Fair Isaac Corp (FICO) 2005 Q2 法說會逐字稿

Good afternoon and welcome to Fair Isaac Corporation's second quarter fiscal 2005 earnings conference call.

Your lines have been placed on a listen-only mode until today's question and answer segment.

Today's conference call is being recorded.

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

I would now like to turn the call over to JD Bergquist Wood, Fair Isaac's Director of Investor Relations.

Thank you.

Ms. Bergquist, please go ahead with your call.

Thank you, Operator and good afternoon, everyone.

Thank you for joining us for Fair Isaac's second quarter fiscal 2005 earnings conference call.

We issued our second quarter earnings release after the market closed this afternoon.

You may access the news release on the investor section of our website at www.fairisaac.com.

A replay of this call will be available on our website approximately two hours after the completion of this call through May 25.

I'd like to remind everyone that, except for historical information, the statements made on this call should be considered forward-looking within the meaning of the federal securities laws, including the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

These statements include statements concerning our business strategies and their intended results and similar statements concerning anticipated future events and expectations.

The forward-looking statements made on this call and in the news release distributed today are subject to risks and uncertainties which could cause actual results to differ materially from those expressed in or implied by the statements provided.

Additional information concerning potential factors that could affect future financial results is included in our annual report and periodically in our SEC filings, including our annual report on form 10-K for fiscal 2004 and quarterly report on form 10-Q for the period ended December 31, 2004.

Fair Isaac disclaims any intent or obligation to update these forward-looking statements.

On the call today are Tom Grudnowski, Chief Executive Officer, and Chuck Osborne, Chief Financial Officer.

We'll review quarterly results, both operations and financial.

In addition, we'll provide updates to our third quarter and annual guidance.

Once we've completed our prepared remarks, we'll open the call for questions.

Tom?

Thank you, JD, and welcome everyone, to our Q2 spring earnings call.

For you weather buffs, it's currently snowing here in Minnesota.

As you can see by our press release, we had an excellent quarter with record earnings and record bookings.

Our net income of 34 million and our bookings of 137 million are both records for us.

Our revenue came in at 196 million, which is slightly below our revenue guidance, but our organic growth and our most profitable products created a more profitable revenue mix for the quarter than we had planned or anticipated.

The positive impact to net earnings because of this mix variance will continue for the rest of the fiscal year.

We're pleased to report the net income of 34.3 million for the quarter, or $0.45 per share, which is about $0.06 higher than analyst consensus.

These earnings do include a tax adjustment as well as some convertible note-related items and Chuck will describe those items later in the call.

However, our ability to better manage not only our growth in operations of the company, but also the financing of it are now paying off.

Because of these results, we are raising EPS guidance for fiscal year '05 from $1.75 to $1.80.

We had several very positive developments obviously this quarter that indicate accelerated organic growth in almost all of our key product areas.

I'm going to give you some highlights of those areas and try to indicate through those highlights why we're very confident about execution for the rest of this fiscal year.

The first one I'll highlight is our Scoring marketing unit.

We had another record revenue quarter here, approximately $40 million.

And this is due, again, to the impact of several new scoring products that we rolled out at the beginning of the year that are gaining excellent traction.

These include Global FICO Score now in several countries around the world, Qualify Score, Expansion Score.

I think you have probably heard of some of these.

However, the use of our FICO scores from marketing and originations has also been very, very strong the first two quarters and remains so this quarter.

And we see this trend continuing for the rest of the year based on our pre-screen contracts that we already have negotiated with the major card issuers.

The good news here is that we had planned for 4% organic growth this year, as you may recall, and we are now on track for 10%.

And this is a very, very large leap for us in this very profitable category, so that's very good news.

In our next franchise area, if you will, fraud, our Falcon product line had a record bookings quarter.

In fact, almost $40 million this quarter alone.

We continue to gain market share with our Falcon product line around the world.

We had planned this fiscal year for about 16% organic growth and now we are trending to 20%.

Also what's very interesting in this particular product line, is we do have some pricing power.

Three very major banks this quarter signed new long-term contracts with us that replaced contracts that we inherited back when we merged with HNC, and the good news is these deals are of much greater value to Fair Isaac than the old ones.

So our Falcon product line is hitting on all cylinders.

Our consumer report -- number three, our consumer report, myFICO, which has been sluggish, the last couple few quarters, as you may recall, had a record revenue quarter due to new product offerings that are really taking off for us.

Interestingly here, we had almost $16 million of new bookings this quarter dominated by our new monitoring products.

This is almost a 100% increase in the sales over last quarter.

Of that 16 million, we recognized a little over 9 million this quarter in revenue, since revenue was spread over 12 months with the monitoring products.

But as these products take off, the revenue in this category becomes more recurring every day.

And with other new product launches coming this quarter and next, we will plan to get to the revenue growth that we anticipated at the beginning of this fiscal year, which we were trending to earlier in the first half.

