Factset Research Systems Inc (FDS) 2007 Q3 法說會逐字稿

Welcome to the FactSet Research Systems third quarter fiscal 2007 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.

Thank you, operator.

Good morning, everyone.

Welcome to FactSet's third quarter earnings conference call.

Joining us are Phil Hadley, Chairman and CEO; Mike DiChristina, Chief Operating Officer; Karen Kennedy, Head of our Investment Banking Business; and Mike Frankenfield, Director of our U.S.

Investment Manager Business.

This conference call is being transcribed in real time by FactSet's CallStreet 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.

More information about factors that could affect FactSet's business and financial results are in FactSet's filings with the SEC.

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

Our agenda today will include four topics.

First, we will review third quarter results.

Second, I will address renewed discussions about soft dollars.

Third, I will cover guidance for the upcoming fourth quarter.

Finally, we'll close with our management team addressing your questions.

Before covering results, I would like to take a moment to highlight one item.

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

During the quarter, we began to factor into our estimated tax liability a deduction under Section 199 which was designed to encourage U.S.

companies to manufacture products domestically, including software applications.

Moving on to the review of the third quarter.

Our third quarter results are indicative of solid sequential quarterly growth in new subscriptions, users and clients, and balanced growth from each major geographic region.

We were able to deliver while investing in new products, including the release of a new version of Marquee in March.

This is a very exciting and busy time for our Company filled with significant opportunity.

We have a lot of work ahead but feel good about our progress and the value created for shareholders.

Let's begin the highlights of the quarter with free cash flow.

Free cash flow captures all the balance sheet and P&L movements.

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

During the last 12 months, free cash flows were $103 million.

Free cash flow generated during the third quarter were $40.8 million, up 31% over a year ago.

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

Third quarter free cash flow exceeded net income by 43%.

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

Drivers of free cash flow during Q3 were record levels of net income and a $14.8 million, or 21% reduction in accounts receivable.

The decline in AR was aided by invoicing clients on the first day of the month effective April 2007.

Our ending cash and marketable securities balance was $189 million, up $33.1 million over the past three months.

During Q3, we invested $12.3 million to repurchase common stock and at quarter-end, there was $103 million in remaining share repurchase authorization.

During the quarter, we paid a dividend of $3 million.

This dividend will double to $6 million starting in Q4.

Capital expenditures in the third quarter were $10.1 million.

Two-thirds of the expenditures related to office expansion.

The remainder was for computer related purchases.

Major expenditures, including building out new space in our London, New York, and Norwalk locations, adding two HP alpha main frame systems to our data centers.

Now moving to the P&L.

Revenues were $121.1 million, up 22.5% versus a year ago.

Excluding currency, the revenue growth rate was 21%.

Operating income advanced 27% to $39.2 million.

Net income rose 36% to $28.6 million in the third quarter.

In addition to higher operating income, net income was favorably impacted by other income and a lower tax rate.

Other income more than doubled to $2.1 million.

Our effective tax rate declined 340 basis points to 30.9% from Q3 last year.

Let's take a look at the revenue drivers.

Subscriptions increased $26.3 million during the quarter and were up $25.7 million excluding currency.

On a constant currency basis, subscriptions advanced $89 million over the last 12 months, up 22%.

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

Please note during the quarter we changed our billing policy to invoice clients in the current month, renew services ordered between the 16th and the 31st calendar day.

Previously, the monthly invoices effected in the following month.

This modification extends the number of days in this quarter subscription change calculation to 104 from February 16th to May 31st.

As a result, we estimate there was a $3.4 million one-time increase to subscriptions in Q3.

For all previous and for all future quarters, the number of days supporting the subscription change calculation was and will be approximately 91.

Let's turn to the trends we see happening in our client base.

Professionals using FactSet increased to 33,300, up from 32,000 at the beginning of the quarter.

Client count was 1,914 as of May 31st, a net increase of 42 clients during the quarter.

We're especially pleased about the deepening engagement of existing FactSet users.

New application features, incremental content and top-rated client service has contributed to our success.

The ability to consolidate multiple services into one through the FactSet platform has proven to be a compelling opportunity for our clients to recognize efficiency.

We're delighted with the progress of Marquee and client reaction to Marquee 3.0 released in March.

