Fair Isaac (FICO) Q1 2016 Results - Earnings Call Transcript

| About: Fair Isaac (FICO)

Fair Isaac Corp. (NYSE:FICO)

Q1 2016 Earnings Call

January 28, 2016 5:00 pm ET

Executives

Steven P. Weber - Vice President, Treasurer & Investor Relations

William J. Lansing - Chief Executive Officer, President & Director

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Analysts

Manav Patnaik - Barclays Capital, Inc.

William A. Warmington - Wells Fargo Securities LLC

James Rutherford - Stephens, Inc.

Matthew Galinko - Sidoti & Company, LLC

Operator

Good afternoon. My name is Caitlyn and I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation's Quarterly Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session.

Thank you. Steve Weber, you may begin your conference.

Steven P. Weber - Vice President, Treasurer & Investor Relations

Thank you, Caitlyn. Good afternoon, and thank you for joining today's FICO first 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 prior quarter, in order to facilitate 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 website, 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 website at fico.com or on the SEC's website at sec.gov. A replay of this webcast will be available through January 28, 2017.

And now I'll turn the call over to Will Lansing.

William J. Lansing - Chief Executive Officer, President & Director

Thanks, Steve, and thank you everyone for joining us for our first quarter earnings call. I will briefly summarize our financial results for this quarter and then I'll discuss some of our strategic initiatives and their expected impact.

In our first quarter, we reported revenues of $200 million, an increase of 6% over the same period last year. We delivered $19 million of GAAP net income, up 34% from last year and GAAP earnings of $0.59 per share, up 36% from last year. We delivered $32 million of non-GAAP net income, up 42% from last year and non-GAAP EPS of $0.99 per share, an increase of 45% from the same period last year.

Our Scores segment was up 27% over the same period last year. Much of this was due to growth in consumer scores but our B2B business is also growing nicely due to higher volumes. Our Applications segment was up 4% over the same period last year and our Tools segment was down 21% due to a one-time favorable settlement last year. It's a strong start to our fiscal year and I'm pleased with the results. Our top line revenue growth of 6% over last year continues our growth trend and I'm pleased to report that recurring revenues were up 12%.

As Scores revenue continues to grow, and we expand our cloud-based business, we expect recurring predictable revenues to be a bigger percentage of our total numbers. And as our revenue growth trend continues, we are beginning to see how we can leverage that revenue growth to the bottom line.

Last year, I talked about some large implementations that encountered cost overruns. Those overruns had a negative impact on our margins and masked much of the progress we were making. This quarter, by contrast, we drove 6% revenue growth, much of which is very high margin revenue. Because of this, and our focus on cost controls, we were able to increase our non-GAAP operating margin by 600 basis points and we were able to super-size that leverage by our ongoing program of share repurchases.

At the same time, we remain focused on driving growth. As promised, we're shifting resources towards distribution. While our overall head count is down 22 from last quarter, our quota-carrying sales force grew by 23 people, to help bring our products to market more quickly and broadly. Our sales force will continue to grow as the year progresses.

Bookings this quarter were up 24% over the same period last year and our pipeline looks strong. Demand is growing for advanced analytics that enable better decision making and we are committed to marketing our technology aggressively to capitalize on that emerging opportunity.

While these distribution investments are primarily in our Tools and Applications segments, we are also pursuing growth in Scores. We again delivered significant Scores revenue growth. Much of this was on the consumer side where the combination of our Experian partnership and growth from our myFICO business continues to drive our high margin recurring revenue.

And we're also growing our B2B business. We're seeing two important trends in Scores B2B. First, we're seeing increased volumes of origination in Scores, as the macro credit market continues to improve. And second, we're seeing significant volume growth in account management scores as customers pull more scores to support their risk management initiatives and customer loyalty programs.

Finally, we remain focused on expanding our market share in all areas of our business and we remain disciplined in our investment strategy. I'll share some summary thoughts later. But now I would like to turn the call over to Mike.

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Thanks, Will, and good afternoon, everyone.

Today, I'll emphasize three points in my prepared comments. First, we delivered $200 million of revenue; that's an increase of $11 million over last year, primarily driven by high margin recurring revenues. Second, we delivered $19 million of GAAP net income and $32 million of non-GAAP net income, which is an increase of $10 million year-over-year. Finally, we had $36 million of free cash flow this quarter and our trailing 12 month free cash flow number was $146 million. We used $28 million to repurchase shares this quarter and improved our net leverage position.

