Fair Isaac Corporation (FICO) — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2018; comparative quarter ended December 31, 2017. Dollar amounts are in millions unless stated otherwise. The comparative 2017 figures were adjusted for FICO’s retrospective adoption of ASC 606.
Business context
FICO provides analytics, software, data-management solutions and credit scores to businesses and consumers. Its reportable segments are Applications, Scores, and Decision Management Software. Management emphasizes growth in Scores and a cloud-first strategy for its software businesses.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018, adjusted | Change |
|---|---|---|---|
| Revenue | $262.3 | $232.4 | +13% |
| Operating income | $49.0 | $36.8 | +33% |
| Operating margin | 18.7% | 15.8% | +2.9 percentage points |
| Income before taxes | $37.2 | $30.9 | +20% |
| Income tax benefit | $2.9 | $2.0 | Benefit in both periods |
| Net income | $40.0 | $32.9 | +22% |
| Diluted EPS | $1.32 | $1.04 | +27% |
| Operating cash flow | $48.9 | $28.8 | +$20.1 |
| Cash and cash equivalents, period-end | $79.9 | $94.2 | Down $14.3 year over year |
Revenue by type: transactional and maintenance $194.2 (+14%); professional services $40.8 (−5%); and license $27.3 (+45%). Cost of revenue was $76.1, or 29% of revenue, versus 32% a year earlier; management expects this ratio to be slightly higher in coming quarters. Research and development was $35.4 (13% of revenue), and selling, general and administrative expense was $100.3 (38% of revenue).
Scores revenue rose 25% to $85.7 and segment operating income rose 37% to $72.2, with an 84% segment margin versus 77%. Applications revenue rose 5% to $147.7, with segment operating income of $40.1 and a 27% margin. Decision Management Software revenue rose 22% to $28.9, but its operating loss widened to $10.6; its segment margin was negative 37%, compared with negative 34%.
Cash used in investing was $8.7, mainly reflecting $6.5 of property and equipment purchases. Cash used in financing was $50.1, including $82.7 of share repurchases and $43.0 of taxes paid on net share settlement of equity awards. Cash declined $10.1 during the quarter. Share repurchases covered approximately 425,000 shares; $116.6 remained under the authorization at quarter-end.
Balance-sheet debt was $832.2, comprising $228.0 of current maturities and $604.2 of long-term debt; cash was $79.9. Separately, FICO disclosed $325.0 outstanding on its $400 million revolving facility, at a weighted-average rate of 3.839%. Senior notes had a carrying value of $513.0, including $400.0 of 2026 notes bearing 5.25%. The company reported compliance with debt covenants. Cash included $63.5 held offshore. Management said cash, expected operating cash flow and available revolver borrowings were sufficient for capital needs and the $28.0 principal payment due in July 2019.
Material changes and management commentary
- Scores was the largest growth contributor, including higher business-to-business scores revenue, which management attributed partly to mortgage origination activity and higher unit pricing. Applications growth included a large multi-year fraud-software license renewal. Decision Management Software growth was associated with the FICO Decision Management Platform.
- Cloud revenue was $63.4, or 36% of non-Scores revenue, compared with $56.2, or 34%, a year earlier. R&D spending increased 22%, primarily due to continued investment in cloud computing and SaaS.
- Bookings were $106.6 versus $82.2; bookings yield was 15% versus 19%. There were 23 bookings over $1 million versus 13, and weighted-average booking term was 31 months versus 27. Bookings are estimates of current and future revenue, and actual revenue and timing may differ materially.
- Net interest expense increased to $9.7 from $6.5, and management expected it to rise further over coming quarters, citing higher average debt and the cost of the 2018 notes. Other expense was $2.2, primarily reflecting unrealized losses on a supplemental retirement and savings plan.
- FICO adopted ASC 606 using the full retrospective method. Adoption changed the timing of certain license and transactional revenue and required gross presentation of certain receivables and deferred revenue, among other effects. For Q1 FY2018, reported revenue was reduced by $3.0 and net income increased by $5.6 versus previously reported figures. FICO also capitalizes qualifying SaaS contract-acquisition commissions.
Outlook, risks and contingencies
Management provided expense-ratio expectations but no specific revenue or EPS guidance in the supplied filing text: cost of revenue as a percentage of sales was expected to be slightly above the Q1 level; R&D and SG&A ratios were expected to remain broadly consistent with Q1. FICO said adoption of lease accounting in fiscal 2020 would increase reported assets and liabilities, with the full impact still under evaluation.
Key disclosed risks include dependence on banking and consumer-credit markets (87% of quarterly revenue came from the banking industry), reliance on major credit-reporting-agency and distributor relationships, competition including a credit-score product developed by the three major bureaus, cloud adoption and execution, data access and privacy/security, regulation, economic conditions, and long or variable sales cycles. Experian represented 11% of quarterly revenue; Equifax and TransUnion together represented 14%.
FICO reported customer disputes over amounts owed, former-employee compensation claims and other ordinary-course matters. It said it had no material aggregate exposure for matters with a reasonable possibility of loss. The filing states there were no off-balance-sheet arrangements expected to have a material effect and no material legal proceedings listed under Part II.
Most important facts for investors to verify
- Whether Scores growth and its unusually high segment margin are sustainable, and how much depended on mortgage activity, pricing and bureau distribution relationships.
- Whether cloud revenue growth and bookings convert into recognized revenue and cash flow as expected; bookings are estimates rather than recognized revenue.
- Debt levels, borrowing costs, covenant headroom and the planned $28.0 million July 2019 principal payment, particularly as management expected interest expense to increase.
- The effect of ASC 606’s retrospective adjustments on period comparisons, and the future balance-sheet impact of lease accounting adoption.
- Exposure to banking-sector concentration, major credit bureaus, data/privacy regulation, cybersecurity and other risks described in the filing.