Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

Good morning. I'm Ashish Sabadra. I cover business and information services companies at RBC Capital Markets. I'm excited to host Steve Weber, CFO of FICO. Steve, thanks for coming.

Thank you, Ashish. Thank you for inviting us. It's a great conference. We're happy to be here. Thank you.

We'll start off or kick off with a question that we're asking all the companies at the conference. It's on macro. And in your -- from your perspective, can you just comment on consumer lending? And if you can talk about like all different kinds of consumer lending, what's happening on cards, autos, personal loans, mortgages? But also from a software perspective, what are you seeing from a financial services and their IT budgets?

Sure. Yes, there's a lot to unpack there, right? So there's a lot happening. It's interesting because this is -- I've been doing this for a long time. This is unlike anything I've ever seen in terms of you have higher rates, you have low unemployment. So the consumer is strong. There's all -- the banks are strong, for the most part. We saw some -- obviously, some fallout earlier in the year. But the bigger banks are very strong and they are still lending. They're cautious about their lending. I think they're probably moving upmarket a little bit. But the rates went up so much so quickly, and I think they stated -- it was higher longer than everybody thought. So that had a big impact on the mortgage market. We saw the refi market basically collapse and shut down almost entirely. And a lot of consumers, I think, are just kind of waiting to see what happens. So even if they are able to get new mortgages, a lot of them are choosing not to because of the rates. So that's interesting to see what happens on how long that kind of takes to get back to some sort of normalcy. Maybe we'll see some loosening of rates, and I think there's probably some pent-up demand on the mortgage side, but we'll see. I think -- I don't -- it's anybody's guess what really happens with rates going forward. So that's kind of that market. But we're still seeing decent volumes there, but it's historic lows. I mean we're not seeing a further decline, but it's just kind of minimal activity that's happening there. Auto has been relatively stable. I think, again, you have relatively full employment. People are living their lives, and the auto market is probably less rate sensitive than other markets, certainly than mortgage. If you need a car, you're probably going to buy a car. You're not making a decision based on what interest rates look like. So that market has been pretty stable. We haven't seen a lot of volatility there. On the credit card side, credit card origination is -- there's still a fair amount. It's -- that can be relatively volatile in short periods of time. It can even be seasonal as some of the large lenders do different campaigns. I think there's definitely been a move up market there, just kind of been squeezing in the subprime market and trying to manage risk a little bit. But it's still a good entry point for a lot of customers into banks. And banks are in business to lend, so they're trying to move to areas that are still profitable for them but probably hold a little bit more risk. So that's kind of how we see the credit markets. On the software side, we're just seeing really good demand for our products. And a lot of what we offer is -- you hear banks talk a lot about digital transformation, and they have since for several years now. But I think our platform business really was propelled by the pandemic. Banks, they were seeing their customers in person less frequently. So people don't go to the branch offices much anymore. So the banks are forced to interact digitally, be that through an app or through text messages or e-mails or sometimes, voice mails. So they have ways to do that, but they have to have a decisioning behind that to determine what to put in those messages. And that's what we provide. So we have the ability with this platform to take in a lot of different data sets, applying analytics on top of that and figure out the best ways to do things that used to be done in person.

That's very helpful color. And if you don't mind, I want to spend one more minute on the macro, particularly talk about marketing. And I was just wondering from a credit marketing perspective, what trends have you seen in the last quarter and any kind of changes there as we -- the last month or so?

Yes. So I mean we have visibility to one subset of marketing, right? So we have visibility to the pre scores that are polled before a mailer is sent out. So if you go back 15 -- I mean, I used to work for a credit card issuer and that was how we did market back then. I mean most of what we did was send out mailers to people. And that was what marketing was back then. You do some events, but you didn't have the kind of Internet marketing you can do. Now I mean a lot of it's done differently. It's done through Internet [ market ]. We don't have any visibility to that. So we see the scores that are pulled before mailers are sent out, and there can be quite a bit of volatility in that. I mean a year ago, it was pretty high. Today, it's down from where it was a year ago. And it's relatively flat that we're seeing, maybe down a little bit, but that can bounce around, again, based off of a large issuer doing a big campaign. So we're not seeing as much of that type of market as we've seen in the past, but it's not like it's fallen off a cliff, either.

