Factset Research Systems Inc (FDS) — Q2 2019 Earnings Call Transcript

Thank you, Stephanie, and good morning, everyone. Welcome to our second fiscal quarter 2019 earnings conference call. Before we begin, I would like to point out that the slides we will reference during this presentation can be accessed via the Webcast on the Investor Relations section of our website. The slides will be posted on our website at the conclusion of the call. A replay of today’s call will be available via phone on our website. After our prepared remarks, we will open the call to questions from investors. To be fair to everyone, please limit yourself to one question plus one follow-up. Before we discuss our results, I encourage all listeners to review the legal notice, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. Additionally, please refer to our forms 10-K and 10-Q for a discussion of risk factors that could cause actual results to differ materially from these forward-looking statements. Our slide presentation and discussions on this call will include certain non-GAAP financial measures. For such measures, reconciliation to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued earlier today. Joining me today are Phil Snow, Chief Executive Officer, and Helen Shan, Chief Financial Officer. Now, I'd like to turn the discussion over to Phil.

Thanks, Rima, and good morning to everyone. We closed the first half of our fiscal year on a solid note. We continued our track record of steady growth with increases to our top line and bottom line as well as operating margin improvement. We executed well against our strategy of providing smarter connected data and technology solutions and saw positive results across all our businesses. Our broadening suite of innovative solutions continues to resonate with the market. We're laser-focused on working with our clients to drive efficiency in their processes and delivering content and analytics in new ways, all while providing our best-in-class service. We're encouraged by an increasing number of high-level conversations with our largest clients regarding our entire solution set as they navigate a challenging economic backdrop. In our second quarter, we increased our organic ASV and professional services at a growth rate of 6%. Organic revenue also grew 6% and adjusted operating margin came in at 33.2%, a 180 basis point improvement year-over-year. We're pleased with our overall cost discipline allowing us to improve our margin and make meaningful progress towards our goal of 100 basis points improvement for the year. Adjusted diluted EPS increased 14% to $2.42, primarily due to stronger operating results. Turning to ASV. Analytics and CTS were the main drivers this quarter, along with the annual price increase for our Americas clients. Both analytics and CTS have been sources of growth for several years due to the competitive strength of our Analytics Suite and the increasing demand for high-quality integrated data in the marketplace. Within analytics, our core portfolio had a strong quarter and provided our sales team with many opportunities to increase ASV with existing clients. Analytics drove the majority of the increase this quarter. CTS was the second largest contributor in the second quarter as it continues to increase its sales of core data feeds such as FactSet Fundamentals. Within the Open:FactSet Marketplace, data exploration is removing friction from the trial and evaluation process to evaluate content. Wealth also had a positive quarter as it continues to expand and take market share. The brand's rollout at Merrill is complete and was successfully implemented in under 6 months. We believe the wealth team has a growing number of significant opportunities in this space. Within research, we saw a healthy increase in users on the sell-side. Additionally, we saw growth of our RMS solutions across both the buy side and sell side. We're also pleased with the results of the detailed banking sector data we rolled out last quarter. We've more than doubled the users for this new content and plan to add new content in other sectors. Lastly, our overall cancellation rate remains stable this quarter versus a year ago. Looking at our Americas and international businesses. Americas delivered a solid growth rate of 6%, driven by our leading analytics and expanded CTS offering. We also see an increase in enterprise discussions across our client base for our workflow solutions. The EMEA region grew 4% this quarter, primarily as a result of analytics and CTS. Cancellations in one market drove a decrease in the growth compared with the first quarter of 2019. We have a good pipeline for the second half of the year, and we believe we will reach our goals for this region. In Asia Pac, we had a strong second quarter with analytics and CTS, again, as the main drivers, followed by research, resulting in an 11% growth rate for the region. Additionally, the cancellation rate in Asia Pac is also trending positive. We believe we have significant opportunities in various markets in Asia Pac, especially with CTS and analytics. As we close the first half of the year, we're pleased with our financial metrics and progress on ASV relative to last year. At the same time, we remain cautious as client cost pressures remain. For the second half of the year, we'll continue to execute on our 2019 goals and are making good progress integrating our products for a seamless investment portfolio life cycle platform, enhancing our risk offering, and unbundling our products to provide open and flexible solutions. Our broad suite of offerings is resonating well with clients who are looking to increase productivity through smarter connected data and gives us confidence in our growth trajectory. As I said before, it's important to look at our company performance on a half-yearly basis. We anticipate that our growth for the full fiscal year could be more concentrated towards our fourth quarter. We reaffirm our outlook for 2019 and look forward to a successful second half. Now let me turn the call over to Helen to talk in more detail about our financial results.

