XNYS:FICO Fair Isaac Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNYS:FICO (Fair Isaac Corp): Fair Value Estimate
Premium
XNYS:FICO (Fair Isaac Corp): Consider Buying
Premium
XNYS:FICO (Fair Isaac Corp): Consider Selling
Premium
XNYS:FICO (Fair Isaac Corp): Fair Value Uncertainty
Premium
XNYS:FICO (Fair Isaac Corp): Economic Moat
Premium
XNYS:FICO (Fair Isaac Corp): Stewardship
Premium
 
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     [NO FEE REQUIRED]

For the transition period from                    to                    

Commission File Number 1-11689

 

 

Fair Isaac Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-1499887

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

901 Marquette Avenue, Suite 3200

Minneapolis, Minnesota

  55402-3232
(Address of principal executive offices)   (Zip Code)

Registrant's telephone number, including area code:

612-758-5200

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   x    Accelerated Filer   ¨
Non-Accelerated Filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

The number of shares of common stock outstanding on July 23, 2012 was 33,843,068 (excluding 55,013,715 shares held by the Company as treasury stock).

 

 

 


Table of Contents

TABLE OF CONTENTS

 

  PART I – FINANCIAL INFORMATION   
Item 1.   Financial Statements      1   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      15   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      33   
Item 4.   Controls and Procedures      35   
  PART II – OTHER INFORMATION   
Item 1.   Legal Proceedings      35   
Item 1A.   Risk Factors      36   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      45   
Item 3.   Defaults Upon Senior Securities      45   
Item 4.   Mine Safety Disclosures      45   
Item 5.   Other Information      45   
Item 6.   Exhibits      45   
Signatures      47   

 

i


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

FAIR ISAAC CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     June 30,
2012
    September 30,
2011
 
     (Unaudited)        
     (In thousands, except par value data)  
Assets   

Current assets:

    

Cash and cash equivalents

   $ 118,681      $ 135,752   

Marketable securities available for sale, current portion

     32,022        105,826   

Accounts receivable, net

     111,863        104,974   

Prepaid expenses and other current assets

     16,850        17,929   
  

 

 

   

 

 

 

Total current assets

     279,416        364,481   

Marketable securities available for sale, less current portion

     5,007        4,170   

Other investments

     11,083        10,934   

Property and equipment, net

     38,138        33,017   

Goodwill

     679,955        664,688   

Intangible assets, net

     17,130        19,498   

Deferred income taxes

     26,864        25,032   

Other assets

     8,702        7,648   
  

 

 

   

 

 

 

Total assets

   $ 1,066,295      $ 1,129,468   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity   

Current liabilities:

    

Accounts payable

   $ 14,014      $ 11,139   

Accrued compensation and employee benefits

     36,077        36,470   

Other accrued liabilities

     34,786        47,031   

Deferred revenue

     50,803        41,768   

Deferred income taxes

     —          2,090   

Current maturities on long-term debt

     8,000        8,000   
  

 

 

   

 

 

 

Total current liabilities

     143,680        146,498   

Senior notes

     496,000        504,000   

Other liabilities

     20,255        13,476   
  

 

 

   

 

 

 

Total liabilities

     659,935        663,974   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock ($0.01 par value; 1,000 shares authorized; none issued and outstanding)

     —          —     

Common stock ($0.01 par value; 200,000 shares authorized, 88,857 shares issued and 33,692 and 37,084 shares outstanding at June 30, 2012 and September 30, 2011, respectively)

     337        371   

Paid-in-capital

     1,100,788        1,098,388   

Treasury stock, at cost (54,165 and 51,773 shares at June 30, 2012 and September 30, 2011, respectively)

     (1,755,053     (1,627,180

Retained earnings

     1,084,271        1,015,624   

Accumulated other comprehensive loss

     (23,983     (21,709
  

 

 

   

 

 

 

Total stockholders’ equity

     406,360        465,494   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,066,295      $ 1,129,468   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

1


Table of Contents

FAIR ISAAC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Quarter Ended June 30,     Nine Months Ended June 30,  
     2012     2011     2012     2011  
     (in thousands, except per share data)  

Revenues:

        

Transactional and maintenance

   $ 113,708      $ 111,740      $ 342,734      $ 337,933   

Professional services

     31,993        29,582        91,147        84,531   

License

     14,777        9,357        56,467        36,970   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     160,478        150,679        490,348        459,434   

Operating expenses:

        

Cost of revenues (1)

     47,832        43,398        142,620        137,707   

Research and development

     14,890        14,290        41,925        48,573   

Selling, general and administrative (1)

     59,123        53,643        173,482        168,725   

Amortization of intangible assets (1)

     1,465        1,942        4,885        5,804   

Restructuring

     —          —          —          12,391   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     123,310        113,273        362,912        373,200   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     37,168        37,406        127,436        86,234   

Interest income

     82        1,923        276        2,084   

Interest expense

     (7,907     (8,023     (23,878     (24,401

Other income (expense), net

     911        631        (271     477   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations before income taxes

     30,254        31,937        103,563        64,394   

Provision for income taxes

     9,505        8,748        32,805        17,451   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

   $ 20,749      $ 23,189      $ 70,758      $ 46,943   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share

        

Basic

   $ 0.61      $ 0.59      $ 2.01      $ 1.18   

Dilluted

   $ 0.59      $ 0.58      $ 1.95      $ 1.16   

Shares used in computing earnings per share:

        

Basic

     34,004        39,451        35,126        39,788   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     35,293        40,241        36,247        40,426   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Cost of revenues and selling, general and administrative expenses exclude the amortization of intangible assets. See Note 5 to the accompanying condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

FAIR ISAAC CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

(Unaudited)

 

    Common Stock                       Accumulated
Other
    Total        
    Shares     Par
Value
    Paid-in-
Capital
    Treasury Stock     Retained
Earnings
    Comprehensive
Loss
    Stockholders’
Equity
    Comprehensive
Income
 
    (In thousands, except per share data)  

Balance at September 30, 2011

    37,084      $  371      $  1,098,388        $ (1,627,180)        $ 1,015,624        $ (21,709)        $ 465,494     

Share-based compensation

    —          —          15,466        —          —          —          15,466     

Exercise of stock options

    1,607        16        (7,328     50,467        —          —          43,155     

Tax effect from share-based payment arrangements

    —          —          3,708        —          —          —          3,708     

Repurchases of common stock

    (5,187     (52     —          (184,238     —          —          (184,290  

Issuance of ESPP shares from treasury

    —          —          2        11        —          —          13     

Issuance of restricted stock to employees from treasury

    188        2        (9,448     5,887        —          —          (3,559  

Dividends paid ($0.02 per share)

    —          —          —          —          (2,111     —          (2,111  

Net income

    —          —          —          —          70,758        —          70,758      $ 70,758   

Unrealized loss on investments

    —          —          —          —          —          (8     (8     (8

Cumulative translation adjustments

    —          —          —          —          —          (2,266     (2,266     (2,266
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

    33,692      $ 337      $ 1,100,788      $ (1,755,053   $ 1,084,271      $ (23,983   $ 406,360      $ 68,484   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

FAIR ISAAC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended June 30,  
     2012     2011  
     (In thousands)  

Cash flows from operating activities:

    

Net income

   $ 70,758      $ 46,943   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     14,555        18,623   

Share-based compensation

     15,466        11,762   

Deferred income taxes

     (1,864     1,185   

Tax effect from share-based payment arrangements

     3,708        (2,338

Excess tax benefits from share-based payment arrangements

     (4,402     (1,312

Net amortization of premium on marketable securities

     200        443   

Benefit from provision for doubtful accounts, net

     —          (583

Net loss on sales of property and equipment

     2        146   

Changes in operating assets and liabilities:

    

Accounts receivable

     (6,149     12,262   

Prepaid expenses and other assets

     1,080        3,869   

Accounts payable

     6,970        5,808   

Accrued compensation and employee benefits

     (230     (4,438

Other liabilities

     (10,099     6,386   

Deferred revenue

     16,413        6,297   
  

 

 

   

 

 

 

Net cash provided by operating activities

     106,408        105,053   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of property and equipment

     (19,616     (8,323

Purchases of marketable securities

     (48,067     (117,675

Proceeds from sales of marketable securities

     —          13,644   

Proceeds from maturities of marketable securities

     121,659        54,545   

Cash paid for acquisitions, net of cash acquired

     (18,192     —     

Distribution from (purchase of) cost method investees

     (149     75   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     35,635        (57,734
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Payments on Senior Notes

     (8,000     (8,000

Proceeds from issuances of common stock under employee stock option and purchase plans

     39,609        7,902   

Dividends paid

     (2,111     (2,389

Repurchases of common stock

     (191,056     (53,761

Excess tax benefits from share-based payment arrangements

     4,402        1,312   
  

 

 

   

 

 

 

Net cash used in financing activities

     (157,156     (54,936
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (1,958     2,335   
  

 

 

   

 

 

 

Increase in cash and cash equivalents

     (17,071     (5,282

Cash and cash equivalents, beginning of year

     135,752        146,199   
  

 

 

   

 

 

 

Cash and cash equivalents, end of year

   $ 118,681      $ 140,917   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for income taxes, net of refunds

   $ 30,415      $ 9,214   

Cash paid for interest

   $ 24,955      $ 25,547   

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

1. Nature of Business

Fair Isaac Corporation

Incorporated under the laws of the State of Delaware, Fair Isaac Corporation (“FICO”) is a provider of analytic, software and data management products and services that enable businesses to automate, improve and connect decisions. FICO provides a range of analytical solutions, credit scoring and credit account management products and services to banks, credit reporting agencies, credit card processing agencies, insurers, retailers and healthcare organizations.

In these condensed consolidated financial statements, FICO is referred to as “we,” “us,” “our,” or “FICO”.

Principles of Consolidation and Basis of Presentation

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with the instructions to Form 10-Q and the applicable accounting guidance. Consequently, we have not necessarily included in this Form 10-Q all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim condensed consolidated financial statements in this Form 10-Q reflect all adjustments (consisting only of normal recurring adjustments, except as otherwise indicated) necessary for a fair presentation of our financial position and results of operations. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with our audited consolidated financial statements and notes thereto presented in our Annual Report on Form 10-K for the year ended September 30, 2011. The interim financial information contained in this report is not necessarily indicative of the results to be expected for any other interim period or for the entire fiscal year.

The condensed consolidated financial statements include the accounts of FICO and its subsidiaries. All intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include, but are not limited to, assessing the following: the recoverability of accounts receivable; goodwill and other intangible assets; software development costs and deferred tax assets; the benefits related to uncertain tax positions; the determination of the fair value of stock-based compensation; the ability to estimate hours in connection with fixed-fee service contracts and transactional-based revenues for which actual transaction volumes have not yet been received; and the determination of whether fees are fixed or determinable and collection is probable or reasonably assured.

2. Acquisitions

On May 7, 2012, we acquired 100% of the common stock of Entiera Inc. (“Entiera”), an innovative provider of customer dialogue management solutions. The acquisition of Entiera was consummated principally to productize our analytics and strategic decision management solutions through an interactive marketing automation platform with the objective of accelerating our growth in marketing solutions across multiple industries.

 

5


Table of Contents

The following table summarizes the consideration paid for Entiera and the amounts for assets acquired and liabilities assumed, recognized based on their estimated fair values at the acquisition date:

 

     (In thousands)  

Consideration

  

Cash

   $ 18,330   
  

 

 

 
   $ 18,330   
  

 

 

 

Acquisition-related costs (included in the company’s condensed consolidated statement of income for the quarter ended June 30, 2012 as a component of selling, general, and administrative expense)

   $ 163   
  

 

 

 

Recognized amounts of identifiable assets acquired and liabilities assumed

  

Cash and cash equivalents

   $ 138   

Accounts receivable, net

     573   

Prepaid expenses and other current assets

     153   

Deferred income taxes

     1,024   

Property and equipment, net

     100   

Intangible assets

  

Completed technology

     2,200   

Customer relationships

     300   

Other assets

     24   

Accounts payable

     (725

Other accrued expenses

     (152

Deferred revenue

     (254
  

 

 

 

Total identifiable net assets

     3,381   
  

 

 

 

Goodwill

     14,949   
  

 

 

 
   $ 18,330   
  

 

 

 

The acquired identifiable intangible assets have a weighted average useful life of approximately 4.1 years and are being amortized using the straight-line method over their estimated useful lives as follows: completed technology, four years and customer relationships, five years. The goodwill of $14.9 million arising from the acquisition consists largely of the synergies created by leveraging Entiera’s SaaS-delivered solution in conjunction with our marketing solutions. The goodwill was allocated to our Applications segment and is not deductible for tax purposes. Entiera has been included in our operating results since May 7, 2012. The proforma impact of this acquisition was not deemed material to the Company’s results of operations for the periods presented.

3. Fair Value Measurements

Fair value is defined as the price that would be received from the sale of an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The accounting guidance establishes a three-level hierarchy for disclosure that is based on the extent and level of judgment used to estimate the fair value of assets and liabilities.

 

   

Level 1—uses unadjusted quoted prices that are available in active markets for identical assets or liabilities. Our Level 1 assets are comprised of money market funds and certain equity securities.

 

   

Level 2—uses inputs other than quoted prices included in Level 1 that are either directly or indirectly observable through correlation with market data. These include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs to valuation models or other pricing methodologies that do not require significant judgment because the inputs used in the model, such as interest rates and volatility, can be corroborated by readily observable market data. Our Level 2 assets are comprised of U.S. government and corporate debt obligations that are generally held to maturity.

 

6


Table of Contents
   

Level 3—uses one or more significant inputs that are unobservable and supported by little or no market activity, and that reflect the use of significant management judgment. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, and significant management judgment or estimation. We do not have any assets or liabilities that are valued using inputs identified under a Level 3 hierarchy.