Yes. No, that's very helpful color. Maybe just switching gears a bit and focusing on the special pricing. We saw some pretty significant tailwinds for the mortgage origination revenues for FICO. And over the last several years, you've had special pricing. How should we think about -- any preliminary color on how should we think about the special pricing for next year?

Yes. I mean first of all, we talk less about special pricing because we have one price for the different scores. And it's kind of confusing, how much is special versus CPI. And a lot of these prices hadn't been touched for decades. So we're kind of trying to bring them up to what we think is kind of a market level. So we do that every year. We don't talk a lot publicly about pricing because it's a sensitive subject, obviously, and we kind of have those conversations with our customers one-to-one instead of in public. But we do think in a lot of cases, the value we provide is well beyond what we charge because we -- the charging -- the price that we put in place in the '80s, in some cases. So a lot of the world has changed a lot since then. So we do look at every year, the different markets and the different scores that we sell, and we try to think about if it's bundled in with other products what -- how much of the bundle is -- are we getting in value versus what are others getting. And what -- we think that's right. So we just try to do market checks and try to understand, again, what kind of value we're deriving versus what we charge for them.

That's very helpful color. And as you pointed out, the -- like FICO score is such a small cost compared to the cost of originating a mortgage loan. And particularly, when you think of the value at risk compared to that, what you're charging is such a small amount. As we think about -- is this kind of not special, but again as we try to think about pricing for value, is that an opportunity as we think about just in '24? Or is this like a multiyear opportunity?

Yes. I mean I think it's multiyear. I mean, I think there's a lot of areas where we're charging less than the value. I think -- and to some degree, those goalposts keep moving out. I mean the world is moving on, and there's a lot of different things that are evolving and there's -- everything is going up in price. So it's -- again, it's something we think about kind of over a multiyear term, but we will look at it really hard every year.

That's great. That's great color. And then one question that we get a lot from investors is around FHFA and their decision to move to -- from tri-merge to bi-merge, that seems to have been pushed out. And so I was wondering, do you have any more clarity on...

On the timing? I don't know. I think it's a difficult change to make. And I think they announced this -- their intentions about a year ago. And I think there was a lot of pushback from different players in the industry in terms of what does this mean, how is that actually going to be implemented. It's a difficult thing to do. I mean it's a very core piece of the financial component to North -- in the U.S. with the conforming mortgages. So it's not an easy thing to do. We have a lot of different players in it that have a lot of different opinions, and they want to know what the benefit is from the costs associated with it. What potential risks they might be taking on. So I think it's just something that has to be done at a pace to make sure everything is done right, because there's -- obviously, it's big dollars involved, backed by the federal government. So we just need to make sure that it's done in a timely but not rushed fashion and that all the things were thought through.

That's very helpful color. And would you say that maybe FICO is also agnostic to it because...

Yes. I mean to the -- I think moving from the tri-bureaus to the 2 bureaus, it doesn't directly impact us. But obviously, I mean, we want to stability in the system. We don't want potential risk put into the system. We don't want uncertainty put into the system. And how would this actually work? I mean, do you have to take 2 or could you take 3? Can you take 3, and then choose the best 2? There's a lot of these things that need to be thought through in terms of how it's actually going to work and how the different players are going to operate in the system.

That's very helpful color. And then just moving on to the B2C front. You've seen pretty good stability there. How should we think about the B2C business going forward?

Yes. I mean -- so there's 2 pieces of that. We have partners. A number of partners -- Experian is our biggest partner. They are very, very good consumer marketers. So they're good at pivoting to whatever kind of -- what the markets look like. And we've had a lot of success with them in their Boost product. So you see a lot of commercials for that. I think you're seeing Travis Kelce lately on those commercials. So there's a lot of that. They're really good at what they do, and that business has been really stable through different types of consumer behavior. The other side of that business is our myFICO.com business. And when the pandemic came, we saw rapid growth in that as people were at home, they're thinking through their finances, they're all looking to refinance. And they're like, well, if I spend some time on myFICO and buy that for a while, I can kind of see how banks are looking at me and maybe manage my way through this and get the best possible deal. So we saw a rapid uptick in growth in myFICO. That leveled off. It came down a little bit. We're down from the highs where we were, but we're still at a pretty high level above where we were pre-pandemic. So we don't really have the refi boom that's kind of -- with the tailwind there. So we get a little bit of headwind there. But we've lapped our -- this last quarter was the last difficult comp we had. So that's been running pretty stable for this last year. So heading into next year, we'll see. We don't do a lot of marketing on the myFICO business. I mean you guys here have probably never seen a myFICO -- you've never seen a commercial on TV unless you saw the Super Bowl 15 years ago and we only ran it once. Otherwise, you probably rarely see digital marketing, every now and then you'll see. So there might be some things we can do there to kind of capitalize on the brand a little bit. But we're really not consumer marketers, so we're not going to step into that in a big way.

