Factset Research Systems Inc (FDS) 2005 Q3 法說會逐字稿

Good morning and welcome to FactSet Research Systems third quarter fiscal 2005 quarterly earnings conference call.

All participants will be able to listen only until the question-and-answer session of the conference.

Today's call is being recorded.

If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Peter Walsh, Chief Financial Officer.

Sir, you may begin.

Thank you.

Good morning, and welcome to FactSet Research Systems earnings release conference call for the third fiscal quarter of 2005.

On the call today are members of our executive team, Phil Hadley, Chairman and CEO; our President, Mike DiChristina; and Mike Frankenfield, Director of our U.S.

Investment Management Business.

Before we begin, I would like to remind you that throughout this conference call there will be certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements are based on management's current expectations and beliefs.

They are not guarantees of future performance and involve certain risks, uncertainties, and assumptions which are difficult to predict.

Therefore, actual results may differ materially from what is expected or forecasted in such forward-looking statements due to changes in economic, business, and/or competitive factors.

More information about these and other potential factors that could affect FactSet's business and financial results are in FactSet's Annual Report on Form 10-K for the year ended August 31, 2004, and quarterly reports on Form 10-Q for each of the quarters ended May 31, 2004, November 30, 2004, and February 8, 2005, all of which are on file with the Securities and Exchange Commission.

FactSet undertakes no obligation to publicly update any forward-looking statements as a result of new information, future events, or otherwise.

I have prepared remarks that will address our operating and financial performance during the third quarter of fiscal 2005.

After my comments, our management team will be happy to address your questions.

Before covering the highlights of the third quarter, please allow me to mention two housekeeping items.

First, earnings per share were positively impacted from the settlement of prior year tax returns and additional income tax planning.

In the third quarter of 2005, EPS was $0.39, up 30% from the year-ago quarter.

Included in this quarter's EPS was an income tax benefit amounting to $1.9 million, or $0.04 per share.

In the year ago quarter, this income tax benefit was $760,000, or $0.02 per share.

Second, to aid in investors' ability to make more precise interpretations of our financial results, please know that included with today's earnings press release were two supplementary schedules.

These schedules highlight facts involving currency, royalty payments to a data vendor and revenues that are not subscription based.

While each item individually and in aggregate have not been material to our annual results, these facts might enhance an investor's overall understanding of quarterly revenues.

In subsequent quarters, we do not plan to disclose these details unless the information is material.

Now turning to the review of the third quarter.

We're pleased to report that FactSet's quarterly performance was strong.

We achieved healthy improvements in subscriptions, workstation, and client count and balanced growth across our products, and from each geographic region.

We continue to demonstrate the power of FactSet's business model by attaining record levels of net income while investing in and pursuing new opportunities to better serve our clients.

We are well aware that our challenge is not just to deliver strong results for a quarter, or even a year or two, but to build long-term value for our shareholders.

This would not be possible if our strength were a single product, or if we were relying on a low-quality client base.

Let's begin the financial performance review by speaking about free cash flow.

Free cash flow captures all the balance sheet and P & L movements, and we believe it is an important metric to measure financial success.

Therefore, maximizing free cash flow per share is vital to creating long-term value.

As a reminder, we define free cash flow as cash generated from operations which includes the cash cost for taxes and changes in working capital less capital spending.

Free cash flow reached a new quarterly record of 36.6 million for the period ending May 31.

Record levels of net income and cash collections propelled our free cash flow forward.

As a result, our earnings quality was very high as free cash flow was 1.9 times higher than GAAP net income during the third quarter.

Free cash flow generated during the third quarter was also approximately three times our average over the trailing 12 quarters.

Now let's turn to the drivers behind the change in cash and what happened on our balance sheet.

Our ending cash and marketable securities balance was 90.6 million, an increase of 27.2 million since the last quarter.

This change in cash was attributable to five primary factors.

Our cash generated from operations of 44.6 million, cash inflows of 2.9 million from the exercise of employee stock options, offset by 10.7 million of cash used for stock repurchases, capital expenditures of 8 million, and dividends paid of 2.3 million.

