FICO reported 4rd Quarter earnings yesterday. The company once again reported outstanding results, driven in part by the usual progress in Scores, and continued execution in Software. Aside from these excellent results, there continue to be developments within Scores that continues to… surprise me.
Scores
Scores revenues came in at $195.5M for Q4 2023. This was an outstanding 12% growth YoY. This was also a slight decrease of 3% QoQ. B2B Scores posted 21% growth YoY with B2C showing a decline of 6%. Within Scores, Mortgage continues to show revenue growth that can only be described with the aid of memes:
YoY growth in Mortgage revenue was 147% - eclipsing the 135% growth of this segment last quarter. As I mentioned in my last update:
As many have been speculating, normalisation in Mortgage originations will be a significant tailwind for the company for quite some time. CY 22 was a year of very precipitous declines in originations due to the stunning rise in interest rates coming out of the Pandemic.
The fact is that Mortgage volumes remian in the toilet, and there’s no immediate line of sight to seeing that change in lieu of the current interest rate regime. What will happen next is somewhat dependant on where interest rates go - I am certainly not as sanguine as some in seeing a clear end game here. If rates drop materially from here, we will probably see a wave of mortgage refinancing which will be a real boon for Scores revenue. The dynamic that has played out so far is that the company continues to take price well in excess of volume declines.
According to my sources (super top secret Twitter DMs), FICO plans on actually pushing even more aggressive pricing through in Mortgage. While much of this is hearsay and innuendo, there are grumblings that the pricing model rolled out in CY 2022 will be changing (if it hasn’t done so already).
A quick primer. Last year it was revealed that FICO was rolling out a tiered pricing model based on Scores volume for the Mortgage industry. While the news headline read that the cost of the Score would be going up 400%, the reality at the time is that Mortgage Scores would see pricing increases between 10-400% depending on the relationship with a particular financial institution. Initially this led me to believe that the weighted average price increase going forward would look something like 20-30%. This has since proven to be dead wrong.
It appears now that the higher volume Scores users have seen significantly higher price hikes than a measly 10%. In fact it looks like the higher volume tier has been abandoned altogether. It also looks like FICO will be pushing through a number of staged price hikes in some of it’s weaker segments, i.e. the so called soft pulls. The industry has also been reporting price taking in Automotive, a segment which isn’t as strong as Mortgage but is still heavily reliant on the FICO Score.
The fact remains that despite the current environment being the most challenging since the GFC in terms of volumes, the company is able to continue to hit it’s financial goals on the back of price alone.
Once again, this quarter’s results were amongst the best in company’s history, and is certainly the best Q4 result on record
In terms of the outlook for Scores volumes going into 2024:
Faiza, what our forecast reflects is lower volumes than last year, so a decline versus last year, and roughly flat volumes from the level we're at today. That's how we think about the volume side. And as you know, we take price action for CPI, and sometimes in excess of CPI, every year. And so this year is no different. We will be doing that again.
Chief Executive Officer, Will Lansing
In terms of where we can expect price to go, it will be much of the same:
Jeffrey Meuler
Can you give us any sense of what you included in the guidance versus what you held back around pricing? For instance, last year, I think you talked about the original guide had the CPI-like pricing increases, but it didn't have the special pricing increases. Just any way to help us kind of like understand what's assumed versus what could still be -- to come.
William Lansing
Yes. Jeff, I know you'd love for us to put a number on it. And you know us, we never do. And so it's not going to happen today either. The way we think about it is we look at the volumes, we make our forecast built around the volumes. We put on a CPI increase, and then we put on what some people call special pricing, but we have some additional increases beyond CPI. And then because the timing of those is uncertain, we leave some of that out of the guidance.
And so call our guidance conservative. It's really designed to reflect the fact that we just don't know how quickly the full price effect will be ramped into our numbers. And so I hesitate to put any kind of a number on it for you. Is it safe to think about it the way we have in years past? Yes. So think about it the way we do it every year. We haven't changed our methodology.
In last quarters update I also wrote a short primer on the developments with the FHFA’s determination on credit scoring arrangements in relation to conforming Fannie and Freddie mortgages. These developments are essential to FICO’s positioning in the industry broadly.
What has been true for the last 12 months is that the industry has been largely unable to transition to the mandated FICO Score 10 and Vantage Score 4.0. Exemptions have now been made, and there seems to be a distinct possibility that some of these changes never fully occur. What this has meant is that the age old practice of the tri-merged credit rating for a conforming mortgage has remained in place. This circumstance benefits everyone: FICO continues to get 3 scores returned in stead of 2 out of every mortgage application, each of the Credit Bureaus continue to get a credit report out of every marginal borrower, and the larger value chain doesn’t need to update their systems or practices.
Each of the Credit Bureaus have been working on compiling further differentiated data sets in response to the bi-merge mandate. The idea here is that while 2 credit ratings would be sufficient for a conforming mortgage, 3 will remain the industry standard as lenders won’t be able to get a full view of credit worthiness without the intelligence of all three bureaus. Crafty as ever.
While developments underlying the Score’ s industry position continue to be fluid, the Score remains a vital part of the wider lending value chain with a large margin between it’s utility and the price that FICO currently charges for them.
Software
Software Revenues also saw another decent bump to 11% YoY growth. Stronger growth in Software last quarter was attributed to unexpectedly strong licence renewals.
The growth in Platform Annual Recurring Revenue (ARR), however, continues ahead at a breakneck pace growing in excess of 53% YoY. Non-platform ARR continues to grow at a very acceptable 14% YoY - however the purely SaaS Platform model is starting to make up a larger portion of annual ARR on the software side every quarter - it now constitutes 26% of overall ARR.
Software Operating Margins reverted somewhat from the 40% of the previous quarter due to an unusual amount of one off business done in the previous quarter. Software expenses were somewhat higher than expectations - but not outside the realms of reason as software compensation remaps up in Q4. Once again, these are very impressive results.
Importantly, the head of Software Stephanie Covert will be leaving the business. Lansing was characteristically tight lipped about the departure, but the bench is deep for FICO in this regard. Lansing himself will step in to lead Software, although whether these responsibilities will be temporary in nature is yet to be seen.
Financial Discipline
I may as well re-post the following from last quarter’s update in perpetuity:
I am never not impressed by FICO’s ability to manage costs. The above chart speaks for itself, and speaks volumes. The company continues to execute strong financial performance well in excess of the costs it takes to generate that performance.
An extra ~$8M in expenses resulted in an additional $41M in revenues. Not a bad result in any man’s league.
Overall Financials
For the visual learners amongst us…
Much more of the same when it comes to the cash flow statement…
Boring, and excellent.
Larry.
God tier company, deservedly high valuation. The market is not giving people who buy now the ability to earn great returns. Such is life. Having said that, I don't think the valuation is completely insane when you adjust for normalisation of volumes. I just don't think the forward returns are great for people who are picking up shares here. Thanks again for the great write up Larry.