FactSet Research Systems Inc. (NYSE:FDS) Q2 2024 Earnings Call Transcript

FactSet Research Systems Inc. (NYSE:FDS) Q2 2024 Earnings Call Transcript March 21, 2024

FactSet Research Systems Inc. beats earnings expectations. Reported EPS is $4.22, expectations were $3.83. FDS isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by. Welcome to FactSet’s Second Fiscal Quarter 2024 Earnings Call. At this time, all participants are on a listen-only mode. After the speakers’ presentation, there’ll be a question-and-answer session. [Operator Instructions] I would like to hand the conference over to speaker today, Ali van Nes. Please go ahead.

Ali van Nes: Thank you, and good morning, everyone. Welcome to FactSet’s second fiscal quarter 2024 earnings call. Before we begin, the slides we reference during this presentation can be found through the webcast on the Investor Relations section of our website at factset.com. A replay of today’s call will be available on our website. After our prepared remarks, we will open the call to questions from investors. The call is scheduled to last for one hour. To be fair to everyone, please limit yourself to one question. You may reenter the queue for additional follow-up questions, which we will take if time permits. 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, reconciliations to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued earlier today. Joining me today are Phil Snow, Chief Executive Officer; and Linda Huber, Chief Financial Officer. We will also be joined by Helen Shan, Chief Revenue Officer, for the Q&A portion of today’s call. I will now turn the discussion over to Phil Snow.

Philip Snow: Thank you, Ali, and good morning, everyone. Thanks for joining us today. In the second quarter, we grew organic ASV plus professional services by 5.4% year-over-year, delivering adjusted diluted EPS of $4.22 and an adjusted operating margin of 38.3%. Given challenging industry factors and continued market uncertainty, our results this quarter were mixed. You may recall that we anticipated the softer top-line growth from our December call. We ended this quarter with more than 8,000 clients, adding 75 net new logos, and our user count was 206,478, down 605 in the quarter, mostly due to consolidation following UBS’ acquisition of Credit Suisse. In addition, please note that the ASV reduction impact of Credit Suisse is not reflected in our second quarter results.

While we cannot share details about ongoing business discussions, our full year guidance continues to assume a conservative view of the Credit Suisse reduction as we indicated last quarter. Overall, ASV retention remained greater than 95% and client retention was 90%. In terms of market conditions, client caution continued to delay purchasing decisions. We saw increased pressure on client headcount as they seek further efficiency gains. As a result, we saw higher erosion this quarter. We had fewer large deals in Q2 and saw a lower impact from our price increase, both of which contributed to a slower growth rate. However, industry cost cutting appears to be stabilizing and we are starting to see pockets of recovery. As we signaled in our December call, anticipation of softer top-line growth drove our own difficult but necessary cost cuts, including headcount reductions during the quarter.

Continued careful expense management will allow us to maintain margins and EPS growth along with investment in new products to drive future performance. Currently, we expect to finish the fiscal year at the lower end of our ASV growth guidance range of 5% to 7%. Turning now to our performance by region. America’s ASV growth decelerated by 200 basis points from the prior quarter to 5.9%, mainly due to a large wealth cancellation, as well as banking erosion and lower price realization. The wealth cancellation resulted from a client’s decision to move a custom non-standard workflow solution in house following a change in its business strategy. In EMEA, ASV growth decelerated 40 basis points to 5%, mainly due to headwinds from lighter institutional asset manager renewals, partially offset by new business acceleration.

In Asia Pacific, ASV growth decelerated 240 basis points to 5.6%. Softer banking expansion coupled with a larger institutional asset manager loss offset wins with asset owners. While new business accelerated modestly across regions, it was offset by greater reductions in both retention and expansion. On the institutional buy side, we saw headwinds across all firm types due to cost cutting and continued headcount reduction. For example, in 2023, passive funds surpassed active funds in total assets under management. As a result, our institutional asset management clients are seeing continued increased fee pressure. To help offset this pressure, we have expanded our capabilities to address users’ needs, including in the front office. Our managed services business is growing as our clients outsource more of their middle office workflows to FactSet.

