Equifax Inc. (EFX) Earnings Call Transcript & Summary

Good morning, everybody. I'm Andrew Steinerman of JPMorgan. I cover business information services here. Alex Hess is in the audience, she's my research associate. Stephanie is on the room next door, she's hosting the business services track. This is the information services track. This is Equifax. On your way out, you could grab one of our information services primers here at the back could also grab a sticky pad. With us today is CFO, John Gamble; IR, Trevor Burns; and Sam McKinstry. It's going to be 30 minutes in total. I'm going to ask questions and leave room for your questions as well.

Awesome. Thanks for having us.

My pleasure.

We appreciate it.

As you know, it wouldn't be the Ultimate Services Investor Conference without you.

Well, thank you so much. Yes.

A lot of things that are on people's minds, investors' minds is the U.S. consumer. So just to start out by telling us, what shape do you think the U.S. consumer is in right now as it might pertain to credit applications that affects your business. And if you can make a comment across the various asset classes, card, P loan, auto, et cetera.

Sure. So I think as we talked about through the end of the third quarter, right, the consumer continues to be relatively strong, right? And I think what we're seeing is certainly in the prime segment. And as a reminder, the prime segment relative to 3, 4 years ago, the percentage of consumers that are prime are probably more like 80% to 81% versus closer to 75%, if you look back 3 or 4 years. So the prime segment is larger as a percentage of the total, and that segment seems to be relatively healthy, right? We are starting to see some increase in delinquencies. If you take a look at auto, delinquencies, 30- to 60-day delinquencies are probably up above where they were in the pre-pandemic period slightly. Card is increasing, but not really quite to pre-pandemic levels. And so generally speaking, you're seeing some delinquency increases, but it's primarily concentrated in subprime. And primarily concentrated in subprime, we think, as you correlate to people that happen to have lower income levels. So this is not a surprise. But this trend appears to be continuing. We talked about this a little bit in July. We said we're starting to see it. It continued to happen as we went through September. And I'd say continued to happen somewhat in October. Although in October, there was a little bit of a plateauing in certain classes, maybe in auto and others, right, where we're seeing a little bit of a plateauing in the level of delinquency increases. Now that's not unusual, but seasonally you tend to see that each year. But I think the good news is we did see it. So I'd say, overall, the consumer still seems constructive overall, especially in prime, relatively strong, but we are starting to see weakening. Mostly in subprime, we are seeing delinquencies increase. The area where obviously delinquencies are incredibly low and at historic lows are in mortgage, right? In mortgage, the level of delinquencies and the strength of consumers in the mortgage market is very, very strong.

When you look at your business overall, how much is, let's call it the base revenue, up or down, because of credit application activity versus everything else you do? New products, more spending with customers, new customers, how much does this type of discussion about transaction activity affect the revenue growth trajectory?

So our business is quite diverse now, right? So we're going to have to split this up, right? So -- but the -- I mean if you think about -- almost half of our business is Workforce Solutions, right? And I know we're going to get into this. But in Workforce Solutions, a lot of the growth is driven by activities that we're driving ourselves, right? A lot of it is driven by record growth, but not just current records but, really importantly, historic records, right, so that we're up to approaching 600 million total records on employment and income in the United States, over 145 million current records. So record growth, which allows us to deliver new products that tend to be at higher price points, using more data, drives growth above the markets we serve. We're substantially increasing penetration. And obviously, we have very, very good price leverage because it's such a unique asset. And that's why you've seen in Workforce Solutions, we've dramatically outgrown the markets that we serve, really substantially. Even in mortgage, right? Where mortgage market is obviously down substantially, down over 55% in the third quarter on originations, we outperformed that market by almost 30 points because of these areas I'm talking about. So we outperformed significantly in Workforce Solutions. In USIS, we outperformed as well, but not nearly to the same degree, right? And same would be true in international. And there, I'd probably refer more back to kind of our long-term model, right? If we're talking about trying to grow our USIS business and our international business in that 6% to 8%, 7% to 9% range that we talked about, 200 to 300 basis points of that is really driven by market growth. And the rest of that is driven by 2 primary drivers, right? The biggest one being new product, which can drive 200 to 300 basis points of growth. Also price, right, which we get some price every year. And then also some new segments we're growing into. So we're getting some outsized growth, for example, against those markets with growth in identity and fraud. And depending on the country that you're talking about, some of those percentages change a little bit, but generally speaking, that's the way to think about our business.

