FactSet Research Systems Inc. (FDS) Earnings Call Transcript & Summary

For those of you who don't know me, my name is Manav Patnaik. I'm Barclays' business and information services analyst. Really appreciate you all being here, but we're very happy to have here with us Linda Huber, who is the CFO of FactSet. I know many of you have seen and met Linda in her many different roles before, but this is the best one, so far, right, Linda? Yes.

Absolutely.

So Linda, just to start, I think FactSet has been around for a long time, but a lot has changed. So for the lack of a better word, let's just say there's a FactSet newco almost. And so just to set the stage, how would you describe to the audience what FactSet is?

Sure. FactSet is a leading or the leading data and analytics provider. And we feature an open platform. We also sell data feeds and a lot of other products with excellent service mainly to support the financial services industry.

Got it. And then just to follow up on that: the way you break out the ASV in your 3 main categories. Can you just remind us of those 3 categories? And how much of -- as a percentage of mix it is?

Sure. So we have 3 different what we call workflows. We do report by geography, but the 3 different workflows -- Research & Advisory is the largest part of the business; followed by the Analytics & Trading business; and then the CTS business, content and technology services part of the business. Wealth would be another part, which is actually part of Research & Advisory, but it splits out. R&A is about 37%. A&T is about 31%. CTS and wealth split the remainder, sort of 15% each, if that adds up correctly.

Got it. And one of the things that's changed over the last couple of years is the growth algorithm. And you guys did a great job of laying that out on the Investor Day, but just again, just what is that new growth algorithm? And how does that break down between price and volume?

Sure. So it's important that everyone understands that FactSet's medium-term goals for the top line would be 8% to 9% growth. And that's a pretty significant change from a historical sort of 5% view that the company had experienced before. So to do that, we're looking at a combination of about 1/3 new logos or new customers for FactSet, 1/3 expansion of existing customers that already use FactSet and 1/3 coming from price. The important thing there is price realization and much better discipline around our pricing bundles or modules to make sure that -- as we deal with price and provide great value for our clients, that we're actually able to realize that price. And we've been doing much better on that journey, lots of thanks to Helen Shan, my predecessor as CFO, who's now Head of Revenue and doing a great job for us.

Got it. And so I want to come back and touch on each of the ASV buckets as well as these growth areas, but first I think, just to set the stage, you've been in your role now just around 2 years, if I got that right?

A little under 2 years.

A little under 2 years. And so perhaps, when you first came in, what was the opportunity that you saw at FactSet that you could bring value to?

Sure. Really saw 3 challenges that could perhaps be addressed and really help the company be much more successful. So the first and pretty typical corporate finance view would be that the capital structure needed to be optimized. So FactSet had no public debt, no public debt rating and in fact had a revolving credit facility when we arrived. So with the CUSIP acquisition, we were able to, I think, bring the capital structure to a more optimized point. That acquisition cost $1.925 billion. We put in place $1 billion of public debt. We did that in February of '22, split evenly $1 billion between a 5-year piece and a 10-year piece. Fortunately, the blended rate on that is 3.25%. Couldn't do that today, so the timing was fortunate. So our capital structure is now an investment-grade capital structure, which is helpful to us should we need to go to the public markets again. So capital structure, I think, in an optimized place. Second challenge was really to get pricing for value correct. And so as I just spoke about, we've actually been able to bring much greater discipline to the pricing effort, kind of get everyone in the sales force on the same page. And so in the second quarter, we talked about our price realization dollar amount was about $31 million, which was $10 million higher than in previous years. So we're making good progress in price realization. That number was for the Americas for the first half of the year. And of course, not every client has pricing changes every single year, but price realization in a much better place. And the third is margin, important that FactSet think about increasing its adjusted operating margin as a way of demonstrating efficient and effective management. So we've talked about 50 to 75 basis points of margin expansion on average per year. This year, we're guiding to 34% to 35% adjusted operating margin. And we're making our way up, perhaps a bit more slowly than some would like, but we are working on getting that margin to a better number.

Got it. So let's go in reverse order to follow up. So on the margin side, I think that was -- one of the complaints, before you joined, with FactSet was why margins are always flattish to even down. So what was it that you changed about the dynamic that's allowing you to commit to this consistent margin expansion every year?

