Steven P. Weber - Fair Isaac Corp. William J. Lansing - Fair Isaac Corp. Michael J. Pung - Fair Isaac Corp..

Manav Patnaik - Barclays Capital, Inc. William A. Warmington - Wells Fargo Securities LLC Matthew E. Galinko - Sidoti & Co. LLC Blake Anderson - Stephens, Inc. Adam Klauber - William Blair & Co. LLC.

Good afternoon. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fair Isaac Corporation Quarterly Earnings Conference Call. Steve Weber, you may begin your conference..

Thank you, Sarah. Good afternoon, and thank you for joining FICO's first 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 the 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 the 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 January 31, 2018. With that, I'll turn the call over to Will Lansing..

Thank you, Steve, and thank you everyone for joining us for our first quarter earnings call. I'm pleased to say, we're off to a good start, delivering solid growth across our portfolio. In our first quarter, we reported revenues of $220 million, an increase of 10% over the same period last year.

We delivered $38 million of GAAP net income and GAAP earnings of $1.16 per share. Our GAAP earnings and EPS were positively affected by the adoption of a new accounting standard, which Mike will detail. Adjusting for that impact, GAAP net income and EPS were both up 7% from last year.

We delivered $33 million of non-GAAP net income and non-GAAP EPS of $1.03 per share, both up 4% from the same period last year.

I'm pleased that we're delivering growth throughout our business both our Scores and Decision Management Software segments were up 6% over the same period last year and Application segment was up 12% over the same period last year.

We're continuing to see positive signs in our cloud business, where revenues were up 14% and bookings were up 48% versus last year. In fact, it was the second largest quarter ever for our cloud business and the pipeline for our solutions remains strong.

As we sign more deals and grow our customer base, we are building a strong transactional revenue stream with recurring predictable revenues. We are seeing more evidence every quarter for increased market acceptance of our Decision Management Software.

Bookings this quarter were up 31% over last year and represented the largest quarter ever in that segment. The investments we have made in distribution over the last year are beginning to pay off and we expect solid growth in this space moving forward.

In the Scores business, we continue to make great strides towards maximizing the value of this cornerstone franchise. It's been two years since we announced the deal with Experian to add FICO Scores to their premium consumer offerings. The first year of that partnership was dedicated to rolling out Scores across the Experian platform.

We continued last year to fine tune the program and pursue other opportunities with Experian. That led to an agreement we signed this month to further expand our relationship. This new agreement broadens the content we provide to Experian's premium consumer offerings.

It also includes licensing the FICO Score as a key component in Experian's direct lead generation business. We believe in the value that this lead gen business can create for consumers and lenders by taking the friction out of the process.

By including FICO Scores, the scores that are used by lenders to originate new loans, this lead gen business can instantly match consumers with the best pre-qualified offers. Furthermore, offering FICO Scores can produce higher response rates, better conversion rates and increased consumer satisfaction.

We're excited about the possibilities of this expanded partnership and we're also pursuing several other meaningful opportunities in the Score space. In partnership with Experian, we're offering consumers world-class financial products in both the lead gen channel and the premium channel. On the B2B side, we're continuing to see positive results.

Originations continue to be strong and we're seeing account growth in account management scores as well. In a rising rate environment, it's important to remember that our biggest point of leverage on the B2B side is in credit cards, which drives nearly two-thirds of our B2B scores revenue.

Unlike other market participants, we price mortgage scores at the same rate as other credit card scores. Because of this, our exposure to mortgage is roughly only 10% of B2B scores revenue. So we're less affected by mortgage market headwinds.

With the current momentum as well as visibilities into new revenue sources, we expect Scores growth to accelerate in the second half of the year. I'll share some summary thoughts later. But now, I'd like to turn the call back over to Mike for further financial details..

Revenues remain unchanged at approximately $925 million; GAAP net income previously guided at $109 million is now adjusted by this quarter's excess tax benefit of $17 million to a new total of approximately $126 million.

GAAP earnings per share is now approximately $3.92, non-GAAP net income remains unchanged at $158 million and non-GAAP EPS is also unchanged at $4.92 per share. With that, I'll turn it back over to Will for a final comment..

Thanks, Mike. As I said in my opening remarks, I believe we are well-positioned for success as we move into 2017 and beyond. Our Scores business has never been stronger, and is now beginning to build market share on the consumer side to match the dominance we have had for decades among financial institutions.