The following table represents financial assets that we measured at fair value on a recurring basis at June 30, 2012 and September 30, 2011, respectively:

 

                                                                                                                                         
June 30, 2012    Active Markets for
Identical Instruments
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Fair Value as of
June 30, 2012
 
            (In thousands)         

Assets:

        

Cash equivalents (1)

   $ 66,447       $ —         $ 66,447   

U.S. corporate debt (2)

     —           2,013         2,013   

Non-U.S. commercial paper (2)

     —           4,999         4,999   

U.S. government obligations (2)

     —           25,010         25,010   

Marketable securities (3)

     5,007         —           5,007   
  

 

 

    

 

 

    

 

 

 

Total

   $ 71,454       $ 32,022       $ 103,476   
  

 

 

    

 

 

    

 

 

 

 

                                                                                                                                         
September 30, 2011    Active Markets for
Identical Instruments
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Fair Value as of
September 30, 2011
 
            (In thousands)         

Assets:

        

Cash equivalents (1)

   $ 67,504       $ —         $ 67,504   

U.S. corporate debt (2)

     —           1,529         1,529   

U.S. commercial paper (2)

     —           13,993         13,993   

U.S. government obligations (2)

     —           44,092         44,092   

U.S. municipal obligations (2)

     —           46,212         46,212   

Marketable securities (3)

     4,170         —           4,170   
  

 

 

    

 

 

    

 

 

 

Total

   $ 71,674       $ 105,826       $ 177,500   
  

 

 

    

 

 

    

 

 

 

 

(1) Included in cash and cash equivalents on our balance sheet at June 30, 2012 and September 30, 2011. Not included in this table are cash deposits of $52.2 million and $68.2 million at June 30, 2012 and September 30, 2011, respectively.
(2) Included in current marketable securities on our balance sheet at June 30, 2012 and September 30, 2011.
(3) Represents securities held under a supplemental retirement and savings plan for certain officers and senior management employees, which are distributed upon termination or retirement of the employees. Included in long-term marketable securities on our balance sheet at June 30, 2012 and September 30, 2011.

Where applicable, we use quoted prices in active markets for identical assets or liabilities to determine fair value. This pricing applies to our Level 1 investments. To the extent quoted prices in active markets for assets or liabilities are not available, the valuation techniques used to measure the fair values of our financial assets incorporate market inputs, which include reported trades, broker/dealer quotes, benchmark yields, issuer spreads, benchmark securities and other inputs derived from or corroborated by observable market data. This methodology applies to our Level 2 investments. The Company has not changed its valuation techniques in measuring the fair value of any financial assets and liabilities during the period.

 

7


Table of Contents

For the fair value of our derivative instruments, see Note 4 to the condensed consolidated financial statements.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Assets and liabilities measured at fair value on a nonrecurring basis primarily include goodwill and definite-lived intangible assets which are measured at fair value for the purposes of our annual impairment assessment.

4. Derivative Financial Instruments

We use derivative instruments to manage risks caused by fluctuations in foreign exchange rates. The primary objective of our derivative instruments is to protect the value of foreign currency denominated accounts receivable and cash balances from the effects of volatility in foreign exchange rates that might occur prior to conversion to their functional currency. We principally utilize foreign currency forward contracts, which enable us to buy and sell foreign currencies in the future at fixed exchange rates and economically offset changes in foreign currency exchange rates. We routinely enter into contracts to offset exposures denominated in the British pound, Euro and Canadian dollar.

Foreign currency denominated accounts receivable, liabilities and cash balances are re-measured at foreign currency rates in effect on the balance sheet date with the effects of changes in foreign currency rates reported in other income (expense), net. The forward contracts are not designated as hedges and are marked to market through other income (expense), net. Fair value changes in the forward contracts help mitigate the changes in the value of the re-measured accounts receivable and cash balances attributable to changes in foreign currency exchange rates. The forward contracts are short-term in nature and typically have average maturities at inception of less than three months.

The following tables summarize the fair value of our derivative instruments and their location in the consolidated balance sheet as of June 30, 2012 and September 30, 2011:

 

June 30, 2012                        
(In thousands)   

Assets

    

Liabilities

 

Derivatives not designated as hedging instruments

  

Balance Sheet Location

   Amount     

Balance Sheet Location

   Amount  

Foreign currency forward contracts

   Other current assets    $ —         Other current liabilities    $ —     

 

September 30, 2011                        
(In thousands)   

Assets

    

Liabilities

 

Derivatives not designated as hedging instruments

  

Balance Sheet Location

   Amount     

Balance Sheet Location

   Amount  

Foreign currency forward contracts

   Other current assets    $ —         Other current liabilities    $ —     

 

8


Table of Contents

The following tables summarize our outstanding forward foreign currency contracts, by currency, at June 30, 2012 and September 30, 2011:

 

     June 30, 2012  
     Contract Amount      Fair Value  
     Foreign
Currency
     US$      US$  
     (In thousands)  

Sell foreign currency:

        

Canadian dollar (CAD)

     CAD 2,350       $ 2,293       $ —     

Euro (EUR)

     EUR 2,700       $ 3,414       $ —     

Buy foreign currency:

        

British pound (GBP)

     GBP 4,121       $ 6,450       $ —     

 

     September 30, 2011  
     Contract Amount      Fair Value  
     Foreign
Currency
     US$      US$  
     (In thousands)  

Sell foreign currency:

        

Canadian dollar (CAD)

     CAD 8,000       $ 7,663       $ —     

Euro (EUR)

     EUR 4,830       $ 6,524       $ —     

Buy foreign currency:

        

British pound (GBP)

     GBP 3,911       $ 6,100       $ —     

The forward foreign currency contracts were all entered into on June 30, 2012 and September 30, 2011, respectively; therefore, their fair value was $0.

Gains (losses) on derivative financial instruments are recorded in our condensed consolidated statements of income as a component of other income (expense), net. These amounts are shown for the quarters and nine months ended June 30, 2012 and 2011 in the tables below:

 

                                                                             
     Quarter Ended
June 30, 2012
     Quarter Ended
June 30, 2011
 
     (In thousands)  

Foreign currency forward contracts

   $ 116       $ (279

 

                                                                             
     Nine Months Ended
June 30, 2012
     Nine Months Ended
June 30, 2011
 
     (In thousands)  

Foreign currency forward contracts

   $ 259       $ (528

 

9


Table of Contents

5. Goodwill and Intangible Assets

Amortization expense associated with our intangible assets, which has been reflected as a separate operating expense caption within the accompanying condensed consolidated statements of income, consisted of the following:

 

     Quarter Ended
June 30,
     Nine Months Ended
June 30,
 
     2012      2011      2012      2011  
     (In thousands)  

Cost of revenues

   $ 92       $ 569       $ 789       $ 1,706   

Selling, general and administrative expenses

     1,373         1,373         4,096         4,098   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,465       $ 1,942       $ 4,885       $ 5,804   
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of revenues reflects our amortization of completed technology, and selling, general and administrative expenses reflects our amortization of other intangible assets. Intangible assets, gross were $138.6 and $136.1 million as of June 30, 2012 and September 30, 2011, respectively.

Estimated future intangible asset amortization expense associated with intangible assets existing at June 30, 2012, was as follows (in thousands):

 

Fiscal year

      

Remainder of fiscal 2012

   $ 1,511   

2013

     4,738   

2014

     3,017   

2015

     3,017   

2016

     2,788   

Thereafter

     2,059   
  

 

 

 
   $ 17,130   
  

 

 

 

The following table summarizes changes to goodwill during the nine months ended June 30, 2012, both in total and as allocated to our segments.

 

     Applications      Scores      Tools      Total  
     (In thousands)  

Balance at September 30, 2011

   $ 451,205       $ 146,648       $ 66,835       $ 664,688   

Addition from acquisition

     14,949         —           —           14,949   

Foreign currency translation adjustment

     261         —           57         318   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at June 30, 2012

   $ 466,415       $ 146,648       $ 66,892       $ 679,955   
  

 

 

    

 

 

    

 

 

    

 

 

 

6. Composition of Certain Financial Statement Captions

The following table summarizes property and equipment, and the related accumulated depreciation and amortization.

 

     June 30, 2012     September 30, 2011  
     (In thousands)  

Property and equipment

   $ 191,573      $ 183,826   

Less: accumulated depreciation and amortization

     (153,435     (150,809
  

 

 

   

 

 

 
   $ 38,138      $ 33,017   
  

 

 

   

 

 

 

 

10


Table of Contents

7. Revolving Line of Credit

We have a $200 million unsecured revolving line of credit with a syndicate of banks that expires on September 28, 2016. Proceeds from the credit facility can be used for working capital and general corporate purposes and may also be used for the refinancing of existing debt, acquisitions, and the repurchase of the Company’s common stock. Interest on amounts borrowed under the credit facility is based on (i) a base rate, which is the greater of (a) the prime rate and (b) the Federal Funds rate plus 0.50% or (ii) LIBOR plus an applicable margin. The margin on LIBOR borrowings ranges from 1.000% to 1.625% and is determined based on our consolidated leverage ratio. In addition, we must pay utilization fees if borrowings and commitments under the credit facility exceed 50% of the total credit facility commitment, as well as facility fees. The credit facility contains certain restrictive covenants including maintaining a maximum consolidated leverage ratio of 3.0 and a minimum fixed charge ratio of 2.5, and also contains other covenants typical of unsecured facilities. As of June 30, 2012, we had no borrowings outstanding under the credit facility and were in compliance with all financial covenants.

8. Senior Notes

In May 2008, we issued $275 million of Senior Notes in a private placement to a group of institutional investors. The Senior Notes were issued in four series with maturities ranging from 5 to 10 years. The Senior Notes’ weighted average interest rate is 6.8% and the weighted average maturity is 7.9 years. In July 2010, we issued $245 million of Senior Notes in a private placement to a group of institutional investors. The Senior Notes were issued in four series with maturities ranging from 5 to 10 years. The Senior Notes’ weighted average interest rate is 5.2% and the weighted average maturity is 8.0 years. These Senior Notes require interest payments semi-annually and also include certain restrictive covenants. As of June 30, 2012, we were in compliance with all financial covenants which include the maintenance of consolidated net debt to consolidated EBITDA and a fixed charge coverage ratio. The issuance of these Senior Notes also required us to make certain covenants typical of unsecured facilities. During the quarter, we made a principal payment of $8.0 million which reduced the carrying value of our Senior Notes to $504.0 million as of June 30, 2012 compared to $512.0 million as of September 30, 2011. The fair value of our Senior Notes was $517.2 million and $572.5 million as of June 30, 2012 and September 30, 2011, respectively.

9. Restructuring Expenses

The following table summarizes our restructuring accruals and certain FICO facility closures. The current portion and non-current portion is recorded in other accrued current liabilities and other liabilities, respectively, within the accompanying condensed consolidated balance sheets. These balances are expected to be paid by fiscal 2018. There were no restructuring charges during the nine months ended June 30, 2012.

 

     Accrual at
September 30, 2011
    Expense
Additions
     Cash
Payments
    Accrual at
June 30,  2012
 
     (In thousands)  

Facilities charges

   $ 5,362      $ —         $ (1,529   $ 3,833   

Employee separation

     1,034        —           (1,034     —     
  

 

 

   

 

 

    

 

 

   

 

 

 
     6,396      $ —         $ (2,563     3,833   
    

 

 

    

 

 

   

Less: current portion

     (3,062          (2,624
  

 

 

        

 

 

 

Non-current

   $ 3,334           $ 1,209   
  

 

 

        

 

 

 

10. Income Taxes

Effective Tax Rate

The effective income tax rate was 31.4% and 27.4% during the quarters ended June 30, 2012 and 2011, respectively, and 31.7% and 27.1% during the nine months ended June 30, 2012 and 2011, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the respective full fiscal year.

The effective tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution. The increase in our effective tax rate year over year was due to the recognition of the 2010 extension of Federal Research and Development credit during fiscal 2011, the expiration of the Federal Research and Development credit during fiscal 2012, and the expiration of a foreign tax holiday. In addition, there was a one-time tax cost for entity restructuring in the first nine months of fiscal 2012. The increases were partially offset by higher earnings from international entities with lower effective tax rates.

 

11


Table of Contents

The total unrecognized tax benefit for uncertain tax positions at June 30, 2012 and September 30, 2011 was estimated to be approximately $8.0 million and $9.5 million, respectively. We recognize interest expense related to unrecognized tax benefits and penalties as part of the provision for income taxes in our consolidated statements of income. As of June 30, 2012 and September 30, 2011, we have accrued interest of $0.6 million and $0.8 million, respectively, related to the unrecognized tax benefits.

11. Earnings Per Share

The following table reconciles the numerators and denominators of basic and diluted earnings per share (“EPS”):

 

     Quarter Ended June 30,      Nine Months Ended June 30,  
     2012      2011      2012      2011  
     (In thousands, except per share data)  

Numerator for diluted and basic earnings per share—

           

Net income:

   $ 20,749       $ 23,189       $ 70,758       $ 46,943   
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator—shares:

           

Basic weighted-average shares

     34,004         39,451         35,126         39,788   

Effect of dilutive securities

     1,289         790         1,121         638   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted-average shares

     35,293         40,241         36,247         40,426   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic

   $ 0.61       $ 0.59       $ 2.01       $ 1.18   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.59       $ 0.58       $ 1.95       $ 1.16   
  

 

 

    

 

 

    

 

 

    

 

 

 

The computation of diluted EPS for the quarters ended June 30, 2012 and 2011, excludes options to purchase approximately 890,000 and 2,832,000 shares of common stock, respectively, and for the nine months ended June 30, 2012 and 2011 excludes options to purchase approximately 1,669,000 and 3,747,000 shares of common stock, respectively, because the options’ exercise prices exceeded the average market price of our common stock in these periods and their inclusion would be antidilutive.

12. Segment Information

We are organized into the following three reportable segments to align with internal management of our worldwide business operations based on product offerings.

 

   

Applications. Our Applications products are pre-configured Decision Management applications and associated professional services, designed for a specific type of business problem or process, such as marketing, account origination, customer management, fraud and insurance claims management.

 

   

Scores. This segment includes our business-to-business scoring solutions, our myFICO® solutions for consumers and associated professional services. Our scoring solutions give our clients access to analytics that can be easily integrated into their transaction streams and decision-making processes. Our scoring solutions are distributed through major credit reporting agencies, as well as services through which we provide our scores to clients directly.

 

   

Tools. The Tools segment is composed of software tools and associated professional services that clients can use to create their own custom Decision Management applications.

Our Chief Executive Officer evaluates segment financial performance based on segment revenues and segment operating income. Segment operating expenses consist of direct and indirect costs principally related to personnel, facilities, consulting, travel and depreciation. Indirect costs are allocated to the segments generally based on relative segment revenues, fixed rates established by management based upon estimated expense contribution levels and other assumptions that management considers reasonable. We do

 

12


Table of Contents

not allocate share-based compensation expense, restructuring expense, amortization expense, various corporate charges and certain other income and expense measures to our segments. These income and expense items are not allocated because they are not considered in evaluating the segment’s operating performance. Our Chief Executive Officer does not evaluate the financial performance of each segment based on its respective assets or capital expenditures; rather, depreciation amounts are allocated to the segments from their internal cost centers as described above.