We'll get to around 35% of revenue growth for the fiscal year, so this is also very good news.

On the London Bridge side, our collections and recovery platform also had another record quarter.

We had one last quarter, we had another one this quarter with revenue sequentially growing 30% this quarter alone.

Our integration of London Bridge is complete.

And this new vertical is living up to our expectations and we are on plan to grow revenue 20% beyond that, which we anticipated at the acquisition here a couple few quarters ago.

In account management, we also had another quarter -- strong quarter and of course this is our, our product area where we have TRIAD and our CMT platforms, our customer management TRIAD platforms.

Here our relationship with TSYS continues to grow with their success and the move from TRIAD from a credit card account management platform to a banking customer level management platform is well underway.

This new functionality and our expansion in non-U.S. markets are accelerating our growth here.

We now project organic growth to be 10 % for the year, up from the 6% we had planned at the beginning of the fiscal year.

Another legacy London Bridge set of products related to mortgage and BridgeLink also set new revenue records for us by growing 25% from last quarter.

Of major note here is a product or service that we call BridgeLink.

This ASP network management service connects data and service providers required to enable origination and collection decisions.

We have expanded this service this quarter into a new offering we call Fair Isaac Network Services that provides access to all data and services required for any analytic application of Fair Isaac or other vendors.

This asset and set of services is now growing approximately 60% this year.

We now have 58 different databases from 39 different data vendors, and 1180 service providers all connected in this network that we call the Fair Isaac Data Network.

And this includes AVM providers, appraisal services, mortgage providers, consumer credit, document prep, flood, mortgage, et cetera.

I won't go through all of them.

There's a lot of them.

The objective here is -- for this vehicle is to provide a market for data and service suppliers to gain access to the tens of thousands of customers that use Fair Isaac analytics today as part of the 880 -- the 180 billion decisions we now support for them every year.

While our EDM tools are helping our clients build their own analytic applications, our new Fair Isaac Network provides them access to the data and services needed to support those applications.

So now with both EDM and our Fair Isaac Network, our clients can implement either Fair Isaac applications or their own faster than ever before.

That's a good segue into EDM.

The seventh area I want to talk about.

Here we also had a record quarter as well, due to large increases in the sales of our Blaze Decision engine product.

This product has become the recognized leader by industry analysts in this fast expanding area of decision engines and we are getting excellent traction.

Also our new Model Builder products are also getting good reviews and are being taken up by our largest and most demanding customers.

With our large backlog of opportunities and our good execution this quarter, we anticipate organic growth rate now for the fiscal year will be 25%, up from the 13%, again, we had planned at the beginning of the year.

Also of note, as relates to the acquisition of Braun a couple quarters ago, even at this level of success, we still want to get about $0.30 of services for every $1.00 of license revenue.

Our goal there is to be closer to $1.00 of analytic consulting for every $1.00 of decision engine revenue.

And so we believe we still have a lot of upside here as we integrate and expand our consulting services.

So that's all the good news related to growth.

We do have two units in which revenue is less than we had planned at the beginning of the year.

Our Marketing unit and our Insurance bill review division, I want to speak to those.

In Insurance, our revenue is down because we are shifting our focus within the product line to sell more rented software versus the clinical business process operation services that we also offer.

As you may recall, we offer workman's comp and claims -- auto claims review in two manners.

We either simply rent the software in analytics to a customer, which they run on their site or on ours and they provide the clerical, medical, expert staff to use the system.

Or we also, in addition to that, provide the services dimension as well.

This is harder for us to do on a differentiated and profitable basis, and so we have not sought to aggressively sell or renew this business this fiscal year.

We estimate that about $12 million of such services will atrophy by the end of this fiscal year.

Now, all the large bookings we've been talking about this fiscal year, almost 90 million, if you add up the last year, have been for the more profitable software or software ASP product lines.

So the new revenue from these installs that we've just sold in the last few quarters isn't ramping as fast as the BPO revenue is declining.

So what we've seen is a reduction in quarter-over-quarter revenue this year so far.

And that we believe the ramp back up once we start implementing our software with these new customers will start in the fourth quarter.

So that's one area where our revenue has been going down.

In Marketing services, we've had a similar phenomenon.

We are growing our non-financial services marketing businesses while our financial services business is being reduced by industry consolidation and commodity competition.

We have discussed this with you in the past and we anticipated this again at the beginning of the fiscal year.

However, despite some success in our non-financial services business, it isn't growing fast enough yet to offset the planned falloff of revenue this year in financial services.

You may recall we've been trying to replace about $30 million of business in financial services this year.

We will probably come up short of about 10 million from where we had planned.

We have examined our strategies for Marketing and Insurance and are in a process of finding partners now with more critical mass in these sectors to help us go to market more effectively.

As you know, we have distribution and marketing partners in almost every other successful Fair Isaac product line.

And so we are now looking for partners where our analytic competence will provide them a competitive advantage, and their scale will provide us one as well.

