Fair Isaac Corporation

Greetings and welcome to the Fair Isaac Corporation quarterly earnings call. During the presentation, all participants will be in a listen-only mode. Afterwards, we'll conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. Should you require operator assistance at any time, please press star 0. As a reminder, this call is being recorded today, Tuesday, August 3, 2021. I'd now like to turn the call over to Steve Weber. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining today's FICO third quarter earnings call. I'm Steve Weber, Vice President of Investor Relations, and I'm joined today by our CEO, Will Lansing, and our CFO, Mike McLaughlin. Today, we issued a press release that describes financial results compared to the prior year. On this call, management will also discuss results in comparison to the prior quarter in order to facilitate understanding of the run rate of our business. Certain statements made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve many uncertainties, including the impact of COVID-19 on macroeconomic conditions and the company's business, operations, and personnel that could cause actual results to differ materially. Information concerning these uncertainties is contained in the company's filings with the SEC, in particular in the risk factors and forward-looking statements portions of such filings. Copies are available from the SEC, from the FICO website, or from our investor relations team. This call will also include statements regarding certain non-GAAP financial measures. Please refer to the company's earnings release and Regulation G schedule issued today for a reconciliation of each of these non-GAAP financial measures to the most comparable GAAP measure. The earnings release and Regulation G schedule are available on the investor relations page of the company's website at fico.com. or on the SEC's website at sec.gov. A replay of this webcast will be available through August 3, 2022. With that, I'll turn the call over to Will Lansing.

Thanks, Steve, and thank you, everyone, for joining us for our third quarter earnings call. Before I discuss our results, I'd like to thank our FICO colleagues for their dedication, adaptability, and innovation during this past year. As we begin to open our offices back up, we're moving to a hybrid system where more of our team is working from home. But we've proven in the past year that we can make the most of technology to collaborate and continue to serve our customers and optimize our business both remotely and in person. On the investor relations section of our website, we've posted some slides that offer financial highlights of our third quarter. In our third quarter, we delivered revenues of $338 million, an increase of 8% over the same period last year. As previously disclosed, we completed the divestiture of our debt collections and recovery products during the quarter. Adjusting for that, revenue grew about 9% year over year. We delivered $151 million of GAAP net income and GAAP earnings of $5.18 per share, including the gain on sale of the CNR products. On a non-GAAP basis, which excludes the sale, net income was $99 million, up 29%, and earnings per share of $3.38 was up 31% from last year. We continue to deliver very strong free cash flow growth as well. Free cash flow was $99 million in the quarter and $462 million for the last four quarters, and we're dedicated to using that cash flow to return value to our shareholders through our repurchase program. This is a very strong quarter for us, and we are well positioned for a strong finish to our fiscal year. As we continue our strategy of migrating our business model toward a subscription-based model, we see some disruption in our near-term numbers. We're not recognizing as much revenue up front and not selling and delivering as much lower-margin services revenue. But these efforts are positioning the company for long-term predictable and profitable growth. Beginning next quarter, we will be providing additional metrics that will give additional transparency to our business. Metrics like ARR will complement our revenue reporting. and provide a better indicator of our growth trajectory. We'll also be talking about the different delivery vehicles for our software, specifically whether the products are delivered on platform or off platform. The decision management platform is the linchpin to our software strategic vision, and bringing new customers onto that platform will enable us to scale the business and realize its full potential. As I've stated, we believe we can become the preeminent player in decisioning analytics. That is our singular goal in our software business. On the score side, we remain committed to innovation while maintaining the predictability that has always been the cornerstone of the FICO score, and I'm pleased to report that we continue to drive outstanding growth in our scores business. Scores posted another record quarter, up 31% versus the prior year. On the B2B side, revenues were up 23%. Mortgage originations, as predicted in the marketplace, appear to have peaked and were flat with last year's numbers. It is now a year since the refi boom began, and we expect those numbers to trend down as the market returns to more normal levels. Auto originations continue to be strong, with those revenues up more than 30% year over year. The most dramatic growth came from credit cards and other unsecured lending products. We had a record revenue quarter in card originations, with revenues up more than 50% from last year. We saw acceleration in card origination activity throughout the quarter and expect that activity to continue to be strong. Prescreen volumes were up more than 150% versus last year. This is typically a leading indicator for new card origination activity and shows the financial institutions have a strong appetite to market and originate new accounts in the unsecured markets. We believe banks are in a very strong financial position to pivot to other lending products as mortgage demand wanes, as expected by the industry. On the consumer side, we continue to drive impressive growth. Our B2C revenues were up 50% versus the same quarter last year. Ag growth at MyFICO.com, while still strong, is slowing, which we expected as the mortgage market cools off. Growth among our partners has picked up as Experian and others find new ways to serve an increasingly sophisticated consumer. Finally, this quarter we closed the divestiture of our collections and recovery product line. Mike will review the financial impacts and talk about how we are using the proceeds for share repurchases. As we said last quarter, the divestiture further focuses our resources on refining and distributing the best-in-class decisioning platform that we believe is an incredible opportunity for FICO. I'll have some final comments in a few minutes, but first I'll turn the call over to Mike for further financial details.

