Fair Isaac's CEO Discusses Q2 2014 Results - Earnings Call Transcript

Apr.24.14 | About: Fair Isaac (FICO)

Fair Isaac Corporation (NYSE:FICO)

Q2 2014 Earnings Conference Call

April 24, 2014 17:00 ET

Executives

Steve Weber - VP, Investor Relations and Treasurer

Will Lansing - CEO, President

Mike Pung - CFO, EVP

Analysts

Manav Patnaik - Barclays

Bill Warmington - Wells Fargo

Brett Huff - Stephens, Inc.

Matthew Galinko - Sidoti

Operator

Good afternoon. My name is Tanya, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Quarterly Earnings 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.

Steve Weber, you may begin your conference.

Steve Weber

Thank you, Tanya. Good afternoon and thank you for joining FICO's Second Quarter Earnings Call. I'm Steve Weber, Vice President of Investor Relations, and I'm joined today by our CEO, Will Lansing; and our CFO, Mike Pung. Today, we issued a press release that describes financial results compared to the prior year. On this call, management will also discuss results in comparison to the prior quarter in order to facilitate an understanding of the run rate of our business.

Certain statements made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve many uncertainties that could cause actual results to differ materially. Information concerning these uncertainties is contained in the company's filings with the SEC, in particular, in the Risk Factors and Forward-looking Statements portions of such filings. Copies are available from the SEC, from the FICO Web site or from our Investor Relations team.

This call will also include statements regarding certain non-GAAP financial measures. Please refer to the company's earnings release and Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measure. The earnings release and Regulation G schedule are available on the Investor Relations page of the company's Web site at fico.com or on the SEC's Web site at sec.gov. A replay of this webcast will be available through April 24, 2015.

Now I'll turn the call over to Will Lansing.

Will Lansing

Thanks Steve. Today we announced the results for our second quarter of fiscal 2014. I will briefly recap those results, talk about the progress we are making with the FICO analytics cloud and discuss some important recent announcements we have made.

In our second quarter, we reported revenues of $185 million, an increase of 3% over the same period last year. On a GAAP basis, we delivered $21 million of net income and earnings of $0.59 per share for the quarter versus $18 million and $0.51 per share from the same period last year.

We delivered $29 million of non-GAAP net income and non-GAAP EPS of $0.81 per share increases of 13% and 17% respectively from the same period last year. We had a very good bookings quarter delivering $109 million of new deals, the highest single quarter's since 2011.

Mike will provide more detail on the numbers. But first, I will discuss some of the things we have been working on.

We continue to make progress with the FICO analytics cloud. We signed several deals this quarter that will begin contributing recurring revenues in the next few quarters. These deals involve customers that required SaaS delivery, opportunities that we previously could not have competed for. Though, we are in early stage of rollout, we have already signed about $10 million of future SaaS revenue.

In March, we announced the acquisition of InfoCentricity, a private software-as-a-service based predictive analytics company. With this acquisition, we are able to put the most sophisticated cloud-based analytics modeling tools into the hands of the entire spectrum of users, from first time modelers and seasoned business analysts up through advanced data scientists and the most demanding analytics professionals. FICO now has the industries broadest offering for predictive analytics modeling available in the cloud and on premise.

We also announced last week that we have acquired technology from Karmasphere that will significantly broaden our big data capabilities while increasing the market appeal from the FICO analytics cloud. Karmasphere is a self-serviced product for analyzing data on Hadoop. In the world of big data analytics, easy-of-use is critical because one of the biggest impediments to the wide-scale adoption of big data analytics is the complexity of using Hadoop to discover and apply business insight from various types and sizes of data sets.

This is why you hear so much about big data being over hyped. The fact is that the potential big data is quite real, but the number of experts who are capable of performing Hadoop analytics is tiny compared to the demand.

Now, with the integration of Karmasphere's collaborative, intuitive and self-service application into the FICO analytic cloud entire teams of analysts and business users will find it possible to transform their businesses using big data on Hadoop. So essentially, while this transaction was small, the implications are big. FICO is simplifying the complexity of Hadoop and putting the power of big data analytics into the hands of all the people who can really use it.

