FactSet Research Systems Inc.
Q4 2009 Earnings Call Transcript

Published: 22 Sep 2009

[Operator:]

Welcome to the FactSet Research Systems fourth quarter fiscal 2009 quarterly earnings conference call. (Operator Instructions) Now I will turn the call over to Mr. Peter Walsh, Chief Financial Officer.

[Peter G. Walsh:]

Good morning and thanks to all of you for participating today. Welcome to FactSet’s fourth quarter earnings conference call. Joining me today are

[Operator:]

(Operator Instructions) Your first question comes from Gregg Moskowitz - Auriga USA.

[Gregg Moskowitz:]

I was wondering if you could talk to user count. It's the first time that we've seen user count growth sequentially since the November 2008 quarter. Do you think we're at a potential point of stabilization? Or how should we be thinking about that?

[Michael D. Frankenfield:]

I think it's early in the cycle to really definitively say that headcount has been stabilized. As we look back over what happened when we first went into this downturn, the first thing that happened was our cancellation rate went up and then only later did the rate of adds begin to decline. Now that we think things are beginning to stabilize, the evidence we have of that is that our cancellation rates have stabilized and it is our expectation that the adds will then follow on a forward-going basis. But your typical money manager, even though equity returns are positive, I still think we have a lot of time to go throughout the end of this year before we can definitively say that the markets have stabilize and we're ready to move forward.

[Gregg Moskowitz:]

In terms of ASV, obviously up 1% sequentially and year-over-year, and you had referenced, I believe, both international and domestic, investment management business kind of showing some improvement there. From a sell-side perspective, how did ASV do overall, kind of on those similar metrics?

[Michael D. Frankenfield:]

The IV business remains a challenging market. The sell-side firms are strong managers of their costs. They have a very, very organized procurement process. It's global. They track their spending very, very closely. And they probably adjust their workforce more quickly and are more nimble in the way they adjust the size of their business than the buy side. So we've seen a big headcount reduction on the sell side. It's very difficult to predict the trends going forward, but like the buy side, with the equity markets being up, we have also seen a recent increase in capital market transactions, M&A, filings for IPOs, but many of those deals, while announced, haven't actually closed so it still remains to be seen what happens with that business going forward.

[Gregg Moskowitz:]

How are you planning to manage operating margins over the next 6 to 12 months or so?

[Peter G. Walsh:]

Our [approach to] operating margins consistently remain the same. It's just [inaudible] FactSet with flat operating margin. It's best to utilize the fiscal 2009 operating margin as a guide for the future and we will balance our investments for the future based on whatever our ASV growth rate is going forward.

[Operator:]

Your next question comes from David Lewis - J.P. Morgan.

[David Lewis:]

Can you talk about what pricing expectations are for this coming fiscal year? Should we expect a similar modest 3% increase to the buy side, in line with the previous two years?

[Michael D. Frankenfield:]

We are currently evaluating our strategy when it comes to price for this upcoming fiscal year, or this next calendar year, and we have not made a decision yet. We do know that we have pricing power in the marketplace and the question will be whether we decide to go ahead with a traditional price increase or if we adopt a different strategy.

[David Lewis:]

With regard to Fundamentals, you have made great strides in all the proprietary content, but could you provide more color on what the win rate has been there, currently versus your competitors? And related to that, how is it priced differently and when you're not winning what is the feedback you're getting in response from some customers?

[Philip A. Hadley:]

I think you can tell from the color that Peter gave you in the dialogue that the Fundamental product is doing very well in the system, as to be expected. Fundamental is definitely a core content for us. For it be successful it is certainly a gaining share on the system. We have known for a long time what features are in the marketplace that we want to put into that product and have continued to invest heavily in that product. I would say that on a competitive basis there is no such thing as a 100% win rate, but within the context of the FactSet system and the value that we can create, it's been very, very successful.

[David Lewis:]

The ASV average, ASV was roughly equal this quarter versus last quarter. What should we read into that other the fact that users have now turned and have increased, so lower rate users have, I think, caused that metric to stabilize. The average revenue per user per quarter, it's stable this quarter versus last quarter. Anything more to that than just the sequential improvement in users?

