Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. Thank you for joining us on Day 1 of our Financial Services Conference. Unfortunately, we are doing this virtually. We hope to be in person, but I'll say it again, hopefully, I'm right this time, but next year, hopefully, we'll be in person. But either way, we're very pleased to have with us for this session, Will Lansing, who's the CEO of FICO. So firstly, Will, thank you so much for being here.

My pleasure.

Just for the benefit of the audience, it will just be a fireside chat question. If you want to e-mail some questions, please feel free to do so. But otherwise, there are obviously going to be one-on-one meetings around this. So please contact a salesperson.

So Will, let me just start off with kind of a big picture question, what we're asking a lot of our CEOs. There's been a lot of talk about, despite all the negative news out there, the Delta variant, the labor shortages, et cetera, the CEO optimism and confidence is still pretty high. So maybe I just wanted your perspective just how are you feeling about the business? What are your plans about return to office or work from home? Just some perspective on what you are thinking about as we look into the second half of this year.

So I'm definitely in the camp of optimistic CEOs. Our business is very healthy and strong and looking good for next year. Obviously, we have the same issues as everyone else has. We have a mixed situation in terms of office openings. Some of our offices are open, some not. We're taking appropriate care. We have moved to a lot more remote work, given what we've learned through this COVID period, and we gave our employees a choice of returning to the office full time or part-time or not at all. And majority chose part-time with a lot of remote work. And so I think that's going to be the wave of the future.

All right. That's good to hear. And just on the labor front, I mean, you guys have always been in that competitive field, trying to find the right engineers and technical experts sitting in Silicon Valley. But a lot of people are struggling with that today. Are you seeing that incremental challenge today?

We're very fortunate. I think that we have a strong reputation in Silicon Valley and around the globe, frankly. We've won a number of awards. We just won from Forbes' recognition One Of The Best Places For Women To Work. We were rated by Forbes recently, America's Best Midsized Employer, #1. So we've -- and of course, we have very exciting stuff to work on. If you're an engineer and you're looking to be at the forefront of what's going on in analytics, we're a pretty good place to go. So we have not had trouble recruiting. We're getting more than our fair share. We're very happy with it.

Got it. All right. Just maybe to touch on some of the businesses. Since your -- since the last quarter, I mean, the stock has obviously sold off a bit, and we've talked about this before, but maybe let's address some of the issues there. Let's start with the software business, right? So there's obviously just -- I think, quite frankly, in software, there's just a tremendous amount of noise in what was already a slightly difficult business to understand. So maybe from your perspective, give us a feel for when you're tracking the progress, like what is the underlying momentum that the software business is seeing today?

Yes. So our software business, which is essentially a decisioning software business, it's all about ingesting data, applying analytics, making decisions and then using those decisions in operational flows, workflows to optimize interactions with consumer, customers, typically for financial services. That's our software business. The historical business has focused on a number of specific areas of interest to lending institutions, originations, customer management, fraud and so on. We've increasingly tried to bring those solutions together in a platform so that a big enterprise customer can buy our platform once, do the plumbing for the data once and then having brought all the data in, that it wants to be able to operate on apply wide range of analytics and then put it into operations. So our business today is in transition. We're moving from kind of a point solution license on-prem world to much more of a platform solution where there are a lot more use cases than just the historical solutions that we've provided. And so bigger sales were more embedded in the infrastructure of our customers with the platform business. And also a transition to cloud. So although we continue to support on-prem and are happy to do so and we have many customers who will be using our on-prem software for many years to come, we're building out the cloud business and -- both in our own data centers, but increasingly in public -- in the public cloud. And that's all going really smoothly. There is kind of a long-term view of where we wind up. And 5 years from now, I would say we're not just focused on financial services but we're focused more broadly on B2C companies. But any B2C company, financial services or otherwise that has an interest in optimizing its interactions with consumers, we'll find our decisioning platform to be a great way to do that. And so -- and we think the world is moving in that direction. We think that increasingly you want to have data-driven decisions. You don't want to just have simple rules. You want data-driven decisions that are optimized for each individual interaction. Kind of next-generation CRM is the way to think about it.

Got it. And you threw out a few terms in there, but the 3 that keep repeating are SaaS, cloud and platform. And I was hoping you could try and maybe help us cut each of them differently in trying to appreciate how far along the process you are? You said 5 years outside of financial services. So is that the time line where you'd be more or less done with these transitions?

