Fair Isaac Corp (FICO) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Fair Isaac Corporation Quarterly Earnings Call.

(Operator Instructions) Today's call is being recorded Thursday, July 26, 2018.

And now I'd like to turn the conference over to Steve Weber.

Please go ahead.

Thank you.

Good afternoon, and thank you for joining FICO's third quarter earnings call.

I'm Steve Weber, Vice President of Investor Relations, and I'm joined today by our CEO, Will Lansing; and our CFO, Mike Pung.

Today, we issued a press release that describes financial results compared to the prior year.

On this call, management will also discuss results in comparison to prior quarter in order to facilitate an understanding of the run rate of our business.

Certain statements made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995.

Those statements involve many uncertainties that could cause actual results to differ materially.

Information concerning these uncertainties is contained in the company's filings with the SEC, in particular, in the Risk Factors and Forward-looking Statements portions of such filings.

Copies are available from the SEC, from the FICO website or from our Investor Relations team.

This call will also include statements regarding certain non-GAAP financial measures.

Please refer to the company's earnings release and Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measure.

The earnings release and Regulation G schedule are available on the Investor Relations page of the company's website at fico.com or on the SEC's website at sec.gov.

A replay of this webcast will be available through July 26, 2019.

And now I'll turn the call over to Will Lansing.

Thank you, everyone, for joining us for our third quarter earnings call.

We delivered another very strong quarter.

In fact, we had record revenue for the second straight quarter and that even as we're transitioning our business model from an upfront license revenue to a recurrent-revenue base.

We also had a very good bookings quarter and continue to build an increasing backlog of predictable, recurring revenue.

In our third quarter, we reported revenues of $260 million, an increase of 12% over the same period last year.

We delivered $32 million of GAAP net income and GAAP earnings of $1.04 per share.

We delivered $47 million of non-GAAP net income and non-GAAP EPS of $1.51.

As we've been saying, we've been able to deliver growth even as we shift our business.

It's easy to see how this transition is playing out in our revenues and also in our bookings.

This quarter, we signed $120 million of bookings, up 26% over last year.

Digging deeper into those bookings, our upfront license sales were actually down 24%, and our transactional bookings were up a whopping 44%.

Those represent revenues that are yet to be recognized and that will be recurring revenues well into the future.

It's a model we're putting in place across all of our segments.

In Applications, revenues were up 6% over the prior year and 7% year-to-date.

Our TONBELLER Compliance Solutions and our Originations Solutions were particularly strong, up 55% and 11%, respectively, from last year.

We also signed many Applications deals this quarter, many of which have been due to recent product innovation.

Our new Strategy Director, for instance, provides analytically powered decisions across both the customer management and originations life cycles.

This new product, built on the DMS platform applies optimization technology in real time to deliver faster and easier decisions.

It has a significant pipeline and is being sold to customers in financial services as well as other industries like telecom.

Our recent enhancement of our collections and recovery product has also helped boost sales.

Year-to-date, collections and recovery bookings are up 129% over last year with an increasing number in the cloud.

Our total Applications bookings of $82 million were 32% higher than last year, and we continue to build recurring revenue streams in this segment.

In our Decision Management Software segment, we continue to have near-term revenue headwinds as we shift to a recurring revenue model.

This quarter, upfront licenses were down 36% from last year, which caused total revenues to be down about 7%.

As we've explained, we're now selling these in the cloud, either our own FICO Analytic Cloud or on AWS.

And the results have increased recurring revenue, which we're now building in backlog, and we're seeing proof of demand in our bookings.

In fact, this quarter, DMS bookings were up 27% over last year and 38% over last quarter, making it the biggest ever bookings quarter in the segment.

In the Scores business, we had another great quarter with revenues up 32% versus the prior year and up 29% year-to-date.

On the B2B side, revenues were up 42% over the same period as last year.

Similar to last quarter, this was driven partly by increased originations and account management volumes as well as targeted price increases.

We continue to see strength in this core segment and expect it to continue to perform well.

B2C revenues were up 15% this quarter and 18% year-to-date.

An important innovation in this space is the recently announced FICO Score planner, a first-of-its-kind tool to empower consumers to use on their financial health journey.

The FICO Score planner enables consumers to set a target FICO Score goal and desired time duration to reach their goal.