We are also policed with the progress on sale of proprietary content.

Demand for our portfolio analytics continues to rise.

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

The portfolio analysis work station is the largest revenue contributing member of this product suite.

At May 31st, there were 515 clients representing approximately 4,300 users who subscribed to this service.

Client retention remained above 95%, once again confirming the breadth and depth of our product suite that's deployed to a high quality client base.

Taking a look at geographic performance, our U.S.

business produced revenues of $86 million in the third quarter.

U.S.

business grew 21.5% over the year-ago quarter excluding non-subscription revenue.

On the international front, revenues increased to $35 million.

Excluding currency and non-subscription revenue, the growth rate from overseas operations was 21.4%.

By region, quarterly revenues from our European and Pacific Rim operations were $28.7 million and $6.4 million, respectively.

Subscriptions by non-U.S.

based clients were $146.4 million representing 30% of the Companywide total.

Moving to expenses for the quarter, operating expenses were $81.9 million and our operating margin was 32.4%, down 10 basis points from Q2.

Cost of sales as a percentage of revenues was up 70 basis points over the prior year.

Our compensation and computer depreciation were partially negated by lower communication costs and amortization of intangibles.

Increase in compensation was driven by new employees.

Computer depreciation rose from utilizing a shorter useful life for main frames to account for our plans to transition to HP's newest Integrity machine.

The decrease in communication costs was a result of favorable pricing from industry suppliers and a decrease in amortization expense was caused by a decline in acquisition activities compared to the previous year.

SG&A expenses expressed as a percentage of revenues declined 170 basis points year-over-year.

This decrease was driven by lower occupancy costs and miscellaneous expenses partially offset by higher T&E.

Lower occupancy costs as a percentage of revenues was caused by redundant office space in the prior year during the time our European headquarters was under construction.

Excluding this item, occupancy costs were 40 basis points higher than a year ago.

The reduction of miscellaneous expenses was the result of consolidating corporate expenditures through a purchasing card.

Higher T&E is being driven by more employees conducting sales and consulting activities.

Employee count as of May 31st was 1,544, up 20% from a year ago and up 14% since the beginning of the fiscal year.

Our sales force grew approximately at the rate of revenue.

Our effective tax rate for the quarter was 30.9%.

This rate can be broken down into 35.6% from recurring operations, offset by a benefit of 4.7% primarily from recognizing a tax deduction under Section 199 back to the beginning of fiscal 2006.

Let's move on to the review and discussions regarding the use of soft dollars.

Recently a speech by the SEC Chairman Cox (inaudible) indicating his firm personal preference to eliminate soft dollars.

We do not believe this is a significant fact for the following four reasons.

One, FactSet revenues (inaudible) using soft dollars continue to decline.

It's now 24% of the total, down from 41% three years ago.

Two, the majority of FactSet's revenues paid in soft dollars are derived from large asset managers.

We believe what they pay FactSet is truly minuscule compared to the total operating expenses.

Three, when the soft dollars were (inaudible) several years ago, many asset managers at the time chose to pay for our services in hard dollars.

This action did not reduce our overall spend or affect buying patterns with FactSet.

In fact, most firms that switched have deployed more FactSet services in hard dollars and our revenue growth rate has accelerated during the period.

Fourth, the SEC and the financial services industry debated the soft dollar issue for close to four years.

The effective date of changes by the SEC was in January 2007.

Therefore, we believe the interest level will be visiting the new policy as well and a quick or complete turnaround is remote.

Let's now turn to our outlook for the fourth quarter of fiscal 2007.

First off, please note the earnings release date for Q4 is planned for Tuesday, September 25th.

This date is a week later than our normal schedule to account for the first business day of the month falling on September 4th.

We expect to revert to our normal schedule with our December call.

Now turning to the specifics.

Q4 revenues are expected to range between $126 million and $130 million.

Operating margins are expected to be between 32% and 34%.

The 50 basis point increase in the guidance reflects the seasonal revenue benefit from workstations used by summer interns.

This benefit is temporary and is not expected to repeat in Q1.

Effective tax rate is expected to be between 35% and 36%.

Our CapEx range for fiscal 2007 remains at $35 million to $39 million.

