Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
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ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2016
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 1-11689
Fair Isaac Corporation
(Exact name of registrant as specified in its charter)
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Delaware | 94-1499887 |
(State or other jurisdiction of | (I.R.S. Employer |
incorporation or organization) | Identification No.) |
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181 Metro Drive, Suite 700 San Jose, California | 95110-1346 |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: 408-535-1500
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 ý No o
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 ý No o
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):
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Large Accelerated Filer | ý | Accelerated Filer | o |
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Non-Accelerated Filer | o | Smaller Reporting Company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes ý No
The number of shares of common stock outstanding on January 20, 2017 was 31,058,994 (excluding 57,797,789 shares held by us as treasury stock).
TABLE OF CONTENTS
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Item 1. | | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
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Item 1. | | |
Item 1A. | | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
Item 5. | | |
Item 6. | | |
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PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
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| | | | | | | |
| December 31, 2016 | | September 30, 2016 |
| (In thousands, except par value data) |
Assets | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 88,101 |
| | $ | 75,926 |
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Accounts receivable, net | 155,714 |
| | 167,786 |
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Prepaid expenses and other current assets | 40,929 |
| | 23,926 |
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Total current assets | 284,744 |
| | 267,638 |
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Marketable securities available for sale | 12,262 |
| | 11,016 |
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Other investments | 10,920 |
| | 10,920 |
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Property and equipment, net | 43,959 |
| | 45,122 |
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Goodwill | 789,602 |
| | 798,415 |
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Intangible assets, net | 29,328 |
| | 33,619 |
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Deferred income taxes | 47,798 |
| | 47,598 |
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Other assets | 5,785 |
| | 6,348 |
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Total assets | $ | 1,224,398 |
| | $ | 1,220,676 |
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Liabilities and Stockholders’ Equity | | | |
Current liabilities: | | | |
Accounts payable | $ | 22,417 |
| | $ | 22,952 |
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Accrued compensation and employee benefits | 41,506 |
| | 71,216 |
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Other accrued liabilities | 26,327 |
| | 27,780 |
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Deferred revenue | 57,465 |
| | 47,129 |
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Current maturities on debt | 102,000 |
| | 77,000 |
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Total current liabilities | 249,715 |
| | 246,077 |
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Long-term debt | 518,672 |
| | 493,624 |
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Other liabilities | 34,105 |
| | 34,147 |
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Total liabilities | 802,492 |
| | 773,848 |
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Commitments and contingencies |
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Stockholders’ equity: | | | |
Preferred stock ($0.01 par value; 1,000 shares authorized; none issued and outstanding) | — |
| | — |
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Common stock ($0.01 par value; 200,000 shares authorized, 88,857 shares issued and 31,157 and 30,935 shares outstanding at December 31, 2016 and September 30, 2016, respectively) | 312 |
| | 309 |
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Paid-in-capital | 1,149,832 |
| | 1,185,076 |
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Treasury stock, at cost (57,700 and 57,922 shares at December 31, 2016 and September 30, 2016, respectively) | (2,149,377 | ) | | (2,136,760 | ) |
Retained earnings | 1,512,497 |
| | 1,475,214 |
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Accumulated other comprehensive loss | (91,358 | ) | | (77,011 | ) |
Total stockholders’ equity | 421,906 |
| | 446,828 |
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Total liabilities and stockholders’ equity | $ | 1,224,398 |
| | $ | 1,220,676 |
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See accompanying notes.
FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
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| | | | | | | |
| Quarter Ended December 31, |
| 2016 | | 2015 |
| (In thousands, except per share data) |
Revenues: | | | |
Transactional and maintenance | $ | 153,660 |
| | $ | 147,072 |
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Professional services | 43,543 |
| | 34,152 |
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License | 22,397 |
| | 18,852 |
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Total revenues | 219,600 |
| | 200,076 |
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Operating expenses: | | | |
Cost of revenues * | 69,997 |
| | 62,193 |
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Research and development | 26,142 |
| | 24,631 |
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Selling, general and administrative * | 85,214 |
| | 78,838 |
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Amortization of intangible assets * | 3,320 |
| | 3,580 |
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Total operating expenses | 184,673 |
| | 169,242 |
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Operating income | 34,927 |
| | 30,834 |
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Interest expense, net | (6,172 | ) | | (6,724 | ) |
Other expense, net | (100 | ) | | (334 | ) |
Income before income taxes | 28,655 |
| | 23,776 |
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Provision for income taxes | (9,246 | ) | | 4,535 |
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Net income | 37,901 |
| | 19,241 |
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Other comprehensive loss: | | | |
Foreign currency translation adjustments | (14,347 | ) | | (6,119 | ) |
Comprehensive income | $ | 23,554 |
| | $ | 13,122 |
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Earnings per share: | | | |
Basic | $ | 1.22 |
| | $ | 0.62 |
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Diluted | $ | 1.16 |
| | $ | 0.59 |
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Shares used in computing earnings per share: | | | |
Basic | 30,989 |
| | 31,185 |
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Diluted | 32,536 |
| | 32,436 |
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* Cost of revenues and selling, general and administrative expenses exclude the amortization of intangible assets. See Note 4.
See accompanying notes.
FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
(In thousands, except per share data)
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| Common Stock | | | | | | Retained Earnings | | Accumulated Other Comprehensive Loss | | Total Stockholders’ Equity |
| Shares | | Par Value | | Paid-in-Capital | | Treasury Stock | | | |
Balance at September 30, 2016 | 30,935 |
| | $ | 309 |
| | $ | 1,185,076 |
| | $ | (2,136,760 | ) | | $ | 1,475,214 |
| | $ | (77,011 | ) | | $ | 446,828 |
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Share-based compensation | — |
| | — |
| | 14,519 |
| | — |
| | — |
| | — |
| | 14,519 |
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Issuance of treasury stock under employee stock plans | 480 |
| | 5 |
| | (49,763 | ) | | 17,823 |
| | — |
| | — |
| | (31,935 | ) |
Repurchases of common stock | (258 | ) | | (2 | ) | | — |
| | (30,440 | ) | | — |
| | — |
| | (30,442 | ) |
Dividends paid | — |
| | — |
| | — |
| | — |
| | (618 | ) | | — |
| | (618 | ) |
Net income | — |
| | — |
| | — |
| | — |
| | 37,901 |
| | — |
| | 37,901 |
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Foreign currency translation adjustments | — |
| | — |
| | — |
| | — |
| | — |
| | (14,347 | ) | | (14,347 | ) |
Balance at December 31, 2016 | 31,157 |
| | $ | 312 |
| | $ | 1,149,832 |
| | $ | (2,149,377 | ) | | $ | 1,512,497 |
| | $ | (91,358 | ) | | $ | 421,906 |
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See accompanying notes.
FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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| | | | | | | |
| Quarter Ended December 31, |
| 2016 | | 2015 |
| (In thousands) |
Cash flows from operating activities: | | | |
Net income | $ | 37,901 |
| | $ | 19,241 |
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Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 9,058 |
| | 7,441 |
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Share-based compensation | 14,519 |
| | 14,700 |
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Deferred income taxes | — |
| | 5,986 |
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Tax effect from share-based payment arrangements | — |
| | 9,615 |
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Provision for doubtful accounts, net | 463 |
| | 438 |
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Changes in operating assets and liabilities: | | | |
Accounts receivable | 8,253 |
| | 18,005 |
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Prepaid expenses and other assets | (16,876 | ) | | (14,807 | ) |
Accounts payable | (725 | ) | | 2,022 |
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Accrued compensation and employee benefits | (29,030 | ) | | (16,381 | ) |
Other liabilities | (2,091 | ) | | (2,438 | ) |
Deferred revenue | 11,506 |
| | 6,807 |
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Net cash provided by operating activities | 32,978 |
| | 50,629 |
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Cash flows from investing activities: | | | |
Purchases of property and equipment | (4,319 | ) | | (4,294 | ) |
Net cash used in investing activities | (4,319 | ) | | (4,294 | ) |
Cash flows from financing activities: | | | |
Proceeds from revolving line of credit | 60,000 |
| | 26,000 |
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Payments on revolving line of credit | (10,000 | ) | | (15,000 | ) |
Proceeds from issuance of treasury stock under employee stock plans | 3,663 |
| | 1,199 |
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Taxes paid related to net share settlement of equity awards | (35,598 | ) | | (24,462 | ) |
Dividends paid | (618 | ) | | (622 | ) |
Repurchases of common stock | (30,442 | ) | | (28,382 | ) |
Net cash used in financing activities | (12,995 | ) | | (41,267 | ) |
Effect of exchange rate changes on cash | (3,489 | ) | | (478 | ) |
Increase in cash and cash equivalents | 12,175 |
| | 4,590 |
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Cash and cash equivalents, beginning of period | 75,926 |
| | 86,120 |
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Cash and cash equivalents, end of period | $ | 88,101 |
| | $ | 90,710 |
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Supplemental disclosures of cash flow information: | | | |
Cash paid for income taxes, net of refunds | $ | 7,463 |
| | $ | 4,364 |
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Cash paid for interest | $ | 5,851 |
| | $ | 5,823 |
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Supplemental disclosures of non-cash investing and financing activities: | | | |
Purchase of property and equipment included in accounts payable | $ | 3,816 |
| | $ | 267 |
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See accompanying notes.
FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, telecommunications providers, pharmaceutical companies, healthcare organizations, public agencies and organizations in other industries.
In these condensed consolidated financial statements, Fair Isaac Corporation is referred to as “FICO,” “we,” “us,” “our,” or “the Company.”