Thank you, Phil, and good morning, everyone. It's great to be here with you all again. We delivered a solid second quarter. Both organic revenue and organic ASV plus professional services grew at 6%. We expanded our GAAP and adjusted operating margin year-over-year and grew adjusted diluted EPS by 14%. As I go through this quarter's results, please keep in mind that our GAAP net income and EPS in the second quarter of our prior fiscal year were impacted by one-time tax expenses related to U.S. tax reform. I'll expand on this a little later when I report out on the tax rate. I'll now walk us through our second quarter. GAAP and organic revenue increased 6% to $355 million and $357 million, respectively, versus the prior year. The growth was driven primarily by analytics, CTS, and wealth. Note that our solid first quarter ASV results are a contributor as prior period ASV is more fully recognized as revenue in the second quarter. For our geographic segment, Americas revenue grew 7% and international revenue grew 4% organically. Americas benefited from an increase in wealth, analytics, and CTS. International revenue was largely driven by analytics and CTS. ASV plus professional services increased to $1.44 billion at the end of our second quarter at a growth rate of 6% year-over-year and $21 million since the end of our first quarter. The growth was driven primarily by analytics and CTS and reflects our annual price increase in the Americas. The price impact was approximately $10 million, in line with prior year. Adjusted operating margin increased to 33.2%, a 180 basis point improvement from the second quarter of 2018. This expansion is driven in part by tighter expense management and increased productivity. Some of this improvement comes from the restructuring efforts we took in prior quarters and the continued mix of resources between higher and lower-cost regions. Favorable movement in foreign exchange rates were a notable driver as the dollar strengthened against some of the currencies we are most exposed to, such as the pound sterling, the euro, and the Indian rupee. We believe that we remain on target to achieve the 100 basis point margin expansion for the full year. Operating expenses for the second quarter totaled $246 million, an increase of 3% over the prior year. This increase is lower than our revenue growth, and as a result, we were able to expand our operating margin. As a percentage of revenue, the expense improvement came from our cost of services, which was positively impacted by lower compensation expense and a decrease in data costs. These reductions were partially offset by higher technology costs supporting our infrastructure spending. Additionally, the higher productivity from the restructuring actions taken last year continues to have a favorable impact on cost of service. SG&A expenses, expressed as a percentage of revenue, were in line with the prior year. Lower discretionary spend in marketing and office expenses were partially offset by higher compensation and bad debt expense. Our tax rate for the quarter was 18.8%, impacted by a one-time settlement with tax authorities. Excluding this discrete item, our tax rate would be 17.6%. In the second quarter of our fiscal 2018, our tax rate was 42.4%, reflecting the one-time toll tax that we had to pay on unremitted foreign earnings as a result of the U.S. tax reform. Excluding this and other discrete items, the effective tax rate for that period was also 17.6%. GAAP EPS increased 65% to $2.19 this quarter versus $1.33 in the second quarter of 2018. This increase is attributable to higher revenue, improved margins, a lower effective tax rate, and to a lesser extent, lower share count offset by higher interest expense. Last year's EPS was negatively impacted by $0.57 due to the aforementioned toll tax adjustment. Adjusted diluted EPS grew 14% to $2.42. A reconciliation of our adjustment to GAAP EPS is disclosed at the end of our press release. Free cash flow, which we define as cash generated from operations less capital spending, was $87 million for the quarter, an increase of 1% over the same period last year, primarily due to higher net income and partially offset by the timing of tax payments and higher capital expenditures. We increased the net number of new clients this quarter versus the prior quarter by 108, resulting in a total of over 5,400 clients. The drivers of the growth were mainly due to an increase in corporate and wealth management clients. Looking at our share repurchase program for the second quarter, we repurchased 215,000 shares for $44 million at an average share price of $205. We have $137 million remaining in our share repurchase program, and we remain committed to buying back shares at a steady pace and continue to balance our capital allocation between business investment and shareholder returns. We are changing our guidance for a few metrics. First, we are lowering our annual effective tax rate for the full year. It is now expected to be between 17% to 18%. Second, we are tightening our GAAP diluted EPS guidance to be between $8.70 and $8.85 and our adjusted diluted EPS guidance to be in the range of $9.50 and $9.65. There is no change to our annual guidance for GAAP revenues, organic ASV plus professional services, and GAAP and adjusted operating margin. In summary, we are pleased with our quarter and our first half results, where we had over 6% growth in both revenue and organic ASV plus professional services, an adjusted operating margin of 32.4%, and a 15% increase in adjusted diluted EPS. We continue to demonstrate successful execution against our strategy, both client collaboration and service and on disciplined cost management. As we look ahead to the remainder of this fiscal year, we will make investments to drive business growth, to streamline our cost structure, and to return long-term value to our shareholders. So with that, we are now ready for your questions.