I'll begin by breaking the revenue down into our three reporting segments. Starting with Applications, revenues were $120 million, up 4% versus the same period last year. Much of the increase was driven by our acquisition last year of TONBELLER, a provider of financial crime and compliance solutions. But we also had a strong quarter in fraud solutions, adding two new Falcon customers, and also signed a new Collections and Recovery customer. Our Applications bookings increased 24% from the prior year, with strong growth in transactionally based products.

In the Tools segment, revenues were $24 million, down 21% versus the prior year. The decline this quarter was driven by a onetime favorable settlement last year related to underreported royalties on our Blaze Advisor rules product. More important though is our Tools bookings increased 9% from the prior year, adding to our backlog of revenue that will be claimed going forward.

And finally in our Scores segment, revenues were $56 million, up 27% from the same period last year. We're continuing to see very positive trends in both parts of our Scores business. On the B2B side, we're up 8% versus the same period a year ago. As Will mentioned, volumes are increasing, particularly in originations and account management, as we've added some new customers and have also seen existing customers increase the frequency of score pulls. The B2C revenues were up 88% from the same quarter last year, as we've now completed a full year since initiating our partnership with Experian.

Looking at revenues by region, this quarter 76% of total revenues were derived from the Americas. Our EMEA region generated 17% and the remaining 7% was from Asia-Pacific. Recurring revenues derived from transactional and maintenance sources for the quarter represented 74% of total revenue. Consulting and implementation revenues were 17% of total and license revenues were 9% of total revenue.

Bookings this quarter were $86 million, up 24% from the prior year quarter. We generated $23 million of current period revenue on those bookings for a yield of 26%. The weighted average term for our bookings was 24 months.

Operating expenses totaled $169 million this quarter, compared to $192 million in the prior quarter, which included a $16 million restructuring charge. Adjusting for that charge, operating expenses were still down about $6 million compared to last quarter when we had high cost of revenue associated with certain professional services engagements.

We remain focused on managing costs tightly while still investing responsibly in growth. And we expect our OpEx run rate to be approximately $170 million to $175 million over the next few quarters including amortization expense.

As you can see in our Reg G schedule, our non-GAAP operating margin was 25% for the first quarter. We expect that operating margin to be between 26% to 28% for the full year. GAAP net income this quarter was $19 million, up 34% from the prior year and non-GAAP net income was $32 million for the quarter, up 42%.

The effective tax rate was about 19% this quarter and was positively impacted by a catch-up from the reinstatement of the R&D tax credit. As a result, we expect the effective tax rate for the full year to be about 28% to 30%. The free cash flow for the quarter was $36 million compared to a negative $5 million in the prior quarter. For the trailing 12 months, cash flow was $146 million, up 13% from the prior period.

Turning to the balance sheet. We had $91 million in cash at the end of the quarter. Our total debt is $619 million with a weighted average interest rate of 4.3%. The ratio of our total net debt to adjusted EBITDA declined this quarter to 2.4 times, below the covenant level of three.

During the quarter, we returned $28 million in excess cash to our investors by repurchasing 319,000 shares at an average price of $89.11. We still have nearly 91 million remaining on our latest board authorization and continue to view share repurchases as an attractive use of cash. We also continue to actively evaluate opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio and competitive position. And finally, we are reiterating our previously provided guidance for the fiscal year.

With that, I'll turn it back over to Will.

William J. Lansing - Chief Executive Officer, President & Director

As I've been saying for several quarters, I believe FICO is in unique position with tremendous prospects. This year, we celebrate 60 years in business. We built the legacy of high quality products that are industry leaders, particularly in financial services. Yet there is increasing demand for our IP from our markets. Our build-out of the Decision Management Suite allow businesses to take the same decision making capabilities that our financial services customers have used for decades and apply cutting-edge analytics to improve their decisions.

And our FICO Score continues to demonstrate why it's the industry standard. Among both our existing financial services customers and consumers were increasingly understanding that the FICO Score is indeed the score the matters.

I'll turn the call back now to Steve to cover Q&A.

Steven P. Weber - Vice President, Treasurer & Investor Relations

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

Question-and-Answer Session

Operator

Your first question comes from the line of Manav Patnaik from Barclays. Your line is open.