And now, we're beginning to see the tangible impact of the investments we made in our Software business. We developed products; we've invested in sales resources. Now we're producing higher bookings and building a backlog of recurring transactional revenue.

We're still working in getting our distribution up to speed, as we train and deploy newly hired sales resources but we're gaining momentum and we're confident we're on the right track. I'll turn the call back now to Steve for Q&A..

Thanks, Will. This concludes our prepared remarks and we're ready now to take your questions. Sarah, please open the line..

Your first question comes from the line of Manav Patnaik from Barclays. Your line is open..

Thank you. Good evening gentlemen.

The first question I had was in terms of your expanded agreements with Experian and your commentary on B2C growth should accelerate because of that, could you help us maybe just understand the, I guess, the change in the scope of that agreement? I know you said, I guess it was mainly lead gen and does that include the Discover, I guess, work that you're doing with those guys?.

There is really two pieces to the expansion. One piece has to do with a broader use of FICO Scores with Experian's paid products. And as you know, there is more than one FICO Score and most of the Experian premium products were wrapped around using a single FICO Score as opposed to a broader set of scores.

And the new agreement contemplates the broader use of FICO Scores so that consumers can get effectively a dashboard of multiple FICO Scores and have a more comprehensive view of their credit position. So that's one part of it.

And we've given Experian a great deal flexibility to construct the products in the way that they see is most valuable to consumers and so it's an expanded flexibility that we have tried to drive here so that the consumer winds up with a better offering, Experian gets better offering and we obviously benefit for that.

The second part of it has to do with the lead gen piece and that's a business that we have contemplated for several years now as we've watched other players in the space build lead gen programs.

We have always believed that FICO participation in a lead gen program would be more valuable to the lenders than the offerings by these other players because there is a lot less breakage and friction in going from a FICO Score for a prospect to an offer of credit.

And so working together with Experian, we're now prepared to offer a lead gen offering to the market that uses a FICO Score as opposed to so-called education scores. So that's really the second part of it..

Okay.

And does that include the Experian Discover partnership or is that separate?.

That's separate..

Okay. So it's an expanded Experian and then the Discover work you do. Okay.

And then I don't know maybe I'm reading too much, but your commentary on evaluating M&A options, the technology and so forth, is that just standard commentary or is there something in the pipeline that we should be looking out for?.

That is our standard commentary. So we continue to love buying back our own stock and we set a very high bar for M&A activity.

And at the same time, we're always on the prowl, always looking for opportunities, but as you know and as we've said many times, the alternatives to investing in our own business are obviously being held to a pretty high standard because we're so happy with our own prospects..

Got it.

And then just last question from me, any initial read-throughs or comments that are coming from your customers on the impacts from the new administration that you would want to point out?.

No, I think it is a little early to say. But the obvious elements have to do with if there's a reform in regulation that eases the burden on our bank customers, they're likely to benefit from that and if they do, we will..

Okay. All right. Thanks a lot guys..

And your next question comes from the line of Bill Warmington from Wells Fargo. Your line is open..

Good evening everyone..

Hi, Bill..

So congratulations on a strong quarter and especially on the strong bookings. So I wanted to start out by asking about what's new on the affinity side? That's an opportunity that you guys have talked about in the past and see if we could get an update there..

Yeah, Bill, we are obviously in discussions with others about doing additional affinity programs and work. Those discussions are underway. We're not in a position to announce anything yet. But I think that announcements are coming soon. We feel pretty good about our prospects in the affinity space.

And I guess, connected with that, a little bit different from affinity, but related is our activity in the paid education space where we have been exploring paid programs that go well beyond the free open access program and some of those are imminent as well..

So this is – I've heard this referred to as Open Access Plus, sort of a hybrid between the traditional credit monitoring and the Open Access program.

Is that the way to think of that?.

I think that's a way to think about it. I think we're careful to distinguish between two only because Open Access is a completely free program designed to let the consumer benefit from a score that the bank is already purchasing.

And so this program, it does go above and beyond Open Access, but we don't call it an open access program because it's not a free program. It's a paid program. It's paid by the bank, not by the consumer, but is still a paid program..

So Discover had made some interesting comments on their call last week. It sounded like they're planning to increase their marketing investment to support an acceleration in the credit card loan growth from, looks like they did about 4.7% growth in 2016 and they're talking about talking it up 5.5% to 7.5% in 2017.