Please note that a small portion of the stock repurchases was a result of terminating the company's U.S.

ESOP retirement plan in favor of employer contributions to a 401(k) plan.

Under the terms of the ESOP plan, participants can elect settlement of their ESOP share balance in cash, FactSet shares, or a combination of both between April and August 2005.

It's important to note that our accounts receivable balance at May 31 was 54.2 million, down 13 million, or 19% during the quarter.

Accounts receivable at May 31 was just 1% higher than the accounts receivable balance at November 30, 2004, while revenues grew by 7% over that six-month period.

Previously, we identified and related to you three catalysts which caused our receivables balance to increase in the second quarter.

There's been full resolution or improvement in each area.

First, our new subscription order system was successfully implemented, allowing monthly invoices to be transmitted as scheduled.

Second, commissions on security transactions to pay for FactSet services via Goldman Sachs continued to increase nicely, and third, payments on advanced billings to JCF clients were collected as expected in the normal course of business.

It's important to know that FactSet transmits invoices to virtually all of its clients one month in arrears.

Therefore, 46% of the accounts receivable balance at quarter end was recently billed on or about the balance sheet date of May 31.

Our significant decline in accounts receivable and our DSO when factoring in our policy to bill 30 days in arrears is another indication that FactSet is privileged to service a blue chip client base and that client satisfaction levels continue to be very high.

Looking forward we plan to continue to use our strong balance sheet and free cash flow to enhance value for shareholders through investment in new products, services, and share repurchase activity as appropriate.

Consequently, on June 20, 2005, our Board of Directors authorized the repurchase of up to $50 million of our stock.

The timing of this authorization corresponds to the completion in the May 2005 quarter of 1.5 million shares -- of the 1.5 million share repurchase program approved in July 2002.

The reasoning behind the stock repurchase authorization was that given our strong balance sheet and historical record of generating high levels of free cash flow, we currently believe we have sufficient cash resources to cover a wide range of operating needs.

As such, our intention is to invest excess cash in our own stock when opportunities arise.

We believe these transactions will generate much higher returns than if we were to keep the cash on our balance sheet, thus creating value for shareholders.

Now moving on to the P&L.

The overall summary reflects a high margin business and the leverage of FactSet's business model when users further engage in utilizing our services.

Including the third quarter, FactSet has delivered superior returns to our shareholders.

During the past three years our average return on invested capital was 34%, more than 2.5 times higher than the weighted average return on invested capital of companies included in the S&P 500, or in the Russell 2000.

Now let's turn to the specifics of the third quarter.

Revenues were 79.3 million, up 25% from a year ago.

Excluding acquisitions, our top line grew a healthy 15% on an organic basis.

More users, clients, and subscriptions to database and applications, such as Marquee, and our suite of portfolio analytic products were important contributors.

We finished the quarter with approximately 24,000 workstations, up 800 workstations during the past three months.

Excluding the acquisition of JCF, this represents the highest quarterly increase in users since August 2001.

The client count was 1,464 at May 31, 2005, a net increase of 27 clients during the quarter.

Regarding key client trends we're experiencing, please know that users are more engaged than ever before in leveraging FactSet's expansive set of applications.

Added features and content is causing our services to be more appealing to non-U.S. investors.

We're delighted with the progress of Marquee, and the utility of our portfolio analytic suite of products is constantly expanding.

Demand for portfolio analytics continues unabated.

This suite is comprehensive and includes applications for portfolio attribution, risk, and quantitative analysis.

The Portfolio Analysis workstation is the largest contributing member of this product suite.

At May 31, there were 415 clients representing approximately 3,200 users who subscribe to this service.

This compares favorably to a total of 370 clients and 2,800 users a year ago.

Client retention continued to remain above 95%, once again confirming the importance of FactSet's applications and services to our high quality client base.

Annual client subscriptions totaled 317.9 million at quarter end, up 10.3 million from the end of February, and up 57 million over the past 12 months.

As a reminder, we define subscriptions as the forward-looking revenues for the next 12 months from all subscription services currently being supplied to our clients.

