FactSet Research Systems Inc. (NYSE:FDS) Q2 2023 Earnings Call Transcript

FactSet Research Systems Inc. (NYSE:FDS) Q2 2023 Earnings Call Transcript March 23, 2023

Operator: Good day and thank you for standing by and welcome to the FactSet Q2 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Kendra Brown, Head of Investor Relations. Please go ahead.

Kendra Brown: Thank you and good morning, everyone. Welcome to FactSet’s second fiscal quarter 2023 earnings call. Before we begin, I would like to point out that the slides we will reference during this presentation can be accessed via the webcast and are currently available on the Investor Relations section of our website at factset.com. 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 question plus one follow-up. Before we discuss our results, I encourage all listeners to review the legal notice on slide two, 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 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.

Philip Snow: Thank you, Kendra, and good morning, everyone. Thanks for joining us today. I’m pleased to share our second quarter and first half results. Our Organic ASV plus Professional Services growth year-over-year accelerated to 9.1%, driven by a healthy expansion among existing clients and the successful execution by our sales team of our price increase in the Americas. We saw several large wins this quarter outpacing last year and allowing us to capture more of the addressable market. Our second fiscal quarter performance resulted in adjusted diluted EPS of $3.80 and an adjusted operating margin of 37% exceeding our guidance and situating us well for the remainder of the fiscal year. Growth this quarter was the strongest amongst banking, asset owners and wealth management clients aided by larger wins across each of these client types.

Acceleration was broad-based with double-digit ASV growth from our banking, corporate and private equity and venture capital clients and our investments in Content & Technology supported retention and expansion. We saw our core workstation drive follow-on opportunities for feeds and digital platforms and wealth and increased transactional revenue and demand for content from asset owners. In the first half, our end markets remained largely supportive. However, we are not immune to market volatility. As interest rates rise and macroeconomic conditions remain uncertain, we’re beginning to see a more challenging environment for our clients. This includes reductions in AUM, constrained budgets and headcount rightsizing after increased pandemic hiring.

We’re also monitoring the recent instability across the banking sector, which accounts for 17% of our ASV. In this regard, there are several key factors to keep in mind. First, FactSet is not materially exposed to commercial banking. Second, no one single client represents more than 3% of our ASV. And finally, our multi-year enterprise contracts of our protections that includes seat minimums and longer cancellation notification windows. Given the evolving market dynamics, particularly in banking, we feel it is prudent to take a conservative view on the second half of the fiscal year. As such, we expect continued ASV growth, but with modest deceleration in the second half. We are therefore updating our guidance for fiscal 2023 to reflect organic ASV growth of $145 million to a $175 million, inclusive of CUSIP Global Services, which becomes an organic part of our business in the third quarter.

At the midpoint, this is a $15 million reduction in core business ASV growth. We expect two-thirds of this reduction to come from the challenging conditions facing the banking sector and the remaining one-third is expected to come from lengthening sales cycles and constrained budgets for other firm types. This reduction in ASV will be offset by the addition of $10 million of ASV growth from CGS. Together, these changes represent 8% growth at the midpoint in-line with our medium term outlook. To preserve EPS, we will continue to drive disciplined expense management. As a result, we expect adjusted operating margin of 34% to 35%, as previously communicated. We maintain a long-term view of our business and are steadfast in our commitment to investing for growth and we will speak more about CGS and guidance later in the call.

The demand for data and technology is increasing and we are a proven trusted partner for our clients for their digital transformations. In the second fiscal quarter, we remained focused on building the leading open content and analytics platform and several large deals reinforced our conviction regarding this strategy. First, within Research & Advisory, we were selected as the primary market data provider for BMO’s Wealth Management division. This was a key contributor to almost 9% workstation growth year-over-year. Our on-going investments in our digital platform and content refinery also resulted in wins across banking. The most notable was a seven-figure deal for a global bank sell-side research department, which included workstations and data feeds.

Across the sell-side, we are meeting the needs of flexible integrated solutions, including feeds, APIs, CRM integrations and banker productivity tools. In Content & Technology solutions, we won a major real time deal to provide our market data-as-a-service offering to a premier asset management client. This solution will replace its legacy on-premise infrastructure. Our ability to augment enterprise platform deployments with consistent data is accelerating growth and expanding our share of wallet for Content & Technology solutions. Finally, within Analytics & Trading, investment in our portfolio lifecycle suite has increased cross-sell opportunities with active asset managers and asset owners. Within the middle office, growth accelerated in our core analytics offering, which includes Portfolio Analytics, Quantitative Solutions, Fixed-income and Reporting.