[Philip A. Hadley:]

I think that certainly the stabilization of client growth and the user count is a positive indicator in the marketplace. I think that Mike was giving in a little bit earlier color that to try and predict the future at this point is a little vague based on we come from a place we've never been before. But we are certainly optimistic about how we can execute against our plan. As Peter highlighted, we've got, Fundamentals is a great opportunity for us along with other FactSet content. An addition for us, a new interface for a FactSet work station is a very exciting opportunity for us to deliver to the marketplace.

[Operator:]

Your next question comes from Jonathan Maietta - Needham & Company.

[Jonathan Maietta:]

Mike Frankenfield, I was wondering if you could comment on just kind of what you're seeing in the sales pipeline. It sounds like you're probably seeing more in the way of deals moving through the pipeline, whereas maybe three months ago or so things were kind of frozen in the pipeline. Is that kind of an accurate characterization?

[Michael D. Frankenfield:]

I think that's an accurate characterization. Our traditional product pipeline is very strong and we have new opportunities now with FactSet content, fixed income, and the deployment of the new FactSet, which is very exciting for clients, and quite frankly, very exciting for the sales force. So there is a lot of good sales activity going on.

[Jonathan Maietta:]

Peter, I couldn't quite hear you in your prepared remarks. Did you say after the hedge expires in mid-January you would expect op income to increase by about $1.2 million each quarter?

[Peter G. Walsh:]

The way to analyze FactSet's FX exposure is that we are insulated through January 2010. If you use today's rates, our quarterly operating income would decrease by $1.2 million. If you were going to calibrate our overall FX exposure as it relates to the pound and the Euro, for every 1% change the pound and the Euro would have against the dollar, our operating income would change by $800,000 in annual terms and $200,000 in quarterly terms.

[Jonathan Maietta:]

Tax rate, is this Q4 rate a good proxy for fiscal 2010?

[Peter G. Walsh:]

Yes, it is.

[Operator:]

Your next question comes from John Neff - William Blair & Company.

[John Neff:]

Fundamentals' revenue was up $200,000 sequentially, the operating loss was down $900,000 sequentially. I was wondering if you could explain that dynamic and also remind us of when the TSA payments expire.

[Peter G. Walsh:]

As Phil mentioned, Fundamentals is a product that's selling well for us, both to existing and new users. When existing users convert to FactSet Fundamentals it is a positive impact on operating income and can come from either higher revenues or lower expenses. Many clients who switch to FactSet Fundamentals, it causes us to reduce our payments to vendors that we pay out for client use of their content over our platform. So for fiscal 2009 this reduced our annual expense base by $7.0 million. Obviously this was a significant contributor to making FactSet break even on a run-rate basis.

[John Neff:]

$7.0 million in lower third-party royalty fees?

[Peter G. Walsh:]

Right. In annual terms.

[John Neff:]

The 412 employees that you hired this quarter, can you give us a sense for were they hired relatively evenly, early or late in the quarter, how many of those are sort of content-oriented hires versus sales and product development, and sort of digesting that, the ASV per employee down this quarter to about $209,000. Historically it's been around $300,000—is that a metric you even consider as you're managing the business, and if so, do you envision an eventual return to that kind of level?

[Peter G. Walsh:]

As it related to employee headcount, the overall large majority of our hiring related to offshore employees to support our content operations, particularly FactSet Fundamentals. The hiring happened evenly over the quarter. We do focus historically on revenue per employee. We just have to adjust our historical trends because of the build out of an investment in proprietary content collection, particularly offshore. We just have to adjust that metric to pick up our investment in high-level growth offshore.

[John Neff:]

An update on the fixed income product. I know you turned some customers in recent months. Just curious how those were progressing. And how is that offering benefiting, if at all, from the new platform?

[Michael D. Frankenfield:]

We're very pleased with our progress in fixed income. The problems we're trying to solve are very complicated and they're well suited to what we do well. The problems are complicated because there are a large number of fixed income instruments and it's very difficult to model their valuation. For anyone to be successful delivering valued clients, you are going to need a strong combination of computing power, data expertise, and data integration. And we feel those are our core competencies. We are very encouraged by the early success we've had in some of the larger institutions that are our clients and it is our expectation to continue to refine our process, to build a scalable offering that we'll be able to deploy widely to all of our clients.