To sum it up, Q3 adds to our continuing string of successful quarters.

Our organic revenue growth increased to 21% and net income is tracking slightly better than revenue.

Over the years, regardless of the market cycle, FactSet's relative financial performance has been strong.

Our results clearly highlight the continued strength of our product, a predictable business model and a very talented employee base.

While we're proud of our achievement, ast the same time, we see great opportunity ahead.

We believe the current market opportunity is at least 15 times the size of FactSet's annual revenue.

If we're able to capture even a portion of that, the forward potential to create value for shareholders could be enormous.

Thank you for your participation in today's call.

We are now ready for your questions.

Operator, we can't hear your questions.

Operator, we cannot hear any of the questions.

Can you hear us, please?

(OPERATOR INSTRUCTIONS) The first question comes from Peter Appert.

Hi, good morning.

Apologies, I'm on my cell phone.

Peter, two questions.

First, can you quantify any (inaudible) in fact physically associated with this accounting change that benefited you by $0.5 million on the revenue side?

And then secondly, maybe for Phil, any update on how you're feeling about the traction you're seeing in the market from your fixed income offerings?

Thanks.

Thank you, Peter.

Could I just ask you to repeat the first part of that question because you were breaking up?

Yes.

Sorry.

I was trying to -- wanted to know if there was a -- if you could quantify an earnings benefit associated with the change in subscriber accounting.

So the 3.4 million in incremental revenue, how meaningful is that to operating income or EPS?

The benefit in the quarter was $280,000 to revenue, which would fall to both operating income on a pretax basis.

Okay.

Peter this is Phil Hadley -- the second part of your question on the fixed income offering.

There's really two parts of our offering.

There's the standalone, fixed income and analytics products and then fixed income and TA.

Fixed income and TA is in the marketplace and is being used by clients.

Still very, very early.

I wouldn't even classify it in the first inning as to what its opportunity is.

And then the standalone fixed income product, I would probably put in the same category, non-material impact in the quarter, but we're excited about what the opportunities and the future brings for us.

Okay.

Great.

Thank you.

And then Phil, one other thing.

Your thoughts on the Thomson Reuters potential combination, threat or opportunity to FactSet arising from that?

I guess I have three thoughts on the Thomson Reuters merger.

On the product lines where we would be considered competitors to either Thomson or Reuters, I really don't think the landscape changes much with a merged company as they were standalone.

That's pretty normal in our industry to be both a supplier as well as an application producer of (inaudible) in our industry.

In areas where Thomson competed with Reuters, I think that obviously there's -- they're looking for synergies in the merger, and we will be looking to take costs out and potentially -- potentially take price or increase price in those areas.

In every area where we have supply from either one of those two vendors, we have multiple vendors in that area, and certainly one of the powers of FactSet is the ability to have choice from an end-user perspective, so our clients have the opportunity to explore in the price value relationships of content on the system.

Our goal is always to have the best of breed.

They both have strong product lines in those areas, but we'll always make sure that our clients have the appropriate choices.

As far as just our relationship with either firm, we've been strong business partners with Thomson for more than a decade and Reuters as well.

We generate material revenue for their product on our system and what would normally be considered pretty unique work flows, product lines that they don't produce themselves, so it allows them to generate revenues in areas that they wouldn't otherwise.

And I guess lastly, we all serve the largest mutual clients in the industry, and I think it's in everyone's best interest, in ours and theirs included, to make sure that we stay focused on their needs and supply the best solution to those clients.

So all in all, I don't think it materially affects us either way.

It's a big, large player in the space.

And we continue to do what we've been doing historically and I don't really see that changing much.

Okay.

Thanks, Phil.

The next question comes from Lisa Monaco.

Hi, good morning.

Couple of questions.

Peter, I think in the past, when you've talked about long-term margins, I think you said margins over the longer term will be somewhat flattish relative to where they are currently.

Can you just walk us through why that is so, and why you shouldn't see some margin expansion?

And then I have a couple other questions, thanks.

Thanks, Lisa.

Our guidance on flat margins really reflects a philosophy that it's important for us to invest for the future and we continue to invest in more headcount and more products.

We're in the software business, and things change quickly, and if we don't invest for the future, we're not doing the best stewarding of the capital for our shareholders, and that's really what it reflects.

