Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

All right. Good evening from New York. My name is Manav Patnaik. I'm Barclays' Business and Information Services analyst. And we're very pleased to end the day here with us FICO CEO, Will Lansing. So Will, thank you so much for being here with us.

My pleasure.

Will, I think FICO's name is recognized for its Scores business and a lot of the story so far has been on that side as well. But since this is a TMT conference, I'd like to start with the software business first. Still, quite often, people don't fully understand what software does FICO own. What does FICO do? So maybe you could help just set the stage for us, how you would bucket your software business in simple categories to just help us appreciate what it is that you do?

Okay. And maybe it's worth just a brief historical view here. Our business historically has been serving financial services firms, helping them with credit risk decisions, things like originations and customer management, fraud, collections and recovery. And we developed, over many years, we developed or acquired, we acquired some companies, what I would call point solutions where we were best-in-class for solving a particular kind of a problem for a bank. And that was our business for many years and still is our business. But about, oh, I don't know, 5 years ago, 4, 5 years ago, we made a number of moves. One, like all software companies, we decided we had to make our software available in the cloud. But more importantly, we decided that rather than just be a collection of point solutions, we'd like to have some common R&D that could -- initially was focused on the decisioning engine, and we had common decisioning engines across our solutions. And then we did a bunch of work on the data plumbing infrastructure to make that common and eventually, that evolved into a platform strategy. And so today, the business is our existing application franchises, and we can go through them one by one, and then our platform business, which is the future software business. The existing franchises, in a nutshell, we have a large fraud franchise where we are the biggest player in credit card fraud detection with a product called Falcon. We have originations. Customer management is things like line management, its strategies for consumers -- consumer customers of banks. Collections recovery is just what it sounds like. Then we have CCS, which is our Customer Communication Services that's talking with our customers through text or e-mail or voice, what have you. So that's kind of the collection of point solutions that we're known for and still the biggest part of our software business. But I'm sure we'll spend more time on the platform. That is the future business.

Got it. And so maybe just going to the platform. So is the platform simplistically putting all these points of solutions together, the IP behind it into a one-stop shop kind of sandbox?

Yes. At its simplest, it's that. I mean, the way to think about it is, we want to make it easy for B2C companies to have data-driven decisioning that informs how they interact with their consumer customers. So for a B2C company that wants to optimize every single interaction with the consumer, the goal would be to have -- make data-driven decisions to inform that. And the platform, our platform, which we call the Decision Management platform is designed to do exactly that. And -- but it's not a simple thing. It's a complicated thing. You want to be able to pull data from lots of different sources. First-party data, third-party data. You want to be able to mix and match it in different ways. So there's a lot of data plumbing infrastructure that has to happen, data orchestration, to get -- to ingest the data. Then there's a wide range of analytic tools to be applied to that data to produce good decisions and they vary. They vary by use case. Sometimes they're using combination, but different tools for different purposes. And so we have a wide array of analytic tools available in the platform. And then finally, in order to really leverage all of that and produce true solutions, what you want is an application development environment, we call it FICO Studio. But you want this application development environment where it's very easy to build solutions on top of this platform. And the beauty for a company that has -- that is standardized on our platform is once it's in, you put it in once and then you can do many, many different use cases on top of it through FICO Studio. So that's kind of the broader structure of the platform.

Got it. And it's -- on a high level, it sounds like a lot of the tech companies or software companies are trying to do similar things. So why FICO? Like what's the unique value proposition that you guys are bringing here?

I would say that there's lots of companies do in pockets. But what we -- I think what we do particularly well is understand consumer behavior. And then put it into decisions that can be used in workflows by these companies so that they can optimize their interactions with consumers. That's not a trivial task. I mean getting to scale and operationalizing these decisions is tricky. It's not like a bunch of data scientists theorizing about what the best way to interact with the customer is. You actually have to do it. And so I think we're -- if not distinct -- we're distinctive, if not unique in being able to apply the best analytic tools to make the best, most optimized decisions and then get them built into the workflows and operationalize them.

