All right, we will go ahead and get started. Thank you, everybody, for joining us this afternoon. I know the weather outside is beautiful right now, so I appreciate you sticking around and listening to us talk this afternoon. I'm Patrick O'Shaughnessy. I cover capital markets here at Raymond James. And up next, we have Fair Isaac Corporation, better known to most of you as FICO. And on their behalf, we have Steve Weber, CFO. Steve, thanks for joining us.
Great. Thanks. Great to be here, Patrick.
Maybe just to kick things off, for the benefit of folks in the room who are a little bit less familiar with FICO, maybe just spend a few minutes talking about the company as you see it today.
Sure. So the company, we actually have two different segments that we report. We have a scores business, which most people know. We provide scores that are used for originating new loans, be they a mortgage, auto, or a credit card. And then we also sell scores for account management to look at the underlying risk in a portfolio that a bank may have. And we also sell scores that help with marketing, so determining who to send offers to. So if you get a mailing that says you've been pre-qualified, usually there's a FICO Score that determines who should we mail to. So we do those. Those are mostly in North America. But we also have some scores that are sold throughout the world. It's a relatively small portion of our business, but we do sell scores throughout the world as well.
And then, on the other side, we have a software business that we've had for 40 years now that, historically, it's been sold primarily to financial services to help with different parts of the customer lifecycle, be it originations or account management or fraud detection, collections. And increasingly now, we've built on top of a platform. We have a decisioning platform now that's available to banks and outside of banks, but mostly it's used in banks to help them make decisions on an automated basis. So the more that you hear about digital transformation, they've gathered a lot of data. They need to find ways to actually make that data actionable in real time and make decisions on a one-to-one basis with their customers.
All right. Terrific. Good place to start. And then moving off from that point, what are some of FICO's key priorities for 2025?
Yeah, well, on the software side, we're doing a lot to stabilize and to build efficiencies into the platform. We've built this platform. We've done really well with it so far. We've gotten really good growth off of that. But in order to scale it, we really need to have efficiencies built into the architecture. So it works very well now, but if we put a little bit of investment into that today to move to the new architecture, there's a lot of savings we're going to get from that as it scales. So that's what our real investment is today on the software side. On the scores side, we're doing a lot in innovation with different areas within software. Typically, we don't talk much about the innovation too early or roll it out.
But there will be some things we'll probably see happening throughout the course of this year as we continue to roll out some new products there.
Let's dig into your scores business for a little bit. What is the current role that FICO Scores play across the ecosystem, and how did that role develop over time?
So the FICO Scores have been around for over 30 years. It was introduced in 1989. Originally, it was based on one bureau data set, and then we were managed to put the same algorithm on top of the other data sets as well from the other two bureaus. And then it became kind of over a couple of decades, it became the industry standard for helping to identify how do we who do we originate with. So gradually throughout the credit card industry, and then through the mortgage industry, and then in auto as well, it became the standard measure to determine risk as you made originations decisions. And then as you packaged the different loans into portfolios to sell, it became the way the measure that was used to price securitization or to price mortgage or to price any kind of portfolio that could be sold.
Is there a way to quantify the savings that FICO generates for lenders by allowing them to better underwrite risk and then maybe compare that savings relative to what you would charge?
Yeah, it's hard to really quantify it. It's been in place for a long, long time, and there's multiple ways to look at this, so if you weren't to use a score, you would probably have a person sitting at a desk looking at a credit bureau report and trying to score everything themselves. You'd build a scorecard around that. Obviously, that would be a pretty onerous task. It'd be labor-intensive, and you'd have a hard time probably defending it to regulators. One of the things that beauty of the FICO Score is that over the last 30-plus years, you can show how you've originated in the past and how your loans have reacted through different parts of the credit cycle, through different environments. If, through a recession, you can see how the portfolio has performed.
So there's a lot of value created throughout the whole process, not just with the origination, but also with the ongoing monitoring you do to see how the portfolio performs and how you might want to treat people in that portfolio differently. You might want to offer them more if their credit remains strong. If their credit is deteriorating, you might decide to change the terms that you offer them.
If it's hard to quantify how much savings you're providing to lenders and to the whole ecosystem, how is it that you guys feel comfortable that you're still offering way more value than what you're charging for?
Yeah. Well, I mean, we do have some internal measures. We do that. We look at how the scores are being used and what the alternatives are to that. And we think that, again, we're providing a lot of value in a lot of cases. And frankly, part of it's because of the fact that we didn't change the price for years. We didn't change the price of the FICO Score for 30 years. So when we put this in place in the 1980s, we didn't really know how to price it. We probably could have priced it a lot higher then, but it was probably good that we priced it low. It became ubiquitous. Everybody used it. The usage was dramatically increasing over time.