[John Neff:]

Peter, if you could comment on, if I heard you correctly, why the change in the treatment of non-subscription revenue now on a trailing 12-month basis being included in ASV. And I think you mentioned it was $4.0 million trailing in the fourth quarter, was that part of the reported ASV this quarter?

[Peter G. Walsh:]

The $4.0 million was not included in the ASV change for the quarter. The reason for our change there is just really due to the size and to make things more simplistic. The $4.0 million number is less than 1% of total ASV and by adding it into our methodology for future ASV calculations, starting on November 30, we just feel like it's a simpler, more straight-forward presentation.

[Operator:]

Your next question comes from Shlomo Rosenbaum - Stifel Nicolaus.

[Shlomo Rosenbaum:]

Could you go into why the RDSO dipped so much in the quarter? Is there someone who had an unusual payment? Is this going to snap back in the next quarter more into the 40s?

[Peter G. Walsh:]

AR is an area that we are continually focused on. As it relates to the quarter, it declined by 11% in the fourth quarter. That's a significant movement. It wouldn't surprise me at all to see our AR increase during Q1. Our real focus is to make sure our rate of AR growth is less than our rate of ASV growth. We have been consistently delivering on that year-in and year-out. AR is an area where it takes consistency to have a superlative record over the long term.

[Shlomo Rosenbaum:]

So you have like a normalized level that you expect? Do you think you're breaking new ground here in general, or is it sort of a one-time thing?

[Peter G. Walsh:]

What our expectations are is our AR should never grow more than our ASV growth rate. So I wouldn't say that we've broken new ground but it's something that we continually work on and we focus on because [inaudible].

[Shlomo Rosenbaum:]

Can you go over the FactSet Fundamentals metrics again? The revenues and the losses over there.

[Peter G. Walsh:]

I think if you look at FactSet Fundamentals, the revenue for the quarter was $1.5 million, a loss of $700,000, a dilution in EPS of $0.01. Over the last 12 months, its dilution to EPS was $0.09 versus an estimate when we made the acquisition of $0.15. FactSet Fundamentals is now break-even on a go-forward basis.

[Shlomo Rosenbaum:]

What was the growth in your fixed income product? You know we talked about that a lot over the last two quarters. Are you giving specific growth rates for that?

[Philip A. Hadley:]

That's something we [inaudible].

[Shlomo Rosenbaum:]

Client retention just seemed to dip a little bit sequentially, 88% to 87%. Is there anything to read into that?

[Peter G. Walsh:]

I think the only thing to read into that is that this is a calculation that we used the last trailing four quarters to calculate, so when you see the dip, Q3 versus Q4, that you're pointing out, Q3 last year included the fourth quarter of 2008, which was one quarter prior to the credit crisis. So when you replace that quarter with a comparable adapted to the credit crisis, that's why I adjusted.

[Shlomo Rosenbaum:]

Could you break out the international operating margin between Europe and Asia?

[Peter G. Walsh:]

The operating margin is something that we really manage FactSet on a worldwide basis. The reason why we don't have any further detail is because we would have to go through a massive comp out on Asia based on the way FactSet is operated and run. In order to get an accurate operating margin. We just feel like the informational benefit, even internally, is very low versus all the effort to allocate costs to try to refine that calculation to where it would have value.

[Shlomo Rosenbaum:]

What about the numbers that are going to show up in the 10-K?

[Peter G. Walsh:]

We do break those down in the 10-K, as we do in the segments, and if you look at that in the bottom of the segment disclosure, we always have a paragraph that has some cost sharing which basically explains to the reader that we haven't gone to the exercise of allocating costs but are centralizing the U.S. that benefit the entire world.

[Shlomo Rosenbaum:]

And the gross margin down sequentially, that was primarily hiring, is that the way we should understand that?

[Peter G. Walsh:]

Again, we manage FactSet on an overall basis, but if you're looking at that, it's hiring and higher computer maintenance costs, because computer maintenance costs kick in a year after we purchase a mainframe system, and we purchased several of them in 2008.

[Operator:]

Your next question comes from Analyst for Chris Kennedy for Glenn Greene – Oppenheimer & Co.

[Chris Kennedy for Glenn Greene:]

Any update on the competitive environment, what you're seeing from Thomson as they kind of integrate themselves?

