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Intuit, Inc. (NASDAQ:INTU)

F2Q10 (Qtr End 01/31/10) Earnings Call Transcript

February 18, 2010 4:30 pm ET

Executives

Jerry Natoli – VP of Finance and Treasurer

Brad Smith – President and CEO

Neil Williams – SVP and CFO

Analysts

Heather Bellini – ISI Group

Gil Luria – Wedbush

Adam Holt – Morgan Stanley

Laura Lederman – William Blair

Bryan Keane – Credit Suisse

Philip Rueppel – Wells Fargo Securities

Jim MacDonald – First Analysis

Sara Friar – Goldman Sachs

Kash Rangan – Merrill Lynch

Sasa Zorovic – Janney

Scott Schneeberger – Oppenheimer

Michael Millman – Millman Research

Brad Zelnick – Macquarie

Ross MacMillan – Jefferies

Brad Sills – Barclays Capital

Operator

Good afternoon. I will be your conference facilitator. At this time, I would like to welcome everyone to the Intuit second quarter fiscal year 2010 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 period. (Operator instructions)

With that, I will now turn the call over to Jerry Natoli, Intuit's Vice President, Finance and Treasurer. Mr. Natoli?

Jerry Natoli

Thanks, Patty. Good afternoon and welcome to Intuit's second quarter 2010 conference call. I'm here with Brad Smith, our President and CEO and Neil Williams, our CFO. Before we get started, I would like to remind everyone that our remarks will include forward-looking statements.

There are a number of factors that could cause Intuit's results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2009 and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit's website at intuit.com. We assume no obligation to update any forward-looking statements. Some of the numbers in this report are presented on a non-GAAP basis. We've reconciled the comparable GAAP and non-GAAP numbers in today's press release.

Note also that the sale of our real estate solutions business completed in January is accounted for as a discontinued operation. That means the real estate solutions net operating results appear on the discontinued operations line. These results are excluded from the operational results, operational guidance figures and non-GAAP EPS for all periods presented. GAAP EPS includes the gain on the sale of our real estate solutions business. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. With that, I'll turn the call over to Brad Smith.

Brad Smith

Thanks, Jerry and thanks to all of you for joining us. We are very pleased with our fiscal second quarter results. Revenue and EPS exceeded the top end of our guidance, growing 8% and 12% respectively. And while it's still early in the season, we feel confident in our ability to perform well in the second half. That's why we're raising our revenue and earnings guidance for the year.

We now expect revenue to grow 6% to 9%, up from our prior guidance of 4% to 8%. And we expect non-GAAP EPS growth of 8% to 12%, up from our prior guidance of 4% to 8% as well.

Here's my perspective on our results. In a headline, Intuit is both uniquely advantaged and is helping drive the shift to a connected services economy. Everywhere you look services are transitioning from paper-based, human produced and brick and mortar bound to services that are produced, marketed and delivered through connected devices.

Small businesses are abandoning the shoe box for connected services, taxpayers are moving beyond the tax form at the post office or a visit to their local tax store to a much more preferred method of completing their taxes online and the same structural shift holds true for online banking, electronic payment, online payroll and yes, even the shift to electronic healthcare.

This connected services tide will only get stronger as the next generation of customers enters the market, having grown up with the web, video games and SmartPhones and delivering connected services makes it convenient for the customers to be served any time on any device.

This structural shift in the market place is providing a tailwind to our business performance. And it reinforces the viability of our three-point strategy, which remains focused on, first, driving growth in our core businesses, second, building adjacent businesses and entering new geographies and finally, continuing the acceleration of our transition to connected services.

This quarter’s results once again demonstrate that our strategy is working. Here are a few examples and I will start with the first component of our strategy, driving growth in our core businesses. In consumer tax, the shift to connected services continued to fuel category growth for the tax, software and web categories.

Our Q2 revenue was up 15%. Now that growth was helped by having an extra weekend day at the end of the month when compared with last year. But through February 13, total TurboTax federal units are up 11%. We're growing share, both in the desktop and online categories and we're increasing revenue per return. We now believe the consumer tax business will grow 8% to 12% this year versus the 5% to 9% we had estimated last August. It's still early in the season, but we're off to an excellent start.

In small business, our employee management solutions and our payment solutions segments both grew revenue double digits and grew revenue per customer compared to the second quarter of last year. These results were driven by the strength of Intuit's online payroll service as well as the continuing adoption of electronic payment by small businesses.

And finally, our financial institution segment reported 10% revenue growth, driven by strong online banking and bill pay user growth as well as positive early results for TurboTax for online banking. You may recall TurboTax for online banking is a great example of how we can leverage capabilities between multiple business segments to create a compelling new offering that solves an important customer need and it is not easily matched by competitors. It also shows how we can leverage the banking channel to reach new customers. This is what we had in mind when we made the digital insight acquisition.

Now, the second component of our strategy is to build adjacent businesses and enter new geographies. And we're seeing strong progress here as well. Intuit website customers grew 63% and we have more than doubled the Homestead customer base since completing that acquisition at the end of 2007. These customers are largely new to the franchise and we're excited about the potential for these customers to adopt additional Intuit services, such as e-mail marketing or payments.

Our healthcare initiative continues to show promise. Quicken Health Expense Tracker, which is a web-based offering, is now in market and available to more than 26 million health plan members. We've gone from fewer than 10,000 to more than 40,000 users in the past several months.

And Intuit's first products to the global market, Intuit Money Manager, was launched in India on December 29. In the first four weeks in market, we had over 10,000 registered users actively using its online service and the early feedback was promising. In each of these cases, customer growth is ahead of expectations, so let me be clear.

While we're attempting to be more transparent about the early results, it is still way too premature to bank on any material near-term revenue. However, we do believe these efforts will add a couple of points of revenue growth to the company level over the next several years.