Now, given the growth of our -- of most of the business units I talked to you in earlier and the falloff of the last two, we now expect our revenue for the fiscal year to be around 811 million, a bit lower than the 818 that was at the low end of our earlier range of guidance.

However, as I mentioned earlier, the increased revenue growth of the more profitable units will more than offset these two disappointing units.

So our EPS guidance is actually going up to $1.80, as I mentioned at the outset.

We will get, from a guidance perspective, we will get to revenue in Q3 of 205 million and 214 million in Q4.

And that's how we get to the 811 for the fiscal year.

If you look at the waterfall report which we hand out, that will show you how we -- how much revenue -- new revenue we have to get in the next couple quarters to make that happen.

Our confidence, however, is high for Q3 because of the deals we have already signed this quarter that we just missed Q2 and the strong pipeline of deals in the faster growing units that we've already talked about here earlier.

The traction we have seen in the first half of the year seems to be accelerating for us.

We believe this is due both to external market growth and our improvement in execution.

You may recall we began putting more sales folks on the street a couple quarters ago and the results we're seeing in increased bookings and pipeline are starting to show, I believe.

Our EPS for Q3 will be $0.44 and for Q4 will be $0.55.

And that's how we get to the $1.80.

Our goal from a margin perspective, as you may recall from our last quarterly call was to get to a 30% operating income as a percentage of revenue.

We did raise -- go up another percent to 28% this quarter from 27% last quarter and we believe we will hit that 30% in the third quarter.

Bookings for the quarter, again, were 137 million and we had been guiding you to around $120 million per quarter.

We now believe our bookings in Q3 and Q4 will be closer to the $140 million each level, so we're raising our guidance there.

This quarter we had a record number of large deals and a record number of total deals.

And what is equally impressive to me is the mix of products in our 137 million this quarter comes primarily from the faster growing core products mentioned earlier.

I might also mention we had another record bookings quarter in EMEA we are now -- where we are now focusing more on growth and adding sales capabilities.

Related to other business events, last week we announced the hiring of Mike Campbell as Chief Operating Officer overseeing our global product line of products.

With this addition, we now have two units that report to me.

We have the Services unit with consulting and Steve Braun running it.

And we have a Products unit with Mike Campbell running it and all of the products we just talked about rolling up under Mike.

Mike comes from SAP where he ran about $1.5 billion of P&L and so we're looking forward to him adding some execution capability to our team.

Under Steve, we're now organizing -- whereas under Mike we're organizing by product, under Steve we're organizing by industry.

We're in the process of filling out and recruiting world class industry go-to-market leaders in teleco, CPG and retail, financial services, pharma, healthcare, insurance and media.

Several of those positions are already filled, but we're in the process of expanding our client-facing capabilities there as we continue to try to raise our exposure at the sea level of our customers.

In conclusion, all in all our core products have performed better than planned.

Again this quarter, and we see this trend holding for the year.

The decision analytics market is growing and as its leader, we are taking more of our fair share than before with our increased scale and focus, we are winning more in the marketplace.

We are executing on our growth strategies focused on global expansion, increased sales of our existing product lines in new markets, extension of consulting services to better position us in the executive suite.

So with that quick analysis, I'll turn it over to Chuck, who will go through more financial details.

Okay, thanks, Tom, and good afternoon, everyone.

I'm going to take a few minutes to review our second quarter results and then talk a bit about our third quarter and full year guidance.

As Tom mentioned earlier, we reported net income for the second quarter of 34.3 million, or $0.45 per diluted share.

I'll take a few minutes and explain how these results compared to our prior guidance.

First, the fully diluted earnings per share, prior to any tax or COCO adjustments, would have been $0.42 per diluted share compared with our guidance of $0.40 to $0.42.

Next, on a fully diluted GAAP basis, we provided guidance of between $0.37 per diluted share and $0.39 per share.

In our guidance we assumed that the exchange on the COCO's would be completed by the end of February and did not include any current period costs for that conversion.

However, the conversion did not occur until March 31 and the majority of these -- the costs that we did incur were expensed in the period.

If we adjust our results for this delay on these costs, our fully diluted earnings per share would have been $0.40 per share, or $0.01 over the upper end of our guidance.

Now, turning to our second quarter income statement.

We reported revenue for the second quarter of fiscal '05 of 196 million, a nominal increase over the first quarter and 2 million under the low end of our guidance.

As Tom has already discussed, our second quarter revenue reflects strength in certain segments of our business and weakness in others.

Of equally significant importance, we reported $137 million of bookings for the second quarter.

The revenue contribution by industry segment is as follows -- Strategy Machines contributed 111.3 million, or 57% of total revenue, against 117.8 million, or 60% of revenue in the prior quarter;

Scoring contributed 39.3 million, or 20% of total revenue for the quarter against 39.4 million, or 20% of total revenue in the prior quarter;

Professional Services contributed 33.6 million, or 17% of revenue versus 29.5 million, or 15% of revenue in the prior quarter; and finally, Analytic Software Tools contributed 11.8 million, or 6% of total revenue for the quarter against 8.8 million, or 5% of revenue in the prior quarter.