Neither InfoCentricity nor Karmasphere will have a material impact on our fiscal 2014 financial results. Yet, they are both important building blocks for the FICO analytics cloud and will enable more rapid adoption by a wider array of customers.

We also announced important new program in our sports business, FICO Custom Credit Education. You recall last year, we introduced the FICO Open Access program, which allowed any lender to share the FICO's score with their customers at no additional cost. That program has taken off and this new companion program goes a step further.

Lenders can now purchase the entire portfolio of valuable FICO tools and content. With FICO Custom Credit Education lenders can provide their customers with their richest set of tools in the marketplace to improve their financial literacy. Tools like the FICO Score Simulator, Personalized Credit Analysis and Comparisons to FICO's Score High Achievers and FICO Score monitoring and alerts. Early response from lenders has been extremely positive and we are currently in discussions with numerous large institutions to deliver either Open Access, Custom Credit Education or both.

We also announced that we will release FICO Score 9, the next version of the FICO Score beginning this summer. With this latest version, we have devised an innovative approach to developing FICO 9 Score that enables us to leapfrog our own industry standard benchmark. FICO Score 9 will be the first release in the suite that updated a new FICO Scores. It will be followed by industry-specific FICO Scores for credit cards, auto loans and mortgages. Future scores in the suite will build on FICO's deep expertise and analyzing on broad spectrum of data types as well as the keen understanding of client needs.

These scores will be developed to reliably access the credit worthiness of even more people. Taken together these initiatives are examples of what we are doing to realize FICO's potential. I continue to believe that FICO has a strong portfolio of products and loyal customers by making very selective investments in innovation such as these; we can give an additional boost to our growth trajectory.

I will now turn the call over to Mike for further financial details.

Mike Pung

Thank you, Will, and good afternoon, everyone.

Today I will emphasize three points in my prepared comments. First our revenue this quarter was $185 million, a 3% increase from last year. Our scores business grew 9%, our tools business grew 22% and our applications business was down about 1% from the prior year.

Second, we delivered $21 million of GAAP net income and $29 million of non-GAAP net income. Our free cash flow was $44 million for the quarter. Finally, we repurchased about $40 million of stock this quarter which exhausted our previous $150 million authorization and announced today Board approval for a new $150 million authorization.

I will break the revenues down into three reporting segments. Starting with applications, revenues were $116 million down 1% versus the same period last year and up 3% versus last quarter. We delivered growth in collections and recovery up 22% from the same period last year, in mobility up 20% and in originations up 12%. These gains were offset by fraud banking revenues, which were down from the same period last year due to lower license sales.

While total applications revenue were down slightly versus last year, we did have much higher bookings in that segment. The $79 million dollars of bookings this quarter is up 18% over last year and is the largest quarter for applications bookings we have done in the last 10 quarters.

In the tool segment, revenues were $22 million up 22% versus the prior year. The growth this quarter is driven by models and optimization tools. We also had a good bookings quarter and tools up from the prior quarter and up 123% from the same quarter last year.

And finally, our score segment continues to perform well. Revenues were $48 million up 9% from the same period last year and up 1% from last quarter. On the B2C side, we were up 11% versus the same period a year ago and up 8% versus last quarter.

The B2B revenues were up 8% from the same quarter last year largely due to a royalty true-up and down 1% compared with last quarter when we had a large global FICO score deal.

Looking at our revenues by region, this quarter 72% of total revenues were derived from our Americas region, our EMEA region generated 20% and the remaining 8% was from Asia Pacific.

Recurring revenues derived from transactional and maintenance sources for the quarter represented 71% of total revenues. Consulting and implementation revenues were 19% of total and licensed revenues were 10% of total revenue.

Turning now to bookings, we generated $21 million of current period revenues on bookings of $109 million 20% yield. The weighted average term for our bookings was 28 months this quarter. Of the $109 million in bookings 18% relates to collections and recovery, 15% to marketing solutions, 14% to banking fraud solutions and 10% to origination solutions.

We had 21 booking deals in excess of $1 million, 9 of which exceeded $3 million. Transactional and maintenance bookings were 34% of total this quarter, professional services bookings were 38% of total and finally licensed bookings were 28% in the quarter.