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, 2016. 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
We make estimates and assumptions that affect the amounts reported in the financial statements and the disclosures made in the accompanying notes. For example, we use estimates in determining the collectibility of accounts receivable; the appropriate levels of various accruals; labor hours in connection with fixed-fee service contracts; the amount of our tax provision and the realizability of deferred tax assets. We also use estimates in determining the remaining economic lives and carrying values of acquired intangible assets, property and equipment, and other long-lived assets. In addition, we use assumptions to estimate the fair value of reporting units and share-based compensation. Actual results may differ from our estimates.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Effective October 1, 2016, we early adopted ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. As a result of the adoption, we recognized $17.3 million of excess tax benefits related to share-based payments in our provision for income taxes for the quarter ended December 31, 2016. These items were historically recorded as additional paid-in capital. We elected to apply the change retrospectively in presentation to our condensed consolidated statements of cash flows and no longer classified the excess tax benefits from employee stock plans as a reduction from operating cash flows, which resulted in increases to both net cash provided by operating activities and net cash used in financing activities of $10.1 million for the quarter ended December 31, 2015. Our adoption of ASU 2016-09 also impacted the calculation of diluted weighted-average shares under the treasury stock method as we no longer increase or decrease the assumed proceeds from an employee vesting in, or exercising, a share-based payment award by the amount of excess tax benefits or deficiencies taken to additional paid-in capital. For the quarter ended December 31, 2016, the impact was immaterial. Given our historical practice of including employee withholding taxes paid within financing activities in the statement of cash flows, no prior period reclassifications are required by the clarifications on classification provided by ASU 2016-09. Furthermore, we elected to continue to estimate expected forfeitures of employee equity awards to determine the amount of compensation expense to be recognized in each period.
Effective October 1, 2016, we retrospectively adopted ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance” (“ASU 2015-03”). ASU 2015-03 requires an entity to present debt issuance costs related to a recognized debt liability, other than those relating to line-of-credit arrangements, in the balance sheet as a direct deduction from the related debt liability rather than as an asset. As a result of the adoption, at December 31, 2016, the amount of debt issuance costs reflected as a deduction of long-term debt was $0.3 million. At September 30, 2016, the amount of debt issuance costs reclassified from other assets to a deduction of long-term debt was $0.4 million.
Recent Accounting Pronouncements Not Yet Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. Generally Accepted Accounting Principles when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. In August 2015, the FASB issued ASU No. 2015-14, “Deferral of the Effective Date” (“ASU 2015-14”), which defers the effective date for ASU 2014-09 by one year. For public entities, the guidance in ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods), which means it will be effective for our fiscal year beginning October 1, 2018. Early adoption is permitted to the original effective date of December 15, 2016 (including interim reporting periods within those periods). In March 2016, the FASB issued ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue versus Net)” (“ASU 2016-08”), which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. In April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing” (“ASU 2016-10”), which reduces the complexity when applying the guidance for identifying performance obligations and improves the operability and understandability of the license implementation guidance. In May 2016, the FASB issued ASU No. 2016-12 “Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”), which amends the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. In December 2016, the FASB further issued ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU 2016-20”), which makes minor corrections or minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments are intended to address implementation issues that were raised by stakeholders and provide additional practical expedients to reduce the cost and complexity of applying the new revenue standard. These amendments have the same effective date as the new revenue standard. Preliminarily, we plan to adopt Topic 606 in the first quarter of our fiscal 2019 using the retrospective transition method, and are continuing to evaluate the impact our pending adoption of Topic 606 will have on our consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). ASU 2016-16 requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The guidance is effective for fiscal years and interim periods beginning after December 15, 2017, which means it will be effective for our fiscal year beginning October 1, 2018. ASU 2016-16 should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings at the beginning of the period of adoption. Early adoption is permitted in the first interim period of an entity's annual financial statements. We are currently evaluating the timing of our adoption and the impact that the updated standard will have on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which requires lessees to put most leases on their balance sheets but recognize the expenses on their income statements in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. ASU 2016-02 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018, which means it will be effective for our fiscal year beginning October 1, 2019. Early adoption is permitted. We are currently evaluating the timing of our adoption and the impact that the updated standard will have on our consolidated financial statements.
2. 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.
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• | 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. |
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• | 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. We do not have any assets that are valued using inputs identified under a Level 2 hierarchy as of December 31, 2016 and September 30, 2016. |
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• | 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 as of December 31, 2016 and September 30, 2016. |
The following tables represent financial assets that we measured at fair value on a recurring basis at December 31, 2016 and September 30, 2016:
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December 31, 2016 | Active Markets for Identical Instruments (Level 1) | | Fair Value as of December 31, 2016 |
| (In thousands) |
Assets: | | | |
Cash equivalents (1) | $ | 441 |
| | $ | 441 |
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Marketable securities (2) | 12,262 |
| | 12,262 |
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Total | $ | 12,703 |
| | $ | 12,703 |
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September 30, 2016 | Active Markets for Identical Instruments (Level 1) | | Fair Value as of September 30, 2016 |
| (In thousands) |
Assets: | | | |
Cash equivalents (1) | $ | 440 |
| | $ | 440 |
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Marketable securities (2) | 11,016 |
| | 11,016 |
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Total | $ | 11,456 |
| | $ | 11,456 |
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(1) | Included in cash and cash equivalents on our condensed consolidated balance sheet at December 31, 2016 and September 30, 2016. Not included in these tables are cash deposits of $87.7 million and $75.5 million at December 31, 2016 and September 30, 2016, respectively. |
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(2) | Represents securities held under a supplemental retirement and savings plan for senior management employees, which are distributed upon termination or retirement of the employees. Included in marketable securities available for sale on our condensed consolidated balance sheet at December 31, 2016 and September 30, 2016. |
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 would apply to our Level 2 investments. We have not changed our valuation techniques in measuring the fair value of any financial assets and liabilities during the period.
For the fair value of our derivative instruments and senior notes, see Note 3 and Note 7, respectively.
3. 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 receivable and cash balances from the effects of volatility in foreign exchange rates that might occur prior to conversion to their respective functional currencies. 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 exchange rates. We routinely enter into contracts to offset exposures denominated in the British pound and Euro.
Foreign-currency-denominated receivable and cash balances are remeasured at foreign exchange rates in effect on the balance sheet date with the effects of changes in foreign exchange 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 remeasured receivable and cash balances attributable to changes in foreign 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 our outstanding foreign currency forward contracts, by currency, at December 31, 2016 and September 30, 2016:
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| | | | | | | | | | | |
| December 31, 2016 |
| Contract Amount | | Fair Value |
| Foreign Currency | | US$ | | US$ |
| (In thousands) |
Sell foreign currency: | | | | | | |
Euro (EUR) | EUR | 6,250 |
| | $ | 6,603 |
| | $ | — |
|
Buy foreign currency: | | | | | | |
British pound (GBP) | GBP | 3,451 |
| | $ | 4,250 |
| | $ | — |
|
|
| | | | | | | | | | | |
| September 30, 2016 |
| Contract Amount | | Fair Value |
| Foreign Currency | | US$ | | US$ |
| (In thousands) |
Sell foreign currency: | | | | | | |
Euro (EUR) | EUR | 7,850 |
| | $ | 8,743 |
| | $ | — |
|
Buy foreign currency: | | | | | | |
British pound (GBP) | GBP | 7,721 |
| | $ | 10,000 |
| | $ | — |
|
The foreign currency forward contracts were entered into on December 31, 2016 and September 30, 2016, respectively; therefore, their fair value was $0 on each of these dates.
Losses on derivative financial instruments are recorded in our condensed consolidated statements of income and comprehensive income as a component of other expenses, net, and consisted of the following:
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| | | | | | | |
| Quarter Ended December 31, |
| 2016 | | 2015 |
| (In thousands) |
Losses on foreign currency forward contracts | $ | 560 |
| | $ | 299 |
|
4. 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 and comprehensive income, consisted of the following:
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| | | | | | | |
| Quarter Ended December 31, |
| 2016 | | 2015 |
| (In thousands) |
Cost of revenues | $ | 1,686 |
| | $ | 1,907 |
|
Selling, general and administrative expenses | 1,634 |
| | 1,673 |
|
| $ | 3,320 |
| | $ | 3,580 |
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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 $147.1 million and $149.4 million as of December 31, 2016 and September 30, 2016, respectively.
Estimated future intangible asset amortization expense associated with intangible assets existing at December 31, 2016, was as follows (in thousands):
|
| | | |
Year Ended September 30, | |
2017 (excluding the quarter ended December 31, 2016) | $ | 9,146 |
|
2018 | 6,174 |
|
2019 | 5,662 |
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2020 | 3,527 |
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2021 | 2,372 |
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Thereafter | 2,447 |
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| $ | 29,328 |
|
The following table summarizes changes to goodwill during the quarter ended December 31, 2016, both in total and as allocated to our segments:
|
| | | | | | | | | | | | | | | |
| Applications | | Scores | | Decision Management Software | | Total |
| (In thousands) |
Balance at September 30, 2016 | $ | 582,720 |
| | $ | 146,648 |
| | $ | 69,047 |
| | $ | 798,415 |
|
Foreign currency translation adjustment | (8,165 | ) | | — |
| | (648 | ) | | (8,813 | ) |
Balance at December 31, 2016 | $ | 574,555 |
| | $ | 146,648 |
| | $ | 68,399 |
| | $ | 789,602 |
|
5. Composition of Certain Financial Statement Captions
The following table summarizes property and equipment, and the related accumulated depreciation and amortization, at December 31, 2016 and September 30, 2016:
|
| | | | | | | |
| December 31, 2016 | | September 30, 2016 |
| (In thousands) |
Property and equipment | $ | 130,029 |
| | $ | 126,760 |
|
Less: accumulated depreciation and amortization | (86,070 | ) | | (81,638 | ) |
| $ | 43,959 |
| | $ | 45,122 |
|
6. Revolving Line of Credit
We have a $400 million unsecured revolving line of credit with a syndicate of banks that expires on December 30, 2019. 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 our 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, (b) the Federal Funds rate plus 0.500% and (c) the one-month LIBOR rate plus 1.000%, plus, in each case, an applicable margin, or (ii) an adjusted LIBOR rate plus an applicable margin. The applicable margin for base rate borrowings ranges from 0% to 0.875% and for LIBOR borrowings ranges from 1.000% to 1.875%, and is determined based on our consolidated leverage ratio. In addition, we must pay credit facility fees. The credit facility contains certain restrictive covenants including maintaining a minimum fixed charge ratio of 2.5 and a maximum consolidated leverage ratio of 3.0, subject to a step up to 3.5 following certain permitted acquisitions. The credit agreement also contains other covenants typical of unsecured facilities. As of December 31, 2016, we had $305.0 million in borrowings outstanding at a weighted average interest rate of 1.850%, of which $275.0 million was classified as a long-term liability and recorded in long-term debt within the accompanying condensed consolidated balance sheets. We were in compliance with all financial covenants under this credit facility as of December 31, 2016.