Okay. No, that's helpful. And then as you think about your pipeline and new win opportunities across the board, particularly I'm talking about the scores front. How do you see that going forward?

Yes. I mean the pipeline, we do a lot of innovation that we don't necessarily talk about a lot because a lot of it is long term. We had -- a couple of years ago, we came out with the FICO Resilience Index that we -- it's a tag along to the Account Management Score. And what it does is it shows how different consumers would fare during a downturn. So you might have 2 people that are 680s, but because of the makeup of their -- what's involved in that 680. Some are going to be more resilient in a downturn because maybe they have less debt and they are going to be less impacted. So it's an additional thing we can tack on to what we already sell to the banks to give them a little more visibility. So we have things like that, that we don't necessarily have near-term revenue benefits from. But it kind of -- as part of the package, it gives us a little more ability to raise price for the overall package. We're still working on UltraFICO. We have that in test and in a lot of areas. It's kind of like Boost, but it's a little different, has a little more information available. There's a lot of things we're doing, potentially we don't talk about a lot, they're kind of are still in labs that they look out a little bit further in terms of -- we're always -- we have a fairly large team that always is working on innovation.

That's great. And then on the call, it was also mentioned there was a bank or a lender that adopted FICO 10 T for mortgages. I was just wondering if you can talk about that.

Yes. And that's for nonconforming mortgages, so they can't use them in conforming mortgages yet. But it's -- 10 T is a lot more predictive and it's got trend data in it. So there's a lot of additional lift from that, and they're seeing the benefit of that. So they're committing to using that already today.

That's great. Again, if there are any questions, please raise your hands. We will switch gear to the software side of the business. As you mentioned, very strong demand for your Platform business. Your platform ARR was up 53%, and this is on top of 50%-plus growth last year as well. So very strong momentum in the business. Can you just talk about what's driving that momentum?

Yes. Again, it's back to the same, where we have the right product or the right platform at the right time, I think, for banks. I mean they're all looking to -- you hear it. They kind of become buzzwords, but digital transformation and the 360 view of the consumer, it's really important today, right? I mean banks, it used to be they were all silo-ed, and if you go into the office and if you wanted a car loan, you walk down that hall and talk to Jerry. And if you talk to Lisa if you want a credit card. It was all very silo-ed. And they -- the different parts of the bank would not talk to each other, they -- you were a customer of the different pieces. More and more, they're stepping back and they're taking a holistic view of the consumer. And they realize that if we really want to optimize our relationship with the consumer, we have to optimize every interaction we have, and more of those interactions are digital. And we know so much about the consumer based on all the data we have. We'll know -- in some cases, we'll know what they want before they know what they want, right? We see their DDA accounts. We realize that they got to raise this year. And they -- and by the way, they paid off their car loan 2 years ago, so maybe they're interested in a new car. So rather than wait for them to come to us, we'll take all this information and the analytics you put on top of this, we'll make them an offer specific to that. Historically, they've sent an e-mail to everybody is saying, "Hey, we have rates as low as whatever." And then people go in and be disappointed because my rate is 2% higher than that. So now it's a specialized, more of a one-to-one message they can send to that consumer, telling them exactly what kind of offer they have. And again, the consumers appreciate good offers, not just like mass e-mails coming in. So they have to get better at that, and that's what we're doing. And our platform allows that. It's a way to ingest all the different types of data they have and then apply analytics on top of that. And try different marketing tactics, champion challenger scenarios and figure out the best way to proceed, and then figure out how to push out offers or whatever you're doing to them. It can be used for a lot of different things, offers are just one such kind of metric.