The other comment they made was that about 75% of that loan growth is coming from newer card members.

So I wanted to ask how that was going insofar as you could talk about it and then also ask whether you're in active dialogue with other issuers to replicate that type of an offering?.

So we can't really comment on Discover except to say that we have a program with them today that we're very happy with and we continue to work on expanding it. Don't have anything to announce today, but we're obviously always looking to expand and broaden our partnership with them.

And do we have similar kinds of things in discussion with other players? Yes, we do..

Yeah. And then separately with Experian's right offer, you had mentioned that goal of better matching consumers with a prequalified credit offer with the thought that that will produce a better response rate and better conversion rate for the lenders.

I guess, my question is how is that going? Is the goal of the program actually being met? Is it actually resulting in better conversion? And then how many lenders are working with it, and what kind of a revenue model is it using because it sounds like it is a different model than the traditional per subscriber per month basis..

Okay. So it's early days to provide data. So, our views about the lower breakage for lenders and the higher utility for consumers that comes out using a FICO Score versus non-FICO Score, we don't have data to present.

It's more kind of a logic thing where we just believe that if you give a consumer a real FICO Score and that's the basis for making the decision once the credit offer is made, there is going to be less breakage. That seems like kind of basic. But we don't have data to share there yet.

And then with respect to the revenue model, it is a rev share kind of an arrangement. I can't go into a lot of detail on it. But basically, we have completely aligned interest with Experian on this and it's a rev share model..

Got it.

And then a question on DMS Telco deal that you guys had announced this past May, I think that had plan to go live in November and I wanted to ask how that have performed during the peak holiday season? And then also ask about the next piece of that implementation on the marketing piece how that was looking? And then ultimately, how we should think about modeling the revenue for that?.

Well, so just to take those questions in order, we have gone live. We've gone live without a hitch. We ran smoothly right through the holidays without any kind of outages or failures. Although, I'll say that we were tested. I mean, that's natural, and, this represents a pretty big volume and a big infrastructure play for us.

And so we had a lot of work to do to make sure that we're up to snuff. But we sailed through it and we're happy with the results. Too early to talk about the marketing, but we're feeling pretty good about the way that entire operation have gone..

Got it. And then one housekeeping question.

Just on the B2C growth, how was the growth within the myFICO piece of that?.

So this quarter, Bill, year-over-year, we had 3% growth across all of B2C, and myFICO was about mid-single digits and all the rest collectively was a little bit shy of that..

Got it. Thank you very much..

Your next question comes from the line of Matthew Galinko from Sidoti. Your line is open..

Hey, good afternoon, guys. You called out strength in Customer Communications.

Curious, was there just a single large deal that was pushing on that, or did you have number of deals, and, just generally what's your, I guess, outlook for that product?.

It's across the board. It's not a single deal. That's ratable revenue and so it kind of marches upwards smoothly, at least we hope it does and it is now.

That's been a multi-year journey for us, getting all of the offering on to a single code base, getting the infrastructure in place globally so we can support customers around the globe, leveraging AWS to get to places that we don't have operations. So it's been a journey. Right now we feel like we're hitting our stride.

We think we have the best offering in the market by a fairly right margin. Customers seem to believe that too. And so, it's gone very smoothly. But it's not one single thing, it's kind of everything working together, good execution across the board..

Got it.

And if I'm not mistaken, did you acquire that asset?.

We did. It was....

So I think you had about 20%.

I am sorry, go ahead..

I was going to say I think you had, when you made the acquisition, it was somewhere around low double digit growth rate, maybe around 15% to 20%. And, you talked a little bit about the size of the market for you there. But can you talk a little bit about I know you said you're hitting your stride.

Is there a substantial addressable market ahead of you on that and do you see that as being a product that can drive, your Software business over the next couple of years?.

Yeah, good question. Okay, so just a bit of history. The company was called Adeptra. We bought it a bit over four years ago. It was a good growing company when we bought it. It had reached some scale limits on the infrastructure on which it was operated.

I would say that we spent several years in a retrenchment mode and I don't think it's just kind of post-merger integration blues. I think we really had a lot of rework to do on the code base and on the infrastructure. And so we really didn't have tremendous growth for several years in the middle.

I feel like we're back onto a double digit growing kind of trajectory. Where is the growth coming from? It's multiple areas. There is the growth that comes out of appending Customer Communication Services to our existing franchises.