I think we've had a very good focus on our 4 main cost buckets. And part of it is just having a plan and explaining to the organization what we're all trying to shoot for, so I think we've done a pretty good job with that. So we divide the cost buckets into 4, starting with -- the least important is third-party data costs. So those have only gone up 3%, which is really pretty good given the inflationary environment. So that's careful management of data that we rent from others. The second would be real estate. So FactSet is working on a hybrid model. 70% of our employees are working hybrid, so we don't need every square foot of office space that we have had. Last year, we took a charge for $60 million in real estate. And in the second quarter, we talked about, coming this year, we'll take another $15 million to $20 million of real estate charge. So that will total about $80 million of real estate write-downs, which is very important that we have the right amount of office space for the employees that we have. Next comes the technology budget. That one has continued to move up a little bit. We are a technology company. We're investing a lot, but we're largely complete with our cloud journey now. And we've looked at what we're doing. And you need some cloud capability and some on-premises capability. Cloud mostly for customers, but on prem works just fine for our internal usage. So Kate Stepp, our CTO, has helped us lead an effort to save $20 million over 5 years, bringing some things back on premises, so that's a very big help. We expect technology, though, to still be 8% to 9% or 9.5% of revenues. And then our people costs is our biggest cost bucket. We have to watch that, obviously, quite carefully. We have 2/3 of our employees offshore. Last year, we worked hard to make sure we're paying everyone appropriately, particularly the engineers in a really competitive engineering environment, but last year, our bonuses were quite strong. This year might be a little bit more back to normal. So we talked about our bonus pool going from $115 million down to $100 million, to $105 million, on the second quarter call. So that adjusts depending on the type of year that we're having. So close management of all 4 cost buckets and, I think, some really good thinking and careful tracking as to what we're doing with those buckets.

Got it. Just on the bonus payments. Last year, you said you made that extra amount, which is why I think you came in towards the high end of your guidance range versus people expecting you to come above. So I just wanted to give you an opportunity just to level set going forward the margin ranges for this year. And going forward, how do we think about that as in terms of your target setting there?

Yes. We intend to meet our targets. It's possible we could do a little bit better this year in '23. We'll have to see how that goes, how the rest of the year plays out, keeping in mind our fiscal year-end is August 31. So for us, it's coming a little bit more quickly than many companies. So as I said, 34% to 35% adjusted operating margin this year. And we want to get that to 35% to 36% as we exit 2025. And of course, we would hope to do better, but we'll see. Good focus on the margin, though.

Got it. And just sticking on the margins as well. I mean talking about the downturn playbook. I mean you would obviously be the one in control, in charge of maintaining that margin and EPS when that happens, but can you just talk about the flexibility that you have and how that would play out?

Sure. We've already implemented some steps with downturn playbook, making sure T&E, travel is limited to essential travel mainly by the sales teams. So we've worked on that lever. Also as I talked about, we've reduced our real estate footprint, which has been quite helpful. The bonus targets will self-adjust if this year is a little bit less great than last year was. And then there are some other things we can do in terms of looking at staffing and where we have our employees deployed. And we are going to, though, protect our investment pools, which that investment pool is about the same size as last year. We're not going to disclose what that is, but we just finished our first pass of our investment effort and -- a lot of exciting ideas. We sort of run an internal shark tank-like process: 15 great ideas brought to the management team, and we'll see where we decide to invest the money.

Got it. And so then to the second part you had brought up, around pricing and, I guess, connected to margin as well, the new pricing power that you guys are exerting, I guess. That definitely helps the margin, but can you talk about the sustainability of that? Is it just because you have an inflationary environment where you can do that? Or what other factors are playing in there?

Sure. I think the environment helps. FactSet will never be the highest pricer in the sector. We are not the price umbrella, as it's called. There are other companies that do that. And in fact, that provides a great opportunity for FactSet because companies are very cost conscious, and they're looking for ways to be able to reduce their data and analytics spend. FactSet has a service called blueprinting, where we look at the tech stacks of all of our customer companies and look at ways that we can fit in better for those companies, perhaps increasing their spend with FactSet but reducing their tech spend overall. So that's worked out really -- very well, but price realization and the discipline around it is a very important thing. And we think that there's somewhere in the happy medium there in terms of price increases that will work best for FactSet. So that sort of moderate but consistent strategy is one that I've seen work well before, and I think we want to continue on that path.

Got it. And I know the first point you mentioned, that you changed the balance sheet, so we'll get to that a bit later, but I think -- can you talk about the general influence you've had in terms of helping run a public company? And the team that you brought in as well, like the -- I don't want to say revamp, but you have made changes, so can you just talk about the impact that's had on the way the business is running?

Sure. You're very kind, Manav, but no one had appointed me queen of FactSet. And in fact, Phil Snow is an extremely effective and very collaborative CEO. I'd note, interestingly, that FactSet's executive leadership team is half female, which is pretty interesting for this industry, extremely collaborative and very, very effective. And I think we're all doing this together as very much a team sport. I do have a very strong finance team. And obviously everyone is familiar with Kendra Brown, our Head of IR, a 24-year proud FactSetter, but we have great heads of the various finance functions. And we've been able to do really well with the team that we have. Excellent execution, for example, on the CUSIP acquisition, excellent integration, and I think we've done a great job on the balance sheet as well. Tax rate is very effective. So all the factors are really pulling together well, but I think it has much more to do with a great team than just with me.

