stephens

Okay. And then maybe a little bit on the decision to appeal the trademark ruling and some of the costs associated with that.

Mark Scadina

This is Mark Scadina General Counsel. I think obviously you saw the jury's verdict. We're obviously disappointed in that ruling. I think we continue to believe strongly in obviously the merits of our case. Right now we are in the phase of kind of post trial motions. I think, barring some other events, I think we would currently expect to file appeals and appeal those rulings.

Carter Malloy - Stephens

And any idea for our modeling purposes what those costs would look like?

Mark Scadina

You know, it's certainly not going to be more than what we did during fiscal '09 to ramp up for the trial.

Mark Greene

Yeah, I mean in ballpark it's going to be significantly less, right? So, we are going through the appeal phase. The significant chunk of the expense is run through trial and at this point it's going to be significantly less.

Carter Malloy - Stephens

Okay. And actually what was that cost total in '09?

Mark Greene

We haven't disclosed the legal costs separately.

Carter Malloy - Stephens

Okay. And then lastly, I'll get out of the queue. Sorry for so many questions but on the international front, what was your FX tailwind in the quarter this time around?

Mark Greene

It was very little. Less than $1 million. It's really stabilized from where we were six or nine months ago.

Operator

Your next question comes from the line of Tom Ernst from Deutsche Bank. Your line is open.

Unidentified Analyst

Good afternoon. This is (inaudible) on behalf of Tom. Thank you for taking my question. You talked about operating expenses, growing modestly through the remainder of the year. Where are you focusing on? Is it on the distribution side or R&D or both?

Tom Bradley

By modest increases, you know, I'm talking less than 5%. You know, for example, we gave raises in December for the first time in a while, and that's going to start to come through the numbers. So we'll be seeing inflation like increases on some categories and we are, as Mark mentioned, making investment in product and our capabilities to fill out our roadmap for the rest of the year. So, think about numbers five to slightly under that or under 5%, and in across those kind of categories.

Unidentified Analyst

Has the mix of scoring changed over time? I know you've talked about the prequalified or the market oriented ones going slightly up, but how about the overall mix?

Mark Greene

So there are two dimensions to that as your question suggests. First, by phase of life cycle, yes, we are seeing off late increase in what I call the front of the life cycle which is the prescreen or marketing type of scores. That's beginning to come back. And the other dimension to it is the mix across the different segments. The credit card business which is the majority of the scoring business was the one that took the deepest decline over the last year. That remains in depressed levels of volume but beginning to come back. So the credit card business is a big driver of our overall scoring business. It was under stress until fairly recently and now seems to be stabilizing.

Unidentified Analyst

And how about mortgages?

Mark Greene

Mortgage is about 15% of the scoring business and took a hit as well but proportionally less and seems to be recovering as well.

Operator

(Operator Instructions). Your next question comes from the line of Mike Latimore from Northland Securities. Your line is open.

Mike Latimore - Northland Securities

Yeah, good evening. Just on the SG&A line, that was up a little bit sequentially. Is that where some of these raises and so forth are showing up or was there any one-time item in there?

Mark Greene

No, there is no one-time items of note. It's the organic growth.

Mike Latimore - Northland Securities

And then around just the marketing activity for the scoring business, Mark, do you think that the activity will pick up after the after the Card Act goes into place or have you seen, improvement prior? I think you had originally thought that may be there'd be some activity ahead of the act, just sort of around more testing and prepare and the sort of strategic initiative.

Mark Greene

What I can report for sure is increased contractual commitments in this area. Some of it probably is already in place now, but as you may recall from the reporting delays that we see, there's a bit of a lag on the order of six weeks or so between actual activity and when we see it in our numbers. So some of that increase in marketing activity may well be underway as we speak, but the one thing we know for sure is that we have pretty interesting contractual commitments from a number of customers in this space going forward.

Mike Latimore - Northland Securities

Okay. Got it.

Mark Greene

So I guess it will be on both sides of the deployment of the Card Act is the short answer.

Mike Latimore - Northland Securities

And just think about bookings in fourth quarter versus first quarter. In a more normalized environment, we see some seasonality there where fourth quarter would be stronger than the first quarter? Is there seasonality in that kind of sequential trend?

Mark Greene

I don't think so. I think it was more due to a couple of big opportunistic deals that we closed in our fiscal fourth quarter.

Mike Latimore - Northland Securities

And then just last on the guidance itself, reiterating guidance through I guess the high single digit percent growth. I guess just looking at the numbers here, I mean, that could suggest that the EPS numbers are actually down sequentially or down, in the next three quarters and you still hit that high single digit percent. I mean, is that kind of what you are thinking about here or would you intend to grow a little bit sequentially?

Mark Greene

Well, I think the guidance holds at that high single digit level. I mentioned the potential to refinance our revolver, which is going to increase our interest costs going forward. That could be to the tune of $0.03 a quarter if we are able to do that fairly quickly. So that's one thing that provides some downdraft over the remainder of the fiscal year.

Mike Latimore - Northland Securities

I see. And your guidance is that assume it 31% or 33% tax rate?

Mark Greene

For now, we're assuming it 33%, given that that's the law in place. If that law gets changed by Congress, we'll update our effective tax rate and the related impact.

Operator

There are no further questions at this time. Mike Pung, I turn it back over to you.

Mike Pung

Thank you, Courtney and thank you everyone, for your interest this quarter. Look to talk to you again next quarter.

Operator

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

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