Our second quarter revenue by vertical markets is as follows -- 66% of our revenue came from the financial industry; 9% from the insurance industry; 6% from telecom; 9% from retail; and roughly 10% from all of our other verticals.

In addition, our transactional, or recurring revenues represented approximately 76% of our total revenues as compared to 80% in our prior quarter.

Now this decline is related to the decrease in the Strategy Machine segment revenue and should return to its normal rate in the quarters ahead.

Finally, international revenue represented 26% of our total revenues, which is up from 25% in the prior quarter.

On operating expenses, total operating expenses, prior to amortization of intangibles for the second quarter, were 142.9 million against our guided range of 145 to 149 million.

This also represents a $1.4 million decline from the prior quarter's operating expenses of 144.3 million.

As I previously mentioned, the operating expense for the quarter includes a one-time expense of 1.4 million related to the exchange of our contingent convertibles completed during the quarter.

The breakdown of these expenses, represented as a percentage of total revenue, was as follows --

Cost of revenue was approximately 36%, flat with last quarter.

Research and development costs were 9% compared to 11% last quarter, mainly the result of the timing of certain expenses and the closure of the South African office.

Finally, selling, general and administrative costs were 28% against 27% in the prior quarter.

Looking at other expenses.

Our other expense net was $490,000 for the quarter.

And that includes interest expense from our convertible note and a loss on foreign exchange offset by interest income.

The primary shift in this line item from the prior quarter was the fact that we incurred a loss on foreign exchange in the quarter of approximately $390,000 against a gain in the first quarter of roughly $427,000.

This swing is attributable to the growing base of international activity and the changes in currency values during the period.

As all of you are aware we adopted the provisions of emerging issues task force pronouncement 4-8 as of the last quarter end December 31, '04.

This accounting rule change mandates the addition of shares issuable from our $400 million contingent convertible bonds to our fully diluted share count.

As a result, an additional share count of 9.1 million was added to our fully diluted share count.

As we have previously stated, you would also add back the after-tax interest expense to the bonds to net income when performing the calculation.

As noted in our press release dated February 22, the board authorized the company to exchange the outstanding bonds for new bonds that are convertible into cash, or at our election, a combination of cash and shares of our common stock, subject to certain conditions.

These so-called COCO shares will continue to be dilutive to our earnings per share calculations for the remaining year-to-date EPS references.

And, now that the exchange has been completed, only 0.1% of the bonds and the corresponding interest expense add-back will be included in the fully diluted quarterly earnings per share calculations going forward.

Our reported quarterly results include dilution of approximately $0.05 per share associated with the convertible debenture.

This includes the addition of 9 million shares to the fully diluted share count.

The add-back adjustment of 1.2 million for after-tax interest expense and an $860,000 after-tax related expense related to the exchange.

The calculation is further complicated by the fact that the old bonds were outstanding for 89 of the 90 days and the new bonds were outstanding for only one of the 90 days of the quarter.

Turning to our taxes, our effective tax rate for the quarter was 25.6% as compared to our guidance of 38.5%.

The current quarter expense was reduced by a $6 million adjustment related to revisions made to prior years' tax liabilities.

This tax adjustment was the result of a recently completed tax study commissioned by us, which identified additional federal and state tax credits and other deductions related to prior years' tax returns.

Excluding this adjustment, the current quarter effective rate was 38.5%.

We should also note that we're continuing to study our tax positions, which could result in future adjustments to tax liabilities.

However, any potential adjustments from these studies cannot be determined at this time.

Turning to our balance sheet, cash and investments as of March 31 are approximately 368.3 million, which is up from the 344.3 million reported as of December 31, '04.

This increase is due to an inflow of cash from our normal operating activities and exercised options, partially offset by our stock buyback activity, capital expenditures and an increase in accounts receivable, which I'll discuss here shortly.

Net accounts receivable as of March 31, '05 totaled 166.4 million, up from the December 31, '04 balance of 142 million.

Our DSO or day sales outstanding were up from 67 days at the end of the first quarter to 76 days at the end of the second quarter.

This increase was mainly due to temporary delays in invoice processing in our United Kingdom operations, due to an information system conversion, which was completed during the quarter.

We have placed additional resources on our collections efforts and we expect to see the DSO return to its historical levels.

Our property and equipment balance is at 54.1 million, against 53.2 million last quarter.

With regard to intangibles, net goodwill and intangibles total 807.2 million, which is down from the 818.5 reported as of December 31, '04.

The 807 million is comprised of 679.5 million of goodwill and 127.7 million of intangibles.

Total current liabilities were 161.5 million, which is up from the 151.9 million reported last quarter.