Turning to expenses, operating expenses totaled $147 million this quarter compared to $149 million in the prior quarter down $2 million. We expect operating expenses to increase modestly over the next several quarters. As you can see in our Reg G schedule, non-GAAP operating margin was 27% for the second quarter unchanged from last quarter.

GAAP net income, this quarter was $21 million versus $17 million in the prior quarter. Non-GAAP net income was $29 million versus $26 million in the prior quarter. The effective tax rate was about 33.7% this quarter. We expect the effective rate to continue to be 34% to 36% for the full year unless the R&D credit is reinstated before the end of the year.

The free cash flow for the quarter was $44 million or 24% of revenue compared to $31 million or 18% of revenues in the prior year. Fiscal year-to-date, we delivered $69 million of free cash flow compared with $50 million in the first two quarters of last year.

Moving on to the balance sheet, we have $108 million in cash on the balance sheet. This is up $12 million from last quarter due to increases in cash generated from operations offset by our share repurchases. Our total debt is $483 million with a weighted average interest rate of 5.7%. We now have $28 million balance on our $200 million revolving credit facility.

The ratio of our total net debt to adjusted EBITDA is 1.9x below the covenant level of 3x and our total fixed charge coverage ratio is at 4.9x well above the covenant level of 2.5x. During the quarter, we returned $40 million in excess cash to our investors, repurchasing about 750,000 shares at an average price of $53.40.

These repurchases exhausted the $150 million that the Board authorized in August of 2012. Today, we announced the Board has authorized a new $150 million stock repurchase program. We continue to view share repurchases as an attractive use of cash. We also evaluate opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio on competitive position.

Finally, I would like to review and reaffirm our full year guidance. As a reminder, for fiscal 2014, we guided revenues between $763 million and $773 million. GAAP net income between $91 million and $94 million; GAAP earnings per share between $2.50 to $2.60; non-GAAP net income between $125 million to $128 million; and non-GAAP EPS of $3.46 to $3.56 per share.

Two quarters into our fiscal year, we are not yet half a way to our guided revenues numbers. So a natural question maybe, what do we expect will change in the back half to get to our numbers? We do remain confident. And our confidence stems from revenue flows on deals that we have already signed along with additional matured deals in our pipeline.

So let me provide you a bridge to our revenue guidance range. We reported $370 million of revenue in the first half of this year. So to achieve our guidance range, we need to repeat the first half plus an additional $23 million of revenue. Approximately $15 million of this additional revenue will waterfall from deals we have already signed with our customers. These include services revenue we expect to earn related to recent bookings.

And in addition, we will be claiming revenue on previously sold annual term licenses in the next two quarters. The remaining $8 million of additional revenue is consistent with what we have historically seen in the back of our year. This revenue comes from both license sales and associated services generated from matured deals we see in our pipeline and expect to sign in the back half of the year.

As always, we will exercise discipline at controlling costs and we will remain highly focused on producing strong cash flow.

With that, I will turn the call back to Steve for Q&A.

Steve Weber

Thanks Mike. This concludes our prepared remarks and we're ready now to take any questions. Tanya, please open the lines.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Manav Patnaik from Barclays. Your line is open.

Manav Patnaik - Barclays

Hey, good evening gentlemen. I have a quick question in terms of looking at the M&A strategy and how that's evolved, Will, you have obviously, worked at this now for two years you have made a lot of good sort of tuck-in technology type deals. I was just wondering what the appetite is to do something a little more significant a game changing and just sort of make a bigger impact in terms of diversifying the company and how you think of it with respect to that.

Will Lansing

Yes. Good question. I would say that our M&A strategy has not changed dramatically. I think you will see us continue to do technology tuck-ins as appropriate where we find pockets of talent in technology and IP that are really synergistic of what we are doing especially around decision management platform and pipeline over the cloud. But, I wouldn't confine it just to those areas.

And at the same time, we are always on the look out for bigger, more game changing acquisitions. That said, we remain as conservative as we have always been in terms of evaluating those kinds of acquisitions. And that's not to say we wouldn't do one but it have to meet a pretty high hurdle. We have to be very confident that it's going to advance our business in a pretty material way. And certainly for us to take any dilution, we have to have very high expectations for the return that we will get.