That's great. And AI machine learning comes up a lot in the conversations these days, and particularly Gen AI. Can you talk about how those trends are a tailwind for your platform?

Well, we've been a big user of AI machine learning going back to '90s. I mean Falcon Fraud Manager was probably one of the first products -- software products to actually have AI embedded in it. So a lot of what we use AI for, historically has been fraud detection. It really works well because you're looking at, in some cases, billions of transactions and identifying trends. And then building that, having models that learn from that. So you, in real time, you're constantly updating things. That's been one of the areas we've used it a lot. More and more what we've worked recently is something we call explainable AI. We have a lot of patents around that because we're operating in very heavily regulated industries, right, or our customers are, that have to justify to regulators what they're doing and the changes they're making. So if you have a black box, you can't really explain that to anybody, right? So if you're making decisions based on an AI model that keeps changing, unless you have a paper trail behind that and you can understand all the things that have been done to that, it's difficult to satisfy regulators. But like with originating credit, for instance, is really difficult to do with AI. Because there's -- the regulators -- it's highly regulated in terms of what you can and can't use. You have to be able to explain why you gave someone a loan or didn't give them a loan, and what the risk involved in that is. So anybody that talks about using AI to originate credit, it's really difficult to do because you run afoul of regulators pretty quickly. Because you end up with things that correlate to protected classes that you can't include, and then you end up not being able to explain to somebody why you're turning them down, which, obviously, is not allowed.

That's helpful color. And then as you mentioned, like the platform really gives banks an opportunity to get a 360-degree view of the customers. I was just wondering, how have you seen the adoption? Because the DBNRR have been really strong at the existing customers, so can you talk about like -- or give some anecdotal examples. I know there are the top 3 banks in Brazil, a major big, bank in Canada are all customers and [ different countries ]...

Yes, we've actually signed a lot of banks in the last year in North America. So really, the strategy is to drive down the installation costs as much as possible to get them -- get it installed, get the plumbing hooked up, so the data flows are all working, even for a small use case. Because once they use that, it's pretty easy to get them to ramp it up because the ROIs are really high. The payback on some of this is as soon as a year of installing it, and then you start to see some really significant economic benefits. And then you get evangelists within the bank that are telling others, "This is what we're using. It's a tool we're using. There's different ways you can use it," because the data is already there. So it's -- that's been an effective way for us, get it installed and then once people start using it, they find out the ways on their own to use it. We have teams. We have customer success teams that will come in and help, see, this is what others are doing. But in a lot of cases, there are -- every bank is different. And they have a lot of things that we haven't even thought about, like different ways to use it. And that's been really successful for us as well.

Yes. No, it definitely seems like a great land-and-expand strategy. Even the nonplatform business, which historically had some pretty muted [ mood ], their ARR they accelerated to 14% this last quarter. And so, obviously you talked about pricing and usage. I was wondering if you could drill down further on what's driving that kind of... [Audio Gap]

Yes, there's a little bit of CPI in there more than historically because CPI is a little bit higher. But I mean there's also like a secular trend, again, with more digital interaction. And products like our CCS product, some of that's new and on the platform, but a lot of it is old enough platform. And there's just a lot more of the banks communicating digitally, so their usage drives up. We also have our Falcon Fraud Management, that's another big product. And that kind of just grows with the installed base. So there's just more cards out there, there's just a natural uptick in that. But I mean, overall, yes, I mean, the trends towards digital interaction is really benefiting our business.

That's great. And Falcon, obviously, is the market leader in the space, so...

Right. Right.

Is there also an opportunity for you to migrate some of these non-platform software onto the platform and open up even more...

Yes. That's a great question. I mean, so yes, but it takes time, and banks are slow to move. And banks love the platform, but they also love using Falcon because it runs really well, it's stable and it runs billions of transactions, 24/7. You can't just take it down for the weekend to migrate, so it's difficult. But the longer-term strategy there is just to offer more functionality on the platform. And over time, we'll see that move. But things like Falcon, it's this workhorse that's been in place in some kind -- for 30 years, and it works really, really well. And it's profitable for us and it works well for the customer, so we're not we're not going to shut them off and tell them to move.

No, that's great. And from a platform, we talked a lot about how this platform is being used by lenders or banks in general. But it seems like there's a huge opportunity outside the core traditional FI. I think you already have customers in insurance and telco, but I was just wondering how do you plan to expand into other end markets?

