TransUnion
Q3 2017 Earnings Call Transcript

Published: 27 Oct 2017

[Operator:]

Good morning and welcome to the TransUnion, Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. At this time I would like to turn the conference over to Aaron Hoffman, Vice President of Investor Relations at TransUnion. Please go ahead, sir.

[Aaron Hoffman:]

Good morning, everyone and thank you for joining us today. I’m joined by Jim Peck, President and Chief Executive Officer and Todd Cello, Executive Vice President and Chief Financial Officer. We've posted our earnings release on the TransUnion Investor Relations website. Our earnings release includes schedules which contain more detailed information about revenue, operating expenses and other items, including certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures are also included in these schedules. As a reminder, today's call will be recorded and a replay will be available on the TransUnion website. We will also be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially from those described in the forward-looking statements because of factors discussed in today's earnings release, in the comments made during this conference call and in our most recent Form 10-K, Form 10-Q, and other reports and filings with the SEC. We do not undertake any duty to update any forward-looking statements. So with all that out of the way, let me turn the time over to Jim.

[Jim Peck:]

Thanks Aaron. Before I dive into our quarterly results, I want to spend a few minutes on the cyber attack announced by one of our competitors during the third quarter. First, we can confirm that we did not experience a similar cyber attack to Equifax. The moment we heard the news after market closed of September 7, we activated our data incident response plan and followed our standard process to identify and address organizational implications. We focused on supporting consumers and confirming the effectiveness of our own security program. We immediately conducted a thorough global review of our systems and found no evidence of a cyber intrusion like the ones suffered by Equifax. Clearly data security is an absolute top priority for TransUnion. We have consistently invested in it and built a culture around mitigating this risk. We have a multi-layered security framework approach to mitigate the risk of any single point of failure. This framework covers three major areas of focus

[Todd Cello:]