Okay. Great. With that in mind, is it too early to ask about 2023? Like how are you set up heading into next year, recognizing the uncertainty that you already discussed.

Absolutely. So we didn't really give guidance for 2023, but I think we can talk a little bit about the way we see underlying markets, and that might be somewhat helpful to investors. So again, just starting with U.S. mortgage. As we've seen this year, forecasting the mortgage market is extremely difficult, especially if you go out more than a quarter. So what we do, quite honestly, is we take a look at the 3 big agencies that tend to put out forecast. We look at MBA, we look at Fannie and we look at Freddie. Right now, for 2023 originations, and think origination units, on average I'd say those 3 services are talking about things down something over 20%, with Fannie and Freddie down over 25%. And we don't think that's an unreasonable place to think about the mortgage market as we get into next year. We did talk about the first quarter and somewhat the first half on our earnings call. And that's just because, as you remember, in 2022, the mortgage market was relatively strong still in the first quarter. So we're going to have a pretty substantial wraparound impact as we get into the first quarter, and we would expect the mortgage market again to be down, let's say, on the order of 50% or more. I'm talking about market overall, in the first quarter, but improving substantially as we go through the year, right? Better in the second quarter. And obviously, with the second half of the year being so weak in 2022, looking much, much better against the second half. If we look at nonmortgage, and I'm going to do nonmortgage together, both U.S. and international, we -- as we talked about in the third quarter call, we haven't really seen substantial weakening in many of the markets we serve as we went through the third quarter. Things still continue to be relatively constructive. We did, however, talk about we saw some weakening in the U.S. in our marketing services business and off-line, right? And that was -- this was the first quarter in marketing in our offline business that we actually saw declines. And so that was new information for us. It's -- part of it was year-over-year because we had strength in the second half of last year before coming off of the pandemic, but it is -- but it was a decline and it was something we weren't expecting. So that we saw some weakness there. The other place we saw a little weakness, and obviously we dramatically outgrew it because our Talent Solutions business grew organically in the order of 50%, but we actually saw some weakening in hiring in the U.S., which impacted our Talent Solutions business in USIS. And so those 2 things are probably indications of some weakening in the market that we saw in the third quarter, that we talked about continuing certainly through the fourth quarter. If we think about 2023, we would expect to see weakening in our nonmortgage markets economies in general really in all of our major markets, whether or not we actually have a recession or not, I know it's still open to debate, but we would certainly expect weakening across the U.S. and weakening in our major markets in the U.K., in Canada, in Australia, probably more substantial in the U.K. Australia seems a little better positioned and Canada maybe in the middle. But that's the way we kind of feel about those markets. The other perspective we want to give people is on some specific line items within Equifax, I know it's difficult for people to forecast. So specifically around interest expense, as we take a look at 2023, when we gave our fourth quarter guidance, we talked about interest expense in the quarter being kind of approaching $60 million. It's probably reasonable to think about our 2023 interest expense being at that run rate, perhaps adjusting up a little bit, depending on your own view of interest expense -- sorry, of interest rates. And just for perspective, right now about 20% of our debt balance is floating rate.

Got it.

Also, if you look at depreciation and amortization, excluding acquisition amortization, 2023, we're expecting to see and the rest of 2022 very substantial activity in transformation deployment and customer migrations, which is outstanding for us and something very exciting that we're looking forward to delivering lots of new product opportunities because of that transformation. However, what that does also mean is that we put more assets in production, so our depreciation grows faster. So as we take a look at 2022 versus 2021, we've indicated our depreciation is going to go up about $20 million. '23 versus 2022, the increase in depreciation is probably twice that high, okay? So that's the way we would think about that. And looking at our tax rate, probably our tax rate going into 2023 is probably going to be up something over 100 basis points versus the level that we're seeing in 2022. So we just thought those would be helpful for people to be aware of.