Now, the third component of our strategy is to continue to accelerate our transition to connected services. You've already heard me talk a lot about connected services, so let me share some of the key results in this area. Over half of our company's revenue is generated from connected services and roughly a third of our company's revenue is generated from what the industry refers to as software as a service.

In the second quarter, we posted a 22% growth in our connected services revenue, driven by products like TurboTax Online, Digital Insight’s Online Banking and Intuit's Online Payroll service just to name a few. In every category we serve, Intuit has the leading fast offering as measured by customer satisfaction and user share. For example, QuickBooks Online, which grew its customer base 14% this quarter has more active users than all other small business online accounting software offerings combined.

We're also continuing to build our portfolio of new connected services that customers love, in addition to the acquisitions of such great companies as Homestead, PayCycle's Online Payroll and Mint.com were also building great offerings internally.

For example, in the mobile application space, we recently launched SnapTax in California. Now, this is cool. This application allows Californians filing a simple tax return to take a picture of their W-2 using their iPhone and then they have the data automatically pre-populate their tax return without the need for data entry.

The early feedback has been positive and we expect it to roll out more broadly in the future. All of our offerings have a significant impact on our customer's lives where it matters most. It helps improve their wallet. Nothing excites us more than delivering on our mission of improving the financial lives of our customers so profoundly, I can't imagine going back to the old way of doing things.

And we all know that this didn't happen overnight. Last year, we talked about investing through the downturn and we're seeing some tangible results. We're going to continue to make smart investments like these to solve important customer problems, while accelerating our revenue growth and profitability. Now, let me turn it over to Neil to share some of the operational details.

Neil Williams

Thanks Brad. Let's start with companywide results for the second quarter. Revenue of $837 million, up 8% and more than $20 million over the top end of our guidance range, adjusted for the sale of the real estate solutions business.

Non-GAAP operating income of $206 million, up 20% and $31 million over the top end of our guidance range. Year-to-date, the non-GAAP operating margin is up 100 basis points, indicating our efforts to improve operating leverage are paying off. Non-GAAP diluted earnings per share of $0.38 was $0.06 better than the top end of our guidance range.

On a GAAP basis, operating income was $139 million and GAAP diluted EPS was $0.35, $0.17 better than the top end of our guidance range and that's 35% from the same period of last year. The GAAP results include the $0.10 gain from the sale of our Intuit real estate solutions business.

Turning to the business segments, our consumer tax group had revenue of $216 million in the second quarter, up 15% from last year. We have seen very strong early season filing, particularly on the web. We're seeing a nice increase in revenue per customer, driven by continued conversion from free to pay and continued improvements in product mix. It's early in the season, typically more than two-thirds of our tax units are sold in the third quarter, but based on the strength of the early season, we now expect consumer tax revenue to grow 8% to 12%, up from 5% to 9%.

The accounting professional segment had revenue of $124 million, down 7% from last year, but we previously told you about a revenue shift of $9 million that was deferred from Q2 to Q3, so this is not unexpected. Revenue in Q2 would have been roughly flat, if not for that change. We still expect this segment to have a nice season.

In our small business group, total revenue was up 5%. The growth was driven by payment solutions revenue, which was up 14% and employee management solutions revenue, up 12%. Though financial management solutions revenue was down 3%, revenue per customer was up for the quarter and year-to-date, because we offered fewer promotional discounts on QuickBooks than we did last year.

QuickBooks unit growth may lag revenue as we go through this pricing transition, but we continue to believe there's a large opportunity to grow penetration in this market. And this quarter we had very strong growth in QuickBooks Online and Intuit websites. We believe services like those will be effective front doors to the small business franchise.

We're leading more with those offers and reducing our emphasis on simple start free for the desktop. Payments customers were up 13%, which makes us another strong growth quarter. Charge volume per merchant was down only 3% in Q2 versus 9% a year ago and 8% last year. This is a welcome sign that consumer spending seems to be stabilizing.

And we're continuing to see nice growth from Intuit Online Payroll and steady retention of our existing payroll customers. The financial institutions division had a very strong quarter in what continues to be a tough environment for the financial sector. Revenue grew 10% and bill pay users grew 16%.

For the first time, we've integrated our TurboTax Online product with Digital Insight’s online banking platform, making it easier for our financial institution customers to offer online tax preparation to their customers. About 1200 financial institutions are actively offering TurboTax for online banking this season.

The revenue for TTOB as reported in the financial institution segment, though the units are included with the TurboTax web totals. TTOB revenue contributed about two points of the financial institution's segment revenue growth. Our other businesses segment posted revenue growth of 38% in Q2, driven primarily by strength in personal finance.

The personal finance business is benefiting from a strong new Quicken desktop release and the Mint acquisition. Mint registered user growth has accelerated since the acquisition. We continue to generate strong cash flows in line with our operating income, free cash flow more than doubled in Q2, versus Q2 of last year and we exited the quarter with $1 billion of cash and investments. We purchased 250 million of Intuit stock in the second quarter and have $350 million remaining on our authorization. We expect to continue to repurchase Intuit securities in the market.

As Brad mentioned, we're updating our outlook to reflect the stronger than expected tax season. In fiscal year 2010, we expect revenue of $3.3 billion to $3.4 billion for growth of 6% to 9%, non-GAAP operating income of $1.01 billion to $1.05 billion for growth of 9% to 13%, GAAP operating income of $785 million to $825 million for growth of 15% to 21%. Note that even at the low end of our revenue and operating income guidance range, we expect non-GAAP operating margin to be 30% or better.