This helped drive some gains with asset owners. We have invested in our platform to reduce clients’ total cost of ownership, or TCO. Given our ability to help clients do more with less, they are increasing their reliance on us despite fee pressure. As a result, we are investing in managed services given our growth in this area. We are leveraging our strength in the middle office to further power front-office solutions. This quarter, we displaced a front- office incumbent at an asset management in Asia, and we did this by connecting the client’s entire workflow, including both OMS and EMS capabilities. We also won that business on the strength of our open platform. Simultaneously, we are developing GenAI-enhanced tools and copilots for portfolio managers and fundamental research analysts, which we believe will significantly reduce their time to insight.

In dealmakers. We saw a higher erosion in banking and lower retention in private equity and venture capital. However, corporates are starting to see good momentum with investor relations users. At the same time, expectations are high around the effect generative AI will have on our industry. Initial client feedback has been extremely positive on our new GenAI solutions, including FactSet Mercury, a conversational way to generate answers and insights from documents and structured datasets that is in beta release as part of our FactSet Explorer program. We see early signs that large language models, working with our deep repository of well-curated data in our open platform, can power accelerated workflows for our clients. While we perceive that this trend will drive future growth, these initiatives need time to gain commercial momentum.

In banking, our GenAI banker efficiency tools are gaining users. We had more than 200 GenAI meetings with our banking clients in Q2. Beta products in testing with clients include chart creator and investment banking office refresh API, which allows clients to automate cloud model updates. This is our first client-facing off-platform solution for banker automation and we believe it can drive a new revenue stream. Finally, Transcript Assistant, our GenAI-powered chatbot, is in full release as announced last week. Transcript Assistant accelerates analysis of earnings call transcripts with a conversational, interactive interface. Clients have the freedom to ask their own custom questions or choose from a FactSet-provided prompt. User uptake has been strong.

We are now expanding event coverage and comparative analysis in parallel with the FactSet Mercury integration. You can read more about Transcript Assistant in our press release from last week. Turning to wealth. Activity was more subdued this quarter given one large cancellation and no large deals. However, wealth partnerships are creating stronger connections with portfolio and business development workflows, in turn increasing senior executive level client engagement. We have recently driven major changes in the organization to position ourselves for future growth, including moving to our firm-type focus and reducing costs. Given this rapid pace of change, I am extremely proud of how the company has risen to the occasion. This change process may have been challenging in the short run, but has positioned us well for a market upturn.

Finally, I want to highlight our FOCUS client event in Miami at the end of April. This event brings together top thought leaders, industry experts, and key decision makers from the finance and tech sectors. Our theme for 2024 is the revolution of an ecosystem, discussing the potential of artificial intelligence and machine learning. Attendees can expect a thoughtfully-curated agenda with inspiring speakers, educational sessions, and opportunities for meaningful connections. Registration information can be found at focus.factset.com. I’ll now turn it over to Linda to discuss our second quarter performance in more detail.

Linda Huber: Thanks, Phil, and hello to everyone. As you’ve seen from our press release this morning, despite slower ASV growth, we improved margins and EPS in the second quarter. Second quarter organic ASV grew 5.4% while adjusted operating margin improved 130 basis points to 38.3% and adjusted diluted EPS rose 11% to $4.22. I’ll now share some additional details on our fiscal second quarter performance. As Ali noted, a reconciliation of our adjusted metrics to comparable GAAP figures is included at the end of our press release. For the quarter, GAAP revenue increased 6% to $546 million on sales to asset owners, corporates, hedge funds, and private equity and venture capital clients. For our geographic segments, organic revenues grew by 6.5% in the Americas, 4.8% in EMEA, and 6.4% in Asia Pacific.