7. Senior Notes
On May 7, 2008, we issued $275 million of senior notes in a private placement to a group of institutional investors (the “2008 Senior Notes”). The 2008 Senior Notes were issued in four series with maturities ranging from 5 to 10 years. The outstanding 2008 Senior Notes’ weighted average interest rate is 7.2% and the weighted average maturity is 10.0 years. On July 14, 2010, we issued $245 million of senior notes in a private placement to a group of institutional investors (the “2010 Senior Notes” and, with the 2008 Senior Notes, the “Senior Notes”). The 2010 Senior Notes were issued in four series with maturities ranging from 6 to 10 years. The outstanding 2010 Senior Notes’ weighted average interest rate is 5.4% and the weighted average maturity is 8.7 years. The Senior Notes require interest payments semi-annually and contain certain restrictive covenants, including the maintenance of consolidated net debt to consolidated EBITDA ratio and a fixed charge coverage ratio. The purchase agreements for the Senior Notes also contain certain covenants typical of unsecured facilities. As of December 31, 2016, we were in compliance with all financial covenants.
The following table presents the carrying amounts and fair values for the Senior Notes at December 31, 2016 and September 30, 2016:
|
| | | | | | | | | | | | | | | |
| December 31, 2016 | | September 30, 2016 |
| Carrying Amounts | | Fair Value | | Carrying Amounts (1) | | Fair Value (1) |
| (In thousands) |
The 2008 Senior Notes | $ | 131,000 |
| | $ | 138,035 |
| | $ | 131,000 |
| | $ | 139,902 |
|
The 2010 Senior Notes | 185,000 |
| | 192,295 |
| | 185,000 |
| | 195,715 |
|
Debt issuance costs | (328 | ) | | (328 | ) | | (376 | ) | | (376 | ) |
Total | $ | 315,672 |
| | $ | 330,002 |
| | $ | 315,624 |
| | $ | 335,241 |
|
(1) Balances as of September 30, 2016 have been recast as a result of the adoption of ASU 2015-03, to present debt issuance costs of $0.4 million as a direct deduction from the carrying amount of the Senior Notes.
We measure the fair value of the Senior Notes based on Level 2 inputs, which include quoted market prices and interest rate spreads of similar securities.
8. Restructuring Expenses
The following table summarizes our restructuring accruals related to certain FICO facility closures. The current portion and non-current portion is recorded in other accrued current liabilities and other long-term liabilities, respectively, within the accompanying condensed consolidated balance sheets. The balance for all the facilities charges will be paid by the end of our fiscal 2020.
|
| | | | | | | | | | | |
| Accrual at | | Cash Payments | | Accrual at |
| September 30, 2016 | | | December 31, 2016 |
| (In thousands) |
Facilities charges | $ | 9,233 |
| | $ | (672 | ) | | $ | 8,561 |
|
Less: current portion | (4,266 | ) | | | | (4,144 | ) |
Non-current | $ | 4,967 |
| | | | $ | 4,417 |
|
9. Income Taxes
Effective Tax Rate
The effective income tax rate was (32.3)% and 19.1% during the quarters ended December 31, 2016 and 2015, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the full fiscal year. The effective tax rate in any quarter can also be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution. The effective tax rate for the quarter ended December 31, 2016 was significantly impacted by the recording of excess tax benefits relating to stock awards that vested in December 2016. As a result of the adoption of ASU 2016-09 on October 1, 2016, we no longer record excess tax benefits as an increase to additional paid-in capital, but record such excess tax benefits on a prospective basis as a reduction of income tax expense, which amounted to $17.3 million for the quarter ended December 31, 2016. We also anticipate the potential for increased periodic volatility in future effective tax rates as the impact of the continued application of ASU 2016-09 is dependent upon our future grants of stock-based compensation, our future stock price in relation to the fair value of awards on grant date and the exercise behavior of our stock option holders.
The total unrecognized tax benefit for uncertain tax positions is estimated to be approximately $7.1 million and $6.8 million at December 31, 2016 and September 30, 2016, respectively. We recognize interest expense related to unrecognized tax benefits and penalties as part of the provision for income taxes in our condensed consolidated statements of income and comprehensive income. We have accrued interest of $0.4 million and $0.3 million, related to unrecognized tax benefits as of December 31, 2016 and September 30, 2016, respectively.
10. Share-Based Payments
We maintain the 2012 Long-Term Incentive Plan (the “2012 Plan”) under which we grant equity awards, including stock options, stock appreciation rights, restricted stock awards, stock unit awards and other stock-based awards. All employees, consultants and advisors of FICO or any subsidiary, as well as all non-employee directors are eligible to receive awards under the 2012 Plan. We also have one other long-term incentive plan under which awards are currently outstanding: the 1992 Long-term Incentive Plan, which was adopted in February 1992 and expired in February 2012. Stock option awards have a maximum term of seven years. In general, stock option awards and restricted stock unit awards not subject to market conditions vest ratably over three or four years. Restricted stock unit awards subject to market conditions vest annually over a period of three years based on the achievement of specified criteria.
Stock Options
The following table summarizes option activity during the quarter ended December 31, 2016:
|
| | | | | | | | | | | | | |
| | Shares | | Weighted-average Exercise Price | | Weighted-average Remaining Contractual Term | | Aggregate Intrinsic Value |
| | (In thousands) | | | | (In years) | | (In thousands) |
Outstanding at October 1, 2016 | | 1,521 |
| | $ | 52.37 |
| | | | |
Exercised | | (100 | ) | | 36.52 |
| | | | |
Outstanding at December 31, 2016 | | 1,421 |
| | $ | 53.49 |
| | 3.64 | | $ | 93,412 |
|
Exercisable at December 31, 2016 | | 1,131 |
| | $ | 48.42 |
| | 3.30 | | $ | 80,056 |
|
Vested and expected to vest at December 31, 2016 | | 1,403 |
| | $ | 53.22 |
| | 3.62 | | $ | 92,598 |
|
Restricted Stock Units
The following table summarizes restricted stock unit activity during the quarter ended December 31, 2016:
|
| | | | | | | |
| | Shares | | Weighted- average Grant-date Fair Value |
| | (In thousands) | | |
Outstanding at October 1, 2016 | | 1,211 |
| | $ | 76.93 |
|
Granted | | 401 |
| | 121.25 |
|
Released | | (371 | ) | | 65.16 |
|
Forfeited | | (7 | ) | | 87.13 |
|
Outstanding at December 31, 2016 | | 1,234 |
| | $ | 94.82 |
|
Performance Share Units
The following table summarizes performance share unit activity during the quarter ended December 31, 2016:
|
| | | | | | | |
| | Shares | | Weighted- average Grant-date Fair Value |
| | (In thousands) | | |
Outstanding at October 1, 2016 | | 230 |
| | $ | 73.99 |
|
Granted | | 63 |
| | 121.30 |
|
Released | | (136 | ) | | 65.24 |
|
Outstanding at December 31, 2016 | | 157 |
| | $ | 100.58 |
|
Market Share Units
The following table summarizes market share unit activity during the quarter ended December 31, 2016:
|
| | | | | | | |
| | Shares | | Weighted- average Grant-date Fair Value |
| | (In thousands) | | |
Outstanding at October 1, 2016 | | 142 |
| | $ | 100.40 |
|
Granted | | 155 |
| | 108.09 |
|
Released | | (166 | ) | | 89.09 |
|
Outstanding at December 31, 2016 | | 131 |
| | $ | 123.82 |
|
11. Earnings per Share
The following table presents reconciliations for the numerators and denominators of basic and diluted earnings per share (“EPS”) for the quarters ended December 31, 2016 and 2015:
|
| | | | | | | |
| Quarter Ended December 31, |
| 2016 | | 2015 |
| (In thousands, except per share data) |
Numerator for diluted and basic earnings per share: | | | |
Net Income | $ | 37,901 |
| | $ | 19,241 |
|
Denominator - share: | | | |
Basic weighted-average shares | 30,989 |
| | 31,185 |
|
Effect of dilutive securities | 1,547 |
| | 1,251 |
|
Diluted weighted-average shares | 32,536 |
| | 32,436 |
|
Earnings per share: | | | |
Basic | $ | 1.22 |
| | $ | 0.62 |
|
Diluted | $ | 1.16 |
| | $ | 0.59 |
|
We exclude the options to purchase shares of common stock in the computation of the diluted EPS where the exercise price of the options exceeds the average market price of our common stock as their inclusion would be antidilutive. There were no options excluded for the quarter ended December 31, 2016. There were approximately 15,000 options excluded for the quarter ended December 31, 2015.
12. Segment Information
We are organized into the following three operating segments, each of which is a reportable segment, to align with internal management of our worldwide business operations based on product offerings.
| |
• | Applications. This segment includes pre-configured decision management applications designed for a specific type of business problem or process — such as marketing, account origination, customer management, fraud, collections and insurance claims management — as well as associated professional services. These applications are available to our customers as on-premises software, and many are available as hosted, software-as-a-service (“SaaS”) applications through the FICO® Analytic Cloud. |
| |
• | 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. |
| |
• | Decision Management Software. This segment is composed of analytic and decision management software tools that clients can use to create their own custom decision management applications, our new FICO® Decision Management Suite, as well as associated professional services. These tools are available to our customers as on-premises software or through the FICO® Analytic Cloud. |
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 not allocate broad-based incentive expense, 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, nor capital expenditures where depreciation amounts are allocated to the segments from their internal cost centers as described above.