Thanks Jim. I’ll start by walking you through our consolidated and segment results. For the sake of simplicity, all of the comparisons I discuss today will be against third quarter of 2016 unless noted otherwise. Third quarter consolidated revenue was $498 million, an increase of 14% on a reported basis and 13% on a constant currency basis. As expected, revenue from acquisitions contribute about one point of growth in the quarter. Adjusted EBITDA was $194 million, an increase of 17% on a reported basis and 16% on a constant currency basis. Adjusted EBITDA margin was 39%, an increase of 90 basis points and roughly in line with our full year expectation. Adjusted net income was $93 million, an increase of 33%. Adjusted diluted EPS was $0.49, an increase of 30%. The adjusted effective tax rate for the third quarter was 36.4% in line with our expectations of 36% to 37%. Let’s spend a minute discussing some of the key income statement items. Cost of services was $169 million, an increase of 20% compared with the third quarter of 2016. This increase was largely the result of increased product costs related to revenue growth and the incremental cost to provide quality service to consumers and conduct the thorough global review of our technology systems in the weight of Equifax’s cyber intrusion that Jim discussed earlier. Another factor was our continuing investment in strategic growth initiatives to drive long term top and bottom line performance. SG&A was $142 million, an increase of 4% compared with the third quarter of 2016, driven primarily by investments in strategic growth initiatives, and an increase in incentive and stock-based compensation related to strong business performance. We continue to see revenue growth significantly outpace our SG&A, reflecting the substantial leverage we are able to realize from our business model. And depreciation and amortization was $60 million, a decrease of 5% compared with the third quarter of 2016, continuing the trend we’ve seen each quarter this year. Adjusted operating income was $168 million, an increase of 22% compared with the third quarter of 2016, driven primarily by the increase in revenue. Now looking at segment revenue and adjusted operating income, USIS revenue was $312 million, up 14% compared with the third quarter of 2016, driven by strong growth across all platforms. Starting with online data services, revenue was $200 million, an increase of 12% driven by the favorable macroeconomic environment and strength across products, including CreditVision, CreditVision Link and TLOxp. Marketing services revenue was $48 million, an increase of 17%, due primarily to demand for our new solutions, including CreditVision, CreditVision Link and Digital Marketing, as well as other batch jobs. And decision services revenue was $63 million, an increase of 18%, due primarily to revenue growth in our healthcare and rental screening verticals. Adjusted operating income for USIS was $110 million, an increase of 22% compared with the third quarter of 2016, due primarily to the increase in revenue. International revenue was $95 million, an increase of 15% or 12% on a constant currency basis compared with the third quarter of 2016. Emerging markets revenue was $61 million, an increase of 15% or 12% on a constant currency basis. We saw strong growth in India and other key markets, tempered by ongoing softness in South Africa where our business continues to navigate a challenging macroeconomic environment. Developed markets revenue was $34 million, an increase of 16% or 13% on a constant currency basis. Both Canada and Hong Kong continue to show strong double digit growth. Adjusted operating income for international was $32 million, an increase of 20% on a reported basis or 17% on a constant currency basis, driven by the increase in revenue and continued benefits from leveraging our global operating model. Adjusted operating income margin expanded by 120 basis points as a result. Consumer interactive revenue was $107 million, an increase of 10% compared with the third quarter of 2016. Growth was driven by strong volumes with indirect channel partners, including CreditKarma and Chase. In our direct channel we benefited from an increase in new subscribers for our premium offering in September. Adjusted operating income for Consumer Interactive was $48 million, an increase of 13%, driven by the increase in revenue and favorable shift in revenue mix, partially offset by increased marketing costs. Adjusted operating income margin expanded by 140 basis points as a result. Now moving to the balance sheet, cash and cash equivalents were $253 million at September 30, 2017 and $182 million at December 31, 2016. The increase was driven by strong cash flows from operations. In early October we used a significant portion of this cash to pay for the acquisition of eBureau, which will be reflected in our fourth quarter results. Total debt, including the current portion of long-term debt remained relatively flat at $2.4 billion at September 30, 2017 compared with December 31, 2016, even after acquisitions and share repurchases. In early August we amended and refinanced our credit facilities for the second time this year to opportunistically achieve interest savings, extend maturities and achieve other benefits. Specifically we reduced pricing on our Term B loans, which represent approximately $2 billion of our $2.4 billion in debt by 50 basis points. We increased borrowings on our Term A loans by $33 million to $400 million, extended the maturity by about two years to August 2022 and reduced pricing by 50 basis points. We also increased capacity under the revolver by $90 million to $300 million, extended the maturity by about two years to August 2022 and reduced pricing by 50 basis points. Taken by themselves, these changes result in annualized pre-tax savings of approximately $12 million. We will realize about $4 million of this benefit in 2017. The remaining approximately $8 million of benefit in 2018 will be offset by higher LIBOR. As a result net interest expense in 2018 will likely be up slightly. Overall, our balance sheet remains very strong as we continue to reduce leverage and minimalize borrowing costs. Moving on to the statement of cash flows, we continue to benefit from strong cash flow, which enables us to invest in our business for the long term through organic growth initiatives and strategic acquisitions, and provides opportunities to return excess cash to our shareholders. Jim discussed our acquisition of eBureau and Data Link services. Even as we continue to pursue strategic acquisitions, we remain keenly focused on making high impact internal investments and will fulfill our three year $300 million share purchase plan. That concludes my review of the financial results. I’ll turn the call back to Jim.

[Jim Peck:]

Thanks Todd. As I lay out our guidance, a couple of quick points about our assumptions for acquisition and FX impact

[Aaron Hoffman:]

Thanks Jim. That concludes our prepared remarks. For the Q&A we ask that you each ask only one question so that we can include more participants and now we’ll be glad to take those questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question this morning will be from Tim McHugh of William Blair. Please go ahead.

[Tim McHugh:]

Hi guys, thanks. First question I guess is just the incremental spending on the consumer business. I guess as well you mentioned I think a review of your cyber operations I guess, everything related to that. What was the extra spending in the third quarter and what do you assume in the fourth quarter and is any of that kind of permanent that we should think about as we go into 2018?

[Todd Cello:]

Hey, good morning Tim. It’s Todd. To answer your question, in response to the Equifax breach, we incurred incremental Call Center class, as well as class scale up our websites and those class I talked about within the COS component of the income statement. So we would look at that as largely non-reoccurring, but that is something that you know is pretty much done within the third quarter. What’s important to note, that resides within our USIS segment and that’s where we have our consumer relations business at. On the consumer interactive business, the comment on the margins there, we did have increased revenues in the third quarter from our premium subscription product as consumers are more interested in that offering. So we did incur a little bit of incremental advertising expense in that space.

[Tim McHugh:]

Okay, I get it. And did you say in the cost of service line? I guess how much incremental spending it was in terms of the dollar number?

[Todd Cello:]

Yeah, no we didn’t.

[Tim McHugh:]

Okay, thanks.

[Todd Cello:]

Yeah.

[Operator:]

The next question will come from Manav Patnaik of Barclays. Please go ahead.

