Fair Isaac Corporation (FICO) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is Charlene, I will be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. Mr. Steve Weber, you may begin your conference, sir.

Thank you, Charlene. Good afternoon, and thank you for joining FICO's second quarter earnings call. And 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. 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 the actual results to differ materially. Information concerning these uncertainties is contained in the company's filings with the SEC, in particular, 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 the Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measures. 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 May 24, 2013. Now I'll turn the call over to Will Lansing.

Thanks, Steve. Today, we announced the results for our second quarter of fiscal 2013. I'll briefly discuss those results, update you on our progress with the acquisitions we've made in the last year and discuss some of the internal investments we've been making to generate greater value from our product portfolio. In our second quarter, we reported revenue of $179 million, an increase of 12% over the same period last year. We delivered $25 million of non-GAAP net income and non-GAAP EPS of $0.69 per share, an increase of 5% from the same period last year. On a GAAP basis, we delivered $18.5 million of net income and earnings of $0.51 per share for the quarter, down 8% and 7%, respectively, from the same period last year. The reduced margin is primarily due to soft license sales this quarter as well as implementation expenses as we ramp up applications to drive future recurring revenue. Mike will delve into the numbers in a few minutes and discuss how we expect to deliver the full year results we've guided. But first, let me tell you a bit about our acquisitions and internal investments we've undertaken that are advancing our growth strategy. This quarter, we announced the acquisition of Infoglide, a leading provider of entity resolution and social network analytics. This tuck-in acquisition brings critical link analysis functionality that we've been licensing from them for our fraud prediction products. The technology is state-of-the-art at finding suspicious information in an insurance claim or financial transaction and then making links with other transactions to expose otherwise invisible patterns. And in this era of Big Data analytics, it has applications to other areas that interest our clients, social networks, for example, that extend well beyond fraud management. Watch the space for some exciting developments in the…

Thanks, Will, and good afternoon, everyone. Today, I'll emphasize 3 points in my prepared comments. First, our revenue this quarter was $179 million, a 12% increase over the same period last year and a 6% increase -- 6% decrease over the prior quarter. Our recurring revenue remained strong, representing 71% of total revenue while license revenue this quarter disappointed. Second, we delivered $18.5 million of GAAP net income and $0.51 of GAAP earnings per share, decreases over the same period last year. On a non-GAAP basis, both net income and EPS increased from the same period last year. Finally, we delevered our balance sheet over the past 2 quarters. Free cash flow was $31 million this quarter and our cash balance now stands at $131 million. Turning to revenue. Revenue for the quarter of $179 million or a 12% increase over the prior year. Approximately 10% of the growth related to the Adeptra and CR Software acquisitions. I'll breakdown the revenue into our 3 reporting segments. The first segment is applications. Revenue from applications was $117 million, up $21 million or 22% versus the same period last year but down $7 million or 6% from last quarter when we had several large license deals. Much of the increase is due to the acquisition of Adeptra and CR Software, which accounted for about $17 million of revenue this quarter. The rest of the portfolio performed well, growing about 4% over the same period last year. The second segment is Scores. Overall Scores revenue was $44 million, essentially flat with the same quarter last year and up 1% from the prior quarter. The B2B revenue was flat with last year which has, a reminder, included a one-time Scores project. On the B2C side, the renewed focus we're putting into the business is…

Thanks, Mike. This concludes our prepared remarks. And we're ready now to take your questions. Operator, please open the line.

[Operator Instructions] Your first question comes from the line of Carter Malloy from Stephens.

So can you give us a little more around the license revenues' softness this quarter and really just more around your confidence going forward? Because looking at tax rate up and OpEx up, we're going to be leaning pretty heavily on that on the revenue growth to come through for the back half.

