Fair Isaac Corporation (FICO) Earnings Call Transcript & Summary

Got it. Sorry, since we moved back into mortgage, I have 2 follow-ups, I forgot to ask. One, we heard from the bureaus on their view on the whole bi-merge, tri-merge to bi-merge debate. Where do you stand on whether that will -- I mean, I know they've moved the timeline out to when it needs to start or could start, but do you think that the industry will go to bi-merge? Or...

Only the FHFA knows the answer to that question. It's clear that the bureaus are opposed to bi-merge, and for some good reasons. I think on the margin, there are some consumers who'll be left behind. So if the goal is to make sure that we are scoring as broader population as possible and providing mortgages and credit to everyone who can responsibly handle it, if that's your goal, and I think that is truly the goal. Bi-merge doesn't help, it hurts. And the bureaus are against it. I think the agencies are in a review process where they're reevaluating that. Officially, they're still committed to moving to it at some point in the future, and maybe they will, maybe they won't, maybe they'll decide it's not worth it. We're -- economically, we're neutral because I think that we would be compensated in a bi-merger or a tri-merge world, it doesn't really matter. It sounds like fewer units, but we could charge more to offset the loss of units. So it would -- it doesn't really affect FICO very much. But for the health of the industry, for the good of the order, I think that reevaluating that decision is not a bad thing.

Got it. And just one more, Steve, maybe I can ask you this one, but the 2 kind of new buzzwords for the year were pre-quals and soft-pulls and that's because you went from charging virtually nothing to the same price from your perspective. And then I think in the pre-qual space also, you can now do 1 report versus 3. So maybe just a little bit of history on that and then how it impacts you guys?

Yes, I think on the front end, some originators are -- before they go in -- go out forward with the entire process, they'll just pull one score to see if it's even worth moving forward. And that's where the real pre-qual happens. And in some cases, in the past, they were paying a very small amount for that. We made it at the same price. It doesn't really have that much impact. It wasn't that much of that activity. But again, putting it at the same price has a little bit more impact on the front end than it did before, but not our numbers overall very much at all.

Okay. All right. Fine. Okay. Let's keep going down the line. So auto, I think, there, I believe, and if I got my year right, 2019, maybe you did your first price increase, and then, it's kind of sorted out. So just your view on how you've envisioned the auto landscape and how you would alter pricing in there?

It's the same kind of a situation where we look at it every year, and there is a gap there in terms of the value we provide. I mean you think about what we charge, and you think about the value that the dealer gets out of it, the value that the lender gets out of it, the value the consumer gets out of it getting an auto loan and the fact that we charge not a lot. There's a pretty good value gap there. And so I think price increases there will continue. That said, we're always mindful of a system in which we don't want shocks. We really want to move in a gradual and predictable way for the benefit of the end customers. And so I think auto is the same. I think price increases can be expected, and I think they could be expected to be moderate as they have been and can be planned for and budgeted for.

Got it. Okay. I wanted to move to Software, had a bunch of questions there. So we'll come back to direct-to-consumer if you have time. But -- so earlier in the little history lesson you gave us, you said you started moving to the cloud in 2015, '16. But -- the fruits of that or the real move only happened, or at least from the numbers, in the last couple of years. So why was your cloud transition so slow as opposed to an Adobe or whatever who announced SaaS cloud, and then, like in 3 years, they were done in whatever it was?

Yes. Well, so we started really even earlier than that, really in 2012. And I would say that it was really slow because of market receptivity. So banks were the last to move to the cloud. And in 2012, if any of you can remember that far back, no one thought that banks would actually move to the cloud. There were security issues and would the consumer data ever be allowed to go outside of a bank firewall and so on. That was kind of the predominant thinking. And I had come from several other software companies, cloud software companies, and I really thought that there was a tremendous cost advantage to the public cloud. And so I thought it was going to happen. And our transition took several steps because we started with data centers of our own, FICO private cloud. And then it became pretty clear -- I'd say, in 2014, it became pretty clear that there was no private player who is going to be able to compete with the big public clouds, and at that time, particularly with AWS. And so we decided back then that we would make the move to AWS. And while we continue to run FICO private cloud, private data centers for the benefit of customers who wanted them, we also made available public cloud. And that's been ever since.

