Verisk Analytics, Inc. (VRSK) Q3 2013 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Verisk Analytics Third Quarter 2013 Earnings Results Conference Call. This call is being recorded. At this time, for opening remarks and introduction, I would like to turn the call over to Verisk's Senior Vice President, Treasurer and Chief Knowledge Officer, Ms. Eva Huston. Ms. Huston, please go ahead.

Thank you, Julie, and good morning to everyone. We appreciate you joining us today for a discussion of our third quarter 2013 financial results. With me on the call this morning are Scott Stephenson, President and Chief Executive Officer; and Mark Anquillare, Chief Financial Officer. Following comments by Scott and Mark highlighting some key points about our strategic priorities and financial performance, we will open the call up for your questions. The earnings release referenced on this call, as well as the associated 10-Q, can be found in the Investors section of our website, verisk.com. The earnings release has also been attached to an 8-K that we have furnished to the SEC. A replay of this call will be available for 30 days until December 6, 2013, on our website and by dial-in. Finally, as set forth in more detail in today's earnings release, I will remind everybody that today's call may include forward-looking statements about Verisk's future performance. Actual performance could differ materially from what is suggested by our comments today. Information about the factors that could affect future performance is summarized at the end of our press release, as well as contained in our recent SEC filings. Now I will turn the call over to Scott Stephenson.

Thank you, Eva, and good morning all. Before I launch into the financial results for this quarter, which were solid but shy of our longer-term objectives, I'd like to review several recent accomplishments. We are confident our long-term prospects remain excellent. Over the years, you've heard us speak about running the business with a long-term prospective. Our view on this remains consistent. Recently, we put more emphasis on our innovation agenda, which has always been an underlying theme for how we have grown while delighting our customers. Our long-term management of the business and our determination to innovate are very well aligned. Innovation works over long cycles, and we will continue to invest in a thoughtful way to support new data analytics solutions for our customers, which will result in strong revenue growth over time. We remain focused on our twin goals of organic growth through innovation and operating our business with efficiency and scalability. We were pleased to achieve several innovation milestones in the third quarter, including initial customer use of our pooled data initiative for healthcare, our first provision of Roof Insight reports using aerial imagery and the first sale of our new supply chain platform. While these initiatives are not revenue-generating in the quarter or materially in 2013, they are a good indication of future opportunity. To delve a bit deeper into what these can mean, let me take as an example the new pooled data initiative to fight healthcare fraud, which Verisk Health launched in the third quarter. With some of the nation's leading healthcare payors joining as founding members, we built a database across payor information and analytics designed to combat the estimated $300 billion that America's healthcare loses annually to fraud, waste and abuse. This initiative will turn the identification of improper or elicit…

Thanks, Scott. For the third quarter, we again delivered both revenue growth and increased profitability. In the third quarter, total revenue grew 10%, and organic revenue grew 6.1%. Excluding our historical mortgage business, organic revenue growth in the quarter was 8.2%. Let me dive into the details for you. For the third quarter, our Decision Analytics segment delivered 11.2% of revenue growth, of which 5.2% was organic, excluding the acquisition of Argus. Beginning next quarter, Argus will be part of the organic revenue growth in the financial services category. Within Decision Analytics, our insurance category revenue grew 11.5% in the third quarter. We had discussed our expectation of accelerating revenue growth of the combined insurance revenue this year and are pleased to see ourselves continue in the direction with 9.5% organic revenue growth in the quarter, including Risk Assessment. Our underwriting solutions delivered strong growth, and we saw a continued double-digit growth in our catastrophe modeling solutions in the quarter. Our claims solutions also contributed to growth but not as strongly as in the past due to historical claim trends Scott referenced. Additionally, we saw a benefit of a little over $3 million related to the implementation of our solutions with a large customer. The comparison in the fourth quarter for insurance are a bit tougher as we saw in the past 2 quarters. In financial services, which includes both Argus and the mortgage analytics business, revenue grew 26.6% in the quarter. Argus has continued to perform very well since the acquisition in third quarter 2012. Argus is a very ISO-like business and serves as a trusted, neutral intermediary using a contributory data model to help create analytics, which are deeply embedded in our customers' workflows. The growth outlook at Argus remains positive, including through international expansion and partnering opportunities,…

[Operator Instructions] Your first question comes from the line of Tim McHugh with William Blair & Company. Timothy McHugh - William Blair & Company L.L.C., Research Division: First, I guess, I wanted to ask about the healthcare business. And just, I guess, I apologize if I missed it, but just to make sure I heard it correctly. The weakness was mainly in RQI, and it was isolated to 4 main customers. Is that correct?