The following tables summarize segment information for the quarters ended December 31, 2016 and 2015:
|
| | | | | | | | | | | | | | | | | | | |
| Quarter Ended December 31, 2016 |
| Applications | | Scores | | Decision Management Software | | Unallocated Corporate Expenses | | Total |
| (In thousands) |
Segment revenues: | | | | | | | | | |
Transactional and maintenance | $ | 84,881 |
| | $ | 58,252 |
| | $ | 10,527 |
| | $ | — |
| | $ | 153,660 |
|
Professional services | 34,341 |
| | 521 |
| | 8,681 |
| | — |
| | 43,543 |
|
License | 15,543 |
| | 609 |
| | 6,245 |
| | — |
| | 22,397 |
|
Total segment revenues | 134,765 |
| | 59,382 |
| | 25,453 |
| | — |
| | 219,600 |
|
Segment operating expense | (99,797 | ) | | (13,319 | ) | | (29,085 | ) | | (24,633 | ) | | (166,834 | ) |
Segment operating income (loss) | $ | 34,968 |
| | $ | 46,063 |
| | $ | (3,632 | ) | | $ | (24,633 | ) | | 52,766 |
|
Unallocated share-based compensation expense | | | | | | | | | (14,519 | ) |
Unallocated amortization expense | | | | | | | | | (3,320 | ) |
Operating income | | | | | | | | | 34,927 |
|
Unallocated interest expense, net | | | | | | | | | (6,172 | ) |
Unallocated other expense, net | | | | | | | | | (100 | ) |
Income before income taxes | | | | | | | | | $ | 28,655 |
|
Depreciation expense | $ | 3,868 |
| | $ | 266 |
| | $ | 1,126 |
| | $ | 349 |
| | $ | 5,609 |
|
|
| | | | | | | | | | | | | | | | | | | |
| Quarter Ended December 31, 2015 |
| Applications | | Scores | | Decision Management Software | | Unallocated Corporate Expenses | | Total |
| (In thousands) |
Segment revenues: | | | | | | | | | |
Transactional and maintenance | $ | 80,983 |
| | $ | 55,217 |
| | $ | 10,872 |
| | $ | — |
| | $ | 147,072 |
|
Professional services | 27,126 |
| | 748 |
| | 6,278 |
| | — |
| | 34,152 |
|
License | 12,032 |
| | 37 |
| | 6,783 |
| | — |
| | 18,852 |
|
Total segment revenues | 120,141 |
| | 56,002 |
| | 23,933 |
| | — |
| | 200,076 |
|
Segment operating expense | (87,437 | ) | | (14,169 | ) | | (25,294 | ) | | (24,062 | ) | | (150,962 | ) |
Segment operating income (loss) | $ | 32,704 |
| | $ | 41,833 |
| | $ | (1,361 | ) | | $ | (24,062 | ) | | 49,114 |
|
Unallocated share-based compensation expense | | | | | | | | | (14,700 | ) |
Unallocated amortization expense | | | | | | | | | (3,580 | ) |
Operating income | | | | | | | | | 30,834 |
|
Unallocated interest expense, net | | | | | | | | | (6,724 | ) |
Unallocated other expense, net | | | | | | | | | (334 | ) |
Income before income taxes | | | | | | | | | $ | 23,776 |
|
Depreciation expense | $ | 2,744 |
| | $ | 177 |
| | $ | 635 |
| | $ | 305 |
| | $ | 3,861 |
|
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.
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. 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 opposed 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 us in fiscal 2017.
OVERVIEW
We provide products and services that enable businesses to automate, improve and connect decisions across the enterprise, an approach we commonly refer to as decision management. Our predictive analytics, which includes the industry-standard FICO® Score, and our decision management systems power hundreds of billions of customer decisions each year. We help thousands of companies in over 100 countries use our decision management technology to target and 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 insurers, retailers, telecommunications providers, pharmaceutical companies, healthcare organizations, public agencies and organizations in other industries. We also serve consumers through online services that enable people to purchase and understand their FICO® Scores, the standard measure in the U.S. of consumer credit risk, empowering them to manage their financial health. Most of our solutions address customer engagement, including customer acquisition, customer servicing and management, and customer protection. We also help businesses improve noncustomer decisions such as transaction and claims processing. Our solutions enable users to make decisions that are more precise, consistent and agile, and that systematically advance business goals. This helps our clients to reduce the cost of doing business, increase revenues and profitability, reduce losses from risks and fraud, and increase customer loyalty.
We derive a significant portion of our revenues from clients outside the United States. International revenues accounted for 34% and 33% of total consolidated revenues for the quarters ended December 31, 2016 and 2015, respectively. A significant portion of our revenues are derived from the sale of products and services within the banking (including consumer credit) industry, and 74% and 76% of our revenues were derived from within this industry during the quarters ended December 31, 2016 and 2015, respectively. In addition, we derive a significant share of revenue from transactional or unit-based software license fees, transactional fees derived under scoring, network service or internal hosted software arrangements, annual software maintenance fees and annual license fees under long-term software license arrangements. Arrangements with transactional or unit-based pricing accounted for approximately 70% and 74% of our revenues during the quarters ended December 31, 2016 and 2015, respectively.
For our Scores segment, we continue to drive growth in both revenue and operating margin with our industry leading business-to-business FICO® Scores expanding further into the larger, faster growing U.S. consumer market. Scores Revenue for the quarter ended December 31, 2016 increased 6% to $59.4 million from $56.0 million during the quarter ended December 31, 2015, and Scores operating income increased 10% to $46.1 million from $41.8 million during the quarter ended December 31, 2015. For our Applications and Decision Management Software segments, we continue to expand our investments in sales distributions and go-to-market. As a result, our bookings increased 31% for Decision Management Software and 11% for Applications quarter over quarter. We also began to broaden our investment into product delivery, support and infrastructure operations, which was a primary driver for the quarter-over-quarter increase in our operating loss for the Decision Management Software segment.
Operating income for the quarter ended December 31, 2016 was $34.9 million, an increase of 13% from $30.8 million for the quarter ended December 31, 2015, while the operating margin remained 15%. Net margin increased from 10% to 17% quarter over quarter, a 79% increase, primarily driven by our adoption of ASU 2016-09 effective October 1, 2016, as further described in Notes 1 and 10 of the Condensed Consolidated Financial Statements.
We continue to enhance shareholder value by returning cash to shareholders through our stock repurchase program. During the quarter ended December 31, 2016, we repurchased approximately 0.3 million shares at a total repurchase price of $30.4 million. As of December 31, 2016, we had $199.6 million remaining under our current stock repurchase program.
Bookings
Management uses bookings as an indicator of our business performance. Bookings represent contracts signed in the current reporting period that 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 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 the 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 customer 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.
Bookings Trend Analysis
|
| | | | | | | | | | | | |
| Bookings | | Bookings Yield (1) | | Number of Bookings over $1 Million | | Weighted- Average Term (2) |
| (In millions) | | | | | | (Months) |
Quarter Ended December 31, 2016 | $ | 96.4 |
| | 21 | % | | 13 |
| | 27 |
|
Quarter Ended December 31, 2015 | $ | 86.4 |
| | 26 | % | | 10 |
| | 24 |
|
| |
(1) | Bookings yield represents the percentage of revenue recognized from bookings for the periods indicated. |
| |
(2) | Weighted-average term of bookings measures the average term over which bookings are expected to be recognized as revenue. |
Transactional and maintenance bookings were 30% and 27% of total bookings for the quarters ended December 31, 2016 and 2015, respectively. Professional services bookings were 55% and 52% of total bookings for the quarters ended December 31, 2016 and 2015, respectively. License bookings were 15% and 21% of total bookings for the quarters ended December 31, 2016 and 2015, respectively.
RESULTS OF OPERATIONS
Revenues
The following tables set forth certain summary information on a segment basis related to our revenues for the quarters ended December 31, 2016 and 2015:
|
| | | | | | | | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Percentage of Revenues | | Period-to-Period | | Period-to-Period Percentage |
Segment | 2016 | | 2015 | | 2016 | | 2015 | | Change | | Change |
| (In thousands) | | | | | | (In thousands) | | |
Applications | $ | 134,765 |
| | $ | 120,141 |
| | 61 | % | | 60 | % | | $ | 14,624 |
| | 12 | % |
Scores | 59,382 |
| | 56,002 |
| | 27 | % | | 28 | % | | 3,380 |
| | 6 | % |
Decision Management Software | 25,453 |
| | 23,933 |
| | 12 | % | | 12 | % | | 1,520 |
| | 6 | % |
Total | $ | 219,600 |
| | $ | 200,076 |
| | 100 | % | | 100 | % | | 19,524 |
| | 10 | % |
Applications
|
| | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Period-to- | | Period-to- Period Percentage |
| 2016 | | 2015 | | Period Change | | Change |
| (In thousands) | | (In thousands) | | |
Transactional and maintenance | $ | 84,881 |
| | $ | 80,983 |
| | $ | 3,898 |
| | 5 | % |
Professional services | 34,341 |
| | 27,126 |
| | 7,215 |
| | 27 | % |
License | 15,543 |
| | 12,032 |
| | 3,511 |
| | 29 | % |
Total | $ | 134,765 |
| | $ | 120,141 |
| | 14,624 |
| | 12 | % |
Applications segment revenues increased $14.6 million primarily due to a $6.1 million increase in our fraud solutions, a $5.9 million increase in our originations solutions, and a $3.0 million increase in our customer communications services. The increase in fraud solutions was primarily attributable to an increase in license revenue mainly driven by one large multi-year license transaction. The increase in originations solutions was primarily attributable to an increase in services and transactional revenue. The increase in customer communication services was primarily attributable to an increase in transactional revenues as a result of our growth in the mobile communication market.