These inputs, along with the consumer's current FICO Score and credit report, are analyzed by the FICO Score planner algorithm, which produces a set of personalized potential actions that consumers could take to help reach their target FICO Score goal.

Consumers can then track their progress to their goal or modify their goals along the way.

FICO is committed to financial inclusion and consumer empowerment.

The FICO Score planner, which is available through lenders and resellers, is an important step in helping consumers understand and improve their access to credit.

Finally, we continue to deploy significant resources to our share repurchase program.

In the third quarter, we spent $107 million and another $55 million in July for a total this fiscal year of $286 million.

We exhausted the 2017 Board authorization and today announced a new $250 million share repurchase authorization.

I'll share some summary thoughts later, but now I'd like to turn the call over to Mike for further financial details.

Thanks, Will, and good afternoon, everyone.

Today, I'll emphasize 3 points in my comments.

First, we delivered $260 million of revenue, an increase of $29 million or 12% year-over-year.

Recurring revenue was $195 million, up 17% from last year, and bookings of $120 million were up 26% from last year.

Secondly, we delivered $32 million of GAAP net income, up 28% year-over-year.

And finally, we had $72 million of free cash flow this quarter, and we spent $107 million of it on repurchasing shares.

I'll begin by breaking the revenue down into our 3 reporting segments.

Starting with Applications, revenues were $142 million, up 6% versus the same period last year.

We had a strong quarter in compliance with our TONBELLER products and in originations with increases in transactional volumes.

In Customer Management, we are now beginning to sell our new Strategy Director product, and we had 3 deals over $1 million each this quarter.

Our Applications bookings of $82 million is up 32% from last year.

In the Decision Management Software segment, revenues were $26 million, down 7% versus the prior year due to the decreased license sales.

Recurring revenues in DMS were up 3% from the previous year.

Bookings were $27 million, up 27% from last year and 30% over last quarter.

And finally, in our Scores segment, revenues were a record $92 million, up 32% from the same period last year.

On the B2B side, we're up 42% versus last year, and B2C revenues were up 15% versus the same quarter last year.

Looking at revenues by region, this quarter 75% of total revenues were derived from the Americas.

Our EMEA region generated 15%, and the remaining 10% was from Asia Pacific.

Recurring revenues derived from transactional and maintenance sources for the quarter represented 75% of total revenues.

Consulting and implementation revenues were 17% of total, and license revenues were just 8% of total revenue.

Our cloud revenues were $58 million this quarter, up 14% from last year.

Year-to-date, our cloud revenues are $178 million, which is up 18% from last year.

Bookings this quarter were $120 million, are up 26% from the prior year.

We generated $17 million of current period revenue on those bookings for a yield of 14%.

The weighted average term for our bookings was 28 months this quarter.

This quarter, we had 15 deals over $1 million, and we booked 9 deals over $3 million.

Cloud bookings were $44 million this quarter and are $95 million year-to-date, which is up more than 130% from last year.

Operating expenses totaled $211 million this quarter compared to $210 million in the second quarter.

We expect to maintain a similar run rate in the fourth quarter while actively investing our resources in our highest strategic priorities.

Our non-GAAP operating margin, as shown in our Reg G schedule, is 27% for the third quarter and 26% year-to-date.

We expect the full year operating margin will be somewhere around 27% to 28%.

GAAP net income this quarter was $32 million, and non-GAAP net income was $47 million or $1.51 a share.

And our effective tax rate was about 22% this quarter.

Free cash flow for the quarter was $72 million versus $67 million in the prior year.

And for the trailing 12 months, our free cash flow was $188 million.

Now finally, turning to the balance sheet, we had $120 million of cash on the balance sheet at the end of the quarter.

Our total debt is $765 million with the weighted average interest rate of 4.6%.

The ratio of our total net debt to adjusted EBITDA this quarter is 2.34x, which is below our covenant level of 3x.

And during the quarter, we issued $400 million of fixed interest notes with an 8-year term.

Proceeds were used to repay a maturity on an existing private placement as well as to reduce the amount outstanding on our revolving line of credit.

During the quarter, we returned $107 million in excess cash to our investors, repurchasing 563,000 shares at an average price of $189.75.