Non-GAAP diluted EPS of $1.97 to $2.04 for growth of 8% to 12% and GAAP diluted EPS of $1.63 to $1.70 for growth of 21% to 26%. For the third quarter, we expect revenue of $1.51 billion to $1.59 billion for growth of 7% to 12%, non-GAAP operating income of $860 million to $910 million for growth of 3% to 9%, GAAP operating income of $811 million to $861 million, non-GAAP diluted EPS of $1.75 to $1.85 for growth of 4% to 10% and GAAP diluted EPS of $1.64 to $1.74 for growth of 12% to 18%.

As mentioned earlier, we now expect consumer tax full-year revenue to $1.075 billion to $1.115 billion, which is growth of 8% to 12%. We are also updating guidance for the other businesses segment to reflect the strength in personal finance and the sale of the real estate solutions business. We expect other businesses full year revenue of $240 million to $250 million or a growth of 12% to 17%. With that, I'll turn the call back to Brad.

Brad Smith

Thanks, Neil. So we're off to a good start and we're on track to deliver better than expected revenue and earnings growth for fiscal year 2010. Our long-term goal remains unchanged. We strive to be an innovative growth company that help consumers and small businesses save and do more with their money. And our long-term objectives are to grow this company organic revenue double digits while growing revenue faster than expenses, which generates improved operating income leverage and strong cash flow.

We're pleased to see that our strategic initiatives are having a positive impact and that they are building momentum as we work towards our longer-term objectives. I would like to thank our employees for a great quarter and for all they are doing to position the company for continued success in the future. And with that, I would like to turn it over to you for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Heather Bellini of ISI Group.

Heather Bellini – ISI Group

Hi, good afternoon, everybody. I was wondering, Brad, if you could share with us a little bit, you mentioned a reason for the upside in consumer tax was taking share. I was also wondering if you could share with us what you're seeing from a trend perspective of monetizing free thus far this year versus what you saw last year.

Brad Smith

Yeah. Thanks, Heather. When we started out the year, we talked about four key drivers in the tax business. One is the growth in individual returns, the second is a growth of the online and software category, the third is our ability to grow share in TurboTax and then the fourth is the ability to grow revenue for customer. I would tell you that so far in the season, although it's still early, the tax filings to the IRS are coming in about what we thought. So they are still down a little bit year-over-year according to our best estimates.

But what we are able to do is we believe the online category continues to grow fast and that we have seen our ability to take share both in the desktop, which is up about three points year-to-date, but also online, which is up a couple of points. And we're seeing favorable revenue per customer because of two reasons. One is we're getting a favorable mix shift as customers are seeing more value in our more premium products. And the second is after 3.5, four years getting in the market with free, we're getting a much better execution behind free to paid in terms of conversion. And so to answer your question directly, we're seeing positive trends on the free to pay conversion and we're also seeing a favorable mix shift in our product lineup.

Heather Bellini – ISI Group

So, Brad, can I ask a quick follow-up, which would be last year I think the GAAP between revenue growth and units was about close to four points. Based on what you're seeing about better revenue per customer, should we potentially see that narrow this year?

Brad Smith

Yes. I will tell you that our goal remains to grow the category and grow units, but because we're seeing favorable improvements in both the mix as well as our ability to get free to pay to conversion, I would expect to see a much tighter alignment this year between units and revenue.

Heather Bellini – ISI Group

Great. Thank you.

Brad Smith

You're welcome. Thank you.

Operator

Our next question comes from Gil Luria of Wedbush.

Gil Luria – Wedbush

Yes. Thank you for taking my question. Couple more clarifications on the TurboTax growth number, I think you mentioned an extra weekend day this year. Could you quantify how much of a benefit that was? And then I also wanted to clarify, you said that a couple of points of growth in financial institutions came from TurboTax for online banking. Would that mean that if you had a categorized that revenue under consumer tax, would that mean one extra point of growth in consumer tax?

Brad Smith

Okay. Thanks, Gil. Let me start with the first question. Last year, January 31 fell on Saturday and this year it fell on a Sunday. And we tend to see a spike in tax filings over the weekend when people have more time to sit down and go through the process. So we did get a benefit this year because we got two full days at the end of the month for filing taxes. My best guess and our best guess is a couple of points there potentially. And that's why I think February 13 tax return update is probably a pretty good indication of what we see and why we're guiding the way we're guiding the balance of the year. In terms of TurboTax online banking, we mentioned that it represented about two points of revenue growth for the financial institutions business. If you put that back into TurboTax, it would be closer to about a point. So that would have represented about a percentage point of revenue, if it was in TurboTax's reported numbers.

Gil Luria – Wedbush

That's great. Thank you very much.

Brad Smith

Thank you.

Operator

Our next question comes from Adam Holt of Morgan Stanley.

Adam Holt – Morgan Stanley

Good afternoon and thanks for taking my question. On the tax business, obviously looks like it's off to a terrific start. I wanted to drill down on how you're thinking about the weighting of the season from a timing perspective. In particular, as you continue to see the shift towards online, historically you've seen a little bit more of a back end loading season. Do you think that will continue this year? Do you think you will see a greater percentage of your season come in the last couple of reporting periods or was there anything unusual about the first part of this season that might have been a little bit more front end loaded?

Brad Smith

Well, Adam, this is a – it's a little bit of a tale of two cities. If you look at the macro trend, we continue to see over the last decade, more of a push towards the back end of the season as people start to adopt more online services and it makes it more convenient for them to wait until later in the year. And if you take a look at how many tax filings, at least we estimate have been filed, I think there's still a lot of game to be played. In fact, two-thirds of our business will come in the third quarter.

At the same time, we had a healthier performance in the first part of this season and particularly in our desktop business. And so I think that the overall pattern will continue to be the bulk of the game still to be played in the second half and you'll continue to see people pushing until later into the season. But I have to say that we were pleasantly surprised and we're glad that we had our execution focused on the first part because we're able to capture some pretty strong growth in the first third of the tax season as well.