Scores
|
| | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Period-to- | | Period-to- Period Percentage |
| 2016 | | 2015 | | Period Change | | Change |
| (In thousands) | | (In thousands) | | |
Transactional and maintenance | $ | 58,252 |
| | $ | 55,217 |
| | $ | 3,035 |
| | 5 | % |
Professional services | 521 |
| | 748 |
| | (227 | ) | | (30 | )% |
License | 609 |
| | 37 |
| | 572 |
| | 1,546 | % |
Total | $ | 59,382 |
| | $ | 56,002 |
| | 3,380 |
| | 6 | % |
Scores segment revenues increased $3.4 million due to an increase of $2.8 million in our business-to-business scores revenue and $0.6 million in our business-to-consumer services revenue. The increase in business-to-business scores was primarily attributable to an increase in our transactional scores driven by new originations, account management and prescreen. The increase in business-to-consumer services was primarily attributable to an increase in direct sales generated from the myFICO.com website.
During the quarters ended December 31, 2016 and 2015, 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 recorded in our other segments.
Decision Management Software
|
| | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Period-to- | | Period-to- Period Percentage |
| 2016 | | 2015 | | Period Change | | Change |
| (In thousands) | | (In thousands) | | |
Transactional and maintenance | $ | 10,527 |
| | $ | 10,872 |
| | $ | (345 | ) | | (3 | )% |
Professional services | 8,681 |
| | 6,278 |
| | 2,403 |
| | 38 | % |
License | 6,245 |
| | 6,783 |
| | (538 | ) | | (8 | )% |
Total | $ | 25,453 |
| | $ | 23,933 |
| | 1,520 |
| | 6 | % |
Decision Management Software segment revenues increased $1.5 million primarily attributable to an increase in services revenue, partially offset by a decrease in license and maintenance.
Operating Expenses and Other Income / Expenses
The following tables set forth certain summary information related to our condensed consolidated statements of income and comprehensive income for the quarters ended December 31, 2016 and 2015:
|
| | | | | | | | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Percentage of Revenues | | Period-to- | | Period-to- Period Percentage |
| 2016 | | 2015 | | 2016 | | 2015 | | Period Change | | Change |
| (In thousands, except employees) | | | | | | (In thousands, except employees) | | |
Revenues | $ | 219,600 |
| | $ | 200,076 |
| | 100 | % | | 100 | % | | $ | 19,524 |
| | 10 | % |
Operating expenses: | | | | | | | | | | | |
Cost of revenues | 69,997 |
| | 62,193 |
| | 32 | % | | 31 | % | | 7,804 |
| | 13 | % |
Research and development | 26,142 |
| | 24,631 |
| | 12 | % | | 12 | % | | 1,511 |
| | 6 | % |
Selling, general and administrative | 85,214 |
| | 78,838 |
| | 39 | % | | 40 | % | | 6,376 |
| | 8 | % |
Amortization of intangible assets | 3,320 |
| | 3,580 |
| | 1 | % | | 2 | % | | (260 | ) | | (7 | )% |
Total operating expenses | 184,673 |
| | 169,242 |
| | 84 | % | | 85 | % | | 15,431 |
| | 9 | % |
Operating income | 34,927 |
| | 30,834 |
| | 16 | % | | 15 | % | | 4,093 |
| | 13 | % |
Interest expense, net | (6,172 | ) | | (6,724 | ) | | (3 | )% | | (3 | )% | | 552 |
| | (8 | )% |
Other expense, net | (100 | ) | | (334 | ) | | — | % | | — | % | | 234 |
| | (70 | )% |
Income before income taxes | 28,655 |
| | 23,776 |
| | 13 | % | | 12 | % | | 4,879 |
| | 21 | % |
Provision for income taxes | (9,246 | ) | | 4,535 |
| | (4 | )% | | 2 | % | | (13,781 | ) | | (304 | )% |
Net income | $ | 37,901 |
| | $ | 19,241 |
| | 17 | % | | 10 | % | | 18,660 |
| | 97 | % |
Number of employees at quarter end | 3,167 |
| | 2,778 |
| | | | | | 389 |
| | 14 | % |
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; outside services; internal network hosting costs; software royalty fees; and credit bureau data and processing services.
Cost of revenues as a percentage of revenues increased to 32% during the quarter ended December 31, 2016 from 31% during the quarter ended December 31, 2015. The $7.8 million increase was primarily attributable to a $4.5 million increase in personnel and labor costs, and a $2.7 million increase in allocated facilities and infrastructure costs. The increase in personnel and labor costs was primarily attributable to an increase in professional services delivery cost driven by higher services revenue, as well as an increase in salaries and benefit costs as a result of our increased headcount. The increase in allocated facilities and infrastructure costs was primarily attributable to increased resource requirement due to our expanded investment in product delivery, support and infrastructure operations.
Over the next several quarters, we expect cost of revenues as a percentage of revenues will be consistent with or slightly higher than those incurred during the quarter ended December 31, 2016.
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.
Research and development expenses increased $1.5 million to $26.1 million during the quarter ended December 31, 2016 from $24.6 million during the quarter ended December 31, 2015. The increase was primarily attributable to an increase in personnel and labor cost driven by our increased headcount. Research and development expenses as a percentage of revenues was 12% during the quarter ended December 31, 2016, consistent with those incurred during the quarter ended December 31, 2015.
Over the next several quarters, we expect research and development expenditures as a percentage of revenues will be consistent with those incurred during the quarter ended December 31, 2016.
Selling, General and Administrative
Selling, general and administrative expenses consist principally of employee salaries, commissions and benefits; travel costs; overhead costs; 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 increased $6.4 million to $85.2 million during the quarter ended December 31, 2016 from $78.8 million during the quarter ended December 31, 2015, primarily driven by our continued investment in sales distribution and go-to-market. Selling, general and administrative expenses as a percentage of revenues was 39% during the quarter ended December 31, 2016, materially consistent with those incurred during the quarter ended December 31, 2015.
Over the next several quarters, we expect selling, general and administrative expenses as a percentage of revenues will be consistent with those incurred during the quarter ended December 31, 2016.
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 acquisition method of accounting. Our finite-lived intangible assets, consisting primarily of completed technology and customer contracts and relationships, are being amortized using the straight-line method over periods ranging from four to fifteen years.
Amortization expense for the quarter ended December 31, 2016 was $3.3 million. Over the next several quarters we expect that amortization expense will be consistent with the amortization expense we recorded during the quarter ended December 31, 2016.
Interest Expense, Net
Interest expense includes primarily interest on the senior notes issued in May 2008 and July 2010, as well as interest and credit facility fees on the revolving line of credit. Our consolidated statements of income and comprehensive income include interest expense netted with interest income, which is derived primarily from the investment of funds in excess of our immediate operating requirements.
The quarter over quarter decrease in interest expense of $0.6 million was primarily attributable to the $60.0 million principal payment in July 2016 on the senior notes issued in July 2010 resulting in lower average debt balance for the quarter ended December 31, 2016, partially offset by a higher average balance on our revolving line of credit.
Over the next several quarters we expect net interest expense will be consistent with or lower than the net interest expense incurred during the quarter ended December 31, 2016 due to the $72.0 million principal payment scheduled to occur in July 2017 on the senior notes issued in July 2010.
Other Expense, Net
Other expense, net consists primarily of realized investment gains/losses, exchange rate gains/losses resulting from remeasurement of foreign-currency-denominated receivable and cash balances into their respective functional currencies at period-end market rates, net of the impact of offsetting foreign currency forward contracts, and other non-operating items.
Provision for Income Taxes
The effective income tax rate was (32.3)% and 19.1% during the quarters ended December 31, 2016 and 2015, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the full fiscal year. The effective tax rate in any quarter can also be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution. The effective tax rate for the quarter ended December 31, 2016 was significantly impacted by the recording of excess tax benefits relating to stock awards that vested in December 2016. As a result of the adoption of ASU 2016-09 on October 1, 2016, we no longer record excess tax benefits as an increase to additional paid-in capital, but record such excess tax benefits on a prospective basis as a reduction of income tax expense, which amounted to $17.3 million for the quarter ended December 31, 2016. We also anticipate the potential for increased periodic volatility in future effective tax rates as the impact of the continued application of ASU 2016-09 is dependent upon our future grants of stock-based compensation, our future stock price in relation to the fair value of awards on grant date and the exercise behavior of the our stock option holders.