Thanks, Will, and good afternoon, everyone. Today I'll walk you through our third quarter results in more detail and provide some information on the divestiture of the collections and recovery products we closed in the quarter. Total FICO revenue for the quarter was $338 million, an increase of 8% over the prior year. Our applications segment revenues were $133 million, up 3% sequentially and down 6% versus the same period last year. Adjusting for the CNR divestiture, Applications revenues were up 6% versus last quarter and down 4% from last year. The year-over-year decrease in revenue was primarily driven by reduced professional services revenues. In our decision management software segment, Q3 revenues were $33 million, down 20% over the same period last year, due primarily to decreased upfront license revenues. As Will said, our shifting business model is continuing to impact our software business in the near term. our on-premise license revenues will continue to decline as we move away from licensed sales to a ratable subscription revenue model. Second, at the start of our fiscal year, we noted that we have also changed our revenue recognition assumptions for on-premise term license subscription deals. As a result, we now recognize less upfront license revenue and more revenue ratably over the term of each deal. The net impact this quarter was lower license revenue in our applications and DMF segments of about $4 million versus what it would have been under our prior methodology. We anticipate the full year impact will be about $40 million in lower software license revenue this year, all of which will be recognized in future periods. As a reminder, last year we booked $61 million in upfront license revenue in our fiscal fourth quarter under the prior methodology, So that will be an especially difficult year-over-year comparison. As we've pointed out in the past, this change in timing does not have an impact on pre-cash flows or the total revenue recognized from software license sales over the term of each subscription contract. I'd also like to remind you that we are de-emphasizing low-margin, non-strategic professional services engagements, which is resulting in lower PS bookings and revenues. This is driven by our core strategic goal of selling more high-value software with recurring revenues. This quarter, services revenues were down 18% versus last year. As Will said, we closed the divestiture of our collections and recovery product line in the third quarter. We recognized a pre-tax book gain of $93 million in the third quarter. The sale contributed $2.52 of after-tax EPS to the quarter's gap results. Proceeds from the sale were used to fund a previously announced accelerated share repurchase program. Turning to our score segment, total revenues were $172 million, up 31% from the same period last year. B2B was up 23% over the same period last year, driven by continued high volumes in credit card and auto originations, as well as some unit price increases across our different score categories. B2C scores revenues were up 50% from the same period last year. Both MyFICO.com and B2C partner revenues grew significantly. This quarter, 80% of total revenues were derived from our Americas region. Our EMEA region generated 14% and the remaining 6% was from the Asia Pacific region. Recurring revenues derived from transactional and maintenance sources for the quarter represented 85% of total revenues. Consulting and implementation services revenues were 11% of total revenues and license revenues were 4% of total revenue. Fast software revenues not including related PS revenues, continued to grow and were $67 million for the quarter, up 10% from the previous year. Q3 bookings totaled $75 million, down 29% from the previous year, and had an average weighted term of 30 months. Those bookings generated $9 million of current period revenues, a 12% yield. Much of the decline in bookings was due to our de-emphasis of low margin professional services, and the shorter term lengths of deals signed. Professional services bookings total 21 million, down 50% from last year. We continue to see a strong pipeline in our software business, and typically we have our strongest period for new deals in our fiscal fourth quarter. As we have said, we expect bookings to trend lower overall compared to historical numbers as a result of our de-emphasis of professional services sales and the somewhat shorter term length of typical subscription and on-prem term license contracts. As Will mentioned, we plan to begin providing more subscription software financial metrics next quarter, and we believe that the additional transparency will lead to better understanding of the results of the company, particularly in the software segment. Our operating expenses totaled $144 million this quarter, which included the $93 million gain on the CNR sale, compared to $230 million in the prior quarter. Excluding that one-time gain, expenses were up $7 million, primarily due to increased incentive compensation expense. Compared to Q3 2020, operating expenses, excluding the one-time gain, were up $6 million. We do expect expenses to continue to increase in Q4 as we gradually add strategic headcount to drive our decision management platform development and distribution and increase customer-related travel. Our non-GAAP operating margin, as shown on our Reg G schedule, was 39% for the quarter, a margin expansion of 500 basis points from the same period last year. GAAP net income this quarter was $151 million, which included $93 million of pre-tax gain from the divestiture. Our non-GAAP net income was $99 million for the quarter, up 29% from the same quarter last year. The effective tax rate for the quarter was 20%. We expect our FY 2021 recurring tax rate to be approximately 26 to 27%, and we expect the net effective tax rate for the year to be about 19%, including the impact of the divestiture of our collections and recovery business. Free cash flow for the quarter was 99 million, flat with the same period last year. For the trailing four quarters, free cash flow was 462 million. At the end of the quarter, we had $238 million in cash, of $40 million from last quarter. Our total debt now stands at just over $1 billion with a weighted average interest rate of 3.64%. Turning to return of capital, we bought back 489,000 shares in the third quarter at an average price of $466 per share. This includes a $200 million accelerated share repurchase agreement we entered into following the close of the CMR divestiture. For the nine months ended June 30, 2021, we repurchased 1,031,000 shares. At the end of June, we had about 225 million remaining on our stock repurchase authorization, and we continue to view share repurchases as an attractive use of our cash. With that, I'll turn it back over to Will for his closing thoughts.

