All right, we will go ahead and get started. Thanks, everybody, for joining us this morning. I'm Patrick O'Shaughnessy, the Capital Markets Technology Analyst here at Raymond James. And up next, we have Fair Isaac, better known as FICO. On their behalf, we have CFO Steve Weber. It is FICO's first visit to our conference, so welcome.
Great. Thank you, Patrick. Thank you for having us. We have never been here before, and it's great to be here.
Terrific. So to kick things off, for the benefit of folks in the room who are maybe a little bit newer to the story, can you please just provide a discussion or an overview of what Fair Isaac does, and maybe how that compares today versus five years ago?
Sure. First of all, there's two different pieces to our business. There's the score business, which people are most familiar with. We provide FICO scores to a wide range of users. Almost all decisions on credit in the U.S. and most of Canada are made with the FICO Score. So there are people who use them to originate new loans. They'll use them to market to people. If you've got an offer in the mail for a credit card, typically there's a score pull ahead of that to determine who to mail to. And they're also used for account management purposes, to understand the underlying risk in a portfolio, and to decide who maybe to offer cross-sell or upsell opportunities to. That and we also have a consumer business as well. That's the B2B piece is the scores are used by banks. That's 2/3 of the business.
The other third is a B2C business that there's two components to that. One is our myFICO.com business, where we sell financial monitoring products to consumers directly to consumers through a website. And then we also have a partner program. We have a number of partners, the biggest of which is Experian, and we partner with them on all their consumer on their consumer offerings, like Boost, things like that. So that's that side of the business. That's about roughly half half of the revenues. It's most of the profits. It's a very profitable business. The other half of the business is software. We've had software products for 30 or 40 years now. Historically, they were point solutions sold into banks to help with different pieces of the customer lifecycle, originations, or account management, or fraud detection.
In the last several years, this gets to the second piece of your business question. In the last several years, we've actually changed the architecture underneath it. So it all operates on the same common architecture, and we're now able to offer pieces of the IP as microservices on a platform. So you don't have to buy out-of-the-box, off-the-shelf solutions anymore. You can actually put together your own use cases on top of this platform. It'll ingest all the data, and you can use our analytics on top of that data to do whatever kind of decisioning you want to do. So more and more banks are trying to build their own proprietary decisioning, and we can provide the analytics for them to do that and to put that into their workflows. So that's the piece that's changed.
In terms of the software or score side, the changes have been, you know, again. It's very widely used, and we've started to institute price increases over the last several years. For a long time, we never changed the prices. In the last six or seven years, we started to change prices, and there's a big gap between what we charge and what the value is that's derived. So we're just trying to close that gap a little bit by chart, you know, increasing prices in some areas. And we're also increasing some of the technology we provide with the scores. We have different things like the FICO Resilience Index, which shows it's kind of almost like a score version of a risk potential underlying stress testing, almost. It shows how different consumers would potentially respond to a downturn.
So there are things like that we're doing for innovation on the score side, and we're also doing a lot on the software side, obviously, with innovation.
Perfect. I'm gonna probably circle back to a few of those topics a little bit later on. But for now, what do you think investors that are new to the story don't appreciate about FICO in the way that some of your best-informed shareholders do?
Yeah, I think you know, a lot of people don't really understand the software business. They don't even know we have a software business. It's a big part of our business, and it's a big part of our ongoing growth story. I mean, historically, a lot of these products were, you know, fairly legacy businesses. They were very deeply penetrated, but they weren't really growing much because they were so widely used. But the platform, our new FICO Platform, really is something that's spurred a lot of growth for us. So, you know, we're seeing ARR growth better than 40% on that side. So that piece is. It started out small, but now it's becoming a more significant piece of the overall software business.
So, you know, that growth is gonna—we think that's gonna continue for a long time—and that's gonna drive a lot of our future growth and profitability that we never have seen in the past. So I think that's something that people don't really realize yet. They're starting to recognize it with, you know, with the performance we put up there, but it kind of gets dwarfed by the scores business a lot of times. I think on the scores side, people don't realize how deeply embedded it is and how difficult it is, you know, to come up with something else. It's really become a standard that everybody uses. You know, regulators use it to understand risk. They can, you know, look across the industry and determine risk in Bank A versus B versus C by the FICO Score.