By the time we got around to raising prices on it, now just seven years ago, there was a lot of extra value that had been gained. We realized that there's a lot of price increase we could probably do as we move forward.
So then seven years into this pricing journey, how are you guys thinking about pricing going forward? And maybe how does that look different for mortgages versus auto versus other use cases?
Yeah, I mean, we try to look at how the scores are used and what the value that's derived. We have a lot of discussions with our customers. We do a lot of market checks. We do a lot of, again, we try to learn as much as we can about the processes that are taking place. And we understand how the scores are being used. And frankly, in some cases, they're using a lot of scores throughout the process that they probably don't need to if it was too expensive. So the fact that they're getting that much use, we want to see as much use as possible. Frankly, we want to have because if there's a lot of use, not only does it provide revenue for us, but it provides value for all those different use cases.
So we want to think about that through the process as well. But we're pretty confident that as we move forward, we have a lot of discussions with our customers. And obviously, nobody likes a price increase. But I think in most cases, they'll realize what we're charging, why we're charging it, and what kind of value they're getting out of that.
FICO, the score evolves over time. Your latest and greatest is FICO 10T. Can you speak to the benefits of FICO 10T versus FICO Classic?
Yeah, so it's again FICO 10T. So in the last 30 years, we've introduced 10 scores, essentially, right? So we don't do it really frequently, but we do introduce score updates occasionally. And there's a lot of reasons for that. In some cases, there's more data available. It was not that long ago that the bureaus coded medical debt differently than other types of debt. So we could look at medical debt and the predictiveness of that and score that differently because now we had the access to that level of detail. In some cases, you could see societal changes that happen over time that would change the way we should look at how people are going to repay their debt. That's more of a glacial thing. It takes a long time to do that, but you see some things happen.
Over time, as we walk through the history, we've done updates based on additional data, based on different trends that we're seeing. But for the most part, it's relatively modest changes that happen. I mean, the banks don't want a complete refresh. They don't want to lose their history. So the fact that they've used the score for 30 years, they want to be able to look back and see, okay, how did the score perform? It's important for us to maintain a score that over time maintains the same score- to-o dds ratio so that they're backward compatible, if you will, so that a 650 today is also compatible with a 650 from a prior version. So we look at that. And again, it's important to maintain that consistency throughout time because it's used by so many different constituencies. The banks or the lenders are using it.
Their investors are using it to understand the risk. So if you look at the 10-K for most banks, you're going to see what their average FICO Scores are in their portfolios. The regulators use it to understand the risk that the different lenders are taking on. If you're securitizing it, again, that's used from that point of view to understand how to price a portfolio, to understand what risk is in that portfolio. So there's a lot of different and now you have consumers that are looking at it, right? We have a program called Open Access where we allow banks to share the FICO Score that they're buying for account management purposes with their consumer. So with a lot of banks, if you go online on their app, you can see what your FICO Score is.
That's a value to the consumer because they'll look at that and they'll understand how do banks view me and what can I do to improve my score because I'm going to get a better outcome with the bank as a result of that. There's a lot of different constituencies that look at this and have for a long, long time. That's something we're always mindful of as we make changes.
Current events question for you. To what extent do you see a change in leadership at the FHFA and renewed efforts to end the conservatorship of Fannie and Freddie as changing the competitive dynamics and risk scoring models?
It'll be interesting to see. I mean, I think my sense, I think our sense at FICO is that the new FHFA leader is going to be. He's going to focus on probably inventory, housing inventory. I mean, the FHFA has a big mandate, right? Really, if you want to increase homeownership, one of the best ways to do that is to bring down the cost of homeownership. One of the best ways to do that is increase the supply of homes. When rates went up as quickly as they did, as much as they did, it kind of froze the market to a large degree. A lot of people that would have otherwise been selling their houses and moving on someplace else stayed where they were because they were locked in with the low mortgage. There's been a shortage of inventory.
So you can address that in multiple ways. You could hopefully bring the rates down so there's going to be more movement of the people. But again, one of the better, even better ways is to increase the supply. I mean, if you're at some point, if it's just the same supply, you're kind of playing musical chairs. But if you can actually increase the supply, it's another entry point for people who maybe don't own a house today or are looking to move into that market. So a lot of their focus seems to be on that and looking at what you can do to increase supply. So from that point of view, it doesn't really impact us directly, but it impacts us the fact that if there's more supply, there's probably going to be more volume, and more volume means more revenue for us.