Well, I think a way to think about our business, if you had a four-box way of looking at our software business, we have on-prem and cloud and then we have onetime and recurring, it's subscription based. And our business -- we have business in all 4 of those buckets. And there is movement. We're definitely moving from all on-prem and license to increasingly more cloud and more platform. Both transition and our historical solutions are going to be embedded in customers' infrastructure for many, many years to come. So we'll continue to support that. We like that business. In terms of transition, the goal has been to make available on the platform all of our historical solutions that were previously non-platform. So we're more than halfway through that transition. And now customers can get those kinds of solutions on the platform as well as many others. And then in terms of on-prem versus cloud, that's really up to the customer. We'll offer our solution, including our platform solution in both forms, and we're happy to do that. There's -- the recurring revenue business is bigger than that because we also sell -- even when we sell on-prem license business, there's typically a transaction component which looks like recurring revenue. So that's also part of our business.

Got it. And maybe just talk about this kind of a 5-year horizon. So ideally, what happens in that 5 years? And what should the software business look like at the end of that period?

Well, I think over the next year or 2, you'll see us really kind of maturing and solidifying the platform and turning the APIs outward. Today, the APIs are kind of internally oriented and our own FICO personnel build solutions for our enterprise customers on the platform with these internal APIs. Next step is for our customers to build solutions on the platform with their personnel. And that's not quite public APIs, but it's much more outward facing. And then kind of the longer term is when we get the documentation and really mature those APIs and basically point them outward, you'll have independent software vendors who can come and build solutions on our platform and take them to customers directly.

Got it. And next quarter at the end of the fiscal year-end you guys have talked about providing us some more software metrics. What are some of those metrics that we should expect? And is that going to change our view of the software business? Or how should we think about what that catalyst would look like?

I don't know that you should expect any radical change in the way you think about our software business. But what you'll see is ARR, annual recurring revenue. So that's a very useful metric for understanding the trajectory of the software business, widely used by software companies. And we'll also break out the platform business from the historical non-platform business. And the benefit of that is that you can see there's been a question about our platform business, which is, is the dog eating the food? Are you getting any traction? Are any customers buying it? Because it's a big deal. It's a big infrastructure sale. It's a commitment by the customer to embed a decisioning platform deep into their infrastructure. And so for good reasons, investors ask the question, how are you doing with that? And so what we want to do is provide visibility there. Here's our platform business, small but growing very rapidly. And it's proof points that the customer likes what it's seeing.

Got it. And I think you've said longer term the platform business could be a 20% ARR grower. I forget the exact metrics you used. But is that a long-term target? Or is that something we could see even with the numbers today?

I think I'm going to wait and let you guys see the ARR numbers. So I don't commit myself in something that's reported for all of eternity to a number that's wrong. But I would tell you that we're very happy with the growth trajectory, and I think you will be, too.

Okay. Got it. And one of the questions we get a lot in software is just because it is a very niche collection of businesses that to try and better understand or appreciate the value of the software business, who is the competition? Like, who are you competing against? And how should we think about that landscape there?

For us, it really varies by what solution you're talking about. Within financial services, we compete quite a bit with Experian, with PowerCurve, their Ascend platform. There are also some niche players there. In fraud, there's -- I won't dignify them with the mention of their names. But they're small fraud players that are nipping at our heels. As you know, we have the dominant and established franchise in card fraud. There are other competitors depending on the sector, depending on different competitors and optimization. We have -- we are likely to have new competition as we get bigger and better at the platform business. So I would anticipate in the fullness of time, bumping into [indiscernible] and C3AI and Palantir, that would not be shocking. We don't run into them much right now. We tend to focus on different things. But could I imagine us competing with them in the future? Yes.

Got it. And so in order to compete with those names, obviously, you're spending a lot of money today. How long do you need to keep spending? Or maybe asked another way, like when can we see margins in that software business?

I think 5 years from now you'll see improved margins. But I think the next couple of years will be years in which we're really focused on the investments and on scaling up the number of customers on the platform. And so I wouldn't anticipate tremendous margin improvement in the short term. In the intermediate term, absolutely. And in the long term, I would expect very attractive margins. We're -- it's not that we don't pay attention to cost. We do. And we have to prioritize like any other company. But we do think that we're at a moment in time where it's a race. It's -- this is all about beachhead and laying a foundation. The strategy behind the platform business is very much land and expand. It's a very long sales cycle. And it takes time to win over a customer and persuade them that they should go and bet all of their optimization of consumer interactions on our platform. And so that takes time. And our platform, it's immature, but getting more mature every day. In the fullness of time, we will have a robust mature platform hopefully installed in many, many customers. And then it's all about expansion. It's land and expand. It's additional use cases and solutions that are built on this existing infrastructure. And I think that's also a place where we will scale up very rapidly.

