Fair Isaac Corp Q3 FY2023 Earnings Call

Good afternoon, and thank you for joining FICO's third quarter earnings call. I'm Steve Weber, FICO's CFO, and I'm joined today by our CEO, Will Lansing. 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 the presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve many uncertainties 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 2, 2024. And 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. On the Investor Relations section of our website, we posted slides that offer financial highlights for our third quarter. I am pleased to report we delivered another exceptional quarter with record revenue and profitability and strength throughout our business. Today, I'll talk about this quarter's results and our increased guidance for the full fiscal year. As you can see on Page 2 of the presentation, we reported record revenues of $399 million, an increase of 14% over the same period last year. We delivered $129 million of GAAP net income and GAAP earnings of $5.08 per share, growing 38% and 41%, respectively, over the prior year. On a non-GAAP basis, net income was $143 million, with earnings per share of $5.66, representing year-over-year growth of 24% and 27%. We continue to deliver strong results throughout the business. Scores revenue was a record $202 million, up 13% in the quarter versus the prior year. As you can see on Page 6 of the presentation, B2B revenues were up 24%, driven primarily by increased originations revenues. Mortgage originations revenues were up 135% versus last year. Auto origination revenues were up 5%. Credit card, personal loan and other origination revenues were up 2%. On B2C, revenues were flat with last quarter and down 11% versus the same period last year. That was due to difficult comparisons. In our Software business, we continue to drive growth with FICO Platform, which provides the power of analytics and AI to enable smarter business decisions at scale. You can see on Page 7, we delivered overall ARR growth of 20%, a significant milestone for us, and platform ARR growth of 53%. This represents our 15th straight quarter of platform ARR growth in excess of 40%. We continue to drive strong net retention rates as our customers continue to increase volumes and find new use cases. Overall NRR increased to 117%, as shown on Page 8. Legacy off-platform NRR was 109% as volumes grew in many of our customers. Platform NRR was 142% due to expanded use cases driven by the success of our land-and-expand strategy. And we continue to see strong demand for our software. As you can see on Page 9, we had another quarter of double-digit growth, with ACV bookings up 13% over the same period last year. We continue to see a strong pipeline of opportunities and are seeing strong demand for FICO Platform. We had first-hand confirmation of the critical nature of FICO Platform at our recent FICO World Conference. This is a 3-day event, and it attracted customers from more than 60 countries where they shared best practices, learned about the latest in AI and advanced analytic innovations, and learned new approaches for digital transformation. We talked about how FICO Platform can design, build, and deliver AI-powered hyper-personalized customer journeys across every touchpoint and with every interaction. Personally, I enjoyed the opportunity to meet our customers and hear from them how we're working together to optimize their most difficult decisions. One customer said, 'I knew the FICO Platform had potential to help transform our business from a decision-making perspective, but I'm now blown away by the scope of the platform and communications capabilities.' Another customer told us, 'FICO doesn't sell software; you sell intelligence. That's way more valuable.' And yet another customer simply said, 'We either do this now or we fail forever.' I'm proud of our technological excellence and the team that supports our customers to transform their business. Finally, I'd like to say a few words about our partnership with Chelsea Football Club, where we're working together to empower students, adults and communities across the U.S. with financial literacy tools and knowledge to make informed credit decisions that last a lifetime. We are hosting fundamental workshops in partnership with the U.S. Soccer Foundation to empower the younger generation with essential credit knowledge to jump-start their credit journeys. Financial literacy correlates with better outcomes in education, but we know that the playing field is not always equal. One in five U.S. teenagers lacks basic financial literacy skills. Around 74% of teens aren't confident in their financial knowledge. We're working on tackling this financial education gap to get more young people in the game. In each of the five cities that Chelsea is playing this summer, we're working with local partners to bring teenagers from traditionally underserved communities to these fundamental workshops that are held on or near game day. The students will have an opportunity to attend the Chelsea football game taking place in their city. For the wider community in these cities, FICO is also hosting 'Score a Better Future' credit education events, which are free to the public and will provide local residents with knowledge and tools to gain better insight into their financial health and understanding of their FICO Scores. We know that FICO Scores have allowed much more equitable access to credit, and we're committed to helping educate consumers about processes to foster broader inclusion. I'll have some final comments, including an increase in our guidance, in a few minutes. But first, let me turn the call back to Steve for further details.