So that takes primarily two forms, one is fraud, where we have a very strong franchise and now we have an opportunity to talk directly to our customers' customers about fraud alerts and is that really you and did you make this transaction, and those kinds of things.

And then a second franchise where we have natural extension and have a lot of volume is in collections and recovery where our Debt Manager 9 products offering is naturally complimented by an ability to talk directly to our customers' customer. And, of course, there is a feedback loop there that improves the efficacy, improves the outcome.

So those are kind of the more natural things for us where we build and extend from businesses we're already in.

It does have the potential to open up doors in new areas like marketing and particularly since we now have this DMS platform that allows our customers to use the same data from multiple data feeds but the same data to inform different kinds of activities, whether its origination or line management, or marketing solutions or customer communications, we now can append this Customer Communication Service to many other things.

So we anticipate the demand it will grow beyond even the two franchises were strong right now..

Got it. Thanks.

And maybe a left field kind of question here, but insofar as you have a lot of products that you're I think to some degree experimenting with or testing, that aren't necessarily core at this point, but if you find kind of a non-core product that you think you could better monetize through divesting the product line, I mean, do you think about that at all? Or do you still feel that everything you have today is better taken to market under the FICO umbrella?.

Well that's a great question Matthew. I mean, we have a fairly disciplined process here.

We've adopted GE's S1-S2 strategy process where we review all of our businesses twice a year, kind of mid-year with a look to what the three year outlook looks like, and we look at the competitive environment and the market and total addressable market, and what the headwinds are, how strong our product is, and what its prospects looked like.

And we then we come back towards the end of the year, where we tighten down and lock up the budget for the subsequent year, and that's the S2 part of the S1-S2 process and in that we kind of have the buttoned up tactical next year plan.

In the course of that strategy work, we always evaluate whether it makes sense for us to continue to be in the business, whether the business would be more valuable in someone else's hands, and whether we're adequately resourcing some of our young not yet big and widely profitable businesses.

And of course, that's a challenge for a company like ours because we have prospects that are really tremendous, far more than we can effectively resource. I think we recognize that we have this kind of feast of riches in analytics and we can't participate in all the great opportunities we have around us.

I would say that the businesses that we're in, we have the half dozen or so core franchises where we're typically number one or number two in the business and if we're not number one or number two, we believe we have the industry leading product.

And there is only a couple of exceptions to that in our portfolio and where there is an exception, we're usually in it for a different reason or because we believe that there is an opportunity for us to improve it. And so I would say that that's a long way of saying that we're pretty happy with the portfolio.

There is nothing in the portfolio today that we're prepared to divest or that we're seriously contemplating divesting. There are some growth opportunities that have to be managed carefully because we can't do everything we'd like to do and so we have to pick our winners. For example, we're putting a lot of investment into cyber right now.

That's a money losing business for FICO because we're pouring in resources and the revenue is not there yet. We have every expectation that that's going to be a great business in several years. And so we are resourcing it appropriately.

But of course that's going to crowd out some other opportunities and that's what it is doing and those are the hard decisions we have to make..

Got it. I appreciate that color and congrats on the quarter..

Thank you..

Your next question comes from the line of Brett Huff from Stephens. Your line is open..

Hey, guys, congrats on a nice quarter. This is Blake Anderson on for Brett.

In Applications, I know you briefly touched on your customer communications, but can you size the license sales in Fraud Management Solutions? Was there anything, any outsized deals in fraud for to you call out?.

Just one. We had a scheduled license renewal in fraud that hit this quarter. The scheduled renewal was quarter two and it got signed by end of December at the request of the customer. Beyond that it was kind of routine business in the numbers..

Okay. Thanks. And then your gross margins were down just a little bit year-over-year.

Anything to call out there that was driving that?.

Not really. The mix of the margin is often dependent upon the mix of how much ratable and services business we have in comparison to license revenue and scores revenue, the latter being higher margin, the former being lower margin, and we had a higher mix of services revenue because of some of the deals we booked last year. Beyond that nothing..

Okay.

And then for the margin guidance for the year, are you still attributing that range primarily to your investments and delivering cloud infrastructure, or is there anything that's kind of popped up in the 1Q that might be driving that that we should pay attention to more throughout the rest of the year?.

