Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. Thank you for sticking with us here late at day 1. For those of you who don't know me, my name is Manav Patnaik. I'm Barclays' business and information services analyst. And we are very pleased to end our day 1 at least here with FICO, and we have Will Lansing here, CEO. So Will, thank you so much for being here.

Great to be here.

So it's not going to surprise you, Will, but let's start the conversation with the Scores pricing story. And I guess, maybe let's just jump right to the recent article that was out there on the HousingWire around the 400% price increase and the complaints. And I know on a percentage basis, it always sounds big. But you guys, I think, in your statement had put it really nicely into perspective. So I was hoping you could just take this opportunity to give us -- kind of reiterate that or how you would explain it.

Yes, happy to. I mean, I guess it shouldn't be a surprise to any of us that the people write these articles and looking for headlines and clickbait. And so we do hear about big percentage increases, but it is very important to put the -- our pricing increases in the context of the value that we provide to the people who are buying the Scores. And frankly, most recently, we've been very transparent about the dollar amounts so that people understand just what we're talking about. So specifically in the mortgage area, we had some price increases recently. And again, kind of sensational headlines, but the reality is that we sell mortgage scores for -- from between under $100 to several dollars, and that's out of -- really kind of a $2 to $8 range is what FICO gets from a mortgage to completion, and that's out of $50 or more of credit-related fees. It's out of $3,800 of closing fees to a consumer. So when you measure the FICO mortgage score in single-digit dollars against kind of the greater cost here as you see it in perspective.

Got it. And the other point you made in the article was you obviously take your price increase, but then the bureau partners had a pretty significant chunk on top of that. So at the end customer, it might seem like it's double of what you just described.

Well, that's absolutely right. And obviously, our channel partners need to be paid, too. And they provide some value, and so they do mark up our scores. But sometimes the people buying the scores don't realize that much more than -- most -- much of the money doesn't actually get to FICO.

Got it. And then the other aspect was obviously it's a volume-tiered pricing. And so can you just help us like how many like of your customer base, like what is the large customer mix versus the small customer mix? Or is it just kind of industry?

It's -- well, so the very largest customers had kind of customary cost of living increase this year, and the smallest customers had a bigger increase, but it's still several dollars is what we're talking about. We're not talking about huge price increases. And so there's tiers -- there are several tiers, and that's the range from $100 to several dollars.

Got it. And so then maybe just to step back a bit, this pricing strategy began in 2018. But just the cost versus value dynamic, which is why you're embarking on this pricing strategy. Maybe just remind us, walk us through how you see that gap just to understand the sustainability of this.

Sure. Maybe a little bit of history is useful. For over 25 years, the FICO Score, the FICO mortgage score cost about $0.05, and it didn't change for all those years. It was kind of hardwired into the contracts with our channel partners. In recent years, we've started to bring the price up so that we capture a little bit more of the value that has basically been frozen for all this time.

Got it. And so -- and then the last thing just on this specific piece, do you ever see the regulators get involved and worry about this, like the FHFA or other bodies?

Well, of course, we care about what our customers think. We care about what the regulators think. In this case, we actually -- we proactively reached out to the regulators when we -- before -- when we made the price increase and said, "Look, this is what we're doing. This is what we're planning. This is how we're thinking about it. Here's why we believe this is fair." And so we really want to be completely transparent.

Okay. And then talking about the FHFA, their recent announcement that they made. So I would say it was generally net positive because they basically mandating that you have to get a fact, this go in addition, you could get advantage for as well. But the slight negative, I guess, is instead of getting tri-merge. They're asking you to get a bi-merge, which means you pull one less report in Score. Do you see that as a negative? Or how do you offset that kind of...

Well, not really. I guess the way we think about it is we're delighted that the FHFA in the end selected FICO and is mandating a FICO Score for a conforming mortgage. That's obviously very good for our business. It's good for the system. It's, as you know, a very low-cost way to evaluate credit, and it's great for all the downstream participants from Fannie and Freddie on down to the investors who need to understand the risk associated with the paper that they're buying. It's...

Just the tri-merge to bi-merge reporting, yes.

I'm sorry, the tri-merge to bi-merge, I guess from a simple numerical standpoint, we'll be pulling 2 scores instead of 3 scores because it's bi-merge instead of tri-merge. But we don't really think about it that way. We think about it in terms of the FICO scores as part of the process, and so there's kind of a value provided by FICO to determine whether or not you want mortgage should be extended. And so I think we'll be collecting our fair share of that, whether it's 2 scores or 3 scores.