Thank you. As Will said, we delivered another very strong quarter in both our Scores and Software segments. Total revenues for the third quarter were $399 million, an increase of 14% over the prior year. In our Scores segment, revenues were $202 million, up 13% from the same period last year. B2B Scores revenues were up 24% over the prior year, driven by increased originations revenues. We drove revenue increases in mortgage, auto, and credit card personal loan and other originations. This quarter, mortgage originations revenues were up 135% from the same quarter last year; auto originations revenues were up 5%; and credit card, personal loan, and other origination revenues were up 2% over last year. B2B Scores revenues were down 11% from the same period last year, again, due to difficult comparisons. B2C revenues have been relatively flat throughout FY '23. Software segment revenues in the third quarter were $197 million, up 16% versus the same period last year. Software recognized over time were $147 million or 74% of total Software revenues. License revenues recognized upfront or at a point in time were $25 million this quarter and represented 13% of Software revenues. Our professional services revenues were $25 million, also representing 13% of total Software revenues. In the third quarter, 87% of total revenues were derived from our Americas region, our EMEA region generated 8%, and 5% were from Asia Pacific. Our software ARR in the third fiscal quarter of 2023 was $646 million, a 20% increase over the period the prior year. Our platform ARR was $164 million, up 53% from last year and represented 25% of our total third quarter ARR compared with 20% last year. Our nonplatform ARR also grew very well and was $482 million in the third quarter, up 11%. And as a reminder, all of our ARR numbers have been adjusted for the divestitures we've made. Our dollar-based net retention rate in the quarter was 117% overall versus 109% last year. We continue to show very strong net expansion from our platform customers due to follow-on sales of new use cases and from increased usage. The dollar-based net retention rate for platform was 142% in the third quarter. Our nonplatform customer software usage also increased this quarter due to increased volumes and CPI increases. The nonplatform net retention rate was 109%. We had another good quarter of software sales with ACV or annual contract value bookings of $21 million versus $19 million in the prior year, an increase of 13%. And as a reminder, ACV bookings include only the annual value of software sales and exclude professional services. Total operating expenses in the third quarter were $222 million this quarter versus $208 million in the prior year and $221 million in Q2. Third quarter expenses included our FICO World event in May and a one-time reimbursement of third-party data implementation costs that were previously incurred in the previous quarter. Our non-GAAP operating margin, as shown in our Regulation G schedule, was 53% for the year, a 400 basis point improvement over the previous year. GAAP net income this quarter was $129 million, up 38% from the prior year quarter and included a noncash reduction to income tax expense of $9.5 million associated with the valuation of our R&D tax credits. GAAP EPS of $5.08 was up 41% from the prior year. Our non-GAAP net income was $143 million for the quarter, up 24% versus the same quarter last year. And the non-GAAP EPS was $5.66, up 27% from the prior year. The effective tax rate for the quarter was 18% and included the adjustment to the valuation of the R&D credit I mentioned earlier. We expect our Q4 recurring tax rate to be approximately 25% to 26%. That expected recurring tax rate is before any excess tax benefit or other discrete items. Free cash flow for the quarter was $122 million. For the trailing 12 months, free cash flow was $446 million. At the end of the quarter, we had $195 million in cash and marketable investments. Our total debt at the quarter end was $1.93 billion, with a weighted average interest rate of 5.1%. Currently, about 67% of our total debt is fixed rate. Our floating rate debt is prepayable at any time, giving us the flexibility to use free cash flow to reduce outstanding floating rate debt balances in future periods. Turning to return of capital. We bought back 130,000 shares in the third quarter at an average price of $753 per share. At the end of the quarter, we had $237 million remaining on the current Board authorization, and we continue to view share repurchases as an attractive use of cash. And with that, I'll turn it back to Will for his thoughts on the rest of FY '23 and an increase in our full-year guidance.