The following tables summarize segment information for the three and nine months ended June 30, 2012 and 2011:

 

     Quarter Ended June 30, 2012  
     Applications     Scores     Tools     Unallocated
Corporate
Expenses
    Total  
     (In thousands)  

Segment revenues:

          

Transactional and maintenance

   $ 64,729      $ 41,394      $ 7,585      $ —        $ 113,708   

Professional services

     27,109        500        4,384        —          31,993   

License

     6,484        26        8,267        —          14,777   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     98,322        41,920        20,236        —          160,478   

Segment operating expense

     (69,964     (12,821     (13,790     (19,188     (115,763
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 28,358      $ 29,099      $ 6,446      $ (19,188     44,715   
  

 

 

   

 

 

   

 

 

   

 

 

   

Unallocated share-based compensation expense

             (6,082

Unallocated amortization expense

             (1,465
          

 

 

 

Operating income

             37,168   

Unallocated interest income

             82   

Unallocated interest expense

             (7,907

Unallocated other income, net

             911   
          

 

 

 

Income before income taxes

           $ 30,254   
          

 

 

 

Depreciation expense

   $ 2,420      $ 148      $ 229      $ 244      $ 3,041   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Quarter Ended June 30, 2011  
     Applications     Scores     Tools     Unallocated
Corporate
Expenses
    Total  
     (In thousands)  

Segment revenues:

          

Transactional and maintenance

   $ 63,355      $ 40,798      $ 7,587      $ —        $ 111,740   

Professional services

     25,893        610        3,079        —          29,582   

License

     2,812        385        6,160        —          9,357   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     92,060        41,793        16,826        —          150,679   

Segment operating expense

     (64,413     (11,739     (13,270     (18,352     (107,774
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 27,647      $ 30,054      $ 3,556      $ (18,352     42,905   
  

 

 

   

 

 

   

 

 

   

 

 

   

Unallocated share-based compensation expense

             (3,557

Unallocated amortization expense

             (1,942
          

 

 

 

Operating income

             37,406   

Unallocated interest income

             1,923   

Unallocated interest expense

             (8,023

Unallocated other income, net

             631   
          

 

 

 

Income before income taxes

           $ 31,937   
          

 

 

 

Depreciation expense

   $ 3,050      $ 232      $ 377      $ 252      $ 3,911   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

13


Table of Contents
     Nine Months Ended June 30, 2012  
     Applications     Scores     Tools     Unallocated
Corporate
Expenses
    Total  
     (In thousands)  

Segment revenues:

          

Transactional and maintenance

   $ 192,524      $ 127,227      $ 22,983      $ —        $ 342,734   

Professional services

     77,192        1,309        12,646        —          91,147   

License

     34,956        351        21,160        —          56,467   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     304,672        128,887        56,789        —          490,348   

Segment operating expense

     (210,087     (39,219     (43,698     (49,557     (342,561
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 94,585      $ 89,668      $ 13,091      $ (49,557     147,787   
  

 

 

   

 

 

   

 

 

   

 

 

   

Unallocated share-based compensation expense

             (15,466

Unallocated amortization expense

             (4,885
          

 

 

 

Operating income

             127,436   

Unallocated interest income

             276   

Unallocated interest expense

             (23,878

Unallocated other expense, net

             (271
          

 

 

 

Income before income taxes

           $ 103,563   
          

 

 

 

Depreciation expense

   $ 7,600      $ 540      $ 871      $ 659      $ 9,670   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Nine Months Ended June 30, 2011  
     Applications     Scores     Tools     Unallocated
Corporate
Expenses
    Total  
     (In thousands)  

Segment revenues:

          

Transactional and maintenance

   $ 194,054      $ 121,197      $ 22,682      $ —        $ 337,933   

Professional services

     74,128        1,579        8,824        —          84,531   

License

     17,450        792        18,728        —          36,970   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     285,632        123,568        50,234        —          459,434   

Segment operating expense

     (211,162     (42,252     (41,417     (48,412     (343,243
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 74,470      $ 81,316      $ 8,817      $ (48,412     116,191   
  

 

 

   

 

 

   

 

 

   

 

 

   

Unallocated share-based compensation expense

             (11,762

Unallocated amortization expense

             (5,804

Unallocated restructuring expense

             (12,391
          

 

 

 

Operating income

             86,234   

Unallocated interest income

             2,084   

Unallocated interest expense

             (24,401

Unallocated other income, net

             477   
          

 

 

 

Income before income taxes

           $ 64,394   
          

 

 

 

Depreciation expense

   $ 9,971      $ 783      $ 1,289      $ 776      $ 12,819   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

13. Contingencies

We are in disputes with certain customers regarding amounts owed in connection with the sale of certain of our products and services. We also have had claims asserted by former employees relating to compensation and other employment matters. We are also involved in various other claims and legal actions arising in the ordinary course of business. We record litigation accruals for legal matters which are both probable and estimable. For legal proceedings for which there is a reasonable possibility of loss (meaning those losses for which the likelihood is more than remote but less than probable), we have determined we do not have material exposure on an aggregate basis.

 

14


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING STATEMENTS

Statements contained in this report that are not statements of historical fact should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). In addition, certain statements in our future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other statements concerning future financial performance; (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services, research and development, and the sufficiency of capital resources; (iii) statements of assumptions underlying such statements, including those related to economic conditions; (iv) statements regarding business relationships with vendors, customers or collaborators, including the proportion of revenues generated from international as apposed to domestic customers; and (v) statements regarding products, their characteristics, performance, sales potential or effect in the hands of customers. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “should,” “potential,” “goals,” “strategy,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in Part II, Item 1A, Risk Factors. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our reports on Forms 10-Q and 8-K to be filed by the Company in fiscal 2012.

OVERVIEW

We are a leader in Decision Management solutions that enable businesses to automate, improve and connect decisions to enhance business performance. Our predictive analytics, which include the industry standard FICO® score, and our Decision Management systems power billions of customer decisions each year. We help companies acquire customers more efficiently, increase customer value, reduce fraud and credit losses, lower operating expenses and enter new markets more profitably. Most leading banks and credit card issuers rely on our solutions, as do many insurers, retailers, healthcare organizations, pharmaceutical companies and government agencies. We also serve consumers through online services that enable people to purchase and understand their FICO® scores, the standard measure in the United States of credit risk, empowering them to manage their financial health.

Most of our revenues are derived from the sale of products and services within the banking (including consumer credit) and insurance industries; approximately 79% of our revenues during the quarters ended June 30, 2012 and 2011, and 80% and 78% of our revenues for the nine months ended June 30, 2012 and 2011, respectively, were derived from within these industries. A significant portion of our remaining revenues is derived from the healthcare and retail industries. Our clients utilize our products and services to facilitate a variety of business processes, including customer marketing and acquisition, account origination, credit and underwriting risk management, fraud loss prevention and control, and client account and policyholder management. A significant portion of our revenues is derived from transactional or unit-based software license fees, annual license fees under long-term software license arrangements, transactional fees derived under scoring, network service or internal hosted software arrangements, and annual software maintenance fees. The recurrence of these revenues is, to a significant degree, dependent upon our clients’ continued usage of our products and services in their business activities. The more significant activities underlying the use of our products in these areas include: credit and debit card usage or active account levels; lending acquisition, origination and customer management activity; and customer acquisition, cross selling and retention programs. Approximately 71% and 74% of our revenues during the quarters ended June 30, 2012 and 2011, respectively, and 70% and 74% of our revenues for the nine months ended June 30, 2012 and 2011, respectively, were derived from maintenance or arrangements with transactional or unit-based pricing. We also derive revenues from other sources which generally do not recur and include, but are not limited to, perpetual or time-based licenses with upfront payment terms and non-recurring professional service arrangements.

 

15


Table of Contents

Our revenues derived from clients outside the United States have generally grown, and may in the future grow, more rapidly than our revenues from domestic clients. International revenues totaled $58.8 million and $54.9 million during the quarters ended June 30, 2012 and 2011, respectively, representing 37% and 36% of total consolidated revenues in each of these periods. International revenues totaled $188.1 million and $171.5 million during the nine months ended June 30, 2012 and 2011, respectively, representing 38% and 37% of total consolidated revenues in each of these periods. We expect our revenues derived from international clients will increase in the future, subject to the impact of foreign currency fluctuations.

Bookings

Management uses bookings as an indicator of our business performance. Bookings represent contracts signed in the current reporting period that will generate current and future revenue streams. We consider contract terms, knowledge of the marketplace and experience with our customers, among other factors, when determining the estimated value of contract bookings.

Bookings calculations have varying degrees of certainty depending on the revenue type and individual contract terms. Our revenue types are transactional and maintenance, professional services and license. Our estimate of bookings is as of the end of the period in which a contract is signed, and we do not update our initial booking estimates in future periods for changes between estimated and actual results. Actual revenue and the timing thereof could differ materially from our initial estimates. The following paragraphs discuss the key assumptions used to calculate bookings and the susceptibility of these assumptions to variability.

Transactional and Maintenance Bookings

We calculate transactional bookings as the total estimated volume of transactions or number of accounts under contract, multiplied by a contractual rate. Transactional contracts generally span multiple years and require us to make estimates about future transaction volumes or number of active accounts. We develop estimates from discussions with our customers and examinations of historical data from similar products and customer arrangements. Differences between estimated bookings and actual results occur due to variability in the volume of transactions or number of active accounts estimated. This variability is primarily caused by the following:

 

   

The health of the economy and economic trends in our customers’ industries;

 

   

Individual performance of our customers relative to their competitors; and

 

   

Regulatory and other factors that affect the business environment in which our customers operate.

We calculate maintenance bookings directly from the terms stated in the contract.

Professional Services Bookings

We calculate professional services bookings as the estimated number of hours to complete a project multiplied by the rate per hour. We estimate the number of hours based on our understanding of the project scope, conversations with customer personnel and our experience in estimating professional services projects. Estimated bookings may differ from actual results primarily due to differences in the actual number of hours incurred. These differences typically result from customer decisions to alter the mix of FICO and internal services resources used to complete a project.

License Bookings

Licenses are sold on a perpetual or term basis and bookings generally equal the fixed amount stated in the contract.

 

16


Table of Contents

Bookings Trend Analysis

 

     Bookings      Bookings
Yield*
    Number of
Bookings
over $1
Million
     Weighted-
Average
Term
 
     (in millions)                   (months)  

Quarter Ended June 30, 2012

   $ 57.5         29     8         16   

Quarter Ended June 30, 2011

   $ 50.0         24     10         19   

Nine Months Ended June 30, 2012

   $ 195.2         39     35         NM   

Nine Months Ended June 30, 2011

   $ 191.6         36     32         NM   

 

* Bookings yield represents the percentage of revenue recognized from bookings for the periods indicated.

Transactional and maintenance bookings were 28% and 35% of total bookings for the quarters ended June 30, 2012 and 2011, respectively. Professional services bookings were 52% and 46% of total bookings for the quarters ended June 30, 2012 and 2011, respectively. License bookings were 20% and 19% of total bookings for the quarters ended June 30, 2012 and 2011, respectively.

Transactional and maintenance bookings were 33% and 44% of total bookings for the nine months ended June 30, 2012 and 2011, respectively. Professional services bookings were 47% and 38% of total bookings for the nine months ended June 30, 2012 and 2011, respectively. License bookings were 20% and 18% of total bookings for the nine months ended June 30, 2012 and 2011, respectively.

The weighted-average term of bookings achieved measures the average term over which the bookings are expected to be recognized as revenue. As the weighted-average term increases, the average amount of revenues expected to be realized in a quarter decreases; however, the revenues are expected to be recognized over a longer period of time. As the weighted-average term decreases, the average amount of revenues expected to be realized in a quarter increases; however, the revenues are expected to be recognized over a shorter period of time.

Management regards the volume of bookings achieved, among other factors, as an important indicator of future revenues, but they are not comparable to, nor should they be substituted for, an analysis of our revenues, and they are subject to a number of risks and uncertainties concerning timing and contingencies affecting product delivery and performance.

Although many of our contracts contain noncancelable terms, most of our bookings are transactional or service related and are dependent upon estimates such as volume of transactions, number of active accounts, or number of hours incurred. Since these estimates cannot be considered fixed or firm, we do not believe it is appropriate to characterize bookings as backlog.

Current Business Environment

General economic conditions stabilized in fiscal 2011 from which we realized overall growth in our revenues. However, high levels of unemployment and financial market uncertainty continue to impact our customers and the pace of global recovery. Consumer and small business lending activity, which is one of the drivers of demand for our services, has stabilized in most markets around the world but in most cases is not yet showing strong growth. We expect growth in consumer lending to continue to lag the general economic recovery. In an effort to respond to these market conditions, we have continued to focus on activities related to our ongoing reengineering initiative. As part of this initiative, we continue to manage our expenses to maintain solid earnings and cash flows and grow revenues through strategic resource allocation. Key components of the initiative include ongoing rationalization of our business portfolio, simplifying management hierarchy, eliminating low-priority positions, investing in high-priority positions, consolidating facilities and managing fixed and variable costs.

 

17


Table of Contents

RESULTS OF OPERATIONS

Revenues

The following table sets forth certain summary information on a segment basis related to our revenues for the fiscal periods indicated:

 

     Quarter Ended June 30,      Percentage
of Revenues
              

Segment

   2012      2011      2012     2011     Period-to-Period
Change
     Period-to-Period
Percentage
Change
 
     (In thousands)                  (In thousands)         

Applications

   $ 98,322       $ 92,060         61     61   $ 6,262        

Scores

     41,920         41,793         26     28     127         —  

Tools

     20,236         16,826         13     11     3,410         20 
  

 

 

    

 

 

    

 

 

   

 

 

      

Total revenue

   $ 160,478       $ 150,679         100     100     9,799        
  

 

 

    

 

 

    

 

 

   

 

 

      

 

     Nine Months Ended June 30,      Percentage
of Revenues
              

Segment

   2012      2011      2012     2011     Period-to-Period
Change
     Period-to-Period
Percentage
Change
 
     (In thousands)                  (In thousands)         

Applications

   $ 304,672       $ 285,632         62     62   $ 19,040        

Scores

     128,887         123,568         26     27     5,319        

Tools

     56,789         50,234         12     11     6,555         13 
  

 

 

    

 

 

    

 

 

   

 

 

      

Total revenue

   $ 490,348       $ 459,434         100     100     30,914        
  

 

 

    

 

 

    

 

 

   

 

 

      

Quarter Ended June 30, 2012 Compared to Quarter Ended June 30, 2011

Applications

 

     Quarter Ended June 30,                
     2012      2011      Period-to-Period
Change
     Period-to-Period
Percentage
Change
 
     (In thousands)      (In thousands)         

Transactional and maintenance

   $ 64,729       $ 63,355       $ 1,374         2

Professional services

     27,109         25,893         1,216         5

License

     6,484         2,812         3,672         131 
  

 

 

    

 

 

       

Total

   $ 98,322       $ 92,060         6,262         7
  

 

 

    

 

 

       

The $6.3 million increase in Applications segment revenues consisted of a $3.0 million increase in customer management solutions, a $1.0 million increase in collections and recovery solutions, a $0.8 million increase in originations solutions, a $0.8 million increase in fraud solutions, and a $0.7 million in marketing solutions.

