Factset Research Systems Inc (FDS) — Q3 2023 Earnings Call Transcript

Thank you and good morning, everyone. Welcome to FactSet’s third fiscal quarter 2023 earnings call. Before we begin, the slides we will reference during the presentation can be accessed via the webcast on the Investor Relations section of our website and are currently available on our website. A replay of today’s call will be available via phone and on our website. After our prepared remarks, we will open the call to questions from investors. Before we discuss our results, I encourage all listeners to review the legal notice on Slide 2, 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, reconciliations 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 Linda Huber, Chief Financial Officer. We will also be joined by Helen Shan, Chief Revenue Officer, for the Q&A portion of today’s call. I will now turn the discussion over to Phil Snow.

Thank you, Kendra, and good morning everyone. Thanks for joining us today. I am pleased to share our third quarter results. Our organic ASV plus professional services grew 8% year-over-year. This was driven by double-digit ASV growth in analytics, where we saw strength with asset managers, asset owners, and hedge funds, as well as the successful execution of our international price increase. However, these gains were offset by headwinds to workstation growth among wealth, banking, and corporate clients, as well as deceleration in expansion among partners. Our investments in content and technology have strengthened our competitive position, allowing us to navigate market volatility successfully. In the third quarter, we saw broad-based growth across all firm types, with double-digit ASV growth from our wealth management, banking, hedge fund, corporate, and private equity and venture capital clients. In Analytics & Trading, we have seen continued strength in the middle office as our suite of portfolio reporting, fixed-income, performance, and risk solutions accelerated growth year-over-year. Content & Technology Solutions also experienced double-digit ASV growth, with demand for company data and data management solutions driving ASV this quarter. And in Research & Advisory, we see continued opportunities to capture additional desktops in banking and wealth. Workflow-driven capabilities also contributed to growth, with our research management solutions suite accelerating year-over-year. We ended the quarter with adjusted diluted EPS of $3.79 and an adjusted operating margin of 36%. As we enter our fourth quarter, we are focusing on operational efficiencies and disciplined expense management to support margin expansion, grow EPS, and provide capital to invest in our strategic priorities. As part of this effort, we are working to reduce the run-rate of our expense base by about 3%. Savings will come primarily from rightsizing our workforce, which we expect will also decrease by about 3%, along with further reducing our real estate costs. As discussed last quarter, we are experiencing a modest deceleration in ASV growth. While the markets have largely remained resilient amid macroeconomic turbulence, our clients do remain cautious. Clients have also been executing their own downturn playbooks, resulting in delayed decisions and restricted spending. We are also seeing continued staffing adjustments with firms on both the buy and sell sides reducing headcount, often targeting mid and senior level professionals. Although we have a stronger pipeline than last year, with a good mix of deals that should drive expansion in new business, client decision-making is taking longer. We are monitoring developments in the banking sector closely. Early sentiment is mixed on fiscal 2024 class sizes, with some clients slowing hiring while others are adding junior bankers in preparation for a market upturn. Overall, our top 200 clients, including many of the leading global investment banks, make up two-thirds of our book, and the vast majority of these clients have multiyear contracts, including minimums and 90-day cancellation windows. Given these points and our high ASV retention rate, which consistently exceeds 95%, we believe we have effective downside protection. With this outlook for the remainder of the fiscal year, we are reaffirming our guidance for organic ASV growth and revenue, but guiding to the lower end of our previously disclosed ranges. In addition, we are increasing our guidance for adjusted operating margin and adjusted diluted EPS. Linda will provide further details on this later in the call. We are confident in our strategy and ability to execute. Like our clients, we are ensuring that we are well positioned as the market stabilizes and the capital market cycle turns. We have a long-term view of our business and are committed to investing for growth and becoming a more efficient organization. As part of this approach, starting September 1, we are reorganizing by firm type to better align our operations with those of our clients. Analytics & Trading will become our buy-side organization, focusing on asset managers, asset owners, and hedge fund workflows. Research & Advisory will become dealmakers in wealth, focusing on banking and sell-side research, wealth management, corporate, and private equity and venture capital workflows. Finally, we are combining our Content and Content & Technology solutions groups to create one data solutions organization, which will allow for the end-to-end management of our data from collection and acquisition to client delivery. We will provide more details on our progress and performance of our firm types as we refine the structure over fiscal 2024. Technology is rapidly evolving. As an early adopter of cloud technology, we have digitally transformed our platform and created flexible, workflow-centric solutions. With the focus on generative AI, our open platform and connected content will strengthen our partnership with our clients. While generative AI is not new, FactSet has been using AI and machine learning in our products for many years, and recent advances in large language models (LLMs) present new opportunities. Our strategy is to build a generative AI foundation and capabilities to empower our workforce to transform the end-user experience rapidly. We are investing in generative AI technology to drive next-generation workflow solutions and will continue to invest in scaling our content refinery. We have committed additional resources to LLM initiatives as part of our investment process, and our team members are excited about these investments as we equip all product and engineering teams to use generative AI in their development work. Our early work in generative AI has focused on improving client support, automating content collection, and transforming our products with improved search and copilot solutions. Here are a few examples. During our recent hackathon, almost one-third of our team’s projects utilized LLMs to solve business problems or enhance the client experience. Teams worked on enhancing banker efficiency, pitch automation, and discoverability using our modernized connected data. Earlier this month, we used ChatGPT to produce CallStreet earnings call transcript summaries, reducing summation time by over 90%. This process is currently available for all S&P 500 companies, and we plan to dramatically expand coverage later this fiscal year. We are also testing AI-powered agent assist tools that understand FactSet proprietary codes. This use case is compelling, as questions about FactSet coding comprise half of our daily client call volume. Lastly, we see significant opportunities to accelerate content automation using generative AI, and we have several promising efforts underway to extract information that has previously been difficult to retrieve. Our differentiator remains our content, including our real-time and deep sector data, for which we have also increased investment. FactSet has an incredibly strong moat built over 40 years of proprietary content and data, which is cleanly sourced, auditable, and stitched together with our concordance and symbology. This data is not easily replicable and is incredibly valuable to both FactSet and our clients. Turning to our performance, we saw continued acceleration across all regions. Americas’ organic ASV growth accelerated year-over-year to 8%, driven by wins with premier asset managers and asset owners. These gains were partially offset by workstation headwinds with wealth, banking, and corporate clients. EMEA was the biggest contributor to growth this quarter, with organic ASV growth accelerating to 7.4%. Growth was strongest in banking, given improved retention with banking clients and strong retention and new business with hedge funds. Higher retention was also a key driver in the region, as the ASV uplift from our price increase offset increased erosion. In contrast, expansion slowed as cost pressures led to higher budget scrutiny, lengthening the sales cycle. Finally, Asia-Pacific delivered organic ASV growth of 10.5%. Performance was driven by wealth management, hedge funds, and private equity and venture capital clients, with improved retention and ASV uplift from higher realized price increases. Australia was the strongest contributor to growth with wins among asset managers and asset owners, though sector consolidation and negative seasonal banking hiring contributed to a small deceleration. We also saw acceleration in Japan and India driven by banking, with positive increases in workstation purchases for seasonal hires. In summary, we continue to execute well in challenging markets. As we head into the close of our fiscal year, our pipeline remains solid, and our focus on execution excellence and cost discipline is unwavering. By combining a relentless client focus with exciting new technologies, I am confident in our ability to drive growth. I will now turn it over to Linda to take you through the specifics of our third quarter.

