Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

That's exactly what we're balancing is, should we show margin improvement, which we could do. All we have to do is dive back the R&D a little bit. If we went to 3 or 4 year road maps instead of 2 year road maps, we save a lot of money and margins would improve. So there's things like that, that we could do that we choose not to do because we are in this race to achieve dominance and preeminence in the decisioning space. So I'm not making promises about margins in the software business. I don't think that we'll drive it deeper into the red. I don't think it's -- I mean we'd like the idea of it's kind of it supporting itself, kind of a 0 margin business for a while. And I think you will see margin improvement, but I want the margin improvement to come from land and expand, from usage increase from filling up the infrastructure as we develop multi-tenant cloud solutions. Initially, we just have a few customers in it, it's more expensive. And then as you fill it up, you get returns to scale, so more of that. So there's a combination of factors that will contribute to improved margins over time. And then finally, I don't know if it's 3 years out or 4 years out. But finally, we will start to dial back the R&D. We won't need to spend as much on product and development. So there's a longer-term path to profitability in the software business. And frankly, if we had to, we could speed that up. It's up to us. It's just -- this is the balance we're striking right now.

Got it. That's fair enough. And then just -- another question on the software business is the importance of partnerships. And I guess I was curious because on the Scores side, the Experian partnership has been pretty close to a home run. Is the Equifax partnership as significant? And maybe before you answer that, if you could just give a little bit of a background on what that partnership entails for the audience?

Yes, absolutely. So Experian, starting with Experian, we are partners and competitors. So we're partners on consumer scores, and it's been a tremendous partnership and we get along really well. On the software side, we're fierce competitors, and we go toe to toe with them on RFPs all the time, and so we're -- because they're in both data and software, we wind up competing with them on the software side. Equifax has -- is much more heavy on the data and proprietary data and outstanding data side of the equation, that's been more of their focus. And not that they don't have software, they clearly do, but they felt that the best way to compete with their competition was to partner with us on the analytics software side so that we could bring a connected solution to our customers, where you have best of the data and the best of the analytics software, and we'll bring it to you in a one-stop shop, if that's what you'd like to do. And so that's the vision for the partnership. It's already being executed in the AML/KYC compliance area. We've got a lot of traction in there. The bigger opportunity is really around what we call Connected Platform, which is Equifax data combined with FICO Decision Management Platform. And we've tuned the Decision Management Platform in this instance to work very well with what Equifax brings. And so we think that is a very big opportunity. It just takes time to get it going. We're in year 2 of getting this thing rolling and it's starting to work.

And just some perspective on time line before you can give us some metrics on how much revenue, et cetera, kind of that partnership is bringing? When you say slow, how many more years do we need here?

Slow is probably the wrong word. It's just that the -- because compliance is happening very fast. But the connected platform, it just -- it's more complicated, so it takes longer. And we're selling it now. I mean we're in the process of selling it now, so it's -- I don't know when we'll be comfortable sharing kind of the data. I don't know that we ever will, maybe we will be, I don't know. But we're still totally coming into a partnership. We think it's a great idea. It's working well.

Got it. And maybe just 1 last 1 before we move to Scores. In terms of just the reporting and reporting metrics, I mean, you've talked about before how you -- that was just the way it was from decades ago. Should we be anticipating some new metrics and reporting changes in the coming fiscal year or maybe soon?

Yes and no. So yes, great question. There's a high-level question there, which is, do we anticipate the 3 SEC reporting segments to change? Is there a different or a better way to present our businesses than that? And I would say no immediate plan to change that. But will we tune that up over time? I think we will, but that's not like a 2021 thing. Other metrics, we're in the process of developing a set of metrics that we will start to share publicly that will show you progress on platform, that will show you progress on cloud. And so we want to make it a little more transparent for you.

Got it. That's helpful. So then maybe just on the Scores business, right? I think first question is the credit peers have given us plenty of updates on what the trends are in mortgage, card, auto, so I don't expect anything different from you there. But perhaps you could just help us understand the different mix you have versus the bureaus, and I'm referring to your last call as B2B performance was slightly below what I think or below what the credit bureaus did, and I think it's because of the card versus mortgage mix, but maybe you can just help us appreciate that nuance.

Yes. I mean at an aggregate level, as the bureaus go, so do we. There's obviously differences in mix at the bureaus, and so we get -- we're on the receiving end of that mix shift. And then we have -- we charge more for certain kinds of scores than for others, like we charge more for a mortgage score than for a credit card score. So if mortgage volumes are up, we probably benefit disproportionately. If they're down, we might get hit a little bit harder because, again, it's a big revenue source for us.