Got it. And in terms of your vision to be like this one-stop-shop platform with all your IP in it, I'll get to the details in a second, but one of the questions everyone asks is, who's the competition, right? And so can you just help us break down who you see as your competition in these areas?

Well, I'll tell you, when we look at our loss reports, I look at loss reports every month, we lose mostly to project canceled and project delayed. We don't lose to other competitors. And the reason is that for most of the people -- certainly for the people buying the platform, for the lenders who are buying our FICO software platform, there really is no alternative. You can build your own, and the expense of building what we have -- we spent $500 million building what we have. Could you build something close for $100 million? Maybe. I doubt it. It wouldn't even be as good. Or you can buy our product for single-digit millions. And so invariably, customers come to the conclusion that they should just adopt the FICO Platform. There are other players who do bits and pieces of it. You've got some workflow guys who if they could back -- work backward into decisioning, they have a story to tell. But I wouldn't say that there's significant competition for us. There are some very small horizontal players who don't really focus on financial services, so we don't bump into them. There's companies like Palantir, who are highly skilled, qualified, smart analytics guys. We never bump into them. Some day maybe we will. But -- so I would say the competition is not significant. It's -- the biggest issue is it's just our own execution.

And is that because it's such a niche use cases that you're targeting? Is the TAM small, which is why they're not involved?

No, I don't think it's that. The TAM's huge. I think it's just very hard to do. So -- what's the TAM? Okay, let's just take a step back and say, what is the TAM for what we do? What we do better than anyone else is we take data, we apply some analytics to answer a question. We produce a decision. We put the decision into a workflow. The workflow goes to the consumer in real-time at a moment of truth and optimizes that interaction. Maybe it's to increase conversion rates to maximize revenue. Maybe it's to increase lifetime value, lower revenue. But when the consumer opts for this particular transaction, it will lead to a greater lifetime value. Maybe it's about profitability, we're optimizing for profitability because that's what we need this quarter. The objective function for the B2C company changes but the goal of optimizing that interaction with the consumer, that's what's constant. They -- what you always want to do is optimize that interaction with the consumer. And any time you are interacting with that consumer, e-mail, chat, inbound voice call at a call center, outbound call at a voice center, you pick your channel, text message, anytime you're interacting with that consumer, if you're not bringing to bear everything that can possibly be known about that consumer at that moment in time, you're sub-optimizing. And so when that moment of interaction occurs, you should be doing -- making your offer or making your interaction with an awareness of the last 25 transactions you've had with that consumer. What did they buy? What's their brand proclivity? What's their price elasticity? What is most likely to result in the behavior we want? And that's the holy grail. That's what every B2C company wants to do when they're interacting with the consumer and should always be doing with a view to what happened the last time this consumer interacted with one of our other channels. They shouldn't operate in a vacuum. Well, everyone wants to do this, and yet it's very, very hard to do. I mean, it's just incredibly hard to do. And we've been at it for a long, long time, and we've cracked the code on how to do it. And we've figured out a lot of issues that have to do with scale. How do you compact all that knowledge about brand proclivity and price elasticity based on dozens of interactions over the last several years into a 20-millisecond response with the consumer at this moment? That is not trivial. It's just a gigantic challenge. And we've solved it. I mean, we solved it because we've been doing Falcon Fraud for 24 years. And we can tell you whether a transaction is likely fraudulent or not in 15 milliseconds. And so we brought some of that technology to this. And so where others are doing crude, brute force kinds of interactions, we're doing these highly, highly tailored ones. I think the TAM for it is huge. I just think it's really hard to do it. To do what we do is hard.