And then with regard to equity, our shareholders equity totaled 896.1 million, which is up from -- up 28.5 million from the prior quarter, principally due to earnings and the exercise of options.

As part of the newly authorized $250 million stock repurchase program, we purchased about 507,000 shares of outstanding common stock at an average price of $33.84 for a total of $17.2 million.

Of the 17.2 million, only 12.8 million was included under the new authorization.

We have approximately 237 million remaining under our buyback authorization.

The exchange offer of our convertible debentures limited our share purchase activity during the quarter and we will continue to be active in the market when appropriate.

Looking at head count, our total head count at the end of the quarter was 2869 compared with 2929 at the end of the last quarter.

This decrease of 60 positions was mainly due to normal attrition and non-replacement and reductions in our Insurance bill review division.

Turning now to our guidance for Q3 and the remainder of '05.

For third quarter fiscal '05 we expect revenue of 205 million.

From the waterfall revenue report attached to the release, we believe we have a baseline forecast heading into the third quarter of approximately 185 million.

Therefore, in the quarter, we anticipate closing around $20 million in new revenue.

We anticipate the new revenue to come mostly from traditional license revenue, but will also include professional services, engagements and quick ramping transactional revenue.

By segment, we expect the 205 million to break down as follows -- Strategy Machines at 116 million;

Scoring at 41 million, Tools at 11 million, and Professional Services around 37 million.

In terms of expenses, we estimate that gross margins will continue to be approximately 65%.

Total expenditures and costs are forecast to be roughly 154 million, broken down as follows -- as a percent -- Cost of goods sold, around 35%; research and development coming in at around 10%; selling, general and administrative in the area of 27%; and amortization of intangibles approximately 3%.

Capital expenditures are forecast to remain in line with our prior expectations within the range of approximately 4 to $5 million per quarter.

And depreciation will continue in the range of 5 to 6 million per quarter.

Other expenses net are principally interest expense from our outstanding convertible note offset by interest income from our investment portfolio.

And we expect to see a net expense of approximately 1 million per quarter.

For the third quarter we expect our fully diluted earnings per share to be approximately $0.44 per share, which suggestions net income of 30 million on roughly 69 million shares.

As Tom discussed earlier, we are revising our full year revenue guidance to 811 million.

We expect net income to be about 130 million, this guides to a full year earnings per share of $1.80 on a share count of 74 million shares.

Finally, we've estimated that the effective tax rate will remain at the previously guided rate of 38.5% for the remaining two quarters of the year.

So with that, I'll turn the call over to the operator and we'll begin the question and answer period.

Thank you.

[OPERATOR INSTRUCTIONS]

Your first question comes from Michael Nemeroff with Maxim Group.

Hi, guys.

Can you hear me?

Yes, we sure can.

Tom, over the last couple of quarter, Professional Services has been a little bit weak.

And you put Steve Braun in charge of that.

I know that the goal is to get $1.00 in revenue and services for every $1.00 in product.

How quickly do you think you can get that division going that's kind of been a laggard over the last couple of quarters?

Yes, getting to $1.00 of services for $1.00 of license is going take us a while.

I figured that as a goal, that's a goal similar to other enterprise software companies, so it's a goal that one could compare ourselves to to see whether we're successful.

So the point is we're not very successful yet there at all.

We believe that's an opportunity.

Steve and his team are continuing to recruit good people.

So far, our strategy here has been to maintain a chargeability rate less than I might really like to if I was just going for profits in the anticipation that with the increase in Blaze sale and the big bookings we're getting, that we're going get those resources busy.

With our big -- with our big bookings quarter and with our big Blaze and decision engine quarter, I anticipate you'll see a nice improvement in Professional Services in Q3.

Okay.

So, Chuck, just looking at the baseline revenue, I'm kind of confused here because I'm looking at last quarter's baseline revenue and it appears as if there is a reclassification of some of the revenues.

It shows that you had about 170.5 going into the second quarter, yet it shows that you have 164 -- you had 164.5 going into the second quarter on the new baseline revenues.

Is that a result of reclassification of contracts that were in the old that get resigned and you classify it as new bookings in the quarter and it gets pushed down into the 2005?

You know, as we discussed this analysis before, we are -- in any one of these cells, we have to take a look at the contracts at the time that we sign them and try to assign when we think the revenue's going fall and how much of it is really new revenue versus recurring and sometimes we reevaluate as we look at the contracts and go out and performance how much of is in effect.

We have to make some assumptions about how much is recurring or just a renewal versus a new sales effort.

And after -- sometimes in talking with the sales force and looking at the business as it actually starts to come in, we realize that in fact that was a bigger selling effort than perhaps we gave someone credit for.

We take it out of the baseline, we reclassify it out of the baseline into the -- into the new -- into the new revenue category.

So what you see in that respect, and you will see that throughout in certain elements in cells of this analysis.