Right. And you gave the color on how the underlying market is going to do, but I assume you're also maintaining you expect Equifax to do great outperformance to underlying markets?

Absolutely. So if we talk a little bit about it in Workforce Solutions, right, where we've been very significantly outperforming the underlying markets, and we expect that to continue in and really expect to perform very, very well as we go into next year, again, through record growth, new products, pricing. As a reminder, we tend to see nice improvement from 4Q to 1Q in Workforce Solutions, part of it driven by the fact that annual price increases in Workforce Solutions tend to almost universally be in the first quarter. But international, we've been substantially outgrowing the markets that we've been serving. We've had a really strong year in international this year. We feel very good about their performance. We expect them to continue to perform very well as we go through the fourth quarter and into next year. Maybe not growth rates like we saw in the third quarter, that was kind of an unusual quarter for us, but still very, very good growth rates as we go through the rest of the fourth quarter and into next year. And USIS. USIS performance, we also expect them to outperform their markets, right? And the area where we're -- where we've seen nice performance this year is really in nonmortgage online. And there, that performance is good, really consistent with our long-term model. We have had some issues in our off-line business. We talked about that fairly consistently. We do expect to see some recovery in that as we go into next year, maybe not great growth, but some recovery, but we do expect to continue to deliver nice outperformance in USIS nonmortgage as well, just not to the levels we're seeing in, obviously, Workforce Solutions, but probably also not to the levels we're seeing in international.

Right. And could you just help me out with that off-line marketing? Like is there something wrong there, like you need to introduce a new product or something like it? I just don't quite get the dynamic.

Sure, Absolutely. So offline marketing is really -- I'm sorry, our offline business is really in 3 segments: One is we have a header business, right, where we sell -- and that's the business that's been down most significantly. And your description there is correct, right -- so your description is right. There, I think we need new products, right? So we haven't invested in driving new products to strengthen our header, right, to make it more differentiated. We think we have the assets. As we're deploying more and more into fabric, we think we'll be able to deliver those assets together to strengthen that business. And that's a business that tends to sell header into, for example, other companies that are doing identity and fraud validations, that helps them do identity and fraud validations, we think we'll be able to strengthen that as we launch new products moving through '23. That takes a little bit of time. And that's probably the place where it's really more product than anything else. On marketing, we think we saw some weakness in the quarter, and we talked about why. We think that was more market-based. And then we also have a risk business, right, where that risk business is where companies like JPMorgan are doing portfolio reviews when the markets weaken. That tends to be weaker during strong economies. We would expect to see that strengthen to the extent the economy does weaken next year. And we think that business should perform okay.

So you had an Analyst Day about a year ago, you gave 25 targets. When you gave those 25 targets, did they allow room for a U.S. recession along the way? Are those targets still appropriate for '25?