Tim, this is Scott. Yes, that's correct. They're -- basically all of -- the difference between our original expectations and where the quarter came out were a function of events at 4 customers, and in all cases, that was related to RQI. Timothy McHugh - William Blair & Company L.L.C., Research Division: And did you trade off lower price for more volume at each of those customers? Or was...

No, no. In the comments I made upfront, Tim, I said that of the 4, 3 of them were slowdowns in terms of implementation or ramping. One of them was because we traded off price for longer-term commitments. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. And do you have any sense for why the volumes slowed down, I guess, at those customers?

A lot of it has to do with the ability to get implemented. And the ability to get implemented is not always fully in our control. Timothy McHugh - William Blair & Company L.L.C., Research Division: But these are new -- these are not existing customers that slowed down from what you saw last year necessarily. These are new customers that didn't add as much...

One thing to bear in mind about our business, Tim, is that we have a very healthy mix of new business with new parts of an existing customer, as well as absolutely new customers. And so you actually have those effects inside of what was happening. In other words, an existing customer, which is trying to implement in a different part of their operation, that actually shows up in some of those cases that I was just mentioning. Timothy McHugh - William Blair & Company L.L.C., Research Division: I guess, if we want to look, is there any -- in trying to understand, was there any competitive impact? And/or was there any signs that the customers are less interested or demand is less for these solutions?

No, to both questions. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. And then just the follow-up, did I -- on the margin side, did you say -- with the 100 basis points for the -- was that in terms of margins being down perhaps as much as that? Was that for the year or...

Correct. Yes, it was for a year. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. So obviously, an even bigger decline implied for the fourth quarter.

Correct.

Your next question comes from the line of Andrew Steinerman with JPMorgan. Andrew C. Steinerman - JP Morgan Chase & Co, Research Division: I wanted to also ask about revenue quality intelligence, RQI. This unit primarily serves Medicare Advantage plans, optimizing reimbursements and such. And when you look at the headlines for Medicare Advantage plans at places like UnitedHealth, it seems like Medicare Advantage plans themselves have some headwinds. Do you think that has anything to do with what you described in the Verisk Health business?

Yes, Andrew, this is Scott. I don't actually. And you're right about those headlines, and we're aware of what's going on in the space. But the fundamental fact of our situation remains that we are still a relatively small player inside of this world. And so our opportunity is ahead of us, and it really is centered upon building out our business and acquiring business with a number of plans that we don't even work with today. And so yes, there are the dynamics of what's going on inside of the category. Although I will say that it remains the case that Medicare Advantage plans are still highly incented to get after precise measurement of their performance, both cost and quality, since their reimbursement hangs upon it so deeply, and that's the category that we're providing here. So no, I don't think that there's really any affect in what happened in this quarter nor will there be in the -- at least, in the near-term future because our opportunity is essentially to take more space starting from a relatively small position. Andrew C. Steinerman - JP Morgan Chase & Co, Research Division: Right. And you said these 3 clients will be implemented soon, right?

They are -- we believe that all of them are in the process of moving towards contracting with us and/or expanding their business with us.

Your next question comes from the line of James Friedman with SIG.

So Scott, I had a couple of questions. Upfront you had described some of the innovation initiatives related -- one you mentioned related to pooled healthcare fraud from -- yes, so maybe if you could help us to -- it seemed important, potentially important that you have payers that are joining that initiative. If you could help us to understand how that rolls out and the magnitude of it.

Right. So first with respect to the rollout, a lot of -- a fundamental fact is that a lot of the fraud, waste and abuse the goes on in healthcare is actually perpetrated by providers. And when you take that perspective, then immediately, you're framing on trying to get after this becomes a somewhat local one because you're actually trying to diligence providers in the way they interact with payers more on a market-by-market basis. And so the way that we've gotten started with this is the -- in the first phase of this, we've got -- we have 2 national players who have come in, but they have come in only for certain localities. And so the rollout is going to take 2 forms: one is hope -- we expect that they will bring more and more of their localities into the pooled data initiative; and then secondly, more payers will enter in to the initiative. And so just to kind of give you a sense of kind of the scale of all of this, with the providers that we started with, we're dealing with a relatively small fraction of their total business is inside of what we're doing today. And the next wave of payers to come in, we would expect it to be on the order kind of 3 to 5 additional source of plans, and that sort of pace of build over the course of rest of '13 and into 2014, is kind of what we're looking for. So it does grow. It's not growing linearly. It will be much more than that, and there is the network effect of having more and more payers in the process. So we -- that's the way that we think it'll grow.