 

18


Table of Contents

The increase in customer management solutions revenue was due to license revenue driven by increased sales of TRIAD software, an increase in transactional-based and maintenance revenue, as well as an increase in professional services revenue. The increase in collections and recovery solutions was primarily due to services and license revenues of our Debt Manager product.

Scores

 

     Quarter Ended June 30,               
     2012      2011      Period-to-Period
Change
    Period-to-Period
Percentage
Change
 
     (In thousands)      (In thousands)        

Transactional and maintenance

   $ 41,394       $ 40,798       $ 596       

Professional services

     500         610         (110     (18 )% 

License

     26         385         (359     (93 )% 
  

 

 

    

 

 

      

Total

   $ 41,920       $ 41,793         127        —  
  

 

 

    

 

 

      

The $0.1 million increase in Scores segment revenues consisted of a $1.1 million increase in our business-to-business scores revenue partially offset by a decrease of $1.0 million in our myFICO business-to-consumer services revenue. The increase in our business-to-business Scores was primarily attributable to credit bureau risk scores revenues. The decrease in our business-to-consumer services was driven by direct sales generated from the myFICO.com website, as well as royalties derived from scores sold indirectly to consumers through credit reporting agencies.

During the quarters ended June 30, 2012 and 2011, revenues generated from our agreements with Equifax, TransUnion and Experian collectively accounted for approximately 18% and 19%, respectively, of our total revenues, including revenues from these customers that are recorded in our other segments.

Tools

 

     Quarter Ended June 30,               
     2012      2011      Period-to-Period
Change
    Period-to-Period
Percentage
Change
 
     (In thousands)      (In thousands)        

Transactional and maintenance

   $ 7,585       $ 7,587       $ (2     —  

Professional services

     4,384         3,079         1,305        42 

License

     8,267         6,160         2,107        34 
  

 

 

    

 

 

      

Total

   $ 20,236       $ 16,826         3,410        20 
  

 

 

    

 

 

      

The $3.4 million increase in Tools segment revenues consisted primarily of a $2.1 million increase in license revenue and a $1.3 million increase in services revenue, both related to our Blaze Advisor and Xpress Optimization products.

 

19


Table of Contents

Nine months Ended June 30, 2012 Compared to Nine months Ended June 30, 2011 Revenues

Applications

 

     Nine Months Ended June 30,               
     2012      2011      Period-to-Period
Change
    Period-to-Period
Percentage
Change
 
     (In thousands)      (In thousands)        

Transactional and maintenance

   $ 192,524       $ 194,054       $ (1,530     (1 )% 

Professional services

     77,192         74,128         3,064       

License

     34,956         17,450         17,506        100 
  

 

 

    

 

 

      

Total

   $ 304,672       $ 285,632         19,040        7
  

 

 

    

 

 

      

The $19.0 million increase in Applications segment revenues consisted of a $20.1 million increase in our fraud solutions and a $2.0 million increase in our other applications solutions, partially offset by a $3.1 million decrease in our marketing solutions.

The increase in fraud solutions revenue was primarily due to software revenue attributable to two large multi-year license transactions during the first half of fiscal 2012. In addition, the fraud solutions revenue was also impacted by increased professional services revenue from software implementations and consulting services and a decrease in transactional-based revenues. The decrease in marketing solutions revenue was mainly attributable to a decrease in professional services revenue.

Scores

 

     Nine Months Ended June 30,               
     2012      2011      Period-to-Period
Change
    Period-to-Period
Percentage
Change
 
     (In thousands)      (In thousands)        

Transactional and maintenance

   $ 127,227       $ 121,197       $ 6,030       

Professional services

     1,309         1,579         (270     (17 )% 

License

     351         792         (441     (56 )% 
  

 

 

    

 

 

      

Total

   $ 128,887       $ 123,568         5,319       
  

 

 

    

 

 

      

The $5.3 million increase in Scores segment revenues consisted of a $6.7 million increase in our business-to-business scores revenue partially offset by a $1.4 million decrease in our myFICO business-to-consumer services revenue. The increase in our business-to-business scores was primarily attributable to an increase in Credit Bureau Risk Scores driven by a large non-recurring project conducted by a major customer utilizing historical Credit Bureau Risk Scores, and PreScore revenues. The decline in our myFICO business-to-consumer services was primarily attributable to a decrease in royalties derived from scores sold indirectly to consumers through credit reporting agencies.

During the nine months ended June 30, 2012 and 2011, revenues generated from our agreements with Equifax, TransUnion and Experian, collectively accounted for approximately 18% of our total revenues, including revenues from these customers that are recorded in our other segments.

 

20


Table of Contents

Tools

 

     Nine Months Ended June 30,      Period-to-Period     

Period-to-Period

Percentage

 
     2012      2011      Change      Change  
     (In thousands)      (In thousands)         

Transactional and maintenance

   $ 22,983       $ 22,682       $ 301         1

Professional services

     12,646         8,824         3,822         43

License

     21,160         18,728         2,432         13
  

 

 

    

 

 

       

Total

   $ 56,789       $ 50,234         6,555         13
  

 

 

    

 

 

       

The $6.6 million increase in Tools segment revenues consisted primarily of a $3.8 million increase in services revenue and a $2.4 million increase in software revenue, both related to our Blaze Advisor and Xpress Optimization products.

Operating Expenses and Other Income (Expense)

The following table sets forth certain summary information related to our statements of income for the fiscal periods indicated:

 

     Quarter Ended June 30,     Percentage of Revenues     Period-to-    

Period-to-

Period

Percentage

 
     2012     2011     2012     2011     Period Change     Change  
    

(In thousands, except

employees)

               

(In thousands, except

employees)

       

Revenues

   $ 160,478      $ 150,679        100     100   $ 9,799        7
  

 

 

   

 

 

   

 

 

   

 

 

     

Operating expenses:

            

Cost of revenues

     47,832        43,398        30     29     4,434        10

Research and development

     14,890        14,290        9     9     600        4

Selling, general and administrative

     59,123        53,643        37     36     5,480        10

Amortization of intangible assets

     1,465        1,942        1     1     (477     (25 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

Total operating expenses

     123,310        113,273        77     75     10,037        9
  

 

 

   

 

 

   

 

 

   

 

 

     

Operating income

     37,168        37,406        23     25     (238     (1 )% 

Interest income

     82        1,923        0     1     (1,841     (96 )% 

Interest expense

     (7,907     (8,023     (5 )%      (5 )%      116        (1 )% 

Other income, net

     911        631        1     —       280        44
  

 

 

   

 

 

   

 

 

   

 

 

     

Income from operations before income taxes

     30,254        31,937        19     21     (1,683     (5 )% 

Provision for income taxes

     9,505        8,748        6     6     757        9
  

 

 

   

 

 

   

 

 

   

 

 

     

Net income

   $ 20,749      $ 23,189        13     15     (2,440     (11 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

Number of employees at quarter end

     2,171        1,998            173        9

 

21


Table of Contents
     Nine Months Ended June 30,     Percentage of Revenues     Period-to-    

Period-to-

Period
Percentage

 
     2012     2011     2012     2011     Period Change     Change  
     (In thousands)                 (In thousands)        

Revenues

   $ 490,348      $ 459,434        100     100   $ 30,914        7
  

 

 

   

 

 

   

 

 

   

 

 

     

Operating expenses:

            

Cost of revenues

     142,620        137,707        29     30     4,913        4

Research and development

     41,925        48,573        8     11     (6,648     (14 )% 

Selling, general and administrative

     173,482        168,725        36     36     4,757        3

Amortization of intangible assets

     4,885        5,804        1     1     (919     (16 )% 

Restructuring

     —          12,391        —       3     (12,391     (100 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

Total operating expenses

     362,912        373,200        74     81     (10,288     (3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

Operating income

     127,436        86,234        26     19     41,202        48

Interest income

     276        2,084        —       —       (1,808     (87 )% 

Interest expense

     (23,878     (24,401     (5 )%      (5 )%      523        (2 )% 

Other income (expense), net

     (271     477        —       —       (748     (157 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

Income from operations before income taxes

     103,563        64,394        21     14     39,169        61

Provision for income taxes

     32,805        17,451        7     4     15,354        88
  

 

 

   

 

 

   

 

 

   

 

 

     

Net income

   $ 70,758      $ 46,943        14     10     23,815        51
  

 

 

   

 

 

   

 

 

   

 

 

     

Cost of Revenues

Cost of revenues consists primarily of employee salaries and benefits for personnel directly involved in developing, installing and supporting revenue products; travel costs; overhead costs; costs of computer service bureaus; internal network hosting costs; amounts payable to credit reporting agencies for scores; software costs; and expenses related to our business-to-consumer services.

Cost of revenues as a percentage of revenues was 30% for the quarter ended June 30, 2012 compared to 29% for the quarter ended June 30, 2011. The quarter over quarter increase of $4.4 million was primarily due to a $2.4 million direct materials increase in third party software and data cost, a $0.8 million increase in travel cost, and a $1.2 million increase in other costs. The increase in direct materials cost was primarily attributable to an increase in sales that require data acquisition. The increase in travel cost was primarily attributable to an increase in services revenue that required traveling to client locations.

The year-to-date period over period increase of $4.9 million in cost of revenues resulted from a $6.7 million increase in personnel and labor costs, a $0.9 million increase in travel cost, $0.2 million increase in other costs, partially offset by a $2.9 million decrease in third party software and data cost. The increase in personnel and other labor-related costs was attributable to an increase in salary, related benefit and incentive cost. The increase in travel cost was primarily attributable to an increase in services revenue that required traveling to the client locations. The decrease in third party software and data costs was attributable to a decrease in sales that require data acquisition, as well as cost savings resulting from vendor contract renegotiations. Cost of revenues as a percentage of revenues was 29% for the nine months ended June 30, 2012 compared to 30% for the nine months ended June 30, 2011 as a result of increased sales of higher-margin Applications software and Scores products.

Over the next several quarters, we expect cost of revenues as a percentage of revenues will be consistent with those incurred during the quarter ended June 30, 2012.

Research and Development

Research and development expenses include personnel and related overhead costs incurred in the development of new products and services, including research of mathematical and statistical models and development of new versions of Applications and Tools products.

The quarter over quarter increase of $0.6 million in research and development was mainly attributable to a $0.3 million increase in personnel and labor costs, driven by increased salary and related benefit expenses, and a $0.3 million increase in other costs. Research and development as a percentage of revenues was 9% during the quarter ended June 30, 2012, consistent with the quarter ended June 30, 2011.

 

22


Table of Contents

Research and development as a percentage of revenues was 8% during the nine months ended June 30, 2012, compared to 11% during the nine months ended June 30, 2011. The $6.6 million decrease was mainly attributable to a $4.0 million decrease in personnel and labor costs, a $1.9 million decrease in facilities and infrastructure costs and a $0.7 million decrease in other costs. The decrease in personnel and related costs was due to decreased salary and related benefit expenses, partially offset by an increase in incentive expense for the nine months ended June 30, 2012. The decrease in facilities and infrastructure costs was attributable primarily to a decline in allocated costs resulting from the continued company-wide effort to reduce overhead costs.

Over the next several quarters, we expect that research and development expenditures as a percentage of revenues will be consistent with those incurred during the quarter ended June 30, 2012.

Selling, General and Administrative

Selling, general and administrative expenses consist principally of employee salaries and benefits, travel, overhead, advertising and other promotional expenses, corporate facilities expenses, legal expenses, business development expenses, and the cost of operating computer systems.

Selling, general and administrative expenses as a percentage of revenues was 37% during the quarter ended June 30, 2012, compared to 36% during the quarter ended June 30, 2011. The quarter over quarter increase of $5.5 million in selling, general and administrative expenses was attributable to a $6.8 million increase in labor and personnel costs, a $1.0 million in travel cost, partially offset by a $1.0 million decrease in outside services cost, a $0.7 million decrease in equipment deprecations cost, and a $0.6 million decrease in facilities and infrastructure costs, The increase in labor and personnel costs was due to an increase in stock compensation cost, salary and related benefit costs, incentive cost and severance and retention costs. The increase in travel cost was primarily due to the reinstatement of non-revenue producing travel during fiscal 2012. The decrease in outside services was primarily due to a non-recurring strategic consulting service incurred in the quarter ended June 30, 2011. The decrease in equipment depreciation cost was mainly due to timing of fixed assets placed in service. The decrease in facilities and infrastructure costs was attributable primarily to a decline in allocated costs resulting from the continued company-wide effort to reduce overhead costs.

The year-to-date period over period increase of $4.8 million in selling, general and administrative expenses was attributable to a $7.4 million increase in labor and personnel costs, a $1.7 million increase in marketing expenses and a $0.4 million increase in other costs, partially offset by a $2.4 million decrease in facilities and infrastructure costs, a $1.2 million decrease in outside services cost and a $1.1 million decrease in equipment depreciation cost. The increase in labor and personnel costs was due to an increase in stock compensation cost, salary and related benefit costs, incentive cost and severance and retention costs. The increase in marketing expenses was due to a company marketing event held during the first nine months of fiscal 2012, partially offset by a reduction in marketing programs in areas that were not producing the anticipated sales results. The decrease in facilities and infrastructure costs was attributable primarily to a decline in allocated costs resulting from the continued company-wide effort to reduce overhead costs. The decrease in outside services was due to a non-recurring strategic consulting service incurred in the first nine months of fiscal 2011. The decrease in equipment depreciation cost was mainly due to timing of fixed assets placed in service. Selling, general and administrative expenses as a percentage of revenues was 36% during the nine months ended June 30, 2012, consistent with the nine months ended June 30, 2011.

Over the next several quarters, we expect that selling, general and administrative expenses as a percentage of revenues will be consistent with those incurred during the quarter ended June 30, 2012.

Amortization of Intangible Assets

Amortization of intangible assets consists of amortization expense related to intangible assets recorded in connection with acquisitions accounted for by the purchase method of accounting. Our definite-lived intangible assets, consisting primarily of completed technology and customer contracts and relationships, are being amortized using the straight-line method or based on forecasted cash flows associated with the assets over periods ranging from four to fifteen years.

The quarter over quarter decrease in amortization expense of $0.5 million was attributable to certain intangible assets associated with our Dash acquisition becoming fully amortized in January 2012, partially offset by the addition of intangible assets associated with our Entiera acquisition in May 2012.