Got it. The other question we get a lot from investors is, yes, FICO Score has been around for a long time. But does the FHFA validation of the VantageScore mean that they could actually start gaining some ground in other categories even?

I don't think so. I think it's been a very competitive environment for the last 15 years. And outside of mortgage, it's -- there's no mandates of any kind. Every lender can choose any score that they'd like to use. They typically choose FICO scores. They often use scores of their own. And so we welcome the competition, and it's never hurt us. We've been fine with it, and I imagine that's how it will be in the future. I don't see some incremental validation there. We're dealing with very sophisticated lenders who do their own assessment. They're well aware of what FICO brings and what Vantage brings.

Got it. In your guidance, you assumed CPI pricing and not the special pricing. So maybe just for the benefit of the audience, just help distinguish how you look at CPI pricing annually. And then we already talked about special pricing, but maybe just the CPI side of things.

I don't want to oversimplify, but it's not that complicated. We sit down once a year and think through the pricing for the subsequent year, and we published a new rate card on September 1. One -- it's one card. It's the same pricing across all 3 bureaus. There's kind of equivalency there, parity there. Obviously, there's very different prices for different scores, for different size customers, for different volume levels. We have volume tiering. So I mean there's some complexity in the rate card. But I think the thing to remember is it's one pricing adjustment per year. And when we do it, we don't actually break out CPI versus special pricing versus anything else. What we do, do is when we're explaining to investors what's going on under the covers, we talk in terms of CPI and special pricing. And so CPI tends to be an across-the-board adjustment, a customary adjustment, for cost of living. But then special pricing tends to be a little more surgical where we've identified pockets of opportunity.

Got it. In terms of the other nonmortgage categories, kind of like you helped explain a couple of dollars versus $50 for credit reports, $3,800 for closing. Like how would you describe that cost gap in auto and on credit card as well?

Well, I think in auto, I mean you all know what cars cost, and auto scores are priced even lower than mortgage scores, so you get a sense for the value gap there. And then -- and credit card, the lenders actually spend quite a lot of money acquiring a new credit card customer in the $100 plus. And the FICO score is a very, very small piece of that. The gap might even be bigger in credit card than in mortgage. I mean it's big.

Got it. The one component of your scores guidance, I think you assumed flat volumes. I presume like the MBA right now, for example, has mortgage down 20% or something. So what categories are offsetting that down, call it, 20% in mortgage?

We did anticipate lower volumes there. Credit card is okay. So far, auto is okay. But we did anticipate lower volumes.

Okay. And then maybe just to wrap up scores on the D2C side of the equation. You just announced -- or you talked about extending the big contract, which we presume is Experian for another 5 years. But just talk about like the strength of that relationship and the outlook there, perhaps.

Well, we have a great relationship with Experian. And really, what's going on there, and it's very complementary, we both bring something to the party. We have the FICO Score and the very strong brand that goes with that. And Experian, they have a whole bunch of value for the consumer. And they're tremendous marketers, consumer marketers, and they're building this great consumer relationship. And they're leveraging the FICO brand and the FICO score to acquire customers, which is a great thing for us because we have a rev share when that happens. And so it's just a very healthy relationship working well for both of us.

Got it. Okay. So moving on to the software business. Obviously, Scores is going great. On the software side as well, we expect the platform growth of 50% has continued just as you said you thought it could do. But just help us appreciate if things do slow down next year, if there's a mild recession, what are the flavor of recession, can that 50% continue?

Well, no one can really see into the future. We are anticipating continued growth at that kind of a rate for the platform business. We haven't seen any softness at all. We have tremendous interest from the largest financial institutions around the world in our software platform. And the reason is that it's -- and the reason I think that it's strong even in softer economic environment is that it's so strategic. It's really transformational. So our customers who are adopting the platform are in the midst of reengineering their businesses so that they can really build a very strong relationship -- digital relationship with their consumers. And they recognize that to do that and do it well and to compete with fintechs, that what they need to do is optimize every single interaction with the consumer in a way that leverages everything that's known about the consumer. So you need to leverage all the channels, e-mail and text and call center and walk into the branch. All that stuff, all has to be understood in the context of all the other interactions. And then we need to optimize what we do next with that consumer when we interact with them. And that's something that the biggest, most sophisticated banks are really focused on today, and it can't wait. So yes, we have some softness in the economic environment, but you're not going to wait to reengineer your business when it's a strategic priority.