You will from time to time see some movement as we take a look at the contracts and estimate how things are going to hit.

So you're absolutely right.

There's some reclassification that occurs.

But you'll note -- you'll note -- I think the key issue here is the baseline went down in this quarter because of those revenue reductions that I talked about earlier.

So you -- so -- so that's -- the keynote you should be seeing is the baseline went down because of Insurance bill review and because of Marketing Services, not having as many renewals and not having as -- not having contracts extend that we thought may have been extended.

So that's probably the key take-away of the waterfall.

The other key take-away of the waterfall is to get to the revenue numbers we just projected, you'll note that the amount of revenue we need in the third -- the new revenue we need in the third and fourth quarter isn't that different than what we've just been doing for last two quarters.

Okay.

So, that's supposed to be the good news when you get through all the -- when you get through all the cells.

The bad news is the baseline went down.

The good news is the bookings went up.

The good news is we only need 20 million in the next couple quarters to basically hit the numbers we just set.

That said, looking at lowering the guidance from 818 to 48, it's a pretty drastic drop.

Can you explain to me a little bit more about how the -- you said organic growth is going to be 10%.

Can you just flesh that out a little bit more?

I was kind of confused on that point.

Okay.

It's really simple.

Everything was going up except for two things that went down a lot.

And the two that went down, Insurance and Marketing Services, account for what did I say, big numbers, 12 and plus, right?

So we're talking about, about 22, $23 million of revenue that we thought at the beginning of the year we were going get that we didn't get.

So that's sort of the difference between this 820-ish number down to -- down lower than that.

There's good news on other revenue taking us back up, so the net-net is we get to about 811.

Okay.

So those two bad units, if you will, it went down more.

We went up in other units.

That's how we get to 11.

The point I was trying to make is that those two units, as you well know, aren't anywhere near as profitable as the revenue units that are growing.

So hence, even though our revenue guidance went down a bit, we're still able to make our net income because of the good news in Fraud and Scoring and Account Management and Collections, et cetera, and Blaze.

Okay.

And margin.

Thanks, guys.

Okay.

Next?

Your next question comes from Tony Wible with Smith Barney.

Thanks, guys.

Can you just recap on the $1.80 guidance?

What exactly is included and excluded?

Is the tax benefit in there and is the weighted time on the COCO's in there?

Yes, it's pretty straightforward.

The basically $0.08 benefit from the taxes less $0.03 costs from -- actually, excuse me $0.05 costs from the COCO's, incremental there of $0.03 in -- we're a little over where we had guided and so we're taking the year up to $1.80.

I mean that's the estimate of where we see things going right now.

The $1.80 includes the $0.08 tax benefit.

Yes.

Okay.

Net -- net of -- it's basically got the effect of the one-timers in it, plus a little bit more.

Okay, and what was the dollar cost?

I missed it in your commentary about the cost of the conversion on the COCO. 960?

Yes.

The conversion had a $1.4 million cost.

It's a $400 million issue.

We had legal, accounting, and banking costs.

The manner in which we did this was as an exchange offer, so we actually had to go out and offer to -- new bonds to the old bond holders we included some provisions in the bonds that made this an attractive exchange for them.

There are costs associated with that, which since they are not paid to bond holders must be expensed in the current period.

At the time we gave you guidance, there were some other methods we could have used that probably would have capitalized our biggest costs, either as an increase in the spread.

We chose not to do that because it's an ongoing cost.

This way we put it behind us and we get to a recorded after-tax.

So, we chose to use a method that maybe punishes our current quarter a little more, but in the end we think is a smarter financial play.

What was the dollar amount and --?

1.4 million pretax.

About 860-some million after tax.

Okay.

And it showed up -- where did it show up?

It would be in the other -- other -- or in our operating expenses.

And lastly, your goal to get to a 30% margin, really what -- how are you going to carry to that level considering, I think this quarter I calculate you to be closer to like a mid-20s margin?

I think we're at 28 now, and we think there's -- with the increases in productivity we continue to see, we think we're going to get to 30.

And I, I said last quarter we would get there by the third quarter.

I think we'll be close, based on the run rates we're looking at.

Okay.

Are you excluding anything to get to that 28% margin level?

No, this is before amortization and --

Oh yes.

Sorry, sorry.

-- before amortization intangible.

Sorry.

Okay.

That would do it.

Thanks.

Sorry.

Your next question comes from Ed McGuire with Merrill Lynch.

Yes, good afternoon.

Sounds like you're going to -- you're letting some of the business in your healthcare and insurance business attrit, and wondering what your thoughts are in terms of seeking strategic options for that business, or is it -- at this point, it's declining, but is it worthwhile to keep it around because it's profitable?

Yes.

The -- yes.

The strategy is to -- what happened there?

Oh.

The strategy is that we would -- why are we getting the feedback all of a sudden here?

Okay.

We're getting feedback here.

Can you --

Ed, I think you got to go on mute.