Adam Holt – Morgan Stanley

If I could just ask a follow-up on the payroll and payments businesses, it looked like you saw a nice inflection there as well. Do you feel you've hit a turning point in those businesses and we should start to see progressive improvements in the growth rates there or was there something unusual about this quarter? Thank you.

Brad Smith

Yes, thanks, Adam. We love both of these businesses. There's plenty of head room for growth. We see these businesses being double-digit growth businesses into the future. If you think about payroll first, we have about 1.1 million to 1.2 million of the QuickBooks users today as payroll customers and that's out of an opportunity of about 2.5 million, so we still have a lot of room for continued penetration. And then when we bought PayCycle, that opened up a whole new market of 7.5 million small businesses. We don’t yet use QuickBooks, but do have a need for payroll. And what you're seeing in payroll right now is seeing our ability to use those two approaches to continue to drive that business. In the payment space, the story gets even better. We continue to increase the number of merchants, bringing them into the franchise about 13% year-over-year growth. And we grew that overall segment about 14%, but that's even with a year-over-year decline in charge volume per merchant being down about 3%.

As soon as that charge volume starts to pick up and consumers are starting to use their credit cards and debit cards with small business that will just be tailwind to our payments business and will only accelerate its revenue growth into the future. So do we see a tipping point? What gives me confidence is if you look at last year, charge volume per merchant was down 9%. This quarter, it was down 3%. So we're starting to see a stabilization, which leads us to believe that while we're certainly past the worst part of the economy, we still have some sluggishness ahead of us, but it is starting to improve.

Adam Holt – Morgan Stanley

And just one final follow-up on that. The merchant growth has obviously been terrific. It's double digits even through the most difficult part of the – hopefully of the economy. As we start to see some improvement in addition to the fact that obviously payments per customer will go up hopefully, should we expect to see an acceleration in the new customer adds as well?

Brad Smith

That's our goal. I mean, our goal is to continue to get better at converting quick books customers into our electronic payment services. And I think as the economy starts to get better and small businesses begin to make purchases, it can only be opportunity for us.

Operator

Our next question comes from Laura Lederman of William Blair.

Laura Lederman – William Blair

Yes. Nice quarter. Thank you for taking my questions. A few, could you talk a little bit about the Mint integration and how the product lineup is coming there? Also, can you give us an update on long-term operating profits, sort of goals and how you're thinking is there now? And finally, on QuickBooks, can you talk a little bit about new users versus upgrades and when you expect that business to accelerate more?

Brad Smith

Okay. I'll tag team a little here with Neil, give him a chance to get in. Let me start with the Mint integration. The Mint integration is going very well. Right now, our subscribers in Mint have accelerated since we acquired the company. Aaron Patzer is doing a wonderful job leading the combined businesses of Quicken and Mint and of course we've had very strong performance in our Quicken product line this year. And so we're pleased with the overall results.

I will also tell you that our revenue per active user in Mint have increased since the acquisition as well. All the indicators are moving in the right direction and we feel good with how the integration has gone and we're feeling better about the future. Let me turn it over to Neil to talk about the long-term margins and then I'll come back and talk about new users and upgraders.

Neil Williams

Yeah. Laura, just quickly, we've talked to you about being able to grow our revenue faster than our expenses and you see that continue throughout first six months of this year and we feel really good about the model. We think there's continued opportunity. And we like the dynamics of adding customers and growing and adding leverage through accelerating our revenue growth really well. So, we don't talk about long-term growth, percentages or goals necessarily in those terms, but the basic operating model and our basic operating principal of managing our expense growth in our investments could be slower than our revenue growth that stays intact.

Brad Smith

Okay. And then on the last one, Laura, I'm assuming you're talking about QuickBooks.

Laura Lederman – William Blair

Yeah.

Brad Smith

So let me give you a couple of key headlines. New users were actually up about 5% year to date. On the upgraders, keep in mind that last year we got very aggressive with retail promotion and in the first quarter of this year, we did the same thing to try to get rid of the QuickBooks ‘09 inventory and make space for QuickBooks 2010.

Since our upgraders are not as strong as they were last year, our new users are driving the growth. But what excites me in addition to QuickBooks new users is the fact we're opening new front doors to the franchise. Think about the website performance I talked about earlier and you've probably seen the TV ads for Intuit's websites. Those users are up 63% year-over-year and then QuickBooks online grew its user base 14% this quarter. And those are two excellent new front doors to get customers into the franchise that we can then sell additional services to. Net-net, new users are up. Upgraders are up a little bit because we're going over some pretty aggressive price promotions, but we're offsetting that with new users through other products.

Laura Lederman – William Blair

Can you talk about the health of small business in general and what you're kind of sensing out there?

Brad Smith

Yeah. I can, again, if you look at the optimism index, they are slowly trying to come back, but not near any sort of levels that we saw back before the economy turned downward. I think the real challenge and question is, are customers shopping with them and are they buying their services? And I have to say that we're starting to see some more positive signs. If you use our charge volume per merchant as an indicator, it was down 9% this time last year, it was down 8% just a quarter ago and it's down 3% this quarter, which means that customers are starting to shop with small businesses again and once that happens, small business owners will start to get more optimistic and will start to expand and hire employees. I have to tell you, I think the worst is behind us, but I don't think we see a rapid recovery. If I had to put some sort of a visual on this, I would think about a Nike swoosh. It's going to be a slow, gradual climb to the other side.

Laura Lederman – William Blair

Thank you.

Brad Smith

Thank you.

Operator

Our next question comes from Bryan Keane of Credit Suisse.

Bryan Keane – Credit Suisse

Hi, good afternoon. A couple things surprised me, I guess, the consumer tax and then the other. So taking them one at a time, on consumer tax, the guidance now is 8 to 12 and that's up from 5 to 9. Brad, just to be clear, is the revision due to the gain in market share and the higher revenue per customer? That's what surprised you to take the guidance up?