Got it. And maybe a similar question on the non-platform side, the resiliency there. But also we would have expected a platform is growing north of 50% that there would be some cannibalization, if you call it, as a non-platform and maybe see that bleed, but that's kind of being flat to up low single digits. So what are we missing there?

Well, so what's happening there is we -- our -- whether you call it legacy business, classic business, our solutions that are sold at application by application are very successful. They're deeply embedded in bank ecosystems. Used and typically renewed over and over and over. It could be 2, 3, 4 renewal cycles. And we continue to invest in features and functionality in these solutions so that they don't get stale, so that they continue to provide value. We do have -- when we look at the portfolio of solutions -- off-platform solutions, we have some choices. We can end of life products or we can continue to invest in features and functionality to keep them alive longer, and we do a little bit of both. And so we're -- we kind of cherry-pick in the portfolio and say, "Okay. These really -- it's time to do end of life, and we don't -- we really do not want to incur more technical debt by continuing to invest in these things. But these over here, they have a happy future and the customers really depend on them, and so let's continue to invest and make them really great." That balance between end of life and investing in features and functionality to extend the life of some other products, that balance is driving kind of 0% to 1% growth on that side of the business. And we like it that way. That's a good balance for us.

Got it. Broadly, on the software side, in the -- during the global financial crisis, it was notably impacted. But maybe just help us appreciate the differences both in the business and the mix of the business today, but maybe just the environment as well, why you probably don't see that same kind of a hit.

On the software side or across the broad?

Yes, software side.

Software. Well, sure. So if you go back, the last really big downturn was kind of 2007 through 2012, and what we saw was tremendous cutting of the IT budgets in the financial institutions. They just said we do not have money for this, and they just really hunkered down. And FICO was really -- back then, we really got hurt in that cycle because we're very dependent on financial services, and the budgets kind of dried up for quite a few years. We're just a very different business today. And although our customers face some kind of pressure, I think the financial institution industry is in much better shape today than it was then and our stuff is more strategic, and so stuff likely to be cut.

Got it. And on the margin side, the -- besides the 50% platform growth, what's been positively surprising us as just being the margins on the software business, and I know you had gone through years of investment. So just talk a little bit about how much investment is left in then. Is that something -- is that a lever that you're willing to pull in the event top line slows down?

I think that you have to be prepared to do that for sure. I would say that over the last couple of years, the margins have improved. Some of it was COVID-related as real estate footprint shrink, as travel was reduced, as we learned to operate a little more virtually. So there were benefits that came from that. We're definitely operating with fewer people than we had a couple of years ago. We peaked at 4,000 employees, and we're at about 3,400 today. So we're a leaner company than we once were, and that also contributes to margin improvement. I'd say when we look out into the future, the things -- the kind of the 2 things that would improve margin for us. One is as we scale up the platform business, the margins naturally get better, and so just continued growth is a good thing. Let's grow, grow, grow, and margins will improve. And then the other is as we reach critical mass in our features and functionality, I think that we'll be in a position to dial back a little bit the R&D spending, and that will also contribute to better margins.

Got it. And the portfolio today in software, I guess what I'm trying to understand is, are there other smaller pieces of it that you might be looking to sunset, to get rid of? Because you go into collections and recovery, cyber scores on barrier more recently. So are there more of these smaller things in there that you feel like we should be expecting?

Yes. I would say never say never, but we don't have any immediate plans. I think that we're pretty happy with the portfolio that we have. We've gotten kind of down to fighting weight, if you want to think about it that way. Everything that we're working on right now, platform and non-platform, all of it feels right to us. We're serving our customers well, and so it doesn't look to us like there's anything that needs pruning, but you have to always look at these things.

Got it. And then if you could just help us break down the software portfolio by how you think of the kind of the biggest components and then perhaps who the competition in those areas is? Like in some cases, like Falcon, I don't think you have competition. But just to try and help us appreciate how you called it strategic. Earlier, banks need it, won't really do without it. So if you could just help us with that in perspective.