Okay, that sounds exciting. And then switching gears on the aerial imaging side. Mark, you had mentioned $10 million of incremental investments. Is that -- if you -- so are you putting infrastructure into database, the images? Is it procurement of the infrastructure to get those images? Where is that $10 million going?

Sure. So let me describe, the images are one thing, obviously, a lot of people have pictures. What we are actually trying to do is go one step beyond that and from those pictures derive data through a computer vision actually creating what is specific measurements of roofs and homes and information that can be used for both claims and underwriting in the P&C space. We have been on this agenda now for over a year, and we have built out the infrastructure from standpoint of the technology, the data center and the servers. However, as you actually start to collect and aggregate data in the form of images, that needs to be expensed, not a CapEx item. And so we're trying to call out some of the P&L impact associated with that initiative, and there is a bigger chunk in the fourth quarter. That's what I was trying to describe there in the $10 million.

Okay. And then the last question, if you look at both of these, should we view them between pooled health and aerial imagery as long-term revenue objectives? Or are we going to see some waterfall sooner potentially next year?

We definitely expect revenue from both in 2014, absolutely.

Your next question comes from the line of Joseph Foresi with Janney Capital Markets.

This is Jeff Rossetti in for Joe. I was wondering if you could provide some additional color on healthcare within Payment Accuracy and Enterprise Analytics, maybe how those businesses performed, excluding RQI?

Let me take that one. This is Mark. The general theme is they have performed well. I would tell you that the bigger growth in the opportunity at least recently has been with RQI, and that's where we've seen some big customer contracts. I think the underlying theme around Payment Accuracy, which is the fraud and abuse case, is very strong, and we continue to have nice ramping customers in volumes. Although as the business gets larger, it's tough to grow at the same percentage rate. So what we've seen is growth extension and the opportunity to continue to add dollars. But the dollars are on a bigger base, so the percentages are lower. From an EA, which we refer to as Enterprise Analytics side of things, a little more competition in this space. I think we see opportunities there that extend beyond what as providers -- excuse me, extend beyond what are the payers and into the provider space, and we're ramping up in spending and investing there with the opportunity to kind of extend the market opportunity as what is, call, population management or the world of what we do in Enterprise Analytics can be applied to a shifting set of risks potentially inside of the healthcare space as providers probably take on some more risk in the future.

And I'll just add to that, a very pleasing fact for us is that we now have a material fraction of all the ACOs, which have been launched to date as customers for our EA division, which is a really, really nice place to sit.

And just one follow-up, Mark, I apologize if I missed this. Did you say there was any change to your 2013 investment plans and innovation of -- or is it still tracking at around $90 million?

So I think what we tried to describe, the dealer part was -- and this is more of a CapEx discussion and then I'll double back into the P&L. Our CapEx is higher right now. I want to just at least give a little color and clarity on that. And inside that, I think at least $10 million additional has been added. So now we're at about $30 million inside that CapEx because of these investment initiatives and some of that additional CapEx is really just because operational needs to get the bigger, whether it's around facilities or just it's around computing power. That's been the focus with some additional CapEx. I think that answer your question. If you're more on the P&L side, I'm happy to go into a little deeper dive there, but what we tried to reflect inside of the -- up to 5 -- 100 bps is some of the expense that we would incur resulting from the investment initiatives, which are more than $90 million today from what I'll call P&L perspective.

Your next question comes from the line of Suzi Stein with Morgan Stanley.

I know you've been asked this question a number of different ways, and I'm not sure that I completely understand this. So how significant were the pricing concessions? Because maybe I'm not thinking about this right, but if part of the disappointment in Health in the quarter was related to delays in transactional volume. And I think you mentioned that was the case with 3 of the 4 big customers. Then, why aren't you expecting growth next year to be higher than mid-teens? I mean, is the real underlying organic growth in healthcare now actually lower just given that, that mid-teens number includes some of this catch-up revenue?