Got it. And just for a little bit more flavor, you obviously have your legacy business in the software side. And then we've heard you talk about SaaS, moving to a SaaS model. We've heard about moving to the cloud, and now we're hearing about platforms. Are they all the same thing? Or what are the nuances there that we should be thinking about?

They're not the same thing. So we had all these point solutions, which we're typically on-premise license software solutions, and we still sell those, and they're very strong, what they are. We also offer those in the cloud. So if a customer didn't want to run it in their own data center, they -- they could run it on AWS or in a cloud, and we support that. But each one of the solutions was freestanding and somewhat independent. And with the platform, the platform is available both on-premise and in the cloud. It's -- so what makes it the platform is not that it's in the cloud. What makes it the platform is that it's a unified code base and common data plumbing and common analytic tools. And then we make that platform available to companies who want -- they can use it on-premise, if they want, they can use it on top of AWS, whatever they'd like to do. So that's really the distinction. So our point solutions are available on-prem and in the cloud. Our platform solutions available on-prem and in the cloud.

Got it. And can you help us understand the financial benefits of doing this, right? I mean legacy seems to be flattish to slightly growing. But how -- presumably, these other cloud platform areas will grow faster, how much faster and why?

Yes. So if you get into our software business, the biggest part of it is still our historical, call it, legacy solutions. But the fastest-growing part by far is the platform business. And I would expect that most of the growth to come there. I think that you'll see flattish growth on the legacy side, and you'll see really strong growth, somewhere in the 40% or 50% range on the platform side.

Got it. And then maybe can you just talk about some of the qualitative, at least milestones, that we should be looking forward to hear as you progress on your journey?

Yes. We have very clear goals, and many of which we'll achieve in 2021, and some will take a bit longer. Our vision is for this to be a 2-sided marketplace in which independent software vendors can leverage software development kits provided by FICO to build solutions for customers on our platform. And that does not necessarily just financial services, that could be other verticals, too. And in order to achieve that goal, we have to do a handful of things. One is we have to complete what we call FICO Studio, which is this application development environment that lets, today, our internal developers as well as our customers, build solutions on top of the platform. So we need -- it's a robust environment today. It will be that much better 6 months from now. So that really rounding out FICO Studio is an important goal. Then we have microservices approach to what we do. And it's important for us to be able to mix and match features and functionality to produce a wide range -- a really wide range of solutions. And the way to do that for us is microservices. So we need to make more progress. We're doing well, but we need to make more progress on that. Third, related to those 2 is open APIs. So today, our APIs are still inward facing, and we use them internally, but we have made them available and supported them for external use. So that's something that we hope to do in 2021. And then finally, and this will take more than just this year, it will be in '22 or '23, we need to really flesh out the ecosystem that I talked about before, where we have software developers on one side and customers on the other.

Got it. And I guess all this comes down to the other question we get a lot on the software side is, if it's such a niche business, it sounds like it's a very moody business. Why are margins practically close to breakeven, I guess, is the way you referred to it before. Where is all the spend going in? And what's the trajectory of getting that margin higher?

Well, so the spend is on the platform. It's the things we just talked about. It's building out the microservices and the functionality, building out FICO Studio, making all of these tools available to customers and to third-party developers. That's where the spend is going. The margins are flat today. They're not growing, but if you kind of get underneath it, it's because we're making all this investment in the platform business. I do think that the platform business will be a profitable business, a very profitable business in the fullness of time. But we're very much in a build mode. And so what discipline we bring to our cost side, we wind up reinvesting in more platform. So I think today, the margins are not -- they're not high. And in the future, they will be. And right now, we're focused on growth.

Got it. And maybe just for some perspective, like what inning would you say you are in your software journey, because, I guess, we've heard the -- at some point, we'll have the margins almost every year? So I'm just curious, like maybe we shouldn't ask you this question for the next 5 years and then ask you, just curious.