We also purchased an additional $55 million in July, which exhausted the $250 million Board authorization from last October.

We've repurchased more than 1.6 million shares this fiscal year at an average price of just over $175.

We announced earlier today that the Board has approved a new $250 million authorization and continue to view share repurchases as an attractive use of cash.

And we also continue to actively evaluate opportunities to acquire relevant technologies and products that advance the strategy or strengthen the portfolio and competitive position.

Finally, we are reconfirming our guidance that we updated last quarter with revenue of approximately $1.02 billion, GAAP net income of $140 million, GAAP -- non-GAAP net income of $200 million and non-GAAP EPS of $6.38.

With that, I'll turn it back to Will for some final comments.

Thanks, Mike.

Next quarter, we'll talk about our expectations and guidance for 2019.

But for now, I'll say that we're happy with the progress we've made in 2018 and are very bullish in our future prospects.

In our software businesses, we've made significant progress on our cloud-first analytic forward strategies.

We're signing more deals and larger deals and it's showing up in our bookings numbers.

And we're seeing the cloud bookings, which have more than doubled in fiscal 2018, beginning to turn into cloud revenues.

These recurring revenues give us more visibility to steady, sustainable growth than ever before.

On the Scores side, we're continually looking for new ways to make the most of this incredible IP asset.

On the B2B side, we're working with customers to help them find new ways to use the FICO Score.

On the B2C side, we're committed to providing products and services to promote financial inclusion and to help consumers pursue their financial goals.

In summary, we're well positioned as we finish up our fiscal year and look to the future.

We remain committed to our strategy and are eager to make the most of the many opportunities ahead.

And now I'll turn it back to Steve for Q&A.

Thanks, Will.

This concludes our prepared remarks, and we will now take any questions you may have.

Operator, please open the lines.

(Operator Instructions) We have a question from Manav Patnaik with Barclays.

My first question is maybe we could just revisit the DMS growth profile and how that's changed, because I think at beginning of the year you talked about that should be sort of a low double-digit kind of growth business, but it's been declining.

So can you just help me walk through what changed there, what's going on, again?

Yes, Manav, this is Mike.

So really what's happening is, the DMP as a stand-alone segment is becoming a little less relevant to a separate reportable unit for us.

Where we are seeing growth from the DMS and the DMP platform is primarily coming off of the products that we've created using the DMS and the DMP, which is our originations product and our new Strategy Director product.

And so while we're disappointed, I'd say, in the stand-alone performance of the revenue of what we classically call DMS, we're very, very happy with the value that we're creating from the investment in the platform itself.

And it's showing up in terms of benefits in other areas that are probably buried within the Applications business.

So I guess is there -- so it sounds like there's a few of those products you talked that are disappointing.

But is it being made up for elsewhere?

Or was it the Scores business that's making up for this in terms of your guidance?

I wouldn't say that we're disappointed.

We're not disappointed in any of our products.

No, things are actually going quite well, including in DMS.

The -- you're getting the shift from license to recurring, so that's part of it.

And then as we've talked about in the past, DMS, it's not a pure thing.

It actually underlies so many of our other products.

And sometimes it gets sold as DMS, and sometimes it gets sold as an application with a different name like Strategy Director or originations.

And so I think it's -- I think we're in pretty good shape there.

Okay.

And just on the Scores side, I mean, can you just -- maybe some incremental color on the pricing increases that you had in the mortgage side last quarter?

Any increased adoption?

And also, just any thoughts on the FHFA stopping the review of the scoring alternative, I guess.

Well, first, with respect to the mortgage pricing, we put in place pricing changes some time ago.

As you know, the way that market works, many of the contracts with the end users are over an extended period of time.

And so not all the pricing is completely kicked in.

But we haven't had any issues; things seem to be going very smoothly there.

With respect to the FHFA process, we're on board with it, and it remains to be seen where it goes.

Okay.

And maybe just last question, any thoughts on market trends?

Any color, just the usual, on mortgage or to cars?

Any changes there?

We're continuing to see strength.

I mean, everyone worries about the fall-off in volumes, but we're not really seeing it.

Our next question is from Brett Huff with Stephens.

This is Blake on for Brett.

First one is the bookings.

Those were nice in the quarter.

It seems like you're getting more larger deals, as you pointed out.

