Fair Isaac Corp Q3 FY2022 Earnings Call

Greetings, and welcome to the Fair Isaac Corporation Quarterly Earnings Call. As a reminder, this conference is being recorded today, Wednesday, August 3, 2022. I would now like to turn the call over to Steve Weber. Please go ahead, sir.

Thank you. Good afternoon, everyone, and thank you for joining FICO’s 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. A replay of this webcast will be available through August 3, 2023. And now, I’ll turn the call over to Will Lansing.

Thanks, Steve, and thank you, everyone, for joining us for our third quarter earnings call. We posted some slides with our results on the Investor Relations section of our website. I’ll be referencing some of those slides during our presentation today. We again delivered very strong results in an uncertain marketplace, which demonstrates the resiliency of our business model and the value proposition we deliver. As you can see on Page 2 of the presentation, we reported revenues of $349 million, an increase of 3% over the same period last year or 7% when adjusted for last year’s sale of our collections and recovery products. We delivered $93 million of GAAP net income, and GAAP earnings of $3.61 per share, up 21% and 36%, respectively, when adjusted for last year’s gain on sale. Our Scores business continues to perform well despite headwinds in the mortgage market. As you can see on Page 6 of the presentation, Scores were up 4% in the quarter versus the prior year. On the B2B side, revenues were up 3%. Mortgage continues to be the headwind as originations have declined as interest rates rise. Mortgage origination revenues were down 25% versus last year. Excluding mortgage, total B2B revenues were up about 12% versus last year. Auto origination revenues were up 12%, and credit card and personal loan originations revenues were up 37%. We also had double-digit year-over-year increases in our prescreen scores. On the B2C side, revenues were up 7% from the previous year. The slowdown in growth came primarily in our direct myFICO.com channel, where we are seeing fewer new customers coming online. Our partner channel, which includes paid and freemium components, continues to drive double-digit growth. In our Software segment, we delivered $170 million of revenue, up 2% from last year and 11% after adjusting for the divestiture. As shown on Page 7, total ARR was up 9%, and the Platform ARR again grew at a remarkable 60%. Our net retention rate is also very strong, as our existing customers continued to expand their usage. Total NRR for the quarter, shown on Page 8, was 108%. Platform NRR was 135%. We also had a very good quarter with new sales. Our ACV bookings, as shown on Page 9, was up 64% over last year. We’re extremely excited about the continued growth potential for our FICO platform, and that excitement was shared by our customers at our recent FICO World Conference. The event hosted in May was an opportunity to connect face-to-face with our clients and partners. We hosted 750 FICO clients from leading banks, financial services firms, auto finance companies, insurance providers, and telcos. The event included 90 breakout sessions as well as hundreds of individual strategic consulting engagements, all designed to help our customers identify how FICO can enable them to accelerate and achieve their goals with the FICO platform. It was a great opportunity to hear from FICO customers, with nearly 70 clients presenting during breakout sessions, sharing their success stories and lessons learned. FICO World ‘22 was an essential moment where we had the opportunity to explain and demonstrate our platform strategy directly to our most strategic clients. Clients rated this FICO World the best FICO World of all past events, and we’ve already seen a surge in registrations for the next FICO World, to be held May 13 through 16 in Hollywood, Florida. I’ll have some final comments in a few minutes. But first, let me turn the call back over to Mike for financial details.