From the point of view of the changes to the credit scoring, we don't see any real movement there. We haven't heard any discussion around that. With the GSEs leaving conservatorship, there's a lot of talk about that today. We think that would probably be a good thing. From FICO's point of view, we've had a really good longstanding relationship with the GSEs in the past. I think they understand our business well. We've worked closely with them in the past. So we would welcome that. And we look forward always to working with them. They've been good partners for us for a long, long time.
Speaking of the competitive dynamics in terms of risk scoring models, what should investors read into announcements such as the FHLB of Dallas accepting your primary competitor scores for mortgage collateral? Is that meaningful at all?
Not really. I mean, that's collateralization. I mean, just to be clear, it has nothing to do with Fannie and Freddie. Fannie and Freddie are actually buying the mortgages and then securitizing them, right? The Federal Home Loan Banks, that's essentially an institution that lends to member banks and uses the mortgages as collateral. It is very different. They are not using the Fannie score to originate loans. They are just using it as collateral, I mean, as a representation of the mortgages in that portfolio that are used as collateral. It is not monetized. I mean, they use FICO Scores for that as well, but we do not charge anything for that. We are focused really on monetization, which is on the origination side.
Are alternative scoring models being created by fintechs a threat to FICO?
Not really. I mean, you see the fintechs. It's usually complementary to the FICO Score. So you've seen some fintechs talk about how they've got different ways of looking at it, additional data they'll pull in. But typically, they're built around a FICO Score first, and then they'll pull in any additional information they might have to find. They might look at a FICO band of 650-680 and then say, "Okay, how can we find the best of that band by pulling in additional pieces of information?" There might be other information out there. They might have information around income data from some of them that's not included in the FICO Score. I mean, the FICO Score is built on the credit bureau database. The credit bureau does not have income in there at all. There doesn't have any investment income.
To the degree you have other pieces of information you can pull in, that's always helpful. For the most part, what the fintechs are doing is taking us and they're building on top of that. Because typically, when the fintechs do this, if they're turning around and selling that account then onto a bank, the bank usually demands a FICO score be included with that as a third-party measure of the risk profile of the consumer.
All right. Maybe switching gears to software for a bit then. Revenue growth and ARR growth have decelerated somewhat in recent quarters. Is there cause for alarm here?
I wouldn't say alarm. I would say we had really strong growth, I mean, in the 40% and 50% ARR growth. We knew we were not going to maintain that. We saw it slow into the 30%s for a while. This last quarter was 20%, which is still pretty good for most software companies. It was a little bit lower than what we thought for a few reasons. First of all, we had some lower bookings a year ago. We knew that was going to roll through into this time period and that we would have a temporary dip there. We also saw some headwinds from FX. We have a lot of business in Brazil, and they took a really big hit in that December quarter. That had a little bit of an impact on us as well.
There are things like that that can impact us. We still think by the end of the year, that will be accelerating due to some of the bookings we've seen now in the last few quarters. Just for context, when we book something, we release our annual contract value on our bookings every quarter. It usually takes two to three quarters to actually implement that and then another quarter for that to ramp up. It is a leading indicator of what's going to happen with our software business a few quarters later. A year ago, first and second quarter, our first and second quarter, we had lighter bookings. Now we're seeing the impacts of that in our fourth quarter and our first quarter. Now the third and fourth quarter last year, we saw stronger bookings.
Even in our first quarter this year, we saw stronger bookings. It will take a while for that to kind of come through and waterfall into our numbers.
Gotcha. What are some of the incremental opportunities that you are excited about for software going ahead?
Yeah, I mean, again, the platform that we built is pretty exciting. There's a lot of opportunities for us. It's a pretty huge addressable market. We haven't really quantified it yet externally. We're still working on trying to figure out how to actually calculate that and what to include and whatnot. There's probably more market than we can address, frankly. One of the things we're looking at is how do we build up our partner channel to help with that. In a lot of cases, we do a lot of sales currently with our off platform, our old legacy business through processors that process for smaller banks and mid-market banks. Some of our platform now will be perfect for them to take to market as well. We're working on that. We've signed some deals early. We've signed some deals with that.
It is early stage yet, but we will start to see revenue flowing on that probably at the beginning of our next fiscal year. Outside of that, we are working with different systems integrators to take some of this platform to market in other verticals that we do not serve. We are relatively concentrated in financial services. That is where our domain expertise lies. That is where all of our historical products are. That is where we know that business well. A lot of this software could be used in other verticals as well. We just do not have the wherewithal really to distribute at scale into these other markets. Others do, and they are looking for IP to take to those markets.
Does GenAI pose a competitive threat at all to your software business?