Yes, absolutely, Carter. So at the beginning of the year, we had an annual guidance that had very aggressive license revenue. We saw a very good pipeline coming into the year across the existing businesses we have and since then, we had bought CR Software. And the pipeline of CR Software's -- came very large and is growing even more significantly now that we have a system of record embedded within our collections and recovery business. Coming into the end of this quarter, quarter #2, we had a handful of large transactions that we had line of sight on, that we didn't get the deals done on and didn't get them closed for a variety of reasons, purchasing decisions were delayed and some of the deals slipped forward. We've signed 1 or 2 small ones but we're still pursuing much of the large transactions. With that, we also believe that with the CR Software business and the ramp-up of the Adeptra business, we do have line of sight certainly to the bottom end of our guidance and enough pipeline to safely get us well within the guided range we have on revenue. As it related to OpEx, while we see some modest increases in OpEx over the balance of the year, we pretty much absorbed all the cost associated with the acquisitions. And now it's a matter of simply just running the business as efficiently as we believe we have in the past and we can. And so while we see some modest growth on the OpEx side, it isn't going to be very significant with respect to, certainly, what's been seen with the on-boarding of some of these transactions. As it relates to the tax rate, we've been guiding the full year all along at around 31% to 32%. So really, nothing's changed there but for the reinstatement of the R&D credit, which we assumed would happen within the numbers we provided at the beginning of the year.

So that helps. And on -- so on the R&D expense line, do you expect it to stay down here as percent of revenue and not -- at last couple of calls or 2, 3 or 4 calls back, that was expected to go up. But since, it seems you guys have maybe capped that back off down here in the high single-digits.

Yes. I mean we were expecting it to be around the 9% range. Actually the absolute dollar amount has gone up and part of that is just a redeployment of functions from other areas into R&D, so taking administrative cost out of our R&D team or our IT team and reinvesting it on the R&D line item. But the rate we're running at right now is probably the right absolute dollar amount.

Your next question comes from the line of Manav Patnaik from Barclays.

Well, just firstly, you talked a lot about the -- on -- in the innovation section, you ran through a bunch of different things which you sounded excited about. Could you just again just -- I sort of missed the last one you talked about, the one you're releasing in Miami, if you could just repeat that. And then just when should we start -- like what's sort of time frame should we expect seeing some sort of a benefit or meaningful contribution through revenue from these products that you talked about?

Sure. So if it sounded like we didn't give you a lot of detail around that last item, it was by design. It was because we're announcing it formally at FICO World in 1 week. But I'm happy to give you a little bit more, I don't think it will spoil the party. It -- we call it decision management platform and it's basically our analytics in the cloud, made available on the cloud, that it's very easy for customers to pull down our analytic tools and apply them to whatever it is they like and make better decisions with it. So that's -- we think that's going to have a lot of uptake. We think that's going to be a pretty good product offering, I should say, it's really a service. And so that's one. I'd say one that has more short-term impact is our Infoglide acquisition and how that ties to some of the internal fraud products that we've developed, particularly around application fraud. That is -- as I said earlier, it's a really big problem for the industry and we're now increasingly able to focus on it and help them with it. The -- in terms of time frame, we love all our children equally. We invest in all of our important franchises and we continue to make good progress with Falcon and good progress with our other major franchises. The collection recovery franchise has been challenging, I guess, is a way to put it, because we've been accelerating the migration from our legacy products over to our newly acquired Debt Manager 9 product and that resulted in some incremental expense this quarter, not that it wasn't anticipated but it's expense we don't anticipate recurring. And so I think that we're going to start to see a lot of benefit out of that transition. And particularly, when you look at our collections recovery franchise, not just from the standpoint of a core product in Titanium/DM9 but also the way it works with Adeptra and how those products tie together, I think we're going to see some really meaningful revenue and profit coming out of it. And that could -- that's just going to accelerate in the back half of the year and into next year.

Okay. Fair enough. And Mike, you talked about, in your commentary, that you were encouraged by the macro trends. Could you maybe expand a little more with some specifics on what you guys are seeing and what those data points for that were encouraging?