Got it. And then the big question and the big story in Scores, obviously, is the long-term price discrepancy versus value. And so again, maybe just taking a step back, if you could give us when did you come to this realization that now is the time to make up for those lost years and how you perceive that strategy to be?

So the history here is that FICO developed Scores 25 years ago -- 30 years ago and for the first 25 years, didn't change prices. And so I would say we fell behind, well behind the value. At the same time, we, through innovation, we improved the value of the score dramatically. We went through multiple generations of score, we introduced specialized scores for specific purposes. And we brought in open access. Now we have the FICO Resiliency Score, so we have trended scores now. So tremendous addition of value to the score that's being provided to the lender. And so we came to a view that we should get paid more for our IP, and we started to raise prices a few years ago. We tend to do it very incrementally, surgically. Our goal is not to disrupt the system or to jam any of our customers with really big price increases because we have a good thing going here. It works really well, there's a lot of value being provided. And so our feeling is if we pick at that value equation with pricing moves in an incremental way, that will be successful, and we won't disrupt the ecosystem, and that's been pretty good so far. We do think there's a huge gap between what we charge and the value that we provide. We think it's just like enormous. I mean that -- a question for me could be why don't you just triple your prices next week? And the answer is, we're here for the long haul. We're here for the long -- we have these partnerships with these customers. They buy software from us also, and so we behave reasonably. And I would -- and the fact that we haven't had share loss, notwithstanding the price increases, I think, suggest that we're not overdoing it.

Got it. And I think you said you -- maybe there's $14 billion FICO Scores, call it, pulled in the last 12 months, let's say. You've done some -- so I guess the 2-part question: one, how much of that $14 billion is really the addressable scores that you can raise in terms of your specialist pricing strategy; and I guess, how much of that have you already done?

Well, I think we just get better at it and smarter about it every year. So we've addressed certain obvious pockets, like there was a giant discrepancy in mortgage, where the value of the decision was very high, and what we were getting paid for was very low. It remains very low, frankly, relative to the value created. But the way we think about it is every year, we sit down and we say, where are there opportunities where it's not particularly disruptive for us to raise price where we can close that value gap a little bit more? We also think in terms of our cost relative to the bundle because typically, the scores bought along with a credit report and with other things in a package. And so we have a point of view about where we fit in that relative value. And so if we feel like that's low, that's a place where we would go and spend a little more time on price increase.

Got it. And I think there's still a discrepancy, like you said, between the value and the price. So should we anticipate, every year, you guys doing some targeting in some area? Because you've had 3 years in a row, and the question is, will we see another 3 years of some form of special pricing?

Yes. I think you can expect us to review this annually. We review it continuously, but we make the price changes once a year, and I think you can expect that to continue. I think we'll always be -- there's pricing that goes with the use of the score, there's pricing that goes with the volumes, I mean, tiered pricing. So until very recently, we didn't do tiered pricing. Everybody got the exact same price, and that doesn't make sense. I mean big customers should get a better price and small customers can afford to pay low markets and they're not buying many units. And so just being smart about tiered pricing is a big opportunity for us. And so I think that -- yes, I think that you can expect this to go on for some time.

Got it. And just while you're thinking about the pricing, do things like the DOJ lawsuit or the FHFA ruling to maybe consider alternative scores. Do those play a big role or are they just kind of isolated incidents to determine how much price you want to increase?

I would say we think about them independently. So we take DOJ and we take FHFA very seriously. And our goal with the DOJ is to persuade them, as I think we will, that our business practices are exemplary, and there are no issues. We just settled our issues with Transunion over this, and so we're hoping that the DOJ matters resolve quickly. And no, I don't think it has anything to do with price. I mean that was really a question around business practices. And then on FHFA, they have a process in place for us to submit our scores and they'll evaluate them, and we think that will be done on the merits. We have complete confidence in their ability to look at the science and look at the results and make smart decisions about what they're going to do. And again, we're very comfortable with that.

Got it. And besides just being ingrained in kind of the financial systems over the years, I mean, I think you pointed out earlier, 1 of the reasons why FICO is still where it is, obviously, has been the innovation. And I guess my question is just more around -- we've heard of FICO XD. You just put out Ultra FICO. We can talk about the resiliency index. You've mentioned China before. When do those start becoming bigger pieces of the pie because it's still really down to the main FICO Score that gets pulled for the credit lending decisions?