This is Greg calling on behalf of Manav. I just wanted to ask about the sales pipeline in a couple of ways. Just wondering if there were any delayed buying decisions in the second quarter, given what we saw in December. And then also a little bit of a rationale for why the growth will be tilted towards the fourth quarter.

Greg, it's Phil Snow. So I don't think we saw anything noticeable in terms of delays as a result of what happened in December, nothing measurable that I can point to. And as I said in my script, we really do think about our business in halves. When we look at the pipeline in any given year, it's typically much more heavily weighted towards Q4, and this year is no different.

And then on the margin side, pretty nice results. We had always thought of the margins as kind of being a steady tick-up every quarter, but the second quarter was already above your guidance. So any color on timing that happened in the third quarter or how we should think about the margin trajectory from here?

I'll take that. This is Helen. We're very comfortable with where we are for the first half of the year. It really was driven by things that we've been executing on, which is good discipline on discretionary spend, on employee productivity improvements, which we've seen from, as we noted, the employee mix as well as some of the actions that we've taken over the previous quarters. And then also we benefited from favorable foreign exchange rates, largely exposed to currencies such as the pound, the euro, and the rupee. As we think about it going forward, we're just going to continue to execute on the same plan to achieve operational efficiencies. And so that gives us comfort to be able to meet our target for the year and to be within the range that we've given you guidance on. Any other questions?

Phil, I was curious about the M&A front. It will be almost two years since the company's last acquisition. When you look at the marketplace, are you changing some of your thoughts about organic versus non-organic growth? Or is there something else, like valuations, that's keeping you from closing deals?

So I think I'll just start by saying we made several acquisitions within a couple of years, more software-related. So we intentionally decided to pause and really get those integrated. I think what you'll see in the second half of this year is some exciting new products coming out from FactSet within the analytics and trading space. We're already beginning to monetize some of those. So that's been a big focus for us. When we think about M&A, we're always looking at everything that's out there in the market. There isn't a deal that gets done that typically doesn't come across our desk. We're always interested in content. FactSet does an exceptional job of integrating and monetizing content. High valuations certainly don't help, as we don't want to overpay for anything, but we continue to scan the market for interesting tuck-in opportunities.

And then can you comment on the Burton-Taylor study, which came out recently, talking about an estimate of 2018 data growth of the market of about 5.5% in constant currency and about 10% for data streams? Both of those pretty much matched your ASV growth for fiscal 2018. And I guess that's a difference from historical patterns where FactSet grew faster than the market. Any comment there in terms of your perception of maybe their forecast versus your performance?

So I haven't had a close look at that yet, Peter. We don't address the entire market. There may be some segments of the market that are growing faster than the segments that we address. It doesn't mean that we can't get into those markets, but I can't provide a great answer until I've looked at that in more detail. What I can say is that when we're facing competitors in the markets we serve today, I see that we're winning more than losing, so for the piece of the Burton-Taylor report, that's our addressable market, we're doing well in that space.

I wanted to ask about margins as well. So just given the strong results in the quarter, I was a bit surprised that maybe you didn't raise the operating margin guidance for the year. Is there anything that specifically held you back from raising it? Was there anything onetime in the quarter that sort of led you to stay where you are?