[Michael D. Frankenfield:]

The competitive landscape hasn't changed materially. Our industry is really dominated by a few significant players and our opportunity is very significant relative to their size. I think the challenge for all of the suppliers in this industry is that the client is more cost-conscious and that's putting a burden on everyone to deliver more value. We continue to be increasing the value of FactSet through our proprietary content and our new FactSet initiatives and I think that's improving our competitive position relative to the other players in the industry.

[Chris Kennedy for Glenn Greene:]

Can you give us some type of preview on the upcoming management transition?

[Peter G. Walsh:]

First off, it's important to note that I'm very fortunate to follow Mike. His record at FactSet speaks for itself. He built FactSet from the ground up. And I will be working with a well-organized and experienced group of very competent players, in both content and engineering. Looking ahead, I've worked with Phil and Mike and we've collaborated on a very aggressive and achievable agenda. My teams will continue to focus on improving the utility of FactSet for existing users, developing applications to solve problems for large institutions, and expanding our investment in proprietary content. Given our [inaudible] to work side by side with clients, there is certainly a long list of opportunities we will focus on that impact our existing users. And I feel like we're fortunate that we don't have to reinvent ourselves or assume the risk of trying to create success in a new marketplace.

[Operator:]

Your next question comes from Kevin Doherty - Banc of America Securities.

[Kevin Doherty:]

Looking back over the last year, the revenue base is pretty stable from quarter to quarter but yet you ended the year down with about 3,000 fewer users. So I wanted to see if you could put that in perspective, how you are able to keep the revenue flat. And if you are seeing some of this continued stabilization in the subscriber count, why shouldn't we expect the revenues to move a little higher?

[Philip A. Hadley:]

For those of you who aren't familiar with our revenue model, we get revenue from multiple dimensions. There is a base client relationship where the core product that two users get that's a substantially higher number on a per-seat basis. And then we also sell content and applications above that as revenue dimension. And the third is seats. The seat count for us is only one dimension of our revenue. We don't break out exactly how much it is, but obviously you can tell that there are other ways for us to grow than just to grow seats. So that would be the explanation of how you're able to grow revenue without growing seats. As to the trends, I think it's definitely one of those where if you took the color of Peter, Mike, and I, you kind of get the feel for it. It's a greater forward view for us than it has been historically. I think probably that's true of everyone on this call. But at the same time, the fact that seats have stabilized and the client count has stabilized certainly puts us in a better position than we were a few quarters ago.

[Kevin Doherty:]

And as we think about the stabilization out there right now, how much would you say is more broad-based industry-wide versus some of the share gains that you've seen over the last few quarters, specific to FactSet?

[Philip A. Hadley:]

It's hard to break out. It certainly is a contracting industry, I think. Data on a whole industry is hard to figure out but you definitely get the feeling that at least for several quarters there, client spend was not going in a positive direction for anyone. At the same time, I think our future opportunity is ripe because we're still really a small player in this industry, with potential upside, and our goal is to just focus on the things that we know we can control and good things will happen.

[Kevin Doherty:]

And you talked a little bit about the new software platform, is there going to be an incremental revenue opportunity from that? Meaning is that going to be a premium product or is that something that would more or less be included under existing contracts?

[Michael D. Frankenfield:]

The new FactSet is an exciting initiative for FactSet. Clients have told us for a long time that we have great functionality but that they would deploy more FactSet if it were easier to use. And that's really the goal of the new FactSet. And the early feedback from clients indicates that we are solving the ease of use question. It will take a long time for us to roll that out. We have 38,000 users and those users are used to using our existing products. And our job is to improve client workflow so it will take a while for these users to adopt the new FactSet into their workflow. If you really think about it as sort of an evolutionary process, the success of the initiative will be back-end loaded, towards the end of the year. But we're very, very excited about it. The new FactSet consolidates three platforms that are in the marketplace today, Directions, Marquee, and IV Central. And it combines the three applications into a single application that can be personalized to meet a specific user's needs. It gives us a great benefit to leverage our internal development efforts and really focus on building one excellent product. And from the clients' perspective it's going to unlock a lot of hidden value and it gives clients a tremendous opportunity to explore FactSet and help them discover ways that FactSet can address their problems in ways they haven't done before.

[Kevin Doherty:]

So is that a product where the client will actually make the initiative to upgrade to this? And again, will there be any incremental cost to the client, over time?