Yes, it's not -- no, there's not a catch-up effect here. So I'm not quite sure I'm tracking your question, but let me say it the way that we see it and understand it. So we made some trade-offs in the third quarter with respect to price, which showed up in our third quarter results, will show up on our fourth quarter results. And will have the effect of relating to transaction volumes in '14, '15 and '16 in particular. Then separately, there are customers that we're finding are intending to be our customers, but the rate at which they are moving into being a part of our customer set is lower than we had originally thought it would be. And that applies in the quarter, but also as we try to think about where the business is going to be in '14, we're seeing some of that same effect. And as I think you know, a large fraction of what we do and in healthcare, about 70% of it, is transactional as opposed to the rest of Verisk, which is about 70% subscription and recurrent. And so that which we don't get in '13, it's not -- it doesn't just roll over into '14.

Okay, and then separately, when do you expect mortgage to bottom? And then are you going to continue breaking out mortgage within the financial segment going forward once Argus is brought into organic?

Well, I'm sure that we would -- I'm not on the point about specifically what our reporting looks like, but certainly, we will continue to comment on mortgage just because mortgage is a meaningful part of what we're doing in financial services. With respect to the bottoming, you got to look at 2 things. One is what's happening with respect to mortgage origination volumes. And there, according to the MBA, the expectations for '14 is it'll be a somewhat softer market than '13. And then the other piece is cycling through the forensic piece, and our view is we haven't quite gotten to the bottom yet, but we're moving towards it.

Your next question comes from the line of Paul Ginocchio with Deutsche Bank.

And just another question on healthcare. Just it looks like your fourth quarter, your guidance for 2013 would imply fourth quarter healthcare revenue growth to be about 0% to 6%. Is that what -- is that the right implication? And then on 2014, we just saw the trading pricing for volume, we start to see that pick up in '14, so why -- just maybe one more point of clarification on why we're not kind of reaccelerating back toward that 20%? Then a quick final one on the margin. Are we flat into '14 from 100 basis points down in '13?

Okay, so let me take the healthcare question. So for first of all, in the fourth quarter, you talked about a 0% to 6% range. We think we're at the higher end of that range but yes. Again, the slowdown on the ramp-up is an effect which doesn't happen at just one moment in time. In other words, we're trying to be very clear and very thoughtful about what we see happening across the customer base, existing customers, as well as prospects, the ramping up at existing customers, as well as prospects. And so that effect is at work in '14, as well as '13. And then, Mark, do you want to just talk about the margin question for a moment?

Yes, when I was referring to the 100 bps, I was referring to full year '13. I think we've continued to have a view that we'll be in that high end of the range of 43% to 45% as we roll into '14 and beyond.

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

Just one on healthcare for me as well. But the impact, I guess, the pricing impact on that one customer, I'm just trying to understand like can we see more of that sort of trade off that you're making on additional customers down the road that could have a similar impact.

I would say that it's possible. What happened in this case was very specific to the individual customer. And -- but we're also paying a lot of attention to price realization in the category. And again, we are still sort of the, relatively speaking the new kid on the block in healthcare generally. We were -- in 2010, we did about $55 million of healthcare and you know where we are now. So our position is one that isn't -- is emerging relatively quickly. It's in a category where a lot of the product today tends to be transactional rather than long-term subscription. So we're working very hard to secure that business. But it's also the case that the customers themselves are going to have a view about exactly how rapidly they're looking to grow their own books of business and how rapidly they're looking to grow their engagement with us. And so those are essentially the moving piece parts. And in the middle of all of that, our goal is to become an increasingly relevant part of what it is that they do. So certainly, if there were opportunities to trade off price with volume, we would take a look at those because we want to be a leader. And this is a moment where we're introduced to new customers that we haven't worked with before, and we're expanding relationships with existing accounts, and all of that is -- it's very dynamic. And we're open to what the right way to go about optimizing that going forward.

Okay, fair enough. And then, I guess, just within the healthcare space as well, I mean, and in line with your commentary around an active M&A pipeline, can you maybe talk specifically on how you see your mix shifting towards maybe a little more M&A now that you've been a couple of years so without doing much in that space?

Yes. Well, as you know, 2012 was actually a very active year for us in M&A. So there was a little bit of -- we needed to fulfill our commitments with respect to our leverage, and we accomplished that. But otherwise, we remain as active in them M&A process as we've ever been. We -- and I would just underline that we continue to be thoughtful about what we think is the right assets, and we're certainly looking hard at what are fair valuations. I think it's fair to say that in this time of relatively cheap money, valuations have tended to move up. There have been several transactions this year around assets that, from the headline level, at least you would have said, "Gee, isn't that really logical for Verisk." But as we looked at them, we thought very long and hard about valuation and what we thought was the right way to use our shareholders' money and in some cases, took a pass. But we're as active as ever, and we remain very committed to the M&A agenda as part of long-term value creation here.