Thanks, Toni, for your question. I think there are a couple of things to consider. When you talk about some of the operational efficiencies we've achieved, we take that all into consideration. That puts us above 32% for Q2, which is an increase both quarter-over-quarter on a year basis as well as sequentially. But I think the favorable foreign exchange rates also added about 1 point, which works well when it works our way. But we're not in the business of trying to forecast going forward. So when we look at the first half at 32.4%, which shows good progress against our target, that feels right for us. As we operate going forward, we're going to continue to make the right long-term decisions for the growth of the business and not necessarily trying to manage to a margin.

Well, Toni, this is Phil. So again, it's a tale of two halves. In the first half, we're typically much more heavily weighted to the second quarter. Obviously, we had a significant deal in Q1 of this year. But on the analytics side, we did very well with our core PA product, traditional PA. The seats grew. A lot of what was driving that was new risk clients that we've closed and more enterprise deals that are resulting in more PA deployment within clients. We were positive on both the risk and fixed income side in terms of driving ASV.

Organic revenue growth in the quarter decelerated a bit to 5.7% from 6.4% in the prior quarter, despite easier comps in the year-ago period. Can you elaborate on which areas of the business contributed to this deceleration and how you expect trends to change as you move through the year?

If you're talking about the quarter-over-quarter growth, we had that very large wealth deal in Q1. So I think that's skewing the numbers. On a year-over-year basis, I believe we're pretty much comparable to last year; sort of 5.9% or 6%, which is right in the middle of our guidance range for the year. We are reaffirming our annual guidance from an ASV standpoint and feel good about that range.

We want to look at the first half, as Phil mentioned, rather than just the quarter, so that’s probably another way to consider it as well.

You previously indicated that visibility into large deals should improve as we move through the year. Can you provide us an update on the progress of these large deal conversions, how this compares with your internal expectations, and when you may be in a position to update guidance to reflect progress with these larger deals?

Yes. I think we have good visibility now on the second half, but it’s typically not clear to us more than 6 months out on some of that. Based on what we see in the pipeline for the large deals, we're reaffirming our guidance for the year around the midpoint.

Helen, I just want to make sure I understood you correctly. Of the margin expansion year-over-year of 180 basis points, around 100 is from currency, and 80 is from actions that the company took on its own, between restructuring, better use of resources, efficiency, mix of where work is done, stuff like that. Is that right?

Yes, I think that is correct.

And then, could you talk a little bit about what was going on internationally? I usually expect international organic revenue growth to be faster than Americas. I thought there was a comment about a cancellation or something. Can you give a little more detail about what's going on over there?

Yes. Shlomo, it's Phil. We actually had a very good quarter in the U.K. But there was one market on the continent where we had a significant cancellation that accounts for the majority of the difference that you were seeing in the EMEA region. I believe we accelerated our growth in Asia Pac slightly this quarter. We had a good quarter in Asia Pac.

Was it a cancellation or loss? What was going on over there? I know it's competitive, obviously.

Yes, we don't provide much detail on cancellations. It was a significant step backward, yes.

My first question is just around the client environment. I know you mentioned client cancellations are stable, but any thoughts on where we are in terms of buy-side consolidation? Is it negative or positive for you as you look at the consolidation that's already occurred?

Yes. Hamzah, it's Phil. I'm not sure exactly where we are. As we look further out, we're going to see continued cost pressures for clients. In some cases, consolidation does help FactSet. We have great relationships with our clients. It often forces the new combined entity to look at everything they have. We have a much broader suite of solutions now that we can offer clients. Obviously, there are cost pressures. When firms consolidate, they're looking for efficiencies. It’s a mixture of things, but this environment is what we're used to operating in now, and I'm pleased with how we performed with all of the products we have coming to market. I feel we have a good chance of continuing to gain market share.

You mentioned unbundling of products to provide more open solutions. Any thoughts on what that means, where you are in that unbundling process?

Sure. I've talked about this previously, but we're no longer just a workstation product. FactSet has invested a lot in our technology stack, allowing us to do a lot of interesting things. We have this great new web product, which we're beginning to monetize in wealth and other markets. We can break up pieces of that if we need to and deploy those interestingly, which we’re already doing. We're opening up more APIs to our clients, like our Analytics API. For example, if you wanted the engine that powers PA and plug it into your system, we can assist with that. Additionally, we have our Open:FactSet Marketplace, showcasing our efforts to deliver content in new and interesting ways. We're at the beginning of our unbundling journey, and we believe that's the direction the world is heading in.

