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Mike Pung – VP, Finance and IR

Mark Greene – CEO

Tom Bradley – CFO and EVP


Carter Malloy – Stephens

Nat Otis – KBW

Fair Isaac Corporation (FIC) F4Q2010 Earnings Call Transcript November 3, 2010 5:00 PM ET


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

Mike Pung

Thank you, Alicia. Good afternoon and thank you for joining FICO's fourth quarter earnings call. This is Mike Pung, Vice President of Finance and Investor Relations. And I'm joined today by CEO, Mark Greene and CFO, Tom Bradley. You will 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 the prior quarter, in order to facilitate an understanding of the run rate of our business.

Certain statements made in the 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 statement portions of those filings. Copies are available from the SEC, from our website or from the Investor Relations team.

In order to provide additional information to investors, we will use certain non-GAAP measures on this call. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures entitled regulation G disclosure is available on the investor page of our website under the presentations tab. A replay of the webcast will be available through December 3.

I will now turn the call over to Mark Greene.

Mark Greene

Thanks, Mike and good afternoon. We’ll proceed today as usual in three parts. First, I will summarize the quarter results and assess our business in light of current market conditions. Tom Bradley will then provide further financial details. And then finally, I’ll discuss our business and fiscal 2011 guidance before we take your questions.

For the fourth quarter of fiscal 2010, revenue was $155 million, consistent with prior quarter results. GAAP earnings per share in the quarter were $0.38, down sequentially but up 9% year-over-year and they included a $0.03 per share charge for one-time restructuring activities.

GAAP earnings per share for the entire 2010 fiscal year totaled $1.42, an increase of 6% from fiscal 2009. Bookings in our fourth quarter, which are an indicator of future revenue, were $106 million, up 66% sequentially.

Now, let me break out our quarterly performance by the three segments of our decision management portfolio. First, the application segment consists of business software used by clients to help make smarter decisions over customer life cycles. Revenue from these applications totaled $96 million, up 5% sequentially.

We saw improved performance across most of our applications with impressive results from our marketing, customer management and fraud products. The marketing solutions saw continued strong growth driven by our retail action manager product, with volume increases at several of our customers.

Bookings and marketing solutions totaled $20 million in the quarter, the largest amount in almost three years. Customer management sub segment recorded $12 million of bookings in the quarter. The largest amount in two years, including several sizable triad license deals in the EMEA and Latin America.

The fraud area consisting of our insurance fraud manager and the Falcon product for banking also had a solid quarter with $26 million in bookings including an enterprisewide license with the leading European bank for the latest version of our Falcon product version 6.

Total fraud bookings for the 2010 fiscal year exceeded $70 million, the largest in several years. And finally, in this application segment, during the quarter, we signed an agreement with PNC Financial Services Group, one of the nation's largest diversified financial services organization to provide an integrated solution that supports the bank's growth strategy.

While terms of this agreement cannot be disclosed, it was one of the largest transactions in FICO’s history. When delivered with the FICO solution – when delivered the FICO solution, we will provide the bank a connected learning and decision capability that allows PNC to grow its customer base and expand share of wallet.

Turning now to our score segment, which consists of predictive analytics used to assess risk. Overall scores revenue was $42 million in the quarter, down 10% from the prior quarter, in which we had benefited from a one-time true-up of several million dollars in credit bureau royalties.

We track the score's business in two sub segments

B2B, which are scores sold to financial institutions and B2C, which is scores sold to consumers at website. The B2B sub segment was essentially flat when adjusted for the prior quarter true-up.

We have now seen five quarters of this stability, following the steep fall-off that we observed during recession. In this quarter, we observed the following on B2B. First, a 22% increase in the volume of scores used for marketing and an 8% increase in the volume of scores used in originations.

These uptick in scores that are used early in the financial life cycle suggest that we may see recovery across the entire score spectrum in the quarters ahead despite the continued uncertainty in consumer lending. We also saw, during the quarter, continued adoption of the latest version of the classic score known as FICO 8, the latest version, with 3,000 lenders now using FICO 8 as the foundation for their risk management practices.

In addition, we announced recently the availability from all three major U.S. credit reporting bureaus, a version of FICO 8 tailored for the mortgage industry. This FICO 8 mortgage score was built specifically to help lenders better predict mortgage performance and improve credit decisions for both current and prospective homeowners.