Thanks, Mike. As I said in my opening remarks, I'm extremely pleased with our team's ability to manage our business and serve our customers in the midst of all this uncertainty created by the pandemic. We continue to prove that the FICO business model is strong. Our customers rely on our mission-critical software, scores, and other analytics to manage risk and optimize interactions with consumers. We continue to invest and innovate to provide state-of-the-art solutions for customers looking to use analytics to make better decisions. I'll turn the call back over to Steve now for Q&A.

Thanks, Will. This does conclude our prepared remarks. Operator, if you'd like to open the lines, we're now ready to take your questions.

Certainly, and thank you very much. If you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge that request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. Our first question comes from Surrender Thinned with Jefferies. Your line is open.

Thank you. I'd like to start with a question about just the adoption of a competitor score by a large card issuer that was recently revealed, I guess. Can you talk a little bit about the competitive marketplace at this point in terms of just how you think about the FICO 10 suite and maybe kind of if there's anything unique that prompted the issuer to switch from using FICO?

The short answer is, without getting into all kinds of details, that was a special situation, I think. Those scores have been around for a long time, and our scores are very strong and continue to stand the test in the marketplace of being desirable. We believe our scores are the most predictive out there for what they're used for. And our business in scores is as strong as it has ever been. Our volumes are very strong. We have not seen the decline, and we don't see major issuers switching away. So I guess the best way to characterize that is a one-off. And I think that's really it.

That's helpful. And then in terms of just when I think about the scores business broadly and especially the strength that we're seeing in B2C, Is there any additional color that you can provide in terms of the framework for how we should be thinking about the growth that that business is seeing? If we were to rewind to last year, I think that the thesis was that, you know, there's a lot of people that were concerned with their credit scores, and so there's kind of a rush to kind of do credit monitoring on a personal basis. But now that the pandemic has resided, I guess it worked further through that process. Can you talk about the resiliency of that business and maybe are there additional factors that are now driving the growth? When I think about it on a sequential basis, the growth was still very impressive.

Yeah, I think that there's some offsetting trends here. So the one trend that we worry about, we don't worry about it, but we recognize is that mortgage was super hot over this last year. and we can't expect it to continue at the same levels. And that's what all the market analysts predict, and we don't see any reason to disagree with that. And it is true that when consumers go shopping for a mortgage, they often go to credit score monitoring to get a sense for what they're able to get by way of mortgage and pricing. So that's a positive factor that won't be as present going forward. at least until the next cycle. Offsetting that, I think, is a level of awareness on the consumer's part of the importance of credit scores, which has just been on a steady upward trajectory for a very long time, certainly the last five years. And as I've shared with you in the past, 10 years ago, the FICO score aided awareness was about 30% in the U.S., and today it's over 90%. And most consumers are well aware of how important the FICO score is and continue to try to monitor it. So we see that as a positive and a positive that will continue. And then finally, our partners who provide credit report monitoring, credit score monitoring services are increasingly sophisticated in the way they get the message out and what they provide to their consumer customers. And they're doing very well, and we encourage that. So we feel pretty good about the business.

That's helpful. And then maybe one other quick one. It sounded like auto and credit card volumes were an important contributor to the B2B part of the growth story. Can you talk about maybe where we might be in terms of how close are we to pre-pandemic levels within the credit card segment at this point? I feel like there's a good visibility into auto volumes, mortgage volumes. but just kind of the third leg of that stool.