Okay.

And then just on the revenue growth and expansion in number of clients and passwords, can you just kind of talk to some of the benefits from some of the newer products, like derivative solutions and alpha testing, and if there's any way to give some sort of color, I know you haven't done this in the past, but in terms of the revenue contribution from non-core FactSet -- the basic -- revenues from the basic workstation, can you just isolate kind of what comes from PM, and what comes -- PA, and what comes from some of the other newer offerings?

Thanks.

Lisa, this is Phil.

It's very difficult, even internally, to actually break down revenue by product because sometimes you think of a product as an application, sometimes you think of a product as software, and obviously there are cases where they're intertwined, and you can't break them apart.

It's hard to determine what sold the the workstation, whether it was the content or whether it was the applications themselves.

So I guess the best way for me to describe it is just general areas of health in the business.

And they're pretty consistent through time.

So for analytics, the whole product line, it's not just the seat or the client count that drives that product.

There's half a dozen different things that a client can subscribe to on that seat.

As you mentioned, alpha testing is one of them and we continue to expand that product line.

The newest addition to that product line is publishing, the ability to take that work flow and actually produce output that would be used by a board or for an outside client.

Another area of strength for us has been Marquee.

That certainly is a workstation based product, meaning that it's influenced by seat count more than anything else.

Again, it's very early in its lifecycle.

It's something from your perspective maybe has been around for a long time and that we've been talking about it for a half a dozen years but it takes a long time for a product to ramp up in the marketplace and to start to deliver the value that the clients perceive necessary to make it a primary part of their work flow.

It's been doing well.

And I would say in general, just generic content.

And for us, that falls into probably 10 or so buckets of slices of content, certainly have also helped revenues in the last couple quarters.

Don't see it really changing that much moving forward.

As we look at our business, you can tell from the analyst perspective, what (inaudible) accelerate or decelerate very quickly.

Neither do products in our system, but we're very excited about the strength of our product line, and as Peter mentioned, we continue to invest very heavily forward.

I guess the one comment I would say is fixed income I would not classify as a driver at this point.

It's really more in the investment phase for us to get it to the point where it can some day be a contributor, but it will probably take us years to get to that point.

Okay, one last question.

When you sized your market opportunity, can you just define what you're including in that?

Is fixed income in there?

Derivatives, et cetera?

Thanks.

We went through an exercise recently of sizing the market, and you do a lot of guessing, I guess, and by the time we get to billions, and then it becomes tens of billions, as the precision gets pretty sloppy.

Certainly I think when you start talking about the market being greater than 10 billion globally, you have to include fixed income in that opportunity.

And it really, at that point, includes all asset classes and lots of different work flows.

So I would say at 15 billion, it's the whole market, and however you think about it.

Probably the market defined by who is currently using third-party or some outside vendor to accomplish it.

I'm sure if you were to capture the internal work flows and dollars spent on internal applications in a firm like yours, the market would even be much larger.

So we're so small in this space that we just don't look at dollar spend as even remotely close on the horizon as to what we could achieve in the long run.

Thank you.

The next question comes from Kevin Doherty.

Great, thanks.

Maybe a question for Phil.

Can you just talk a little about the international environment, maybe some of the opportunities there?

It seems like this quarter the organic growth has slowed down a little more where the U.S.

is tracking.

Maybe just how you think about that business longer term.

Actually, we did some research on that.

I think there's some confusion because the international growth rate contains sometimes FX and sometimes not FX, and sometimes some of the more recent acquisitions we've done have been non-U.S.

acquisitions.

But the organic growth rate of non-U.S.

business has roughly been 21%, give or take 100 basis points, for the last two years.

So it's really -- the difference in our business has been that the U.S.

business has accelerated to mask that growth rate.

With that said, I do still believe that we have a greater opportunity on a market share basis, a client seat basis outside the U.S., and it goes from the premise that I do believe that 50% of the opportunities outside the United States, and at this point we're roughly at a 70%/30% mix, and that's really a function of we started in the U.S.

and the international hasn't yet caught up, and then it's difficult for it it to catch up when the U.S.

business has accelerated nicely.

Okay.

And then also on the employee growth, looks like accelerated about 20% this quarter.