So it really is a tool that, you know, the regulators use, investors use, the securitization markets use to really understand a portfolio.
And maybe building off of that last point. So I think a big topic of conversation at the conference this year is Gen AI. And people use Gen AI to, you know, all sorts of different use cases, including risk models. So why do you think FICO has been so resilient to competitive disruption, and including people, you know, using AI to maybe create more accurate risk models, or whatever they would do with it?
Well, yeah, a big part of this is that there are a lot of really great uses for generative AI, but there are limits. You know, particularly when you're running in financial services, where most of our business is, it's so highly regulated, and it's really difficult. If the granting of credit is something that's probably more regulated than almost anything in the world. You have to be able to if you turn someone down, you have to explain why, and you have to have specific examples of why. And that's part of our process. We can provide that. We have, you know, Reason Codes that say, you know, you were turned down for this loan because you had late payments, things like that.
If you have an AI model that's constantly renewing, you kind of lose that, and you lose the ability to explain to a consumer. You lose the ability to explain to regulators what risks you're taking on, and, you know, why you're making the decisions you're making. So you have to be able to prove that, you know, you're not—whatever metric you're using doesn't show a disparate impact to specific groups. And the FICO Score, along with the, you know, the underlying bureau data, has proven to be objective and non-discriminatory over time. So that's the biggest thing. We use a lot of AI, actually, on our software side.
So for things like risk, you know, some types of risk management for fraud detection, we use a lot of AI there, because that's an area where you need to constantly, you know, update your models. And our things like our Falcon Fraud Manager, it's been using machine learning, you know, back to neural nets back to the 1990s. So, I mean, we've been one of the early adopters of a lot of this, and we have a built into our software.
Getting back to something that you touched on in your introductory comments. How do you think about the value FICO is providing to lenders and their customers? And how does that inform your view on pricing in the scores business?
Yeah, I mean, a lot of times, the FICO Score is the primary decision, at least the gate, in terms of whether someone moves forward to the process or not. In some cases, with credit cards, that's the sole metric used to determine whether somebody gets a credit card and what their rate's gonna be and what their you know, what their credit line might be. So it's a very important metric. And the price on it is very small compared to the value that it's provided. So, you know, we look at that, and we look at, you know, are we charging the right amount for the amount of value that's being derived? So it's you know, there's no real magic to that, but it's something we spend a lot of time thinking about.
Then within the scores business, you know, we touched on pricing power. You know, it's basically price times volume. Loan origination volume is something that's out of your control. It's something due to the macro. What's your philosophy in terms of managing the uncertainty of origination volumes as you're thinking about growing scores over time?
Yeah, it's difficult. It's difficult to know, because I don't think anybody can tell you with any degree of accuracy what's gonna happen, you know, with mortgage originations next year. We certainly don't know. It's, you know, mortgage has probably been the most volatile in recent years, because of, you know, when the rates were really low, and people were working from home, there's a lot of refi activity happening. And then, when the rates went up so quickly, so much, so quickly, you know, the market kind of froze. So the volumes are down at, you know, historic lows today. We don't know when that's gonna change. I mean, it's probably a combination of people getting used to the rates and maybe some rates coming down. So over time, that'll, you know, revert to the norm.
But we don't know when that'll be. So it's difficult for us to really project that. We tend to think longer term. We, you know, we can't really manage quarter to quarter, even for a year. We tend to think about, where do we want this to go over time? And then, you know, those volumes we have a long time horizon. So we try to get to where we think we need to be and let the volumes kind of be what they are, because, again, we have really no control over the volumes at all.
In terms of, you know, just you guys thinking about revenue and the revenue generation that you want to have for a particular year, to the extent that origination volumes are coming in weak, do you have the flexibility to maybe flex pricing a little bit more in that environment?
We do. We do. Although, again, we don't really know what's gonna happen. So we'll probably flex pricing no matter what. We don't think, well, this year it's, you know, volume's gonna be lower, so let's raise it more. This year, volumes are gonna be higher, so let's raise it less. We kind of raise what we think is the right amount. And, you know, hopefully, that's enough to, you know, to cover what if our volume decreases. But, you know, again, we don't really. It's difficult to really project with any kind of precision what volumes are gonna be. So we, you know, when we guide, we kind of guide at the lower end of what expectations are on revenue, because the last thing we want is to miss, because the volumes weren't as high as we thought.