In terms of geographic revenue growth our U.S. business produced revenues of 58.2 million, up 15% over the year-ago period.

Revenues from non-U.S. sources increased 65%, to 21.2 million.

Excluding the JCF acquisition, the year-over-year organic revenue growth from non-U.S. operations was a stellar 22%.

By region, quarterly revenues from our European and Pacific Rim operations rose 74% and 33%, to 17.3 million and 3.9 million, respectively.

Subscriptions by non-U.S.-based clients now total 84.8 million, representing 27% of our total subscriptions.

Moving to the expense side of our P&L, operating expenses increased 24.4% to 52 million for the third quarter, and our operating margin was a strong 34.5%.

Cost of sales as a percentage of revenue increased 110 basis points compared to the third quarter of fiscal 2004.

This rise was driven by increases in data cost and amortization of intangible assets.

Partially offsetting these increases as a percentage of revenues were lower communication costs and depreciation on computer-related equipment, and a shift in employees performing activities considered SG&A.

The rise in data expenses was largely due to new costs from acquisitions included for the first time in the third quarter P&L, and incremental content costs associated with royalty payments to data content suppliers.

The increased amortization expense is a result of our recent acquisitions, principally JCF.

Lower computer-related and communication costs were primarily the result of favorable pricing trend from industry suppliers.

Selling, general, and administrative expenses, as a percentage of revenues, decreased by 120 basis points from a year ago.

This decline was largely the result of lower rent and miscellaneous expenses, partially offset by non-cash charges from furniture and fixtures and leasehold improvements.

Our effective tax rate for the quarter was 29.4%.

Included in the effective tax rate was the realization of $1.9 million income tax benefit from the final settlement of prior year tax returns and the result of additional federal and state income tax plans.

Excluding this benefit, the effective tax rate for the third quarter would have been 36.2%, down from 37% for the first half of 2005.

With respect to capital spending, CapEx during the quarter, and during the first nine months of the fiscal year, totaled $8 million and $17 million respectively.

Approximately one-third of the fiscal year to date total was used to purchase computer-related equipment while the remainder was spent on furniture and leasehold improvements.

Capital expenditures related to the relocation of the company's headquarters totaled 9.3 million in fiscal 2005.

During the third quarter, we installed two HP GS1280 alpha server mainframe systems, each with 16 processors and 64 gigabytes of memory.

Our guidance for capital spending for fiscal year 2005 remains at 22 million.

Thank you for listening in to my review of our operating and financial performance.

We would now be happy to entertain any questions you may have.

Thank you.

At this time we're ready to begin the question-and-answer session. [Operator Instructions.] One moment, please, for our first question.

Our first question comes from Brett Manderfeld of Piper Jaffray.

Good morning, guys, and nice job, especially on the free cash flow and DSOs.

My question, just wanted to better understand the reclassification related to the redistribution of content for a client.

I guess, you know, what exactly is that, what kind of content, and why, I guess, are you all doing this?

Thanks.

Sure.

Thanks, Brett, I'll handle that.

The accounting for data royalty costs follows the contractual language between FactSet and its suppliers.

A data supplier agreement for one existing data vendor was recently renewed.

Previously that supplier maintained separate contracts for the data with our mutual clients.

FactSet collected their data fees on their behalf and recorded that activity only on our balance sheet.

Now, FactSet maintains a client relationship and the data supplier is paid for their data based on a formula in its contract with FactSet.

This is similar to the majority of FactSet contracts with its data supplier and involves a royalty payment based on a formula that's only triggered when the product is sold.

As such, when that sale occurs, the cost of sales and revenues are impacted by an identical amount representing the royalty payment.

Obviously, these events have no impact on our operating or net income.

Okay.

Is that a common relationship, I guess, and would you expect to see more of those kind of relationships going forward?

They do happen from time to time, but it's very rare.

I don't expect to see that event happen every quarter.

Okay.

And given it was a relatively small number, less than 2 million, is it fair to assume that it had less than a half a million dollar impact on the revenues in the quarter, too?