Yes. That's a really good question. So we -- so essentially, it's a platform that we could easily expand horizontal -- easily maybe is not -- nothing is easy, I guess. Because we don't really have a lot of domain expertise outside of financial, so most of the areas we're selling into, directly with our own sales force is things that are closely aligned to financial. I mean even telecom companies, if you go into a telecom provider, you go in there and you want a new phone and the plan, it looks a lot like a credit card transaction, right? Because it's -- you're getting a device that they're giving you, you're putting it on a plan that you're going to have to pay for monthly. So the originations process, walking you through what should the pricing be, how does all this work is a lot like a financial transaction. So from that point of view, we have a -- we work with a large telecom provider where we have like a point of sale that's on an iPad, essentially, and walks the customer through it. And again, it can be -- the strategy can be pushed out from somebody centrally and it can be changed every day, if they want to. And the people working in the stores don't need to know all the interworkings to this because it's all run off an iPad. So there are things like that we can do more broadly. If you're -- really, the idea of the platform is you take all the data on the consumer and you try to optimize every interaction you have with that consumer, so that it's satisfactory for the consumer and for you. You want to know what the consumer wants, so you're not -- there's not just a deluge of worthless offers. But you also want to offer that, if they accept it, it's good for you. So it's matching that up and understanding that on a one-to-one basis. Because historically, it's all been crude segmentations. You fall into 5 different categories. You were a soccer mom or a young professional, whatever they were. Now it's much more one-to-one. It's like we know so much about you, we will optimize every interaction. So that's big in financial services, obviously. But there's a lot of other areas that are trying to do the same thing. Financial services was the easiest because they're used to making decisions that way. They have a lot of the systems in place and we have a lot of relationships there. But as we move outside of that, it's harder. So the longer-term plan we have is to work with systems integrators that already have these relationships, and they're looking for more IP to build practices around. So we're making some investments this year to kind of make it easier for those SIs to build practices around it. We're developing software developer kits and different APIs to do that. I mean most of our focus has been on -- internally on how we would help implement. But if we can -- we can only scale that so much. If we can extend it to have others implement and build on top of it, that would be a great thing for us, to kind of build on a marketplace.

That sounds great, because it essentially helps you tap into their -- as you said, their relationship and their network. And so it makes it easier for you to scale faster.

Right, right. Exactly. That's what we're trying to do.

That's great. Do you already work with SIs? Or is that...

A little bit. But I mean, again, the way the platform is built today, we still have to have a lot of involvement. So we're trying to build more functionality in it, so we don't have to be involved at all. So ideally, we turn it over to the SI and say, "Here you go. You can implement. You build on top of this. You work with your clients and we'll just run the infrastructure underneath." We're not at that point yet, but we're getting close to that.

That's helpful. And then you've been deemphasizing or FICO has been deemphasizing professional services. Is that also part of...

It's part of that same strategy, right? So I mean as we build something that's easier to implement, we don't need to be as involved. Even if we fully implement it, it doesn't require as much implementation as it used to. And then if we can get others involved, we don't have to have -- it's hard to ramp up the professional services piece and it's low margin. So we kind of want to emphasize the IP piece and make it as easy to implement as possible.

Yes, yes. And then you mentioned some investments there in order to build those SDKs and open APIs. How should we think about those investments? I think there was a reference to software investments for next year.

They're relatively modest, honestly. I mean from an overall point of view, you might see a couple of points of expansion in costs. In some cases, we'd like to go out and hire 500 salespeople, but you just can't. But we're always looking to figure out how do we scale the business. And sometimes, you have to put some cost into it on the front end of that. But again, they're relatively modest. So it's things like the SDKs and APIs to kind of make it so that we can scale the business. In some cases, it gets retiring a little technical debt to make sure that the business will scale properly. But it's only because we think the growth trajectory is so high. We need to make -- we need to build on those efficiencies today, so that we'll enjoy the results of that in '25 and '26.

No, that's great. And just given how big the opportunity is, it makes sense to -- and the momentum that you're seeing in the business, it's helpful. And maybe just another way to ask question is given how strong the top line momentum is even with the cost, slight cost uplift, can we continue to see pretty robust -- we saw a very good robust margin expansion in the software business this year. Does your guidance for fiscal year '24 also...