Turning now to expenses. GAAP operating expenses increased 5% year-over-year to $364 million. This was driven by higher employee expense, net of $7 million decrease to our bonus accrual, as well as by increased intangible asset amortization. Compared to the previous year, GAAP operating margin increased by nearly 50 basis points to 33%. This was due to increased revenues, partially offset by higher personnel expenses, including an approximately $11 million restructuring charge. On an adjusted basis, operating expenses grew 4%. Looking at each of our four major cost buckets in turn, as we’ve frequently discussed, technology continues to be our main area of expense growth. Specifically, technology costs increased 11% year-over-year. Technology costs now represent about 8.4% of revenue, consistent with our medium-term outlook.

In contrast, employee expenses grew only 1% year-over-year, driven by increased compensation expenses, partially offset by the lower bonus accrual. This small increase reflects some of the cost reduction efforts we took during the second quarter. Next, our third-party content costs increased 3% due to higher variable fee expenses. And finally, real estate expenses saw an 8% decrease year-over-year as we took early and significant steps to reduce this expense bucket. We believe we have now rightsized our real estate footprint. As we have mentioned before, thoughtful expense management is positioning the company for future growth while allowing us to continue to invest in technology and strategic initiatives. Turning now to margin. Adjusted operating margin improved by 130 basis points to 38.3%.

This was due to lower personnel expenses, given the lower bonus accrual and higher capitalization benefit, partially offset by higher technology expenses and higher bad debt expense. As always, you’ll find an expense block from revenue to adjusted operating income in the appendix of today’s earnings presentation. As a percentage of revenue, our cost of services was flat year-over-year on a GAAP basis and about 90 points lower on an adjusted basis. And SG&A as a percentage of revenue was 40 basis points lower year-over-year on a GAAP basis. The decrease was due to revenues outpacing the increase in SG&A expenses and lower compensation costs, partially offset by an increase in bad debt expense. SG&A was about 40 basis points lower on an adjusted basis.

Turning now to tax. Our tax rate for the quarter was 16.4% compared to last year’s rate of 16.1%. This increase was due to higher taxable income, offset by higher stock option exercises and higher foreign credits, which reduced the tax rate. Turning now to EPS. GAAP EPS increased 8% to $3.65 this quarter versus $3.38 in the prior year period. This was driven by higher revenues and margin expansion, partly offset by a higher tax rate. On an adjusted basis, EPS increased 11.1% to $4.22, also driven by revenue growth and margin expansion, partially offset by a higher tax rate. Adjusted EBITDA increased $218 million, up 9.2% year-over-year due to higher net income, driven primarily by an increase in operating income, excluding the impact of depreciation and amortization and the impact of non-recurring non-cash expenses.

Free cash flow, which we define as cash generated from operations less capital spending, was $122 million for the quarter, a decrease of 17% over the same period last year. This was due to the timing of remitted payroll taxes related to employee stock compensation and higher income taxes payable, which are seasonally higher in the second quarter. Turning to share repurchases. For the quarter, we repurchased 113,050 shares for $52.3 million at an average share price of $462.23. Our fiscal 2024 share repurchase plan targets $250 million of repurchases. We have $188 million remaining for repurchases in the second-half of fiscal 2024. We remain disciplined in our buyback program and committed to returning long-term value to our shareholders. Combining our dividends and share repurchases, we returned $434.1 million to our shareholders over the last 12-months.

And regarding leverage, during the second quarter, we paid down $62.5 million of our outstanding term loan, which brings our gross leverage down to 1.8 times. This is consistent with our plan to repay that term loan in full by the second quarter of fiscal 2025. Finally, as Phil mentioned, we’ve carefully managed our cost base while continuing to invest in GenAI and other strategic initiatives. We believe that we are well positioned for growth as the markets pick up. We are now ready for your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Faiza Alwy with Deutsche Bank. Your line is open.

Faiza Alwy: Yes, hi. Good morning. So I wanted to talk a little bit about the pipeline and what you’re seeing from here. Phil, I think you said that industry cost cutting appears to be stabilizing, and you’re seeing some pockets of recovery. So maybe just start there and give us a sense of what you’re hearing from your clients?

