FactSet Research Systems Inc. — Q2 FY2017 Form 10-Q
Reporting period: Quarter and six months ended February 28, 2017. FactSet provides subscription-based financial information, analytics, applications and related services to investment professionals. The interim financial statements are unaudited.
Financial results and key metrics
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Revenue | $294.4 million (+4.5%) | $281.8 million | $582.4 million (+5.5%) | $552.3 million |
| Operating income | $91.7 million (+7.5%) | $85.3 million | $182.1 million (+5.5%) | $172.7 million |
| Operating margin | 31.2% | 30.3% | 31.3% | 31.3% |
| Net income | $66.7 million (-1.6%) | $67.8 million | $133.3 million (+4.4%) | $127.7 million |
| Diluted EPS | $1.68 (+3.1%) | $1.63 | $3.34 (+9.2%) | $3.06 |
- Q2 organic revenue growth, excluding recent acquisitions, dispositions and foreign exchange, was 7.0%. Annual subscription value (ASV) was $1.187 billion, up 6.5% organically year over year. Buy-side ASV grew 6.8%; sell-side ASV grew 4.9%.
- International revenue grew 11.5% in Q2, compared with 1.0% growth in the U.S. Europe grew 10.6% and Asia Pacific 14.2%. International operations represented 34.9% of Q2 revenue.
- Q2 operating margin improved as revenue growth and foreign-exchange benefits more than offset higher compensation, rent and derivative losses. Cost of services rose 6.2%; SG&A declined 2.2%.
- Q2 net income was affected by a higher tax provision, the $1.2 million pretax Market Metrics sale adjustment loss, and higher interest expense. The prior-year quarter included a $7.3 million tax benefit from retroactive renewal of the U.S. R&D tax credit. Share repurchases reduced diluted shares and supported EPS growth.
- Management’s non-GAAP adjusted Q2 net income was $71.8 million, up 8.7%; adjusted diluted EPS was $1.81, up 13.8%. Adjustments include intangible amortization and other specified items; the prior-year adjustment removes the R&D tax benefit.
Cash flow, balance sheet and capital
- For the first six months, operating cash flow was $128.1 million versus $164.2 million. Capital expenditures were $18.0 million versus $26.4 million; free cash flow was $110.0 million versus $137.8 million, down 20.2%. FactSet attributed the decline mainly to working-capital movements, including higher receivables and payroll timing.
- Cash and cash equivalents were $155.4 million at February 28, 2017; investments were $30.0 million. Total cash and investments were $185.4 million. Cash decreased $73.1 million during the half, with repurchases, acquisitions and dividends among the principal uses.
- Accounts receivable was $130.8 million; days sales outstanding increased to 40 days from 31 at August 31, 2016. Management cited invoicing changes associated with the U.K. operational realignment and recent acquisitions as contributing factors.
- Long-term debt was $365.0 million at quarter-end, up from $300.0 million at August 31, 2016; the floating-rate debt matured September 21, 2018 under the then-current agreement. Current assets were $344.0 million and current liabilities $155.1 million. Management said available liquidity was sufficient for expected operating and investment needs.
- FactSet repurchased $160.4 million of shares and paid $39.6 million in dividends during the half. The quarterly dividend was $0.50 per share. On March 27, 2017, the board expanded the repurchase authorization by $300 million, bringing available authorization to $336.5 million.
Material changes, outlook and risks
- Growth was positive, but management said organic ASV and revenue growth rates were below the prior year. It cited financial-industry cost pressures, the shift from active to passive investing, and increased cancellations offsetting higher sales. Annual client retention exceeded 95% of ASV and was 93% by client count.
- FactSet acquired Vermilion for approximately $67.9 million in November 2016, adding client reporting capabilities. The first-half results include Vermilion from its acquisition date. The company recorded $50.8 million of acquisition goodwill. Market Metrics was sold in July 2016; the second-quarter working-capital settlement resulted in a $1.2 million pretax loss.
- Subsequent events: On March 17, 2017, FactSet acquired BISAM for $205.2 million in cash. On the same date it replaced its prior debt with a $575 million revolving facility, borrowed the full $575 million, and used proceeds to fund BISAM and retire the $365 million prior loan. The new facility matures March 17, 2020 and bears interest at daily LIBOR plus 1.00%.
- Management expected the September 2016 operational realignment to benefit FY2017’s annual effective tax rate by approximately 250 basis points. Q2 effective tax rate was 25.5%; first-half rate was 25.7%.
- Q3 FY2017 guidance: Revenue of $311–$317 million; GAAP operating margin of 29%–30% and adjusted operating margin of 31%–32%; annual effective tax rate of 25%–26%; GAAP diluted EPS of $1.68–$1.74 and adjusted diluted EPS of $1.81–$1.87. Management said the midpoint of adjusted EPS guidance implied 12% growth year over year.
- Key risks include demand exposure to equity markets and clients’ assets under management, continued migration from active to passive investing, investment-bank consolidation or cost reductions, foreign-exchange movements and Brexit-related uncertainty. FactSet reported hedging about 50% of its sterling exposure through FY2017 Q4 and 75% of rupee exposure through FY2019 Q3. A hypothetical 25-basis-point change in one-month LIBOR was estimated to change annual interest expense by $0.9 million on the quarter-end debt.
- Gross unrecognized tax benefits were approximately $10.0 million, including accrued interest. Management did not expect pending tax examinations or ordinary-course legal matters to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- After quarter-end, FactSet disclosed the resignation of its Executive Vice President, Global Director of Sales, effective April 21, 2017, with severance and accelerated vesting of certain options.
Important facts for investors to verify
- Whether organic ASV growth and client retention hold up given management’s comments on cancellations and industry cost pressure.
- Whether the higher DSO and working-capital drag reverse, and how cash conversion compares with reported earnings.
- BISAM’s post-acquisition contribution, integration costs and final purchase-price allocation, which was still in progress at filing.
- The impact of the $575 million borrowing, floating interest rates and the revised credit agreement on interest expense and leverage.
- Whether Q3 guidance and the expected FY2017 tax-rate benefit are achieved; adjusted figures are non-GAAP and should be considered alongside GAAP results.
- Potential effects of foreign exchange and Brexit, including the extent to which FactSet’s hedges offset operating exposure.