Brad Smith

Yeah. We had planned on taking market share. We're actually being more successful at that than we had originally built into our forecast. And then the even more positive surprise is our ability to effect the mix as well as our ability to get better at free to pay conversion. So those are the two key catalysts right now, in addition to the fact that just the online and tax software category continues to grow even when the number of tax filings are down.

Bryan Keane – Credit Suisse

But is that online and software tax category growing faster than the 8% that we've seen over the last several years on average?

Brad Smith

Bryan, we won't know until the IRS reports their numbers. We have internal data that leads us to believe that it's a little healthier, but we have to always wait until the IRS report their numbers because they have a much better view than we do.

Bryan Keane – Credit Suisse

Okay. And the market share gains, last year you lost a little bit of share. Is some of that just gaining it back as your pricing is a little more competitive than some of the competitors?

Brad Smith

Well, last year we actually lost about a point of share in retail because we had about a $15 price premium to block. But on the web, we took share. This year, we're seeing that we have picked up about 3 points of share in the retail category versus block, so we not only took back the point we lost, we added a couple more to it. And on the web, we're continuing to gain market share there as well. And that's based upon our internal research and some external data with comScore. So we're not gaining back anything we lost on the web. We're actually accelerating our share gains like we did last year.

Bryan Keane – Credit Suisse

Okay. And just on other, can you remind us how much the personal finance, the Quicken business is in there and I assume FX probably boosted those numbers a little bit as well, if you could break that out? And then I guess finally, I don’t know is Mint material on the revenue boost when we're looking at the 38% year-over-year? Thanks.

Neil Williams

Bryan, personal management software is about a third of the other category. And as Brad mentioned, while we're ahead of three weeks expected to be in terms of active users and revenue per customer, it's still off a pretty small base with Mint. So the key driver in the category right now is still Quicken.

Brad Smith

Yeah. Bryan, I would tell you one of the things is we had a really good Quicken 2010 release this year and our execution to retail has been very strong. But we also worked closely with Microsoft, as Microsoft shut down Microsoft Money, we made it very easy to help those customers to make it over to Quicken and that's given us a nice boost in Quicken as well.

Neil Williams

Bryan, just to tie up the last part of your question, the FX impact is about $3 million in the quarter on that line, positive.

Operator

Our next question comes from Philip Rueppel of Wells Fargo Securities.

Philip Rueppel – Wells Fargo Securities

Great. Thank you very much. Couple of follow-ups. First on the small business comment that you made Brad. Are you seeing any recovery in new company formation that would eventually drive QuickBooks revenue in, or units and then revenue? And then second of all, on the tax business, the only area that looked sort of flattish was free file. Is there any issues there? Is there any new rules, anything that worries you about losing share, anything to be concerned there? Thanks.

Brad Smith

Yeah. Thank you, Phil. So the first one is a hard one to nail down, which is new business formations. It's a lagging indicator and we typically refer to the Kauffman [ph] report, which is produced externally to let us know what's happening. I will tell you, though, if you see new user growth up, it would suggest that we are seeing small businesses getting formed again and that's good news, because with unemployment at the levels it is, a lot of people are looking for an avenue to create some income. And so historically, that's always been a nice little driver for new business formation. So I think you're starting to see a slight improvement, but we won't really know until the Kauffman [ph] study is updated.

On the second question you asked around free file. First, the good news is the IRS and private industry reached an agreement to extend the free file alliance for the next five years. And so that's positive news. In terms of any rule changes, they actually increased the standard and limited the ability for any of the players in that – in the industry to do any cross-selling or upselling which has always been the rules they have been playing by for the last couple years, too.

So there hasn't been anything that impacted our ability to do what we want to do in the free file which is make sure the people who are underprivileged and underserved get access to free tax software. I think what you see here is a couple of other players who potentially had deemphasized it last year, who are reemphasizing it this year. And so when it all shakes out, we're down to slightly because we were probably the strongest beacon in that group last year. And now you got a couple of other alternatives as well.

So that's kind of it in a nutshell. Nothing has materially changed; nothing that causes us concern. We actually do that as a philanthropic effort and we're glad that consumers are getting access to that software for free

Philip Rueppel – Wells Fargo Securities

Great. Thanks.

Brad Smith

Thank you.

Operator

Our next question comes from Jim MacDonald of First Analysis.

Jim MacDonald – First Analysis

Good afternoon, guys.

Brad Smith

Hi, Jim.

Jim MacDonald – First Analysis

Last quarter you guys were pretty cautious and now you're raising guidance. Is the biggest reason something you're seeing in the economy or is it your own performance or what are the big reasons that you're willing to do that?

Brad Smith

Yeah. Jim, I would tell you. The macro environment has not materially changed from what we saw last quarter. We have always felt for the last three or four months that it's going to be a slow slog to get back to what we would consider to be more normal. So we've just gotten better at execution, understanding how to convert free to paid, understanding how deep to take a discount and still drive the right lifetime value in QuickBooks and small business. If you look across our major business lines, all of our core businesses are performing well and getting better. And so that gives us confidence that we have learned and adjusted and regardless of the macro environment, we see the ability to deliver at these new levels of guidance and if the economy gets better, that's just more tailwind for us.

Jim MacDonald – First Analysis

And I know these are probably small, but I've got to ask, how is it going with the workers' comp and the 401(k) provision add-ons to the payroll business?

Brad Smith

Yeah. No, Jim, I'm glad you asked those questions because as you know well following the industry. The ability for many of the competitors that we see in the market to sell additional services into his their payroll base provides real revenue upside and also solves important problems for their small business customers. And we have just started to do that in the last year. We have still very early results, but our 401(k) plan and our workers' comp offerings are doing well against our payroll base. And we're looking at additional services like that to introduce into our payroll base over time. So still very small and immaterial, but certainly, a good indicator of the direction we're going in the future.

