Factset Research Systems Inc (FDS) 2006 Q3 法說會逐字稿

Welcome to the FactSet Research Systems third-quarter fiscal 2006 quarterly earnings conference call.

At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS).

Today's conference is being recorded; if you have any objections you may disconnect at this time.

Now I will turn the call over to Mr. Peter Walsh, Chief Financial Officer.

Sir, you may begin.

Good morning, everyone, and thank you for joining us.

Welcome to FactSet's third-quarter earnings conference call.

Joining me today are Phil Hadley, Chairman and CEO;

Mike DiChristina, President and Chief Operating Officer;

Mike Frankenfield, Director of the U.S. investment management business; and Scott Beyer, Director of our non-U.S. business.

This conference call is being transcribed in real-time by FactSet's Call Street service and is being broadcast live via the Internet at FactSet.com.

A replay of this call will also be available on our website.

Our call will contain forward-looking statements reflecting management's current expectations based on currently available information.

Actual results may differ materially from what is expressed or forecast in such forward-looking statements.

More information about factors that could affect FactSet's business and financial results are in FactSet's filings with the SEC including its most recent 10-K and 10-Q.

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

Consistent with previous quarters, we have reported GAAP and non-GAAP financial measures.

These measures, including operating income, net income, EPS and free cash flow, have been adjusted where appropriate to exclude stock-based compensation, incremental expenses related to redundant London office space, and income tax benefits primarily from the closure of previously filed tax returns.

Reconciliations between GAAP and non-GAAP financial measures are also included in the earnings press release which can be found at our website under the investor relations section.

We hope by utilizing these reconciliations will help you understand our results and our performance versus the year ago period.

We'll divide our time today around three topics; we'll start with a review of the third quarter.

Next, I'll cover our business outlook for the upcoming fourth quarter.

Finally, our management team will take your questions.

Before I talk about results I'd like to take a moment to highlight new items.

One, as previously announced, FactSet consolidated four London-based offices into one new location.

Incremental expenses from a redundancy of leased office space were $1 million during the third quarter.

Our new European headquarters opened yesterday and is already fully operational.

Two, included in this quarter's EPS was an income tax benefit amounting to $751,000 or $0.01 per share.

In the year ago quarter this income tax benefit was $1.9 million or $0.04 per share.

The main catalyst behind the tax benefits in both years was closure of previously filed tax returns.

Now moving on to the details about the quarter.

Q3 was another excellent quarter for FactSet.

We saw momentum across many of our productlines in all geographies.

This is evident in our strong organic revenue growth of 17% and record net income of $21 million.

This translated into a net margin of 21%.

Among New York Stock Exchange companies FactSet ranged in the 93rd percentile in terms of the highest net margin over the past three years.

Underlying in driving this performance in broad based growth.

Key ingredients enabling us to attract more clients and users continue to be developing new functionality, expanding content choices and delivering blue-chip service.

Excluding acquisitions and currency, subscriptions have increased 56 million or 17% over the past 12 months.

Every quarter we reinvest capital in our business to create organic growth by innovating solutions to a never-ending list of client problems.

This combined with high service levels has resulted in a more engaged user base than ever before.

Let's turn to the highlights of the quarter starting with 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.

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 generated during the third quarter was $31.2 million.

Record levels of net income and strong cash collections drove free cash flow.

One very interesting relationship is the comparison of our earnings to our free cash flow.

Third-quarter free cash flow exceeded net income by 48%.

This illustrates the quality of our earnings since at the majority of public companies free cash flow is less than net income.

Now let's turn to what we did with the cash and what happened to our balance sheet.

Our ending cash and marketable security balance was $118.6 million, an increase of $28.4 million during the quarter.

The overall increase in cash was attributable to five primary factors -- our cash provided by operations of $44.6 million and cash inflows of $7.7 million from the exercise of employee stock options, offset by $13.4 million of capital expenditures, $6.7 million related to stock repurchases, and dividends paid of $2.4 million.

During Q3 the quarterly dividend was increased 20% from $0.05 to $0.06 per share.

The Company also repurchased 156,000 shares of common stock.

At May 31st we had $45 million in remaining repurchase authorization.