So we tend to be very conservative with the way we guide. We don't assume things are gonna get better anytime quickly, because, again, we have no control over that. So things do get better faster than we'll get the upside from that. But we don't want to be in a position where we're basically crossing our fingers and hoping that things get better.
Makes sense. So you've kind of touched on earlier, FICO is best known for its scores franchise, but software is almost half the company's total revenue, and it's growing at a very healthy pace. Can you describe the interconnectivity between the scores business and the software business, how it all fits together?
Yeah, you know, they have common customers. That's probably the biggest thing. Our domain expertise really is primarily in financial services. That's our history. Going back, I mean, the company was started in the 1950s. So, with the premise, it was two Stanford grads. Their premise was that you could use data and make better decisions. If you look back at the way credit was granted in the 1960s and 1970s, it was kind of who you knew. You'd go into a, you know, you'd go into the office, and you'd talk to somebody. And if they knew your uncle, you probably would get the loan. If they didn't know who you were, you probably wouldn't. So it was not fair by any means. But they had really no way to judge creditworthiness.
So what we did is we built scorecards originally, and then we built a score on top of bureau data, which was being collected. And we found a way to kind of objectively look at how creditworthy is someone. And then we realized that we could actually kind of build some of this into software and make it repeatable. And, you know, we were one of the probably one of the first analytics companies, true analytics companies. And we built this these analytics into software. So we looked for ways to, you know, take all that you knew about somebody and figure out use that to figure out how to price it, right? So that's what our Triad account management was. You know, who should we give credit line increases to? Somebody calls in, wants a credit line increase. How do you make that decision? And Triad helps with that.
And then there's other parts of the same life cycle. What, you know, what information? And we have Origination Manager. What information do you need to gather to determine whether to get someone a loan or not? That score is pulled in, but you want to automate the process, right? You would, you don't want to have to have somebody looking at the score. You have the software that pulls it all in, pulls all the information you need, and can generate the new account. So we had point solutions like that that really helped, you know, help banks use the score in an automated fashion. That was really the genesis of the software business.
That's kind of why the two kind of make sense together, because there are some synergies just in terms of pulling it all together, and people understand FICO, and they know the FICO Score, and they're more, you know, they look to trust us on the software side as well.
So the competitive dynamics of your software that your software business faces are pretty different than what the scores business faces. How much of your software growth is coming from market share gains versus just taking advantage of a growing end market?
Yeah, that's a good question that's hard to define. You know, a lot of our growth right now is on the platform. The platform use is for a lot of things that we don't have products for, and a lot of things that products don't exist for. A lot of it is really customer specific. It's, you know, the proprietary decisioning they're trying to build. All the banks have, you know, they've gathered a lot of data. They're looking for ways to use that data. They have a lot of data scientists, but they need the tools to actually automate the process. And, you know, banks are all talking about digital transformation. And especially, this has been spurred by the pandemic. They realize that people don't come into offices anymore. So more and more of their decisioning is through an app or through a website.
So they have to have a way to automate that. They have to have a way to in real time to make decisions. And, you know, if a customer applies for something, you can't just say, "We'll get back to you next week," because, you know, that's what they used to do. Or they used to come into the office, and they would sit for somebody for two hours, and then they'd say, "We'll get back to you in two days." It doesn't really work anymore. So you have to it has to be more instantaneous. So that you have to have a full view of the consumer when you have the interaction, and you have to know what you're gonna do before the consumer calls. So in some cases, they're running batch processing overnight in case someone calls tomorrow and asks for this, what are we gonna offer them?
Or in some cases, it's real time. In some cases, you're taking all the data and realizing, you know, based on what we know about somebody and based on the fact that, you know, we have their DDA account. They got a raise three weeks ago, and they don't have a car loan. Maybe they're gonna want a new car. So let's offer it to them before they go shopping, because they might not come to us. So they're trying to get more and more of a 360 view of the consumer and understand what the consumer wants and provide that to them before they ask. Because if you just flood them with emails, I think all of us know that you get flooded with emails. At some point, you just tune them out.