As always we evaluate everything against the alternative of buying back own shares and because we are so confident in the brightness of our future that's a high hurdle too. So we absolutely look at bigger deals all the time. I mean its very much within our scope and it remains to be seem whether we are going to build one or not, but we are always looking.

Manav Patnaik - Barclays

Okay. Fair enough. And just on the scores business maybe can we get a quick update on sort of what the mix there in terms of looking at the different end markets like credit cards, autos and so forth. And are there any early signs that you guys maybe picking up with the economy improving that could be sort of an early read on – if that can start gaining some real good momentum there?

Mike Pung

Sure Manav. So this is Mike. We had a very – once again a pretty solid quarter across our scores business on both the consumer and on the B2B side. As it relates to the mix of our business, any comparison to last year, we saw our marketing or acquisitions scores grow pretty dramatically. The volume grew from last year roughly 20% volume. Much of that volume was coming from the card side of the business. The bank card as opposed to last year, our business was more driven from originations in new mortgages.

So the increase on the acquisition side on cards were about to offset by the decline in the mortgage refinancing and on the origination side – we saw – we look at our business. So one great solid quarter. And time will tell us if those acquisition scores ultimately originate and open up new accounts.

Manav Patnaik - Barclays

Okay. Fair enough. All right. That's all I have. Thank you.

Operator

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

Bill Warmington - Wells Fargo

Good afternoon, everyone.

Will Lansing

Hey, Bill.

Bill Warmington - Wells Fargo

I have a couple of questions for you. The first if you could talk a little bit about what's behind the strength in application in terms of what's changed, why now you are seeing this sudden surge on the application side?

Will Lansing

Yes. So over the past three, four quarters now we have had a very long cycle for getting deals completed mainly in the U.S. banks and then the U.S. markets. Some of the deals that have been held up in the sales cycle since last year are starting to sign. And we are starting to see of that in the form of bookings and some of that as part of the revenue that we reported this quarter.

But, that cycle is kind of continuing to push. So we have seen a little bit of that backlog come through. We're also seeing some very nice strong services deals for companies that are upgrading to our current version of a product. And so generally, when a company upgrades to a current version, they get that version through the maintenance they have been paying and they hire us to come in and help install, and implement. And so we have a fairly healthy backlog of implementation service that's embedded in part of these deals.

Bill Warmington - Wells Fargo

Okay. And then I wanted to ask about how quickly you plan to implement this buy back?

Will Lansing

How quickly that we plan to implement it?

Bill Warmington - Wells Fargo

Implement the buyback, just something where you just going to basically match it to cash flow quarter-by-quarter, or is it something you will take on from additional leverage to accelerate?

Mike Pung

We generally are sitting with the pretty decent position of cash on the balance sheet and we also obviously have access to take on a little leverage on the line of credit. We took a little bit last quarter.

The buyback program itself, we are just – we are quite regular buyers of the program and so the rate and pace that we have been buying the past is all depending upon alternative cash needs. So I wouldn't say there is a time we are going to turn it on and turn it off. It's just an ongoing program for us and we just assess it with the cash flow in the near term and other alternative uses for.

Bill Warmington - Wells Fargo

Okay. And then I had a question for about FICO 9, and why switch to FICO 9 now, what drives the adoption?

Will Lansing

Well, we are constantly looking at improving on the technology that we have out in the marketplace. And just as FICO 8 replaced the scores that preceded that, we have the next generation of scores coming. This has been in the works actually for several years and so why now, I mean why not now. It is a regular thing for us to move generationally from one score to the next and we do it with tremendous caution because FICO 8 obviously has very wide spread adoption that we want to do in a way that's not disruptive to the marketplace.

But there is – the beauty of the way we are going at it is – that it is both backwards compatible for people who have FICO 8 in place. And there are opportunities for more kinds of customization for our bank customers who want to do other things that they weren't able to do before.

Bill Warmington - Wells Fargo

Okay. And then a final question for you on the score side of the business in terms of the demand that you are seeing for scores for pre-screening for banks and credit card use. How are you finding the banks appetite at this point, as it started, are you starting to see a lift there, it sounded with a pick up in volume that you referenced, answer that would be yes, but I wanted to just ask that.

Will Lansing

The answer to that is yes.