[Manav Patnaik:]

Thank you. Good morning gentlemen. Maybe just to follow-up on that, you mentioned you know excluding the potential revenue impact and then you referred to like a subscription window ended in Jan 1, 2018. I was wondering if you could just elaborate on what that means and just somewhat tied to this, I mean do you guys – are you willing to give you know statistics or your view on what the fees lock numbers look like and if that you know would have any impact to sort of the lending environment?

[Jim Peck:]

Sure. So I think you’re talking about the subscription period that Equifax is offering where they will kind of allow consumers to sign up for free credit monitoring and since we you know that period hasn’t ended yet, we don’t want to speculate on how many consumers that might be and so therefore we haven’t reflected that in our forward-looking revenue. Once we know that, then we’ll be able to kind of give you a better idea of what that is going forward so that’s what we meant by that. What was the second question? Yes, so I think we’ve seen something like 2% of U.S. consumers putting kind of a freeze or a lock on and that you know we don’t believe is going to have a dramatic impact on you know our -- I guess the quality of our files which you are asking about.

[Operator:]

Your next question will come from Jeff Miller of Baird. Please go ahead.

[Jeff Miller:]

Yeah, thank you. On the USIS business I thought the growth was particularly strong. Can you just I guess comment, does there appear to be any revenue or share benefits because of the competitor breach or if not to the extent to which it’s just underlying strength. Any additional color would be appreciated. Thank you.

[Jim Peck:]

Sure. So to answer your first question, you know it was only a month in, so that feverishly had no impact on our USIS performance related to Equifax as far as the business goes, about half of our growth came from our innovation of new products, including CreditVison and others that we talked about and the other half is just strong growth from the core. But we always kind of strive for doing things that are going to help us take share and we’ll continue to do that going forward. So we feel very good about the business as it performances and we feel like it’s going to continue performing well going forward.

[Jeff Miller:]

Okay, thank you.

[Operator:]

The next question will come from Gary Bisbee of RBC. Please go ahead.

[Gary Bisbee:]

Thanks guys and I appreciate the opening Jim with the comments on how you think about IT security and risk there. I guess along that line, what if any risk you see or is there any way to think about the risk from increased awareness of things like the free lock and unlock that you have been offering and that Equifax will be offering. How that might impact you know paid direct-to-consumer within the consumer business and then more broadly, what risk is there at this point or is there any way to frame it from the regulators tightening up or changes and sort of backlash to what happened at Equifax. Thanks.

[Jim Peck:]

Sure, okay good. Yeah so you kind of got to remember here that the three have been around for years now, right. And so I don’t believe this will have a material impact on the for-pay because there are things in the for-pay that are for consumers who are interested in it that give them a heightened level of service. If anything there is probably more engagement from the consumer when these kinds of things happen. So we don’t – in our particular business we don’t see a material impact. And then like I said, there is just more of a consumer legislative standpoint. You know there is lot of discussion going on right now and I think people are trying to kind of understands the role that the credit industry plays in the whole economy and how important it is, making sure that there are no unintended consequences of certain kinds of actions that can be taken and so I think it’s in the stage of kind of learning and education and we are engaged in that process as it kind of unfolds.

[Gary Bisbee:]

Thank you.

[Operator:]

The next question will come from George Mihalos of Cowen. Please go ahead.

[George Mihalos:]

Great, good morning and congrats on another good quarter guys. So just two quick things I want to dig into a little bit more. I understand that the breach happened in September and it didn’t have much of an impact on the third quarter results. But just interested Jim, if maybe the tenor or the number of conversations on the B2B side with banks has ticked up since then and then conversely as it relates to conversations you are having with regulators, legislations, it seems like sort of the free lock and free products our out there. Are you seeing any sort of a push or can you envision more of a push to give other direct-to-consumer services away and like monitoring? Thank you.

[Jim Peck:]

Sure. On the question around I guess share shift as you’re asking me, as you can imagine it’s more or less a way of life for TransUnion to try and innovate and bring these solutions to our B2B customers to take a bigger footprint in their operations. And so that hasn’t changed, and we feel like we were already doing very well in that area, which has been driving out good results basically for the last two, three years. You know I think it’s probably too early to comment on if there is, due to this situation there is going to be some share shift and frankly I think it’s the most healthy for TransUnion not to rely on that, but to continue to rely on being innovative, being thought leaders, etcetera in order to drive share shift, because that’s what really is going to sustain us, not only in the U.S. but internationally in the long run. So that’s the comment there. As far as regulation I’ll just go back. I do think that the regulators and everyone are trying to understand you know the kind of the whole ecosystem and how free locks and freezes and other things might impact the economy. At this point in time we don’t envision – we already have a free lock and it’s instantaneous and it works. We don’t envision the time where we would you know go and put something in like a free freeze, you know those are all different by state and much more complicated than just simply using an app or an online version of essentially doing the lock. So that’s what we are going to continue to support going forward.

