Fair Isaac Corporation F3Q10 (Qtr End 06/30/10) Earnings Call Transcript

Jul.28.10 | About: Fair Isaac (FIC)

Fair Isaac Corporation (FIC) F3Q10 (Qtr End 06/30/10) Earnings Call Transcript July 28, 2010 5:00 PM ET

Executives

Mike Pung – VP, Finance & IR

Mark Greene – CEO

Tom Bradley – EVP & CFO

Analysts

Carter Malloy – Stephens

Michael Nemeroff – Wedbush

Mike Latimore – Northland Capital

Operator

Good afternoon. My name is Simon and I will be your conference operator today. At this time, I would like to welcome everyone to the FICO third quarter 2010 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. Pung, you may begin your conference.

Mike Pung

Thank you, Simon. Good afternoon and thank you for joining FICO's third quarter earnings call. I am Mike Pung, Vice President of Finance and Investor Relations. And I'm joined today by CEO, Mark Greene, and CFO, Tom Bradley. You will find on the Investor Relations portion of the FICO website, a copy of our press release, our Reg G disclosure schedule, and our financial highlights. While our press release describes financial results compared to the prior year, today management will discuss results in comparison to our 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 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. 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. Also a replay of this web cast will be available through August 28.

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

Mark Greene

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

For the third quarter of fiscal 2010, revenue was $155 million, up 8% from the prior quarter. Bookings, one indicator of future revenue, totaled $64 million, up 17% sequentially. We see continued signs of stability across our markets, and are pleased to report solid performance across all three business segments. In addition, we have made good progress in improving our sales execution from last quarter with our previously announced new sales leadership team now firmly in place.

Revenue in the applications, tools and scores segments were all up sequentially returning to a level that is comparable to what we observed at the beginning of the year. GAAP earnings per share in the quarter were $0.40, up both sequentially and year-over-year, driven by a combination of increased revenues, expense management and share repurchases.

Let me now break out the quarterly performance according to the three segments of our decision management portfolio. First, the applications segment consists of business software used by clients to help make smarter decisions over a customer life cycle. Revenue from these applications was $91 million in the quarter, up 5% sequentially. We saw improved performance across most of our applications with impressive results from our fraud and collections and recovery products.

In fraud, we signed a large multi-year deal for our Insurance Fraud Manager, or IFM, with a leading healthcare IT provider. This is the second such deal this year for IFM, following a similar partnership announced last quarter with Emdeon, a leading provider of health care revenue and payment cycle management solutions. We also saw continued success with our banking fraud management product, Falcon, with a significant booking in Europe.

In the collections and recovery area, we released Debt Manager Version 8 in June. This updated version of Debt Manager delivers business functionality that is unmatched in the industry, setting a new standard for collections and recovery. It is a clear example of our decision management strategy, enabling connected decisions on a unified architecture. In the few weeks since its release, we have already sold DM 8 to two large banking customers.

Turning now to the scores segment, scores consists of predictive analytics that are used to assess risk. Revenue in this core segment was $47 million, up 9% from the prior quarter. This segment has two components, B2B scores, which are those that we sell to financial institutions and B2C scores, which we sell to consumers at myfico.com. B2B scores revenue was up 11% sequentially, aided by a (inaudible) of several million dollars in credit bureau royalties. We had two updates in the B2B arena. First, we saw slight volume increases in acquisition and origination scores this quarter, but a corresponding decline in account management volumes.

The overall volume picture is mixed as consumer lending remains temperate. Though many banks began credit card marketing programs earlier this year, consumer response rates have been low. We anticipate the pace will remain sluggish, until we see improvement in the US economy, especially in unemployment. Second update is that we are continuing to see increased market adoption of the latest version of the classic FICO score known as FICO 8 with over 2500 lenders now using FICO 8 as the foundation for their risk management practices. This widespread market adoption occurs as lenders see the benefit of the enhanced predictive analytics in our new score.

Many clients are now completing their validation of FICO 8, and are moving towards implementation to enhance risk management practices, and to assist in segmenting customers for cross selling opportunities. While FICO 8 adoption does not produce incremental revenue for us, it does provide market validation of our long-standing leadership in this space.

Turning to the consumer part of this scoring business, B2C score revenue grew 4% sequentially thanks to increased traffic at our myfico.com website. We have seen two sequential quarters of growth in this B2C business, and are pleased that our myFICO website has won for the second year in a row Kiplinger's Award as the best place for consumers to receive credit product and advice information.