We have a lot of AI built into our software, and we have for years. We have a lot of patents around AI. We have a lot of patents around explainable AI and ethical AI. One of the things in the markets that we operate in, particularly in the financial services, is you have to be able to explain everything. If you're using AI, you have to explain why your model's changed. Anything that deals with originations or credit, you have to be able to explain what you've done to make sure that you haven't taken on additional risk. Less so with marketing and fraud detection. Anything that could potentially impact your risk profile, you have to explain that to regulators. We have a lot of patents around that front. We do have a lot of AI built into our products.
Our Falcon Fraud product was probably one of the first to use AI in software. We used neural nets back in the 1990s, continually built in things to look for more ways to identify fraud. The AI is built into that. Different types from machine learning into different types of AI we've used for a long, long time. If it's an opportunity or a threat, it's probably more of a, frankly, I don't know if it's either because it's an opportunity for us as we move forward. A lot of what you've heard in the last six months is probably more hype. We're not really much of a, we don't talk about a lot of the things we're doing publicly because, again, we don't want to be thought of as somebody who's trying to hype it.
We talk to our customers a lot about how do they want to use AI and how can we help with that and how do you not want to use AI. Where would it be a problem for you? We will make sure that we can provide what they're looking for.
How does FICO use pricing as a growth lever within software? How does that differentiate between platform versus some of the legacy software?
Most of our deals tend to be three years long with pricing locked in, excuse me, with escalators for CPI. For the most part, you've got a unit cost built in for three years with CPI built into that. We don't typically price a whole lot there. When the contract's up for renewal, typically there's another chance to reprice depending on how the customer's using it. It's probably more dynamic on the platform side than on the legacy business because the legacy business, most of it's run on-prem. It's very profitable for us. It's kind of installed. We have very little incremental costs. If their portfolio has grown, there's a benefit we're going to get there. The unit cost doesn't change much beyond CPI because, again, it's a very mature product.
We're happy to let it run as long as it'll run there because, again, it's very profitable for us. All we need to do is maintain it, essentially. On the platform side, when that three years is up, typically there's a lot more functionality available. They're going to end up buying more kind of modules, if you will, or more microservices that are going to provide more upside for us there.
I think there's a long-term bull case that your software segment should have structurally higher margins. But segment adjusted EBITDA margin was actually down 50 basis points in fiscal 2024. Maybe it's going to be flattish in fiscal 2025. Has your view on the long-term margin trajectory of that business changed at all?
No. I mean, we still think there's a lot of long-term margin. Frankly, we're focused on growth right now. We could easily drive more margin. I think it would cost us in growth. Frankly, what we're doing today in terms of investments that we're making, like I said before, it's really a lot of we're making investments now in the short term to pull long-term costs out. We'll start to see that even as soon as next year that we'll be able to pull a lot of costs out and that the cost of running these we should be able to inflate our gross margins just by doing some of the structural work we're doing today. To me, that's an easy call to put the dollars in short term to get the long-term benefits from that.
Again, we don't think we don't run the business on short-term margin targets. We run the business on longer-term growth and longer-term margin. And we're really bullish on what we can do longer-term for margin.
As you think about your growth opportunities ahead, how do you think about that US versus non-US? I imagine for scores, it still is going to primarily remain US, but software probably more of a mix?
Software is definitely more of a mix. Software always has been more of a mix. About half of our software revenue comes from in the U.S. and half outside the U.S. Yeah, the bulk of our scores business is North America, U.S., and Canada, probably 90% or close to that. The software business has always been spread around the world. There's a lot, I mean, we do business of one kind or another with almost every large bank in the world. We've seen a lot of early adoption of the platform with a lot of emerging markets. We saw really early adoption in Brazil with all the large banks there. We saw a lot of early adoption in Canada and in the U.K. as well. We're starting to see more adoption now in North America or in the U.S.
It takes longer, frankly, because in a lot of cases, there's more committees to go through. They're just less agile. We are seeing a lot of interest there in the U.S. We signed a big deal with a very large U.S. bank last year. We are seeing more interest throughout the U.S.
Got it. On the capital allocation front, you guys continue to primarily deploy the majority of your cash flow towards share repurchases. How actively does the management team and the board kind of revisit that policy and look for acquisitions or other potential uses?
Yeah. I mean, it might look like we don't at all because we don't do any acquisitions. But we look at a lot of different things. We look at we have a team that looks at acquisitions. The bar is pretty high for what we would do. There aren't a lot of opportunities on the score side because, frankly, we can do all that ourselves. There's some potential foreign things we could do. But there aren't a lot of opportunities on the score side. There's a lot of things we look at on the software side. They tend to be smaller tuck-in acquisitions that we've done and that we continue to look at. We look at bigger things. But if you buy a we've put a lot of effort into maintaining as close to a single code base as we can. We try to build everything on the common architecture.