[Operator:]

The next question will come from Andrew Steinerman of JPMorgan. Please go ahead.

[Andrew Steinerman:]

Hi. Could you tell me how your healthcare vertical within the USIS is doing, like eScan and ClearIQ?

[Jim Peck:]

Sure Andrew. So our healthcare business continues to form very, very strong, both on the front end and then particularly on the backend and the acquisitions in Auditz and RTech also continue to perform very strong in their own right and integrate it in with eScan; it’s increasing our yield. So we are using all that IP in combination and its increasing the amount of – basically the amount of revenue we are able to return to the hospital systems. The pipelines remain strong, and still plenty of kind of market share to gain there. So we see our healthcare business continue to be performing very strong this year end going forward.

[Andrew Steinerman:]

Great. Thank you.

[Jim Peck:]

Thank you, Andrew.

[Operator:]

The next question will come from Andrew Jeffrey of SunTrust. Please go ahead.

[Andrew Jeffrey:]

Hi, good morning, thanks for taking the question. I wonder if you could Jim speak to in your view the sort of tenor of demand generally in the market place for indirect solutions. I’m thinking about from the CreditKarma and the Chase’s whether there has been an uptick in inquires and sort of as a corollary you talked about the Equifax product, the free credit product. Is there any way you can provide some insight directionally to what unit pricing might look like there?

[Jim Peck:]

Yeah. So, on your first question, in the indirect business, in the consumer space. So where we really use CreditView platform as a way to help our clients deliver solutions to consumers, demand has been and remains very strong. So with the customers we currently have, definitely an uptick. We announced that we now partner with Intuit and so there are new players in the industry understanding the benefits that the consumer and they can get from providing these kinds of services. So I think the indirect business, yes transactions are growing, but also the pipeline looks really strong with some very powerful partners and so we feel really good about that business. As you might expect, we really can’t comment on pricing for things like credit monitoring, but we will give you an idea of kind of the volumes once we understand them and if we understand them next time we all talk.

[Andrew Jeffrey:]

All right, I appreciate it. Thanks.

[Operator:]

The next question will be from Toni Kaplan of Morgan Stanley. Please go ahead.

[Toni Kaplan:]

Hey, good morning. I just wanted to get a sense of if you have seen any increased demand for Auditz or any other change in behavior from your B2B customers since you know September 8. And basically have you had to increase staffing in response in USIS if that’s the case or just any sort of changes in behavior on the B2B side. Thanks.

[Jim Peck:]

Sure. Honestly there hasn’t been a real change in behavior. They have always been concerned with the various kinds of security we have and procedures we have relative to following the regulation that guides their industry and our industry. Certainly there have been phone calls and discussions between our cyber folks and their cyber folks to understand our, or confirm our security stand. No particular increase in staffing associated with that. As we referenced in, I’ll kind of reinforce, we’ve over time continue to increase our resources both internally and externally, that support our cyber security program as that’s become a bigger part of I would say the world that we live in, not only our company but all companies, and that will continue to be an area of interest for us going forward. But those kinds of things are all in what I would say our guidance and our long term guidance.

[Toni Kaplan:]

Thank you.

[Operator:]

The next question will be from Kevin McVeigh of Deutsche Bank. Please go ahead.

[Kevin McVeigh:]

Great, thanks. I just want to follow-up on the USIS. The core growth accelerated despite a much tougher comp year-over-year and just Jim it sounds like half was innovation, half strong core growth. Can you just help us understand the components for the core? Was it better than expected demand on the mortgage side or auto or just can we frame that out a little bit more?

[Jim Peck:]

Yeah, it’s hard to kind of pick at each one of those, because we don’t always know exactly why each credit report is bring pulled by our customers and so I think I would just say overall we expected mortgage to be down high single digits. It was probably not down that far. Card was a little soft compared to a really strong ’16, but still positive headwinds and new car sales were kind of offset by the strength in the used car sales, so that tread the water and consumer lending is strong, very, very strong for the FinTech space and that is largely driven by our ability to innovate and the uptake of things like CreditVision and some of the other things we are doing. And of course included in our USIS business is healthcare, which also continued to perform very, very strong. So you take that as a base and then you add on the new, I guess contracts or the new revenue that we’ve gained from our things like Fraud Solutions and in our rental screen business and our SRG business. In CreditVision, CreditVision Link and then just simply taking share I think in some cases associated with these new things, that’s what is driving our strong growth.