Thanks, Steve. As we finish our fiscal 2023 year, I am extremely pleased with the progress we've made in advancing our strategic initiatives. And I'm bullish on both segments of our business. Our Scores business continues to deliver strong growth, and we're dedicated to innovation to face industry challenges in the years to come. And our Software business, through FICO Platform, is enabling customers to use the latest analytics and AI technology to optimize their consumer interactions. Finally, today, we're again raising our full-year guidance as we enter the final quarter of our fiscal year. We are raising our full-year revenue guidance to $1.5 billion. We are also increasing our GAAP and non-GAAP net income guidance. GAAP net income is now expected to be $428 million. GAAP earnings per share is now expected to be $16.90. Non-GAAP net income is now expected to be $500 million. Non-GAAP EPS is expected to be $19.70. And I'll now turn the call back to Steve, and we'll take some Q&A.

Thanks, Will. This does conclude our prepared remarks, and we are ready now to take your questions. Operator, please open the lines.

Your first question comes from the line of Manav Patnaik with Barclays.

I was hoping for my first question if you could help us understand the changes in guidance. It seems like you raised it, but it doesn't fully reflect the extent of the beat. I'm curious about what you're projecting for the last quarter and how variable these projections might be from quarter to quarter.

Yes, we tend to be conservative with our guidance. We want to avoid being in a position where we need to close deals in the last week of the quarter to meet our targets. If a better deal can be pushed into the next year, we are open to that. We usually provide full-year guidance and update it mid-year instead of doing it on a quarterly basis. Raising guidance with just one quarter left is significant for us, but we felt it was necessary. You can interpret that as you wish, but we remain cautious in our guidance approach.

Okay. Fair enough. And then obviously the... .

And I will say just one more thing, Manav.

Sure.

We did have a fair amount of one-time license revenue this quarter that we may or may not have in the fourth quarter, so we don't want to rely on that.

Yes. Fair enough. Okay. And then just on the Scores business, I mean the mortgage origination numbers speak for your pricing efforts there. But can you just tell us where we are on card, auto, and the other stuff, like in terms of the pricing strategy there?

They all experienced some pricing increases this year, likely in line with the Consumer Price Index. In terms of volumes, mortgage remains down, reflecting the decreases reported by the bureaus. Auto stayed relatively flat compared to last year, while card numbers have dropped slightly. Originations this quarter are down a bit as well. I won't go into further detail right now, but we observe the same trends regarding volumes as the bureaus do.

And your next question comes from the line of Faiza Alwy with Deutsche Bank.

So I wanted to follow up first on the Software side of the business. You mentioned one-time licensing revenue. And maybe I missed that, but talk to us more about like what drove that? And I know you said you're not counting on that for 4Q. But what were some of the drivers around that?

We had some renewals. We had one fairly large renewal. If you look at our point-in-time revenue, it was $25 million this quarter. That's a little bit more than we have been trending. So it's not that sizable, but that's a number that can have some variability from quarter-to-quarter. So I think it was $20 million a quarter before that. So those things happen when they happen, and we don't want to be put in a position where we have to have them happen in specific quarters. So we're cautious with where we guide. And that's not much of our business anymore. It used to be 20-plus percent of our business; now it's 10%. So actually, it's less than 10%. So it's a small part of the business, but it's still a meaningful number when you're looking at one quarter.

Okay. Okay. And so my next question is generally around the Scores business. So with only one quarter left, we're looking ahead to next year, and I know you're sort of getting to the time where you start talking about pricing for next year. So curious how you're thinking about that. There's obviously a lot of changes that are supposed to happen in the mortgage space, in particular. So talk to us about any initial thoughts you might have around pricing.