Can you maybe just talk a bit about the hiring environment?

Are you seeing any signs of a tight labor market?

FactSet primarily does its hiring on two sides of our business -- software engineers, which we hire globally.

We have software development occurring in at least five major areas in FactSet in both Europe, the U.S., and Asia Pacific.

We also hire -- consultants is really our primary entry point from a hiring perspective.

The answer is it varies by market as to supply and demand.

But we've, as you can tell by the numbers we've produced, been able to meet what we like and desire as headcount needs.

And it all really stems from making sure we're investing in a future product.

Okay.

Thanks, guys.

The next question comes from Peter Heckmann.

Yes, good morning.

This is Craig Richard in for Pete.

First question -- could you give us an update on the New York City office consolidation project, when that's scheduled to take place, if we'll see any additional expenses flow through the income statement in the fourth quarter?

And then going forward in fiscal '08 and beyond, is there any potential cost savings associated with the consolidation of the five offices into one?

Thanks, Craig.

We signed the lease, and that lease became effective during the third quarter, as the lease was for 33,000 square feet.

We're currently building out the space, and it will house up to 170 employees.

We're scheduled to move into that space the very end of July.

That's where we currently stand.

Our CapEx that we plan for the quarter is built into our CapEx guidance.

Okay.

And the total square feet, is that more than the current five offices combined?

Yes.

Okay.

And then it looks like you forecasted to exit the year with north of $200 million in cash and marketable securities.

Can you just review for us your priorities for use of cash going forward?

Sure.

Our current cash balance is $189 million.

We haven't forecasted cash -- what we're exiting at the end of the quarter.

We continue to analyze all opportunities to deploy excess capital, whether that relates to investing back into our own product development ideas through new employees or whether we find opportunities to repurchase share, we're open minded to acquisitions and investing in our tax rate.

Thank you.

(OPERATOR INSTRUCTIONS) The next question comes from Ashley Hemphill.

Hi, guys.

Great quarter.

I was wondering if you could give us the impact of the accelerated depreciation from the computer using the shorter life of the mainframe in terms of EPS in the third quarter.

I think if you looked at depreciation as a percentage of sales, comparing Q3 '06 to Q3 '04, you'll see that it increased by 40 basis points, quarter over quarter, and that really reflects the reduction in the employees.

Okay.

And then just a question in terms of DSOs being a record low in the quarter.

Is this due to the new invoicing time frame, and is this a one-time benefit, or should we expect this to continue?

Should we expect DSOs to continue to be lower going forward?

Thanks, Ashley.

Yes, the lower DSOs is a reflection of revising the timing of our bills, invoicing on the first of the month, effective in April.

We would expect that this is a one-time benefit and as long as our collection efforts stay steady and client satisfaction levels are high, we hope to maintain it in the future.

great.

Thank you.

[Casey Romman], your line is open.

Hello?

Your line is open, sir.

Yes.

Good morning, guys.

Thank you for taking the call.

We have recently become your shareholder.

I have one comment and one question.

First the comment.

When we analyze your financial data, it is amazing to find that you guys are consistently growing sales and EPS year after year.

It is truly a remarkable achievement.

Job well done.

Now the question as a bigger picture question, it it would be nice if you can share your vision with the shareholder what are the three growth drivers for the next two to three years in terms of product, market, and the geographical region?

This is Phil Hadley again.

Well, thank you for the compliment.

The growth drivers for our business in the future are really the growth drivers historically.

We really feel that we have lots of opportunities.

We tend to talk about the bigger projects, or the bigger product contributors, but if you had the inside information, the detailed product information we have, it's really a list of 50 different things that drive our business forward.

Some of them small, some of them much larger.

The larger opportunities for us are certainly in the (inaudible) analytic space, news and quotes in Marquee space.

Content would be certainly an opportunity for us, as well as expanding our product geographically, and working toward making the opportunity for FactSet closer to the 50% U.S.

business, 50% non-U.S.

business.

I would summarize it simply in that way.

Thank you, guys.

Keep up the good work and pleasure to be your shareholder.

Thank you.

And there are no other questions at this time.

Thank you, everyone.

Have a nice summer.

That does conclude our conference.

You may disconnect at this time.