Okay.

There we go.

It's not working, but I'll try to listen to myself reverberate back.

Gosh, now I know what I sound like.

The strategy is exactly that.

It's to make this division more profitable by selling the differentiated analytics and software that in fact drive the value that's letting us win in the marketplace.

As you know, we had a couple few hundred clerical and medical specialists who had actually performed the bill review function for those customers that wanted to us do that for them.

That's business that we've grown over the last, maybe three years.

However that was not as profitable and the switching costs for people who just sent us bills was actually low for them.

So with our software we actually install the software, the switching costs are high.

So, we've moved to just selling products with high switching costs and get out of the products lines, if you will, that have low switching costs.

And we have effectively attrited by raising our prices there to try to make more profit, but in doing so, lose business as a result.

So that is exactly the strategy.

The business, therefore, of revenue that we do have is getting better.

As relates to the partnership, we are therefore seeking relationships with other companies that would provide those kind of services as an edge onto our software.

So that's what we're looking for.

Okay, and moving on to the -- the marketing, you had made the point about looking to establish partnerships.

What kind of partners are you looking for?

Would they be services partners or other ISDs?

Yes, all the above.

Actually the simple idea here is that like with TRIAD and Falcon and other product lines, we actually have other distributors and partners who help us go to market.

We have not done that in our Marketing Services area and we believe in the financial services arena, we need to do that and so we have discussions going with some folks who believe they can help in that regard.

Okay, and just a follow-up on some comments you made about pricing power in the Falcon product.

Could you talk a little bit about some of the bookings that you saw during the quarter and whether you have any large Falcon contracts coming up for renewal over the next few quarters?

Thank you.

No.

All of them that we had, we did, this quarter and they were big and they were important and we got them.

And we were able to -- the prices that were in these contracts date back to many, many, many years and we were able to negotiate price -- and actually they were at prices that were grandfathered long time ago by HNC, which are no longer the current market rates and we were simply able to complete those arrangements at the market rates that persist and exist today.

So that's very good news.

Okay.

Thanks a lot.

Your next question comes from Tom Ernst with Deutsche Bank.

Go ahead.

Hi, Su Wasudev for Tom Ernst.

I was wondering if you had more details to share on the integration of London Bridge and Braun.

I'm interested in knowing what's left to do in terms of that integration, how turnover has been, and how Braun has helped you penetrate some non-core verticals.

Yes, the integration is complete in the sense that those organizations are integrated with our organization.

They are on the same computer systems, they're on the same policies and processes of Fair Isaac, and we no longer are keeping track.

We're not talking about legacy Braun, legacy London Bridge.

We're one happy organization, if you will.

So, that's good news.

I think on the product side -- London Bridge is much more of a product company, obviously.

And as you heard, we're making very, very good traction with several of their product lines and we are meeting or exceeding our expectations there, and that's the result of a lot of folks' hard work, both on the legacy London Bridge side and the Fair Isaac side and our turnover there has not been any different than what we anticipated or we caused to happen.

On the consulting side, we've had Steve Braun's organization, I guess for a quarter and a half or two now, so less amount of time.

So we have yet to see, as mentioned earlier, a big takeup in consulting revenue.

That's going to take time to do.

However, I'm optimistic that if we put the processes in place it will make it happen.

I think over the next couple quarters we'll find out.

Okay, and then I apologize if I missed this, but what was the overall organic growth rate for the quarter?

And then what are your expectations for the year?

You know, again, I, I'm losing track of the organic versus non-organic versus pre-dilutive versus after dilutive, versus -- I'm just trying to focus on one number.

We're going to try to get to 811, so if we did 811, we did what, 706 last year.

That's about a 15% revenue growth over last year, is our projections, and at 1.80, I think we were at 1.40, 1.41 last year.

That's about -- where's my math majors?

That's a 29% increase in earnings if we hit the $1.80.

So add -- as you could tell by the conference call, we have a lot of good organic growth and then we have some bad organic decline and we have some acquisition and it all adds up to 15% as we sit here today.

Okay.

Thanks.

Your next question comes from Bruce Simpson with William Blair.

Good afternoon.

Hello.

Tom, could you talk a little bit about this reorganization on vertical lines, how that's going?

Yes, this is really laying the groundwork for what we hope will be processes that will evolve over actually the next couple of years.

The first big idea is to basically have two business units reporting to me, one that has all of our product-related revenue and one that has our service-related revenue.

And the reason for that -- so that's sort of idea one.

The reason for that is their business models and -- and processes vary and so I think we finally organized ourselves into some -- into some -- into a more productive and more efficient organization.

The services organization's objective is to grow demand for our products and grow demand for services, but do it in markets and using market offerings that are independent.

So, Steve's out there building a group of industry leaders across the industries that I mentioned, and we are going to market and going to those organizations, trying to sell consulting services that would pull through products.

Okay?

Okay.