Thank you, Phil, and hello to everyone. As you have seen from our press release this morning, we delivered solid operating results in the third quarter with continued growth of organic ASV, GAAP revenue, and adjusted diluted EPS year-over-year. I will now share some additional details on our third quarter performance. As Kendra noted, a reconciliation of our adjusted metrics to comparable GAAP figures is included at the end of our press release. We grew organic ASV plus professional services by 8% year-over-year. While we are seeing lower expansion and higher erosion due to the macroeconomic environment, our performance reflects excellent execution by our sales team. Pricing realization continues to improve with our international price increase, adding $17 million in ASV this quarter, up $4.5 million from last year. Internationally, 7% more clients were subject to the annual price increase compared to the prior year. Fiscal year-to-date, our 2023 price increase has yielded $18 million more ASV than last year. GAAP revenue increased by 8.4% to $530 million for the third quarter. Organic revenue, excluding any impact from acquisitions and dispositions over the last 12 months and foreign exchange movements, increased 8.5% to $530 million. Growth was primarily driven by Analytics & Trading and Content & Technology solutions. For our geographic segments, on an organic basis, revenue growth for the Americas was 9%, benefiting from increases in Content & Technology solutions and Analytics & Trading. EMEA revenue grew by 7.5%, primarily driven by Content & Technology solutions and Analytics & Trading. Finally, Asia-Pacific revenue growth came in at 7.9%, due to increases in Research & Advisory and Content & Technology solutions. While GAAP operating expenses decreased by 8.6% year-over-year to $358 million, adjusted operating expenses grew by 9.4%. The drivers were as follows. First, people. Our costs rose by 10% year-over-year in the third quarter, primarily due to increased salaries for existing employees. As a percentage of revenue, this was 68 basis points higher year-over-year, driven by higher salary growth as a percentage of revenue, partially offset by higher labor capitalization and lower bonus expense. For fiscal 2023, we expect the bonus pool to be in the range of $100 million to $105 million. Headcount increased by 12.9% year-over-year with most new positions in our Centers of Excellence. Overall, 65% of our employees are located in our Centers of Excellence. Next, facilities expense remained relatively flat, increasing by only 1.6% year-over-year as more employees returned to in-office work. Our continuing efforts to right-size our real estate footprint mostly offset this increase. As a percentage of revenue, facilities expense was 24 basis points lower year-over-year. Moving on, technology expenses increased by 22.5%, driven by third-party software costs and higher amortization of internal-use software, partially offset by lower cloud-related expenses and lower depreciation. As a percentage of revenue, growth was 90 basis points higher year-over-year. In partnership with our Chief Technology Officer, Kate Step, we have realized increased capitalization through improved time tracking and other efforts. Technology costs currently equal 7.8% of our revenue and will likely continue to increase as we invest for growth. As part of our medium-term outlook, we anticipate technology costs being 8.5% to 9.5% of revenue. Finally, our team continues to do an excellent job of controlling third-party content costs, with expenses increasing by only 1.9% year-over-year despite the inflationary environment. As a percentage of revenue, growth in third-party content cost was 31 basis points lower year-over-year. Given the pressure on our top line, it is imperative that we focus on cost management. Using our downturn playbook, we took proactive steps to control our expenses, protect margins, and preserve EPS. We plan to further identify areas where we can reduce costs. As part of the efforts Phil spoke about earlier, we plan to take an approximately $45 million restructuring charge in the fourth quarter. This charge includes approximately $15 million to $20 million for continued real estate rightsizing, as discussed in last quarter’s call. Compared to the previous year, our third fiscal quarter GAAP operating margin increased by 1,260 basis points to 32.5%, mainly driven by the prior year’s $49 million impairment charge and expenses related to the acquisition of CGS. Excluding both non-recurring transactions, GAAP operating margin was around 30 basis points higher than the prior year. Adjusted operating margin decreased by 60 basis points to 36%. This was largely driven by higher personnel costs and technology expenses, partially offset by lower third-party content costs and lower facilities expense. You will find an expense walk from revenue to adjusted operating