 

23


Table of Contents

The year-to-date period over period decrease in amortization expense of $0.9 million was attributable to certain intangible assets associated with our Dash acquisition becoming fully amortized in January 2012, partially offset by addition of intangible assets associated with our Entiera acquisition in May 2012.

Over the next several quarters we expect that amortization expense will be consistent with or slightly lower than the amortization expense we recorded during the quarter ended June 30, 2012 due to certain intangible assets related to our Dash and London Bridge acquisitions becoming fully amortized during fiscal 2013.

Restructuring

There were no restructuring charges during the three and nine months ended June 30, 2012.

There were no restructuring charges during the quarter ended June 30, 2011. During the nine months ended June 30, 2011, we incurred net charges totaling $12.4 million consisting of severance costs and costs for vacating excess leased space.

Interest Income

Interest income is derived primarily from the investment of funds in excess of our immediate operating requirements. The quarter over quarter decrease in interest income of $1.8 million was primarily attributable to interest received on tax refunds during the quarter ended June 30, 2011.

The year-to-date period over period decrease in interest income of $1.8 million was primarily attributable to interest received on tax refunds during the nine months ended June 30, 2011.

Over the next several quarters we expect that interest income will be consistent with the interest income we recorded during the quarter ended June 30, 2012.

Interest Expense

The quarter over quarter decrease in interest expense of $0.1 million was attributable to an $8.0 million principal payment in both May 2011 and May 2012 on the Senior Notes issued in May 2008 resulting in a lower average debt balance for the quarter ended June 30, 2012.

The year-to-date period over period decrease in interest expense of $0.5 million was attributable to an $8.0 million principal payment in both May 2011 and May 2012 on the Senior Notes issued in May 2008 resulting in a lower average debt balance for the nine months ended June 30, 2012, as well as a decline in credit facility fees as a result of the company lowering the revolving line of credit in the second half of fiscal 2011.

Over the next several quarters we expect that interest expense will be consistent with levels recorded during the quarter ended June 30, 2012.

Other Income (Expense), Net

Other income (expense), net consists primarily of realized investment gains/losses, exchange rate gains/losses resulting from re-measurement of foreign-denominated receivable and cash balances into the U.S. dollar functional currency at period-end market rates, net of the impact of offsetting forward exchange contracts, and other non-operating items.

The $0.3 million quarter over quarter increase in other income (expense), net was primarily attributable to a higher dividend income during the quarter ended June 30, 2012.

The $0.7 million year-to-date period over period decrease in other income (expense), net was primarily attributable to a one-time vendor termination fee, as well as increased foreign currency losses during the nine months ended June 30, 2012.

 

24


Table of Contents

Provision for Income Taxes

The effective income tax rate was 31.4% and 27.4% during the quarters ended June 30, 2012 and 2011, respectively, and 31.7% and 27.1% during the nine months ended June 30, 2012 and 2011, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the respective full fiscal year. The effective tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution. The increase in our effective tax rate year over year was due to the recognition of the 2010 extension of Federal Research and Development credit during fiscal 2011, the expiration of the Federal Research and Development credit during fiscal 2012, and the expiration of a foreign tax holiday. In addition, there was a one-time tax cost for entity restructuring in the first nine months of fiscal 2012. The increases were partially offset by higher earnings from international entities with lower effective tax rates.

Operating Income

The following table sets forth certain summary information on a segment basis related to our operating income for the fiscal periods indicated.

 

     Quarter Ended June 30,     Period-to-Period     Period-to-Period
Percentage
 

Segment

   2012     2011     Change     Change  
     (In thousands)     (In thousands)        

Applications

   $ 28,358      $ 27,647      $ 711        3

Scores

     29,099        30,054        (955     (3 )% 

Tools

     6,446        3,556        2,890        81

Corporate expenses

     (19,188     (18,352     (836     5
  

 

 

   

 

 

     

Total segment operating income

     44,715        42,905        1,810        4

Unallocated share-based compensation

     (6,082     (3,557     (2,525     71

Unallocated amortization expense

     (1,465     (1,942     477        (25 )% 
  

 

 

   

 

 

     

Operating income

   $ 37,168      $ 37,406        (238     (1 )% 
  

 

 

   

 

 

     

 

     Nine Months Ended June 30,     Period-to-Period     Period-to-Period
Percentage
 

Segment

   2012     2011     Change     Change  
     (In thousands)     (In thousands)        

Applications

   $ 94,585      $ 74,470      $ 20,115        27

Scores

     89,668        81,316        8,352        10

Tools

     13,091        8,817        4,274        48

Corporate expenses

     (49,557     (48,412     (1,145     2
  

 

 

   

 

 

     

Total segment operating income

     147,787        116,191        31,596        27

Unallocated share-based compensation

     (15,466     (11,762     (3,704     31

Unallocated amortization expense

     (4,885     (5,804     919        (16 )% 

Unallocated restructuring

     —          (12,391     12,391        (100 )% 
  

 

 

   

 

 

     

Operating income

   $ 127,436      $ 86,234        41,202        48
  

 

 

   

 

 

     

 

25


Table of Contents

Applications

 

     Quarter Ended
June 30,
    Percentage of
Revenues
    Nine Months Ended
June 30,
    Percentage of
Revenues
 
     2012     2011     2012     2011     2012     2011     2012     2011  
     (In thousands)                 (In thousands)              

Segment revenues

   $ 98,322      $ 92,060        100     100   $ 304,672      $ 285,632        100     100

Segment operating expense

     (69,964     (64,413     (71 )%      (70 )%      (210,087     (211,162     (69 )%      (74 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 28,358      $ 27,647        29     30   $ 94,585      $ 74,470        31     26
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Scores

 

     Quarter Ended
June 30,
    Percentage of
Revenues
    Nine Months Ended
June 30,
    Percentage of
Revenues
 
     2012     2011     2012     2011     2012     2011     2012     2011  
     (In thousands)                 (In thousands)              

Segment revenues

   $ 41,920      $ 41,793        100     100   $ 128,887      $ 123,568        100     100

Segment operating expense

     (12,821     (11,739     (31 )%      (28 )%      (39,219     (42,252     (30 )%      (34 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 29,099      $ 30,054        69     72   $ 89,668      $ 81,316        70     66
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tools

 

     Quarter Ended
June 30,
    Percentage of
Revenues
    Nine Months Ended
June 30,
    Percentage of
Revenues
 
     2012     2011     2012     2011     2012     2011     2012     2011  
     (In thousands)                 (In thousands)              

Segment revenues

   $ 20,236      $ 16,826        100     100   $ 56,789      $ 50,234        100     100

Segment operating expense

     (13,790     (13,270     (68 )%      (79 )%      (43,698     (41,417     (77 )%      (82 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 6,446      $ 3,556        32     21   $ 13,091      $ 8,817        23     18
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The quarter over quarter $0.2 million decrease in operating income was primarily attributable to a $7.2 million increase in segment expenses, a $2.5 million increase in share based compensation, a $0.8 million increase in unallocated corporate expenses, partially offset by a $9.8 million increase in segment revenues.

At the segment level, the quarter over quarter $1.8 million increase in segment operating income was driven by a $2.9 million increase in our Tools segment and a $0.7 million increase in our Applications segment, partially offset by a $1.0 million decrease in our Scores segment and a $0.8 million increase in unallocated corporate operating expenses.

The increase in Applications segment operating income was attributable to a $6.3 million increase in segment revenue partially offset by a $5.6 million increase in segment operating expenses. The increase in segment revenue consisted of a $3.0 million increase in customer management solutions, a $1.0 million increase in collections and recovery solutions, a $0.8 million increase in both originations solutions and fraud solutions, and a $0.7 million in marketing solutions. The increase in segment operating expenses was mainly attributable to increased labor cost as a result of increased consulting services activities, and increased direct materials cost as a result of higher license and transactional revenues.

The decrease in Scores segment operating income was attributable to a $1.1 million increase in segment operating expenses, partially offset by $0.1 million increase in segment revenue.

 

26


Table of Contents

The increase in Tools segment operating income was attributable to a $3.4 million increase in segment revenue partially offset by a $0.5 million increase in segment operating expenses. The increase in segment revenues was primarily driven by a $2.1 million increase in license revenue and a $1.3 million increase in services revenue, both related to our Blaze Advisor and Xpress Optimization products. Segment operating income as a percentage of segment revenue for Tools increased from 21% to 32% mainly due to increased sales of higher margin software products.

The year-to-date period over period $41.2 million increase in operating income was primarily attributable to a $30.9 million increase in segment revenues, a $12.4 million decrease in restructuring expense, a $1.8 million decrease in segment operating expenses, partially offset by a $3.7 million increase in share-based compensation expense and a $1.1 increase in unallocated corporate expenses.

At the segment level, the $31.6 million increase in segment operating income was driven by a $20.1 million increase in our Applications segment, an $8.3 million increase in our Scores segment, a $4.3 million increase in our Tools segment, partially offset by a $1.1 million increase in unallocated corporate operating expenses.

The increase in Applications segment operating income was attributable to a $19.0 million increase in segment revenue primarily due to two large multi-year license transactions and a $1.1 million decrease in segment operating expenses. Segment operating income as a percentage of segment revenue for Applications increased from 26% to 31% mainly due to increased sales of higher margin software products.

The increase in Scores segment operating income was attributable to a $5.3 million increase in segment revenue, primarily attributable to an increase in Credit Bureau Risk Scores driven by a large non-recurring project conducted by a major customer utilizing historical Credit Bureau Risk Scores, and a $3.0 million decrease in segment operating expenses, driven by a decrease in digital marketing and third party data costs.

The increase in Tools segment operating income was attributable primarily to a $6.6 million increase in segment revenue partially offset by a $2.3 million increase in segment operating expenses. The increase in segment revenue was primarily due to an increase of services and software revenues related to our Blaze Advisor and Xpress Optimization products. Segment operating income as a percentage of segment revenue for Tools increased from 18% to 23% mainly due to increased sales of higher margin software products.

Capital Resources and Liquidity

Outlook

As of June 30, 2012 we had $155.7 million in cash, cash equivalents and marketable security investments. We believe these balances, as well as available borrowings from our $200 million revolving line of credit and anticipated cash flows from operating activities, will be sufficient to fund our working and other capital requirements as well as the $49.0 million principal payment due in May 2013 on our Senior Notes issued in May 2008. Under our current financing arrangements we have no other significant debt obligations maturing over the next twelve months. In the normal course of business, we evaluate the merits of acquiring technology or businesses, or establishing strategic relationships with or investing in these businesses. We may elect to use available cash and cash equivalents and marketable security investments to fund such activities in the future. In the event additional needs for cash arise, or if we refinance our existing debt, we may raise additional funds from a combination of sources, including the potential issuance of debt or equity securities. Additional financing might not be available on terms favorable to us, or at all. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited.

 

27


Table of Contents

Summary of Cash Flows

 

     Nine Months Ended June 30,  
     2012     2011  
     (in thousands)  

Cash provided by/(used in):

    

Operating activities

   $ 106,408      $ 105,053   

Investing activities

     35,635        (57,734

Financing activities

     (157,156     (54,936

Effect of exchange rate changes on cash

     (1,958     2,335   
  

 

 

   

 

 

 

Increase in cash and cash equivalents

   $ (17,071   $ (5,282
  

 

 

   

 

 

 

Cash Flows from Operating Activities

Our primary method for funding operations and growth has been through cash flows generated from operating activities. Net cash provided by operating activities increased $1.3 million to $106.4 million during the nine months ended June 30, 2012 from $105.1 million during the nine months ended June 30, 2011. The increase was attributable to higher net income for the nine months ended June 30, 2012 partially offset by a $22.2 million decrease caused by the timing of receipts and payments in our ordinary course of business, including an $18.4 million decrease from timing of cash receipts on accounts receivable.

Cash Flows from Investing Activities

Net cash provided by investing activities totaled $35.6 million during the nine months ended June 30, 2012 compared to net cash used in investing activities of $57.7 million during the nine months ended June 30, 2011. The change in cash flows from investing activities was primarily attributable to $73.6 million of proceeds from sales and maturities of marketable securities, net of purchases, for the nine months ended June 30, 2012 compared to $49.5 million of cash used in purchases of marketable securities, net of sales and maturities, during the nine months ended June 30, 2011. The increase was partially offset by $18.2 million cash used for the acquisition of Entiera and an $11.3 million increase in purchases of property and equipment during the nine months ended June 30, 2012.

Cash Flows from Financing Activities

Net cash used in financing activities increased $102.3 million to $157.2 million during the nine months ended June 30, 2012 from $54.9 million during the nine months ended June 30, 2011. The increase was primarily due to $191.1 million of common stock repurchased in the nine months ended June 30, 2012 versus $53.8 million of common stock repurchased in the nine months ended June 30, 2011, partially offset by a $31.7 million increase in cash generated from stock option exercises attributable to a higher average stock price for the first nine months of fiscal 2012.

Repurchases of Common Stock

In June 2010, our Board of Directors approved a common stock repurchase program that allowed us to purchase shares of our common stock up to an aggregate cost of $250.0 million in the open market or through negotiated transactions. The June 2010 program was terminated in October 2011. On November 2, 2011, our Board of Directors approved an open-ended stock repurchase program to acquire shares of our common stock up to an aggregate cost of $150.0 million in the open market or through negotiated transactions. Pursuant to these programs during the three and nine months ended June 30, 2012 we repurchased 835,632 shares of our common stock for $34.0 million and 5,187,304 shares of our common stock for $184.3 million, respectively. As of June 30, 2012, we had $0.2 million remaining under the November 2011 authorization.

Dividends

During the quarter ended June 30, 2012, we paid a quarterly dividend of two cents per common share, which is representative of the eight cents per year dividend we have paid in recent years. Our dividend rate is set by the Board of Directors on a quarterly basis taking into account a variety of factors, including among others, our operating results and cash flows, general economic and industry conditions, our obligations, changes in applicable tax laws and other factors deemed relevant by the Board. Although we expect to continue to pay dividends at the current rate, our dividend rate is subject to change from time to time based on the Board's business judgment with respect to these and other relevant factors.

 

28


Table of Contents

Revolving Line of Credit

We have a $200 million unsecured revolving line of credit with a syndicate of banks that expires on September 28, 2016. Proceeds from the credit facility can be used for working capital and general corporate purposes and may also be used for the refinancing of existing debt, acquisitions, and the repurchase of the Company’s common stock. Interest on amounts borrowed under the credit facility is based on (i) a base rate, which is the greater of (a) the prime rate and (b) the Federal Funds rate plus 0.50% or (ii) LIBOR plus an applicable margin. The margin on LIBOR borrowings ranges from 1.000% to 1.625% and is determined based on our consolidated leverage ratio. In addition, we must pay utilization fees if borrowings and commitments under the credit facility exceed 50% of the total credit facility commitment, as well as facility fees. The credit facility contains certain restrictive covenants including maintaining a maximum consolidated leverage ratio of 3.0 and a minimum fixed charge ratio of 2.5, and also contains other covenants typical of unsecured facilities. As of June 30, 2012, we had no borrowings outstanding under the credit facility and were in compliance with all financial covenants.