But if you can, if somebody knows you really well and targets you with the right information, you're probably more likely to develop a longer-term relationship. And they're all the banks are trying to get a bigger share of the customer's wallet. And they're all trying to, you know, improve the loyalty and improve the relationship with the consumer.
Why does FICO win in that space with your software customers? There are a number of other credible alternatives, whether it's some stuff that Moody's might do or SAS or some other platforms. Why are you guys winning?
Yeah, I think it's because we can provide an end-to-end solution. I mean, we really provide the whole decisioning behind this. We have lots of different pieces, components of this. So we have a rules engine. We have optimization. We have modeling capabilities that can pull all this together on an end-to-end basis and then deliver the decision to whatever the actual workflow is. And there's a lot of people that have pieces of this, but there really isn't anybody right now in the financial services space that offers this kind of technology end-to-end. And again, that's important, because all the components together is a much more powerful solution than just trying to cobble pieces together.
So changing gears a little bit, when you are meeting with investors, in particular, your biggest, long-term shareholders to really understand the company well, what are they asking of the management team at FICO? And what are they saying, "Hey, don't do this"?
Yeah, I think it's probably more of the same that we've done. You know, keep the strategy progressing that we're on today. I think, you know, five years ago, the software business, it wasn't very interesting. You know, we had a mature business that was growing, you know, mid-single digit and didn't, you know, show any signs of accelerating off of that. Now we're seeing a lot of growth there. So I think a lot of, you know, a lot of our longer term, bigger investors are interested in seeing what that can become. And they now think there's a lot of value on the platform side. So I think there's a lot of interest in continuing to invest in that and make sure that we make the most out of that opportunity.
So we get a lot of questions about our, you know, what kind of investments do you still need to make in that? What, you know, how do you make those decisions? And what are the trade-offs? And are you investing enough, frankly, to make the most of this? We, you know, we get that a lot on the score side. It's about, you know, what's the trajectory of the scores business? And how do you maintain your market share? And how do you, you know, what's your pricing strategy going forward? You know, we don't really talk a lot about that. It doesn't really serve anybody's interest to talk a lot about all the details of that.
But, you know, we're we spend a lot of time and money reinvesting in the scores business to make sure that we have the best possible score available. And we do a lot of things, you know, around the classic FICO score in terms of new innovation to drive more value. We have something called FICO Resilience Index, which we released a few years ago, which shows the, you know, again, the potential risk in a downturn. Things like that that we're not just sitting back and taking the money in. We're actually investing a lot in that in terms of what they don't want us to do. They don't want us to, you know, completely change course and go off and do something crazy. So there's a lot of times there's questions about M&A.
Are you gonna buy it, you know, spend $1 billion on something, you know, that doesn't really fit? And we don't do a lot of M&A. There's not a lot that would fit with us. We look at a lot of things. But on the, you know, the software side, you know, our strategy is to really build on top of this, you know, platform and maintain, you know, a significant amount of similar code base. And if we were to buy a large product line from somebody, it really wouldn't fit. The integration would be difficult. We'd probably overpay. And we'd spend a lot of time just trying to get it to fit into the rest of it. So typically, we build rather than buy. And we use our cash flow primarily for buybacks.
We drive a lot of cash flow. We have a really strong cash flow generation. We don't have a lot of capital expenses. Our capital CapEx is tiny. We're a capital-light company. So we typically use our free cash for buybacks. And that's worked really well for us. At a high level, we think we can drive, you know, strong top line revenue growth. We think that, you know, through efficiencies, we can drive better than that in terms of net income. Then, you know, with buybacks, we can drive better than that with the EPS growth. So we're, you know, giving our long-term shareholders a bigger piece of a growing pie.
You kind of touched on capital intensity, and that's something I've been thinking about the last few weeks as it pertains to my information services coverage. You guys are relatively unique in very little CapEx, as you mentioned. That's different from some of the other companies that I cover. Is that an accounting decision from you guys? Or you just have everything as operating expense? Or are you not making big, you know, big software investments in the same way that some of your competitors might be?