We also see increased buy-side demand for outsourced performance and risk solutions, consistent with the trend toward investment firms outsourcing middle office functions. Our open platform and enterprise solutions have positioned us well to capitalize on this with several other opportunities in our pipeline. As we celebrate the first anniversary of the acquisition of CUSIP Global Services, I’d like to congratulate the team on a job well done. CGS has exceeded expectations with ASV growth of 8% since the acquisition. CGS’s Core Securities Identification capabilities align well with FactSet’s data management strategy. And with the integration now complete, we are focused on growth across asset classes, geographies and capabilities. We are working on expanding into loan data and private companies.

For more than 50 years, CGS has provided mission-critical solutions to the front, middle and back-office. This work continues and in close partnership with the American Bankers Association we will continue to innovate. Turning to performance across our regions. Organic ASV growth in the Americas accelerated year-over-year to 9.3% driven by strength in Analytics & Trading and Content & Technology solutions and the execution of our price increase. Our Americas price increase delivered $30.7 million in ASV, up $10.6 million from last year. In addition, the region benefited from improved expansion with banking, wealth management and asset management clients. We also had strong sales of middle office solutions. While new business decelerated overall for the quarter, we saw strength in new logos from asset owners.

In Asia-Pacific, we delivered Organic ASV growth of 10.8%, performance was driven by research with improved expansion and retention in banking. Expansion also improved among asset managers and asset owners, although this was partially offset by client cancellations. Given the recent changes in COVID policy across Asia, we are starting to see improvement in the pipeline. However, we expect a light effect as the market normalizes. Finally in EMEA, Organic ASV growth accelerated to 8.1%. Acceleration was driven by Analytics & Trading, where we saw an improvement in expansion and retention among asset owners. Improved retention among private equity and venture capital firms and hedge funds also contributed to growth. However, we also experienced headwinds as the major markets in the region remain under cost pressure and the United Kingdom begins to see an adverse impact from Brexit.

In summary, I’m pleased with our first half performance. We’re confident in our ability to meet our medium term outlook, despite marketing conditions, and as we head into the second half, we have a solid pipeline, driven by our open platform, connected content and market-leading workflow solutions. And with more than 40 years of growth, FactSet, has a proven history of successfully navigating market volatility. Our greatest asset is our people and I’d like to wrap-up by recognizing their diligence and commitment to our strategic priorities. We were honored to be named one of Glassdoor’s Best Places to Work in 2023 and I want to thank all FactSetters for helping create the culture that made this award possible. At FactSet, we’re committed to growth for our clients, employees, investors and communities.

We recently published our fiscal year 2022 sustainability report themes commitment to action. The report highlights the progress we have made in turning our commitments into action. And I encourage you all to take a look. I’ll now turn it over to Linda to discuss our second fiscal quarter performance in more detail.

Linda Huber: Thank you, Phil, and hello to everyone on the call. As you’ve seen from our press release this morning, we’re pleased to report continued high single-digit organic ASV growth and double-digit growth of revenue and adjusted EPS year-over-year. I will now share additional details on our second quarter performance. Consistent with our definition of organic revenues in ASV, we will exclude any revenue in ASV associated with CUSIP Global Services when reporting organic metrics. Given the first anniversary of the CGS acquisition on March 1st, 2023, CGS will be included in the organic results of FactSet as a component of our CTS business starting in the third fiscal quarter of 2023. 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 9.1% year-over-year and acceleration over the last quarter and a solid finish for our first half. Our performance reflects the strength of our recurring sales model and disciplined execution by our sales team as our clients look to technology and data to drive alpha. We saw improved retention and expansion among existing clients. Price realization also continues to improve as we executed a higher price increase over a larger client base. GAAP revenue increased by 19.5% to $515 million for the second quarter. Organic revenue, which excludes any impact from acquisitions and dispositions over the last 12 months and foreign exchange increased 8.9% to $470 million. Growth was driven primarily by CGS and our Analytics & Trading and Content & Technology solutions.

For our geographic segments, on an organic basis, revenue growth for the Americas was 8.2%, benefiting from increases in Content & Technology solutions and Analytics & Trading. EMEA revenue also grew at 8.2%, primarily due to growth in Analytics & Trading. And finally, Asia Pacific revenue growth increased 15.3% due to increases in Research & Advisory and Content & Technology solutions. GAAP operating expenses grew 12.4% in the second quarter to $346 million. And I’ll now detail the drivers based on our primary cost buckets. First, people, our expenses grew by 10% year-over-year in the second quarter, primarily due to increased salary and bonus expenses for existing employees. As a percentage of revenue, this was 350 basis points lower year-over-year, driven by slower salary growth as a percentage of revenue, higher labor capitalization and FX benefit.