It really is a little bit early for us to talk about pricing. We're still thinking that through. But I think you can anticipate that there will be continued increases in price, where we think that the market warrants it, where the value we're providing demands it. And in terms of significant changes to the structure of the market and the structure of our pricing, we don't anticipate that.

Yes. I believe many of those timelines have already been pushed back. We make decisions based on the information available to us, but beyond that, it's hard to predict what will happen and when.

I think the thing to keep in mind is this is a big and very important market. And it's important that any kind of changes happen slowly, incrementally, and with the ability to anticipate kind of how the market will behave. And so you can expect us to be good players as far as all that goes.

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

The first question is just around FICO World '23. The conversations that you have with clients there, how quickly do those conversations translate into signed contracts and then eventually revenues? And related to that, how big a source of new customers is that for you?

So great question. Thanks, Surinder. It's a tremendous source of business for us with existing customers and with new customers. And the speed with which it translates into business is it's actually quite a large continuum. We have deals that get signed at FICO World. I mean, we obviously try to close business on the spot, where appropriate. But then there's other things that just go into the pipeline and then we work the pipeline over the subsequent year. Our pipeline has been getting shorter. Our pipeline used to be over 400 days. We're down well below that today and continuing to trend downward, which is a good sign. The thing with FICO World is it's really an opportunity for our customers to talk to other customers who have shared problems, shared experience and to really get kind of real-world feedback from customers who've implemented our software, on how it's worked and what it's done for them and what kind of returns they can expect and the timelines for implementation and so on. And because of the platform, in particular, is so successful, it's working so well, there's a lot of good stories to be told. And it's obviously way more credible when our customers are telling the story and acting as reference customers than we're out just selling our wares. And so FICO World is a very important event for us to be able to put customers in touch with one another. And frankly, they do the selling. We're there to facilitate.

That's helpful. And then a question about the FHFA timeline for just switching over to the new mortgage scores. Any color there in terms of the conversations that you're having with customers or clients at this point in time just to understand whether the timelines are realistic? Are things already being engaged at this point? How should we think about the transition period?

I think that it's likely that the timelines will be extended. There's additional review going on. And there's obviously a lot of detail that needs to be worked out that wasn't completely worked out at the time of the announcement. And so I think all signs point to a more thoughtful and more drawn-out timeline.

Your next question comes from the line of Kyle Peterson with Needham.

Just wanted to touch a little bit on the guidance raise and kind of where you guys have been kind of seeing upside, at least, kind of year-to-date here, particularly on the Scores side of the business, I guess. Where have things maybe been trending a little better than expected? I mean, it seems like mortgage has been notably strong since a lot of that is price. But I guess is there anywhere in the guide, at least, so far, where you guys have been kind of tracking above and is kind of part of what allowed you guys to raise today?

What enables us to increase our guidance is simply that more time has passed, reducing our risk. We've already accumulated three quarters of data. As we entered the year and even at its midpoint, there were many uncertainties, especially following the Silicon Valley bank crisis and several interest rate hikes. Looking back to the beginning of the year, there was significant uncertainty. However, now that we have three quarters of data, there is less uncertainty. We still have another quarter ahead, and we will see how that goes. Nevertheless, the strong results we have achieved so far give us greater confidence in raising our guidance.

Great, that's helpful. I have a follow-up regarding the platform ARR, which has shown over 50 percent year-on-year growth for another quarter. It's impressive to see. Are you experiencing an expansion in your customer base? It appears that you've gained significant traction with some international banks early on, but it seems like this might be broadening to other related sectors. How should we consider the pipeline and your ability to sustain these strong growth rates, especially as the law of large numbers begins to make comparisons more challenging?

The growth of the platform is driven by both our existing and new customers. We continue to attract enterprise clients as they discover our offerings and compare us with their competitors. Once our solutions are implemented, most customers find additional applications and increase their usage over time. We are still early in this journey and are signing many new customers. In the long run, I expect more focus on expanding existing accounts rather than just acquiring new ones, but for now, both aspects are balanced. This is a positive narrative for us. We have always acknowledged that growth cannot be infinite, and we do not foresee sustained growth rates above 50%. However, I am quite pleased that in our 15th quarter, we continue to experience significant growth without any signs of slowing. The adoption rate is excellent, and the potential market and use cases are extensive. Therefore, we are not concerned about encountering the law of large numbers just yet.

