FactSet Research Systems Inc. (FDS) Q2 2019 Earnings Conference Call Transcript

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FactSet Research Systems, Inc. (NYSE:FDS)Q2 2019 Earnings Conference CallMarch 26, 2019, 11:00 a.m. ET

Contents:
Prepared Remarks Questions and Answers Call Participants
Prepared Remarks:

Operator

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the FactSet Second Quarter 2019 Conference Call. All lines have been placed on mute to avoid any background noise. After the speakers’ remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press *, then the No. 1 on your telephone keypad. If you’d like to withdraw your question, press the # key. Thank you. Rima Hyder, Vice President of Investor Relations, you may begin your conference.

Rima Hyder — Vice President, Investor Relations

Thank you, Stephanie, and good morning, everyone. Welcome to FactSet’s second fiscal quarter 2019 earnings conference call. Before we begin, I would like to point out that the slides we will reference during the course of this presentation can be accessed via the webcast on the Investor Relations section of our website at factset.com. The slides will be posted on our website at the conclusion of this call. 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. To be fair to everyone, please limit yourself to one plus a follow-up.

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, 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.

F Philip Snow — Chief Executive Officer

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 topline 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 continued 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 FactSet’s 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 over 6%, and adjusted operating margin came in at 33.2%, 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 toward 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 analytics suite 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. And 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 branch rollout at Merrill is complete and was successfully implemented in under six 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 workforce 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 hit 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, bring seamless investment portfolio lifecycle platform, and 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’ve 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 toward 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.

Helen L. Shan — Executive Vice President & Chief Financial Officer

Thank you, Phil, and good morning, everyone. It’s great to be here with all of you 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 margins 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 past expenses related to U.S. tax reform. I’ll expand on this a little later when I report out on the tax rate. I will 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, and 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 primarily driven 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 by 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 a 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 spend. 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 discreet 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 discreet items, the effective tax rate for the 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 investments 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 17-18%. 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 cents. There is no change to our annual guidance for GAAP revenues, organic ASV plus professional services, and GAAP and adjusted operating margins.

In summary, we are pleased with our quarter, and with our first-half results, where we had over 6% growth in both revenue and organic ASV plus professional services, and 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 that 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. Stephanie?

Questions and Answers:

Operator

At this time, I’d like to remind everyone, in order to ask a question, please press * then the No. 1 on your telephone keypad. We’ll pause for a moment to compile the Q&A roster. Your first question comes from Manav Patnaik with Barclays. Please go ahead.

Gregory R. Bardi — Barclays Investment Bank — Analyst

Hi, this is Greg calling, on for Manav. I just wanted to ask about the sales pipeline in a couple 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 the rationale for why the growth will be tilted toward the fourth quarter.

F Philip Snow — Chief Executive Officer

Hey, 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 toward Q4, and this year is no different.

Gregory R. Bardi — Barclays Investment Bank — Analyst

Okay. And then, on the margin side, pretty nice results. We had always thought of the margins as 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? Thanks.

Helen L. Shan — Executive Vice President & Chief Financial Officer

Yeah, sure. Thank you for your question. 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 improvement — 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’ve benefited from foreign exchange favorable rates, largely exposed to the ones that we’re most open to, which is 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, on getting operational efficiencies. And so, that gives us comfort of being able to meet our target for the year, and to be within the range that we’ve given you guidance on. Any other questions?

Operator

Your next question comes from Peter Heckmann with Davidson. Please go ahead.

Peter Heckmann — D.A. Davidson & Co. — Analyst

Good morning, everyone, thanks for taking my questions, Phil, I was curious on the M&A front. It’ll be almost two years since the company’s last acquisition. Are you — when you look at the marketplace, are you changing some of your thoughts about organic versus nonorganic growth, or is there something else, like valuations, that’s keeping you from closing deals?

F Philip Snow — Chief Executive Officer

Yeah, it’s a great question. So, I think I’d just start with we did make a number of acquisitions within a couple of years — more software. So, we intentionally decided to pause and really get those integrated. And I think what you’re going to see in the second half of this year is some real new exciting products coming out from FactSet, within the analytics and trading space. And we’re already beginning to m