Thanks, Will, and good afternoon, everyone. We delivered another quarter of strong results and remain confident that we can deliver on the increased guidance we issued last quarter. Total revenue for the third quarter was $349 million, an increase of 3% over the prior year or 7% after adjusting for the divestiture of our Collections and Recovery product line last June. In our Scores segment, revenues were $179 million, up 4% from the same period last year. B2B Scores revenue was up 3% over the prior year. As Will mentioned, we continue to see a decline in mortgage origination revenues, which were down 25% from the same quarter last year. However, other parts of the portfolio continue to be strong. Credit card and personal loan originations revenues were up 37%, and originations revenues and auto origination revenues were up 12%. B2C Scores revenues were up 7% from the same period last year driven by strong growth from our partner channel. FICO’s Software segment revenues in the third quarter were $170 million, up 2% versus the same period last year or 11% after adjusting for the divestiture of our Collections and Recovery business. Software license revenue recognized upfront was $20 million in the quarter compared to $13 million in the same period last year. Point-in-time revenues will vary from quarter to quarter driven primarily by the mix of on-premise versus SaaS subscription sales. As expected, we continue to see lower Software professional services revenues. Those revenues were $27 million this quarter, up slightly from last quarter, but down 24% from the same period last year, much of it due to last year’s divestiture. This quarter, 84% of total company revenues were derived from our Americas region. Our Software ARR at the end of the third fiscal quarter of 2022 was $561 million, a 9% increase over the prior year quarter. Our Platform business continues to perform extremely well. Platform ARR was $108 million, representing 19% of our total third quarter ARR, with a growth rate of 60% versus the prior year. The dollar-based net retention rate in the quarter was 108% overall. Again, we’re seeing exceptional performance in our Platform business as customers continue to expand their usage. The dollar-based net retention rate for Platform was 135% in the third quarter. Our non-Platform customers' software usage continues to be relatively stable, with a net retention rate of 101% this quarter. Software sales were again strong this quarter, with annual contract value bookings of $19 million versus $11.6 million in the prior year, an increase of 64%. Turning now to our expenses for the quarter. Total operating expenses were $208 million this quarter, up slightly from our second quarter. We expect expenses to continue to increase modestly in our fourth quarter. Our non-GAAP operating margin, as shown on our Reg G schedule, was 49% for the quarter. We delivered non-GAAP margin expansion of 1,000 basis points over the same period last year. GAAP net income this quarter was $93 million, and our GAAP EPS was $3.61, which was down from last year when we had a $93 million pretax gain on sale of our collections and recovery product line. Our non-GAAP net income was $116 million for the quarter, up 17% from the same quarter last year. The effective tax rate for the quarter was 23%. We expect our FY 2022 recurring tax rate to be approximately 25% before any excess tax benefit and other discrete items. For the trailing 12-month period, free cash flow was $449 million. At the end of the quarter, we had $182 million in cash and investments. Our total debt at quarter end was $1.96 billion, with a weighted average interest rate of 3.86%. With that, I’ll turn it back over to Will for his thoughts on the rest of FY ‘22.

Thanks, Mike. As I said in my opening remarks, I’m pleased with our ability to continue to deliver strong results and how we can meet our customer needs while working in the best interest of our shareholders. We continue to deliver mission-critical software and analytics to customers. As the financial services industry continues to navigate the impacts of economic volatility, the need for precision through advanced analytics has never been more important. Lenders are seeking more ways to assess risk and opportunity in real-time to inform decision-making. Our Scores business continues to provide lenders with time-tested analytics that help manage risk throughout the consumer lending market. On the Software side, we continue to drive remarkable Platform ARR and NRR growth, demonstrating a strong market appreciation and appetite for our latest decisioning technology. Finally, as you know, it’s our practice to provide only annual guidance, so it’s not our policy to raise guidance in our fourth quarter. I’m pleased to say we are reiterating the full-year guidance that we raised last quarter. We remain confident that we are well-positioned to meet or beat the numbers we have presented and look forward to discussing our fiscal ‘23 expectations when we release our results next quarter. I’ll turn the call back to Steve for Q&A.

Thanks, Will. This concludes our prepared remarks, and we’re now ready to take any questions you may have. Operator, please open the line.

The first question will come from Manav Patnaik with Barclays.

Well, I just wanted to touch on the last point you made where you said you’re kind of prepared to meet or beat the guidance. But I was hoping you could just walk us through some of the moving pieces. It sounds like maybe mortgage could work, myFICO.com could work. And anything else that perhaps either got worse or better, and maybe throw in some comments on pricing in there as well?

Pricing is really a topic for next year as it is already set for this year. We have some challenges in the mortgage sector, but other aspects of the business are performing well.

Our next question will come from the line of Kyle Peterson with Needham.

I just wanted to have a question on Software. Results are really strong, especially on the ARR side this quarter for Platform. Have you guys seen any change, whether it’s in longer sales cycles or clients looking at potentially down-gauging deals with some recessionary fears kind of perking up here?

No, we really have not. I would say that the IT spending in the financial services industry seems to be on track and hasn’t moved a whole lot. Sales cycles have not gotten any longer. They’re the same, which is not to say they’re short, but they’re what they have always been. So I would say no change.

Understood. That’s really helpful. And then, I guess, just following up on the expense run rate. You showed some really good margin leverage this quarter despite having your conference. Then you guys said expenses will be up modestly next quarter. What are the biggest drivers of higher expenses here? Is it just higher personnel and wage costs, just given the tight labor market? Or are there any other investments that you guys are making, that you want to call out right now?

It’s a couple of things. We’re going back to a little bit more of the pre-COVID travel expense that is just starting to kick in again. And I would say that we are hiring. Attrition is more or less where it’s always been, but I think it’s taking us a little longer to backfill than in years past. It’s a tight market out there.

Our next question comes from the line of Surinder Thind with Jefferies.