Got it. So it sounds like you still have a lot more investment than you want to do. So is it an intentional target that you kind of spend enough to keep the margins breakeven just to kind of balance what you want to do versus what the shareholders want to see perhaps?

That's probably a fair way to think about it. We don't want the margins to get worse. Now if I believe that we could spend the money well and get to a more mature platform faster, maybe we'd spend more money, but I don't believe that to be the case. I think we're spending the money in a thoughtful way and we're getting good returns out of the money we're spending. And so I think we're on the right course right now. I wouldn't spend more. But at the same time, I wouldn't spend less. I actually think we have it balanced just right.

Got it. And scale in software is important for these margins. And you already have scale, but perhaps you need bigger scale. So just curious on if you've ever thought about maybe a combination with someone strategic could help accelerate this process? Because it sounds like everything in today's world is going so fast that are you missing an opportunity by trying to go at it over 5 years?

We do think about that. But for all kinds of reasons, we're very reluctant to grow that way. As you know, acquisitions are hard. Some companies are great at acquisitions. They acquire companies for a living, and they do it smoothly. They integrate seamlessly. The deals are accretive, high success rates. And I would say that's not FICO. We do acquisitions. We do small tuck-ins. We've occasionally done slightly bigger things, but it's been many, many years since we did a big acquisition. And I think that's likely to continue. The fact is that we really like our own business, and we find few candidates outside of our business that we like as much as ourselves. And what that means is we'd rather take the free cash flow and invest it in FICO stock than invest it in an acquisition, even if it makes us bigger, faster. So that -- we're on this path with predominantly organic growth and returning excess cash to shareholders through buyback.

Got it. And I'm presuming you're doing a lot of that today with the recent underperformance. But somewhat tied to that, let's segue into the Scores business, right? So obviously, you had the Wall Street Journal article talk about one particular customer switch completely away from the FICO Scores, which is the first time it's ever happened. Just curious how we should think about it? How do you get comfortable? Like is that truly a one-off? Or just -- or maybe how you assess what the risk level with the rest of your customers look like?

Look, I think it is a one-off. This is -- that's a unique situation. I can't really go into the details of it, but I think it's a fairly unique situation. We're not aware of any other major customers who are planning to switch away. There were some questions raised in the Wall Street Journal article about big lenders using their own proprietary scores. That is not new news. That's been done for many, many years. And frankly, we encourage it. It would be surprising if big lenders didn't do that. They do it today and they're likely to continue to do it. I don't think that presents a problem for Scores. When you think about what a FICO Score does, it uses this credit card payment data and produces at very low cost in a very efficient way with a high level of predictive value, a score on individual tells you propensity to repay debt. And it's hard to top that for what it is. What you can do is you can bring other data to the equation and make a more informed decision by leveraging additional data. And frankly, lenders do that when they do mortgages, they go and they ask about income, they ask about other things. And sometimes fintechs and others come up with ways to bring alternative data to the party to be able to make a really great decision about credit risk. But frankly, if the FICO Score is available, it's pretty crazy not to use it. And so the idea that -- and even when lenders have their own proprietary scores, they typically back test against the FICO Score usage in conjunction with the FICO Score.

Got it. And I think this might be the same answer for the next question, which is, you always have these new fintech companies like Upstart and everyone else talk about their own proprietary algorithms, their own data sets, but at the same time, I think they're still clients of yours. So what does that dynamic look like?

Yes. Most of these fintechs are -- they are our customers, and they use a FICO Score because the FICO Score is available and it's the best building block on which to build with more creative solutions. So sure, these -- many of these fintechs have come up with interesting and unusual and creative ways to do underwriting, and to identify good credits out of the pool. But if a FICO Score is available, as I said earlier, if a FICO Score is available, start with a FICO Score and then add to it, go find other things that will improve on that decision. But to ignore it, to not use it, to not consume it if available at the prices that we charge, which are very, very low, it doesn't make any sense. So we're fine with that. And some of our best customers are fintechs.

Got it. And the one thing though that I know we've had the discussion before that always frustrates you is the VantageScore claims that they can score many, many more million individuals in the U.S. than the FICO Score can do. And maybe if you can just help us understand that perspective and why you guys stick to what you're doing today?