Yes. So the 2025 goals, obviously, a lot has changed since we gave them. But yes, we still believe we have a path to deliver against those, right? Now just as a reminder for everybody, when we gave those '25 goals, we were pretty explicit about the fact that they assumed that we have a U.S. mortgage market that was kind of back to normal. And at the time, the mortgage market was much stronger than normal. And we defined normal as kind of the average level of origination or transaction activity between, say, 2015 and 2019, pre pandemic. And we also had some view on what we would see in '22 and '23 around our nonmortgage growth and our level of NPI or new products vitality index, which we talked about being around 10%. So just talking about revenue to start. What happened is on the very positive side of the ledger, we have substantially outperformed our expectations on new product launches. Our vitality index now is -- was over 14% in the third quarter. We expect 13% for the year. So very strong. And our growth in nonmortgage is much stronger than we expected when we gave that 2025 goal. So that's -- so that's a significant positive. Obviously, the mortgage market, much weaker than we would have expected. I don't think anyone expected the mortgage market to do what it's done here in 2022. And then 2023 being down again to the extent Fannie, Freddie and MBA are correct, also isn't something we would have expected. So we do need to see recovery in the mortgage market as we move toward '25, but not all the way back to the level we talked about last year, right? We don't get -- need to get back to normal, but we do need recovery from the levels we're talking about in 2023. I'm not going to specify a level at this point, but we need some reasonable recovery. And I think with some reasonable recovery in mortgage, which we don't think is hard to expect, and the very strong performance we're delivering in non-mortgage, we still have a path delivering our $7 billion goal in 2025. Delivering that goal on revenue helps us drive margins higher, right? And we talked about over 50% of our improvement in margins of our path to 39% would be driven by that growth rate. So delivering the revenue will help that. And we're still committed and still believe we're going to execute on the savings from transformation, which we said was on the order of a couple of hundred basis points, and that's how we were going to get to our 39% margin. So obviously, the path much different than we would have thought about last year. More difficult clearly because of the weakness we saw in the mortgage market. But to the extent we see recovery in the U.S. economy as we move out of '23, which, again, we don't think hard -- unreasonable to expect, and some recovery in mortgage markets as we move out of 23, then yes, we think we still have a path to that $7 billion of revenue.

In '25.

In '25.

All right. So I just want to repeat one thing you said. I just want to make sure I got it right. So you're still assuming the mortgage market has some reasonable recovery, but it does not have to get back to the average of '25 to -- 2015 to 2019?

That's correct.

Okay. That's very reasonable. And 39% will be reported margins, right? This includes all the reinvestment that you need to continue to be a growth company.

That's the EBITDA -- it's EBITDA margins consistent with the EBITDA margins we disclosed today. No change in method.

Right. Yes. The funny thing is that when you say like half of it will come from our cloud transformation, I was just wondering like aren't you sort of tempted to reinvest part of that cloud savings in growth initiatives? Or is that portion already kind of after reinvestment-type of number?

So I think by definition, the answer to that is yes, right? And we think we have enough, with the variable margins we generate through growth to $7 billion, we have more than enough, we believe, available to invest in new product to continue to drive growth at the level we'd like. The other thing that's happening is we complete cloud transformation is the amount that we have to invest in, let's call it, technology maintenance, right, and the amount we have to invest to actually launch a new product decline, right? So we think what we're going to be is much more efficient because the assets we have are far easier to migrate and to launch new products against. And so as we move -- complete the U.S. transformation principally in 2023, we think that unlocks available, not just expense dollars, but also capital, quite honestly, that should allow us to fund the growth we need to get to that $7 billion. And again, we understand capital has been running a little higher this year. We have invested in the transformation at a higher pace than we talked about starting the year. We still expect 2025 to get to 7.5% of revenue -- sorry, to get the capital spending is about 7.5% of revenue.

I got you. That's perfect. EWS 2 divisions, Verifier Employer Services, or is it Employer Solutions.

Employer Solutions. Employer services. You got it right the first time.

Services, yes, yes. I always call it EWS. How should each of these pieces and how should EWS in total perform on an organic revenue basis during a garden variety recession? And also should the directions of margins be the same as organic revenue growth?

So I don't think we've given an organic growth in recession discussion, right? What we have talked about is that in total for Equifax, right, that we think in the order of 55% of our businesses are either recession-resistant or countercyclical. So we -- and that's substantially higher than it was 10 years ago, right? So we think we're much better positioned to perform better in a recession than we were 10 years ago. The other significant benefit we have is kind of what we talked about at the beginning, per your question on growth drivers, right? The growth drivers that we have in Workforce Solutions, and I know this is where your question was going, but the growth drivers we have in Workforce Solutions relative to the market are just substantially stronger than in the remainder of the, let's call it, the traditional credit business. And because of that, and because Workforce Solutions is now approaching half of our revenue base, that positions us much more strongly to have a much better performance relative to any market we serve, right? So do we -- do we expect to significantly outperform any market we serve even in a recession? We do. Do we expect that the spread between our performance and the underlying market to stay strong in a recession? We do. I'm not going to tell you that it's not going to decline some or grow some, but we do think it's going to stay very, very strong. So we feel good about our ability to operate effectively during a weaker market. Did I answer your question?