In the consumer or B2C portion of the scores business, revenue decreased 9% sequentially, as we shifted our marketing emphasis in the quarter from one-time transactional sales, which generate immediate revenue to subscription sales, which generate revenue over a forward period. Our B2C business unit won a four-year contract in the quarter with the financial industry regulatory authority or FINRA investor education foundation.

Working with the U.S. Department of Defense, the FINRA foundation has selected myFICO as the exclusive provider of consumer scores and credit education for U.S. Armed Forces personnel stationed around the globe. This is part of FINRA's financial preparedness initiative, which equips military personnel with the knowledge and tools necessary for lifelong financial success.

The third and final segment of our business is tools, which consists of rules management, modeling and optimization products, embedded within our applications and also sold standalone to clients building their own applications. Revenue in this tool segment was $17 million during the quarter consistent with the level achieved in the prior quarter.

So to summarize our Q4 results, we reported solid performance across all three segments. With continued signs of stabilization in scores and growth in our applications segment. Bookings were $106 million, the largest single quarter since fiscal 2006 and included one of the largest transactions in our history. We delivered solid earnings, while investing in critical sales and development resources.

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

Tom Bradley

Thank you, Mark. Mark has already discussed our revenue results by segment. So I will provide some additional comments as they relate to specific aspects of our business. Revenue for the quarter was $155 million, consistent with the prior quarter.

This quarter, 73% of total revenue was derived from our Americas region which includes both North and South America versus 78% in the prior quarter. Our EMEA region generated 20% of our revenue, compared to 16% in the prior quarter and the remaining 7% was from Asia-Pacific, which was consistent quarter-over-quarter.

Recurring revenue derived from transactional and maintenance sources for the quarter, represent 71% of total, versus 75% in the prior quarter. Consulting and implementation revenues were 18% of total, versus 16% in the prior quarter and license revenues were 11% of total revenue, versus 9% in the prior quarter. We had several large license deals this quarter and based on the trends we are seeing, we would expect license revenues as a percent of total revenue to increase slightly over the next year.

Bookings of $106 million, created $21 million of current period revenue, a 20% yield. This compares with bookings of $64 million, current period revenue of $18 million and a 29% yield last quarter. The weighted average turn for our bookings was 27 months compared to 28 months last quarter.

Of the $106 million in bookings, 24% related to fraud products, 18% to marketing solutions products and 13% to tools. We had 18 booking deals in excess of million dollars, of which five exceeded $3 million.

Transactional and maintenance bookings were 52% of total this quarter, versus 44% in the prior quarter. Professional services bookings were 32% versus 34% in the prior quarter. Finally, license bookings were 16% this quarter, versus 22% last quarter. Operating expenses totaled $128 million, up $3 million from the prior quarter. There were several items driving this net increase. First, cost of revenue increased due to an increase in hours spent by our professional services team on large implementation projects. As a result of increased utilization towards client projects, less time was allocated to research and development, which had a corresponding decrease.

Second, our SG&A expenses increased due to additional costs related to sales commissions and professional fees. Our commission plan includes accelerators for exceeding sales quotas for both bookings and revenue. And considering the large amount of bookings this quarter, we had an increase in this expense.

Finally, we had a restructuring charge related to facility lease costs and severance this quarter.

As you can see in our Reg G schedule, non-GAAP operating margin before amortization, stock-based Comp and restructuring was 23% for the quarter, compared to 24% last quarter. Our non-GAAP operating margin has been negatively impacted by the mix of revenue, which has included a higher percentage of professional services that carry a lower margin and the increasing commission expense. As we invest in our products over the next several quarters, we anticipate that our operating margin will continue to be dampened.

Net income this quarter was $16 million, down 12% from last quarter. This quarter, we absorbed an additional $2.4 million of pre-tax interest expense, related to the refinancing of our debt in July. We also incurred a restructuring charge of $1.6 million, related to facilities and severance. The effective tax rate was about 21% for the quarter, which reflects a change in the mix of income generated from higher tax jurisdictions to lower tax rate areas and a favorable adjustment to our year-end tax reserves. Fiscal 2010 tax rate was about 30%.

We define free cash flow as cash flow from operations, less CapEx and dividends paid. The free cash flow for the quarter was $16 million or 10% of revenue, compared to $8 million or 5% of revenue in the prior quarter. Free cash flow was negatively impacted by a $4 million increase in accounts receivable driven by extended payment terms on several large deals. In fiscal 2010, we generated $85 million of free cash flow.