income in the appendix of today’s earnings presentation. As a percentage of revenue, our cost of sales was 7 basis points higher than last year on a GAAP basis and 283 basis points higher on an adjusted basis, largely due to personnel costs, expenses related to CGS, and technology costs. As a percentage of revenue, our impairment expense was 994 basis points lower than last year on a GAAP basis as we lapped the prior year’s impairment charge. On a GAAP basis, SG&A was 269 basis points lower year-over-year as a percentage of revenue and 46 basis points lower on an adjusted basis, primarily due to decreases in professional services, partially offset by increased personnel costs. Turning now to tax, our tax rate for the quarter was 16.9%, compared to last year’s rate of 12.2%. Our higher tax rate is primarily due to lower stock option exercises. We currently expect to end fiscal 2023 with an effective tax rate of 14% to 15%. While we continue to experience variability, including increases in foreign tax rates, we are researching strategies to help reduce the overall rate. GAAP EPS increased by 79.3% to $3.46 this quarter versus $1.93 in the prior year, driven by the lapping of the prior year’s non-recurring items, partially offset by a higher effective tax rate. Adjusted diluted EPS grew by 1% to $3.79, primarily due to revenue growth, offset by a higher effective tax rate and lower operating margin. Adjusted EBITDA increased to $205 million, up 15.6% year-over-year due to higher operating income. Finally, free cash flow, which we define as cash generated from operations less capital spending, was $193 million for the quarter, an increase of 9% over the same period last year, primarily driven by cash generated from working capital changes and the timing of income tax payments. Our ASV retention for the third quarter remained greater than 95%. We grew our total number of clients by 451 compared to the prior year, driven by corporate and wealth clients and partners. With client retention of 92% year-over-year, our sales and client support teams are to be commended for continuing to execute well despite market conditions. We remain committed to returning long-term value to shareholders. As previously discussed, we resumed share repurchases in the third quarter. We repurchased 165,950 shares for a total of $67.1 million at an average share price of $404.29. Under our current plan, which we anticipate completing in the fourth quarter, $114.2 million was available for share repurchases as of May 31, 2023. Additionally, this week, our Board of Directors approved a new share repurchase authorization plan of $300 million that will take effect on September 1. Over the last 12 months, combining our dividends and share repurchases, we have returned $202.1 million to our shareholders and recently increased our dividend by 10%. This marks the 24th consecutive year of dividend increases. Finally, our guidance for fiscal 2023. While there are signs that the macro environment will start to recover over the next few months, the markets remain uncertain. Last quarter, we updated our guidance to reflect organic ASV growth of $145 million to $175 million, a slight deceleration from the guidance provided at the beginning of the fiscal year. This range reflects ASV growth of $135 million to $165 million from the core business and $10 million in ASV growth from CUSIP Global Services. We also updated our revenue guidance from $2.08 billion to $2.1 billion, a slight deceleration from the previous guidance. As discussed earlier, we are reaffirming our guidance for those metrics, but at the lower end of the ranges. For GAAP operating margin, we expect our one-time restructuring charges to decrease our guidance range to 29% to 30%, a 50 basis point decrease from the previous guidance. GAAP diluted EPS is expected to be in the range of $12.24 to $12.65. For adjusted metrics, we expect our financial discipline and cost management focus to drive an adjusted operating margin of 35% to 36%. This represents a 100 basis point increase from the previously communicated guidance range and meets our 2022 Investor Day outlook two years ahead of our 2025 target. Finally, we are increasing the range of adjusted diluted EPS by $0.25 at the midpoint to $14.75 to $15.15 for fiscal 2023. In closing, we are encouraged by our performance this quarter and our ability to execute on a solid pipeline as we finish the fiscal year. We are confident in our ability to balance macro headwinds with margin expansion and expense management to continue investing in our people and products. As the pace of innovation accelerates, our deep content moat and open digital platform will strengthen our partnership with our clients and allow us to capture additional market share. We are committed to sustainable growth and excited about the opportunities before us. And with that, we are now ready for your questions.