I'm not sure actually, John. My question was, do you expect positive organic revenue growth for EWS during garden variety recession? I think your answer is I'm not saying.

I think what I'm saying is we're going to substantially outperform the market. So if you're talking about a market that's declining slightly, overall, then we're going to substantially outperform that. So yes, we should perform well, right? So what we need -- the overlay we need to lay against that is what are you assuming is going to happen in the mortgage market given where we are today, right? So a garden-variety recession in 2023 with a much weaker mortgage market, I'm not going to give specifics, right? But we just need to make sure that when we're talking about as we look forward, we expect to perform very, very well against a recessionary environment. Just the recessionary environment, if we get one next year is in the backdrop of a mortgage market that's probably weaker than it's been -- than it will be this year.

Yes. No, I understand you're making a mortgage caveat. I think that's fair. And how about the other question, if organic revenue growth is positive, if, I'm not saying it will be, if organic revenue growth is positive during garden variety recession, would margins move in the same direction of organic revenue growth, especially knowing that you have a lot of cost savings coming over the next 2 years regardless of the top line?

So we expect -- you we're talking about Workforce Solutions again?

Yes.

Okay. So again, Workforce Solutions, when workforce delivers organic revenue growth in any period, positive or strongly positive, they're in a good position to drive margin enhancement, right? So we feel good about that. We feel good about their ability to deliver above 50% margin. So again, can we come up with an economic environment, we just had one, will they deliver below 50% margins? Sure, okay? But generally speaking, with nice organic revenue growth, they're able to deliver 50% or above margins, which they did in the first half of the year, and we already saw that. So we feel very good about the positioning of the business and the growth opportunities of the business.

Right. You also, on the call, gave a margin for EWS in '23 of 50%. My question is, I assume you had an underlying mortgage assumption, mortgage market assumption when saying you could do that margin for '23. Is that consistent with the mortgage market activity that you now see and articulated earlier in this session?

It is. Absolutely. So we certainly had that view as we made that statement. And again, when you think about -- generally, when you look at Workforce Solutions, they have -- they have a nice uptick. We've been asked, "Gee, that means margins are going to get better in the first quarter." Historically, you've seen that, right? That's a normal pattern. Two big drivers of that across Workforce Solutions, because of the industries they serve and also just historical precedent, price increases tend to occur on January 1, right? So that's a nice tailwind. Plus some of the businesses in employer services have stronger revenue in the first half of the year. I'm not saying -- so those 2 things allow us to drive nice margin accretion early in the year to drive us above that 50%. And then we expect to be able to stay there as we work through the year.

Right. And just remind me again, in Employer Services, if we are in a recession, there's countercyclical elements to the top line, that also helps their margin, right? I know you don't reveal the Employer Services margins, but that's helpful to Employer Services margin?

Absolutely, right? It's principally in unemployment insurance. It can be in some other portions also. We now have a much bigger government business, which is in Verifier, but much bigger than we've had historically. So we think that's also a very positive in a weaker environment. And yes, the way UC works, when companies have overages, right, then they pay for those overages and those overages are delivered at relatively healthy margins.

You talked a lot about record growth. I assume you're assuming high record growth for the coming year, and that's all included in the 50% margins that you're talking about because when you take on record.

Absolutely.

[indiscernible] some investments and those records. My question is now about the other markets that you're excited about, 1099s, pensioners, how long will it take to get critical mass in these adjacent, let's say, earner markets?

