Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

Hello, everybody. Thank you for joining us at our TMT conference again at the end of the year, another virtual event, unfortunately, but it's safe. And we're very pleased to have again back with us Will Lansing, who's the CEO of FICO to talk with us for the next half an hour here. So Will, thank you for being here again.

My pleasure.

Thank you. I have some prepared questions here I'm going to be running by, Will. [Operator Instructions] And if I can, I'll try and squeeze them in, but I think we should have plenty to talk here. So Will, with that out of the way, I wanted to -- typically, at this TMT conference, we start with your software business just because it is more a technology software-focused conference. But given, I think, the reaction in the stock price and kind of some of the questions we're getting, I think it makes sense to start with the Scores business. And so maybe if I can just get your overview today on the Scores business, starting with the special pricing story that we've heard from you for a long time. We've had 3 good years of that, that's come through the numbers. So just your thoughts on how much runway is left in the special pricing and how you look at that cost versus value difference there?

Well, the short answer to the question is that there's a lot of runway left. Our Scores business is as healthy as it's ever been. It's -- our Scores are used very widely, continue to be used very widely, and we expect that they'll continue to be used very widely. And the reason is that they do the job they're supposed to do. They're very low cost and efficient way of evaluating credit. In terms of the special pricing, just a bit of background for those who are not familiar with it, we had 25 years of frozen pricing. We never raised the Scores price for 25 years. And so several years back, we started to raise the prices and that continues. And that's because there's a tremendous value gap between what we charge and the value that our customers get from using the Score. We try not to shock the system. We try to be fair about it. We try to be thoughtful about it. But there continue to be opportunities for price increases. So the short version of the answer is continued strength in that business.

Got it. And so when you gave guidance recently, you did not include the special pricing in your guidance, but it sounds like we should still see some. So what are the moving pieces between figuring out what you can or cannot include in the guidance numbers?

Well, we have historically not included the special pricing -- so-called special pricing in our guidance because the timing of it is uncertain. So typically, what we do is we increase prices across the board for inflation. And then we go and we study the portfolio of Scores and say where is our big value gap and where should we be increasing our pricing? And it's that latter piece that we don't include in our guidance because the timing of it is uncertain.

Got it. And that -- the -- in terms of the portfolio that you have found that there's a value gap and you have done special pricing, is there any way to quantify how much of the portfolio you've already touched versus how much is left?

Well, I think -- this is an ongoing process, and I imagine that for many, many years to come, there will continue to be us touching the portfolio in terms of pricing. What we do is go through it fairly methodically and look for pockets of an elastic demand. We look for places where the increases are less visible, less noticed. I mean it's just good business practice. And that goes on. That happens every year. And it used to be that it was very easy to just point at some area that was -- that got a step function increase, and we still sometimes do that. And we may continue to do that. We probably will continue to do that. But I consider it success if no one even knows where the price increase happened.

Got it. And in terms of the value gap, right, can you give us some perspective on the cost of the Score versus the value of the Score, the way you look at it? It sounds like you said there's a long runway left, but just any flavor for that would be helpful.

Well, we do about 14 billion Scores a year and pricing ranges from basis points to cents and upward to kind of under $1. And it all goes to the use case and how the Score is being used and what fees and revenue are associated with the use of that Score. And so it really varies. It's all over in a map. But we try to be thoughtful about it. The -- in terms of the gap, we believe that our Score is so far below the value that it confers that we really -- we don't -- we really don't think about the ceiling, we think about not tracking the system.

Got it. So 2 follow-ups to that then. When you look at the rating agencies, for example, I mean, I think one way to figure out the value gap is the cost of the debt with or without a rating. And so just curious if there's something similar that you guys can help us appreciate why there's no ceiling and -- that's a worry really for you guys.