Got it. So this concept of cracking the code, I guess, over the last couple of years, to a certain extent, is reflected in your platform growth rates, and platform is 20% of your software mix. So it was growing 50%, then you said you can see it growing 40%. Now you've kind of brought this down to 30%. So just help us like is it just with the macros maybe now? What do you think the right growth rate for the platform business is?

So it's -- we grew over 50% for 15 quarters. And then now we're at -- we have a 30% growth -- 32% growth quarter. I don't know what the actual number is. I mean, 32% growth on a $200 million ARR software business is not a bad -- that's not a bad number. I don't know whether it'll slide into the 20s or it'll have popped into the 40s. I do think that you catch up with large numbers, and we're very happy with growth rates in the 30s. I can tell you that the customer is very happy. We have a land and expand strategy that's working extremely well. There's plenty of room for growth. If we have any constraint at all, it's probably our sales force. We don't have enough distribution for our IP. So that would -- that's probably a little bit of a lid on how fast we can grow, but that's up to us to fix.

Got it. And -- I've been to many FICO worlds, but the last 2 have been tangibly different, and this kind of excitement that you're talking about shows up in there. From this past one in April, what would you say were your 1 or 2 main conclusions that give you this confidence in this kind of high growth rates?

Well, so we -- I've shared with you guys the vision for what it is that our platform does. We would get up at FICO World 4 years ago and share the picture of what we could do, but it was hard to find customers who are really implementing it and getting the power and the use out of it. Last year, we had customers get up on stage, say, put it in the FICO Platform, surpassed all expectations on business case, pays back in year, 80% ROI, kind of great results. This year, even more so. This year, we had customers clamoring to get on stage and brag about all the things they were doing with the FICO Platform. And so they're very tangible shift in the direction. I think that the people who are doing it have been rewarded in the banks in which they work. Those who have put in the platform have been promoted to positions of greater responsibility, and they look like heroes. The stuff really works. It works, customers are happy with it. The payback is real. And so -- and the sense of that was palpable at FICO World. It was just a month ago.

Got it. And, Steve, you can help with some numbers here, too. But like -- Will, you talked about you've already spent $0.5 billion on this platform initiative. To maintain these growth rates and to achieve -- or go after that big TAM you talked about, how much more spend should we be expecting?

Well, I mean we don't anticipate a step function in more spend. As a percentage of revenue, it probably starts to trend down. We're starting to see some scale now. We're still continuing to invest to add features and functionality. But we've built a product that works very well. So we don't expect to have to spend more, but there's always things we have to spend on. And we're looking for ways to build efficiencies into it to give us more scale as we move forward. So those are the kind of investments we're making today, are ways that solidify the platform, build an efficiency so we can take COGS out and then build more features and functionality that drives more demand.

Got it. And, Will, you talked about sales being your constraint -- salespeople being your constraint. And the TAM and the ambition you talk about, FICO is a relatively small company in the scheme of software, if you call it, in that TAM. So at some point, do you envision needing to be with another bigger player or something to get to your ultimate goal?

