Fair Isaac Corporation (FICO) Q1 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the FICO First Quarter Earnings Conference Call. [Operator Instructions] Mr. Steve Weber, Vice President of Investor Relations, you may begin your conference call.

Thank you, Rob. Good afternoon, and thank you for joining FICO's first quarter earnings call. I'm Steve Weber, Vice President of Investor Relations, and I'm joined today by our CEO, Mark Greene; CFO, Mike Pung; and Will Lansing, our newly appointed CEO. You'll find on the Investor Relations portion of the FICO website a copy of today's news release, our Regulation G Disclosure schedule and our financial highlights. While our press release describes financial results compared to the prior year, today, management will also discuss results in comparison to the 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. 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 Regulation G Disclosure, is available on the Investor page of our website under the Presentations tab. A replay of this webcast will be available through February 27, 2012. Now I'll turn the call over to Mark Greene.

Thanks, Steve, and good afternoon. Today, we announced the results for our fiscal first quarter of 2012. In addition, we announced that I'm retiring as CEO, but will remain with FICO in an advisory role. Will Lansing has been named Chief Executive Officer and will assume those duties effective tomorrow, January 27. Will has a 30-year track record in the technology industry, and has been a member of the FICO Board for the past 6 years. Will is joining us on today's call, and he'll have some remarks in a few moments. I look forward to working with him through a seamless transition. We'll take your questions after our prepared remarks. But first, I'll summarize the quarterly results, and Mike Pung will then provide financial details. I'm pleased to report that we have a strong start to our fiscal year 2012. Our revenue of $170 million was the highest since the fourth quarter of 2008, and with an increase of 9% over the same period last year. We delivered $30 million of net income versus $16 million last year and earnings of $0.81 per share versus $0.40 per share last year. We also continue to produce strong free cash flows, $33 million this quarter versus $31 million last year. All 3 segments of our Decision Management portfolio grew in the quarter. The first segment is our Decision Management applications or business offer used by clients to understand and predict consumer behavior in order to make smart decisions over customer life cycle. Revenue from these applications was solid this quarter, up 13% both sequentially and year-over-year. This is a particularly strong quarter in our Fraud Management Application business, which saw a year-over-year revenue growth of more than 50% due to several large term license renewals. Our second segment is Scores, which consists of predictive analytics used to assess risk. Overall Scores revenue was up 4% from the prior year. We track 2 subsegments here, business-to-business or B2B, which are Scores sold to financial institutions, and business-to-consumer or B2C, which is Scores sold directly to consumers at myFICO.com on a direct basis or as Scores sold indirectly to consumers through bureau partners. The B2B Scores subsegment performed well, up 6% from the same quarter last year, making it our best first quarter since 2009. We continue to invest in this business and are beginning to see the results in both our core business, as well as our innovations that will provide new revenue streams. Highlights for the quarter include the following: Revenues from Scores sold across all parts of the life cycle, acquisitions, Originations and account management were up year-over-year. Scores sold for acquisition or marketing purposes to solicit new customers were up 14% year-over-year. Second, market adoption of FICO 8, which is the latest vintage of our classic Score continues to grow. 7,500 lenders have now standardized on FICO 8, accounting for over half of our revenues. And thirdly, we're gaining good traction on 2 recent Score innovations, particularly the FICO Medication Adherence Score for the healthcare industry and our strategic default solution for the mortgage industry. The B2C Scores subsegment saw a small revenue decline in the quarter of 1% versus the prior year. This week, we announced the introduction of a Spanish language website as part of our ongoing efforts to expand credit literacy and empowerment to all U.S. consumers. This website, which is the Spanish version of myFICO.com, is the first website where some 34 million Spanish-speaking consumers in the U.S. can obtain their personal credit report, FICO Score and analysis all in Spanish. We're committed to serving this consumer marketplace and are continuing looking for innovative ways to grow this business. Our third business segment is Decision Management Tools, which consist of rule management, modeling and optimization products, both embedded within our applications and also sold standalone to clients building their own applications. Revenue in this Tool segment was up 1% versus the prior year and the prior quarter. During the quarter, we announced an upgrade to our business rural management tool called Blaze 7, with a groundbreaking visualization capability that makes it easier to understand and manage complex rule sets. This visualization feature of Blaze 7 is helping financial institutions to explain their complex lending and risk management policies to bank examiners. Turning finally to our performance by geography, all 3 of our regions grew during the quarter on a year-over-year basis. Europe, Middle East and Africa was up by 25%, Asia Pacific was up by 11% and the Americas grew 6% over last year. While we continue to be wary of macroeconomic challenges especially in Europe, we're encouraged that we've been able to deliver strong results even in these volatile and uncertain times. In summary, we're pleased with our first quarter results. We are well on track to meeting our fiscal 2012 guidance, and we believe this quarter demonstrates a considerable operating leverage that our company can deliver when we achieve top line revenue growth. Now let me pass the call to Mike Pung for further financial details.