Now allow me to switch gears and move to the P&L.

GAAP operating income for the quarter was $31 million.

This compares to GAAP operating income of $27.4 million last year.

Non-GAAP operating income was $33.9 million advancing 24% over year ago figures.

GAAP net income was $21 million as compared to $19.5 million a year ago.

Non-GAAP net income rose 26% to $22.3 million.

Non-GAAP operating and net income exclude where appropriate stock-based compensation charges, incremental occupancy cost from a temporary increase in London real estate and the tax impact primarily from the settlement of prior year tax returns.

Let's turn to the details regarding our third quarter.

Subscriptions increased $19.1 million during the quarter and totaled $399.4 million at quarter end.

Excluding the impact of foreign currencies the subscription increase was $16.4 million in Q3.

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.

FactSet continued its forward momentum from the first half of fiscal 2006.

We welcomed 56 net new clients during the quarter.

Over the last nine months we've added 121 clients, 33% higher than total client additions for the entire fiscal year of 2005.

Client count at May 31st was 1,722 representing 27,900 users.

Quarterly revenues were $98.8 million, up 25% year-over-year.

The 25% growth breaks down into 17% growth in underlying organic revenue and 8% growth related to acquired companies owned for less than a year.

Let me expand on trends we see happening at our client base.

We're especially pleased about our ability to establish new client relationships.

The ability to consolidate multiple services into one platform is a compelling opportunity for firms to recognize efficiencies.

New businesses have also been driven by our ability to service professionals with a global reach.

Higher demand for global content among clients reflects a recent shift in asset allocation to non-U.S. investments.

Demand for the Portfolio Analytics suite of applications continues to rise.

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

At quarter end users totaled 3,750 spread out among 458 clients.

Client retention continued to remain above 95% -- once again confirming the breadth and depth of a product suite that's deployed by a high-quality institutional client base.

Taking a look at geographic performance, our U.S. business produced revenues of $70.2 million in the third quarter.

U.S. revenues, excluding Derivative Solutions acquisition grew 15%.

Revenues from non-U.S. sources increased 35% to $28.6 million.

Excluding the StreamVPN and Europrospectus acquisitions and holding currencies constant, revenue growth from non-U.S. operations advanced 23%.

By region quarterly revenues from our European and Pacific Rim operations were 23.5 and $5.1 million, respectively.

Subscriptions by non-U.S. based clients were $116.2 million representing 29% of the company wide total.

Moving to expenses for the quarter, GAAP operating expenses were $67.9 million and our operating margin was 31.3%.

The GAAP operating margin declined 30 basis points from Q2.

The decline was due to a full quarter of owning Europrospectus and a higher redundant office space in London.

Excluding stock-based compensation and additional real estate charges in London the corresponding operating margin rose to 34.3%.

Pretax stock-based compensation charge was $1.9 million for the third quarter compared to 0 in the year ago period.

Stock-based compensation is included in both cost of services and SG&A.

Please refer to the consolidated statements of income in the press release for a split of stock-based compensation between those cost categories.

Cost of sales as a percentage of revenues increased 190 basis points from the year ago quarter.

This rise is driven primarily by increases in amortization of intangible assets and the first-time inclusion of stock-based compensation partially offset by lower communication costs.

The rise in amortization expense was a result of the Derivative Solutions, StreamVPN and Europrospectus acquisitions.

Communication expense declined as a percentage of revenues due to lower industry pricing partially offset by higher bandwidth requirements.

SG&A expenses expressed as a percentage of revenue increased 120 basis point year-over-year.

This increase was driven by the first time inclusion of stock-based compensation and higher occupancy cost (technical difficulty) London and in Tokyo.

In terms of headcount, employees at quarter end totaled 1,286, up 21% from a year ago.

This percentage increase in employees breaks down to 13% of organic growth and 8% from acquisitions.

Other income from the quarter tripled from a year ago.

Drivers behind the improvement were higher cash balances and after-tax interest rates.

Our GAAP effective tax rate for the quarter was 34.3%.

Included in this rate is a net benefit of 2.3% primarily from the closure of previously filed tax returns.

GAAP EPS on a fully diluted basis for the third quarter was $0.41 per share; non-GAAP EPS advanced 23% to $0.43 per share.