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

You now have several months under your belt from when you raised prices in Scores at the beginning of the year. Can you provide an update on customer receptivity to overall pricing actions this year? And what credit volume assumptions for fiscal 4Q are reflected in your full year guide?

Customer reaction is an important topic. Our customers see significant value in the Scores and appreciate the benefits they provide, even though no one is fond of price increases. So, naturally, when we raised prices, there were discussions, and we received feedback. However, the satisfaction levels among our customers with the product and its functionality are quite high. This has been consistent for many years, and I don't foresee that changing. We don't plan to disclose our assumptions for the next quarter. Typically, we aggregate all our numbers to create a forecast and then adjust that based on what we're comfortable guiding. This involves various factors, much like running a mining simulation. Therefore, we don't operate with a single set of expectations for the next quarter, but we approach our guidance conservatively to ensure we exceed expectations.

Got it. That's helpful. And then on the software side, ARR growth was very strong at 20% this quarter. Can you talk a little bit more about what's fueling that growth acceleration, particularly in this relatively tough macro environment? How much of the growth reflects large bank adoption of your platform solutions, increase in use cases, increase in usage or other factors?

We had some big deals with existing customers, and then we also added new customers. It's really both.

On the non-platform side, we experienced good volume, and those numbers look impressive. The ARR for the non-platform segment showed solid performance, with strong volumes on the CCS side and robust numbers in the Falcon Fraud segment as well. Overall, there's significant strength across the portfolio. On the platform side, we continue to see expansion, with several major customers going live this quarter, contributing to new revenue.

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

Let me just pick up there. Is there some thought that the non-platform business has some decent growth potential like you saw this quarter? And then if you could just maybe address if the license step-up in the large renewal was in platform or non-platform.

Yes, it's difficult to determine. We experienced some pent-up demand following the pandemic, which has led to increased activity. I don't believe that our off-platform segment will significantly drive growth in the long term. However, it's encouraging to see those numbers perform reasonably well.

And the license deal?

The license deal was a legacy business deal that was not associated with the platform. It was a renewal of an existing legacy deal.

It's important to highlight that our legacy software is currently installed and tends to have a very long lifespan. We typically see renewals every three years, and these can be renewed multiple times. Therefore, for our current business and on the legacy side, we anticipate ongoing renewals and continued customer interest in that software for an extended period, usually up to a decade. We have not phased out the software; in fact, the term "legacy" should not be viewed negatively. Our legacy software is leading in the industry, and it performs better than any other software available. Our customers recognize its value and appreciate it. We are committed to investing in innovation and research and development to ensure optimal functionality. As Steve mentioned, while we do not view it as a growth avenue, it is also not declining; it remains a very stable business.

I want to add that the license deal was a renewal of a term deal, so it is not included in the Annual Recurring Revenue. The Annual Recurring Revenue was primarily driven by volumes on CCS, along with Falcon Fraud, maintenance, and other factors. Therefore, our term license deals fall outside of that.

Got it. And then I get that it's early to talk '24 pricing, but maybe if you can just talk about the '23 experience. Like you said, the numbers speak for themselves, and they speak loudly. '23, historically high pricing. So just what did you learn from the experience? And is there the potential that the '23 pricing level could be the new normal going forward after you have some time under your belt on seeing how it resonated?

I think it's a bit early to make definitive statements, and we will need to observe how things develop. However, you can expect continued growth in Scores, driven by both price increases and higher volumes that we anticipate for next year.

And there are no further questions. I'll turn it back to yourselves for closing remarks. Thank you very much.

Great. Thank you very much, everyone, for joining today. This does conclude our call, and we look forward to speaking with you again soon. Thanks.

And that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.