Mike, I don't know if you have any detail on that that we can share.

Yeah, we need to be careful about that because of the nature of our relationships with the bureaus, of course, but it feels as though there's definitely still room to grow. They have rebounded smartly, and you can see that in our results, but we're not in the business of predicting credit card volumes, as you can understand, but... From what we can see, looking backwards, which is all we can do, is, you know, it's still growing and doesn't appear to be plateauing. That's helpful. Thank you.

I'll get back to you. Thank you.

Our next question comes from Kyle Peterson with Needham. Your line is open.

Hey, good afternoon. This is actually Sam Salveson for Kyle today. I was wondering if you guys could provide a little more color around the pricing environment for the score business. Did that last round of pricing changes have any noticeable impact on the scores business this quarter?

Thanks. Yeah, I would say not dramatic differences, not dramatic changes, not dramatic impacts from that.

That's helpful. And then just a quick follow-up. How should we think about the expense and margin trajectory of the business moving forward after that recent divestiture there?

I wouldn't expect tremendous changes. I mean, there's some benefit that comes from de-emphasizing lower margin professional services, as we talked about. So there's a benefit there. But at the same time, You've heard us talk about the opportunity in the platform space and the tremendous amount of R&D that we're pouring into it. And so I think there's focus on cost and expense control on the one hand, but at the same time, our investment levels are high. So I think those offset one another, and I wouldn't look for tremendous margin improvement. There's also, and this is a much more modest effect, but there's also coming out of COVID, there'll be more travel expense, that sort of thing. Yep, got it.

All right, thanks, guys.

Our next question comes from George Tong with Goldman Sachs. Your line is open. Hi, thanks.

Good afternoon. Going back to the scores business, revenue grew 31% in the quarter, and you mentioned mortgages were relatively flat from a volume perspective, cards and autos strong. Can you at a high level discuss how much card and auto volumes grew by and how much pricing contributed to growth?

Well, I don't think we break that out. I think that's something we've kept to ourselves. Mike, do you want to help me with that?

Well, sure. There were some numbers in the script, which we can revisit with you on the one-on-ones if you'd like. But as Will said in his previous answer, the story this quarter was about volumes, not price. It's not that there was no impact of price, but it was – the lion's share for sure about volume in the segments we discussed.

Okay, got it. And I'd like to dive a little bit more into your on-platform strategy. Can you talk about evidence that you're seeing increasing customer adoption of your on-platform solutions and what initiatives you have to further drive client adoption of your on-platform products?

Yeah, absolutely. So, If you think about our major franchises, customer management, the Triad franchise, which goes to line increases and judgments about how and what to do with existing customers, and our other franchises, we are increasingly putting those solutions on top of the platform. We're selling our software in a couple of ways. One is where the customer is after a solution and they happen to get that solution on top of the platform, or they will, but they're still after a particular solution. But increasingly what we're seeing is major financial institutions saying, we want to standardize on the platform and we want to do not two or three or four solutions. We have an intent to do 10 or 15 or 20 solutions on top of this platform. We want to leverage all of our data across all the different places where it resides and and apply analytics and do it in a unified way so we leverage everything that we have to make decisions with respect to customers. And that's very much the future of our – that's our platform strategy, and that's our future is doing that. We have – it's a lumpy business, so we've landed a number of big customers over the last 12 months for the platform for this very purpose with an intent to start with five or 10 or 15 use cases and then expand beyond that. So we're pretty happy that the solution is meeting the need in the marketplace that, you know, the platform strategy has legs and it seems to be working. That said, we have a lot of work left to do. Not all of our solutions are completely ported to the platform and the platform isn't as modular as we wish it were. We're working on that. So, you know, there's, there's definitely plenty of investments still going in, but from a customer reception standpoint, we have, medium and large financial institutions who have adopted it.

Got it. Very helpful. Thank you. Our next question comes from Ashish Sabhadra with RBC Capital Markets. Your line is open.

Thanks for taking my question. I was just wondering if it's possible to quantify how we should think about the impact from the CNR divestiture in the fourth quarter. or a quarterly impact going forward?

Mike, do you want to take that? I can take that one. Yeah, I'm happy to. We mentioned last quarter, or actually perhaps it was in the press release when we announced the deal, that roughly it's 6% of our revenues, and that's rounding from the nearest percentage, and expenses are in the near term that we'll be able to flex are in the same ballpark as those as those revenue numbers. It's a Q4 heavy business just like our other software businesses are, so the year-over-year impact of not owning that business in Q4 and 21 would have some seasonality associated with it versus a pure linear spread, but that would give you the ballpark of what to expect.