Philip Snow: Yes. Well, from — hey Faiza, yes, from my conversations with clients, it feels a way more constructive in the last three months than it did towards the last three months of last year. So just being out there with the clients talking to salespeople, it definitely feels like activity is picking up. We are seeing, I think, increased pressure on headcount of clients, in particular. But I would say our more enterprise solutions and our platform solutions is showing some good strength there. So I’m cautiously optimistic here that as we move into the second-half, we’ll probably have a weaker Q3, but I’m cautiously optimistic that Q4 will be stronger than last year. I’m going to turn it over to Helen now for a bit more detail.

Helen Shan: Sure. Thanks for your question. Yes, we’re seeing sort of a health — we are seeing a healthier pipeline in H2 versus H1. We’re seeing higher deal volume. I would say that the pipeline is more along the lines of last year, if not a little bit stronger. The makeup is about half of it is coming from buy side, 20% in the dealmakers or banking, 20% wealth and the rest in partnerships. So we’re seeing the pipeline accelerate since the beginning of the calendar year, really the strength in data solutions, in the middle office and in Quant Solutions. But as Phil was just saying, timing on decisions is a little bit difficult to gauge. And more of our pipeline, I would say, are in the later stages of the funnel, which gives us more confidence, but many of them are really more into the fourth quarter.

Faiza Alwy: Great. Thank you.

Operator: One moment for our next question.

Helen Shan: You’re welcome.

Operator: Our next question comes from Manav Patnaik with Barclays. Your line is open.

Manav Patnaik: Yes, thank you. Phil, so I just wanted to touch on the managed services comments you made, I think. If you could just help elaborate exactly what you were referring to in investing more in the managed services? What percentage of your revenues today is managed services? And is it fair to assume that’s a lower-margin business? Just I was hoping you could elaborate more on that.

Philip Snow: Sure, Manav. Thanks for the question. You’re right. It is a much smaller piece of our business, and we’re really stressing sort of the subscription part of FactSet. I think that’s who we are as a company and how we continue. But what we have observed is as we’ve become more of an enterprise solution for clients, and we’re delivering more mission-critical services for them, particularly with analytics and off-platform that you need sort of another level there to sort of help the clients. So we do think that there’s a good opportunity for clients to outsource solutions to FactSet and leave it up to us to do what we do best. And a good example of that was last — at the end of last year, we had that very large outsourced performance deal with one of our clients, where we really invested heavily in this group to build that out.

And I think we’re seeing continued momentum and interest in this. So it’s a piece of our business that we think is necessary. You’re right, it is typically, I think, a lower-margin business. But we think overall, combined with the solutions that we’re including with it, which is the main part of the sale, that it’s a good opportunity for us.

Operator: Thank you. One moment for our next question. Our next question comes from Kelsey Zhu with Autonomous. Your line is open.

Kelsey Zhu: Hi, good morning. Thanks for taking my question. I was wondering if you can share a little bit more color on how much pricing, cross-selling and new logo drove Q2 ASP growth, and how much do you expect them to drive growth for the full-year?

Helen Shan: Hey, it’s Helen. Thanks for that question. So this year’s growth in the price increase on the Americas, it was $25 million this quarter, which is in line with FY ‘22, although lower than last year as we were able to take advantage of some of the inflation and CPI on last year’s situation. But the overall price increase continues to provide that uplift. I would say the price realization against our rate card is about flat to last year. It does vary across firm types, plus or minus a few percentage points. As noted before, our price realization in new business is lower than last year, I think, reflecting that more competitive environment. But we’ve actually seen total new business ASV increase. So we’ve had higher new logos, although average — a bit smaller on the average price. So I do think that it’s continuing to provide that sort of same growth rate that we’ve seen in the past.

Operator: Thank you. One moment for our next question. Our next question comes from Heather Balsky with Bank of America. Your line is open.

Heather Balsky: Hi. Thank you for taking my question. I was hoping you could talk about your expense cadence for the rest of the year. You had really strong margins this quarter. So just curious, your expectations around OpEx for the back half, and was there any timing shift from 2Q into the back half?