If we were to buy something sizable, then we'd have to integrate that somehow. There is a lot of risk with that. We'd end up paying a lot of money to do that. At that point, a lot of times, you're just better off building. We choose building more than buying most of the time. We do look at a lot of things. The fact is we drive a lot of free cash flow. If we do not do a lot of acquisitions, which we do not, that leaves you with the chance to either buy shares back or pay down debt or you could dividend it back. We do not have a dividend today. We had one in the past. It was very small. We eliminated that. We like the ability to buy shares back because we think it is more flexible.
We can ramp that up and down easier than you can with a dividend. We think it's probably more tax advantageous to our shareholders than the dividend. Our shareholders tend to like it. We think over the time horizons we look at, it makes a lot more sense than paying down debt because we like the prospects of the business longer term. That's what we've done. We tend to be pretty programmatic. We look at it a lot. We don't try to time the market. There are opportunities where the market's a little bit where we maybe get beat up along with the rest of the market more than we think we should. We might lean in a little bit harder there. We tend to kind of dollar cost average and then lean in a little bit more when we have the opportunity.
Gotcha. I want to circle back to a couple more questions I have on the scores business. So your B2C scores business, it kind of been a modest decline for most of the last several quarters. It did flip back to positive growth this most recent quarter. What are you guys doing differently there to reaccelerate results? And what's your, let's say, medium-term outlook for that?
Yeah. So there's a little history there. For a long time, we've had the business for 20 years. We haven't done a whole lot with it because it takes a significant investment to really go out and market heavily to consumers. What we saw during the pandemic and during the refi boom was a lot of just the power of the brand. A lot of people signed up for the myFICO product, which drove a lot of growth, really rapid, 70%-80% growth with us doing almost nothing. When rates went up, we saw the volume start to tick back down again. Not go back to the levels they were before. They came down a little bit, but it was a relatively modest decline.
Just in the last year, we've done some testing with different types of marketing we could do, small kind of targeted kind of guerrilla marketing almost, if you will. We're never going to be running an ad in the Super Bowl or doing really mass marketing like you see some others do. We have a really good partnership with Experian. Experian does a lot of consumer marketing and uses the FICO brand in a lot of their consumer marketing. We're happy to do that. We're happy to share a lot of the findings we have with Experian to help them grow that business because it's good for all of us. At the same time, we realized that a little bit of targeted marketing here and there, we can grow that myFICO business. We've done a little bit of that. We did some testing last year.
This year, we're putting a little bit more behind that. Not a lot. I mean, it's single-digit millions of dollars of marketing in really specific niches that we can see some nice returns on that. We're doing a little bit of that this year, which is helping us on that business.
Gotcha. Maybe lastly, origination volumes. Ten-year goes up, 10-year goes down, kind of been a bit of a roller coaster. Higher for longer seems to be the current theme. How do you guys think about the origination volume outlook in terms of your kind of current year forecast and then in terms of how you guys plan your multi-year budgeting processes and the rest of it?
Boy, I wish I knew. I mean, that's the hardest part, right? I mean, so much of our business is driven by the macro environment. We were still able to grow last year really nicely, even in a really, really rough macro environment, particularly in mortgage. We haven't seen it get a lot better yet. I mean, we'll do okay through that. It'd be a lot easier if I knew what the volumes are going to be as you plan your budget. What we do is plan for things to not get better. I mean, if we plan and just crossed our fingers and hoped things would get better, it would be pretty ugly because a lot of this revenue comes through at a really high incremental margin. We wait until we can see the revenues before we spend anything.
When there is a recovery or when the volumes return, it'll be very good for us because we see a lot of uptick there. I don't know when that'll happen. I mean, it'd be nice to know. It seems like the market right now, the mortgage market is looking fairly stable. It's relatively modestly up or down every week, depending on what you see the latest numbers look like. Again, until you see the rates come down and every time that the 10-year moves even a little bit, you see a lot of overreaction to that. If there was some sustainable trend, we probably could plan a little bit better. Really, I mean, as it is now, we're starting to see a little bit of an uptick in refi volumes because the rates are a little bit lower than they were last year.
The refi was really down last year when the rates kind of peaked. We will see what happens. I mean, again, we look at this from a longer time horizon. At some point, things will come back to some sort of normal. Then we can work at it from there.
All right. Terrific. We will leave it there. Thank you, everybody, for joining us. Thank you.