Got it. Okay, I wanted to focus a bit on the macros.

Sure.

So the first part is going to be kind of the customer environment and then get into a little bit of the data and the AI picture as well, but on the customer environment, can you just give us a sense of your exposures? There's obviously a lot of questions on regional bank, big bank, IB, hedge fund -- but just a sense of what your exposures are, first.

Sure. So if we start with the banking sector in its entirety. That's 17% of our ASV, so not a particularly big number. Most of those numbers -- most of that 17% tends toward the larger global banks, the household names. We have very limited exposure to regional banks, which is helpful, if you think about our main products might be analytics for investment banking and corporate banking analysts and then also wealth products. So regional banks are not a big exposure for us. Our largest client is only 3% of our revenues, so we don't have great concentration. We did do second quarter guidance on March 23, which was 4 days after UBS acquired Credit Suisse and a week after Silicon Valley Bank. So we're happy to see that the pressures on the banking sector have abated to some degree, somewhat normalized. We hope, with the acquisition of First Republic by JPMorgan, that most of that is behind us. We hope. So the issue around that was really extending sales cycles. We saw customers sort of stepping back while all of this was going on, Perfectly normal response, really important to state that the pipelines remained the same. The pipelines are strong; however, just a little bit more hesitance to make those decisions to actually sign contracts. So we've seen that banking pressure abate a bit, quite a bit, but now the focus turns to the U.S. debt ceiling; and the June 1 or thereabouts, what Janet Yellen calls X day, when U.S. government no longer has cash. So we're very hopeful that this resolves in a constructive way. And we'll hope that we get back to the normal pace for our fourth quarter, which is our traditionally strongest revenue quarter, ASV quarter, is the fourth quarter.

Got it. Just to get back on the abating banking pressures. I think, in the last week or so, we saw Morgan Stanley looking to lay off, Citi looking to lay off, so maybe just -- and so part one is just I guess maybe you're not seeing some of that, but the main question is -- I think, before, there was this impression that FactSet was a very head count-focused business, but it isn't that, so if you could just talk about how you will describe the contract structures.

Yes. If I could get rid of one urban myth, it would be that FactSet is completely seat-based. That's absolutely not true. Most of our customers are on 3-year contracts. And those contracts have longer, quite long, 90-day cancellation periods; and floors and ceilings. So those contracts remain in place. We have about 96% recurring revenue base, so it's a very sticky, consistent business, so we're very lucky in that regard. So for investment banking, the main thing for us is what the incoming hiring classes look like. And though cuts have been made in head count at some investment banks, oftentimes, that's pruning in the middle layers. And we will have to see how incoming classes look, but generally those classes would probably be similar in size. You have to recall, during the pandemic, many of these institutions didn't do the normal sort of trimming and pruning that they would have done; and that's being done now. That has less impact on us than what happens with the incoming analyst classes.

Got it. Now the one thing that probably does impact you is big mergers and shutdowns. And I think you said, UBS, CS, neither one of those were your 3% customer or whatever, but can you just talk about how we should think about the pluses and minuses when that eventually happens? I don't believe that's in your guidance but just when that eventually happens.

We've actually thought about that and we did consider that in our guidance change for the second quarter. So if you think about UBS acquiring Credit Suisse -- and my first employer was First Boston, which became Credit Suisse First Boston. So an extraordinarily unfortunate moment in the industry. If you think about where UBS will go with that, this is not decided yet, but one would think UBS wants to keep the wealth managers of Credit Suisse. And that would be an intact customer base. And then secondly, for the investment bankers and others, there are some very strong franchises at Credit Suisse, including the technology group, the health care group, the financial sponsors group, so all of those, I think, would probably continue at pace, which is fine. So that is to say that we don't see that the change would be absolutely that dramatic as that process moves along, but that will probably take a year, so we'll see what happens.

Got it. And then let's shift to the buy-side part of our ASV, which I guess is 83% of the mix, so definitely the biggest. Within that, how much is hedge funds? And is the rest basically long-only asset managers?

Most of it is long-only asset managers. The hedge fund space is still pretty small. And I don't have that exact breakout. About 5% is hedge funds, so mostly long-only asset managers.

Got it. In terms of trying to move from the macro environment that you talked about, into this, what's a hot topic out there now, which is around AI, generative AI specifically, right? Because next year, there's going to be a deep -- fake version of me doing the chat with you out here, so if...

We're going to miss you, Manav.

I'll miss these carpets too.

Our engineers are already working on duplicating your voice.

All right, good, perfect.