Jim MacDonald – First Analysis

Thanks very much.

Brad Smith

Thank you.

Operator

Our next question comes from Sara Friar of Goldman Sachs.

Sara Friar – Goldman Sachs

Thanks for taking my question. Two elements. First, on the cash flow side, really strong performance there, just wanted to make sure there's nothing no more one-off extraordinary in that number, or is it just more of the shared revenue services revenue, talking about cash that is starting to come through ahead of, when we start to see it on the P&L? Then I have a follow-up if I may.

Neil Williams

Hi, Sara, this is Neil. Nothing really unusual in the second quarter, other than just strong performance and good execution, as Brad mentioned. We had the sale of IRES and those proceeds that came in, but offsetting that, we also had great performance with our employee stock purchase and option exercises in the quarter as well.

So other than those things, I would go back to the operating income being the primary driver and executing on our stock repurchase program, as we've talked about.

Sara Friar – Goldman Sachs

Got it. And then just – a more long-term strategic question around the shift of software as a service, or SAS's we're seeing and clearly you now have many elements of SAS within your business. How do you think about what percent, I don't know if you think about it in terms of percentage of revenue coming from SAS a year from now, three years from now, how do you see that evolving as Intuit kind of makes this shift for all?

Brad Smith

Yeah. So let me talk about some of the numbers I shared earlier, Sara. We talked about a 56% of the company's revenue comes from connected services and actually about a third of our revenue, call it – in fact $900 million comes from software as a service, pure hosted applications. That part of the company has grown 48% compounded annually over the last five years and grew 22% in this quarter.

So if we just take those numbers and extrapolate them out over time, you're going to see the company's revenue continue to shift much more significantly to software as a service and also to overall connecting services, which are highly reliable recurring revenue streams for us.

At this point, we haven't put a stake in the ground and said three years from now what percent will that be, but we actually are working towards that sort of an outlook. So when we get together for our annual investor day in the fall, we would be more than happy to share with you what we think that looks like as we look ahead.

Sara Friar – Goldman Sachs

Terrific. Thank you, both.

Brad Smith

Thank you.

Operator

Our next question comes from Kash Rangan of Merrill Lynch.

Kash Rangan – Merrill Lynch

Hi. Thank you very much. Two questions. One is on the free to fee conversions in both TurboTax and QuickBooks side of the business, how much more of a tailwind do you guys have ahead of you, if you can quantify it in some way, shape or form?

And secondly, Brad, to your earlier point about the SAS revenues, nice to see the SAS revenues show very good acceleration here. If this trend were to continue, at what point do you think, or maybe if you could quantify, what could be the longer term growth rate of the company as you really approach the SAS model because it is clear to us that the SAS model you are growing faster. So does that really potentially accelerate the longer term growth rate of the company and also what that would mean for the operating structure? That's it. Thanks.

Brad Smith

Got it. Thanks, Kash. Let me start with the free to fee conversion. First of all we think that this is a wonderful tool to help get new customers into the franchise in both tax, as well as small business. And then our ability now over multiple years to turn them into paying customers by introducing other services to them has proven to be a great way to expand the category and accelerate our share.

So I only see this as upside and it's something we're going to continue to do aggressively, particularly in tax and also continue to get better at executing in terms of upgrading them.

Let me address the SAS revenue piece. We do see this as a key catalyst. We refer to it internally as connected services. And since it is accelerating the growth rate and it is the way that customers preferring to buy and use products in the future, this is why we continue to say that we see the company as a double-digit organic growth rate company, so we will continue to accelerate with and will supplement that with acquisitions.

So we do see this as a faster growing company than what you've seen last year or even right now with this year's guidance. And that's why we feel confident in making those statements as we look for the long-term. The second part of the question was on –

Brad Smith

Operating model. Yeah.

Neil Williams Two points I would make there, Kash that give us a lot of optimism. First of all, not only are we under penetrated in the categories, but we have lots of opportunities to cross-sell our products and services to our existing customers, which keeps our customer acquisition costs lower than a typical SAS business model you might look at. So we think that's an advantage we have that we certainly want to exploit.

And secondly, we are on a multi-year journey to transition our hosting activities to our new data center in Quincy, Washington that we built and opened last year. And this is a state of the art facility with best in class utility costs and as we move forward to get our SAS offerings hosted in that environment, it gives us an opportunity to actually bring our operating costs down we think from our model today, rather than see an incremental cost.

So we think there are advantages in the operating model that are unique to Intuit, but we think it gives us continued opportunities to drive operating margins, even as we grow in SAS revenue.

Kash Rangan – Merrill Lynch

Thank you very much.

Brad Smith

You're welcome.

Operator

Our next question comes from Sasa Zorovic of Janney.

Sasa Zorovic – Janney

Yes. Firstly, what was the revenue that you generated from Mint.com? Has it been material, can you break that out for us?

Brad Smith

Yes. Sasa, we haven't broken out the revenue for Mint.com and it's not material. However, we do see it, not only as a future opportunity to accelerate growth in that segment, but it's technology capabilities and its algorithms, the way to save engine are going to be key growth catalysts for not only Quicken, but also for TurboTax and our small business franchise. So today it's a very immaterial revenue number, but it is moving in the right direction and we like the progress of the business overall.

Sasa Zorovic – Janney

Thank you. And then secondly, on QuickBooks, if you had to apportion sort of the strength in the segment there on execution versus the environment, how would – that would be difficult to quantify really, but how should we sort of think about that?