A question about the ACV bookings here. It’s the third consecutive quarter of a really strong number. Any color or commentary there, in addition to what you’ve kind of said on the call, in the sense that I think the expectation is that relative to where expectations were, you guys are well ahead of that. And there also tends to be seasonality next quarter. So how should we think about that? Has there been any pull forward? Or should we just expect the normal seasonality as well?

So ACV bookings, as you know, is a new metric reported externally. We’ve been tracking it internally longer than that, of course. And we set high goals for ourselves for this year in terms of new sales, and we’re on track to hit those. There isn’t a material amount of pull-forward or any that I can put my finger on that’s happened this quarter or quarters before.

Fair enough. And then in terms of the professional services, they had been declining for a while. I think, last quarter, you talked about them kind of bottoming. And then there was a meaningful uptick this quarter. I mean I realize it’s not a large number, but it’s that was a bigger uptick than I was anticipating. Any color there? Or what kind of drives the run rate there? Where should that balance out?

Yes. I think it was my prediction, as you correctly point out, last quarter that we may have reached the bottom. I think that’s demonstrated early, so we have 1 quarter’s data point that, that is the case. When we shifted our strategic focus away from lower-margin professional services to focus more of our go-to-market energies on annual recurring software, we saw significant decline in the bookings of new professional services once we made that decision. The decline in bookings stabilized about 3 to 4 quarters ago, so the bookings are no longer declining. This kind of $25 million a quarter is probably a pretty good expectation in the near term.

Helpful. And then a question or a color on the B2C part of the business. You talked about continued double-digit growth at your partner, potentially seeing a slowdown in growth at myFICO.com. Any color there in terms of is it simply the net new additions number? Are you seeing a bit more, perhaps, turnover at myFICO.com? Any color you can provide there?

No, it’s really the net new additions. It has to do with the fact that we see a spike in that business when people are out mortgage shopping. As mortgage volumes fall off, consumers subscribe to that in smaller numbers.

The next question comes from the line of George Tong with Goldman Sachs.

You provided revenue performance across mortgage, autos, and card and personal loans. Can you describe how price and volume trends contributed to performance in those categories?

Price played a part. I think that if you look at the externally available numbers for performance in those 3 categories, our volume realizations were similar to what you would think they would be if you looked at things like J.D. Power or the NBA or the results of the bureaus that reported in the last week. I would say, as we said last quarter, that the mortgage decline in terms of units has been pretty consistent with what we expected it would be for the year when we set guidance and then revised it. Last quarter, autos have been a little worse than we expected, but our revised guidance bakes in that change.

Got it. Regarding your Software business, the percentage of ARR that’s transitioning to the Platform continues to increase. Can you share what internal targets you have for the desired distribution of ARR on-Platform versus off-Platform in the near to medium term?

We don’t have a forced mix. We aggressively go after as much new Platform business and expansion Platform business as we can get. That is a strategic priority for us. At the same time, we continue to invest in features and functionality for our legacy solutions. We’re pretty happy with the mix the way it is, with dramatic growth on the Platform side and kind of flat growth on the legacy side.

Our next question comes from the line of Jeff Meuler with Baird.

On B2B Scores, what’s the typical lag from when the bureau gets the inquiry, to when it’s recognized by FICO as revenue? And the reason I ask is like it looks like you’re seeing some acceleration in card growth relative to last quarter.

Yes, Jeff, there really isn’t a timing difference with one caveat. The last month of the quarter, the data that we get from the bureaus is tentative and subject to revision. So occasionally, there will be a little bit of a true-up when we get the final data in there, but it’s not material and it’s not an explanation to the dynamic that you see in the data you just cited there. It’s real-time for June.

Okay. And then on myFICO, just so I understand it correctly, it’s still growing year-over-year, is that correct?

It’s more or less flat on a quarter-to-quarter basis, which means it’s still growing on a year-over-year basis. But we’re seeing a lot less net new, probably because less people are shopping for mortgages. That leads us to be cautious about the next couple of quarters at myFICO.

Understood. Yes, the whole industry is seeing a much softer direct channel. And then just on FICO World. Great to hear the registrations and that you’re doing it again in May of next year. How is the pipeline build? I would imagine that was a pretty significant pipeline building event for you itself, a little bit like a coming-out party for Platform.

Yes, that’s exactly right. FICO World is several days of showcasing our product. The heavy relationship building occurs in consultation sessions where we sit down with clients individually. The pipeline that comes out of FICO World is phenomenal.

And our next question comes from the line of Ashish Sabadra with RBC Capital Markets.

Can you just talk about the slowing total Software ARR growth in the quarter?

Well, it’s slowed by a relatively small amount, and I would attribute that to normal quarter-to-quarter variability. It’s not a reflection of anything fundamental.

And that does conclude the Q&A session for today. Mr. Weber, I’ll turn the call back to you.

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

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