Operating Income
The following tables set forth certain summary information on a segment basis related to our operating income for the quarters ended December 31, 2016 and 2015:
|
| | | | | | | | | | | | | | |
| Quarter Ended December 31, | | Period-to-Period | | Period-to-Period Percentage |
Segment | 2016 | | 2015 | | Change | | Change |
| (In thousands) | | (In thousands) | | |
Applications | $ | 34,968 |
| | $ | 32,704 |
| | $ | 2,264 |
| | 7 | % |
Scores | 46,063 |
| | 41,833 |
| | 4,230 |
| | 10 | % |
Decision Management Software | (3,632 | ) | | (1,361 | ) | | (2,271 | ) | | 167 | % |
Corporate expenses | (24,633 | ) | | (24,062 | ) | | (571 | ) | | 2 | % |
Total segment operating income | 52,766 |
| | 49,114 |
| | 3,652 |
| | 7 | % |
Unallocated share-based compensation | (14,519 | ) | | (14,700 | ) | | 181 |
| | (1 | )% |
Unallocated amortization expense | (3,320 | ) | | (3,580 | ) | | 260 |
| | (7 | )% |
Operating income | $ | 34,927 |
| | $ | 30,834 |
| | 4,093 |
| | 13 | % |
Applications |
| | | | | | | | | | | | | |
| Quarter Ended December 31, | | Percentage of Revenues |
| 2016 | | 2015 | | 2016 | | 2015 |
| (In thousands) | | | | |
Segment revenues | $ | 134,765 |
| | $ | 120,141 |
| | 100 | % | | 100 | % |
Segment operating expense | (99,797 | ) | | (87,437 | ) | | (74 | )% | | (73 | )% |
Segment operating income | $ | 34,968 |
| | $ | 32,704 |
| | 26 | % | | 27 | % |
Scores
|
| | | | | | | | | | | | | |
| Quarter Ended December 31, | | Percentage of Revenues |
| 2016 | | 2015 | | 2016 | | 2015 |
| (In thousands) | | | | |
Segment revenues | $ | 59,382 |
| | $ | 56,002 |
| | 100 | % | | 100 | % |
Segment operating expense | (13,319 | ) | | (14,169 | ) | | (22 | )% | | (25 | )% |
Segment operating income | $ | 46,063 |
| | $ | 41,833 |
| | 78 | % | | 75 | % |
Decision Management Software
|
| | | | | | | | | | | | | |
| Quarter Ended December 31, | | Percentage of Revenues |
| 2016 | | 2015 | | 2016 | | 2015 |
| (In thousands) | | | | |
Segment revenues | $ | 25,453 |
| | $ | 23,933 |
| | 100 | % | | 100 | % |
Segment operating expense | (29,085 | ) | | (25,294 | ) | | (114 | )% | | (106 | )% |
Segment operating loss | $ | (3,632 | ) | | $ | (1,361 | ) | | (14 | )% | | (6 | )% |
The quarter over quarter $4.1 million increase in operating income was attributable to a $19.5 million increase in segment revenues, a $0.3 million decrease in amortization cost, and a $0.2 million decrease in share-based compensation cost, partially offset by a $15.3 million increase in segment operating expenses and a $0.6 million increase in corporate expenses.
At the segment level, the quarter over quarter $3.6 million increase in segment operating income was the result of a $4.2 million increase in our Scores segment operating income and a $2.3 million increase in our Applications segment operating income, partially offset by a $2.3 million increase in our Decision Management Software segment operating loss and a $0.6 million increase in corporate expense.
The quarter over quarter $2.3 million increase in Applications segment operating income was due to a $14.6 million increase in segment revenues, partially offset by a $12.3 million increase in segment operating expenses. Segment operating income as a percentage of segment revenue for Applications was 26%, materially consistent with the quarter ended December 31, 2015.
The quarter over quarter $4.2 million increase in Scores segment operating income was due to a $3.4 million increase in segment revenue and a $0.8 million decrease in segment operating expenses. Segment operating income as a percentage of segment revenue for Scores increased to 78% from 75% primarily due to a decrease in sales related expenses.
The quarter over quarter $2.3 million increase in Decision Management Software segment operating loss was due to a $3.8 million increase in segment operating expenses, partially offset by a $1.5 million increase in segment revenue. Segment operating margin for Decision Management Software decreased to a negative 14% from a negative 6% primarily due to our continued investment in sales distribution, an increase in services delivery cost driven by increased professional services revenue, as well as our expanded investment in cloud infrastructure operations.
CAPITAL RESOURCES AND LIQUIDITY
Outlook
As of December 31, 2016, we had $88.1 million in cash and cash equivalents which included $67.0 million held off-shore by our foreign subsidiaries. We believe these balances, as well as available borrowings from our $400 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 $72.0 million principal payment due in July 2017 on our senior notes issued in July 2010. Additionally, we do not anticipate the need to repatriate any undistributed earnings from our foreign subsidiaries for the foreseeable future.
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 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.
Summary of Cash Flows
|
| | | | | | | | | | | |
| Quarter Ended December 31, | | Period-to-Period |
| 2016 | | 2015 | | Change |
| (In thousands) |
Cash provided by (used in): | | | | | |
Operating activities | $ | 32,978 |
| | $ | 50,629 |
| | $ | (17,651 | ) |
Investing activities | (4,319 | ) | | (4,294 | ) | | (25 | ) |
Financing activities | (12,995 | ) | | (41,267 | ) | | 28,272 |
|
Effect of exchange rate changes on cash | (3,489 | ) | | (478 | ) | | (3,011 | ) |
Increase in cash and cash equivalents | $ | 12,175 |
| | $ | 4,590 |
| | 7,585 |
|
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 decreased to $33.0 million during the quarter ended December 31, 2016 from $50.6 million during the quarter ended December 31, 2015. The $17.6 million decrease was mainly attributable to a $20.0 million increase in payment associated with our accrued incentive from prior year.
Cash Flows from Investing Activities
Net cash used in investing activities was $4.3 million for the quarter ended December 31, 2016, materially consistent with the quarter ended December 31, 2015.
Cash Flows from Financing Activities
Net cash used in financing activities decreased to $13.0 million for the quarter ended December 31, 2016 from $41.3 million for the quarter ended December 31, 2015. The $28.3 million decrease was due to a $39.0 million increase in proceeds, net of payments, from our revolving line of credit, and a $2.5 million increase in proceeds from stock options exercise, partially offset by an $11.1 million increase in taxes paid related to net share settlement of equity awards, and a $2.1 million increase in repurchases of common stock.
Repurchases of Common Stock
In July 2016, our Board of Directors approved a stock repurchase program following the completion of our previous program. This program was open-ended and authorized repurchases of shares of our common stock up to an aggregate cost of $250.0 million in the open market or in negotiated transactions. Pursuant to this program, we repurchased 258,176 shares of our common stock at a total repurchase price of $30.4 million during the quarter ended December 31, 2016. We had $199.6 million remaining under the July 2016 authorization as of December 31, 2016.
Dividends
During the quarter ended December 31, 2016, we paid a quarterly dividend of $0.02 per common share. 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.
Revolving Line of Credit
We have a $400 million unsecured revolving line of credit with a syndicate of banks that expires on December 30, 2019. 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 our 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, (b) the Federal Funds rate plus 0.500% and (c) the one-month LIBOR rate plus 1.000%, plus, in each case, an applicable margin, or (ii) an adjusted LIBOR rate plus an applicable margin. The applicable margin for base rate borrowings ranges from 0% to 0.875% and for LIBOR borrowings ranges from 1.000% to 1.875%, and is determined based on our consolidated leverage ratio. In addition, we must pay credit facility fees. The credit facility contains certain restrictive covenants including maintaining a minimum fixed charge ratio of 2.5 and a maximum consolidated leverage ratio of 3.0, subject to a step up to 3.5 following certain permitted acquisitions. The credit agreement also contains other covenants typical of unsecured facilities. As of December 31, 2016, we had $305.0 million in borrowings outstanding at a weighted average interest rate of 1.850% and were in compliance with all financial covenants under this credit facility.
Senior Notes
On May 7, 2008, we issued $275 million of senior notes in a private placement to a group of institutional investors (the “2008 Senior Notes”). The 2008 Senior Notes were issued in four series with maturities ranging from 5 to 10 years. The outstanding 2008 Senior Notes’ weighted average interest rate is 7.2% and the weighted average maturity is 10.0 years. On July 14, 2010, we issued $245 million of senior notes in a private placement to a group of institutional investors (the “2010 Senior Notes” and, with the 2008 Senior Notes, the “Senior Notes”). The 2010 Senior Notes were issued in four series with maturities ranging from 6 to 10 years. The 2010 Senior Notes’ weighted average interest rate is 5.4% and the weighted average maturity is 8.7 years. 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 December 31, 2016, the carrying value of the Senior Notes was $315.7 million and we were in compliance with all financial covenants under these facilities.
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, 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 condensed 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 assumptions. 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.
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.
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 probable. 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. 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. We have not experienced significant variances between our estimates and actual hours in the past and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason 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.
Services that are sold in connection with software license arrangements generally qualify for separate accounting from the license element because they do not involve significant production, modification or customization of our products and are not otherwise considered to be essential to the functionality of our software. In arrangements where the professional services do not qualify for separate accounting from the license element, the combined software license and professional services revenue are recognized based on contract accounting using either the percentage-of-completion or completed-contract method.
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 customer life. 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 our 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 expected life of the customer relationship. ASP transactional fees are recorded monthly as earned.
Multiple-Deliverable Arrangements including Non-Software
When we enter into a multiple-deliverable arrangement that includes non-software, each deliverable 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; for example, we conclude professional services offered along with our SaaS subscription services typically have standalone value using this criteria. 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 our 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. Historically, there have been no significant changes in our ESP used in allocation of arrangement consideration. We do not believe there is a reasonable likelihood there will be a material change in the future estimates.
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.
Business Combinations
Accounting for our acquisitions requires us to recognize, separately from goodwill, the assets acquired and the liabilities assumed at their acquisition-date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred and the net of the acquisition-date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of income and comprehensive income.
Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date, including our estimates for intangible assets, contractual obligations assumed, pre-acquisition contingencies and contingent consideration, where applicable. If we cannot reasonably determine the fair value of a pre-acquisition contingency (non-income tax related) by the end of the measurement period, we will recognize an asset or a liability for such pre-acquisition contingency if: (i) it is probable that an asset existed or a liability had been incurred at the acquisition date and (ii) the amount of the asset or liability can be reasonably estimated. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Subsequent to the measurement period, changes in our estimates of such contingencies will affect earnings and could have a material effect on our consolidated results of operations and financial position.
Examples of critical estimates in valuing certain of the intangible assets we have acquired include but are not limited to: (i) future expected cash flows from software license sales, support agreements, consulting contracts, other customer contracts and acquired developed technologies and patents; (ii) expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; and (iii) the acquired company’s brand and competitive position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. Historically, there have been no significant changes in our estimates or assumptions. To the extent a significant acquisition is made during a fiscal year, as appropriate we will expand the discussion to include specific assumptions and inputs used to determine the fair value of our acquired intangible assets.