With that in mind, I was wondering if we could get an update on the pace of cloud infrastructure investment and maybe the duration of that.

Any update on how that is going, how long it should last?

And specifically in the quarter, gross margin was a little bit lower than we had modeled at least.

Was there any incremental infrastructure investment in the quarter maybe that was in that line item?

Yes, so we're seeing -- well, we entered the year with an internal mantra of cloud first.

And our sales organization, their compensation plans, even our internal nonsales comp plans are really focused on building out a world-class cloud business that we believe we're well underway to doing that.

What we've seen so far through 9 months is we've seen a tremendous amount of growth on the booking side, well over 130% year-to-date, compared to the prior year.

And along the way, as I think we've mentioned numerous times, we've increased our investment in our security, in our operations, in our infrastructure.

And frankly, most of the new employees that are finding their way into FICO are tied to those kinds of activities.

Many of them are in our lower-cost areas, including in Bangalore.

But the point is a lot of the investments that we're making this year are to basically build out the infrastructure to keep up with all the demand and the actual growth in that business.

So I would say the increase in costs that you've seen over the past few quarters has primarily been tied to that, and it's starting to level off, but it's at this new run rate.

The only other item that is maybe of interest on the expense run rate at least this quarter is it was a bit inflated in quarter 3 because we had our annual FICO World customer user conference in April, and that's $3 million to $4 million onetime marketing dollars get spent for that event.

But beyond that, we're just kind of continuing to put money against the growth and the opportunity in the cloud.

Great.

And then on the -- with regards to the price increase in mortgage, can you talk about the potential for maybe other price increases you maybe see in the future in the B2B segment?

Are there any specific verticals or use cases you think most likely?

And then any timing you'd give on that as well?

There's no specific verticals and no specific timing.

We regularly and continuously review our pricing.

We have the flexibility to change our pricing once a year, and so there is a kind of an annual cycle for that.

I think -- I think that you can be assured that our Scores people are trying to strike the right balance between not shocking the market with price increases, but at the same time, making sure that we are adequately compensated for the value that we're providing.

And so there's a continual assessment of that.

There's -- we interview customers, and our distribution channels understand what's appropriate.

And we recognize we're in a special position and are careful about that.

All right.

And then last one for me was on -- you mentioned the refi.

That other expense was a little bit higher than we expected.

Did that higher interest expense kick in, in the third quarter at all?

And then maybe any comments on the impact there on interest expense line?

Yes, the debt was refinanced in May, first week of May.

And so I guess it was a partial quarter where we had reduced the revolver, which is just around 3% debt, around that area, and we replaced it with about 5% debt on the new offering.

But what you ought to see over the course of the next few quarters going forward is some nominal increase in interest expense but not all that significant because our weighted debt is just nominally higher than what it was pre-refinancing.

And the revolver is tied to LIBOR, and that's been ticking up.

So that's some of it too.

(Operator Instructions) We have a question from Bill Warmington with Wells Fargo.

So first of all, congratulations on the really strong bookings.

That's impressive.

The first question for you is I wanted to ask about the cybersecurity product.

It looked like you had started on a new strategy, a freemium/premium model.

So I was going to ask about what the plan is with that and then how also you think about the overall opportunity in terms of what it could be for you.

Thanks for asking that question.

We're very excited about our prospects there.

So as you know, we call it the Enterprise Security Score.

It comes in 2 forms.

One is an outside-in look at a company.

So you can look at all your vendors, you can look at all kinds of people from the outside-in without their permission just based on what's publicly visible.

And then there's an inside-out look, which goes much deeper and is the kind of thing that companies would do for themselves and insurance underwriters might insist on for underwriting cyber insurance for an insured.

And so those are the 2 broad flavors.

What you're referring to, the freemium model, is it turns out that it's not that hard for us to produce this score, and there are some costs associated with it but not huge costs.

And therefore, we thought that the interest -- in the interest of adoption, we should make it free and let people get their own FICO Enterprise Security Score by going to the website and signing up and they'll get their score and they get the feedback.

And then they also have an opportunity, I should point out, to improve their score.

If they think that any of the data on which the score is based is erroneous, they have an opportunity to submit that and potentially improve their scores if they feel like there's any error there.