There's a lot of pieces to that question. Let's take it a step at a time. So first, Software business as part of FICO, how do you manage that constraint? Well, a, on the direct sales side, we are adding salespeople. It's a long, slow process. I mean, we -- it's the highly technical sale, you need super skilled people. We sell to the C-suite. It's not your Average Joe who can go do that. So we're working that side of the equation, but there -- again, there's limits to how fast you can grow with direct sales. The other part that we're doing to kind of push on the distribution end is we're focused on partnership. So we are -- this year, at FICO World, we announced publication of our APIs. We're going to have open APIs, heavily documented open ecosystem. We're trying to encourage systems integrators and VARs and resellers and ISVs to come to use the FICO Platform and to design solutions for their customers in their verticals, leveraging our decisioning platform. And that's perfect for us because we sit at the center and collect our rents as provider of the platform and let them go and work all the detail around these other verticals, where we really don't have the domain knowledge nor do we have the sales skills. That's underway today. We have a pretty big investment going in in-direct sales, in partnership, and it's working. Is the software business more valuable in someone else's hands? Well, that is super interesting question. You can imagine I've thought about it. Most software businesses when they hit sales of $100 million or maybe $150 million of revenue, they wind up getting acquired by one of the big software companies. And the pretty simple reason for that is there's so much value to be created by taking the software product and putting it through the distribution of a big software player that value is instantly created. In FICO's case, we've been a subscale software business forever and should have been in the hands of another much larger software player throughout our existence, but we had this very, very profitable Scores business with which to subsidize the Software business and to keep it independent. And so we've grown this thing into an $800 million software revenue business within FICO, even as our distribution is truly anemic. I mean, with all due respect to our terrific salespeople, it's -- we have a little over 100 quota-carrying salespeople. We have several hundred salespeople in our sales organization. That's pretty small for an $800 million revenue business, and it's certainly small relative to the TAM and the potential. So yes, more valuable to somebody else. How is that ever going to happen? We think about it. I think that today, the Software business is not valued appropriately by the markets. They don't recognize just what a special asset we have. And so we're going to continue to grow it and nurture it internally and grow it organically. I think the day will come when the 2 businesses, Scores and Software, gets separated. That's not crazy. That's something that we explore periodically. And within that, one option would obviously be to sell it to a large software player that would be interested. There's a tax implication for that. Our cost basis is nearly zero. And so there'd be a significant 21% tax if we were to do that. If we spun it off to FICO shareholders, that would be tax advantage, that would be the way to do it. So under the right market conditions, if and when we felt that was the right thing to do, I think FICO shareholders could expect to hold 2 pieces of paper. I think that's not unlikely. I think someday in the future that could happen. It won't happen anytime soon. I think there's just a lot of growing we need to do first.

Fair enough. In the few minutes we have left, let's just touch on capital allocation. I think we all know the answer, but it's always good to hear it again. But -- since you joined in 2012, I think you've done 2 acquisitions, one medium size that's now a very successful CCS business, and the other was a tiny anti-fraud something that you sold back anyway, and the rest, buybacks. Any changes?

No, no change. I mean our philosophy on capital allocation is pretty simple. We love our business more than any other business that we see out there, although we look. We look. I mean, someday, we might find one we like as much as our own. Almost anything that we could buy would be accretive in the short term. So if that's all we cared about, you could go do it. But the way we think about it, any business that we look at that we don't love as much as our own, that includes pretty much the whole universe, would be dilutive in the long run. And so we're not very acquisitive. We have a really strong corporate development function. Suhas Joshi runs it, and he's like the Maytag repairman. But he brings us a lot of stuff to look at. But it's -- so never say never, but I would say that acquisitions are very low on the use of cash. We're big believers in buyback. We think there's a natural level of debt for a company like ours. I think that there's a natural level of cash to hold. There is an optimal capital structure, and we target 2.5x to 3x leverage. We're a little low right now. I think you can expect us to continue to play in that range for the indefinite future. We could certainly handle more. Our cash flow is extremely predictable, and we could go over 3, and might, on an opportunistic basis, if -- every so often, there's like a bad news story gets published or it gives us an opportunity to dial up or buyback a little bit. When we had the FHFA overhang, a lot of people were very worried about what was going to happen to FICO. We weren't worried, but a lot of other people were, and it showed up in our stock price, and we wound up buying in $2 billion worth of stock over a 2-year period, where our free cash flow at the time was about $500 million a year. So we do dial it up opportunistically. But in general, our goal is to maintain leverage in that 2.5 to 3x range. And I don't expect that to change.

Got it. All right. We're just about out of time. So let's leave it there. Thanks, Will and Steve, for being here. And thanks everyone else.

Thank you.

Thanks.