The impact on the quarter, and that's really one of the reasons why we provided that supplementary schedule, I mean, the accounting happened at the beginning of the quarter, and the amount in the supplementary schedule will allow you to calculate the impact on revenues and cost of services.

But the 1.8 million on the subscription side, that's a yearly amount, right?

Correct.

Thanks a lot.

Our next question comes from Monica Logani of Foresight Research.

Okay, yes, just a couple of questions.

One is, when you talk about this, or in your press release, when you state the commitment number going forward and you talk about this pass-through you also mention an FX amount, which is about $2 million, as well.

And I was curious, is that something that has only happened this quarter, or has that been happening every quarter?

So we've -- thank you, Monica.

We've been exposed to currency for many quarters, but most of it became more significant after the purchase of JCF.

Approximately 9% of our revenues are subject to currency fluctuations.

And really the key currencies to monitor include the pound sterling, the euro, and the Japanese yen.

We're fortunate to have a natural hedge with operating expenses in paid and similar currencies for our non-U.S. business.

So can I assume that in the last quarter that it was about the same amount, or was it different?

I think you should really look at the currencies I mentioned and look at their fluctuations versus the U.S. dollar to peg their impact on previous quarters.

Okay.

Yeah, I'm just trying to understand if this is just -- because you never mentioned it in the last quarter's press release, so I'm assuming it was not a big contributor.

It wasn't a material amount.

The other question I have is, I was just wondering if you could give us some color on just the components of your revenue.

The one thing I noticed is that on your -- you obviously give us these client and password numbers every quarter, and I notice for the first time that your client growth was less than your password growth.

Usually it's the other way around.

And I was just wondering if you could provide some reasoning as to why that happened?

Monica, it's Mike Frankenfield.

We've experienced a nice uptick in workstation growth.

A lot of that has to do with the deployment of our Marquee product, which is enabling us to reach larger groups of users within our clients.

And can I -- you know, I'm just trying to figure out here, just in terms of revenue per password, is that staying the same, or how is that changing?

Monica, it's Phil Hadley.

I think the three metrics we give you, the number of clients, the number of seats, and the subscription number, should give you enough information to be able to calculate what you think the yield would be on our marginal passwords.

Obviously, all three of those together, if one is not healthy, it would show up in the other two metrics.

But I think if you look at this quarter the yield on clients and passwords have remained consistent with history.

One final question.

Just in terms of your international, just in terms of color, this JCF acquisition, obviously, their subscription price is substantially lower than FactSet's average subscription price.

And I was just wondering, is that something you guys have been working on, is getting those JCF clients you acquired, getting them to a higher price point?

Is that one of the dynamics going on here?

No.

Certainly they have a lot of client relationships, and there's an opportunity to cross-sell our products into the client relationship they had, and vice versa.

But our client mix ranges all the way from huge at the top to prices that are similar to JCF's.

So there really wasn't that much of a price differential.

It's certainly, on average, if you took the mix of the two client bases, our average was significantly higher, but there's a substantially different mix of products those clients are receiving, as well.

Okay.

Thank you very much.

Our next question comes from Douglas Pratt of Galleon Group.

Thank you.

Just a follow-up question on the FX.

First, you (indiscernible) said that there's no impact to margins from FX.

That would, I guess, deal with your natural hedge, but what about the actual currency translation?

That wouldn't be affected by any hedges.

There's some dollar amount that's translated at a higher or lower rate.

If you go back to the table on ASV -- I apologize, I got in late to the call -- can you walk me through -- that's for the quarter that just ended, not for the year to date?

Thank you.

Let me answer those in reverse.

The table that's included in the subscription value, so that's a point in time.

Okay.

And that really relates to the subscription value or the annual subscription value at the end of May and trying to show you the components and how they change for the quarter.

Okay.

So the currency change you show there, that negative 1.7 million, that was for the third quarter, that was an impact for translation?

That's for currency, yes, for currency translations.

It's the revenues we bill in a currency other than the U.S. dollar.

So is that a negative or a positive?