Brad Smith

Yeah. That is hard to quantify. We're not getting a lot of help today from the external environment. What we are doing is we've gotten much wiser at how deep we want to promote and discount our products, which we'll start to get a real value for the price. So you see our ASP and our revenue per customer going up, although our units are down year-over-year.

The other thing I really like about that segment is you're starting to see strong growth in QuickBooks online, which continues to accelerate, but you also see a strong growth rate continuing in the QuickBooks enterprise product, our up market product. And so net-net, I would say the majority of it was execution and just a better understanding of how deep we need to go to get customers in. And as the economy comes back and new businesses really start to form at a faster rate and that will detail in for us.

Sasa Zorovic – Janney

Thank you.

Brad Smith

Thank you.

Operator

Our next question comes from Scott Schneeberger of Oppenheimer.

Scott Schneeberger – Oppenheimer

Thanks, good afternoon, nice work. First question, focusing on TurboTax, Brad, you mentioned you think that filings with the IRS are down thus far. What indication do you have of that and when do you anticipate an update from the IRS?

Brad Smith

Yeah. Our only indication that we can get at or we have internal capabilities, we have our Pro tax business, the accounting professionals division, then we have TurboTax. And we're a pretty decent majority of the IRS tax filings. And then we also do external research. We do poll surveys, not only of our customers, but of tax filers overall and we basically ask them if they filed their taxes yet and we compare that to studies we did last year.

And that indication lets us know that at least year to date, our internal research would suggest that it's down a few points over where it was this time last year. And so the IRS producing their report and they don't necessarily announce a particular date. And it comes out at different times each year and so we'll have to wait and see when they publish their information. So this is all based upon our own internal research right now.

Scott Schneeberger – Oppenheimer

Thanks. Where do you think market share is coming from overall? Obviously, you're seeing some strong volume growth. Is it coming out of store front, if IRS is net down?

Brad Smith

Yeah. We believe today, based upon the data that we have, that it's coming from two areas. It's coming from tax stores and it's also coming from the all other competitors, the smaller competitors online. And we think those have been the two biggest sources of our market share advantage so far this year online.

Scott Schneeberger – Oppenheimer

Thanks. Two more quick ones on, tax if I could. Desktop, you obviously taking some nice share, do you have any explanation for why? Is it – are you seeing more, more locations than your main competitor at retail? Or is it just, it's just consumers picking you side by side? Any – just facing or anything different?

Brad Smith

I would boil it down to execution. If you go in the retail stores our team has a very focused approach to making sure that we have best position in all the stores and that we have a well merchandised display. And so there really isn't anything materially different year-over-year in terms of distribution, it just comes down to execution. And so no, I can't pin it down anything other than that.

Scott Schneeberger – Oppenheimer

Thanks. And then finally, you mentioned the revenue per consumer tax user in improvement. And you've chalked it up a bit to mix and a bit to conversion from free. Could you give us a feel for, which of those was stronger and perhaps why?

Neil Williams

Scott, this is Neil. At this point, it's still too early for us to grow any firm conclusions from that, we're watching it carefully. But it's too early for us to really draw any conclusions or make any comments about that.

Scott Schneeberger – Oppenheimer

Okay. Fair enough. Thanks, guys.

Brad Smith

Thank you.

Operator

Our next question comes from Michael Millman of Millman Research.

Michael Millman – Millman Research

Thank you. Continuing on the tax questions, can you tell us what your plans are for RTs next year, considering that the looks like the banks are being prohibited from offering some of these products?

Brad Smith

Yeah, Michael. Thanks for the question. Let me separate something first. There's refund anticipation loans and then there's the RT or the refund transfer. As you know, we're not in the refund anticipation loan business or the RAL business. And that's the business under a tremendous amount of scrutiny and heat right now. It's a business we felt about five years ago was not one we wanted to be in because we anticipated this being the potential outcome. So we don't have that sort of risk that others may have in the industry.

In terms of RT, we continue to see customers valuing the ability to take a portion of their tax refund and then use that to pay for their tax software, that's what the refund transfer is. And we continue to see that as a value proposition that makes sense. It's doing well in the market. We have no issues in terms of having that service provided and so no change to our current thinking right now in terms of RT.

Michael Millman – Millman Research

Okay. So related to that, while block really hasn't seemingly yet used their RT capability to full extent, what are your plans if they start to be more aggressive in using their own bank?

Brad Smith

The same plans, Michael. That we would probably use every day, try to make sure that our product is easier to use and perceived as a better value. And just continue to out compete in the market place. I think the more awareness there is around RT, the better it is for the category overall because it's still one of those services that isn't completely understood. And so if block or anyone else got more aggressive, I think that's only good and it would be up to us to make sure we're better at executing so that the customer chooses us over them.

Michael Millman – Millman Research

Thank you.

Brad Smith

Thank you.

Operator

Our next question comes from Brad Zelnick of Macquarie.

Brad Zelnick – Macquarie

Hi, nice job guys. And thanks for taking the question. Most of my questions have actually been asked, but I guess I've got one. You mentioned that you more than doubled the Homestead base from when you acquired the company. I was hoping you maybe could talk a little bit about the white space there. Are there any metrics on the number of customers that are actually using other products, payment, payroll and maybe even quantify what the opportunity is there?

Brad Smith

Yeah. Thanks, Brad. It's a business that we're excited about as a new front door and why we say that is because we learned that when a small business is getting started the first thing they have to do is get found and get customers and then they worry about what they are going to record in their accounting software. And it's proven to be true. That's why we've been able to put some marketing muscle behind it with the Intuit brand and you've seen us running TV ads. And we've been growing that customer base pretty aggressively.