Good morning. This is Brendan on for Manav. Just first off, I want to ask about the ASV guidance. And obviously, the high end is still there, but you are talking about it closer to the lower end. Is the higher end still possible? Did you leave it that way because there are a couple of deals in the pipeline you are not sure if you’re going to close, or can you just walk through the logic of how you’ve kind of framed the guidance update?

Sure. This is Helen. Thanks for your question. I am happy to give you some further insight on that. H1 was solid for us, but we had already seen end markets beginning to soften, which is why we reduced the guidance last call by $15 million, two-thirds coming from banking, as we said, a third coming from delayed decisions or reduced spending. Over the last 90 days during this past quarter, we have seen those trends continue, especially in banking. For example, middle-market firms, which had been doing quite a bit of hiring, picking up from other universal banks that were letting folks go, we saw that begin to slow down. Additionally, we did see some universal banks have larger reductions as well. Given our 90-day notice period, client decisions made in Q1 of the calendar year or early spring will be reflected more in this quarter, which is why you’re seeing some of that net reduction. It gives us some greater visibility. We also saw some erosion pick up on the buy side as clients looked for cost reduction. On the positive side, as Linda indicated earlier, we are still above 95% ASV retention, and we are seeing that diversification of spending in banking, for example, as we sold more in analytics and fees as many of the firms there are looking to do more technology and off-platform solutions. The second is timing. Client reviews are taking longer with more authorizations on spending. We saw more deals move from Q3 into Q4 but also into early FY 2024. Budget constraints are leading clients to pursue even cost-saving projects without having all the IT resources or initial upfront spend needed to accommodate. Many of the opportunities we see in the pipeline are open, but we can see and expect some of that to be delayed. The clear trend is that clients are looking for more help with non-core activities, which will provide momentum both in managed services and data management solutions. Lastly, reduced spending and hiring are impacting our Q3 numbers; we had the same number of six-figure expansions and new logo wins as the previous year but with a slightly lower average size, about 4% lower. The expansion we’ve seen from hiring has also slowed down, which is affecting our new business as well. However, the positive sign is that we’re not losing out on opportunities; the number of deals falling out is consistent with previous years, and we have great strength in the middle-office solutions with performance and risk. We are trying to provide our best thinking while being realistic about market timing and the ability to monetize.

