Will Lansing - Chief Executive Officer Mike McLaughlin - Chief Financial Officer Steve Weber - Vice President, Investor Relations

Greetings! And welcome to the Fair Isaac Corporate Quarterly Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this call is being recorded today, Tuesday, August 3, 2021. I’d now like to turn the call over to Steve Weber. Please go ahead.

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

Thanks Steve, and thank you everyone for joining us for our third quarter earnings call. Before I discuss our results, I'd like to thank our FICO colleagues for their dedication, adaptability, and innovation during this past year. As we begin to open our offices back up, we're moving to a hybrid system where more of our team is working from home, but we've proven in the past year that we can make the most of technology to collaborate and continue to serve our customers and optimize our business, both remotely and in person. On the Investor Relations section of our website we posted some slides that offer financial highlights of our third quarter. In our third quarter we delivered revenues of $338 million an increase of 8% over the same period last year. As previously disclosed, we completed the divestiture of our debt collections and recovery products during the quarter. Adjusting for that, revenue grew about 9% year-over-year. We delivered $151 million dollars of GAAP net income and GAAP earnings of $5.18 per share, including the gain on sale of the C&R products. On a non-GAAP basis, which excludes the sale, net income was $99 million, up 29% and earnings per share of $3.38 was up 31% from last year. We continue to deliver very strong free cash flow growth as well. Free cash flow was $99 million in the quarter and $462 million for the last four quarters, and we're dedicated to using that cash flow return value to our shareholders, through our repurchase program. It was a very strong quarter for us, and we are well positioned for a strong finish to our fiscal year. As we continue our strategy of migrating our business model towards a subscription based model, we see some disruption in our near term…

Thanks Will and good afternoon, everyone. Today I'll walk you through our third quarter results in more detail and provide some information on divestiture of the collections and recovery products we closed in quarter. Total FICO revenue for the quarter was $338 million, an increase of 8% over the prior year. Our applications segment revenues were $133 million up 3% sequentially and down 6% versus the same period last year. Adjusting for the C&R divestiture, applications revenues were up 6% versus last quarter and down 4% from last year. The year-over-year decrease in revenue was primarily driven by reduced professional services revenues. In our decision management software segment, Q3 revenues were $33 million, down 20% over the same period last year, due primarily to decreased upfront license revenues. As Will said, our shifting business model is continuing to impact our software business in the near term. Our on premise license revenues will continue to decline as we move away from license sales to a notable subscription revenue model. Second, at the start of our fiscal year we noted that we have also changed our revenue recognition assumptions for on premise term license subscription deal. As a result, we now recognize less upfront license revenue and more revenue ratably over the term at each deal. The net impact this quarter was lower license revenue in our applications and DMS segments, of about $4 million versus what it would have been under our prior methodology. We anticipate the full year impact will be about $40 million and lower software license revenue this year, all of which will be recognized in future periods. As a reminder, last year we booked $61 million in upfront license revenue and our fiscal fourth quarter under the prior methodology. So that will be an especially difficult year-over-year…

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

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

Certainly and thank you very much. [Operator Instructions]. Our first question comes from Surinder Thind with Jefferies. Your line is open.

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

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

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

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

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

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

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

That’s helpful, thank you. I'll get back in the queue. Thank you.

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

Hey! Good afternoon. This is actually [Inaudible] for Kyle today. I was wondering if you guys could provide a little more color around the pricing environment for the Score business. Did that last round of pricing changes have any noticeable impact on the Scores business this quarter? Thanks.

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

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

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

Yes, got it. Alright, thanks guys.

Your next question comes from George Tong with Goldman Sachs. Your line is open.

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

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

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

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

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

Got it. Very helpful. Thank you.

Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open.

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

Mike, you want to take that?

I can take that one. Yes, I'm happy to. We mentioned last quarter or perhaps it was in the press release when we announced the deal, that roughly it's 6% of our revenues and that's you know rounding to the nearest percentage. And expense are in the near term that we'll be able to flex in the same ballpark as those revenue numbers. It's a Q4 heavy business just like our other software businesses are. So the year-over-year impact of not owning that business in Q4 in ’21 would have some seasonality associated with it versus a [inaudible] respect, but what will give you a ball park of what to expect.

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

Yes, I would say both of those proceed to pace, and that we have – am I hearing this interference. We are making progress on both the external facing APIs and on FICO Studio, there’s more of that to come, but much of that will be ready this year.

That's very helpful. Thanks.

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

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

Yes, I guess I would say that it is right sized. We don't have any plans for any significant divestiture going forward, at least not at this time. So I would call it right sized. I think the way to think about it is that the application solutions will increasingly be available on top of the decision management platforms and you so [inaudible] bear with you how those things break out. But you know right sized, yes.

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

Will started with the revenue and I think we'll have the TBD on getting down to margin level.

Okay, thank you.

[Operator Instructions] Next question comes from Jeff Mueler with Baird. Your line is open.

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

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

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

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

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

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

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

Got it. Thank you.

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

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

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