Capital expenditures over the first nine months were $20.5 million; approximately 50% of the CapEx went towards the purchase of computer equipment and the remainder related to office expansions.

Now turning to our business outlook for the upcoming forth quarter.

Please allow me to remind you that the following comments are intended to fall under the Safe Harbor provisions outlined at the beginning of this call.

They are based on preliminary assumptions and are subject to change.

As reported earlier, FactSet opened its new London-based European headquarters yesterday.

We expect that $1 million to $1.2 million will be incurred in Q4 related to this event.

The projected revenue range for the fourth fiscal quarter is 102 to $105 million.

Operating margins for Q4 should range from 31% to 33%.

Excluding stock-based compensation and redundant London occupancy costs operating margins should range between 33% to 35%.

Stock-based compensation expense should approximate $1.9 million.

The effective tax rate is expected to be between 36.3 and 36.8%.

We're increasing the fiscal 2006 CapEx range to 24 to $26 million from 18 to $22 million.

This CapEx range includes build out of our new London headquarters.

So in conclusion, FactSet has continued its [run] at growth.

Our financial results have accelerated over the past 12 months and our balance sheet is strong with $118 million of cash and no debt.

In terms of clients, we service just one-third of the potential buy and sell side firms and our installed user base represents only approximately 5% of the total investment professionals.

We have enormous opportunities ahead and believe we have the right people, resources and strategy to build deeper client relationships with the best financial firms all over the globe.

Thank you for your participation in today's call.

We are now ready for your questions.

(OPERATOR INSTRUCTIONS).

Lisa Monaco, Morgan Stanley.

Peter, could you just elaborate on what is driving the increase in CapEx; it's a rather significant increase?

And then subscriptions per password in the quarter were actually a little higher than we expected -- the increase was better than expected, what should we expect going forward?

Thanks.

Thanks, Lisa, for your question.

I'll handle the first and pass over to Phil for your second one.

As far as our CapEx increase and guidance, two primary components.

First, we are expecting to have higher CapEx with our build out of our London headquarters which is primarily based from increases in currency.

And the second is increases in system usage.

We're planning to increase the number of mainframes and that potentially could happen at the end of the fourth quarter or the very beginning of fiscal 2007.

Hi, Lisa.

This is Phil.

As far as the revenue per password, I think it's primarily driven -- we had very strong client growth this quarter, so obviously the revenue per password for a new client, the first two workstations, generally is much higher than the marginal cost per workstation and then strong product growth as well within the current client base.

That coupled with the fact that primarily -- significant fluctuations we have in workstation count are driven by the sell side and our hiring patterns in the summer just caused the number to tweak up this quarter.

But in all obviously the subscription number is the most important element.

Okay.

And then just, Peter, can you tell us what total compensation expense represents as a percentage of total operating expenses?

And then I think you cited in the quarter a 13% increase in headcount.

I think that was organic and that was obviously below the organic revenue growth of 17%.

Should we expect similar trends going forward?

Thanks.

As far as compensation expense, the best I can tell you is it's our largest expense, we don't give the exact percentage of total revenue.

We do expect to grow headcount in line with our intended plans for revenue growth.

And I think you'll see that number increase going forward.

So you're saying that expenses will grow in line with revenue, so it's a 13% --.

Headcount.

I'm sorry, headcount will grow in line with revenues?

Right.

Okay.

And the third quarter -- so that 13% might accelerate as we progress?

Yes.

Okay, thank you.

Brett Manderfeld, Piper Jaffray.

Good morning, guys.

Just looking at the strong sequential improvement in subscriptions, I think it's the strongest actually that you've seen since August of last year in a seasonally strong quarter.

Hopefully you can dig in a little bit deeper as that grows the U.S. versus international, buy versus sell side and then maybe give your thoughts in terms of headcount additions in the summer.

I'm really kind of focused on the investment banking side and what you think the trends will be in terms of headcounts for new analysts, etc.?

Thanks.

Brett, it's Phil.

So the sequential growth is really coming all the way across the client base.

Peter broke out the subscriptions organically both U.S. and non-U.S.

I think probably the significant driver over the last year has been the acceleration of the U.S. business.