Great. And then just a quick follow-up, Linda, on the margin. Last year, you were caught a bit by surprise regarding the Q3 to Q4 decline. Can you help us with our updated guidance? It seems like the midpoint would be nearly a 500 basis points move, which is what it was last year. So if you could help us with how to think about that?

Yes, Brendan, happy to provide some further clarity on that. Given the top-line situation, we had to focus a little bit harder on costs, and we’ve received substantial support from the organization in this regard. Sequentially, the margin will be considerably higher than before. Our guidance of 35% to 36% adjusted is what we said would be the exit rate for 2025, and we are well ahead of schedule. In terms of what we’re doing, there are really two concepts here. First, we are planning to take a charge in the fourth quarter to reduce our run rate going into 2024, and we’ve already executed several actions to reduce expenses this year. To reassess what we have done in 2023, we pulled back significantly on hiring as we moved through the second quarter, which is expected to give us around $15 million back. We have also done quite well in managing third-party content costs, coming in about $10 million lower than we expected. The technology team has effectively increased capitalization resulting in savings of about $7 million, and last year’s facilities charges came through a bit stronger than we anticipated, saving around $5 million. In total, we're projecting end-of-year savings of about $37 million to $38 million. With an expected fourth-quarter restructuring charge of about $45 million, including $15 million to $20 million for real estate rightsizing, we are carefully selecting which areas to target. We are anticipating a workforce reduction of about 3% or less. While these decisions are tough, we’re appreciative of organizational support to maintain an appropriate cost base while navigating this challenging environment. Overall, this clarification should help you better understand the guides.

Hi, thanks. Good morning. I wanted to follow up on the margin question. Based on your updated full year guidance for margins, fiscal Q4 margins are tracking to contract year-over-year to approximately 30%. Can you discuss the reasons behind the year-over-year margin contraction?

Yes, George, it appears you’re light by about close to 200 basis points. I think we’ll be closer to around a 32% range for the fourth quarter. This is due to an increase in personnel and a higher salary run-rate cost than we had at this time last year. We have also seen a 12.9% rise in the number of employees we have, although two-thirds of those are in lower-cost locations. The primary reasons for the contraction are the increase in employee salary run-rate costs and technology costs. The fourth quarter is traditionally our heaviest expense quarter, and we expect our bonus expense to be around $25 million, which has been consistent over the first three quarters this year.

Yes, thank you for taking my question. Regarding generative AI and its impact on both revenue and expenses, can you discuss how generative AI could potentially affect your revenue model? Will it be an add-on service that allows you to negotiate better pricing, or can you charge separately for AI-enhanced products? Furthermore, regarding cost savings, how much do you anticipate being able to save in labor costs if you fully implemented AI today?

Sure. The way we are currently thinking about generative AI is that it will significantly enhance FactSet’s search capabilities, thus improving the end-user experience and allowing us to take additional market share while boosting retention. This will help our revenue model by offering more value to clients. As for cost savings, while it’s easy to project figures in a spreadsheet, the reality is more complex as we must always produce more value than we did the previous year. We're focusing on balancing efficiency gains from AI implementation against the need to reinvest in product functionality and data expansion. Although we recognize significant opportunities are there, we will still prioritize long-term growth over immediate cost-cutting measures.

We have seen a notable pace of expansion in our pipeline across different workflows. While I can’t give you precise figures, our analytics, research, and Content & Technology Solutions all show strong interest, notably in analytics. Given our current market analysis and observations, we believe we will maintain continuity in our performance metrics.

Thank you for your insights today. I appreciate your time.

Thanks for your understanding and patience with this session today. We value your insightful questions and look forward to providing further updates in the upcoming quarter.