When you think about Scores, there's a few things going on. First start with how is it that the FICO Score is the standard in the industry that it is. You start with a good value proposition. Start with the fact that it does the job it's supposed to do. It predicts creditworthiness pretty well, propensity to repay debt. It does a good job of predicting that at a very low cost. So there's a good value proposition for the lenders. That's the cornerstone of the whole system. But it doesn't -- what happened with our -- with the development of the FICO Score and it becoming the center of the system is that regulators found that it was a very useful metric for understanding the risk in the portfolios of the banks they're regulating. And so it became shorthand for understanding the risk of those portfolios. And so you develop a second constituency that relies on the score, which is the regulators. Then you have the investor community. So as lenders securitize the paper, investors who are buying that paper insist on some kind of a metric to understand the risk profile of what they're buying. And again, the FICO score is a very useful, not just intuitive, I mean it is a useful and scientifically derived basis for understanding the risk in the paper that they're buying. And so it's terrific shorthand. And so the investors have come to rely on it. And then finally, with our Open Access program, we put scores in the hands of hundreds of millions of consumers who now rely on their lenders to share the FICO Score with them, so they understand what their own credit profile looks like. And probably everyone listening to this call knows that you can get your FICO Score from your bank, and it's free. And so you have this situation where a number of different constituencies rely on the FICO Score. And that's what makes it the center of the ecosystem. And that's what gives it its staying power.

Got it. And so that almost benchmark like status that you've described has been one of the main attractions to the FICO story. But I guess recently, just given the way the stock has been reacting, I think there's some fears around competition, I suppose. And so I just want to address those with you as well. So the first one is just around VantageScore, the more traditional competition. And just curious on what your thoughts are with respect to the upcoming FHFA decision. Maybe we can just start there and then touch on a few others after that.

Well, the FHFA will be making a decision, we hope, in the next year, probably in the next 6 months as to what score to be used for mortgage. And we really have no comment on it, except that we're confident that we have a highly predictive score, a very good score. We were successful in getting FICO 10 T -- FICO 10 and 10 T are most recent scores. We got those into commercial production in time for them to be part of the evaluation process. So that's good news for FICO. And in terms of cost of the system, which is the other criterion that the FHFA is looking at, I think it's easy to imagine how the cost of the system would be lower if you stayed with a FICO Score than if you switch to something else. And so I think we'll have to wait and see how the FHFA decision comes out. But at least we put our best foot forward, and we feel pretty good about what we've put up. In terms of competition and VantageScore, look, we welcome competition. Competition is always healthy, and it's good, and it keeps us on our toes. How do we compete with VantageScore and with others? We compete on the basis of innovation, really. It's not enough to rest on our laurels and say, "Well, we're at the center of the ecosystem, and therefore, we're safe." We invest tremendously in R&D to bring out new scores. Now VantageScore and FICO Score rely on the same credit bureau data to develop -- to produce a score. And so there are claims that VantageScore scores more people. I guess I would start by saying FICO Scores collectively score more people. We score far more people, over 260 million people collectively. But more importantly, we do that by not lowering our standards in any way. We do it by looking to incremental data, additional data, alternative data to produce scores to score the previously unscorable population. We think that's a better way to score the hard-to-finds, the so-called credit visibles, is to find out more information about them rather than lower standards. So that's our approach. Competitors do other things, but that's our approach.

Got it. And maybe just on that, I mean, recently, you lost one of your customers to the VantageScore. I know they were a small percentage of your revenues. But maybe just help us appreciate if that's a one-off or if maybe pricing is the equation here?

Well, we prefer not to comment on our customers. I would put it in the category of one-off. And of course, it's unfortunate for FICO to lose any customers, but we don't see a lot of other losses coming. We have no visibility into any other major customers leaving us.

Got it. And just one of the points you made, which is you compete on innovation and you have the FICO 10 and the 10 T, and you collectively score over 260 million people. I think that's one of the things maybe investors don't fully appreciate. And maybe just like the Open Access program, you need to do some big marketing campaign out there. But maybe just help us appreciate FICO 10, FICO 10 T, all these alternative scores, like what's the potential there in terms of the opportunity?