We saw headcount increase by 10.3% year-over-year, with two-thirds of these new positions located in our Centers of Excellence. And as a reminder, more than 66% of our employees are located in our Centers of Excellence. Next, facilities expense decreased by 7% year-over-year due to our reduced real estate footprint lapping of the previous year’s impairment charge of $10 million and FX benefit. As a percentage of revenue, this was 360 basis points lower year-over-year. As we continue our intense focus on cost management, we expect to take another real estate charge of approximately $15 million to $20 million later this fiscal year. Moving on, technology expenses increased by 27%, driven by increased cloud spend, third party software costs and higher amortization of internal use software.

As a percentage of revenue growth was 50 basis points higher year-over-year due to higher capitalization of internal use software. As we explained during last year’s Investor Day, we anticipate technology costs being 8.5% to 9% of revenue over the medium term. Technology expenses will likely continue to increase as we invest for growth. And finally, third party content costs increased by 5% year-over-year. Our team is doing an excellent job of controlling third party data costs despite inflationary pressure. As a percentage of revenue growth in third party content costs was 70 basis points lower year-over-year. And now turning to the margin front. Our GAAP operating margin increased by 430 basis points to 32.9% compared to the previous year.

Our adjusted operating margin improved by 330 basis points to 37%. Margin expansion resulted from higher revenue, lower personnel costs as a percentage of revenue. The lapping of the prior year’s impairment charge and lower content and facilities costs. These savings were slightly offset by higher technology costs and expenses related to CGS. As a percentage of revenue. Our impairment expense was 230 basis points lower than last year’s on a GAAP basis. You’ll 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 50 basis points higher than last year’s on a GAAP basis, largely as a result of increased amortization of intangible assets expenses related to CGS and technology costs.

This was partially offset by lower personnel costs as a percentage of revenue. On an adjusted basis, it was 180 basis points lower due to lower personnel costs as a percentage of revenue, partially offset by expenses related to CGS and higher technology costs. And finally, on a GAAP basis, SG&A was 245 basis points lower year-over-year as a percentage of revenue and 150 basis points lower on an adjusted basis. This was primarily due to decreases in facilities expense and professional services. This was partially offset by an increase in T&E as our teams resumed essential travels. Turning now to tax. Our tax rate for the quarter was 16.1%, a 6.2% increase compared to last year’s rate of 9.9%. The higher Q2 tax rate is due to higher pre-tax income and lower stock option exercise.

Going forward, it’s important to note that we expect more volatility in our tax rate. One driver will be foreign tax. In April, the UK statutory rate will increase from 19% to 25%, increasing FactSet’s foreign effective tax rate and reducing the tax benefit of foreign income. Stock option exercise will also fluctuate with our stock price generally, resulting in lower tax rate when the stock price is higher and higher tax rate when the price is lower. Also, as we finalize our tax returns for prior years, we have the potential for one -time charges, which could also be helpful. Even with this variability and a higher tax rate for the second quarter, we expect to end fiscal 2023 with an effective tax rate of 13.5% to 14.5%. GAAP EPS increased 19% to $3.38 this quarter versus $2.84 in the prior year.

Adjusted diluted EPS grew 16.2% to $3.80. Both EPS figures were driven by higher revenue and margin expansion, partially offset by increased interest expense and the higher tax rate. Also of note, Q2 EBITDA increased to $200 million, up 45.4% year-over -year due to higher operating income. And finally, free cash flow, which we define as cash generated from operations less capital spending was $147 million for the quarter, an increase of 34% over the same period last year. This was due to higher net income, partially offset by increased capitalization costs from internal use software. We would note that strong free cash flow continues to be an attractive feature of FactSet’s business model. Our ASV retention for the second quarter remained greater than 95%.

We grew our total number of clients by 558 compared to the prior year, driven by corporate and wealth clients and channel partners. Our client retention remains at 92% year-over-year, demonstrating excellent execution by our sales and client support teams. Moving on to our balance sheet, during the second quarter, we completed another $125 million prepayment of the three-year term loan for the CGS acquisition. This was our fourth prepayment since the start of the loan. This brought our gross leverage ratio down to 2.4 times from 3.9 times level when we initially financed the CGS acquisition. This is well within our 2.5 times to 2 times gross leverage target and appropriate for our investment grade rating. Given that we are within our target range, we will slow the pace of repayment of the remaining 500 million outstanding balance of the term loan, which matures in 2025.

Also, given our reduced leverage levels, we intend to resume share repurchases for the remainder of fiscal 2023. We currently have $181.3 million available for share repurchase under the company’s existing authorization. We plan to allocate this amount equally in the third and fourth fiscal quarters. While bringing our repurchases back to previous levels will take time. We’re focused on returning capital to shareholders. We will provide updates on our share repurchase program in the coming months. As Phil stated earlier, given our reduced core ASV outlook and the inclusion of CUSIP Global Services as part of our organic results, we are updating our guidance for fiscal 2023. We expect organic ASV growth of $145 million to $175 million, which is a $15 million reduction in core ASV growth at the midpoint.