Senior Notes

In May 2008, we issued $275 million of Senior Notes in a private placement to a group of institutional investors. These Senior Notes’ weighted average interest rate is 6.8% and the weighted average maturity is 7.9 years. On July 14, 2010, we issued $245 million of Senior Notes in a private placement to a group of institutional investors. These Senior Notes have a weighted average interest rate of 5.2% and a weighted average maturity of 8.0 years. All of the Senior Notes are subject to certain restrictive covenants that are substantially similar to those in the credit agreement for the revolving credit facility, including maintenance of consolidated leverage and fixed charge coverage ratios. The purchase agreements for the Senior Notes also include covenants typical of unsecured facilities. As of June 30, 2012 we were in compliance with all financial covenants under these purchase agreements.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. These accounting principles require management to make certain judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We periodically evaluate our estimates including those relating to revenue recognition, the allowance for doubtful accounts, goodwill and other intangible assets resulting from business acquisitions, share-based compensation, income taxes and contingencies and litigation. We base our estimates on historical experience and various other assumptions that we believe to be reasonable based on the specific circumstances, the results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition

Software Licenses

Software license fee revenue is recognized when persuasive evidence of an arrangement exists, software is made available to our customers, the fee is fixed or determinable and collection is probable. The determination of whether fees are fixed or determinable and collection is probable involves the use of judgment. If at the outset of an arrangement we determine that the arrangement fee is not fixed or determinable, revenue is deferred until the arrangement fee becomes fixed or determinable, assuming all other revenue recognition criteria have been met. If at the outset of an arrangement we determine that collectability is not probable, revenue is deferred until the earlier of when collectability becomes probable or the receipt of payment. If there is uncertainty as to the customer’s acceptance of our deliverables, revenue is not recognized until the earlier of receipt of customer acceptance, expiration of the acceptance period, or when we can demonstrate we meet the acceptance criteria. We evaluate contract terms and customer information to ensure that these criteria are met prior to our recognition of license fee revenue.

 

29


Table of Contents

We use the residual method to recognize revenue when a software arrangement includes one or more elements to be delivered at a future date provided the following criteria are met: (i) vendor-specific objective evidence (“VSOE”) of the fair value does not exist for one or more of the delivered items but exists for all undelivered elements, (ii) all other applicable revenue recognition criteria are met and (iii) the fair value of all of the undelivered elements is less than the arrangement fee. VSOE of fair value is based on the normal pricing practices for those products and services when sold separately by us and customer renewal rates for post-contract customer support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established. Changes to the elements in a software arrangement, the ability to identify VSOE for those elements, the fair value of the respective elements, and change to a product’s estimated life cycle could materially impact the amount of earned and unearned revenue.

When software licenses are sold together with implementation or consulting services, license fees are recognized upon delivery provided that the above criteria are met, payment of the license fees is not dependent upon the performance of the services, and the services do not provide significant customization or modification of the software products and are not essential to the functionality of the software that was delivered. For arrangements with services that are essential to the functionality of the software, the license and related service revenues are recognized using contract accounting as described below.

Revenues from post-contract customer support services, such as software maintenance, are recognized on a straight-line basis over the term of the support period. The majority of our software maintenance agreements provide technical support as well as unspecified software product upgrades and releases when and if made available by us during the term of the support period.

Transactional-based Revenues

Transactional-based revenue is recognized when persuasive evidence of an arrangement exists, fees are fixed or determinable, and collection is reasonably assured. Revenues from our credit scoring, data processing, data management and internet delivery services are recognized as these services are performed. Revenues from transactional or unit-based license fees under software license arrangements, network service and internally-hosted software agreements are recognized based on minimum contractual amounts or on system usage that exceeds minimum contractual amounts. Certain of our transactional-based revenues are based on transaction or active account volumes as reported by our clients. In instances where volumes are reported to us in arrears, we estimate volumes based on preliminary customer transaction information or average actual reported volumes for an immediate trailing period. Differences between our estimates and actual final volumes reported are recorded in the period in which actual volumes are reported. We have not experienced significant variances between our estimates and actual reported volumes in the past and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we were unable to reasonably estimate transaction volumes in the future, revenue may be deferred until actual customer data is received, and this could have a material impact on our consolidated results of operations.

Consulting Services

We provide consulting, training, model development and software integration services under both hourly-based time and materials and fixed-priced contracts. When consulting services qualify for separate accounting, revenues from these services are generally recognized as the services are performed. For fixed-price service contracts, we use a proportionate performance model with hours as the input method of attribution to determine progress towards completion, with consideration also given to output measures, such as contract milestones, when applicable. In such instances, management is required to estimate the total estimated hours of the project. Adjustments to estimates are made in the period in which the facts requiring such revisions become known and, accordingly, recognized revenues and profits are subject to revisions as the contract progresses to completion. Estimated losses, if any, are recorded in the period in which current estimates of total contract revenue and contract costs indicate a loss. If substantive uncertainty related to customer acceptance of services exists, we defer the associated revenue until the contract is completed. If we are unable to accurately estimate the input measures, revenue would be deferred until the contract is complete, and this could have a material impact on our consolidated results of operations.

Hosting Services

We are an application service provider (“ASP”), where we provide hosting services that allow customers access to software that resides on our servers. The ASP model typically includes an up-front fee and a monthly commitment from the customer that commences upon completion of the implementation through the remainder of the contractual term. The up-front fee is the initial setup fee, or the implementation fee. The monthly commitment includes, but is not limited to, a fixed monthly fee or a transactional fee based on system usage that exceeds monthly minimums. Revenue is recognized from ASP transactions when there is persuasive evidence of an arrangement, the service has been provided to the customer, the amount of fees is fixed or determinable and the collection of the Company’s fees is probable. We do not view the activities of signing the contract or providing initial setup services as discrete earnings events. Revenue is typically deferred until the date the customer commences use of our services, at which point the up-front fees are recognized ratably over the contractual term of the customer arrangement. ASP transactional fees are recorded monthly as earned.

 

30


Table of Contents

Multiple-Deliverable Arrangements including Non-Software

Each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting if the following criteria are met: (i) the delivered item or items have value to the customer on a standalone basis and (ii) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. We consider a deliverable to have standalone value if we sell this item separately or if the item is sold by another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a general right of return relative to delivered products. Revenue for multiple element arrangements is allocated to the software and non-software deliverables based on a relative selling price. We use VSOE in our allocation of arrangement consideration when it is available. We define VSOE as a median price of recent standalone transactions that are priced within a narrow range, as defined by us. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE. In circumstances when VSOE does not exist, we then assess whether we can obtain third-party evidence (“TPE”) of the selling price. It may be difficult for us to obtain sufficient information on competitor pricing to substantiate TPE and therefore we may not always be able to use TPE. When we are unable to establish selling price using VSOE or TPE, we use estimated selling price (“ESP”) in its allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis. Our determination of ESP involves weighting several factors based on the specific facts and circumstances of each arrangement. The factors include, but are not limited to, geographies, market conditions, gross margin objectives, pricing practices and controls, customer segment pricing strategies and the product lifecycle. We analyze selling prices used in our allocation of arrangement consideration on an annual basis, or more frequently if necessary. Selling prices will be analyzed more frequently if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.

Gross vs. Net Revenue Reporting

We apply accounting guidance to determine whether we report revenue for certain transactions based upon the gross amount billed to the customer, or the net amount retained by us. In accordance with the guidance we record revenue on a gross basis for sales in which we have acted as the principal and on a net basis for those sales in which we have in substance acted as an agent or broker in the transaction.

Allowance for Doubtful Accounts

We make estimates regarding the collectability of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we analyze specific accounts receivable balances, historical bad debts, customer creditworthiness, current economic trends and changes in our customer payment cycles. Material differences may result in the amount and timing of expense for any period if we were to make different judgments or utilize different estimates. If the financial condition of our customers deteriorates resulting in an impairment of their ability to make payments, additional allowances might be required.

Valuation of Goodwill and Other Intangible Assets – Impairment Assessment

Our business acquisitions typically result in the recognition of goodwill and other intangible assets, which affect the amount of current and future period charges and amortization expense. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including identified intangible assets, in connection with our business combinations. We amortize our definite-lived intangible assets based on forecasted cash flows associated with the assets over the estimated useful lives. Goodwill is not amortized, but is assessed at least annually for impairment.

The determination of the value of these components of a business combination, as well as associated asset useful lives, requires management to make various estimates and assumptions. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from product sales and services, maintenance agreements, consulting contracts, customer contracts, and acquired developed technologies and patents or trademarks; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired products and services will continue to be used in our product portfolio; and discount rates. Management’s estimates of fair value and useful lives are based upon assumptions believed to be reasonable. Estimates using different assumptions, or unanticipated events and circumstances could produce significantly different results.

 

31


Table of Contents

We assess potential impairments to our intangible assets when there is evidence that events and circumstances related to our financial performance and economic environment indicate the carrying amount of the assets may not be recoverable. When impairment indicators are identified with respect to our previously recorded intangible assets with finite useful lives, we test for impairment using undiscounted cash flows. If such tests indicate impairment, then we measure and record the impairment as the difference between the carrying value of the asset and the fair value of the asset. Significant management judgment is required in forecasting future operating results used in the preparation of the projected discounted cash flows. Should different conditions prevail, material write downs of net intangible assets and other long-lived assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

We test goodwill for impairment at the reporting unit levels, which we have determined are the same as our reportable segments, at least annually during the fourth quarter of each fiscal year. The timing and frequency of our goodwill impairment test is based on an ongoing assessment of events and circumstances that would be an indicator of potential impairment of a reporting unit, with the fair value below its carrying value. The first step of the goodwill impairment test is a comparison of the fair value of a reporting unit to its carrying value. We estimate the fair values of our reporting units using a weighted combination of discounted cash flow valuation model (known as the income approach) and a comparison of our reporting units to guideline publicly-traded companies (known as the market approach). These methods require estimates of our future revenues, profits, capital expenditures, working capital, costs of capital and other relevant factors, as well as selecting appropriate guideline publicly-traded companies for each reporting unit. We evaluate historical trends, current budgets, operating plans, industry data, and other relevant factors when estimating these amounts. The determination of an impairment loss, using assumptions that are different from those used in our estimates but in each case reasonable, could produce significantly different results and materially affect the determination of fair value and/or goodwill impairment for each reporting unit. For example, if the economic environment impacts our forecasts beyond what we have anticipated, it could cause the fair value of a reporting unit to fall below its respective carrying value.

The key assumptions that require significant management judgment for the income approach include revenue growth rates and weighted average cost of capital. In our analysis, revenue growth rates were primarily based on third party studies of industry growth rates for each of our reporting units. Within each reporting unit, management refined these estimates based on their knowledge of the product, the needs of our customers and expected market opportunity. The weighted average cost of capital was determined based on publicly available data such as the long-term yield on U.S. treasury bonds, the expected rate of return on high quality bonds and the returns and betas of various equity instruments. As it relates to the market approach, there is less management judgment in determining the fair value of our reporting units other than selecting which guideline publicly-traded companies are included in our peer group.

In the fourth quarter of fiscal 2011 we performed our annual goodwill impairment test. In step one of that test we compared the estimated fair value of each reporting unit to its carrying value. The estimated fair value of each of our reporting units exceeded its respective carrying value in fiscal 2011, indicating the underlying goodwill of each reporting unit was not impaired as of our most recent testing date. Accordingly, we were not required to complete the second step of the goodwill impairment test and recorded no goodwill impairment charges for the twelve months ended September 30, 2011.

During our fiscal 2011 goodwill impairment analysis, we concluded the estimated fair values of all of our reporting units substantially exceeded their carrying values. As discussed above, estimates of fair value for all of our reporting units can be affected by a variety of external and internal factors. We believe that the assumptions and estimates utilized were appropriate based on the information available to management. The timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions.

Share-Based Compensation

We account for share-based compensation using the fair value recognition provisions as required in the accounting literature. We estimate the fair value of options granted using the Black-Scholes option valuation model. We estimate the volatility of our common stock at the date of grant based on a combination of the implied volatility of publicly traded options on our common stock and our historical volatility rate. Our decision to use implied volatility was based upon the availability of actively traded options on our common stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. We estimate the expected term of options granted based on historical exercise patterns. The dividend yield assumption is based on historical dividend payouts. The risk-free interest rate assumption is based on observed interest rates appropriate for the term of our employee options. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For options granted, we amortize the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods. If factors change we may decide to use different assumptions under the Black-Scholes option valuation model in the future, which could materially affect our share-based compensation expense, net income and earnings per share.

 

32


Table of Contents

Income Taxes

We use the asset and liability approach to account for income taxes. This methodology recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax base of assets and liabilities and operating loss and tax credit carryforwards. We then record a valuation allowance to reduce deferred tax assets to an amount that more likely than not will be realized. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, which requires the use of estimates. If we determine during any period that we could realize a larger net deferred tax asset than the recorded amount, we would adjust the deferred tax asset to increase income for the period or reduce goodwill if such deferred tax asset relates to an acquisition. Conversely, if we determine that we would be unable to realize a portion of our recorded deferred tax asset, we would adjust the deferred tax asset to record a charge to income. To the extent an adjustment in our deferred tax assets relates to a business combination the adjustment is recorded either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. Although we believe that our estimates are reasonable, there is no assurance that our valuation allowance will not need to be increased to cover additional deferred tax assets that may not be realizable, and such an increase could have a material adverse impact on our income tax provision and results of operations in the period in which such determination is made. In addition, the calculation of tax liabilities also involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could also have a material impact on our income tax provision and consolidated results of operations in the period in which such determination is made.