Manav Patnaik - Barclays Capital, Inc.

Yeah. Hi, good evening, gentlemen. My first question was going to be around sort of what you guys were hearing in the economy but I think you sort of answered it with your comments around origination activity. I was hoping if you could give us a little bit more color maybe by the different origination lending areas, like what was driving the growth? Was it broad based? And also when you said the account management score pulls were increasing, just curious, what drove that because it sounded like the pulls in account management were already increasing for quite some time because of just the increased risk management by the banks?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Yeah, Manav, what was driving originations this quarter is a lot of what we've seen leading up to this quarter, which is the auto scores that are being pulled for auto sales, along with more credit card pulls, that are starting to appear within the underlying numbers. As it relates to account management, we have been seeing a trend of an increase in scores pulled; in fact, this quarter was one of the largest we've seen in a number of years. And what's been driving that in part is enhanced credit risk management going on within the banks, as well as more and more banks who are rolling out open access programs, are beginning to pull scores more frequently in order to provide that to their customers in the form of a monthly report.

Manav Patnaik - Barclays Capital, Inc.

Okay. And then just stick on Scores, and it seems like obviously everyone is pulling the FICO Score more and more. I was hoping you could provide some of your thoughts on – we've seen in the recent press obviously you've had someone like SoFi take pretty aggressive stabs in the marketing of the FICO Score. And then there's also been some noise around making sure FICO is not mandated to be used, or however you want to phrase it, in the mortgage market? I was hoping we could hear your views on that.

William J. Lansing - Chief Executive Officer, President & Director

Sure. The very short answer to your question is the FICO Score franchise has never been stronger. It's very healthy and what we're seeing is more and more customers coming to FICO, not customers departing from FICO. As you know, in the U.S. we have a 90% share in credit decisioning in situations where scores are used. And what we're seeing is, in the 10% we don't have, we're seeing customers come back rather than departures.

I'm glad you raised the question because it's worth commenting on some of these recent articles and the discussion with the alternative lenders. When we put together a FICO Score, our goal is to provide precision credit decisioning with the most predictive power possible across as large a population as we can, an actionable population for our clients. And so the FICO Score that we're all familiar with is designed to do that. It's designed to provide a high level of prediction across a large population.

There are always situations where you can take a very narrow population and find some dataset that has high predictive power for a credit decision for a very narrow population. And that's not a problem for FICO, in fact, we do custom scores for our bank clients and we're happy to use all sorts of alternative data in a custom score to provide a more precise decision with respect to a particular population.

But when you get into some of these alternative lending situations, you see players who are focused on very narrow populations and so they look at data beyond the tradeline data that we tend to focus on. Now of course we can look beyond that too and we do. And we're always on the lookout for new and different data sources that can score populations that are previously unscored. And so for example, we've launched this FICO Score XD which lets us score on the order of 50 million consumers who were previously unscorable. And that's leveraging utility payment data, telecom payment data, some rental payment data. And although it's not as broad as the tradeline data that we use in the traditional FICO Score, it is predictive and useful for a smaller population that wasn't being picked up before. So where we can do it, we do do it. I think some of the headlines reflect a bit of a desire by some of these alternative lenders to stir up controversy. We're not really seeing it in our numbers. We're not selling fewer Scores. In fact, we sell our Scores to many alternative lenders and those volumes are going up not down.

Manav Patnaik - Barclays Capital, Inc.

Okay. And then just last one. Thank you. That was really helpful. Just the Experian contract looks like it's going pretty well. I just wanted an update, I think last time you had said that you had a few other sort of things in the pipeline with respect to D2C, any updates there for us?

William J. Lansing - Chief Executive Officer, President & Director

We do have things in the pipeline but we don't have updates for you at this time. We continue to have bigger prospects there and we have very strong partnership with Experian but nothing to announce right now.

Manav Patnaik - Barclays Capital, Inc.

Okay, fair enough. Thank you, guys.

Operator

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

William A. Warmington - Wells Fargo Securities LLC

Good afternoon, everyone.

William J. Lansing - Chief Executive Officer, President & Director

Hi, Bill.

William A. Warmington - Wells Fargo Securities LLC

So congratulations on a solid quarter.

William J. Lansing - Chief Executive Officer, President & Director

Thanks.