The change in ownership of Thomson's F&R business is a significant change in the competitive landscape. Any commentary on what you are seeing in terms of opportunity or threat or more broadly in the competitive universe?

I don’t think much has changed there. We’ve been competing with Thomson Reuters for a couple of decades now. We continue to feel optimistic about our product offerings versus theirs in the markets we compete in, and I haven’t seen much of a change to date in how they are coming to market.

I think you mentioned a little bit about not managing to margin, which aligns with what the company has said historically. However, given your tenure now, do you have a thought on what might be the appropriate level of margin for the FactSet business longer term? Thanks for your question. I can only use my early tenure for so long. But I think we continue to have opportunities for operational improvements. As I noted, we need to think about long-term growth. We’re also making investments back into the business, whether it's on infrastructure, product, or even facilities. So I don't have a particular target in mind. I believe we can continue to drive operational productivity improvements.

You mentioned the Merrill deal is done. I was wondering if you could touch on the process and if you're seeing any flow-through into the model already?

Yes. Drew, it's Phil. The process went exceptionally well, completed in under 6 months. Historically, deployments of that scale were sometimes 2 or 3 times that long. We're very pleased with how efficient we were in deploying the product. I personally observed one of the advisers getting trained, and it was exciting to see their reaction to our product versus what they had. Our team did an amazing job, and we've received exceptional feedback. Our pipeline is building for other deals like this, and we feel good about this market for our business moving forward.

In terms of the Americas, could you touch on the demand there and what you see moving forward?

Our Americas team had a strong first half. The banking number contributed globally, but we've seen impressive growth in users on the sell side. Our deep sector strategy has paid off, released in October last year, with thousands of users already utilizing that data. It's gaining momentum rapidly.

The employee count was down quarter-to-quarter while the user count was up, suggesting that perhaps the ramp in the BofA business required less implementation staff than expected. Is that accurate?

I'll take the first part. When you think about our employee growth rate over time on an organic basis, it's important to note that previous acquisitions drove that growth rate. Overall, we have experienced a decline but also remember we have a larger base of employees. We have become more productive, whether in content or engineering. We've utilized automation and technology to drive greater productivity, and the restructuring actions taken in previous quarters impact our total numbers. It’s uncertain we would directly tie this back to BAML, as this organic deal required focused efforts on the BAML win, and as that winds down, efforts will be refocused on new business. Long term, our organic ASV growth is running around 6%. The margins are rebounding to the mid-30s, but due to the competitive environment, we must reinvest in R&D and customer service to maintain those margins. Mathematically, with the 6% growth and lacking margin expansion, how do you sustain double-digit EPS growth? Thank you for your question. We are continuing to invest back into the business as noted. Phil mentioned new products and our openness to ways of delivering. We also think about returning value to shareholders through cash and share buybacks, which will help maintain our performance.

Can you elaborate on the sell side? I know you discussed some new products, but how much is the wealth management deal driving success, and are you seeing hiring within investment banking clients?

Sure, Tim. Just to clarify, the wealth business is categorized under the buy side, so none of those users or BAML users are included in the sell side number. We're driving new seats in banking. That number was over 1,000 in this quarter, with one significant deal in Asia Pac using our web platform, which we could deploy easily to a large user group. It's simply a combination of our excellent software for banking and our ongoing investment in content for those users. Regarding Europe, there was the cancellation mentioned, and the macro environment is somewhat jittery. Is that affecting your client discussions and pipeline for growth outside the U.S.? Yes, there’s certainly a lot occurring in Europe, such as Brexit and MiFID II, but it’s tough to directly tie these to whether we expect deceleration. We have a great team and product, and, at the moment, we are viewing that market similarly to America. If that changes, we’ll keep you informed.

Helen, regarding operating margins, with 32.4% for the first half of the year on top of your guidance, are those FX tailwinds factored into the adjusted guidance for the rest of the year? Or could they present potential upside?