Moving to the balance sheet. We now have $219 million in cash and marketable securities on the balance sheet. This declined from last quarter, due to share repurchases and debt reduction. Our total debt remains at $520 million, with a weighted average interest rate of 6.1%. Going forward, the cost of our debt will be fairly fixed at about $8 million per quarter. We have no balance outstanding on our revolving credit facility and a very balanced debt maturity profile with no significant maturities until fiscal 2013. The ratio of our total net debt to adjusted EBITDA is 2.2 times, below the covenant level of 3 times. Also, our total fixed charge coverage ratio is 4 times, well above the covenant level of 2.5 times.

During the fourth quarter, we repurchased 2,492,000 shares in the open market at a total cost of $58 million or an average cost of $23.46 bringing our basic share count outstanding at September 30 to 39.9 million shares. Fiscal year-to-date, we repurchased 8,790,000 shares at a total cost of $198 million or $22.52 per share. We have 175 million remaining under our current board authorization. We continually evaluate the best way to deploy excess cash to maximize shareholder value. While we may continue share repurchases during fiscal ‘11, we will also be looking for opportunities to acquire relevant technologies and products that compliment our strategy or fill white space in our portfolio.

I will now turn the call back to Mark.

Mark Greene

Thanks. In this concluding section, I will discuss the health of our business and our prospects for fiscal 2011. Let me begin with a quick review of the past year. We entered fiscal 2010, amid an extremely challenging economic and business environment. Moreover, our clients faced additional pressures from heightened regulation, notably, the card act and the Dodd-Frank Wall Street Reform Act. As we exited fiscal 2010 in September, we saw indications of stabilization or modest growth across our business, but not yet robust recovery as high levels of unemployment and difficult housing market continue to overhang the markets that we serve in the United States.

Our response to these conditions in FY 2010 was to establish a path to growth, focused on product innovation and sales execution, while tightly managing expenses and aggressively repurchasing shares. In scores, we secured multi-year partnerships with two of our three credit bureau partners. We also drove market adoption of our latest FICO 8 credit score and improved our marketing on the consumer side, driving up traffic and conversion rates. We’ve seen several quarters now of clear stabilization of our scores and feel that it’s well positioned to grow as the economy recovers.

In applications, we released important updates during the year to our solutions for account management, triad 8.5, collections, debt manager 8, bank fraud, Falcon 6 and insurance fraud, IFM3.1 establishing a solid foundation for growth in fiscal 2011. We capitalized on our strong fraud pipeline by signing over $70 million of new bookings during the year, in part by expanding our sales and distribution capabilities in Europe and China.

And in tools, we delivered updated versions of the Blaze Advisor rules engine, our Decision Optimizer product and Model Builder product. We successfully stabilized the tools business overall and started or enlarged reseller relationships in Europe that should drive meaningful incremental revenue in the year ahead.

During the year, we also strengthened our management team, particularly in sales and marketing with the addition of executive vice president Charlie Ill and in scores with the recent addition of EVP Jordan Graham. And finally, we delivered strong cash flow, allowing us to repurchase 9 million shares of stock over the year or an 18% reduction in shares outstanding from the prior year.

Now, looking ahead, FICO is now well positioned to actually realize growth across our business, driven by several factors. Beginning with new product delivery, our sustained R&D investment is now yielding a pipeline of innovative analytic applications. Next month, we plan to introduce a new originations manager product, which will be the third in a series of connected decision applications that allow financial institutions to manage their customer relationships consistently over time and across products and across channels.

We will also keep advancing the state-of-the-art in fraud prevention, for both banks and insurers and build on the strong momentum that our fraud solutions already enjoy in those markets. And finally, we expect to deliver faster, more powerful versions of our key tools such as Blaze Advisor, Model Builder and Xpress Optimization to keep pace with market demand.

Second factor that influences our growth prospects is our expanded sales distribution. The revenue growth and strong bookings that we recorded last quarter tell me that our direct sales channel is sharpening its execution under its new sales leadership. I expect steady momentum here throughout 2011. In addition, several recently-agreed indirect channel partnerships should start to bear fruit in 2011 including Emdeon in health care, China UnionPay for banking account management and Software AG as a valued reseller of FICO tools.