William A. Warmington - Wells Fargo Securities LLC

So one of the themes that seems to be coming across in the number of different segments is new customers and you mentioned that for Falcon. You mentioned it for Collection and Recovery. You mentioned it for B2B. And I was hoping if you could just go to those segments and talk about what is it that suddenly in what's perceived to be a relatively mature market, highly penetrated, you're actually bringing in new customers?

William J. Lansing - Chief Executive Officer, President & Director

Yeah, absolutely. Some of it is increasing capability and additional features around our core offering. Some of it there is some amount of international expansion that's going on. With questions on recovery what started out as being a bit more of a focus on third-party collections has really broadened so that we believe we have the premier offering for both banks and third party. So there's a broadening there and an expansion of our Collections and Recovery franchise.

And then B2B Scores, we touched on it earlier. You're seeing some activity that just comes from the economy picking up and more attention to risk management from the banks but also we believe that banks are pulling the scores much more frequently to support their communication of the scores to consumers. And so as they put FICO Scores on to bank statements, they're reaching out for scores on a more frequent basis and sometimes for more accounts than they were pulling before.

William A. Warmington - Wells Fargo Securities LLC

Okay. So question for you on DMS. You mentioned that you'd added 23 quota-carrying sales people, what's your total up to now?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Our total, Bill, I got to check. Give me a second to check.

William A. Warmington - Wells Fargo Securities LLC

Okay. While you're checking – my question is going to be, you were selling previously. It sounded like average sale was running about $0.5 million. You were seeing some of your existing customers come back and buy more. What have been the trends there? Are you adding new customers? Are you able to – are the existing customers coming back and buying more?

William J. Lansing - Chief Executive Officer, President & Director

We're adding new customers and we're seeing existing customers buy more. Although we don't position DMS as a platform when we sell it, and we position it as a solution to a problem, the fact is the way it's architected, we're putting in a lot of platform capability when we sell the very first solution. And so the ability to expand on that, and to broaden the solution and to move into adjacent areas for our customers is pretty high, flexible and fast. And so we are seeing initial DMS sales followed by follow-up sales.

William A. Warmington - Wells Fargo Securities LLC

So on the Tools side, what was the size of the one-time royalty settlement? I'm just trying to get at a normalized growth rate for Tools?

William J. Lansing - Chief Executive Officer, President & Director

It was just under $6 million a year ago.

William A. Warmington - Wells Fargo Securities LLC

Got you. So that was the onetime royalty settlement?

William J. Lansing - Chief Executive Officer, President & Director

Yes, so if you pull that out, you'll get a sense for where we are.

William A. Warmington - Wells Fargo Securities LLC

Got it. And what was driving the increase in the transactional and maintenance revenue on a year-over-year basis from 69% to 74%?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

A lot of it, Bill, was the myFICO Scores and the B2B Scores business, along with the Experian revenue as well as fraud and TRIAD revenue that comes through our channels on a transactional license basis. So it's kind of the big products.

William A. Warmington - Wells Fargo Securities LLC

And I wanted to ask about your – you mentioned potentially using your free cash for repurchases and M&A. I wanted to ask, given the pullback in the share price, what your leanings were now and whether you guys have been out in the market in January.

William J. Lansing - Chief Executive Officer, President & Director

We have been in the market and we continue to view our stock as just a terrific opportunity especially at these levels. And so you can imagine and expect that we'll continue to participate in stock repurchase at these levels in a fairly aggressive way.

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

We are, though, Bill, just as a remainder, blacked out during the period leading up to our call, but beyond that we're in the market.

William A. Warmington - Wells Fargo Securities LLC

Got it. Thank you very much.

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

And Bill, just to close off on your first question on sales, at the end of this last week, we have roughly 345 people in all of sales and roughly 190 of them are field sales quota-bearing reps.

William A. Warmington - Wells Fargo Securities LLC

Got it. Thank you.

Operator

Your next question comes from the line of Brett Huff from Stephens, Incorporated. Your line is open.

James Rutherford - Stephens, Inc.

Hey, this is James Rutherford in for Brett. Congratulations on the quarter. I just want to ask on Affinity, and I apologize if you talked about this for the first couple of minutes that I was actually absent from the call. But have you guys made any kind of headway in those discussions you've been having with financial institutions on Affinity?