Thanks, Mark, and good afternoon, everyone. We had a very good first quarter and demonstrated what we've been saying since we restructured a year ago, that our business model provides significant operating leverage. This quarter, we delivered $170 million of revenue, a 9% increase over the same period last year, and this translated into an 87% increase in net income and 105% increase in earnings per share as we realized the benefit from our share repurchase program. This leverage enabled us to post a non-GAAP operating margin of 34% this quarter, a 500 basis point increase from quarter 4. While we believe margins for the rest of the year will be closer to 30%, this quarter's results show what is possible when we have spikes in revenue. As we've stated in the past, we're actively pursuing and winning larger deals, and the timing of those deals can cause lumpiness in our license revenues from quarter to quarter. This quarter, we signed some very large deals, which carried very little incremental cost. Now I'll discuss the quarter in more detail. Revenue was $170 million, a $10 million increase over the prior quarter and a $14 million increase over the prior year period. Applications revenue was $110 million, up 13% over the prior quarter and the prior year. Scores revenue was $43 million, down 5% over the prior quarter but up 4% over the prior year. Tools revenue was $18 million, essentially flat when compared to both the prior quarter and the prior year period. By region this quarter, 74% of total revenue was derived from our Americas region, compared to 75% in the prior quarter. Our EMEA region generated 20% versus 18% in the prior quarter and the remainder of 6% was from Asia-Pacific compared to 7% in the prior quarter. By revenue type, recurring revenue, which is derived from transactional and maintenance sources, represented 67% of total revenues versus 72% in the prior quarter. Consulting and implementation revenues were 17% of total versus 20% in the prior quarter and license revenues were 16% of total revenue versus 8% in the prior quarter. The year-over-year increase in license revenue was primarily due to 2 very large term license deals for our Falcon Fraud Manager product. As I've mentioned in the past, our customers will occasionally request a term license rather than a usage-based fee. And in these instances, we recognized the revenue when the license is signed and paid. Although our guidance does not assume similar deals of this size, we expect license revenues as a percent of total revenue to increase during the year. We generated $13 million of current period revenue on bookings of $59 million or a 22% yield. This compares with $15 million of revenue on bookings of $112 million or a 13% yield last quarter. The weighted average term for our bookings was 22 months compared to 27 months in the prior quarter. Of the $59 million in bookings, 26% related to Fraud Solutions, as our Falcon Fraud Manager maintains its dominant market position, 18% was related to Decision Management Tools and 15% related to Customer Management solutions. We had 14 booking deals in excess of $1 million, 3 of which exceeded $3 million. Transactional and maintenance bookings were 33% of total this quarter versus 43% in the prior quarter. Professional service bookings were 46% this quarter versus 34%, and finally, license bookings were 21% this quarter versus 23% in the prior quarter. Operating expenses totaled $118 million this quarter, down $1 million from quarter 4. As you can see on our Reg G schedule, non-GAAP operating margin, which is before amortization and stock-based compensation, was 34% for the first quarter compared to 29% in the prior quarter. GAAP net income was $30 million and the effective tax rate was about 31% for the quarter, slightly higher than we expected due to the expiration of the R&D credit last month. As a result, we expect the effective tax rate to be around 31% to 32% for our fiscal 2012. Free cash flow, which we defined as cash flow from operations, less capital expenditures and dividends, was $33 million or 19% of revenue compared to $25 million or 15% of revenue in the prior quarter. Moving on quickly to the balance sheet, we had $232 million in cash and marketable securities. This is down about $10 million from last quarter due to share repurchases, offset by the strong cash flow from operations. Our total debt is at $512 million with the weighted average interest rate of 6.1%, and our cost of debt is fairly fixed at about $8 million per quarter. The ratio of our total net debt to adjusted EBITDA is 1.7x, below the covenant level of 3x, and our total fixed charge coverage ratio was at 4.2x, well above the covenant level of 2.5x. We had no borrowings under the line of credit facility, which we refinanced in September. We repurchased 1.9 million shares in our first quarter at a total cost of $50.9 million or about $26.96 per share, and we have $134 million yet remaining under our current Board authorization. We continually evaluate the best way to deploy excess cash to maximize shareholder value and consider our share repurchase plan a very attractive use of our cash flow. We also regularly evaluate and consider opportunities to acquire relevant technologies and products that advance our strategy or strengthen our portfolio and competitive position. Finally, I'd like to take a few moments to thank Mark on behalf of our shareholders and our employees for his leadership these past 5 years. He approached every day with amazing passion and conviction, and certainly has positioned us for continued success. Thanks, Mark. I'll now turn the call back.