I don't mind if you keep asking. But I don't think we're in the eighth or ninth inning. I think that we're halfway through. We have a lot of work to do still to achieve it because our ambition is great. We won't be satisfied with just having converted our point solutions to platform-based solutions and selling them to the same customers we always sold them to. Our aspiration is much greater than that. So it's going to take some time.

Got it. And just maybe a second last question on the software side is, I think part of why it's hard for us to appreciate some of the businesses, just the segment reporting, and I suppose the lack of software disclosure that investors would like to see. Should we be expecting that from you anytime soon?

We -- segment reporting is a complicated business. And what we do want to do is tweak it over time so that it's more useful to the investor community and reflects more of the way we think about our business. There's a basis for our reporting the way it is today. We can explain that. But increasingly, we think about our business as platform and off platform. So at some point in the future, I think that we need to break that out. Another useful distinction is the distinction between software and services. Today, we blend them together. It's probably important because they have very different margin profiles to separate them out. So that's something we'd be working on. We have historically shared bookings, and we'll continue to do that but I think in this next year, you'll see us start to share other metrics that would be useful like ARR, annual recurring revenue. So those kinds of things.

Got it. And is there any gaps in your software platform if this is going to be the studio, call it in one-stop shop? I mean presumably, your client would want to have everything in there. So is there something you think you're missing in that piece of the puzzle?

I don't think there's any gaps. Well, of course, there's gaps, right? This is a work that's never finished, right? There's always work to be done and progress to be made. I don't think there's any major gaps that stand between a customer using the platform today and achieving any particular goal. So some combination of our internal people and customer personnel can build virtually any kind of solution they want on top of the platform today, right? That's -- so there's no gap there. But I do think that there's a gap when it comes to having outward-facing APIs that third parties can easily use. And so we're on that journey of making the platform available, accessible, open to others, so that we're not the only developers working on it.

Got it. And then just one more on the software side. You used the word decisioning, studio, analytics. A lot of that underlying is AI, machine learning, et cetera. So all those buzzwords seem like the story from some of these recent IPOs at Palantir or C3 AI coming up and so forth, but should we be perceiving them as competition to you? Or how do you think about the competitive landscape? Maybe it's another way to ask about this.

Yes. Well, so we don't bump into C3 AI or Palantir much in the marketplace today. That could easily change in the future because I think all of us are targeting some of the same space, this decisioning analytics space. So yes, I think there will be more competition in the future because this is a big, big addressable market. It's very important. It's the next-generation of CRM. Data-driven decisioning is the future. I mean I really believe that what ERP was to the '90s and what CRM has been for the last 15 years, I think that's where data-driven decisioning is for the next 15 years. And so we aim to be preeminent in that space. We'll certainly attract competition and there is competition coming in. And -- but it's a big space. There's a lot of room for everybody.

Got it. And actually, just one more question I have in software, which will then segue and discourse real quickly is the Equifax partnership that you signed about a year or so ago now. Just any updates there? I mean any clear milestones there that you reach that we should be looking for?

Yes, that's going very well. We've made quite a bit of progress on -- in one area, which is around compliance, where we have a lot of happy customers, mutual customers. And then we're working on what we call connected platform, which is a combination of Equifax's data assets and some of our analytics software. And again, that make it a one-stop shop for customers who are interested in the data and analytics together. And we're making progress there, too. So the partnership is off to a great start.

All right. Great. And then maybe just touching on Scores in the 7 minutes or so that we have left here. So firstly, just in terms of some of the credit trends out there. I know the credit bureaus are better indicators, I guess, of the volumes and the forecast. But just generally, your views. I think we all have heard the mortgage forecast and the potential upside, but maybe just some thoughts on each of the verticals and how you guys plan for it?