The non-U.S. business has continued to do very well, it just hasn't accelerated and is already at a higher growth rate.

When it comes to where the business is coming from, it's really universal all the way across our client base, both IM and IB, all the productlines we have contributed significantly in the story.

It sounds like we're not being very specific because you can't be.

Quarter after quarter it's new client growth, new seat growth and our strong productlines, PA is the one we highlighted in the call, but there are many other contributors that contribute to the increase in subscription value.

As far as the color on the summer -- I think you might have a better feel for that than we do.

It's a little early for us to know exactly what's going on in the financial markets when it comes to banking hiring, but obviously that's a cyclical hire for a cutting pattern for the sell side and the financial markets are certainly stronger than they were three or four years ago, but it's still too early for us to give you an indication as to how this is going to turn out.

Okay.

So just maybe a follow-up or two.

Can you comment on the receptivity of Marquee, and maybe just thinking about the PA product, how much more run rate do you think that has?

Thanks.

Marquee is still classified as very early as far as where its opportunity is.

It's making great progress through our client base and really gives us some market opportunity within the current plans we have as well as it extends our reach and allows us to provide a very compelling product for a smaller client to subscribe to FactSet by delivering more value.

So it's very, very early in that opportunity.

When it comes to PA, I don't think -- a significant portion of that opportunity for us is greenfield opportunity, meaning that we're actually creating the marketplace as we go.

I think it's still also very early relative to the opportunity that we see in front of it as to what we can create and the problems we can solve for our clients.

Okay, very good.

Thank you.

John Neff, William Blair.

Gross margins excluding stock comp, 68.7% was the lowest in quite some time and I think you cited amortization probably as the key reason for that.

Can you just give us a sense of what the run rate of amortization of intangible expense is currently?

I think the closest number that you can get to that, John, is in our cash-flow statement, we give you the D&A as one number.

We haven't broken out that separately.

It is on a run rate perspective amortization of intangibles.

From a margin perspective we certainly -– when we're talking -– running up and down the hallways at FactSet we're already focused on the operating margin, not necessarily the gross margin.

We've seen improvement on that quarter to quarter.

Okay, but it's safe to say that the gross margin of 68.7, again excluding stock comp, is down because of the amortization of intangible expense?

There's no other factor?

That is one of the components.

Europrospectus was in for the first full quarter.

The acquisitions of Derivative Solutions and StreamVPN were year-over-year obviously and for the first time in the third quarter as well.

There is stock-based compensation that's also included in that and attributable to that increase when comparing to the year ago period.

Okay.

And I was curious about the strength in the increase in the subscription value sequentially, again to reiterate Brett's point, was very strong.

Can you talk at all about contributions from some of the new products that have come via acquisition?

John, it's Phil again.

It's really all the way across our productline.

We've got U.S. investment manager and the global investment banks and the non-U.S. business -- everybody is doing well.

You know our product well enough to know it's 15 or 20 different products and each little piece adds up to the share of full.

So it's lots of different components.

Some of it comes from the application side, some of it comes from the content side.

Peter does a pretty good job of giving you a feel for what's coming from acquisition.

So just to make sure that everybody is on the same page, the organic growth rate is acquisitions of less than a year.

And if you work the numbers backwards you can certainly get a feel for how acquisitions are doing and what they're contributing to the growth rate.

Okay.

A quick couple of just housekeeping questions.

I missed the remaining share repurchase authorization that you cited earlier, Peter.

That's $45 million at the end of the quarter.

And the increase in CapEx, I think you alluded to this, I just want to make sure this is what you said.

Part of the increase here, is that drawing from next year's plan?

So you would accelerate it forward.

Obviously CapEx ends and begins at definite periods of time.

So we're moving forward some decreases in hardware from '07 into '06.

But as long as our -- either user base continues to use the system it doesn't necessarily mean '07 would be lighter because we could be heading out at the end of that year as well.

And I apologize, last question, probably for Mike Frankenfield.

Just given the jittery market we've been in in recent weeks, are you seeing any impact from that in terms of client demand or interest?

Thanks again.

John, we're not really seeing any impact from the markets.

I think our clients have a pretty long-term view of it.