Bill Warmington - Wells Fargo

Okay. Well, thank you very much.

Mike Pung

Thanks Bill. Thanks.

Operator

(Operator Instructions) Your next one comes from Brett Huff from Stephens, Inc. Your line is open.

Brett Huff - Stephens, Inc.

Good afternoon. Thanks for taking my questions.

Will Lansing

Hi, Brett.

Brett Huff - Stephens, Inc.

One follow-up on the applications question that was asked earlier, did you – I didn't – I'm not sure if I heard it in the prepared comments that if you broke down which of the applications are providing some of that growth, which of the deals or what variety of deals are coming through. And I guess, my question is both which product and what's the delivery mechanism, is it typically license or some other deals I know you have been developing some SaaS versions of those products. Can you give us – just characterize that for us?

Mike Pung

Let me walk you through that from my portion of the script here. This is Mike. So the growth on the application side came through first collections and recovery which is our Debt Manager 9 product. And all the versions of Debt Manager that are out in the marketplace, those are typically licensed revenues, so the term license is signed and we claim it up front. We were up 22% from the prior year.

The second area of strength on the application side was in mobility, which is what we gained when we acquired Adeptra, little over a year-and-a-half ago. Mobility is a ratable model. And its all subscription based. So first shows up in the booking and then once live it shows up in an ongoing revenue stream that we call transactional. That was up 20% over the prior year.

And finally, origination, our Originations Manager product, which was up 12% over the prior year. The originations product is also generally more of a licensed based term, licensed based product. Though the SaaS revenues that Will was describing which are going to yield future revenue to us are going to come in a ratable model. Did that help?

Brett Huff - Stephens, Inc.

That's helpful. Yes. That's great. Thank you.

Mike Pung

Okay.

Brett Huff - Stephens, Inc.

And then just kind of a follow up question to the SaaS question, I know you developed various SaaS versions of some of the products you have developed – some of them developed, some of them. Can you give us just a status update of where are we are on that, what any more in or how do you want to characterize it to us that's a big part of the story for FICO right now. I want to just get an update on that.

Will Lansing

I don't know exactly what anything you call it, the products are there. They have been made available as services and we are just starting to sell them now. The market is increasingly interested in it maybe faster than we even expect it. And we have done our first few SaaS deals where we literally took the functionality that we had in the non-premise application like Originations Manager 4 and have it in the marketplace now and deals done in – on a SaaS basis with Origination Manager 4.5. That would be an example. But, we have that across the board.

Brett Huff - Stephens, Inc.

It's helpful. And then, last question for me is, the scores business any commentary on pricing or competition or any update on that front?

Will Lansing

We have to earn our wins everyday in that business. We don't take anything for granted. The appetite of our customer base for Open Access seems to be very large. And although that's not a lot of revenue that comes from Open Access, it really does help us with cementing the franchise. And we hope that the strong position in Open Access leads to additional revenue in programs like our education program – the credit education program.

Brett Huff - Stephens, Inc.

Okay. That's what I needed. Appreciate your time. Thank you.

Operator

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

Matthew Galinko - Sidoti

Hey, thanks for taking my question.

Will Lansing

Hi, Matt.

Matthew Galinko - Sidoti

So, is there any revenue from the customer credit education program built into your fiscal 2014 guidance?

Will Lansing

No. There is not.

Matthew Galinko - Sidoti

Okay. Thanks. And then, any color you can provide around just the length in the bookings term?

Will Lansing

The length, is what you said?

Matthew Galinko - Sidoti

Yes. The length in bookings term?

Will Lansing

Oh, sorry. I didn't hear you. Yes. Normally our bookings term is usually 23 or 24 months quarter-after-quarter, little bit longer 28 months this quarter. I won't necessarily read into any about it other than we have a couple of our large deals we did 9 deals over $3 million. A couple of them have 36 and 48 month terms to it. One in particular has a four term but that was a larger deal. And so that skews a little bit of the pie.

Matthew Galinko - Sidoti

Got it. Thanks.

Operator

(Operator Instructions) There are no further questions at this time. I turn the call back over to the presenters.

Steve Weber

Thank you, Tanya. This concludes our call for the quarter. Thank you all for joining.

Operator

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

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