Yes. I mean, you said it yourself, we're not a leading indicator. We get our royalties and our information and arrears from the bureaus. So I really would counsel others to look first to the bureau forecasts on where the trends are. And we can corroborate it. But again, it's -- by the time we corroborate, it's historical. I think just broad comments, we've had quite a run-in mortgage this last year, a combination of low interest rates and who knows what else. But we've had quite a run in mortgage. And there were questions about how long that would last and whether that -- would that taper off in '21, early '21, mid '21, late '21, what could we count on? I think we've all been -- we -- the industry have been pleasantly surprised that it looks like it still has quite a bit of life left in mortgage. So we're optimistic about the prospects for mortgage this year. Auto is pretty strong. Card volumes aren't what they were pre-pandemic, but we imagine that they will come back also at some point. So those are really broad and general comments, but we feel pretty good about '21.

Got it. And the special pricing strategy on the B2B side on the Scores business, that's had 3, I guess, very successful years. Can you just talk about where you see that in early stages, presumably, just to talk about the gap between the price and the value?

Yes. So we continue to believe that there's a very large gap between what we charge and the value that our customers get from the Score. And so is there room for us to continue to increase prices over time? I think there's some room there, no question. At the same time, we are very mindful of the role that we play in the system. And it's our intention to never shock the system and to not antagonize our customers. And so we're -- we have a very measured approach to pricing. We try to be surgical. We try to be thoughtful. We look for places where the demand is less elastic or -- and/or where the price increases are less noticeable for obvious reasons. And so our commitment to our customers and to the system is no shocks. But at the same time, our commitment to investors is that there's continued pricing discipline in our business.

Got it. All right. That's helpful. The one area this year has been a real positive surprise has been the B2C business and primarily myFICO.com. It was always a small business that I don't think we discussed in detail for some time. And this year, it really spiked. Have you done something different? Is it just the nature of the pandemic? And do you think it's sustainable?

I think it's a combination. So there's no question that the environment is excellent for credit score monitoring, D2C. We're seeing that with other players in the industry, and we ourselves are experiencing terrific growth. So some of that is for sure, environmental because not just us. I do think that there's innovation and good execution in our team. And that also is reflected in the numbers. When we think about myFICO, we are -- we consider ourselves at some level. Besides being the gold standard in credit report monitoring for consumers, we think of ourselves that way. Besides that, we also consider ourselves to be a bit of a lab environment where we can test out different kinds of score reporting, score monitoring ideas and then share them with our partners for their use. And so there is a fair bit of innovation that goes on at myFICO.

Got it. And on the other side of the D2C spectrum, I mean, you obviously have the very lucrative Experian partnership, but there was always this talk about having a wide pipeline of partners. And I was just curious if you could talk about what that looks like? Or does being a partner with Experian, maybe limit how much further you can get there?

Well, we do -- Experian is a terrific partner and we have a great relationship there. We do have relationships with other firms. We have lots of partners. I'm not at liberty to name names. So a lot of our partners would prefer to keep it quiet. But we do have a strong partner business in D2C.

Got it. And then maybe we can end in the last minute -- couple of minutes here, capital allocation. I think we all know the answer, but I'm going to ask anyway. We've seen obviously a lot of big deals happening, not only in our space, but just generally out there. And so, is FICO tempted to do a deal to accelerate some of the initiatives? Or are we still going to see the buybacks?

Short answer, you'll see the buybacks. I think there's no question that we could do a lot of accretive deals. There are deals to be done. That said, we rarely run into businesses that we like as much as our own and as much as our own prospects. And so the way we feel is appropriate to invest in ourselves and invest in our prospects ahead of acquiring other assets is to do share buyback. And so we're pretty committed to share buyback. As you know, we've done it for many, many years. As a general guide, we try to spend our free cash flow every year on buyback, and that's likely to continue. We also try to manage our leverage to 2.5, kind of 2.5 to 3 kind of a range. And so that goes up and down. But we pride ourselves on running an efficient balance sheet with appropriate levels of risk and not too much. And so anyone who knows our firm knows we're all about Goldilocks strategy. And so I think you'll continue to see the buybacks. You'll see the efficiency in the balance sheet, not crazy leverage, but not no leverage either. And that will continue.

All right. Great. Well, we're just about out of time. So thank you so much for your thoughts and for your time, Will. Really appreciate it.

Thanks, Manav.

Bye. Take care, guys.