[Michael D. Frankenfield:]

We have built a roll out plan and based on multiple criteria, put each client into an individual slot, when we think will be the best time to upgrade them and the sales force will be working with clients on an individual basis to determine what's going to be the best time to receive the upgrade, as well as discuss any cost implications.

[Kevin Doherty:]

Peter, you obviously talked about maintaining the strategy of flattish margins. If we're assuming no benefit from FX and if environment of roughly flattish revenue continues, do you think you can keep those margins flat without further cost savings and do you think some of the cost savings that you rolled out over the past year are pretty much behind you?

[Peter G. Walsh:]

As we look ahead, I think the beauty of our ASV model is the visibility that it provides us. And we will always adjust our investment levels up or down to correlate our investment levels to keep our margins flat. And most of those investments come in the form of headcount. So while we have based our headcount plans on conservative ASV environment, it's certainly more constructive that it has been in the past. Our cost savings initiatives, while successful, this will be the year where we get a full year value of the cost savings initiatives. We don't have any material new initiatives planned for fiscal 2010. And finally, our headcount plan has an offshore tilt, which is more cost efficient on a per person basis.

[Operator:]

Your next question comes from Peter Appert – Piper Jaffray.

[Peter Appert:]

Peter, can you remind what the seasonality around passwords is, and specifically how many fourth quarter passwords are there associated with the summer internist associate classes?

[Peter G. Walsh:]

Historically, seasonality for Q4 has been our strongest quarter, primarily due to college hiring by investment banks. I would say that that's probably not the case this year, just because their hiring plans were impacted by the credit crisis. As it relates to summer interns, we do not include summer interns in our user counts for any periods. And so that's why we have just—it does impact revenues. The summer intern revenue is this quarter about $900,000 and that's something that won't repeat itself in Q1.

[Peter Appert:]

So based on that, do you think then that the fourth quarter will mark the bottom in terms of password count?

[Peter G. Walsh:]

I think what we really saw there in the quarter was a stabilization of the cancellation rate, which we see as a prerequisite to—in client demand, improving to buy new or subscribe to new services. There is a long way to go from the buy side perspective. You know, this thing of paper profits and the calendar year needs to turn before it translates into flexibility at a budget level. On the sell side, there are lots of recent articles, but it is very recent over the last couple of weeks about increasing capital markets activity, but as you know, banks don't get paid until deals closes. Or IPOs are launched. And there's still a long way to go there, too.

[Peter Appert:]

And to follow on to the prior question, you have done a masterful job in managing the cost side of the equation in the past year, and I'm just wondering from your perspective, has there been any deferral of cost that you might have to play catch-up here in the next year in terms of marketing, T&E, etc.?

[Peter G. Walsh:]

From our cost-savings plan strategy was long in the offing, so when we started on cost savings we started last summer. The way we started was we engaged a management group that I call the operating committee. We asked that group to submit ideas on how to make FactSet more efficient and we got a more than 100 ideas and we narrowed them down to 45 we wanted to execute. The beauty is that it takes time to make yourself more efficient and because we gave ourselves time, we were able to execute successfully. The second benefit is that these are things that pay dividends not just last year but in the years going forward. So our approach hasn't been rationed in any way and we haven't been deferring on key investments that are important for FactSet to grow its top line.

[Peter Appert:]

And for fiscal 2010, the double-digit increase in staff that you're tentatively thinking about, is that still primarily in data-oriented positions or relatively low-cost headcount?

[Peter G. Walsh:]

Yes, it is.

[Operator:]

Your final question is a follow-up from John Neff - William Blair & Company.

[John Neff:]

The double-digit employee increase that you're anticipating this year and the comments you made about ASV providing the kind of visibility you need to plan for those investments, does that mean we should expect, or that you're expecting a double-digit growth in ASV and that employee count approximating what you expect in ASV growth.

[Peter G. Walsh:]

As you know, we give revenue guidance that goes out a quarter. Historically, when all our hiring was done onshore, there was a stronger correlation between ASV growth and the growth of our headcount. Just this year is a great example where that historical trend has been broken, where our headcount was up 25% but our ASV growth was up a percent. So as we continue to invest offshore that historical measure isn't as useful as it once was.

[Operator:]

There are no further questions in the queue.

[Philip A. Hadley:]

Thank you, everybody.

[Operator:]

This concludes today’s conference call.