Yes, and I think the competition varies with the solution and with the kind of offering that we have. Certainly, on the platform side, we have less competition. The competition is really from build your own. So we're dealing with large financial institutions, very sophisticated. They know what they want to do. They have a clear picture of this digital relationship they want to build, and a lot of them have embarked on this with all homegrown. They've kind of gotten started doing it themselves. When they see our platform and they find out how much stuff FICO has already done for them and they think about the time to market and the time to completion, if they were to leverage the FICO platform and then build on top of it relative to just trying to do it all themselves, they all come to the same conclusion, which is they'd be foolish to try to recreate what we've done, and they should build on top. And so the FICO platform is very much a toolkit for large, sophisticated lenders to build out all these different use cases and things that will improve the way they work with their customers. So I hate to say there's no competition. Of course, there's alternatives, but the biggest alternative to the platform is really homegrown by the customer. In some of the older solutions, some of the point solutions, I should call them, we have -- in originations, it's Experian. In fraud, although we have a very large market share, and we really -- we're happy with our presence and position in that space, we do compete with SaaS. There are some small players that occasionally win business in that space. So we're not alone there, but I think it's really -- it's kind of solution by solution.

Got it. And so kind of tying software into the broader capital allocation question, I mean still no M&A in the pipeline?

And I get asked this all the time, and the thing is this, we've done 10 acquisitions over the last 10 years. Several have been good, very good for us. One, really, really good for us, CCS Adeptra. But we've also had some -- I wouldn't call them misses, but just they didn't really do very much for us. They turned out to be less exciting than we hoped when we did the acquisitions. We're of a view today that particularly because we want the cleanest code base around the platform that you can possibly have, and when you bring in outside acquisitions, it's hard to make that work. So we're happier to do organic development around the platform than to buy stuff. And then you say, well, what about missing technologies. And I would say so many of the missing technologies we can get by licensing, by buying as a customer as opposed to buying the company. We don't actually have to buy the company to get the solution. And so we're -- that drives our thinking. And then finally, probably the thing that drives us the most is when we think about $1, investing $1, do we want to invest in our own business, FICO through stock buyback? Or do we want to buy dollars' worth of somebody else? And there are just so few businesses that we see out there that we like more than our own that it just makes M&A not that interesting.

Got it. That makes sense. I just wanted to pause and see if there are any questions in the audience. We have a couple of minutes left here. Okay. So on the buyback front, well, because you're kind of in the software like Score, but you covered by a lot of generous. We always get the question around you have a big stock comp number, dollar number at least. Just talk us through your strategy on why issue so much stock and then why -- I understand the buyback component of this.

Well, the buyback piece -- there's 2 pieces. One is, yes, we do have a fairly significant stock comp expense, and I would say it's really simple. It's because we have great people, and we pay them well. And what we want to do is encourage them by aligning their incentives with shareholders, and so we'd rather pay in stock than in cash. We recognize it's an expense, but we'd rather pay in stock than cash, and we get the alignment of interest with the shareholders. In terms of buying back the stock, we think it's a very efficient way to return capital to shareholders, and so we've been doing that for a lot of years. As you know, we peaked at about 74 million shares. And when I joined the Board 16 years ago, we were at 36 million shares. And then when I became CEO 11 years ago, we were 30 million shares. And today, we're at 25 million shares. So some people think we're kind of a public LBO.

And then maybe let's just end with -- we've got -- I mean it's a fabulous story. You've got the Scores pricing. You got the direct to customer with Experian. Software seems to be well. Are there any other strategic initiatives that we should be keeping a look out for? I mean since you joined, you've obviously made some big strategic decisions with Open Access, with the special pricing, with the platform transition. What else should we be keeping an eye on?

Yes, thank you for asking the question because so many people think that Scores is just a pricing game, and it's not. We have -- we invest very, very heavily in innovation. We're constantly bringing to market new scores. We have a score called FICO Resiliency Index, which is a tool for the times. It really is sensitivity in economic downturns and how do consumers behave in that kind of an environment. We have other things in the pipeline that I can't talk about yet, but you'll be excited when you see them. So a lot of innovation on the Score side. And then -- and similarly, on the software side, I mean we're just -- we're constantly doing new and interesting things. So those are the big areas where we invest. There's not like some new secret project. We don't have a Manhattan project or anything like that.

Got it. And then I lied, let's just end with, I think, obviously, the stock is closer to $600 now. Where it was at $400, I think you were probably frustrated at where it was sitting there. But just based on your invested conversations today and over the past few months, like is there something you feel like investors are missing or underappreciating from your standpoint?

Well, I think a lot of times, people see a big stock jump and they think they missed it, and I would just say we're just getting started. I mean at $600, our stock is still quite a value, and we have great opportunity ahead.

All right. Well, I don't need to say anything more than thank you, Will. And thank, everybody, for being here as well.

Thank you.

All right. Thank you.