Thank you.

Neil Godsey, FBR.

A couple of quick ones for Peter and then one for Phil.

So for Peter on CapEx -- and I apologize if I missed this earlier -- of the 24 to $26 million that you expect in '06, how much of that is related specifically to London?

The 24 to $26 million is honestly a full-year number.

The buildout of our London headquarters, I don't know that exact component of it.

I would characterize it as less than 20% of that number.

Okay.

Did you say that for the $13 million or so that was in the third quarter that half of it was related to the relocation efforts?

Did I hear you right?

I'm sorry, could you repeat that, Neil?

I thought I heard you say something earlier about -- the $13 million or so in CapEx in just the third quarter, did you say half of that was related to London?

No, I said that of the CapEx that we incurred for the first nine months of the year half was related to computer equipment and approximately half was buildout of real estate operations.

Okay, got it.

Other locations than in London.

Okay.

And secondly, do you have the end of period (technical difficulty] count and on the number of shares repurchased in the quarter?

We repurchased 156,000 shares during the quarter and I don't have the end of period shares handy.

Okay.

And then one for Phil.

Could you just update us on where things stand with your fixed income productlines?

We have three different value propositions in the marketplace.

The first value proposition is a product that we've had for several years called Fixed Income Explorer, that's part of our Directions productline and it continues to do well in the marketplace.

Not a huge product for us, but certainly one that's made significant progress over the last several years.

There's the Derivative Solutions productline, Fixed Income Manager, that was the company that we acquired last summer.

It's primarily focused on the structured products and a higher end analytical product than Fixed Income Explorer which is primarily focused on big corporates.

And then we've also released Fixed Income in Portfolio Analytics which is part of our Portfolio Analytics productline and it's just starting to get traction in the marketplace.

So those are the three products we have, they're all doing well in the marketplace.

But we don't break out revenue and impact on a productline basis.

Okay, thanks very much.

Chuck Thomas.

Hi, a couple quick questions here.

First, going back to the cost of services, how much of that increase on a percentage basis was due to increased expenses related to your third-party data feeds?

And could you give me some color on that?

So the primary drivers of the increase in the cost of services was the first time inclusion of stock-based compensation, increases in amortization because we made three acquisitions over the last 12 months that were not included in the prior year quarter, offset by lower communication costs.

Those are the three primary drivers.

So there's no real change in the data feed, the cost data.

So you'd expect your cost of services to persist in the 31, 32% level going forward?

We haven't given any guidance on where cost of services would be in the future.

We just have provided guidance on our expected overall operating margin which is really the way in which we operate FactSet on a day-to-day basis, Chuck.

Fair enough.

In looking at that, if I could just follow-up on that line.

Fixed income seems to be an increased effort, PA and other greenfield products as well as Europe.

What sort of incremental expense should I think that that would add to your SG&A?

As Europe gets bigger is that an upward bias on your SG&A -- as you focus more on Europe is that an upward bias on SG&A?

This is Phil.

I don't think so.

I think -- we've always had the business invested forward in our productlines all the time.

So whether it be building on offices or building on products we're always rolling forward.

I couldn't give you the exact number as to what percentage of our resources is basically on viewer or feature product.

But we're pretty mature when it comes to the trends from history and trends forward.

And typically when we're thinking about running the business we really think about margins on a flat basis.

Sometimes there's fluctuation in that but that's really the way that we approach it.

I would say that we've gone through certainly substantial office upgrades in the last two years between Norwalk, Tokyo and London.

Those are kind of one timish in nature but as you're expanding you continue to add more office space around the world.

As far as the infrastructure and the employee base, we're pretty well distributed there as well, more than 30% of our employees are outside of the United States which is approximately what our revenues are.

So we don't have any special significant new investment coming up that would cause things to go askew from history.

So you would continue to find some operating leverage in your model then?

The (indiscernible) in business always is there's absolutely operating leverage there, but we tend to have a bias toward investing in the future with the leverage that you could potentially get.

So that's why we tend to have a flat bias towards the operating margins.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS).

At this time there are no more questions.

Thank you, everybody.

We'll see you next quarter.

Thank you for your participation.

This does conclude today's conference call.