In addition, uncertain tax positions and tax-related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly based upon facts and circumstances that existed as of the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill provided that we are within the measurement period. Subsequent to the measurement period or our final determination of the tax allowance’s or contingency’s estimated value, whichever comes first, changes to these uncertain tax positions and tax-related valuation allowances will affect our provision for income taxes in our condensed consolidated statements of income and comprehensive income and could have a material impact on our consolidated results of operations and financial position. Historically, there have been no significant changes in our valuation allowances or uncertain tax positions as it relates to business combinations. We do not believe there is a reasonable likelihood there will be a material change in the future estimates.
Goodwill, Acquisition Intangibles and Other Long-Lived Assets - Impairment Assessment
Goodwill represents the excess of cost over the fair value of identifiable assets acquired and liabilities assumed in business combinations. We assess goodwill for impairment for each of our reporting units on an annual basis during the fourth quarter using a July 1 measurement date unless circumstances require a more frequent measurement. We have determined that our reporting units are the same as our reportable segments. When evaluating goodwill for impairment, we may first perform an assessment qualitatively whether it is more likely than not that a reporting unit's carrying amount exceeds its fair value, referred to as a “step zero” approach. If, based on the review of the qualitative factors, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, we would bypass the two-step impairment test. Events and circumstances we consider in performing the “step zero” qualitative assessment include macro-economic conditions, market and industry conditions, internal cost factors, share price fluctuations, and the operational stability and the overall financial performance of the reporting units. If we conclude that it is more likely than not that a reporting unit's fair value is less than its carrying amount, we would perform the first step (“step one”) of the two-step impairment test and calculate the estimated fair value of the reporting unit by using discounted cash flow valuation models and by comparing our reporting units to guideline publicly-traded companies. These methods require estimates of our future revenues, profits, capital expenditures, working capital, and other relevant factors, as well as selecting appropriate guideline publicly-traded companies for each reporting unit. We estimate these amounts by evaluating historical trends, current budgets, operating plans, industry data, and other relevant factors. 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.
For fiscal 2016 and 2015, we performed a step zero qualitative analysis for our annual assessment of goodwill impairment. After evaluating and weighing all relevant events and circumstances, we concluded that it is not more likely than not that the fair value of any of our reporting units was less their carrying amounts. Consequently, we did not perform a step one quantitative analysis in fiscal 2016 or 2015. For fiscal 2014, we elected to proceed directly to the step one quantitative analysis rather than perform the step zero qualitative assessment. There was a substantial excess of fair value over carrying value for each of our reporting units and we determined goodwill was not impaired for any of our reporting units.
Our intangible assets that have finite useful lives and other long-lived assets are assessed for potential impairment 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, 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 cash flows. Should different conditions prevail, material write downs of our intangible assets or other long-lived assets could occur. We review the estimated remaining useful lives of our acquired intangible assets at each reporting period. A reduction in our estimate of remaining useful lives, if any, could result in increased annual amortization expense in future periods.
As discussed above, while we believe that the assumptions and estimates utilized were appropriate based on the information available to management, different assumptions, judgments and estimates could materially affect our impairment assessments for our goodwill, acquired intangibles with finite lives and other long-lived assets. Historically, there have been no significant changes in our estimates or assumptions that would have had a material impact for our goodwill or intangible assets impairment assessment. We believe our projected operating results and cash flows would need to be significantly less favorable to have a material impact on our impairment assessment. However, based upon our historical experience with operations, we do not believe there is a reasonable likelihood of a significant change in our projections.
Share-Based Compensation
We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the stock award (generally three to four years). We use the Black-Scholes valuation model to determine the fair value of our stock options and a Monte Carlo valuation model to determine the fair value of our market share units. Our valuation models and generally accepted valuation techniques require us to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, expected dividend yield, employee turnover rates and employee stock option exercise behaviors. Historically, there have been no material changes in our estimates or assumptions. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions. See Note 10 to the accompanying condensed consolidated financial statements for further discussion of our share-based employee benefit plans.
Income Taxes
We estimate our income taxes based on the various jurisdictions where we conduct business, which involves significant judgment in determining our income tax provision. We estimate our current tax liability using currently enacted tax rates and laws and assess temporary differences that result from differing treatments of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities recorded on our condensed consolidated balance sheet using the currently enacted tax rates and laws that will apply to taxable income for the years in which those tax assets are expected to be realized or settled. We then assess the likelihood our deferred tax assets will be realized and to the extent we believe realization is not likely, we establish a valuation allowance. When we establish a valuation allowance or increase this allowance in an accounting period, we record a corresponding income tax expense in our condensed consolidated statements of income and comprehensive income. In assessing the need for the valuation allowance, we consider future taxable income in the jurisdictions we operate; an analysis of our deferred tax assets and the periods over which they will be realizable; and ongoing prudent and feasible tax planning strategies. An increase in the valuation allowance would have an adverse impact, which could be material, on our income tax provision and net income in the period in which we record the increase. We have historically had minimal changes in our valuation allowances related to deferred tax assets, as described in Note 9 to the accompanying condensed consolidated financial statements.
We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the technical merits of the tax position indicate it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions more likely than not of being sustained upon audit, the second step is to measure the tax benefit as the largest amount more than 50% likely of being realized upon settlement. Significant judgment is required to evaluate uncertain tax positions and they are evaluated on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results. Historically, settlements related to our unrecognized tax benefits have been minimal, as described in Note 9 to the accompanying consolidated financial statements.
A description of our accounting policies associated with tax-related contingencies and valuation allowances assumed as part of a business combination is provided under “Business Combinations” above.
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. Historically, there have been no material changes in our estimates or assumptions. We do not believe there is a reasonable likelihood there will be a material change in the future estimates.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Effective October 1, 2016, we early adopted ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. As a result of the adoption, we recognized $17.3 million of excess tax benefits related to share-based payments in our provision for income taxes for the quarter ended December 31, 2016. These items were historically recorded as additional paid-in capital. We elected to apply the change retrospectively in presentation to our condensed consolidated statements of cash flows and no longer classified the excess tax benefits from employee stock plans as a reduction from operating cash flows, which resulted in increases to both net cash provided by operating activities and net cash used in financing activities of $10.1 million for the quarter ended December 31, 2015. Our adoption of ASU 2016-09 also impacted the calculation of diluted weighted-average shares under the treasury stock method as we no longer increase or decrease the assumed proceeds from an employee vesting in, or exercising, a share-based payment award by the amount of excess tax benefits or deficiencies taken to additional paid-in capital. For the quarter ended December 31, 2016, the impact was immaterial. Given our historical practice of including employee withholding taxes paid within financing activities in the statement of cash flows, no prior period reclassifications are required by the clarifications on classification provided by ASU 2016-09. Furthermore, we elected to continue to estimate expected forfeitures of employee equity awards to determine the amount of compensation expense to be recognized in each period.
Effective October 1, 2016, we retrospectively adopted ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance” (“ASU 2015-03”). ASU 2015-03 requires an entity to present debt issuance costs related to a recognized debt liability, other than those relating to line-of-credit arrangements, in the balance sheet as a direct deduction from the related debt liability rather than as an asset. As a result of the adoption, at December 31, 2016, the amount of debt issuance costs reflected as a deduction of long-term debt was $0.3 million. At September 30, 2016, the amount of debt issuance costs reclassified from other assets to a deduction of long-term debt was $0.4 million.
Recent Accounting Pronouncements Not Yet Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. Generally Accepted Accounting Principles when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. In August 2015, the FASB issued ASU No. 2015-14, “Deferral of the Effective Date” (“ASU 2015-14”), which defers the effective date for ASU 2014-09 by one year. For public entities, the guidance in ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods), which means it will be effective for our fiscal year beginning October 1, 2018. Early adoption is permitted to the original effective date of December 15, 2016 (including interim reporting periods within those periods). In March 2016, the FASB issued ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue versus Net)” (“ASU 2016-08”), which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard. In April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing” (“ASU 2016-10”), which reduces the complexity when applying the guidance for identifying performance obligations and improves the operability and understandability of the license implementation guidance. In May 2016, the FASB issued ASU No. 2016-12 “Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”), which amends the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. In December 2016, the FASB further issued ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU 2016-20”), which makes minor corrections or minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments are intended to address implementation issues that were raised by stakeholders and provide additional practical expedients to reduce the cost and complexity of applying the new revenue standard. These amendments have the same effective date as the new revenue standard. Preliminarily, we plan to adopt Topic 606 in the first quarter of our fiscal 2019 using the retrospective transition method, and are continuing to evaluate the impact our pending adoption of Topic 606 will have on our consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). ASU 2016-16 requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The guidance is effective for fiscal years and interim periods beginning after December 15, 2017, which means it will be effective for our fiscal year beginning October 1, 2018. ASU 2016-16 should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings at the beginning of the period of adoption. Early adoption is permitted in the first interim period of an entity's annual financial
statements. We are currently evaluating the timing of our adoption and the impact that the updated standard will have on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which requires lessees to put most leases on their balance sheets but recognize the expenses on their income statements in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. ASU 2016-02 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018, which means it will be effective for our fiscal year beginning October 1, 2019. Early adoption is permitted. We are currently evaluating the timing of our adoption and the impact that the updated standard will have on our consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Disclosures
We are exposed to market risk related to changes in interest rates and foreign exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
Interest Rate
We maintain an investment portfolio consisting of bank deposits and money market funds. The funds provide daily liquidity and may be subject to interest rate risk and fall in value if market interest rates increase. We do not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates. The following table presents the principal amounts and related weighted-average yields for our investments with interest rate risk at December 31, 2016 and September 30, 2016:
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| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2016 | | September 30, 2016 |
| Cost Basis | | Carrying Amount | | Average Yield | | Cost Basis | | Carrying Amount | | Average Yield |
| (Dollars in thousands) |
Cash and cash equivalents | $ | 88,101 |
| | $ | 88,101 |
| | 0.10 | % | | $ | 75,926 |
| | $ | 75,926 |
| | 0.17 | % |
On May 7, 2008, we issued $275 million of senior notes to a group of institutional investors in a private placement (the “2008 Senior Notes”). On July 14, 2010 we issued an additional $245 million of senior notes to a group of institutional investors in a private placement (the “2010 Senior Notes” and, with the 2008 Senior Notes, the “Senior Notes”). The fair value of the 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” for additional information on the Senior Notes. The following table presents the carrying amounts and fair values for the Senior Notes at December 31, 2016 and September 30, 2016:
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| | | | | | | | | | | | | | | |
| December 31, 2016 | | September 30, 2016 |
| Carrying Amounts | | Fair Value | | Carrying Amounts | | Fair Value |
| (In thousands) |
The 2008 Senior Notes | $ | 131,000 |
| | $ | 138,035 |
| | $ | 131,000 |
| | $ | 139,902 |
|
The 2010 Senior Notes | 185,000 |
| | 192,295 |
| | 185,000 |
| | 195,715 |
|
Debt issuance costs | (328 | ) | | (328 | ) | | (376 | ) | | (376 | ) |
Total | $ | 315,672 |
| | $ | 330,002 |
| | $ | 315,624 |
| | $ | 335,241 |
|
We have a $400 million unsecured revolving line of credit with a syndicate of banks that expires on December 30, 2019. 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 our 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, (b) the Federal Funds rate plus 0.500% and (c) the one-month LIBOR rate plus 1.000%, plus, in each case, an applicable margin, or (ii) an adjusted LIBOR rate plus an applicable margin. The applicable margin for base rate borrowings ranges from 0% to 0.875% and for LIBOR borrowings ranges from 1.000% to 1.875%, 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 $305.0 million in borrowings outstanding at a weighted average interest rate of 1.850% under the credit facility as of December 31, 2016.