The decline is offset by the $10 million addition of CUSIP and remains within our medium term outlook of 8% to 9% organic ASV growth. Given the headwinds to ASV and lag timing of ASV in the first fiscal quarter, we expect revenue for fiscal 2023 to be in the range of $2.08 billion to $2.1 billion. At the midpoint, revenue growth is expected to be about 13%, a deceleration of 95 basis points from our previously issued guidance. Despite a slightly softer top line, we are confident that our disciplined expense management will allow us to protect margins and preserve EPS. Consistent with our downturn playbook, areas of focus include ongoing real estate rightsizing, rationalization of third party content costs and limiting hiring to essential positions.

Based on forecasted performance, we also expect our year-end bonus pool to be in the range of $100 million to $105 million, roughly $10 million less than last year, which will provide an additional margin benefit. As a result of these measures, we are maintaining adjusted margin guidance of 34% to 35%, consistent with our Investor Day commitment of 50 basis points to 75 basis points of adjusted margin expansion on average per year. And finally, given the strength of our adjusted operating margin and revenue growth, we expect adjusted EPS of $14.50 to $14.90 for fiscal 2023 as previously communicated. Despite the uncertain environment, we remain confident regarding long-term growth. We have a diverse pipeline and are seeing higher retention, better expansion, improved price realization and increased demand for our products.

In addition, our enterprise contracts and diverse end markets provide us with some downside protection in a turbulent market. As a result, we remain committed to our medium term outlook and are positioned well for the future. And with that, we’re now ready for your questions. Operator?

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Q&A Session

Operator: And thank you. And our first question comes from Manav Patnaik from Barclays. Your line is now open.

Brendan Popson: Good morning. This is Brendan on for Manav. Just want to ask on, you know, the ASV — obviously not — not entirely unexpected with everything going on. I appreciate the disclosures there on — on where it’s coming from. I want to ask you — you talked about two-thirds of being from banking. You know would have expected maybe, maybe some of it’s coming from venture capital to, if you guys walk through where exactly you expect that impact to be. And maybe it’s just — it’s venture capital just such a small part of ASV doesn’t matter. But if you could quantify that for us too, that would — that would be great.

Helen Shan: Sure. Hi, this is Helen Shan. I’ll take that — that question. So the end markets did begin to soften a bit at the beginning of the calendar year and obviously more volatile in the last few weeks. And as we said, two-thirds comes, we think, from banking and the third from the other types. And so we did plan for lower growth in banking after such strong years of growth post the pandemic. And actually the first quarter was continued to be strong, but we did see some greater erosion in Q2 in part due to layoffs. And so that kind of got us to our number there of that two-thirds. PVC, we’ve not seen that. In fact, we’ve continued to see double-digit growth there. And so we don’t feel that, that’s going to be as big a factor.

And it is, as you noted, somewhat relatively small. But for us, we’ll have a lot to say more when we can see what happens in the hiring classes in in the fourth quarter. So that’s really the driver of the — of the banking piece. The rest comes from really just changes in client behaviour that we’re — we’re seeing as Linda and Phil talked about earlier.

Brendan Popson: Okay. And then just one follow-up pivoting over to two margin. Obviously, a really strong performance in the first half. And I know that second half is typically seasonally worse, but it’s still, the number you guys have there still feels a little conservative, even if — even if ASV comes in a little lower. Is there — is there something to call out? I mean, it sounds like maybe more real estate charges are coming in. I mean, it seems like it feels like the 30 even 35 seems pretty beatable. But just — if I’m missing something, just let me know.

Linda Huber: Brendan, it’s Linda. And we appreciate your optimism on the margin front. A couple of things going on. We see ASV growth slowing primarily because we’re now, excuse me, lapping the CUSIP acquisition. So growth, which had been as strong as 19.5%, will now come down toward 8%. And we see expense growth continuing at about 11% in the back half of the year. So those two things will combine to give us some margin compression. In the first half, we’ve had adjusted operating margin of about 37.6% and we do like our guidance of 34% to 35%. So if you do the math, you can see that adjusted operating margin will be closer to the zip code of 32% as we get to the back half of the year, we think. But we do hope that continued expense management will help us.

The biggest piece that we’re looking at here, as we said in the script, is potentially reducing our real estate footprint by another $15 million to $20 million as we get closer to the end of the year. Now that given the length of the leases that we have, provides another call it $3 million to $4 million back into the P&L for next year. And in total last year we did $62 million of real estate rightsizing. So with this, we’ll be approaching $80 million in real estate rightsizing. So we think we’ve handled that quite well. Otherwise, we just keep our eyes on our downturn playbook. And we’re — we’re managing all of this pretty closely. So hope that helps.