And then from there, obviously, you move to paid product and you'll be paying for assessing all of your vendors and so on.

Then on the -- the revenue trends look very strong.

The bookings trends look very strong.

I wanted to ask about how we should start to think about the timing of when we should see some of that strong incremental profitability actually flow through and drive some margin expansion.

That's another great question, Bill, and we wrestle with that one -- we wrestle with that one internally all the time because as you know, we have a lot of control over our expenses and we can improve the software margins at any time at will.

And we really can.

And so for us, the debate is always is this the year to do it?

Should we be dialing back our investment and stretch out the road map, the time line, for producing all this innovation that we're producing, in the interest of showing our investor base that we have this profit-making potential?

Or alternatively, should we continue to invest based on what we believe the market opportunity is to carve out kind of first-mover advantages?

I mean, I think we have the absolute world-leading analytics platform.

There's no one who has anything quite like what we have.

And so we're in a little bit of a race, and we're really throwing a lot of energy and resource at it.

But the balance is there, and it's in our control.

And so I think you'll just see us going year-by-year and making a determination about how much and at what pace do we want to make these investments.

I think it would be fair to assume that over the coming 5 years, the margin's just going to continually trickle upward.

It's going to tick upward.

But in terms of a commitment to improving the margin right now, I think that really depends on this balance between market opportunity.

And then you talked about a number of different applications.

You didn't mention CCS, and I just wanted to check in on that one.

That's one that I know you had been getting a lot of traction with in the past.

Just wanted to get a sense for about approximately what it was in terms of dollar size, what kind of growth rate you're seeing on it and where you're getting the best adoption.

Okay.

So Mike will give you the growth rate in a second, but I would just say that CCS continues to be a very strong business for us.

We have the world's leading product there.

Obviously, the components of messaging to a consumer, many of those are commoditized and are available at commodity price levels.

But CCS has a tremendous amount of value-add and case management associated with it, and we obviously have all the analytics horsepower that we bring to it.

And so in a world where our customers are increasingly focused on customer journey and understanding the consumer through the entire life cycle, having the ability to interact with the consumer and optimize every one of those interactions is increasingly important.

And so we're just seeing a lot of appetite and uptake for it.

It's very strong in Asia right now.

We finally have enough capacity between owned data centers and AWS extension.

We have the capacity now to support customers in a way that we never had before.

And so we're seeing geographic expansion.

And of course, our core customers in the U.K. and in the U.S. are very happy and renewing our product.

In terms of the numbers, Bill, the CCS business is growing year-to-date, about 14%, and the run rate is just around $25 million per quarter of all recurring cloud revenue.

Third quarter, we were slightly below that, in fact, half that mainly because of some volume declines that happened at a couple of large customers as they were realigning some of their strategies.

But we see those as kind of short-term items.

But long term, the pipeline is very fat and healthy in this area and the product is world-class.

I just wanted to ask for a little clarification on the -- within Applications, of course, everybody always thinks of you guys in terms of Falcon and TRIAD.

But it seems like if you group together a couple of your other products like CCS and, I don't know which ones exactly in terms of the size, whether you would throw in Originations Manager in there or Strategy Director, but it seems like they're almost getting to the size of Falcon and TRIAD on a combined basis.

Maybe you can help us understand the dynamic within the portfolio of Applications.

Yes, so you're absolutely right.

There is growth.

We're seeing good growth in originations and in Strategy Director and frankly, in collections and recovery also.

I mean, so if you think about our big franchises, obviously, Score is big and strong and in good shape.

Falcon, same thing.

And then you get into the CCS is in good shape.

We just talked about that.

And then if you go down to our fourth and fifth and sixth businesses, they're all very healthy and doing really well and kind of taking share in the market, and that would be originations, Strategy Director.

Those -- I'd say those are the big ones.

So Strategy Director, one way to think about that is it's the next generation of TRIAD.

So it's not really a distinct thing, and yet very often it's sold together with originations.

And so it's both kind of a successor product to TRIAD as well as a sister product to originations.

One last thing I'd add to that, Bill, that probably wasn't evident in the pre-comments, but the collections and recovery product of ours, which we've had for now a little while, we've added a lot of features, capabilities certainly to the cloud.