Thank you, Mike. In this concluding section, I'd like to summarize the current state of our business and then turn the call over to Will for his comments. As you look ahead to the balance of the fiscal year, we are reiterating the guidance that we gave the last quarter, but with increasing confidence that we can achieve the high end of that guidance range. As a reminder, our guidance is as follows: Revenues between $640 million and $645 million or roughly 3% to 4% increase for the year compared with the $620 million of revenue generated last year; net income between $86 million and $89 million on a GAAP basis, up 19% to 24% from the $72 million of net income last year; and GAAP earnings per share between $2.45 and $2.55 based on 35 million shares outstanding, an increase of between $0.37 and 42% versus the prior year. We're off to a strong start for this year, while we understand that there are macroeconomic uncertainties that may impact our business, especially in Europe, and while we're increasingly confident, we remain cautious in our guidance for the remainder of the year. To sum up, we're pleased that this is also the quarter which demonstrate that our business model is driving solid earnings growth and margin expansion. We expect this to continue generating healthy earnings for our shareholders as we stay focused on driving top line revenue growth. Now before I turn the call over to Will, I'd like to offer a few comments as I reflect in my 5-year tenure as FICO's CEO. I'm proud of what we've accomplished over that time, especially given the turbulence of financial markets. During my tenure, we streamlined and simplified the business, exiting non-core areas so that we could focus on leadership products in 4 industries: Banking, Insurance, retail and healthcare. We re-branded the company under the FICO logo, sharpening and raising our market profile and our reputation. We make good on our promise of connected decisions, delivering industry-leading solutions that truly allow clients to make every decision count. And finally, we instilled greater operational and fiscal discipline across the company. These efforts have borne fruit as reflected in the company's current good financial health. As a result, I'm very optimistic about FICO's prospects and the outlook for sustained growth under Will Lansing, who succeeds me as CEO starting tomorrow. With that, happy turn the call over to Will for introductory comments.