Well, here's the thing. I think that what you see is from time to time, fintechs, Wall Street darling fintechs, will position themselves. They'll build their brand identity around the idea that they are going to supplant the FICO Score, they will replace the FICO Score in some way, they're the next generation of innovation and credit evaluation. And I think it's important to pick this thing apart because I think there's a lot of misconception out there. So for starters, what is the FICO Score? The FICO Score is a low-cost, very broad-based, effective way to evaluate credit if you had to rely on a single data set. If you're just going to look at the credit card payment history of a consumer, there's no better way to understand -- if you're going to look at 1 data set, there's no better way to understand the creditworthiness of a consumer than to look at the credit card payment history, and it's obvious. Are you going to pay me back in the future? Well, let's look at whether you paid me in the past. I mean it's very straightforward. But can you make a better decision if you add other data? Of course, you can. And major banks have been doing this forever. They add additional data that they have access to, first-party data. They look into the checking accounts of their consumers to understand the behavior a little bit better. I think you have other companies, companies like Upstart, other companies adding other information on top of -- typically on top of a FICO Score to improve on the decision. There's nothing wrong with that. We encourage that. Frankly, we think that's a wise thing to do. And you're really only limited by your imagination. You start with a FICO Score and then you add to it your secret sauce to do a better job on originations. Now another thing that's a bit of a misconception out there is that somehow these fintechs are competing with the FICO Score. They're really not. The truth is that most of these fintechs, including the ones that talk about how they're going to replace the FICO Score, use millions and millions of FICO scores every month and their usage is growing. And the reason is that the FICO Score is very good for what it does. But the angle where you hear about fintechs going out and getting other kinds of data and using thousands of attributes to try to understand the consumer better, well, that's fantastic that they do that. And frankly, that's what FICO software does. Our FICO origination software does exactly that. So I think it's important to have an apples-to-apples comparison. It doesn't make sense to compare Upstart originations to a FICO Score. It makes sense to compare Upstart originations to FICO origination software because that would be a valid comparison. And in terms of the score usage, the scores are used. They're very heavily used by the fintechs, and they'd be foolish not to use them.

Got it. And so just on that point, I mean, I think one of the arguments and perhaps why investors are a little fearful today is, I guess, Upstart, maybe a couple of these other fintechs, seemed like the model works better than the prior fintechs. And therefore, that creates maybe more of a risk on whether FICO is required in the future. Again, maybe it's comparing apples and oranges, but just your thoughts there?

Look, I think it's understandable why the fintechs position themselves as innovators and moving beyond the current system, and FICO looks like a very big part of the current system. But the reality is that these fintechs all use FICO Scores and use them heavily. Upstart, for example, consumes millions of FICO Scores a month. Upstart's usage of FICO Scores is up dramatically from -- over the last year. So I would just say, be careful how to interpret the remarks that you hear, consider the source and then pick up the data.

Okay. That's helpful. And just to follow up on your comment that a lot of the fintechs use the FICO Score. Is that more as a benchmark to what they are doing? Or how do they use the FICO Score in your experience?

Well, there's different places it can be used. It can be used in their own evaluation process, in their own algorithm, secret sauce, underwriting. That's kind of a primary use. It can be used as a filter to decide which of the leads to pass to a lender. And it can be used by the lender as a filter in terms of which of the leads that come across will -- are good candidates for loans. So there's really 3 different places where it can be used. We think that the FICO Score is used extremely widely in all 3 places. And frankly, even if it were used a little bit less in one place or another, it doesn't change the dynamic. It's still going to be used by the lenders, it's going to be used by the investors...

Got it. And so one of the points that come up here is obviously, a lot of these fintechs are using alternate sources of data, not just the credit bureau data and therefore, are getting better. And so that brings me to FICO XD and UltraFICO where I think you are using alternate sources of data. But perhaps there's a debate that you're not using many more alternate sources of data or maybe you don't have access to alternate sources of data. I know you're not a data company, so how do you guys tackle that issue?

Well, there's -- so we tackle it in 2 ways. One is on the score side and the other is on the software side. So with respect to scores, we're constantly looking for data sets that have reasonable breadth, so we can score a decent-sized population but that also provide incremental calories, caloric content for figuring out credit. And so -- and that would be FICO Score XD, which is based on telco data, utility payment data. It's FICO boost where we incorporate checking account data, rental data. So -- and it's UltraFICO where we go into -- with the consumer's permission, of course, we go into the consumer's checking account and we look at indicia of responsibility, have you not had any overdrafts? Do you keep reasonable minimum balances? Those kinds of things are predictive, and we'd like to give consumers credit for that. And so UltraFICO is built around that idea. So that's on the score side. We're looking for additional data sets but not one-off data sets. I mean data sets that score a reasonable-sized population. Then when you go over to the origination software, which we provide to banks and to credit unions and other innovative lenders, the idea is incorporate any data that you want, I mean, up to thousands and thousands of different kinds of data where it cover thousands of attributes. And the idea there is let's go ahead and whatever data you have access to, let's bring it into the evaluation and make a good determination. And the way to think about it is it's a continuum. If you start with a credit score, low-cost, broad-based population and easy to make a decision, say, for an entry-level credit card. As you move up in the stakes of the decision to auto, to mortgage, higher dollar values, higher stakes decisions, you're going to want to bring more information to the decision. And that's what the software is designed to do, is to incorporate all that incremental information.