In addition, the latest banking leader to adopt our FICO Score View service is a large private-label card issuer, which will make this service available to millions of customers. We believe that every American can benefit from a greater understanding of their FICO score, which we also make available at myfico.com, and we applaud lenders who are proactively helping their customers to understand and manage credit effectively.

The final of our three segments is our tools segment, which consists of rules management, modeling and optimization products used both in our application and sold standalone to clients looking to build their own systems. Revenue in this tools segment was $17 million during the quarter, a sequential increase of 22%, and consistent with the level achieved in our first fiscal quarter.

So to summarize results, we reported solid revenue across all three segments with continued signs of stabilization in scores. Bookings likewise improved. (inaudible) solid earnings and managed expenses wisely, while investing in critical sales and development efforts.

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

Tom Bradley

Thanks, Mark. You have already provided some revenue the results by segment. So I will provide some additional comments as they relate to other aspects of the business.

Revenue for the quarter was $155 million, up 8% compared to the prior quarter. This quarter’s 78% of the total revenue was derived from our Americas region, which includes both North and South America. Our EMEA region generated 16% of our revenue and the remaining 6% was from Asia-Pacific. All percentages are consistent with the prior quarter. Recurring revenue derived from transactional and maintenance sources for the quarter represented 75% of the total revenue, versus 79% in the prior quarter. Consulting and implementation revenues were 16% of the total versus 17% in the prior quarter, and licensed revenues were 9% of the total, versus 4% in the prior quarter.

Bookings of $64 million yielded $18 million of current period revenue, a 29% yield. This compares with bookings of $54 million and 17% yield last quarter. The weighted average term for our bookings was 28 months compared to 22 months last quarter. Of the $64 million in bookings, 18% related to our tools products and another 18% to the fraud management products. We had 12 booking deals in excess of a million dollars, of which two exceeded $3 million.

Operating expenses for the quarter were $124 million, up $4 million from the prior quarter due to increased sales commissions and incentive expenses. As you can see in our Reg G schedule, non-GAAP operating margin before amortization and stock-based compensation was 24% for the third quarter, compared to 22% last quarter.

Net income for the quarter was $18 million, up 38% from last quarter, and the effective tax rate was about 33%, consistent with the year-to-date rate.

We define free cash flow as cash flow from operations, less capital expenditures and dividends paid. The free cash flow for the quarter was $8 million or 5% of revenue, compared to $34 million or 24% of revenue in the prior quarter. Our free cash flow was diminished by an increase in accounts receivable and the payment of interest on our debt, which is made semi-annually. Year-to-date we have generated $69 million of free cash flow.

We have $261 million in cash and marketable securities on the balance sheet. This declined from $382 million last quarter due to share repurchases and debt reduction. Earlier this month, we announced the issuance of $245 million of senior notes in a private placement. These new notes have maturity ranges of 6 to 10 years with a weighted average interest rate of 5.2%. And have similar covenants to the previously issued notes.

All of the proceeds were used to pay off the existing revolving credit facility. This refinancing takes advantage of the current favorable debt market conditions, and eliminates the risk of the large revolver maturity in October of 2011. We now have a very balanced debt maturity profile with no significant maturities until fiscal 2013.

Combined with our previously issued senior notes, our total debt now stands at $520 million with a weighted average interest rate of 6.1. Compared with recent quarters, the new quarterly interest expense will increase by approximately $0.03 to $0.04 per share one a forward basis. Over the next year, we will look to opportunistically renew the $600 million revolving credit facility at a much lower level. The ratio of our total net debt to adjusted EBITDA is now 1.9 times, well below the covenant level of 3 times and our fixed charge coverage ratio is at 4.4 times, well above the covenant level of 2.5 times.

During the first quarter, we repurchased 3,604,000 shares in the open market at a total cost of $82 million or an average cost of $22.75 per share bringing our basic share count outstanding at June 30 to 42.3 million shares. Since June 30, we have repurchased an additional 570,000 shares at a total cost of $13 million or $23.33 per share. Fiscal year-to-date, we have repurchased 6,868,000 shares at a total cost of $153 million or $22.24 per share.

In June, the board of directors approved a new $250 million share repurchase program and we have $220 million remaining under that authorization. We continually evaluate the best way to deploy excess cash, to maximize shareholder value, and we expect to continue share purchases during the fourth quarter.

I'll now turn the call back to Mark.