Well, our CapEx is typically has been data centers, which right now we don't have many yet. We're trying to get out of the data center business. We're putting more and more on AWS and other public clouds, primarily AWS. But we're not in the data center business. We in some cases, we had to have our own private data centers for to host some of our clients, because AWS took a while to become PCI compliant. So the security wasn't there early on, but now they are. So and they can scale data centers much better than we can, and they can have them all over the world. So, you know, early on, again, you know, most countries have a limit on what kind of data can leave the country.
So you had to have they had every bank had to have data centers in country, and AWS wasn't available everywhere. But now they are. So we're getting out of the data center business. So that was typically a big use of CapEx for us. We don't capitalize our R&D that goes way back. You know, a lot of our R&D is on prem, or historically has been on prem. So we don't capitalize very, very little of that. We tend to expense it as we go. And we're happy with that because we don't have a, you know, a overhang from expense that's gonna still out there. So we pretty much pay as we go. We tend to be very conservative overall in terms of accounting practices. And we're happy with that. So what you see is kind of what you get.
You're not gonna have, you know, a whole lot of capitalized expense out there that we're kind of hoping to pay for. We have very little of that. So yeah, our CapEx is very small. You'll see also, you know, our depreciation is a tiny number. Amortization is a tiny number just because of all the decisions we've made.
And then relative to the other information services companies that I cover, FICO does tend to be on the higher end of using stock based compensation. Can you talk about that philosophy of why that's a pretty material part of total compensation?
Yeah, we're probably more like a lot of tech companies in terms of the stock-based comp. So just from a cultural point of view, that's an important part of our compensation. I mean, you look at throughout the company, the salaries are fairly low. They're pretty much below market, typically. And a big piece of the compensation for a lot of the people in the company is the stock-based comp. Part of that comes from our kind of legacy in Silicon Valley. You know, we were competing with a lot of tech companies there. But we have a large number of our employees that participate in stock-based compensation. So I think it's a little over 40% of the company that has a part of their compensation is a stock-based comp.
It really comes to our it's one of our core values. We've got, you know, core values like anybody else. One of them is act like an owner. We really want people to think of this as, you know, they are an owner of this company. You know, they're making decisions like an owner would and like a shareholder would in terms of, you know, in terms of really optimizing for long term shareholder value. So an important part of that is, if you have shares, you feel like an owner. You know, it's good for us because, you know, most employees tend to get an RSU that invests over four years. So by the time you've been there a few years, you have a significant amount of money that's investing every year.
It makes, you know, it makes it attractive to stay. And, you know, when we've everybody's interested in how the company's performing, and they're really invested in that. So it's something we kind of feel strongly about and that, you know, we're if we are different, you know, than some. I think it's been a good thing for us. But we do think of it as a cost, right? I mean, internally, we think of stock-based comp and salaries together. We don't really think about compensating people in a total basis. So the, you know, the grants every year are value-based. They're not, you know, share-based.
Speaking of compensation, so management at FICO is not compensated on returns on invested capital. It kind of seems as if you're optimizing for that metric anyway. How does management and the board think about RoIC? And how has that informed your capital allocation decisions?
Yeah, I mean, we do think that way, right? We do think and some of these are all kind of play together. So, I mean, you know, that's not the way the compensation model set up. That's not to say that it'll never will be. But it, you know, that's really kind of the way we think. Every investment we make is with an eye toward what's the return on this? We spend a lot of time, you know, especially on the software side, there's a lot of potential investments we can make. And a lot of it is about, you know, what is the return on this specific investment? And what is our total, you know, company's return on invested capital? I mean, it's something we do think a lot about.
Really, we try to be as efficient as possible in terms of the balance sheet, in terms of all the investments we make, you know, efficiency and, you know, and how that will impact the long-term value of the company. It's something we spend a lot of time thinking about. The board certainly does as well.
Then, as your software business has grown in recent years, it does seem to require at least some incremental working capital. How do you think about the free cash flow implications of continued growth in software?