That's a great question, Manav, and different answers for different scores. But I would say that broadly, score adoption takes a long time. In general, score adoption takes a long time. Our experience has been that when we introduce a new generation of FICO Score, it takes 4 years until half of the market adopts that score. So today, that is FICO 9. FICO 9 is half the market -- or over half the market. And there are still people in FICO 8 and earlier versions of FICO -- FICO Scores. And then -- but we have now FICO 10. We have FICO 10, we have FICO 10T, which is the trended data score. And we think over the coming 3 or 4 years, that will be adopted and will become the industry standard replacing FICO 9, and that's kind of a 4-year cycle. Then we have all these specialty scores, as you referenced, XD and Ultra FICO and others. And so again, a different story for each one. So with XD, that was developed in partnership with Equifax on some proprietary data that they have. And there are limits on the data use and that put limits on the expansion of that score, but we think it has a lot of potential. We think it's useful, and we're working on expanding the usage. Ultra FICO, as you know, is very interesting because it's -- it lets a consumer supply consumer information, permissioned information and influence the score. And so it's a big idea, and it gets you to a better decision, a better result when that data is incorporated. We launched it at just the same time that Experian put out their Boost score. And although there are 2 different things, they're related and they achieve some of the same benefits. So the Experian Boost score is a FICO score. And what they've done is they said, let's look at other data, give us permission to look at other data, we'll treat it like a trade line, and we'll recompute your FICO score based on the addition of that incremental data. And for a lot of consumers, that results in a higher FICO score, and they get better pricing, more credit availability. And it's been a big hit. I mean there's no question that Experian Boost has been very successful. Ultra FICO works in a slightly different way. It actually is a separate score. It's not the same -- it's not the FICO score, it's a sister score. And we use demand -- the deposit checking side of the equation, where we look at number of overdrafts and things like that to demonstrate responsibility or not on the part of the consumer. And again, very effective, but not -- it hasn't -- we haven't really pushed it through the market in the same way because Experian has frankly been putting the marketing and muscle behind Boost, understandably. And Ultra FICO is a parallel kind of a score. We still have high hopes for it. I mean I think that in the fullness of time, consumer permission data is a very important part of the equation, and the regulators are going there and the bureaus are going there. And so Ultra FICO is the right kind of a score, it's just a little bit ahead of its time.

Got it. And maybe just in the few minutes that we have left, I wanted to touch on capital allocation, right? I mean it's -- and we know you prefer to do buybacks, and that's what you've done for a long time other than a couple of acquisitions when you first came in. But why not do a few more deals? It sounds like there could be some gaps in the software portfolio you could add in there. It sounds like scores, there's maybe not much to do. But just your thoughts on, I'm sure you have a pipeline, but I guess we still haven't seen a bunch of deals there.

We, as you know, we are very committed to having an efficient balance sheet, and so we have taken virtually all of our free cash flow for many years and applied it to stock buyback, which has been terrific for the shareholders. We like that approach. We like that strategy. Your point is well taken that there are opportunities out there, and you could argue that we're a high multiple stock, and so we should be using our paper for currency to acquire other businesses. We don't feel that way at all. We feel like our paper is still undervalued, and the last thing we want to do is go buy other things that with what we consider to be undervalued currency. We do have a corporate development arm where we're looking at M&A candidates all the time, typically, small technology tuck-ins, but we look at big stuff, too. And what happens is we, over and over and over, and this has been a tale of the last 6 or 7 years, we just don't see businesses we like as much as our own. And when we do a stock buyback, we're investing $1 in FICO, and we know what our scores business looks like. We know what the opportunity for the software business is. There's a lot of certainty in our minds. We have really good information inside, internally, so we have lots of confidence in the success of a strategy we're investing $1 in FICO. When we take $1 and invest it in an acquisition, it's a gamble. It's -- maybe it's a great idea, maybe it's not a great idea. You have integrated issues, you have all the challenges to go with M&A. But you couple -- is it as good a business as the FICO business? With the uncertainty around integration and the risks, culture assimilation and everything else, these things tend not to be very attractive targets for us. And I think that's just the way it is. It means that we will grow organically, maybe it's a little more slowly because of it. Maybe someday in the future, we'll have a big robust M&A arm that's gobbling up companies, but we're not in that mode right now.

Okay. That's fair enough. Well, I think we're just about out of time. So why don't we leave it there? Thank you so much. It sounds like there's a lot of great things going on, so looking forward to tracking that progress.

Thank you, Manav.

Right. Thanks, Steve. Bye-bye.

Thanks.