Thanks, Mark. Good afternoon. I am delighted to become FICO's CEO and to get more involved with a company that I've known and respected for many years. I've served on the Board of Directors for the last 6 years, so I have some knowledge and perspective on FICO, including all the good work that's been done under Mark's leadership over the past 5 years. And so I start with a thank you to Mark for turning over to me a company in such fine shape and with such excellent future prospects. I've also been around long enough to know that I have more to learn, and that's what I aim to do in the weeks ahead, learn as much as I can about our customers, about our partners and about our competitors. We've just reported an impressive start to the fiscal year as you heard earlier. The team feels good about our direction. We have some interesting growth opportunities before us, but those are tempered by a bit of uncertainty, for example, the debt crisis in Europe. You're probably wondering what to expect with this transition. I don't think that you should expect large directional shifts. As a Board member, I have supported the strategy and approach that has taken us to where we are now. Given our current trajectory, I do not anticipate dramatic change. We have a strong confident team here at FICO, and I have worked with this executive team for years. You'll see in my background that I have been involved in deals and M&A. Should you expect more of that at FICO in the future? Well, FICO has had some wonderful acquisitions in the past, for example, our acquisition of HNC. And we have, from time to time, made acquisitions of smaller companies where we thought it would be helpful. I believe that we can complement our organic growth with M&A growth, but I think we have a very high bar. Our own business is highly attractive and our prospects are bright, so any acquisition would have to be at least as attractive as investing in ourselves, and that is truly a high bar. As you know, we've had a successful value creating stock buyback program over the last few years, and I have fully supported that. Buying back FICO stock served us well, and our intention is to continue with the buyback program. I'm about to dive into meetings with our employees, customers and partners all over the world, and certainly plan to meet with investors, too. I look forward to meeting with you. Thanks. Mark?

Well, thank you for your kind comments, and well, now let me turn the call back over to Steve for our question-and-answer period.

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

[Operator Instructions] Your first question comes from the line of Manav Patnaik from Barclays Capital.

Just wanted to congratulate Mark and William, I guess, on the transition going on, and looking forward to meeting you, William. One quick question on the 2 Fraud Management and license bookings, I guess, that you mentioned. Is there any way -- I know you mentioned there was very little incremental cost, but is there any way to quantify that in terms of what EPS benefit that had in the quarter? If basically those were not signed, what the number might have looked like?

So, Manav, we aren't in the practice of or would I be in the practice of pulling out any specific transaction or sets of transactions to do an EPS calculation. I think looking at the face of the income statement and seeing the growth in our license revenue can give you an indication of how important those deals were to us. But we don't do any what if calculations on specific transactions.

Okay, fair enough. And then related to that, I think you had mentioned that you would expect license revenue as a percentage of total revenue creep up. So I just want to clarify, so that was about 16%, I think, of revenues this quarter, so you expect that 16% number to either stay there or continue to rise for the rest of the 3 quarters?

No, what I meant to say is I expect for the full year the percentage of revenue coming from license sales will be larger than it was last year. It won't creep up from the 16%.

Got it. So it was on a yearly basis?

On a yearly basis, yes.

Okay, fair enough. And then if I could ask just on the Scores business, Mark you mentioned that all forms, the acquisition, Origination and account management were up. I was just hoping if you could maybe give a little more sort of macro color on those 3 different things and how you might see that trending given the economic environment you're in right now?

Happy to do so, Manav. What we are seeing -- what I've been hoping to see for several quarters, which is the monkey flowing through the snake as it were. So we continue to see increased activity [indiscernible] end of the life cycle and applications, that's the of 14% number that I mentioned, but now we're also seeing an uptake in subsequent originations in account management, so that's a good thing. I would only temper that by saying one quarter does not sit in our trend line make yet, so let's see several more quarters of that before we really feel good about this growing business. But it is nice to finally see growth occurring across the spectrum here. We've not seen that since the downturn. So I'm cautiously optimistic that we've turned the corner, we see tentative signs of recovery in the U.S. but we want to see another quarter or 2 of that kind of behavior before we conclude that we've actually really turned the corner.