Mark Greene

In this concluding section, I will discuss the outlook for FICO over the balance of this fiscal year. Following disappointing results in the prior quarter, it is satisfying to report that our third quarter revenues recovered to the levels we have seen earlier in the year. Looking ahead, we see growth prospects in Asia, and selectively in Europe and Latin America, but the overall macroeconomic picture remains mixed.

We are cautious about the US as high unemployment and depressed consumer sentiment dampened the outlook for consumer lending and thus the near term growth prospects for scores. That said, I’m confident about the longer term outlook for scores for three reasons. First, scores volume continue to grow at the front-end of the life cycle, namely in the acquisitions and originations phases. This will eventually convert into improved volumes in the account management phase as consumers sign up for and use new credit facilities.

Although this conversion may take several quarters if the economic recovery remains tepid, but we’re not sitting still waiting for this recovery. On the B2B side, we continue to drive score volumes by advancing the adoption of FICO 8 scores, and by encouraging lenders to pull scores more frequently as a prudent risk management practice. And on the consumer side, we’re sharpening our digital marketing to improve traffic attraction [ph] and conversion rates.

Second reason for optimism is that FICO scores continue to occupy a prominent place in the fabric of American commerce. I have two cases in point, one being the recent press attention paid to the latest FICO score trend figures that were issued by our FICO lab, and second, the widespread dissemination of credit scores that is called for in the recently passed Wall Street Reform And Consumer Protection Act.

We maintain our thought leadership efforts to underscore the relevance and value of FICO score solutions in areas such as credit line management and mortgage loan loss mitigation. And thirdly, we are growing our talent pool in the scores business. We announced today the appointment of Jordan Graham as Executive Vice President of Scores and President of FICO Consumer Services.

Jordan is a veteran financial technology executive with experience both in consumer markets, as the former CEO of Match.com and in B2B commerce, including senior roles at Cisco, Sun Microsystems, and most recently as managing director in Citigroup’s global transaction services unit. Jordan will build on our scores team’s turnaround with the aim of placing that business on a sharper growth trajectory, particularly pursuing the growth opportunities that we see in our consumer business.

I am similarly pleased with the progress being made in our sales execution, an effort being led by Charles Ill, who joined us in February as the EVP for Sales and Marketing. Charlie has moved quickly to retool our sales leadership in the Americas and Asia Pacific, and he has strengthened our sales management systems and disciplines across the globe. The early results are encouraging. I expect Charlie’s efforts to continue to bear fruit in the quarters ahead.

This brings me finally to guidance. We are now in the midst of our fiscal fourth quarter, and we remain on track to achieve high single digit percentage growth in earnings per share this fiscal year compared to last, chiefly as a result of previously completed stock repurchases and cost controls.

With that I think we’re ready for the question-and-answer period. Mike.

Mike Pung

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Carter Malloy with Stephens. Your line is open.

Carter Malloy – Stephens

Hi, guys. Congratulations on the quarter. Looking at back to myFICO piece of the business, Mark you said how much it grew earlier, and I’m sorry I missed that, can you give us that and also what size that business is and what the specific drivers were this quarter, specifically I’m wondering if the brand or strategy change with Experion [ph] had any impact for your guys?

Mark Greene

Carter, the sequential growth in the consumer business was 4% last quarter, and that translates into about a 9% year-over-year growth. And I suspect there are a couple of reasons for this. Three come to mind, one there is heightened awareness generally in the market place for consumer scores, partially as a result of deliberations in Washington. Two, you may be right that there are some transitions from some competitive sites that may have benefited us. And three, I think we helped our own [ph] by some work we have done in recent months to improve the navigation, the traffic attraction, the conversion rates on the website. We are getting smarter about how to run that business.

Carter Malloy – Stephens

And do you expect that that where you guys are at that website now will continue or anticipate from here?

Mark Greene

We like where we’re going and the addition of this new executive, who will see both parts of this growing business, but be particularly focused on the consumer side, Jordan Graham. I think that will position us well to exploit some opportunities that we see for further growth.

Carter Malloy – Stephens

Great. And did you guys give FX for the quarter?

Tom Bradley

That is not material.

Carter Malloy – Stephens

Not material, okay. And then on Blaze, it looks like there were several larger wins this quarter, are we going to return back to a normal type run rate for that business or how should we see it?