William J. Lansing - Chief Executive Officer, President & Director

Headway, yes, but we have nothing to announce.

James Rutherford - Stephens, Inc.

Okay. Are there any expectations in the guidance for the year in terms of Affinity acceleration? I'm trying to get kind of a feel for how your expectations are on that?

William J. Lansing - Chief Executive Officer, President & Director

No. No, we did not build Affinity into our guidance.

James Rutherford - Stephens, Inc.

Okay. And then I wanted to follow-up on Bill's question on Tools, if we take out that settlement benefit last year of $6 million, growth would have been...

William J. Lansing - Chief Executive Officer, President & Director

It was closer to $5 million, it was under $6 million. Just around $5 million.

James Rutherford - Stephens, Inc.

Okay. So growth would have been roughly flat, I think by my math. I just wanted to clarify what the expectations are going to be for the remainder of the year? I assume we're still expecting growth but kind of what's going to drive that change?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Yeah. So James, we built into our guidance, which is the number we reconfirmed today, for Tools high single digit, and we still expect to get there through a combination of license deals and any SaaS offerings that we sell through the DMS.

James Rutherford - Stephens, Inc.

Okay. That's helpful. Thank you. I was actually going to ask about SaaS next. You guys won couple of Falcon deals; that's a nice sign. Were those SaaS, and even if not, can you give us an update on kind of how the sales in the SaaS business are going in general?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Yeah. So on the Falcon deals, those were on premise deals with some European customers. So they were not SaaS. They were sold under the classic Falcon model. Though on a SaaS basis, we had another strong quarter. We had almost $8 million of booked deals across a variety of our products, including the Collections and Recovery products and the Debt Manager products, and of course the Adeptra product line which is all SaaS basis.

James Rutherford - Stephens, Inc.

Okay, excellent. And then just a question on Scores, very, very nice growth on the B2C side. I was curious, are you guys breaking out sort of what the growth would have been excluding the Experian contract, just to kind of get a flavor for how to model that once that sort of lapse?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Yeah, it lapsed. What we did is we built into our guidance the run rate exiting the year our fourth quarter. That's what we built into the guidance. It essentially lapsed in our quarter ending in June which is when we had almost the first full rollout of all of the Experian subscriber base.

And let's see, the other part of your question was do we break that out separately? We don't but I will tell you that our myFICO business grew at very high double-digit rates this quarter compared to last year.

James Rutherford - Stephens, Inc.

Great, okay. I just had one more quick one, if I may. Are there any quarters this year that have a hard licensed comp in Applications or in Tools that might make growth outsized in one direction or another, so we can get an expectation for how that might flow through?

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Yeah, well our fourth quarter last year the one ending in September was a record quarter where we had I think it was roughly $40 million, $45 million of license revenue. So if there is a tough comp that'd be it.

James Rutherford - Stephens, Inc.

Okay. That's very helpful. Thank you so much.

Operator

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

Matthew Galinko - Sidoti & Company, LLC

Hey, guys. Good afternoon. My question is, are you actively marketing myFICO at this point, or is it simply benefiting from some of the other promotional activities like Open Access or Experian's efforts?

William J. Lansing - Chief Executive Officer, President & Director

We do actively market it but as you can imagine, we don't have anything like the war chest that our competitor have for marketing their offerings. And so you don't see us on television for example. We're footing the tab for the advertising costs but we do market it. It's not a hobby, it's a business.

Matthew Galinko - Sidoti & Company, LLC

Sure, fair enough. And in terms of your goals on hiring out the quota-carrying sales force, how far along are you in that process? Are you still looking to hire? Are you satisfied with the pace that you've been able to bring people on board to push your Applications strategy?

William J. Lansing - Chief Executive Officer, President & Director

We're not quite satisfied with the pace and we are pushing to hire and we'll continue to hire. What's happened is we're getting traction with the products and the services. We've got this terrific offering. And we're really in the mode now hiring – hiring confidence sales people to sell this kind of stuff as quickly as we can and we still have openings.

Matthew Galinko - Sidoti & Company, LLC

Got you. All right. That's all for me. Thank you.

Michael J. Pung - Chief Financial Officer, Executive Vice President & Investor Relations

Thanks, Matt.

Operator

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

William J. Lansing - Chief Executive Officer, President & Director

Thank you. This concludes today's call. We'd like to thank you all for joining.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!