Yes, good question. We both -- both FICO and VantageScore rely on the credit card payment history, that data at the bureaus to produce the scores. So we're both using the same core data. And so the question is, how do you get more scores out of the same data? I would represent to you that we could get more scores out of the same data too. It all has to do with where we want to snap the chalk line and say, I'm comfortable with the quality of the data above this level, but below this level, I would be unwilling to produce a score. And there's reasons. There's things like how long has the account been open? Is the data stale? Those are the kinds of things that prevent FICO that we have self-imposed said, we won't produce a score if the data's stale or if the account hasn't been open in a certain amount of time, that sort of thing. And I think that VantageScore takes greater liberties there. They're more -- call it more aggressive about scoring on this data that FICO wouldn't be willing to use. That's a decision that we make. We do it because our lenders don't want us to drop the quality of the score. They don't want us to take those kind of steps. It'd be easy to do its math, right? We can do it. But we've chosen to go our path and VantageScore has chosen theirs.

Got it. So maybe somewhat in -- to tie that in, just the FHFA evaluation going on, on the mortgage side, whether to include the VantageScore or choose you with the VantageScore. Can you just talk about how you look at that process and maybe what the realistic expectation should be?

Yes. I think that -- I mean, obviously, I can't speak for the FHFA. But from the outside looking in, I think that there are probably a couple of factors that work in the evaluation and the decision about what score should be used for the mortgage. And the first question is, does the score work? What's the predictive value of the score? Is it a good score? And does it do the job that it's supposed to do in terms of predicting propensity to repay debt? The second piece of it is, what's the cost to the system of using Score A versus Score B, switching from Score A to Score B. And I think those are the factors that work in this process that the FHFA is in. Again, without knowing what they see, we believe that we have the best score in the marketplace. We think that it is as predictive or more predictive than anything else out there because we spend a lot of money on innovation and have worked with this for a long time. And so we're pretty comfortable with the first part of it. And then with the second part, the cost of the system, I think that a system in which you mandated multiple scores would be more costly, a system in which you switched away from the FICO score to a different score would be more costly because there's tremendous switching costs for probably little benefit, if any benefit at all. So I think on the cost side, cost of the system, the FICO Score scores well. But again, we'll have to see. We'll see how that decision goes. But we're confident that our score is strong and that it's the most cost effective for the system.

Got it. So I guess with that as background, just tie that into what the discussion you've had in the past, which is the cost of the Score versus the value of the Score and how -- what is your current thinking on what that gap looks like? And if that changes your kind of recent special pricing strategy that we've witnessed?

No. In terms of our pricing strategy, it hasn't changed, and it's not likely to change for many years to come. What we do is we think that there's a big gap between what we charge and the value that the customer receives. We start with that premise. And it's not true everywhere. We produce many billions of scores and we think there's a gap in a lot of those scores, not in every single one. And so we're thoughtful about where we do price increases. We try to focus on places on customers where the impact is not likely to be felt in a painful way. We look for pricing sensitive, pricing elastic, smaller customers. I mean there are different places you would go to do your price increase, but the goal is to not antagonize our big customers.

Got it. And in terms of the -- I guess the way I'm trying to phrase it is, what inning are we in the price increases, the special price increases? Like how much have you already tackled? How much do you think there is to do in the years ahead?

Yes. I mean I'm not even sure that a nine-inning game is an apt metaphor. I mean if you want to go that way, call it inning number one, because we don't see any -- we see a long runway here, a very long runway here.

Okay. Maybe in the 5 to 7 minutes we've got left, let's talk about the B2C side of the Scores business. So there are 2 pieces in that. So maybe the first one that has perhaps got people a little bit of surprised was the impressive growth that myFICO.com has seen. You haven't spoken about that business before. So was it just a factor of the environment that just helped that business or was it something that you did or changed in your strategy?

I'd say it's 2 things. Probably the single biggest factor is the strength in mortgage. What we know is that when consumers are thinking about getting a mortgage they get very focused on what their credit score is and they typically come to us or Experian and they get into some kind of a score monitoring program to see what their score is, to see what their options are for mortgages, what kind of pricing they can anticipate. So that -- a very typical behavior when mortgage spikes upward for the credit report monitoring business to spike upward as it has for myFICO and for others as well. So I think that's the exogenous factor. And then the other factor is that we have a very strong team there, a very strong management team, really smart and always exploring ways to decrease the churn, increase the value, increase the lifetime value and they've just done a great job.