And I think that's a model that we will use, I would guess for the next, I'm going say year or two.

Now, in theory, at the point in time that our -- we become a much larger technology company -- most technology companies as they exceed the billion dollar level, tend to be organized and have quite a bit of focus on industry -- industry.

And so I'm now -- the way we're organized now, the individuals are sorting our revenue internally by product, by geography, by industry, several different dimensions.

And over time, I think we'll probably start to focus on and provide more information on, is our retail practice really growing, is our CPG practice really growing, is our telco practice really growing?

I don't usually talk that way, haven't for the last few years.

As we make this transition, get better leaders and start to focus on that, I'll start to report more directly on how that -- how we're making progress.

As you know, we also put one of our leaders, Paul Perleberg in Europe and are now starting to talk more about how's Europe and Asia going, are we getting more bookings there, are our sales people growing there?

Which you're going to hear -- you'll hear more and more of that now that we have somebody over there driving that focus.

You're going see similar focuses on Steve's organization by industry.

Okay.

I also want you to update me on the sales force.

Your head count, where you think you are in the ball game of getting the people that were moved forward as product specialist people into real production roles and so forth.

Yes, we're at-- I told you we would get to a couple hundred people that are out there on the street and we're at that number and Eric and his organization have been very successful at training people up and getting them effective and that's why our bookings are going up.

Our pipeline -- although I'd rather not -- I don't want to share the specific details, is also increased dramatically as a result of simply getting more proposals and more people focused on customers.

Given our success, we're anticipating continuing to increase the sales organization well beyond that number now.

We're in the process of -- with Mike on board now, Mike and Eric are in the process of coming up with some metrics on a new tranche of sales personnel in Europe and Asia, as well as North America and we'll be coming out with something very specific on that very soon.

I would rather not do that today, but we've been very successful.

As you know, if you got good products and you're in good markets, if you hire more sales guys, stuff happens.

That's been happening and so we're going to accelerate our success there.

Okay.

Last thing.

Chuck, if you could just give us a cash flow from operations and/or free cash number for the quarter and anything, any kind of expectation for the full year.

Well, you've got the cash flow statement.

I think we've got cash flow from operations before CapEx of 119-plus million.

We've got CapEx in there of about 10 million.

We think that will continue -- that rate of CapEx into the -- into the second half of the year.

I think as we said in the script of about 4 or $5 million a quarter.

We're still targeting on -- we've got in the first period, we had a, as I think we mentioned, a deferred revenue item that boosted our cash flow.

In the second quarter we also had a receivable item that, as you see the pop in receivables that detracted from that.

I think the effect of those two will -- will be averaged in as you go out to the end of the year.

And I think we really are still tracking on free cash flow that gets us to roughly, again, 50 million a quarter minus our CapEx, $45 million per quarter.

So that would get you to about 190, 180, 190 million for the year.

And so, I think that's in line with some of the discussions we've had up to this point.

Of course the large item against our cash flow that will impact any of this is the extent to which we're able to -- and discretionary the extent to which we'll be able to buy back stock in the open market.

We are -- we are somewhat constrained on that.

Obviously we do this according to the trading restrictions on the exchange and with the exception of blocks that may be put to us, we really have a [inaudible] volume that I think you're all familiar with and can calculate.

But we intend to continue to pursue that -- that option I think as we indicated on the call, that's still to us, a very attractive use of cash going forward and that could be, obviously with the remaining authorization, could be very significant in size against this -- against this estimate of other cash flows as you see based off of the first two quarters.

So, the only other thing I would add there on share repurchase, we were somewhat limited in the second quarter because of the exchange offer that we had outstanding for the COCOs.

That in effect, the COCO's are themselves a equity instrument and so we really weren't able to be in the marketplace while we had that exchange offer outstanding.

How many dollars are left on the authorization?

It's two minus -- 12 -- 238.

238.

Last thing, when you gave us the guidance for $1.75 last time.

Yes.

What was your -- what were you including in terms of the COCO in share count -- in cents per share?

Well, in the second quarter we thought that it would dilute us by, $0.02-plus.

It ended up diluting us $0.05.

We had an extra month of dilution and then we had -- as the -- our operating earnings were punished by the costs that we had to pile into the quarter for the actual exchange offer.

So the combined effect was $0.05 and so we took an additional $0.02-plus from the -- than we had over guidance.

So just kind of thinking about how guidance is compared to what it was before we came into today, the COCO is sort of $0.03 worse, but the tax help is $0.08 better, so there's your nickel in change to guidance?

It's basically no change, is that -- would that be right?

Yes, that's about right.

Okay.

Thanks, guys.

That's all the time we have for questions today.

Mr. Grudnowski, I'll turn it back to you for closing remarks.

Thank you very much, and we'll talk to you next quarter.

Thank you.

This concludes today's Fair Isaac Corporation's second quarter fiscal 2005 earnings conference call.

You may now disconnect.