[Kevin McVeigh:]

Super, and just one quick follow-up on that. Any – the kind of step-up from the hurricanes around auto, is that on the comp or you started to see that obviously in September?

[Jim Peck:]

We might see something going forward, so that’s nothing you really saw kind of in either direction, good or bad in September.

[Kevin McVeigh:]

Thank you.

[Operator:]

The next question will come from David Togut of Evercore ISI. Please go ahead.

[David Togut:]

Thank you, good morning. Jim, could you comment on how you expect the premium versus paid consumer channel to evolve over the next couple of years in light of the Equifax data breach. In other words, the consumers want a lot more handholding through a paid offering or are they willing to take more of a basic premium offering to protect their credit.

[Jim Peck:]

Yeah, I would say that I think we need to learn from what’s just happened and so all the learning has not happened yet. But I don’t think there is going to be a material change. I think any time the consumers get more engaged, it’s good for consumer and good for companies like TransUnion. Certainly the free products are very effective, but there are consumers who want more, maybe in the areas to help them deal with fraud or other things and so there always will be a demand there. For our particular business as you know, our consumer direct business is not relatively large compared to some other and so our particular kinds of consumers, I guess you’d say the ones who are probably going to stick around a little longer. It’s just not – we never built a big huge businesses across the whole consumer base. So we are not necessarily dealing with maybe the Venn diagram of those who want, who are paying maybe can now go to free necessarily. So we don’t have that dynamic occurring in our business. You know that said, I do think there will continue to be a demand for free, continue to be demand for the kinds of solutions that our partners are putting out using credit view in their own services to help the consumer understand not only where they stand now as far as their credit ability, but also where they might go if they change some of their behaviors. Those are things like credit journey, and other things that we do with some of our B2B customers. So I don’t see a meaningful shift in what is happening already in the market.

[David Togut:]

Understood. Thank you very much.

[Operator:]

The next question will come from Shlomo Rosenbaum of Stifel. Please go ahead.

[Shlomo Rosenbaum:]

Hi, thank you very much for squeezing me in. Hey Jim, how much did the breach result in just the direct-to-consumer demand spiking after that happened and how much has that continued on just kind of at the elevated levels or is that kind of tapered off a little bit?

[Jim Peck:]

Yeah, so there was a lot of interest in September, and as you know we grew the overall business by about 10%. I think we were guiding towards more of a – and we get back to mid-single digits. I will say our indirect business performed very strong anyway. So we were likely going to over achieve that. But then you add on a little bit of a blip that happened in September and that’s what kind of helped us just kind of get that little extra to get to 10%. That has moderated since then and so I don’t think that will be something that is kind of sustained going into next year.

[Shlomo Rosenbaum:]

Thanks. Just if you don’t mind, I just want to ask about free cash flow. Is there any pull forward because it was really strong free cash flow in the quarter.

[Todd Cello:]

No Shlomo, there was nothing of any significance that was put forward within the quarter. So I think you are just seeing the output of the strong performance in the quarter.

[Shlomo Rosenbaum:]

Great. Thanks so much.

[Operator:]

And the final question will be from David Chu of Bank of America. Please go ahead.

[David Chu:]

Hi, thank you. So just around margins, I know it’s a bit early to talk about 2018, but based on the breach, the Equifax breach and other developments, is there any reason we shouldn’t expect the 100 basis points of expansion next year.

[Jim Peck:]

Yes so we are not guiding, I don’t think that any specific number. But I will say, as you know we have very strong margins in our business and part of our operating model and objective is to bring in quality revenue that produces or continues to expand our margins. That said, we always as you know like to say that if there are opportunities that are in front of us in any particular quarter that we think could really help us drive growth going forward, we are going to take those. But even with all that said, you know there is no reason to believe that we are going to change from our objective to continue putting on quality revenue that helps to drive margin expansion.

[David Chu:]

Okay, thank you.

[Aaron Hoffman:]

Okay, great. Thanks everyone for joining us. We appreciate that and have a wonderful day, wonderful weekend.

[Operator:]

Ladies and gentlemen, the conference has concluded. Thank you for attending today’s presentation. At this time you may disconnect your lines.