It's a multiyear process, right? So what we're excited about is we have now delivered the first significant pension administrator as a record contributor, right? And the analogy I would give to payroll processors is it took us a while to get our first significant payroll processor to join us as a partner. And then it took a little bit of time to get the second significant one. And then what happened is it snowballed, right? Because the industry understood the value of being on The Work number, not just monetarily, royalties, but also because the services they provide to their end customers are enhanced because they're able to provide a free verification service that if they're on The Work number, they can provide, but their peers cannot who are not on The Work Number. And that's why we think we saw the significant snowball of people joining The Work Number because of the benefits, not just financially, but also to their customer base that are provided. So we're excited by delivering the first one. We're having conversations with multiple others. We think as we deliver another, we have a real opportunity to start seeing that pace of addition of pension contributors accelerate. But it takes years. I mean, it's not -- it's not something that happens in a short period of time. 1099, we're further back, right? I mean on the part-time workers or 1099 base workers, as you said, that we're still working on a path to deliver. We'll figure it out, right? And then we do have some. We do get some through our payroll partners, and we continue to work that path to try to expand that record contribution. But we'll continue to make -- we'll find a path there, and I'm confident that we'll be talking about that next year or the year after about how that's accelerating.

So a couple of times in our conversation today, you mentioned the price increases for Verifier on January 1. I didn't ask you about them, you just sort of put it up. Obviously, it sounds like you're pretty confident about your competitive position in EWS. Would you describe EWS' competitive position as strong as ever even though you've attracted some newer competitors and providers in the market?

We think it's very strong, right? So -- and it's really driven by the depth of the record base, right? Given that we have, again, 146 million current records and I think approaching 600 million over 550 million historic records, that allows us to deliver products that deliver a high hit rate on your current income for an individual, because again we're approaching 70% of U.S. nonfarm payroll, but increasingly, historical information on either income and jobs, or just jobs in terms of providing a digital resume, and we can now do that dramatically better than we could just 3 years ago and we think substantially better than any peer. We don't think any peer can do that nearly as effectively as we can. And you're seeing that in the shift in the revenue, right? So the revenue, the percentage of revenue in our non-mortgage segments and verification services that use current and historical or just historical records, is now approaching 60%, right? And you're even seeing it in mortgage, where you're seeing an acceleration in mortgage where we're approaching almost 40% of the transactions we execute -- dollar value transactions we execute include historic records. And we think what that's showing is the value of what we're delivering as we keep making the database deeper keeps getting more valuable. So we know we have competitors. Certainly, we know Experian is a competitor. A great company. They're a company we respect a great deal. We just think in this particular case, we have a very, very strong competitive position.

Absolutely. Let's get questions from the audience. If there's not a question, I'm going to ask my last question. Big opportunity. Okay. So here's my last question. You know we're going to be back here next year?

Yes, we are.

So what are investors not thinking about today that you think a year from now will be important and impactful for the years ahead at Equifax?

So there's probably a lot of things, but -- but as I pick one, right, I mean the -- and maybe this is 2, but.

Go for it.

I'll try. So so much of the focus of the company is around new product innovation. And new product innovation -- and I'm going to bundle in with that data acquisition, right? And both of those things are just dramatically benefited by the technology transformation itself but also by its completion because it allows our people to focus on new product innovation and data acquisition as opposed to transformation, right? And we have to focus on transformation to complete it because it's so critically important. And the transformation itself, the technology benefit we'll have that we think, we'll have for many, many years because we're truly cloud-native, we think that's a differentiator. But what we're going to be talking about as we get through next year is that those people, those outstanding people that are our subject matter experts, that are focused in transformation are now going to get unleashed to spend all their time, hopefully, right, focused on new product and focused on data acquisition to create new products faster. And we think that is a huge leg up in our growth and opportunity for us to really go faster. The other thing that completing transformation is going to let us do is we think we're good at acquisition integration. Once transformation is completed, we think we can be very good at it. And we think that will help us a tremendous amount of being able to integrate companies and data faster so that we can generate products off of that acquired data even more quickly. So we feel good about it. The other thing that we're excited about is we drive revenue growth and margin enhancement is, our cash flow generation is going to accelerate, and that's going to free opportunities for us to not only execute on our acquisition program, which we've said is at the top of our capital priorities, but also to begin talking to you about how we're going to return cash to shareholders, which is an absolute goal. And we'll be able to talk to you a lot more about that as we go through next year.

Excellent. John, Trevor, thank you so much. I appreciate it.

Thank you.

My pleasure.