On a year-to-date basis, that part of our business has the largest bookings of the entire software suite -- is in collections and recovery, and most of that's sitting in backlog, which is pretty remarkable because just 2.5, 3 years ago, that product was much smaller.

And when we sold it, it was all upfront license revenue, and that's just not the model with that anymore.

So that will become more prominent along with CCS and originations, I think, over the next 12 to 18 months.

One housekeeping item.

Number of shares that you actually bought in July?

We bought -- we spent $55 million, and it was -- let me give you the number, 300-and-some thousand shares.

Give me a quick second and I'll put my finger on that for you.

While you're doing that, I'll slip in another one.

I just wanted to check in on FICO XD just to see where that was in the adoption.

I know that we've gone through beta testing with a number of banks.

I think there were a couple of banks who were trying it out.

Just trying to get a sense for how that's doing.

So far so good.

I mean, everything's right on track with XD.

You know that adoption is slow, but there's a lot of appetite for it and it continues to proceed apace.

We announce adoption as we can, once our customers are comfortable that they're going to adopt and it's gotten through the testing and so on.

And so Bill, we took in about 240,000 shares in the month of July.

Our share count is just over 29.2 million, 29.1 million, right in that range right now after the plan.

Got it.

That's what I was trying to get at.

All right.

Well, I've got to go because I've got to get home and work on my tasks that are being assigned to me by the score planner so I can improve my FICO score.

(inaudible) You'll get up there yet and we'll get you a mortgage someday.

And we have a question from the line of Adam Klauber with William Blair.

Just a couple of follow-ups.

So on the Applications bookings, how much -- just a ballpark, how much actually is coming from the origination and collection?

Is that the majority of it now?

Adam, give me a second, I'll take a peek.

We had a pretty good quarter in both originations, collections and recovery and fraud banking.

So that was -- between the 3 of them now, that was about $50 million of the $80 million, those 3 product lines.

Okay.

Okay.

And I think you said the pipeline even for more new business is still pretty good in both those products.

Yes, collections and recovery, in particular, where we have a very large cloud pipeline.

We're starting to see it level off a little bit in originations.

We've been on fire the last 2 years, and that's leveling off some and it's being replaced, frankly, with collections and recovery in our Strategy Director products.

And with the collections and recovery, is that more replacing competitor products?

Or is that more sort of a new tool for banks that they just haven't had before?

No.

It's replacing usually an existing vendor or an internally built product.

Most of these are third-party vendors.

So it's a complicated piece of software.

It's 5 million lines of code, our collections and recovery business.

So those if you're big and complicated, you don't build them yourself.

You go look for a vendor and we're, more often than not, now on that shortlist.

Okay.

And what's the average term of the contracts both on the origination and collections?

Do they tend to be longer on average?

No.

They tend to be -- our average term blended all in was 28 months.

These tend to be around 3 years.

Okay.

Okay.

And then DMS, I think you've talked about transition a fair amount.

But for next year, do you think overall revenue will be flat or up based on that transition?

We'll let you know here in 3 months.

To be quite honest, we're -- and the reason I say that is a big contributor to our growth rates on a go-forward basis is the amount of deals we book and how they -- what we call waterfall or how they roll out and get recognized in the future.

And because we have such a heavy weighting of our bookings in the fourth quarter, it's often hard to do an estimate of how much revenue we'll have in the bank and rolling forward into next year until we get closer to the end of the quarter.

So that's why we really haven't given a whole lot of directional guidance at this point yet.

Yes, that makes sense.

And then on the FICO Score planner, how is that business being monetized?

It becomes part of the package, the bundled package, that we sell on myFICO or that our vendors and resellers are selling into their package.

So it really helps support the existing consumer pricing and in maybe some cases, it creates a little premium.

But right now it just becomes a part of a richer bundle of packages and gives consumers more reason to go and sign up and stay longer.

Great.

And is that having a -- I'm not asking for a number, but is that having a material effect on the growth in B2C right now?

Not yet.

No, not yet.

We just announced it here a month ago.

It's a pretty neat innovation, but it just literally got announced within the last 30 days.

And there are no further questions at this time.

Okay.

This concludes today's call.

Thank you all for joining.

Ladies and gentlemen, that concludes the call.

We thank you for your participation and ask that you please disconnect your lines.