Mark Greene

I have previously described the second quarter as hopefully the time in anomaly. I think this quarter that just ended suggests it was an anomaly, and so I think most parts of the business including the tools and Blaze are feeling like they are back on the kind of trajectory we saw earlier in the year. So, I will not make greater claims in that, but I think we had a fluke in the second quarter that we have demonstrated our ability to correct from in the third quarter.

Carter Malloy – Stephens

Absolutely, okay. And then last, I will jump back in the queue. But I’m just curious looking at Debt Manager 8; it looks like a great product. When you guys sell that – when you said you sold 2 to large bank customers I assume those were existing customers, and if so, what type of upside do you get from those sales.

Mark Greene

You know that can be high six-digit, low seven-digit type deals.

Carter Malloy – Stephens

Incremental, high six; low, seven-digit.

Mark Greene

Yes.

Carter Malloy – Stephens

Well, okay, great.

Tom Bradley

And Carter, one of the things to know about this, this is actually the second product following the Falcon product for Fraud that we have rolled out under the new architecture, and without getting too geeky, these products talk to each other. So you can now link your collection capability with your fraud detection capability, which allows you for instance to figure out the receivables. So, you are not going to be able to collect the fraudulent, you write them off, and you become more efficient doing collections as a result. And this notion of connected decisions will be expanded in the months ahead as we roll out additional products that use the same new architecture.

Carter Malloy – Stephens

And do you guys feel you are accelerating ahead of your competition in this environment, are they seeing them become more rationale, or irrational with you with them going up head-to-head?

Mark Greene

I don’t think the competitive landscape is changing that much. What is changing is that customers are looking forward to the day when they can start spending again. So we’re having a larger number of RFPs. We got pretty good pipelines from the areas that I just mentioned, and we are seeing increasing signs of market demand. We have to be cautious about how quickly that converts into actual business.

Carter Malloy – Stephens

Okay, great. Thank you.

Mark Greene

Thank you.

Operator

Your next question comes from the line of Michael Nemeroff with Wedbush. Your line is open.

Michael Nemeroff – Wedbush

Thank you. Thanks for taking my questions guys. Good afternoon.

Mark Greene

Hi.

Michael Nemeroff – Wedbush

Just a couple of, you mentioned in your prepared remarks that the scoring business, you saw a little bit of a true up on the B2B side, which drove the plus 11%, could you tell us how much that trip [ph] was, and whether that is something you expect to continue going forward.

Mark Greene

First, the nature of it. We have such trips from time to time. They are not predictable or regular, but they do occur. So, this was not an unprecedented event, and we characterize it as several million dollars. So, do I expect another several million in the current quarter? No. But I wouldn’t be surprised if there is a similar event down the road, but several million will be the way I characterize it.

Michael Nemeroff – Wedbush

Several million as in 4 million or 5 million, I am just trying to…

Tom Bradley

You are little on the high side. I would consider, I would look at it as we would like closer to flat without stuff like this.

Michael Nemeroff – Wedbush

Flat from Q1 from the original guidance.

Tom Bradley

From the prior quarter.

Michael Nemeroff – Wedbush

Okay, great. Thanks. And then, just looking at the cash flow it was a little bit lower than what I was expecting on the operating side this quarter, I was just wondering if you could tell us what you expect the free cash flow would be for the year, or just give us what you expect the operating cash flow should be in Q4?

Mark Greene

Yes, the growth this quarter off the low revenue last quarter of $12 million pretty much all in into receivables. So, we took it in on the working capital going forward. I think, we still target the fourth quarter about a $25 million range, which is close to our year-to-date actual which is at $69 million. Going back first quarter it was about 25, second quarter was 34, which actually benefited from having the low revenue, with receivables going down and we are seeing that being reversed this quarter.

Michael Nemeroff – Wedbush

I am sorry, go ahead.

Mark Greene

I would look for 25 in the fourth quarter.

Michael Nemeroff – Wedbush

And that is on the free cash side, correct?

Mark Greene

On the free cash flow.

Michael Nemeroff – Wedbush

Right. And then going forward for fiscal 2011, how should we think about the cash flow as it relates to either revenue or income?

Tom Bradley

You know, I don’t see it going up. As we grow the business, we will have working capital go into accounts receivable. We will have maybe some better guidance on that, when we come back at year-end. But I don’t see it rising moving into fiscal ’11.

Michael Nemeroff – Wedbush

Okay. And then the last question, I guess if for Mark, you know, you guys are buying back a lot of stock, you spent a lot of money over the last couple of quarters, are there any investments that you see outside of share repurchases that may drive shareholder value, maybe start to reinvest it back?