And the third factor is growth in our scores business. Several influences will be material for the scores business in the coming year. First, is the gradual improvement in macro-economic conditions in the United States. Second, legislative changes enacted over the past year, notably the Card Act and the Dodd-Frank Wall Street Reform Act will do much to raise consumer awareness of credit scores. Beginning in January, lenders will be required to disclose to consumers the credit score actually used in making a lending decision whenever the lender either denies credit or offers credit under less than most favorable terms. This will cause millions of consumers to become aware of their FICO score, presenting opportunities for us to expand the range of financial literacy and credit management capabilities they would offer on our consumer website, myFICO.

And the recent appointment of Jordan Graham as President of FICO Consumer Services brings to this business a seasoned executive with a deep background in building strong consumer brands. Jordan is working with his team to position the FICO brand as the score that matters to consumers as well as to lenders.

So to summarize, we're well positioned to realize growth in the current environment, by capitalizing on improving market conditions, a robust product portfolio and strengthened leadership in organization.

Now, to guidance going forward. The pace of global recovery is likely to be modest and uneven in the near-term, with an anemic labor market and continued housing market challenges in the U.S., robust growth in core Europe, offset by slow recovery in peripheral Europe and double digit percentage growth across much of Asia. Overall, this suggests a checker board of business conditions in the year ahead.

We believe that our business has stabilized and we do see signs of gradual improvement. We're investing prudently to drive modest revenue growth, while keeping a close eye on expenses. So in fiscal 2011, we expect revenue of between $620 million to $625 million or a 2% to 3% increase from fiscal 2010.

We expect net income between $65 million and $67 million, compared with $64 million in fiscal 2010. And we expect earnings per share between $1.63 and $1.68 compared with $1.42 in fiscal 2010, assuming an average of $39.9 million shares outstanding.

As I wrap up, let me share some feedback from the Chief Risk Officers of 12 large customers, who gathered recently at a FICO Client Advisory Board meeting. Their financial institutions are all seeking a global infrastructure that helps them grow their businesses, while managing risks under increasingly restrictive regulatory environment.

They believe that FICO has the world class solutions to help them do just that and that our product road map is closely aligned with their priorities. They understand FICO's ability to help them manage risk/reward trade-offs. And they told us that they understand that their quest for profitable growth demands best of breed analytic solutions for managing decisions in areas such as customer acquisition and retention, collections and fraud mitigation, which are the very things that FICO excels at.

I take from this feedback that we're on the right path and that we will soon have some wind at our back. With that, I will turn the call back to Mike for Q&A. Mike?

Mike Pung

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

Question-and-Answer Session


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

Carter Malloy – Stephens

Hi, guys. Thanks for taking my questions. I would like first on the scores business first here, you said that volumes were up in marketing and origination. I assume we can make that assumption as well for the mortgage application volumes but can you help us give a sense – get a sense of how much of your score's business is more interrelated.

Mark Greene

About 15%. And that number is growing a little bit. So it is trending toward 20% and it is taking share away from credit card, which has been about 60%, 65% and coming down a couple points.

Carter Malloy – Stephens

Okay. And so it appears that volumes are up there but revenues are somewhat flat. Is there pricing…

Mark Greene

Carter, you're right. A number of our clients are on a grid where, as volumes go up, the price per unit comes down, so that tends to flatten the revenue impact. And there has also been a little bit of volume downtick in the middle part of life cycle which we call account management scores. But the way this business works is we discussed in the past, is when you see an uptick in volumes on the front end is we did last quarter, that will usually percolate through in the next quarter or two to the middle site. So the downtick that we saw on volumes in account management should reverse itself in the next quarter or two.

Carter Malloy – Stephens

Okay. Great. And then on the competitive environment there, I think you guys have one of your large competitors talking about a significant win there against – against – VantageScore against FICO. Have you guys seen any major losses there or any losses at all in the core FICO score business?

Mark Greene

I don't think there is much change there. We've always known that we have competitor products out there. By the way, in-house competitors are at least as important as external competitors. And with the FICO 8 product, we've done quite well in our competition against VantageScore. We remain of the view that we don't think we lost any customers. It is hard to know whether we've lost share or volumes to, you know, mixed shift, by customers to competitors but we don't see that happening. And we do know that we get very good feedback about how our product compares in benchmarks and performance uplift relative to prior versions.

Carter Malloy – Stephens

Okay. And then a couple housekeeping ones for Tom. One is what is FX in the quarter?

Tom Bradley

I'm sorry?

Carter Malloy – Stephens


Tom Bradley

About 4 million. I'm sorry, FX, I thought you said CapEx. FX is basically zero. I mean, no material number.