We evaluate that from a few perspectives. If we consider larger currencies, the dollar has strengthened in the latter half of the year, so when we compare that to where we think we’ll be, that’s already included. It can work for or against us. We don’t predict, but with current market conditions, we would expect to hit the provided range.

Were there any expenses you didn’t incur this quarter that you believe you'll need to account for in the back half of the year?

Not necessarily. We haven't overlooked anything significant in our outlook.

You have mentioned that you expect to achieve 10% ASV growth in the long term. Given the context of the last two years where growth has stagnated near 6%, do you foresee a change to that expectation, especially considering market challenges? We feel good about our performance in this market and our growth rate, yet we remain focused on acceleration. The primary metric for us is top line growth. New products can take time to gain traction, and while the environment continues to be challenging, I see products gaining traction, such as wealth and CTS. I maintain optimism that momentum will sustain into the next fiscal year.

Do you believe there's a new long-term growth target, such as 8% instead of 10%, that you might be pursuing?

I’m not going to provide a specific number today. We are working on our long-term strategic plan. If we conclude on any longer-term guidance for you, in terms of growth rates, we will communicate that.

How much incremental ASV was added from the BofA contract in the quarter? Is it something small like 5% of the total? Or is it something more substantial?

I don't think we're going to break that out specifically, but most of the ASV was already accounted for in Q1 of this year.

As for the ERP system implementation, where do you stand today, and when is it expected to go live? It's Helen. Regarding the finance system, we’re looking at fiscal ’20 for it to go live. The HR system is already live. We’re pleased with the progress we've made.

Do you expect this system to yield cost-saving benefits over time? Or are you already seeing those effects?

We don't have those savings included yet, as it's too early to be discussing savings. The focus is on productivity and obtaining better insights into how we manage the business, which we'll evaluate over time.

Phil, regarding the banking data you rolled out last quarter, how does this new product compare to your competitor, SNL Financial, from a competitive perspective? You mentioned doubling the number of users. How do you view the target market here?

It’s early days, and we've only begun to invest here. I can’t provide specifics on competitors, but we’re encouraged by the data from the increasing user count and market demand for more of this, giving me confidence that this investment in banking data is the right strategy.

You also mentioned other sectors you prioritize. Can you share more about sectors equally as important as financial or banking data?

We are looking across various sectors right now. We will share insights on specific sectors when we have more clarity.

With this new data on new sectors, how does that affect your CTS business? Does it assist with that as well?

It certainly does. We are also effective at monetizing data, whether in workstation to web or off-platform. More detailed data often yields better insights for data scientists. As we build this out, we’ll be able to sell it through feeds effectively over time.

I have follow-up questions on the margin. You mentioned that discretionary spending helped this quarter, starting in December, which was a choppy period. Did you pull back some spending quickly? This showcases how you can react, which is obviously a positive if needed.

As it relates to certain spending, you can’t hold back on everything, and some things are already in flight. Certain professional fees were actively managed. Marketing can be adjusted slightly, and T&E is another area where can be more judicious in spending. We pulled some of those levers, but we wouldn’t attribute that solely to December; it aligns more with executing our yearly plan.

Lastly, you mentioned how your restructuring has borne fruit. Are we nearing the end of that? I’m curious as you continue to see restructuring charges each quarter — does it become routine?

The main program around significant restructuring occurred in Q4. We may have had small segments post-restructuring, but that's not ongoing. The significant productivity gain has more to do with the employee mix shifting toward centers of excellence, predominantly outside the U.S., which we expect to continue.

Your margin has been a central topic for this call, tracking closely with your expectations year-to-date. You previously stated a goal for 100 basis points of margin expansion in fiscal '20. Is that still the case?

At our last Investor Day, we did state our aim was to improve margins for the next 2 years. Helen is new, and we will continue to evaluate our long-term strategy. As we enter the end of the year, we will consider whether to maintain the goal or invest more for growth. In terms of EMEA, yes, the cancellation was a one-time event. It was competitive. However, we are entering a period where FactSet frequently competes for high-value deals, which might lead to some lumpiness over time. Thank you all for joining us today on this call. We want to extend gratitude to all our employees for delivering strong results and express appreciation to both our clients and shareholders; many of whom we’ve enjoyed long-term relationships with. If you have additional questions, please reach out to Rima Hyder. We look forward to speaking with you next quarter.