Mark Greene

So, as we prepare our plan for next year, we’re looking at two things. One is sort of organic investment in the business. We mentioned previously that we are doing some hiring, particularly in sales and service, sort of revenue generating roles, and we will see whether we can do more about or invest elsewhere organically. We are also looking at a smallish number of what I would characterize as tuck in type acquisitions. We are not of the mind to do anything large here. But where there is functionality that is better bought of the shelf than developed. So, we’re receptive to small and moderate sized acquisitions, and we’re looking to a few of those as well.

Michael Nemeroff – Wedbush

Okay, thanks for taking my…

Tom Bradley

And we will have more to say about both of those topics when we return next quarter with thinking about FY11.

Michael Nemeroff – Wedbush

Okay, great. Thank you very much guys.

Tom Bradley

Thank you.

Operator

Your next question comes from the line of Mike Latimore with Northland Capital. Your line is open.

Mike Latimore – Northland Capital

Great. Thanks a lot.

Mark Greene

Hi, Mike.

Mike Latimore – Northland Capital

Hi, good evening. On the insurance fraud manager, you said you had another deal in the healthcare space, did that rollout in a similar fashion that the way the Emdeon deal did?

Mark Greene

Yes, it will be installed at this provider and they will in essence become the distributor of this to their customers. So, there will be a lag time, while they turn around and sell it to their customers over the course of the next 12 to 18 months after installation.

Tom Bradley

General distribution model here, the business strategy if you will, is to find partners in the healthcare payment space, who have the touch points that are needed to be wired into the whole healthcare system, much like we were with credit card processors to reach end customers and banks; we are doing something similar here.

Mark Greene

Mike, I’m just going to add these, the other difference in this model is the prior version we talked about with Emdeon, we sold on a straight usage base, and with this latest deal we have done it on a license basis with some limits built into it. So it is a slightly different model, but it gives us just different ways to go to market with this product.

Mike Latimore – Northland Capital

Okay, got it. And then you mentioned that you had a couple of Debt Manager 8 wins already. Were those in June or July?

Mark Greene

One each.

Mike Latimore – Northland Capital

One each, okay. And you talked a little bit about account management, demand on the scoring side being a little bit slower, what do you attribute that to and I guess, you said in a couple of quarters, maybe you will pick up again as the closure [ph] from the other segment come in…

Mark Greene

As we discussed in prior calls, there is a sort of foreseeable linkage across the different phases of the life cycle. If you have period where you weren’t sort of finding the pump with a lot of new acquisition and origination activity, that eventually shows up as reduced account management activity, and that is what we saw in account management last quarter. On the other hand, what we are seeing now for a couple of quarters is improving front-end volumes, and those will flow through over time.

It is the famous (inaudible) analogy of – it is just a question what the delay time is, and I think things are moving a little bit more sluggishly in that pipeline today, then we sometimes have seen under more robust economic initiatives.

Mike Latimore – Northland Capital

And you know, you guys have a new product release every quarter, so when should we expect another new product release, and what category would it be in?

Mark Greene

The place that we have been working that we have indicated in the marketplace is (inaudible) in the origination space, and we are on track to have something there in the next couple of months.

Mike Latimore – Northland Capital

Great. Okay, thanks a lot.

Mark Greene

Thank you.

Operator

(Operator instructions) Your next question comes from the line of Carter Malloy with Stephens. Your line is open.

Carter Malloy – Stephens

Yes, hi guys, just returning back to the guidance, if I look sequentially taking into account the true up and especially the debt refi, the role in your guidance implies flat sequential EPS, but those two things are probably just call $0.04 to $0.06 in headwinds. Is that made up from new business in your other segments, or is it buyback, or just help me explain you guys are taking plenty of guidance?

Tom Bradley

Hi, Mike. I think your math is about right. So, we have got additional expenses mostly for the interest expense on the new debt. We have got continued tailwind from the share repurchases we have already made. So that is most of the balance between where we expect the fourth quarter to come versus the third quarter. Mark has previously indicated a revenue level more like the beginning of the year, more like we have now. This is actually a little better than we had guided. So, something along that range probably gets you a similar EPS for the fourth quarter.

Mike Latimore – Northland Capital

Okay, that helps. Thanks.

Mark Greene

Thank you.

Operator

There are no other questions at this time. I now turn the call back over to our presenters.

Mike Pung

Thank you, Simon, and thank you everyone. That concludes today’s call.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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