Got it. Maybe if we can -- and then switch to the Experian partnership, right? So we spoke to Experian last week at our Credit Bureau Day and they obviously had a lot of good things going on at that business, a lot of investments, a lot of good growth. My understanding is you guys have kind of almost a revenue share partnership with that. So do you just grow alongside Experian or are there some other dynamics we should make note of?

We have a really great partnership with Experian on the consumer business. We're obviously fierce competitors when it comes to software, but on the consumer business, we're great partners. And they are -- they've really distinguished themselves as masterful consumer marketers. They are fabulous at customer acquisition. They have a great product, a great offering. They also understand the value of the FICO brand and how to leverage it, and they're doing a great job with that. There was a time when we wanted to kind of control our destiny a little more and have more rules around exactly where and how FICO would be used in different situations. And we've developed a relationship of trust with them such that we really think they are the guys who understand what the right pricing is, how to optimize it, how to maximize it. And so we've given them pretty wide latitude. And yes, we have a rev share arrangement with them where we participate and what works for them works for us. And we completely trust their judgment on how to optimize that business.

Got it. And we had talked about it when you were first kind of forming that partnership strategy that perhaps there could be a lot more avenues to take that. But I don't think we've seen any new announcements. So just curious what your pipeline on that direct-to-consumer side looks like?

Well, I think it's very strong right now. I mean the partnership -- I mean you all see the boost television advertising, and that's -- I don't have to be the one to tell you how great that's going for them. And we participate in that, what are you boosting? You're boosting the FICO Score. So that's a great program for both of us.

Got it. But what I meant though was just partnership pipeline beyond Experian. Like can you partner with other...

Yes. Yes, of course. Of course. And we're -- our -- the use of the FICO Score is not exclusive to Experian, and we do have other partners. And they're -- we're constantly looking at other partners. But Experian -- I would say that Experian is the big player in that space.

Got it. Maybe we can end with capital allocation. Since you were on the Board, I think you helped orchestrate this focus on buybacks, which has worked remarkably for you guys. But maybe just some perspective on why buybacks? Why almost minimal to no M&A? Like how does that decision-making process work for you guys?

Sure. So just a bit of background, our high point were 76 million shares down to about 36 million shares 10 years ago when I took over and now we're down under 30 million shares, well under 30 million shares. And we have every intention of continuing to buy back our stock. We like running an efficient balance sheet. We have a sense for the right level of risk for a business of ours -- like ours. What's clear is -- our objective is to maximize returns for equity shareholders. And so we can handle a fair bit of leverage, more than we have now actually. I mean our leverage has slipped a little bit, and we'll likely take it back up. But we have focused on using buyback to return excess cash to shareholders. And it has historically worked well for us, and I anticipate that it will in the future. Comparing it to M&A is a fair point. There are certainly lots and lots of opportunities out there that would be accretive, if all I cared about was accretive deals. But when you really dig under the covers and you say, how much do I like that business compared to our business? There are a few businesses outside of our own that we like as much as our own. And so as between investing in ourselves with 100% certainty about what the return looks like versus speculating on acquisitions, we tend to be very conservative on acquisitions. We do a few tuck-ins here and there, but really the main event for us with our free cash flow is the buyback. We just authorized a $500 million buyback.

Got it. Yes. And I'm sure you're active in the market with the pullback. But just to follow up and wrap up here, but -- I appreciate the organic and the buyback, but just to play Devil's advocate a bit. At the pace the world is changing today and almost everyone around you seems to be accelerating the M&A strategy, so does that tempt you at all or perhaps you're just in a different kind of niche positioning where you don't feel the need for that?

There are so many companies that do great with acquisitions. It's a core part of their growth strategy, and it's not a core part of our growth strategy. It just is not. We really like our own business. We like the risk profile of our business. We like the growth opportunity and TAM in our business. And I just think it's hard for us to find, not impossible, and we're always on the lookout. We actually have an active M&A staff. But that said, it's very hard to find things that we think could compete with FICO. And look, I don't need to tell the people who are watching this thing. If you look at our TSR over the last 10 years, there are a few things out there that we ought to have bought relative to having bought the FICO stock instead, which is what we did. So we're pretty comfortable with the strategy.

Got it. All right. Well, thank you so much. I think we'll leave it there. I really appreciate your time and looking forward to next quarter's results when we get the new software metrics.

Thank you.

All right. Thanks, Will. Have a good day, everybody.