And then maybe just to follow up on the earlier question around the software, I was wondering if you could talk about the adoption, like the progress on the API, the external API strategy, as well as the studios. Any color there will be helpful. Thanks.

Yeah, I would say both of those proceed at pace. And we have... Am I hearing this interference? All... We are making progress on both the external facing APIs and on FICO Studio. But much of that will be ready this year.

That's very helpful. Thanks.

The next question comes from Caroline Conway with Autonomous Research. Your line is open.

Thank you for taking my question. I wanted to ask about the expectations for applications going forward following the recent divestiture. Would you say that the business at this point is right-sized? And can you talk about the strategic role of the business unit at this stage, particularly as it relates to the decision management business?

Yeah, I guess I would say that it is right-sized. We don't have any plans for any significant divestiture going forward, at least not at this time. So I would call it right-sized. I think the way to think about it is that the application solutions will increasingly be available on top of the decision management platform. And so we hope to be able to share with you how those things break out. Right-sized, yes.

Okay. Thank you. And my other question is, next quarter, as you're talking about the ARR and other metrics, are you expecting to provide additional detail on decision management profitability, especially the timing of turning to a profitable level, and will we see some guidance at that point as well on growth rates?

We'll start with the revenue, and I think we'll have the TBD on getting down to margin level.

Okay. Thank you.

As a brief reminder to all to register for a question, it is 1-4 on your telephone keypad. Next question comes from Jeff Mueller with Barrett. Your line is open.

Yeah, thank you. Anything further you can say on bookings? It was the third quarter in a row of relatively weak bookings, and it sounds like the emphasis of professional services is a large part of that. You also mentioned shorter term lengths, and I guess is that customer's electing shorter terms or you and customers jointly preferring shorter terms because of how the subscription-based software is sold? Or is that timing of large deal activity? Just how much of the weaker bookings is that? How much of it is other things?

The shorter term length is significant. It's, you know, Mike can keep me honest, I think it's on the order of 25% reduction in term length. So it's significant. In terms of whose idea is that, we always do what the customer wants. That said, if we have, you know, to the extent that we have a choice in the matter, our preference is for shorter because we do think that that's a better way to go. We think that there are more opportunities for us to revisit things sooner if we go for the shorter term length. So, and this is part of why we changed the way we compensate our Salesforce as well. We, we, um, we used to compensate on bookings and longer terms that do commissions. Um, and, and, uh, and we no longer do that. I mean, our, our goal is to provide the term that our customer wants, but shorter is absolutely fine with us.

And Jeff, I can add a little bit of, I can add a little bit of color to that. So the, term length the average term length was 37 months a year ago and it was 30 this time that's about a 20 percent decrease 19 to be specific and if you apply the rough math that's you know 15 to 20 million dollars of bookings right there just because of term length and the other factor is ps intensity our ps bookings were 20 million dollars lower this quarter than they were last quarter you see we're 30 million dollars down in total bookings so those two factors alone would you know, all else being equal, explain that.

Helpful. And then when you're giving the example of customers landing on the platform with a eventual intent to do 10 or 20 solutions, how many, how many skews are there? Like how many solutions could a customer buy today if they bought everything or like, where is that going?

Well, probably SKUs is not even the right way to think about it because when we think about SKUs, we're at, I don't know, call it 150 SKUs. But the platform in its modular form provides the opportunity to do hundreds and potentially thousands of combinations of things. And so I think what we're moving to is more of a usage-based pricing and a modular pricing that lets customers mix and match the components that they want to achieve the goals that they want from a solution standpoint. Okay. And so it's not like everything will be prepackaged.

Okay. And then last one for me, just on B2B scores, how do you maintain an ongoing dialogue with the ultimate end market enterprise customer? So I think technically it's your customer's customer because your Q and K disclosure is, um, revenue concentration based on the Bureau relationships. So how do you maintain that end market dialogue and I guess monitor, um, uh, their commitment to, uh, staying on FICO scores?

Obviously we stay close to it through our channel partners, the bureaus. Um, but we also, certainly for all of the major institutions, we have direct sales relationships. And so any significant activity in one direction or another is well understood by our people, and we are in a dialogue with them. Got it. Thank you.

And there are no further questions at present time. I'll turn the presentation back to you. Please continue with your presentation or closing remarks.

Thank you. Thank you. Thank you, everyone, for joining. This concludes today's call. We look forward to speaking with you again soon. Thanks for joining.

And that does conclude the conference call for today. We thank you very much for your participation. You may now disconnect.