Foreign Currency Forward Contracts
We maintain a program to manage our foreign exchange rate risk on existing foreign-currency-denominated receivable and cash balances by entering into forward contracts to sell or buy foreign currencies. At period end, foreign-currency-denominated receivable and cash balances held by our various reporting entities are remeasured into their respective functional currencies at current market rates. The change in value from this remeasurement is then reported as a foreign exchange gain or loss for that period in our accompanying condensed consolidated statements of income and comprehensive income and the resulting gain or loss on the forward contract mitigates the foreign exchange rate risk of the associated assets. All of our foreign currency forward contracts have maturity periods of less than three months. Such derivative financial instruments are subject to market risk.
The following tables summarize our outstanding foreign currency forward contracts, by currency, at December 31, 2016 and September 30, 2016:
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| | | | | | | | | | | |
| December 31, 2016 |
| Contract Amount | | Fair Value |
| Foreign Currency | | US$ | | US$ |
| (In thousands) |
Sell foreign currency: | | | | | | |
Euro (EUR) | EUR | 6,250 |
| | $ | 6,603 |
| | $ | — |
|
Buy foreign currency: | | | | | | |
British pound (GBP) | GBP | 3,451 |
| | $ | 4,250 |
| | $ | — |
|
| | | | | | |
| September 30, 2016 |
| Contract Amount | | Fair Value |
| Foreign Currency | | US$ | | US$ |
| (In thousands) |
Sell foreign currency: | | | | | | |
Euro (EUR) | EUR | 7,850 |
| | $ | 8,743 |
| | $ | — |
|
Buy foreign currency: | | | | | | |
British pound (GBP) | GBP | 7,721 |
| | $ | 10,000 |
| | $ | — |
|
The foreign currency forward contracts were entered into on December 31, 2016 and September 30, 2016, respectively; therefore, their fair value was $0 on each of these 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.
Item 1A. Risk Factors
Risks Related to Our Business
We continue to expand 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 continue to expand 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:
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• | changes in the business analytics industry; |
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• | our inability to obtain or use key data for our products; |
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• | saturation or contraction of market demand; |
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• | failure to execute our selling approach; and |
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• | 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, including the development and sale of our cloud-based product offerings. 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 or certain client or other systems. 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.
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. Many of our customers are significantly larger than we are and may have greater bargaining power. The businesses of our largest customers depend, in large part, on favorable macroeconomic conditions. If these customers are negatively impacted by weak global economic conditions, global economic volatility or 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, retailers and public agencies. 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, the U.S. and other key international economies have experienced in the past a downturn in which economic activity was impacted by falling demand for a variety of goods and services, restricted credit, poor liquidity, reduced corporate profitability, volatility in credit, equity and foreign exchange markets, bankruptcies and overall uncertainty with respect to the economy. The European Union continues to face great economic uncertainty which could impact the overall world economy or various other regional economies. The potential for 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 could result in a 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 (including credit card processors), 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.
Our acquisition and divestiture activities may disrupt our ongoing business and may involve increased expenses, and we may not realize the financial and strategic goals contemplated at the time of a transaction.
We have acquired and expect to continue to acquire companies, businesses, products, services and technologies. Acquisitions involve significant risks and uncertainties, including:
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• | our ongoing business may be disrupted and our management’s attention may be diverted by acquisition, transition or integration activities; |
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• | an acquisition may not further our business strategy as we expected, we may not integrate acquired operations or technology as successfully as we expected or we may overpay for our investments, or otherwise not realize the expected return, which could adversely affect our business or operating results; |
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• | we may be unable to retain the key employees, customers and other business partners of the acquired operation; |
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• | we may have difficulties entering new markets where we have no or limited direct prior experience or where competitors may have stronger market positions; |
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• | our operating results or financial condition may be adversely impacted by claims or liabilities we assume from an acquired company, business, product or technology, including claims by government agencies, terminated employees, current or former customers, former stockholders or other third parties; pre-existing contractual relationships of an acquired company we would not have otherwise entered into; unfavorable revenue recognition or other accounting treatment as a result of an acquired company’s practices; and intellectual property claims or disputes; |
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• | we may fail to identify or assess the magnitude of certain liabilities or other circumstances prior to acquiring a company, business, product or technology, which could result in unexpected litigation or regulatory exposure, unfavorable accounting treatment, unexpected increases in taxes due, a loss of anticipated tax benefits or other adverse effects on our business, operating results or financial condition; |
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• | we may not realize the anticipated increase in our revenues from an acquisition for a number of reasons, including if a larger than predicted number of customers decline to renew their contracts, if we are unable to sell the acquired products to our customer base or if contract models of an acquired company do not allow us to recognize revenues on a timely basis; |
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• | we may have difficulty incorporating acquired technologies or products with our existing product lines and maintaining uniform standards, architecture, controls, procedures and policies; |
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• | our use of cash to pay for acquisitions may limit other potential uses of our cash, including stock repurchases, dividend payments and retirement of outstanding indebtedness; |
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• | to the extent we issue a significant amount of equity securities in connection with future acquisitions, existing stockholders may be diluted and earnings per share may decrease; and |
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• | we may experience additional or unexpected changes in how we are required to account for our acquisitions pursuant to U.S. generally accepted accounting principles, including arrangements we assume from an acquisition. |
We have also divested ourselves of businesses in the past and may do so again in the future. Divestitures involve significant risks and uncertainties, including:
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• | disruption of our ongoing business; |
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• | reductions of our revenues or earnings per share; |
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• | unanticipated liabilities, legal risks and costs; |
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• | the potential loss of key personnel; |
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• | distraction of management from our ongoing business; and |
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• | impairment of relationships with employees and customers as a result of migrating a business to new owners. |
Because acquisitions and divestitures are inherently risky, our transactions may not be successful and may have a material adverse effect on our business, results of operations, financial condition or cash flows. Acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of conducting operations in international markets.
Charges to earnings resulting from acquisitions may adversely affect our operating results.
Under business combination accounting standards, we recognize the identifiable assets acquired and the liabilities assumed in acquired companies generally at their acquisition-date fair values and separately from goodwill. Goodwill is measured as the excess amount of consideration transferred, which is also generally measured at fair value, and the net of the amounts of the identifiable assets acquired and the liabilities assumed as of the acquisition date. Our estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain. After we complete an acquisition, the following factors could result in material charges and adversely affect our operating results and may adversely affect our cash flows:
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• | impairment of goodwill or intangible assets, or a reduction in the useful lives of intangible assets acquired; |
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• | amortization of intangible assets acquired; |
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• | identification of, or changes to, assumed contingent liabilities, both income tax and non-income tax related, after our final determination of the amounts for these contingencies or the conclusion of the measurement period (generally up to one year from the acquisition date), whichever comes first; |
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• | costs incurred to combine the operations of companies we acquire, such as transitional employee expenses and employee retention, redeployment or relocation expenses; |
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• | charges to our operating results to maintain certain duplicative pre-merger activities for an extended period of time or to maintain these activities for a period of time that is longer than we had anticipated, charges to eliminate certain duplicative pre-merger activities, and charges to restructure our operations or to reduce our cost structure; and |
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• | charges to our operating results resulting from expenses incurred to effect the acquisition. |
Substantially all of these costs will be accounted for as expenses that will decrease our net income and earnings per share for the periods in which those costs are incurred. Charges to our operating results in any given period could differ substantially from other periods based on the timing and size of our future acquisitions and the extent of integration activities. A more detailed discussion of our accounting for business combinations and other items is presented in the “Critical Accounting Policies and Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7).
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:
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• | variability in demand from our existing customers; |
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• | failure to meet the expectations of market analysts; |
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• | changes in recommendations by market analysts; |
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• | 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; |
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• | consumer or customer dissatisfaction with, or problems caused by, the performance of our products; |
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• | the timing of new product announcements and introductions in comparison with our competitors; |
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• | the level of our operating expenses; |
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• | changes in competitive and other conditions in the consumer credit, banking and insurance industries; |
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• | fluctuations in domestic and international economic conditions; |
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• | our ability to complete large installations on schedule and within budget; |
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• | acquisition-related expenses and charges; and |