Yes. In particular, Manav, we've been experiencing a long period of time, as you know, where our Scores business and the volumes underneath our Scores business on the Originations side have been going sideways. And we're starting to see some improvement on that end. It just so happens we had a tough comparable period for our B2B Scores business and that last year we had a large transaction that hit our revenue line item. But except for that line item, we're starting to see some nice growth on the B2B side. I wouldn't say we're off to the races and I am not trying to imply that. But certainly compared to what we've seen in the past, we're starting to see further progress on the macro side on the Scores business.

And I guess, in the balance sheet, you talked about the mix of your business here between credit card, mortgage and the rest. Can you provide any more color between those like anyone doing better than the other that's taking, I guess, the modest growth that you're referring to?

Yes, I know. We're -- things haven't changed materially on any of the individual particular line items. We're seeing a little bit more out of credit cards but fundamentally, things haven't materially changed.

Our next question comes from the line of Matthew Galinko from Sidoti. Matthew Galinko - Sidoti & Company, LLC: I saw CapEx seems to be trending a little bit higher through the first couple of quarters for the year. Just curious what's driving that and how do you expect it to close out back half of the year?

Yes, that's a great question. CapEx, year-to-date, is probably twice what it was last year at this same time, Matt. And a big part of what is driving the growth was the opening up of 2 office facilities, one in Roseville, Minnesota and one here in expansion in San Jose where we've, in Minnesota, consolidated from 2 facilities to 1. And that included some build-out along with just equipping the facility, much of that hit in the first quarter. In the second quarter here, much of the driver behind the CapEx number was investment that we have made in -- on the Adeptra side to set up distribution opportunities outside the U.S. and Asia, in particular, where we signed a couple of very large deals along with simply the equipment in PCs and things of that nature that we have upgraded and put into the hands of the people in the companies that we bought. We'll probably end the year up with, in total, $25 million to $28 million of CapEx, which is quite a bit larger than we'd historically run. But we're investing in parts of the company that -- especially on the Adeptra side that does have revenue payback, it's just not overhead. Matthew Galinko - Sidoti & Company, LLC: Got you. And I mean, how substantial are the investments in billing some hosted infrastructure as I think you talked about in some of the new products?

Overall, they're not material in that an Adeptra data center, as an example, is not a significant full service data center, it's more of a telecom data center. And so the investments aren't that large individually. And in the aggregate, we're putting them in place in countries where we see the largest of opportunities. So in the grand scale, they're not really significant. For the rest of the business, we generally made our data center investments about 1.5 year ago and we still have enough capacity in the U.S. for, I'll call them, legacy FICO ramp-up. Matthew Galinko - Sidoti & Company, LLC: And then can you just repeat what you saw on the B2C side of the Scores business?

Yes. Our B2C side grew 13% on a year-over-year basis. We were very close to $11 million of revenue on the B2C side, something we haven't seen in several years. Much of it is driven from an increase, conscious increase, to grow our subscription side of that business as opposed to onetime Score polls. And as you compound enough of that backlog of subscription revenue, you begin to see some lift and, in fact, we're starting to see that along with the benefits of some of the infrastructure changes that we made 1 quarter ago.

Our next question comes from the line of Tom Ernst from Deutsche Bank.

Nandan Amladi on behalf of Tom. Going back -- I have a 2-part question. On some of these new products, I know you sell subscriptions. Has the nature of the sales process changed at all as a result? And second part of the question is do you have enough sales capacity to address the stronger second half?

So the answer to the first question, yes, absolutely. There's a difference in the way you incent salespeople for SaaS business. And when we acquired Adeptra and Entiera both, I mean, there was -- we incorporated into our sales plans some of the sales incentive methodology that was in place there. As more and more of our business becomes available on a SaaS basis, we will be working through the implications of that for how we drive incentives through our sales force. To the second part of your question, the capacity -- we actually feel like our capacity is adequate. We feel pretty good about it. And we are always adding and subtracting salespeople on the margin. But we're -- I -- we feel comfortable about where we are.

[Operator Instructions] There are no further questions in queue at this time. I'll turn the call back over to the presenters.

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

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