Got it. And one final question on R&D, the $13 million, I mean, any color on what we should expect that number trending for the rest of the quarters? I mean it seems like for the last 5 quarters, you guys have cut that number lower and lower, and maybe if you can comment on why it just keeps going down as opposed to maybe throwing that into developing new stuff.

Sure, Manav. So R&D this quarter was roughly the same as it was in our fourth quarter, which has been our run rate. Last quarter, I think I gave guidance that I was expecting the R&D expense to be somewhere around 9% to 10% of total revenue, and that's still where I expect it to be by the end of the year. And so I wouldn't expect the trend to drift downward from where we are. We're at a spend level now that we're very comfortable with in terms of investment against the roadmap we're operating under.

Your next question comes from the line of Carter Malloy from Stephens Inc.

Will and Mark, congratulations to both you guys, and the rest of the team there as well for a great quarter and what appears to be a great trajectory coming into the year here. I do want to go back to the questions on Fraud Management there and the license revenues. You said license was 16% this quarter versus 9% year-over-year. So we're looking at an incremental $15 million in license revenue give or take. Should I assume that most license revenues are concentrated within Fraud, is that one way to look at it without having to have -- have you call it out specifically?

No, the increment is within Fraud, but most of the other license revenue is really derived from our Blaze or our Tools products and a couple of other parts of the applications. But the increment this quarter is the Fraud products that I described.

Got it. Got it. So if we back that up or back that out of our models, we're sort of looking at returning to a more normalized call it $155 million, maybe $160 million run rate for the rest of the year, that's how you build up the guidance?

Well, we built up the guidance a little bit differently, but let me get to that in a second. We wouldn't advise you to back out anything in terms of looking at our revenue. In fact, every quarter, we have license revenue, whether it be perpetual or term, that come and go depending upon the timing of a deal. It just so happens we had 2 very large ones this quarter, and in future quarters I expect us to have other license deals that will flow in and out as the timing occurs. So I don't think it's safe just to back those out and say that's a new run rate. If you follow the math around the guidance that we gave you for revenue, at the top end, $645 million of revenue minus what we did in the first quarter would suggest something around $158 million of revenue going forward for the rest of the year. And that would be a way for you to back into how we constructed our guidance.

Got you. But effectively, if we look at $158 million, if you have other Falcon-type deals that are this big, then we can have another quarter or 2 throughout the year that looks something like this, where we are surprised to the upside by a whale contract that comes through.

Well, there's always the possibility of a whale contract coming through and we've not built any of that into our guidance. We've not made an assumption, in other words, that there would be another whale. But certainly, as you saw last quarter in our bookings, we have 3 very large booking deals. This quarter we had 2 very large term license revenue deals, and it is possible that the from time to time we'll see larger transactions, though the ones we saw this year are much larger than normal. They also can come, by the way, Carter, in areas outside of Falcon, for example, Blaze.

Okay. Okay, very helpful there. And then also, your EPS guidance for the year, which appears equally, if not more so, conservative, I'm assuming though in your end there is no more buyback built into your guidance, is that a safe assumption?

We do have a little bit of guidance built into our plan. And as you remember, it's not much. But as you remember, we took a large amount of shares in the month of October when we were trading in the low 20s and our stock price has drifted upwards and the pace by which we've been buying shares back was changed based upon the way the market has been on our stock recently.

Sure, we noticed that. It's great. Then lastly on CapEx, decent-sized tick-up this quarter, is that a fair run rate or is there some one-time stuff in there?

No. Last quarter, I'd mentioned that the fourth quarter CapEx was a little light as we've been building out a data center, and that some of the spend we thought would come in, in the fourth quarter, actually hit in our first quarter. We're fundamentally done with equipping the data center, and so it's not a run rate, it's a little bit of spillover, I'll call it, from the fourth quarter. I would say our CapEx is probably trending more to the $20 million range as a result of that rather than the $16 million to $18 million that we've historically done.

[Operator Instructions] There are no further questions in the queue.

Thanks. This concludes our call. Thank you all for joining.

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