Okay. And just, Mark, finally on the mortgage side, can you -- what is the mix between forensic and the front-end piece? And just to clarify, in your comments, you said that the front end, the one tied to originations was down as much as the market was?

That is correct. So what we've seen is, at one point, the forensic was as much as 60% of the business. I think we're kind of trending towards that 50-50 at this point. And to clarify, yes, we have seen a lower or lighter decline on the forensic side. And with regard to the front end of the business, which is more closely tied to originations, it was kind of down consistent with what has been a drop in the overall market in the a number of originations there.

[Operator Instructions] Your next question comes from the line of David Togut with Evercore Partners.

Could you give us a sense of, Scott, of the performance of some of your acquisitions in revenue and quality intelligence? That seems to be the area within healthcare where you've been most active from M&A standpoint, in particular MediConnect. As you look at the properties you've acquired over the last couple of years, have they performed about in line with your buy plan?

They have, yes. They -- and one of the things that we talked about a couple of quarters ago, actually, when we were characterizing MediConnect upfront, was that we thought that something unique would happen when we put MediConnect together with the assets of what we used to call HRP because essentially we were now sort of fulfilling a value chain where it began with chart abstraction and ends with the analytics to support the payer in making their argument for their cost and quality outcomes. And so we had -- we were putting all of those assets together. And in fact, what we saw over the course, particularly of third and fourth quarter 2012 and first and second quarter of 2013, was that some demand was essentially liberated by virtue of our ability to provide that end-to-end solution. And you certainly saw that in our results and in the substantial organic growth that took place there. That effect continues to occur, and that's why we believe that we're going to have a very healthy level of growth in the healthcare business next year. But there was sort of a moment in time response to a capability that just was not there for us prior to the 2 assets coming together. And each of them individually has continued to do well. MediConnect has very much been operating according to plan.

Good. And just as a quick follow-up, historically, you don't provide growth rates for the 3 segments within healthcare. But in light of the slowdown this quarter, can you give us just some broad ranges on growth for Enterprise Analytics, Payment Accuracy, and revenue and quality intelligence?

This is Mark. I mean, I think we tried to characterize earlier the nature of the growth there, it has been primarily driven by some of the RQI. The other 2 businesses have continued to perform nicely but not at the levels of RQI.

So all 3 businesses actually grew within healthcare in the quarter?

All businesses were strong. As we kind of think about the businesses, we think there's opportunities across the board, yes.

Your next question comes from the line of Bill Clark with KBW. William Clark - Keefe, Bruyette, & Woods, Inc., Research Division: Just one more on healthcare. How long is the typical implementation in RQI? So if you get those 3 customers locked in, how long would it normally take for us to see a meaningful contribution to the top line there?

It's sort of weeks to months. So it's -- and it all depends on -- in many ways, it actually depends on the nature of the customer's operations. But think of it as several weeks to sort of a low count in terms of number of months.

Your next question is a follow-up from the line of Suzi Stein with Morgan Stanley.

In the past, you guys talked about seasonality in the healthcare business. Is there anything we should be thinking about as we model healthcare for next year?

I think the one thing that we are trying to do, so we get a little bit away from some of the seasonally is we have tried to work with our customers so there wouldn't be quite as much kind of second half demand so that the opportunity and their needs are spread more broadly across the entire year. I think we've been somewhat successful there, but I think you're going continue to see more in the second half of the year. Typically, that was in that 60% to 70% range. So hopefully, we're trending towards the lower percentage there as we're thinking about that in the future.

At this time, there are no further questions in queue. I'll now turn the call back over to Scott for closing remarks.

Okay. Well, we appreciate everybody being with us for the call. We appreciate all the questions, and we certainly understand the interest in our -- the healthcare part of our business. We remain focused on making it a really very strong and important part of Verisk. It's a long march but one in which we're very confident. We're also very excited about a lot of other things happening in our business. And the agenda remains focused on innovation, and we believe that we are becoming an increasingly strong company with respect to innovation and growth. And so we look forward to being with you again next quarter, and thanks for your time today.

Ladies and gentlemen, this does conclude today's Verisk Analytics Third Quarter 2013 Earnings Results Conference Call. Thank you for your participation. You may now disconnect.