Contingencies and Litigation

We are subject to various proceedings, lawsuits and claims relating to products and services, technology, labor, shareholder and other matters. We are required to assess the likelihood of any adverse outcomes and the potential range of probable losses in these matters. If the potential loss is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. If the potential loss is considered less than probable or the amount cannot be reasonably estimated, disclosure of the matter is considered. The amount of loss accrual or disclosure, if any, is determined after analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies. Due to uncertainties related to these matters, accruals or disclosures are based on the best information available at the time. Significant judgment is required in both the assessment of likelihood and in the determination of a range of potential losses. Revisions in the estimates of the potential liabilities could have a material impact on our consolidated financial position or consolidated results of operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market Risk Disclosures

We are exposed to market risk related to changes in interest rates, equity market prices, and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

Interest Rate and Equity Market Price

We maintain an investment portfolio consisting mainly of income securities with an average maturity of three years or less. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity, and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. The following table presents the principal amounts and related weighted-average yields for our investments with interest rate risk at June 30, 2012 and September 30, 2011:

 

33


Table of Contents
     June 30, 2012     September 30, 2011  
     Cost Basis      Carrying
Amount
     Average
Yield
    Cost Basis      Carrying
Amount
     Average
Yield
 
     (Dollars in thousands)  

Cash and cash equivalents

   $ 118,681       $ 118,681         0.21   $ 135,752       $ 135,752         0.14

Short-term investments

     32,029         32,022         0.20     105,819         105,826         0.16
  

 

 

    

 

 

      

 

 

    

 

 

    
   $ 150,710       $ 150,703         0.21   $ 241,571       $ 241,578         0.15
  

 

 

    

 

 

      

 

 

    

 

 

    

In May 2008, we issued $275 million of Senior Notes to a group of institutional investors in a private placement. In July 2010 we issued an additional $245 million of Senior Notes to a group of institutional investors in a private placement. The fair value of our Senior Notes may increase or decrease due to various factors, including fluctuations in market interest rates and fluctuations in general economic conditions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity”, above, for additional information on the Senior Notes. The following table presents the principal amounts, carrying amounts, and fair values for our Senior Notes at June 30, 2012 and September 30, 2011:

 

     June 30, 2012      September 30, 2011  
     Principal      Carrying
Amounts
     Fair Value      Principal      Carrying
Amounts
     Fair Value  
     (In thousands)      (In thousands)  

May 2008 $275 million Senior Notes

   $ 259,000       $ 259,000       $ 274,961       $ 267,000       $ 267,000       $ 305,874   

July 2010 $245 million Senior Notes

   $ 245,000       $ 245,000       $ 242,271       $ 245,000       $ 245,000       $ 266,620   

We have interest rate risk with respect to our five-year $200 million unsecured revolving line of credit. Interest on amounts borrowed under the line of credit is based on (i) a base rate, which is the greater of (a) the prime rate and (b) the Federal Funds rate plus 0.50% or (ii) LIBOR plus an applicable margin. The margin on LIBOR borrowings ranges from 1.000% to 1.625% and is determined based on our consolidated leverage ratio. A change in interest rates on this variable rate debt impacts the interest incurred and cash flows, but does not impact the fair value of the instrument. We had no borrowings outstanding under the credit facility as of June 30, 2012.

Forward Foreign Currency Contracts

We maintain a program to manage our foreign currency exchange rate risk on existing foreign currency receivable and cash balances by entering into forward contracts to sell or buy foreign currency. At period end, foreign-denominated receivables and cash balances held by our U.S. reporting entities are remeasured into the U.S. dollar functional currency at current market rates. The change in value from this remeasurement is then reported as a foreign exchange gain or loss for that period in our accompanying consolidated statements of income and the resulting gain or loss on the forward contract mitigates the exchange rate risk of the associated assets. All of our forward foreign currency contracts have maturity periods of less than three months. Such derivative financial instruments are subject to market risk.

 

34


Table of Contents

The following table summarizes our outstanding forward foreign currency contracts, by currency at June 30, 2012 and September 30, 2011:

 

     June 30, 2012  
     Contract Amount      Fair Value  
     Foreign
Currency
     US$      US$  
            (In thousands)         

Sell foreign currency:

        

Canadian dollar (CAD)

     CAD 2,350       $ 2,293       $ —     

Euro (EUR)

     EUR 2,700       $ 3,414       $ —     

Buy foreign currency:

        

British pound (GBP)

     GBP 4,121       $ 6,450       $ —     

 

     September 30, 2011  
      Contract Amount      Fair Value  
     Foreign
Currency
     US$      US$  
            (In thousands)         

Sell foreign currency:

        

Canadian dollar (CAD)

     CAD 8,000       $ 7,663       $ —     

Euro (EUR)

     EUR 4,830       $ 6,524       $ —     

Buy foreign currency:

        

British pound (GBP)

     GBP 3,911       $ 6,100       $ —     

The forward foreign currency contracts were all entered into on June 30, 2012 and September 30, 2011, respectively; therefore, the fair value was $0 on each of those dates.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of FICO’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of FICO’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that FICO’s disclosure controls and procedures are effective to ensure that information required to be disclosed by FICO in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

No change in FICO’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this quarterly report and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Not Applicable.

 

35


Table of Contents

Item 1A. Risk Factors

Risks Related to Our Business

We have expanded the pursuit of our Decision Management strategy, and we may not be successful, which could cause our growth prospects and results of operations to suffer.

We have expanded the pursuit of our business objective to become a leader in helping businesses automate and improve decisions across their enterprises, an approach that we commonly refer to as Decision Management, or “DM.” Our DM strategy is designed to enable us to increase our business by selling multiple products to clients, as well as to enable the development of custom client solutions that may lead to opportunities to develop new proprietary scores or other new proprietary products. The market may be unreceptive to this general DM business approach, including being unreceptive to purchasing multiple products from us or unreceptive to our customized solutions. If our DM strategy is not successful, we may not be able to grow our business, growth may occur more slowly than we anticipate or our revenues and profits may decline.

We derive a substantial portion of our revenues from a small number of products and services, and if the market does not continue to accept these products and services, our revenues will decline.

We expect that revenues derived from our scoring solutions, fraud solutions, customer management solutions and tools will continue to account for a substantial portion of our total revenues for the foreseeable future. Our revenues will decline if the market does not continue to accept these products and services. Factors that might affect the market acceptance of these products and services include the following:

 

   

changes in the business analytics industry;

 

   

changes in technology;

 

   

our inability to obtain or use key data for our products;

 

   

saturation or contraction of market demand;

 

   

loss of key customers;

 

   

industry consolidation;

 

   

failure to execute our selling approach; and

 

   

inability to successfully sell our products in new vertical markets.

If we are unable to access new markets or develop new distribution channels, our business and growth prospects could suffer.

We expect that part of the growth that we seek to achieve through our DM strategy will be derived from the sale of DM products and service solutions in industries and markets we do not currently serve. We also expect to grow our business by delivering our DM solutions through additional distribution channels. If we fail to penetrate these industries and markets to the degree we anticipate utilizing our DM strategy, or if we fail to develop additional distribution channels, we may not be able to grow our business, growth may occur more slowly than we anticipate or our revenues and profits may decline.

If we are unable to develop successful new products or if we experience defects, failures and delays associated with the introduction of new products, our business could suffer serious harm.

Our growth and the success of our DM strategy depend upon our ability to develop and sell new products or suites of products. If we are unable to develop new products, or if we are not successful in introducing new products, we may not be able to grow our business, or growth may occur more slowly than we anticipate. In addition, significant undetected errors or delays in new products or new versions of products may affect market acceptance of our products and could harm our business, financial condition or results of operations. In the past, we have experienced delays while developing and introducing new products and product enhancements, primarily due to difficulties developing models, acquiring data and adapting to particular operating environments. We have also experienced errors or “bugs” in our software products, despite testing prior to release of the products. Software errors in our products could affect the ability of our products to work with other hardware or software products, could delay the development or release of new products or new versions of products and could adversely affect market acceptance of our products. Errors or defects in our products that are significant, or are perceived to be significant, could result in rejection of our products, damage to our reputation, loss of revenues, diversion of development resources, an increase in product liability claims, and increases in service and support costs and warranty claims.

 

36


Table of Contents

We rely on relatively few customers, as well as our contracts with the three major credit reporting agencies, for a significant portion of our revenues and profits. Certain of our large customers were negatively impacted by the recent financial crisis. If these customers continue to be negatively impacted, or if the terms of these relationships otherwise change, our revenues and operating results could decline.

Most of our customers are relatively large enterprises, such as banks, credit card processors, insurance companies, healthcare firms and retailers. As a result, many of our customers and potential customers are significantly larger than we are and may have sufficient bargaining power to demand reduced prices and favorable nonstandard terms.

In addition, since mid-2007, global financial markets have suffered substantial stress, volatility, illiquidity and disruption. The potential for increased and continuing economic disruption presents considerable risks to our business, including potential bankruptcies or credit deterioration of financial institutions with which we have substantial relationships. Such disruption would result in a continued decline in the volume of transactions that we execute for our customers.

We also derive a substantial portion of our revenues and operating income from our contracts with the three major credit reporting agencies, TransUnion, Equifax and Experian, and other parties that distribute our products to certain markets. The loss of or a significant change in a relationship with one of these credit reporting agencies with respect to their distribution of our products or with respect to our myFICO® offerings, the loss of or a significant change in a relationship with a major customer, the loss of or a significant change in a relationship with a significant third-party distributor or the delay of significant revenues from these sources, could have a material adverse effect on our revenues and results of operations.

We rely on relationships with third parties for marketing, distribution and certain services. If we experience difficulties in these relationships, our future revenues may be adversely affected.

Most of our products rely on distributors, and we intend to continue to market and distribute our products through existing and future distributor relationships. Our Scores segment relies on, among others, TransUnion, Equifax and Experian. Failure of our existing and future distributors to generate significant revenues, demands by such distributors to change the terms on which they offer our products or our failure to establish additional distribution or sales and marketing alliances could have a material adverse effect on our business, operating results and financial condition. In addition, certain of our distributors presently compete with us and may compete with us in the future either by developing competitive products themselves or by distributing competitive offerings. For example, TransUnion, Equifax and Experian have developed a credit scoring product to compete directly with our products and are collectively attempting to sell the product. Competition from distributors or other sales and marketing partners could significantly harm sales of our products and services.

If we do not engage in acquisition activity, we may be unable to increase our revenues at comparable market growth rates.

Our past revenue growth has been augmented by numerous acquisitions, and we anticipate that acquisitions may be an important part of our future revenue growth. We may be unable to increase our revenues if we do not make acquisitions of similar size and at a comparable rate as in the past.

If we engage in acquisitions, significant investments in new businesses, or divestitures of existing businesses, we will incur a variety of risks, any of which may adversely affect our business.

We have made in the past, and may make in the future, acquisitions of, or significant investments in, businesses that offer complementary products, services and technologies. Any acquisitions or investments will be accompanied by the risks commonly encountered in acquisitions of businesses, which may include:

 

   

failure to achieve the financial and strategic goals for the acquired and combined business;

 

   

overpayment for the acquired companies or assets;

 

   

difficulty assimilating the operations and personnel of the acquired businesses;

 

   

product liability and other exposure associated with acquired businesses or the sale of their products;

 

   

disruption of our ongoing business;

 

   

dilution of our existing stockholders and earnings per share;

 

   

unanticipated liabilities, legal risks and costs;

 

   

retention of key personnel;

 

   

distraction of management from our ongoing business; and

 

   

impairment of relationships with employees and customers as a result of integration of new management personnel.

 

37


Table of Contents

We have also divested ourselves of businesses in the past and may do so again in the future. Any divestitures will be accompanied by the risks commonly encountered in the sale of businesses, which may include:

 

   

disruption of our ongoing business;

 

   

reductions of our revenues or earnings per share;

 

   

unanticipated liabilities, legal risks and costs;

 

   

the potential loss of key personnel;

 

   

distraction of management from our ongoing business; and

 

   

impairment of relationships with employees and customers as a result of migrating a business to new owners.

These risks could harm our business, financial condition or results of operations, particularly if they occur in the context of a significant acquisition. Acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of conducting operations in international markets.

Our reengineering initiative may cause our growth prospects and profitability to suffer.

As part of our management approach, we implemented an ongoing reengineering initiative designed to grow revenues through strategic resource allocation and improve profitability through cost reductions. Our reengineering initiative may not be successful over the long term as a result of our failure to reduce expenses at the anticipated level, or a lower, or no, positive impact on revenues from strategic resource allocation. If our reengineering initiative is not successful over the long term, our revenues, results of operations and business may suffer.

The occurrence of certain negative events may cause fluctuations in our stock price.

The market price of our common stock may be volatile and could be subject to wide fluctuations due to a number of factors, including variations in our revenues and operating results. We believe that you should not rely on period-to-period comparisons of financial results as an indication of future performance. Because many of our operating expenses are fixed and will not be affected by short-term fluctuations in revenues, short-term fluctuations in revenues may significantly impact operating results. Additional factors that may cause our stock price to fluctuate include the following:

 

   

variability in demand from our existing customers;

 

   

failure to meet the expectations of market analysts;

 

   

changes in recommendations by market analysts;

 

   

the lengthy and variable sales cycle of many products, combined with the relatively large size of orders for our products, increases the likelihood of short-term fluctuation in revenues;

 

   

consumer dissatisfaction with, or problems caused by, the performance of our products;

 

   

the timing of new product announcements and introductions in comparison with our competitors;

 

   

the level of our operating expenses;

 

   

changes in competitive and other conditions in the consumer credit, banking and insurance industries;

 

   

fluctuations in domestic and international economic conditions;

 

   

our ability to complete large installations on schedule and within budget;

 

   

acquisition-related expenses and charges; and

 

   

timing of orders for and deliveries of software systems.

In addition, the financial markets have experienced significant price and volume fluctuations that have particularly affected the stock prices of many technology companies and financial services companies, and these fluctuations sometimes have been unrelated to the operating performance of these companies. Broad market fluctuations, as well as industry-specific and general economic conditions may adversely affect the market price of our common stock.

Due to recent uncertainty in economic conditions and weakness in financial credit markets, the fair value of our businesses has declined. If difficult market and economic conditions continue over a sustained period, we may experience a further decline in the fair value of one or more of our businesses. Such further declines in fair value may require us to record an impairment charge related to goodwill, which could adversely affect our results of operations, stock price and business.

 

38


Table of Contents

Our products have long and variable sales cycles. If we do not accurately predict these cycles, we may not forecast our financial results accurately, and our stock price could be adversely affected.

We experience difficulty in forecasting our revenues accurately because the length of our sales cycles makes it difficult for us to predict the quarter in which sales will occur. In addition, our selling approach is complex as we look to sell multiple products and services across our customers’ organizations. This makes forecasting of revenues in any given period more difficult. As a result of our sales approach and lengthening sales cycles, revenues and operating results may vary significantly from period to period. For example, the sales cycle for licensing our products typically ranges from 60 days to 18 months. Customers are often cautious in making decisions to acquire our products because purchasing our products typically involves a significant commitment of capital and may involve shifts by the customer to a new software and/or hardware platform or changes in the customer’s operational procedures. This may cause customers, particularly those experiencing financial stress, to make purchasing decisions more cautiously. Delays in completing sales can arise while customers complete their internal procedures to approve large capital expenditures and test and accept our applications. Consequently, we face difficulty predicting the quarter in which sales to expected customers will occur and experience fluctuations in our revenues and operating results. If we are unable to accurately forecast our revenues, our stock price could be adversely affected.