Carter Malloy – Stephens

Okay. And then on the free cash, I think last quarter we had talked about or you guys talked about getting to 25 million this quarter, came in a little light, it looks like there was some AR there that did not help us out. Any other reasons behind that? And can we expect that to step back up to the 20, 25 million a quarter range?

Tom Bradley

You know, I think the run rate over the course of '11 is the 20 to 25 million a quarter, is the right number. The first quarter is actually a lower quarter in general, because we pay bonuses and commissions. But I think over the course of 2011, that is the right number. And I think the increase in AR last quarter and some of the expenses, jumping up that I mentioned, drove the difference from what we talked about last quarter.

Carter Malloy – Stephens

And then maybe last question and then I will jump back on. On your margins in guidance, it looks like you guided well above the street on revenues but below on EBIT and you had mentioned some pressures there, at least initially in 2011. I'm sorry if I missed it, what are the drivers there to drive margin down next year?

Mark Greene

I don't know if it drives down. I just think, as we do see some growth, we are going to be carefully investing in our business and our products. We think there is longer term opportunities here. So we're not going to just – we're not going to see revenue growth just drop to the bottom line. We will be investing a lot of that back into the business. So the margin won't come automatically up with the revenue.

Tom Bradley

Two areas to say, Carter. Given improving market condition, we're investing quite heavily in client facing sales and service. And given what we hear from customers about their spending intentions, we're adding a little bit to the development team to make sure that we can intercept market opportunities with new products.

Carter Malloy – Stephens

Okay. Thanks. I will jump back in the queue.

Mark Greene

Thank you.


(Operator Instructions) Our next question comes from the line of Nat Otis with KBW. Your line is open.

Nat Otis – KBW

Hey, good evening.

Mark Greene

Hi, Nat.

Nat Otis – KBW

Just to maybe follow up on that last question, then you talked about investing. I guess one thing, it looked like R&D was down a little bit this quarter, certainly at a point in time that SG&A is up and you talked about spending more on sales and commissions. Any comfort that you can give that you're not necessarily going to be – you're not going to have that pattern going into 2011, because certainly you want to make sure that you're funding future projects and products?

Mark Greene

Yes, I can offer that you assurance. The bulk of the hiring that we just referenced is in fact going into – for the next quarter, into R&D. What you saw last quarter is quite a bit of add to the sales staff, but that will taper and will ramp up more on the R&D side. You're correct that analytic innovation is our secret sauce. And we need to keep that adequately funded.

Tom Bradley

And as I mentioned, we also saw last quarter, a number of our development and services resource focused on some big implementations, where they might have otherwise spent time on pure development activity. So part of that is a cost allocation, as we address these client issues last quarter.

Nat Otis – KBW

Okay. Fair enough. Can you give a little bit more color on the restructuring charge?

Tom Bradley

Yeah. Basically, about a million of it was on two office leases, where we had taken restructuring charges, two or three years ago and we were updating, basically the assumptions around the sub-leasing coming in those facilities. So basically we didn't get the sublease income that we had expected two years ago. And we're updating our charge across the ends of those lease terms. And the rest was a – for a set of severances for a set of risks that occurred right at the end of the fourth quarter.

Nat Otis – KBW

Okay. And then just two last quick ones. I don't know if you can provide any color but it sounds obviously like that PNC contract was a big contract. Any way you can gauge, can say how much that impacted bookings or where it impacted bookings? Any type of percentages or anything like that?

Tom Bradley

It still would have been a very large bookings quarter without PNC. It is fair to say it is a big deal, but it still would have been a very large quarter for bookings otherwise.

Nat Otis – KBW

Okay. Okay. All right. Fair enough. Just last question from a modeling standpoint. Tax rate down as you said, what should we look at from a tax rate standpoint in 2011? Is that mix shift going to be in there 2011 as well?

Tom Bradley

A little bit. I think maybe down to 31%, instead of 32 or 3 that we've seen the last couple of years. Part of the benefit this year was one time coming out of the tax reserve adjustment, so where we finished at a 30, I think a 31 run rate is probably a better estimate?

Nat Otis – KBW

Okay. Thank you.

Tom Bradley


Mark Greene

On that last point, the only other thing to look at is there is still hope in the industry that the R&D tax credit will be reinstated and of course we would benefit from that if it happened.

Nat Otis – KBW

Okay. Great. Thank you, gentlemen.


We have no further questions at this time. So I will turn the call back over to the presenters.

Mark Greene

Thank you, Alicia. And thank you for participating in our fourth quarter call.


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

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