Got it. One more on this fintech disruption narrative, and that's around Buy Now Pay Later. And it's more kind of an industry question, meaning the view is Buy Now, Pay Later could disrupt credit cards. And I know credit cards is a big volume for you guys, and therefore, there might be a hit to the usage of FICO Score. So maybe you can help clarify the misinformation there in terms of FICO's role in Buy Now Pay Later? And as that grows, how things change?

Well, I think Buy Now, Pay Later, even though it's growing, it still represents a very small percentage of the total. And I don't imagine it's going to displace credit cards anytime soon. It's up to the Buy Now, Pay Later companies to decide what they want to report to the credit bureaus. And so some do report and some don't report. And they're kind of sorting that out for themselves. When they do report, it is included in the FICO Score. FICO Scores can be built on that data, too, just like any other kind of payment data. So I think we'll just have to see how things evolve and the extent to which the Buy Now, Pay Later guys want to report and the bureau similarly providing that data to be incorporated in a FICO Score. But the score is absolutely capable of capturing it and using it. It's -- look, it's a trend. It's a good thing. It's another way for consumers to buy, and we'd love to see it.

And just one more to that point. In your experience, as these fintechs grow bigger and bigger, do they have a choice whether they need to report it to the bureaus or follow kind of the regulatory guidelines of credit bureau and FICO Scores?

They are -- they make the determination whether or not they want to report. Now it's to the benefit of their customers to report. So they typically want to report, try to report, and a lot of them build that into the value proposition for the consumer, which is do this Buy Now, Pay Later with us and build your credit with us because we're going to share it in a way that it is beneficial for you to build your credit. So -- but it's up to them. That's their decision.

Okay. Understood. All right. So in the next 8 to 10 minutes that we have left, let's touch on software quickly because you've obviously given a lot of new disclosure there and it's important. And just on a broad level, we've talked about this before. I think ideally, you'd want, obviously, the stock to be a lot higher, and maybe half of the valuation comes from the software business. But how do we get there? Because today, still, as we've been discussing, the stock moves on the Scores business. It probably trades mostly on the Scores business. And so how do we get investors to appreciate what the true worth of software is?

Well, so our software business, it's a terrific business. And -- but it's really a tale of 2 businesses. And it's probably worth just spending a minute on the evolution of the business so that you can understand where we are today. We started out years ago with point solutions that we built for banks to solve very specific problems. So for example, credit card fraud. We wanted to be able to evaluate how likely a transaction was to be fraudulent. And so we've built software to do that, origination software that we just talked about. Customer management software, how do you manage a customer over time in terms of raising or lowering the credit line, that sort of thing. And so there's all these strategic decisions that have to be made around the customer in the financial services space. And our software was designed to solve very specific problems. What we recognized was that each of the problems that we tried to solve, our distinctiveness was around the decisioning. What made FICO special was we're really good at the analytics part of it and understanding how to predict consumer behavior and understand risk. And so what we did was we started to broaden our thinking about what it was we were offering in the marketplace and move from point solutions to more of a platform-based approach. We would have common decisioning across all of our solutions, and we have the same decision engine built into our different solutions. Well, it didn't take very long for us to figure out that you want to have common data plumbing, common data orchestration, common data wrangling. You wanted all of it to be able to come into the system and then apply a wide range of analytics. And so the platform -- our platform strategy evolved from these point solutions into being a platform strategy. Well, when you take a step back and you look at what we have today, our aspiration is to be the preeminent decisioning platform for B2C companies that are trying to optimize their interactions with consumers. And the way we get there is we leverage data, as we always have done. We leverage data, we apply analytics and then we optimize the interaction. It might be a text message. It might be an e-mail. It might be a phone call, inbound or outbound. It could be walking into a bank branch or a store. But all of those things should be done with a view to everything we know about that consumer. It should be true one-to-one interaction. And so that's what our software is designed to do. Think of it as next-generation CRM because that's really what it is. It's the 360-degree view of the customer, the customer journey, all of those kinds of things. That's what our software is designed to do. So we are, as a business, we're in this transition from our point solutions, which are, frankly, terrific solutions. They're deeply embedded in the financial services industry today. Banks use them and will continue to use our solutions for many years. We continue to invest in enhancements and improvements and additional features and functionality in our point solutions. But going forward, the action is really on the platform side where our strategy is built around building -- providing a platform to B2C companies so that they can do great things with their consumers.