I mean, it's a negative, obviously on the column.

It would be a negative to our revenues.

Okay.

And then how about the broader question on currency?

You've got some 9% of your revenues that have some impact on operating line.

That would -- obviously if the dollar goes down that becomes a larger amount, if it goes up that becomes a lesser amount, so there's still a translation issue on the income statement, isn't there?

Yeah, so we have -- our functional currency is the U.S. dollar but it's not in every jurisdiction.

So you'll see, you know, a small currency impact in our -- you know, from translating revenues and expenses from our business that has always been there, and it's never been material.

Since we purchased JCF, you know, when we revalue their monetary assets and liabilities that currency impact is shown as a translation adjustment as a component of our stockholders equity, because their functional currency is not the U.S. dollar.

Okay.

And one last follow-up.

In terms of acquisition -- again, I apologize, I came late -- acquisitions addition to the quarter was how much in terms of revenue?

We didn't make any -- or complete any acquisitions during the quarter.

Okay, great.

Thank you very much.

Our next question comes from John Neff of William Blair.

Hi, guys, and congratulations on a good quarter.

I was wondering if you could comment on your use of term contracts.

In other words, contracts that have a specific time period attached to them.

I know the use of the small asset manager contract with one year.

I was wondering, how material is that in the quarter?

Hi, John, Mike Frankenfield.

We have contracts with our clients merely to document the business relationship that we have with them.

The vast majority of our clients are free to add or delete service on a monthly basis, or, indeed, cancel the entire service if that's the best solution for them.

We do have a contract policy with our smallest clients which requires them to sign to a one-year term.

At this point that represents an immaterial amount of clients and subscriptions.

Thanks.

And also, you mentioned on the call clients were more engaged than ever in using FactSet.

I was wondering if could you elaborate on that comment at all.

Any statistics?

I don't think we have any specific statistics, but as our product suite expands to provide capabilities, as Peter outlined in the portfolio management area, in the company analysis area, in the real-time quote area, clients are able to use FactSet to do more and more of their daily work flow.

Okay.

And also, last question, on the tax rate, 36 to 36.4% for next quarter, is that a reasonable rate to assume going forward as we look into fiscal 2006?

Thank you.

We haven't provided any guidance on our tax rate for fiscal 2006, but I think that is -- our guidance for the fourth quarter is our expectations at this point.

Our next question comes from Lisa Monaco of Morgan Stanley.

Hi.

Just a couple of questions.

Phil, if you could just speak to, you know, qualitatively on the small client count, you know, I realize that there's a different pricing structure, slightly different pricing structure for, I believe, it's accounts that manage under a billion dollars.

If you could talk qualitatively as far as the number of accounts deemed to be on the smaller side, whether it's up or down from a year ago or sequentially?

Phil, if you could also just speak to longer term growth, where you really think that's coming from, number of clients, increased penetration per client, number of users, new products, international, et cetera.

And then, thirdly, if you could speak to accounts receivables and what we can expect for the next quarter.

Thanks.

I'll answer the first two and let Peter take the third one.

On the small clients, we certainly focus on trying to provide as broad a solution.

Our client focus really is the financial professionals in the marketplace.

As we've been able to expand our product line, we're able to deliver a higher level of functionality and reach a different size client base than before.

The mix of clients that come on, on a net basis on a -- typically start at the small end, but as anybody who's been in the industry for a long time, they can grow up to be very large clients over a long period of time.

So I would guess the vast majority of clients that come on we start with small relationships.

As far as where the business is coming from and what our focus, that's something that hasn't changed for a long time.

We always focus on getting new clients, getting new users with clients, and selling more product to our clients, and all three of those drive the opportunity.

It's important for us to build a new client relationship because it allows us to continue to up-sell that client with more and more product.

I think that's how you see the subscriptions divided by the number of seats stay a high number.

It's really the current clients continuing to subscribe to more and more product.

As you can see this quarter, the seat count growth was very strong, and that's really just because our product is becoming a broader solution inside of many of our clients and providing us with a lot of opportunity.