The better news is, we've been testing what are the right products to attach to a website and while it's still early in the game things like email marketing and things like accepting electronic payments and credit cards are two very promising attach opportunities. So in terms of quantifying how big it could be, it's one of those front doors that will ultimately have other services attached to it but I would tell you we're excited enough about it that we're continuing to advertise it on TV. And about everywhere you turn, if it's not a TurboTax ad you see, it's an Intuit website ad you see and that pretty much gives you how much confidence we have.

Brad Zelnick – Macquarie

Thanks. Brad and if I just ask one more as I reflect on the strength in desktop tax units. In my recent trip to Costco with my family, I saw many smiling customers walking out the door holding TurboTax but also as I look up to the shelves, there are huge, exciting pallets of your product. And just as I think about inventory management and the visibility that you have out there to the stores, can you comment at all about what visibility you might have and what it looks like relative to what it might have been in the past? Thank you so much.

Brad Smith

Yeah. Thank you, Brad.

Neil Williams

Brad, this is Neil. We worked on that a lot in the last couple years. We work with the large suppliers very closely. This is clearly an area that's a big opportunity for us and the stores have gotten much better on this, too. Clearly they are controlling their inventory costs and they want to have items in the store that they know they are going to sell in a quick period of time.

So when you see those large pallets in Costco, you can assume there's a pretty tight correlation between their prediction of how many they are going to sell and how many we have on the floor. So we watch that carefully but I don't see that as a big risk for us.

Operator

Our next question comes from Ross MacMillan of Jefferies.

Ross MacMillan – Jefferies

Yeah. Thanks. A lot of mine have been asked as well but may be just to reflect on TurboTax. What's interesting is desktop units declined a lot less, almost flat actually year-over-year which is a much better performance than this time last year and the web units grew nicely but obviously at a much lower clip, 23% versus 39%.

So what that tells me is that there's actually been almost like less of an impact on the desktop this year relative to web. Can you just talk to that just qualitatively? That would be helpful. Thanks.

Brad Smith

Yeah. Sure, Ross. So I would say and we would say that the trends will continue to shift online. That's where the future game is going. Even with the numbers you cited, the online category growing 23% over a pretty healthy clip this time last year and then the desktop, just slow, just eroding less slowly. So instead of being down several digits, it's down one digit this year. I think that's an indication that the game is going online. What I believe and what we believe so far that we've seen is just really good execution at retail.

And last year there was a little bit of confusion in the market because we made a change to how many e-file returns would be included in desktop. H&R Block made a change and those value propositions were trying to get clearly communicated in the market and that probably played a little bit into what happened last year and this year those messages are a lot cleaner and tighter. But net-net, I wouldn't read anything into whether we think if it's going to shift back to desktop. We do see this game going to the web and it's only going to continue to do so.

Ross MacMillan – Jefferies

Makes a lot of sense. That's it for me. Thank you.

Brad Smith

Great. Thank you, Ross.

Operator

Our final question comes from Brad Sills of Barclays Capital.

Brad Sills – Barclays Capital

Hey, guys. Thanks for taking my question. Most of my questions have been answered as well. But just a question on payroll and payments businesses. You mentioned QuickBooks units rebounding here. How much of the strength in that business do you attribute to just better attach to new units versus up-sell, cross sell into the existing install base?

Brad Smith

Yes. So I'll start with the payments business. It has single-digit penetration into our QuickBooks space. And so we have a lot of opportunity to continue to sell to existing QuickBooks users, as well as capture new users. Now, we do believe that the better opportunity to get them to buy an additional service is earlier in the relationship with us, call it the first few years.

There's still all kinds of opportunity for us to go against customers that have been using QuickBooks for a lot of years. On payroll, the growth you see there is not only continuing to sell into the QuickBooks space, which we still have opportunity to do but it's also the ability now to get non-QuickBooks customers to come in for our online payroll offering, which was previously known as PayCycle and so we have a lot of opportunity there as well. But net-net, it is just better penetration into the QuickBooks base for payment and for payroll, it is the QuickBooks space, plus the new online payroll offering going against non-QuickBooks customers.

Brad Sills – Barclays Capital

Great. And one last question, if I may, on the share gains you mentioned for tax. How much of that would you attribute to macro versus actions you took, whether it's advertising or promotion?

Brad Smith

And when you say macro, just you talk about the economic environment or you talk about general trend online?

Brad Sills – Barclays Capital

Yes. Just the general consumer, state of the consumer year-over-year, this tax season versus last tax season?

Brad Smith

Yes. I would tell you, I think that the tax category has been pretty competitive for quite a few years and it's been shifting online for as many years as well. I think it comes down to better execution and an easier to use product that people will then start talking about positively in the market. We have a lot of advertising out there. Our competitors do as well. If you go on the web, you'll see TurboTax ads pretty much on all the major websites and search engines.

But then after that, you have to go to the user reviews and see what customers are saying. And TurboTax continues to have a very positive word of mouth and that helps accelerate our growth rate. So I think it comes down to having a good quality product and having a good execution behind our advertising and marketing.

Brad Sills – Barclays Capital

Great. Thanks very much.

Brad Smith

Great. Thank you.

Operator

Gentlemen, that's all we have time for today. I'll turn the call back over to you for any final comments.

Brad Smith

Great. Thank you, Patty. And we want to thank everybody, again, for joining us and thanks for the great questions. We clearly feel good about our performance in the second quarter. From our view, this is our second raise in guidance for the year. In the first quarter, we saw the opportunity to go ahead and absorb the dilution from our IRES divestiture and our acquisition of Mint and that was in the neighborhood of 4 to $0.05.

And in this particular quarter, obviously we continue to feel good about our execution, so we've taken it up another $0.08. And so net-net, we're feeling good about the year and we're looking forward to talking to you again in another quarter. Take care, everybody.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference call. This concludes the call.

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Source: Intuit, Inc. F2Q10 (Qtr End 01/31/10) Earnings Call Transcript
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