Yes. I mean our guidance is probably pretty conservative in terms of margin expansion. We'll probably -- we'd like to think we can beat that. We don't really have near-term targets for margin [ expansion ]. I mean, we were so focused on the top line growth and more of the medium- to long-term margins. We don't want to do anything today that -- we don't want to -- if we fail to invest in a couple of these small investments today, we could pay a big price later on a margin expansion. So putting a little bit in it today when it's still small enough, you can -- to build out all the multi-tenancy, to make sure that you can actually scale this, it's worth doing. Because it has minimal impact today on the margins, but it has a huge impact going forward.

That's helpful. Maybe just switching gears talking about capital allocation. You obviously generated a lot of good free cash flow, great allocators of capital, bought back a lot of stock when the stock had pulled back. So your -- so how should we think about free cash flow -- use of free cash flow going forward?

Yes. I mean it's probably the same. We have predictable free cash flow. It's -- we have a little bit higher accounts receivable now because some of the mechanisms about how quickly our revenue came up. But yes, we have good throughput on that. We've always had good free cash flow. It's very predictable. And we generate cash that we really don't have use for. We don't do much M&A. We have -- we did some tuck-ins, small tuck-ins occasionally, but it looks more like a software buy than a company buy. And we have the choice to either pay down debt, we have some variable debt that we could pay down. About 30% of our debt today is variable, we could pay down or we could buy shares back. And we're really bullish on the future of the company. So we have a longer time horizon. So we look out over the next several years, and we think that if we can take shares out today, that we won't regret it. So we do that fairly systematically. And then when there's a pullback, a lot of times, if there's a broad market pullback or if it's something specific to us, then we'll go in heavily and take out a lot more shares. So we can be a little bit opportunistic, but we're more systematic because -- and you can wait a long time for the right opportunity. So if we had been opportunistic, we wouldn't bought many shares back in the last 10 years.

Yes. Yes. No, absolutely. And just to clarify, your guidance doesn't include any of the capital allocation decisions, none of the debt pay-down or buybacks, none of that is included...

No, yes. Yes. There's too many assumptions you have to make with -- there's too many different things. So we try to simplify it as much as possible and that's upside.

Sure, sure. Maybe if I can go back to the special pricing because that's being very -- like on the top of investor minds. One of the questions that we get is like, particularly for mortgage last year, there were 3 different -- based on the news articles, there were 3 different tiers. And does those tiers make sense? Or is there like a potential for everyone to have the same pricing?

Yes. I mean every year, we look at it and determine what makes sense going forward. So we had put a pricing tier mortgage last year for the first time. That's not to say that we will always have a pricing tier in place. I think it might make sense to have -- collapse those or there's a lot of different things we could look at in terms of that, and we'll probably be talking about that more in the future as it actually gets implemented.

Okay. That's helpful color. And 2 questions that we're asking all the companies. First one is, what is the biggest decision you think the management team will have to make over the next 3 years?

I think it's all about resource allocation, right? I mean we have to determine how much to -- there's a lot of opportunities, but you have to focus. And if you try to do too many things, put too many bets around the table, you have to be focused on what the strategy really is. And I think we've been really good at that. I mean I think we've run the 2 sides of the business really well. But from the software side, we need to make sure that we maintain that focus and don't get distracted. And honestly, that's one of the reasons we don't do a lot of M&A. It's easy to see something -- the kind of the shiny objects you could chase after for a while, and that kind of distracts you from your focus. And I think we're really good at being focused. But that's always the continued focus on that, the resource allocation around that and then execution.

Yes. No, obviously, and then you've had such a strong track record, both on-platform and non-platform ARR. And maybe the last question in closing. What is one thing that you're most excited about the future of the company?

I think the software business is an amazing opportunity. And I think if you -- 4, 5 years ago, people thought you're crazy. Banks are never going to move to the cloud, they're going to want to keep all their data in-house. And we kind of -- Will Lansing, our CEO, was adamant that we had to have a cloud strategy. And I think we're now starting to see it pay off, and we're way ahead of really anybody else.

That's great. Again, thank you, Steve. Thanks a lot. Thank you, everyone, for joining.

Thanks.