Hi, Lisa.

It's Peter.

I'll cover your question regarding AR.

As I relayed in the call, 46% of our AR balance at May 31 represents items that we recently billed on or about the balance sheet date, and so we really have I think a terrific level of DSOs when you consider that.

It's very difficult to predict the payment patterns of our clients.

We certainly expect that we'll have no trouble billing them on a timely basis.

The volatility in AR that we saw both in the second quarter and the third quarter is not something that we expect going forward.

We think that that volatility will moderate quite a bit, and that you'll see AR trend with our revenue growth, as you have in previous historical quarters.

Great.

Thank you.

Our next question comes from Carla Cooper of Robert Baird.

Good morning.

I wonder if you could give us a little more color on what drove the traction on the international side.

You mentioned kind of, some sort of -- or the way I interpreted it was some sort of maturation of JCF within the product set, but I wondered if you could give us more color there?

Carla, it's Phil Hadley.

I think Peter said the organic, which would not include JCF, was 22%, which is really what would you think of as the historic core FactSet.

I think we've been international with our product for 15 years at this point, but it takes a long time to truly make it something that is a true solution for local markets around the world, and as we continue to add content and opportunities the mix of product is shifting to become more favorable for us.

So I think that's really driving the opportunity.

We certainly have a worldwide sales force that's able to provide the same level of service outside the U.S. as we provide in the U.S., so I think it certainly -- that's a major factor.

I think the other factor is the world markets swing in different directions.

Asia Pacific was a tough market for several years, and is doing quite well, and I think it took a little bit longer for the European market to come out of the 2002-2003 Wall Street depression, so all of those are just positive factors in our favor.

And just as another point, is there anything in particular that sort of came on line in the last few months that's been -- you know, that's the reason that you think that local product set is now more complete?

We continue to add content sets, so in the global fundamental category we have the Thomson Worldscope product, it's an outstanding product; we have the Reuters Fundamental product, that's an outstanding product; we just added the S&P Fundamental product, that's an outstanding product.

So it gives the client lots of choice in that space.

On the estimate side they now have three choices, all of which are great solutions for the client.

So I think that trends in our favor to be -- allow the client a choice and choose their preference, whatever is going to meet their business needs, and we continue to make those products the best products we can on our system.

And then one question for Peter, or I think Peter, just as I look at the, you know, the year-over-year changes in annualized revenue per user, you obviously had some strong double-digit increases back in '01, '02, and part of '03, or most of '03.

Those are now looking single digits.

I guess, can you comment on things that that might cause that to deviate outside of kind of the trend that we've been seeing in the last couple of quarters?

Well, I'll redirect that one to Phil, Carla.

Okay.

Carla, I think that was really just the mix of business we had at that point in time.

We had some very, very large clients who had some very broad distributions of our product, way beyond what our normal user population would have been.

And as Wall Street was looking to cut costs, all of those users got cut.

But our revenue proceed on those users was very low.

So it would change that statistic.

I think from what I can see in our business at this point, that's all been gone for several years now.

So the statistics that you're looking at in the last two years probably are far more consistent with the real value being delivered and the product being purchased from a client perspective at a user level.

Thank you.

Our next question comes from Lisa Monaco, Morgan Stanley.

Hi, Peter.

Can you just elaborate on the cost of services line?

It was up a little bit more than we expected, and you ran through some of the reasons why.

Should we expect that going forward?

It sounds like we should.

Thanks.

Obviously, I provided some detail previously on cost of services.

I think the one piece that we'll -- that will continue on going forward is the reclass that we made in the second quarter concerning employees that we're now considering SG&A.

I think that will continue forward into the next quarter.

The item regarding, you know, the previous reclass of the data royalty charge obviously impacted cost of services, but not to a significant amount.

We've provided obviously guidance on our operating margin, and that's really the figure that we really manage the business and we would, you know, encourage everyone to closely monitor.

Thanks.

Once again to ask a question, please press star 1.

One moment.

At this time, there are no additional questions.

Thank you.

This concludes the conference.

You may disconnect at this time.