So maybe asked another way, you talked about in the last earnings call how platform revenue should probably grow 50%, 5-0 percent, every year. And then the legacy business or the remaining business is kind of flattish. So how does that dynamic work? Like how does platform grow that quickly without the expense of the rest of the revenues?

Well, the way it grows is increasingly -- and we're really financial services based today. I think 3 or 4 or 5 years from now, you'll see a wide range of nonfinancial services verticals leveraging FICO technology. But today, we're more focused on financial services. And a typical platform growth comes from large lenders who decide they're in the middle of the digital transformation and they need a mechanism for bringing it all together. And the FICO platform is the perfect solution for a large lender who's trying to go through a digital transformation because we do talk to the consumer through all the different channels, through all the different ways that you're going to interact with the consumer, and it's all digital. So that's why we have the growth that we have on the platform side, the 50% growth. On the legacy side, our software goes in, and it typically is in for many, many years. We might start with a 3-year contract, but it typically gets renewed at least a couple more times at 3-year intervals. So our software could easily be there for 6 years, 9 years, 12 years. And we're seeing that. And so that's why I don't think the classic FICO business is going away anytime soon. It's -- we will continue to support it. We have a lot of customers who rely on it. And when they're ready to make a move to platform, we're there to help them, but we won't abandon them.

Got it. And we're coming up close to 10 years now since you took over as CEO. And still, I don't think a lot of people really give software the credit it's due. How much longer do you keep putting in this effort before you decide you have to find another way to unlock value here?

It's true that we don't get credit for a lot of value for our software business today. I mean I think anybody who analyzes our stock price comes to the conclusion that you can explain 100% or maybe 120% of our market cap with the Scores business. Meaning that the software business really is disrespected. That's true. And could we unlock value in the short term by doing -- taking some steps? We could. I think that the question is can we unlock much more value in the intermediate term by continuing on the path that we're on. So we have tremendous success right now. We have 19 enterprise customers who have decided to standardize and build their future digital operations around the FICO decisioning platform. And while that doesn't flow into revenue instantly, it absolutely is the cornerstone of a land and expand strategy where we become the center of their operations and then we continue to provide more value by building out additional use cases. I think what we'll see is, over time, there will be recognition of the way that the market is embracing the software. And we ought to start to see some kind of appreciation for what it is that we're building here. And I would liken it to Salesforce 20 years ago when they weren't making any money, but they were building out quite the ecosystem. I think that we are on that kind of a path.

Got it. And so maybe just to round it up here. Obviously, we've talked about Scores. We talked about software. It sounds like you're extremely bullish on both the businesses. And one of the things you've done brilliantly over the last 10 years as well is the buyback program. I noticed just since last quarter, you've already bought back $170 million worth of stock, and you just authorized yourself another $500 million, which sounds like it gets used up immediately. But just your thoughts on the aggression today on that program.

Well, so we have always been fans of our own stock. That's not new news. I mean the stock -- when I first got involved with FICO, we had 76 million shares outstanding. When I became CEO 10 years ago, we had 36 million shares outstanding. Today, we're at around 28 million shares outstanding. So interpret that at how you will, the fact is we are very fond of leverage, we're fond of buying back our own stock. And why is that? Well, we have very predictable cash flows, and we don't think there's a lot of risk in running our leverage up a bit. And so we're comfortable with that. And we believe in a clean, efficient balance sheet that's good for supporting the business we're in, but that doesn't have a lot of extra in it either. And so that's kind of our thought process on that. In terms of intrusive acquisitions, while we're always looking for candidates, we just love our own business. It is really hard to find businesses that are as attractive as our own. And when we buy back our own stock, we have 100% confidence that it's going to work out. We will be successful integrating a really wonderful business. Whereas with acquisitions, sometimes they work, sometimes they don't. We do, do acquisitions from time to time, small ones typically, usually technology tuck-ins. But I would say that in general, our philosophy is we like our own business more than most others. And so we want to invest in ourselves rather than buy other businesses. So that's our capital allocation and M&A strategy in a nutshell.

Well, that's great. That's great to hear. We're just out of time here, Will. So thank you very much. I appreciate you being here and looking forward to hosting you next year, hopefully, in person.

Thanks a lot. My pleasure.

Thank you.