No, nothing changed from what we said in November when we set the guidance. It really is tied to two things. It's tied to the additional investments we built into our budget that we're making with respect to our infrastructure and our cloud. That's number one.

And, number two, it's tied to the ultimate mix of business we have between lower margin ratable and services business compared to the higher margin license and scores. And thus the 300 basis point range. But nothing has changed from November..

All right. And then lastly, how does paying down debt kind of stack up in your uses of cash priorities? I know you said share repo, is number one. I know you mentioned the comments on M&A.

But how do you guys think about paying down debt?.

Well, so the current debt we have, the blend is at about 4.1%. So it's pretty cheap debt. More than half of it is in a revolver, which is under 200 basis points. And I guess, we could pay that down, but we think we have a better use of cash than paying down 2% debt.

On the other hand, the rest of it is in term notes that have scheduled maturities and if we pay those off early we have a penalty, a make whole penalty and as a result we have just simply let the maturities happen and we rolled them into the revolver.

So at least under the current kind of regulatory environment and tax environment, what we have been doing is what we will continue to do until we reach a point where we think it's sensible to refinance the entire debt structure and we're a little a ways away from that, probably a year away from that..

We don't really think about it as a paying off debt. I mean, we like our leverage where it is in this 2 times to 2.5 times area. And so to the extent that we have maturities, we replace it with lower cost revolving debt. And at some point we could reevaluate that equation.

But I wouldn't expect a very big difference in our leverage position going forward..

Thanks a lot..

Your next question comes from the line of Adam Klauber from William Blair. Your line is open..

Hi, good afternoon, and thanks.

When we look at the bookings, could you give us a rough idea on the Decision Management? How many of those came from sort of the existing core of financials versus newer verticals?.

Yeah. I don't have the exact numbers, Adam. It's probably this quarter more slightly weighed towards financial services than it is outside of financial services. So of our total bookings, I can tell you 60%, 68%, 69% were with our kind of core financial services business. The remainder was outside.

As it relates to DMS, I just don't know that level of detail offhand..

Sure..

It's probably similar..

Okay. That's helpful. Then just following up on the margin. You know, just on an absolute basis, as you mentioned you've been investing in sales and delivery and expenses are up compared to year ago, but its looks like they're flattening out.

So is that a way for us to think about it? Are they at a better run rate today compared to a year ago but you won't see big jumps up over the rest of the year?.

Yeah. Our current run rates are around $185 million plus or minus..

Yeah..

You usually see a little bit of uptick in our second quarter, the one we're in right now, simply because our annual salary increase happens in December and so you see the first full impact of 2% to 3% salary increase in our fiscal second quarter. And then oddly enough, you see a payroll tax reset.

Most people have hit their payroll tax maximum by the end of the year and it gets reset January 1. So we see actually $2 million, $3 million increase in that. So that kind of will put the number up a little bit higher than $185 million.

But we're kind of locked in, in this range, and are kind of managing our business at that level as we pursue a more top-line growth..

Great.

And that sounds like more normalized growth going forward then sort of jumps we've seen over the last couple of quarters then?.

Yeah..

Okay. Okay. Then as far as the Experian, obviously a great sign.

Is that a couple of quarters that we'll see some of the impacts from those new agreements or can we see that more near term?.

I think a couple quarters is pretty near term, but I think you'll see it grow throughout the year. It's going to start smaller and ramp up..

And remember it's kind of tied to Experian's marketing budgets and marketing plans which are outside of our area of control. And so it can vary, the speed and pace at which the, basically tied to their new fiscal year coming up here in April..

Right. Right. Okay. And then as far as cyber you mentioned and obviously that's a long-term effort and it's still very, very early.

Any chance we'll see even a little revenue this year or is that probably more of an 2018 type occurrence?.

It's really more than 2018 occurrence, although little bit of revenue trickling in. There is a lot of interest. There is a lot of interest. There are lot of conversations going on. We've got a little bit of business going. We've got business going with our iboss partnership.

So things are coming along, but it's way premature to expect any kind of revenue in 2017. Could it be meaningful in 2018? It will be visible. It will be visible in 2018 and meaningful in 2019..

Okay, great. That's great to hear. Thanks, guys..

Thanks, Adam..

And there are no further questions in the queue at this time. I will now turn the call back over to the presenters..

Thank you. This concludes today's call. Thank you all for joining..

This concludes today's conference call. You may now disconnect..