Yeah, and the working capital piece is on both sides, frankly. I mean, I think, you know, the way when we have increases in revenue, typically what happens on the score side, we have once a year, the price increase goes up, and that you get a pop in receivables. And it just takes a while for that to flush through. So that's it kind of happens to us every year. On the software side, we do have a lot of, you know, a lot of banks around the world, and some of them just tend to be slower payers. We don't have really any issues with the real delinquencies or with charge offs, bad debt. But some of the, you know, some of the larger banks, particularly in South America, are slower pays.
Sometimes they'll negotiate longer payment cycles, especially if there's FX issues. So, you know, we do have to deal with that occasionally. But, you know, it's something we look at. It's something we try to manage and try to manage the, you know, the DSO down, certainly.
Well, I'm gonna pause there and see if there's any questions out in the room.
I'm wondering about regulation interfering with predictability. In other words, the extent that the government decides medical debt should be in or out.
Yeah.
Is there a concern, given the predictability of the product?
Yeah. Yeah. So the questions around regulation and if that impacts predictability, like medical debt as an example. So actually, medical debt's an interesting thing, because it didn't used to be that when we looked at a consumer's credit file, or when anybody looked at it, you couldn't tell what was medical debt and what wasn't. And actually, it's better to be able to look at medical debt separately, because medical debt's less predictive than other types of debt, because a lot of times it's not sure who should pay it, right? You get a bill. You don't know if you should pay it or the insurance company. So sometimes that'll go longer. Now that, you know, with the latest scores that we score medical debt a little bit differently.
It doesn't have that much of an impact on everyone. But there's, you know, it can certainly have an impact to some. In terms of government regulation, I mean, we try to do the right thing and try to make the score the most predictable we can. Regulators, for the most part, I think they want the best outcome to the degree that they don't like the outcome. In some cases, we try to look at this objectively and say, "This is what it looks like." If there are other factors you want to take into this, if you want to put your finger on the scale somewhere else, then you do this outside of the score. We try to maintain, you know, complete objectivity in the score.
All right. Well, nothing else in the room. I will keep going. We've spent a lot of time talking about the B2B component of scores. But the B2C component, how do you guys think about the long term growth opportunities in that part of your business?
Yeah, it's an interesting piece, you know, that we didn't have. I mean, if you go back 15 years ago, it was almost a nonexistent business. So there's 2 different pieces of the B2C business. One is our own myFICO.com business, where we sell financial monitoring products to consumers. And it's a product that has, you know, dark web monitoring. You have access to your, you know, your bureau reports and your score. And you have simulators to show what might happen if your behavior was different, what that might impact your score, and, you know, how the, you know, different score would give you different rates. It also has ID theft protection and insurance around that. So it's kind of a full on product. We're also doing some things. We have a really great team running that product line.
We're doing some things in terms of a, you know, freemium product where we're offering some free services that people could, you know, add onto. So there's a lot of different things we're doing in that space. It's become a really good business for us from something that was really small during the pandemic. A lot of people really got engaged with that kind of a service. We had, you know, really massive growth there. Even as, you know, as people kind of got back to normal, it kind of waned a little bit, but it still held up really well. It's a really good business for us. It's a really good extension of our brand. The other side of the B2C business is partners. Our biggest partner in that space is Experian.
If you see Experian running Experian Boost commercials, things like that, we partner with them on that. We provide scores and simulators and things into that package as well.
All right. Maybe one last question then. How do you think about the trajectory margins for each of the segments going forward?
Yeah, the scores business, the margins really can't get a lot better. It's like an asymptotic line. You just can go and get so close to 100%. It'll fluctuate a little bit as the mix between B2C and B2B fluctuates. B2B has a little bit higher margin than B2C, because our myFICO business has some cost of goods sold. So you get a little bit of noise in there. But it's not gonna move much. I mean, we'll get more dollars, but the percentage can't go up a whole lot more. On the software side, we're investing heavily into it right now. So the margins, we're running probably we're at the bottom in terms of margins on the software side.
And as we get more scale and as we kind of build some of the efficiencies into the platform, there's a lot of room for those margins to expand. So we're totally subscale. And we're happy running the business as is, because we're really focused on growth. But we're gonna see a lot more margin growth in the future on the software side, more like normalized software margins. But we're, you know, it's early stage yet.
All right. Terrific. I think that's a good spot to end. Thank you, everybody, for attending. And thank you very much to Steve.
Great. Thanks.