We typically have revenue-generating transactions concentrated in the final weeks of a quarter, which may prevent accurate forecasting of our financial results and cause our stock price to decline.

Large portions of our software license agreements are consummated in the weeks immediately preceding quarter end. Before these agreements are consummated, we create and rely on forecasted revenues for planning, modeling and earnings guidance. Forecasts, however, are only estimates and actual results may vary for a particular quarter or longer periods of time. Consequently, significant discrepancies between actual and forecasted results could limit our ability to plan, budget or provide accurate guidance, which could adversely affect our stock price. Any publicly-stated revenue or earnings projections are subject to this risk.

The failure to recruit and retain additional qualified personnel could hinder our ability to successfully manage our business.

Our DM strategy and our future success will depend in large part on our ability to attract and retain experienced sales, consulting, research and development, marketing, technical support and management personnel. The complexity of our products requires highly trained customer service and technical support personnel to assist customers with product installation and deployment. The labor market for these individuals is very competitive due to the limited number of people available with the necessary technical skills and understanding and may become more competitive with general market and economic improvement. We cannot be certain that our compensation strategies will be perceived as competitive by current or prospective employees. This could impair our ability to recruit and retain personnel. We have experienced difficulty in recruiting qualified personnel, especially technical, sales and consulting personnel, and we may need additional staff to support new customers and/or increased customer needs. We may also recruit skilled technical professionals from other countries to work in the United States. Limitations imposed by immigration laws in the United States and abroad and the availability of visas in the countries where we do business could hinder our ability to attract necessary qualified personnel and harm our business and future operating results. There is a risk that even if we invest significant resources in attempting to attract, train and retain qualified personnel, we will not succeed in our efforts, and our business could be harmed. The failure of the value of our stock to appreciate may adversely affect our ability to use equity and equity based incentive plans to attract and retain personnel, and may require us to use alternative and more expensive forms of compensation for this purpose.

The failure to obtain certain forms of model construction data from our customers or others could harm our business.

We must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our products. In most cases, these data must be periodically updated and refreshed to enable our products to continue to work effectively in a changing environment. We do not own or control much of the data that we require, most of which is collected privately and maintained in proprietary databases. Customers and key business alliances provide us with the data we require to analyze transactions, report results and build new models. Our DM strategy depends in part upon our ability to access new forms of data to develop custom and proprietary analytic tools. If we fail to maintain sufficient data sourcing relationships with our customers and business alliances, or if they decline to provide such data due to legal privacy concerns, competition concerns, prohibitions or a lack of permission from their customers, we could lose access to required data and our products, and the development of new products might become less effective. Third parties have asserted copyright interests in these data, and these assertions, if successful, could prevent us from using these data. Any interruption of our supply of data could seriously harm our business, financial condition or results of operations.

 

39


Table of Contents

We will continue to rely upon proprietary technology rights, and if we are unable to protect them, our business could be harmed.

Our success depends, in part, upon our proprietary technology and other intellectual property rights. To date, we have relied primarily on a combination of copyright, patent, trade secret, and trademark laws, and nondisclosure and other contractual restrictions on copying and distribution to protect our proprietary technology. This protection of our proprietary technology is limited, and our proprietary technology could be used by others without our consent. In addition, patents may not be issued with respect to our pending or future patent applications, and our patents may not be upheld as valid or may not prevent the development of competitive products. Any disclosure, loss, invalidity of, or failure to protect our intellectual property could negatively impact our competitive position, and ultimately, our business. There can be no assurance that our protection of our intellectual property rights in the United States or abroad will be adequate or that others, including our competitors, will not use our proprietary technology without our consent. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could harm our business, financial condition or results of operations.

Some of our technologies were developed under research projects conducted under agreements with various U.S. government agencies or subcontractors. Although we have commercial rights to these technologies, the U.S. government typically retains ownership of intellectual property rights and licenses in the technologies developed by us under these contracts, and in some cases can terminate our rights in these technologies if we fail to commercialize them on a timely basis. Under these contracts with the U.S. government, the results of research may be made public by the government, limiting our competitive advantage with respect to future products based on our research.

If we are subject to infringement claims, it could harm our business.

We expect that products in the industry segments in which we compete, including software products, will increasingly be subject to claims of patent and other intellectual property infringement as the number of products and competitors in our industry segments grow. We may need to defend claims that our products infringe intellectual property rights, and as a result we may:

 

   

incur significant defense costs or substantial damages;

 

   

be required to cease the use or sale of infringing products;

 

   

expend significant resources to develop or license a substitute non-infringing technology;

 

   

discontinue the use of some technology; or

 

   

be required to obtain a license under the intellectual property rights of the third party claiming infringement, which license may not be available or might require substantial royalties or license fees that would reduce our margins.

Breaches of security, or the perception that e-commerce is not secure, could harm our business.

Our business requires the appropriate and secure utilization of consumer and other sensitive information. Internet-based electronic commerce requires the secure transmission of confidential information over public networks, and several of our products are accessed through the Internet, including our consumer services accessible through the www.myfico.com website. Security breaches in connection with the delivery of our products and services, including products and services utilizing the Internet, or well-publicized security breaches, and the trend toward broad consumer and general public notification of such incidents, could significantly harm our business, financial condition or results of operations. We cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in our systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology protecting the networks that access our net-sourced products, consumer services and proprietary database information.

Protection from system interruptions is important to our business. If we experience a sustained interruption of our telecommunication systems, it could harm our business.

Systems or network interruptions could delay and disrupt our ability to develop, deliver or maintain our products and services, causing harm to our business and reputation and resulting in loss of customers or revenue. These interruptions can include fires, floods, earthquakes, power losses, equipment failures and other events beyond our control.

 

40


Table of Contents

Risks Related to Our Industry

Our ability to increase our revenues will depend to some extent upon introducing new products and services. If the marketplace does not accept these new products and services, our revenues may decline.

We have a significant share of the available market in portions of our Scores segment and for certain services in our Applications segment, specifically, the markets for account management services at credit card processors and credit card fraud detection software. To increase our revenues, we must enhance and improve existing products and continue to introduce new products and new versions of existing products that keep pace with technological developments, satisfy increasingly sophisticated customer requirements and achieve market acceptance. We believe much of the future growth of our business and the success of our DM strategy will rest on our ability to continue to expand into newer markets for our products and services. Such areas are relatively new to our product development and sales and marketing personnel. Products that we plan to market in the future are in various stages of development. We cannot assure you that the marketplace will accept these products. If our current or potential customers are not willing to switch to or adopt our new products and services, either as a result of the quality of these products and services or due to other factors, such as economic conditions, our revenues will decrease.

If we fail to keep up with rapidly changing technologies, our products could become less competitive or obsolete.

In our markets, technology changes rapidly, and there are continuous improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems, database technology and the use of the Internet. If we fail to enhance our current products and develop new products in response to changes in technology or industry standards, or if we fail to bring product enhancements or new product developments to market quickly enough, our products could rapidly become less competitive or obsolete. Our future success will depend, in part, upon our ability to:

 

   

innovate by internally developing new and competitive technologies;

 

   

use leading third-party technologies effectively;

 

   

continue to develop our technical expertise;

 

   

anticipate and effectively respond to changing customer needs;

 

   

initiate new product introductions in a way that minimizes the impact of customers delaying purchases of existing products in anticipation of new product releases; and

 

   

influence and respond to emerging industry standards and other technological changes.

If our competitors introduce new products and pricing strategies, it could decrease our product sales and market share, or could pressure us to reduce our product prices in a manner that reduces our margins.

We may not be able to compete successfully against our competitors, and this inability could impair our capacity to sell our products. The market for business analytics is new, rapidly evolving and highly competitive, and we expect competition in this market to persist and intensify. Our regional and global competitors vary in size and in the scope of the products and services they offer, and include:

 

   

in-house analytic and systems developers;

 

   

scoring model builders;

 

   

enterprise resource planning (ERP) and customer relationship management (CRM) packaged solutions providers;

 

   

business intelligence solutions providers;

 

   

credit report and credit score providers;

 

   

business process management solution providers;

 

   

process modeling tools providers;

 

   

automated application processing services providers;

 

   

data vendors;

 

   

neural network developers and artificial intelligence system builders;

 

   

third-party professional services and consulting organizations;

 

   

account/workflow management software providers; and

 

   

software tools companies supplying modeling, rules, or analytic development tools.

We expect to experience additional competition from other estblished and emerging companies, as well as from other technologies. For example, certain of our fraud solutions products compete against other methods of preventing credit card fraud, such as credit cards that contain the cardholder’s photograph, smart cards, cardholder verification and authentication solutions and other card

 

41


Table of Contents

authorization techniques. Many of our anticipated competitors have greater financial, technical, marketing, professional services and other resources than we do, and industry consolidation is creating even larger competitors in many of our markets. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources than we can to develop, promote and sell their products. Many of these companies have extensive customer relationships, including relationships with many of our current and potential customers. Furthermore, new competitors or alliances among competitors may emerge and rapidly gain significant market share. For example, TransUnion, Equifax and Experian have formed an alliance that has developed a credit scoring product competitive with our products. If we are unable to respond as quickly or effectively to changes in customer requirements as our competition, our ability to expand our business and sell our products will be negatively affected.

Our competitors may be able to sell products competitive to ours at lower prices individually or as part of integrated suites of several related products. This ability may cause our customers to purchase products that directly compete with our products from our competitors. Price reductions by our competitors could negatively impact our margins, and could also harm our ability to obtain new long-term contracts and renewals of existing long-term contracts on favorable terms.

Legislation that is enacted by the U.S. Congress, the states, Canadian provinces, and other countries, and government regulations that apply to us or to our customers may expose us to liability, cause us to incur significant expense, affect our ability to compete in certain markets, limit the profitability of or demand for our products, or render our products obsolete. If these laws and regulations require us to change our current products and services, it could adversely affect our business and results of operations.

Legislation and governmental regulation affect how our business is conducted and, in some cases, subject us to the possibility of governmental supervision and future lawsuits arising from our products and services. Globally, legislation and governmental regulation also influence our current and prospective customers’ activities, as well as their expectations and needs in relation to our products and services. Both our core businesses and our newer initiatives are affected globally by federal, regional, provincial, state and other jurisdictional regulations, including those in the following significant regulatory areas:

 

   

Use of data by creditors and consumer reporting agencies. Examples in the U.S. include the Fair Credit Reporting Act (“FCRA”), as amended by the Fair and Accurate Credit Transactions Act (“FACTA”);

 

   

Laws and regulations that limit the use of credit scoring models such as state “mortgage trigger” laws, state “inquiries” laws, state insurance restrictions on the use of credit based insurance scores, and the Consumer Credit Directive in the European Union;

 

   

Fair lending laws, such as the Truth In Lending Act ("TILA") and Regulation Z, as amended by the Credit Card Accountability Responsibility and Disclosure Act of 2009 (“Credit CARD Act of 2009”), and the Equal Credit Opportunity Act (“ECOA”) and Regulation B;

 

   

Privacy and security laws and regulations that limit the use and disclosure of personally identifiable information or require security procedures, including but not limited to the provisions of the Financial Services Modernization Act of 1999, also known as the Gramm Leach Bliley Act (“GLBA”); the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH”); the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”); identity theft, file freezing, security breach notification and similar state privacy laws;

 

   

Extension of credit to consumers through the Electronic Fund Transfers Act and Regulation E, as well as nongovernmental VISA and MasterCard electronic payment standards;

 

   

Regulations applicable to secondary market participants such as Fannie Mae and Freddie Mac that could have an impact on our products;

 

   

Insurance laws and regulations applicable to our insurance clients and their use of our insurance products and services;

 

   

The application or extension of consumer protection laws, including, laws governing the use of the Internet and telemarketing, advertising, endorsements and testimonials and credit repair;

 

   

Laws and regulations applicable to operations in other countries, for example, the European Union’s Privacy Directive and the Foreign Corrupt Practices Act;

 

   

Sarbanes-Oxley Act (“SOX”) requirements to maintain and verify internal process controls, including controls for material event awareness and notification;

 

   

The implementation of the Emergency Economic Stabilization Act of 2008 by federal regulators to manage the financial crisis in the United States;

 

   

Financial regulatory reform stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act and the many regulations mandated by that Act, including regulations issued by, and the supervisory authority of, the Bureau of Consumer Financial Protection (“CFPB”); and

 

   

Laws and regulations regarding export controls as they apply to FICO products delivered in non-US countries.

 

42


Table of Contents

In making credit evaluations of consumers, or in performing fraud screening or user authentication, our customers are subject to requirements of multiple jurisdictions, which may impose onerous and contradictory requirements. Privacy legislation such as GLBA or the European Union’s Privacy Directive may also affect the nature and extent of the products or services that we can provide to customers, as well as our ability to collect, monitor and disseminate information subject to privacy protection. In addition to existing regulation, changes in legislative, judicial, regulatory or consumer environments could harm our business, financial condition or results of operations. These regulations and amendments to them could affect the demand for or profitability of some of our products, including scoring and consumer products. New regulations pertaining to financial institutions could cause them to pursue new strategies, reducing the demand for our products.

In response to market disruptions over the past several years, legislators and financial regulators implemented a number of mechanisms designed to add stability to the financial markets, including the provision of direct and indirect assistance to distressed financial institutions, assistance by the banking authorities in arranging acquisitions of weakened banks and broker-dealers, and implementation of programs by the Federal Reserve to provide liquidity to the commercial paper markets. The overall effects of these and other legislative and regulatory efforts on the financial markets are uncertain, and they may not have the intended stabilization effects. Should these or other legislative or regulatory initiatives fail to stabilize and add liquidity to the financial markets over the long term, our business, financial condition, results of operations and prospects could be materially and adversely affected. Whether or not legislative or regulatory initiatives or other efforts designed to address recent economic conditions successfully stabilize and add liquidity to the financial markets over the long term, we may need to modify our strategies, businesses or operations, and we may incur additional costs in order to compete in a changed business environment.

Our revenues depend, to a great extent, upon conditions in the banking (including consumer credit) and insurance industries. If our clients’ industries continue to experience a downturn, it will likely harm our business, financial condition or results of operations.

During fiscal 2011, 78% of our revenues were derived from sales of products and services to the banking and insurance industries. Since mid-2007, global credit and other financial markets have suffered substantial stress, volatility, illiquidity and disruptio