SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
-----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
[ ] 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
0-16439
FAIR, ISAAC AND COMPANY, INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 94-1499887
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Smith Ranch Road, San Rafael, California 94903
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 472-2211
-----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes __x__ No ____.
The number of shares of Common Stock, $0.01 par value per share,
outstanding on May 6, 2002, was 23,142,631.
1
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements................................................ 3
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.......... 26
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.................................... 27
SIGNATURES ................................................................. 28
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
FAIR, ISAAC AND COMPANY, INCORPORATED
CONSOLIDATED BALANCE SHEETS
March 31, 2002 and September 30, 2001
(in thousands)
(UNAUDITED) (AUDITED)
March 31, September 30,
2002 2001
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 106,100 $ 24,608
Short-term investments 7,728 13,800
Accounts receivable, net 51,947 51,619
Unbilled work in progress 34,653 28,452
Prepaid expenses and other current assets 10,488 10,565
Deferred income taxes 7,038 5,217
--------- ---------
Total current assets 217,954 134,261
Investments 68,016 116,143
Property and equipment, net 48,241 49,383
Intangibles, net 9,350 6,530
Deferred income taxes 5,504 5,504
Other assets 5,382 5,192
--------- ---------
$ 354,447 $ 317,013
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,497 $ 1,415
Accrued compensation and employee benefits 15,549 18,233
Other accrued liabilities 16,219 9,959
Billings in excess of earned revenues 10,796 10,030
--------- ---------
Total current liabilities 44,061 39,637
--------- ---------
Long-term liabilities:
Accrued compensation and employee benefits 4,363 4,755
Other liabilities 409 849
--------- ---------
Total long-term liabilities 4,772 5,604
--------- ---------
Total liabilities 48,833 45,241
--------- ---------
Stockholders' equity:
Common stock 239 233
Paid in capital in excess of par value 124,375 95,875
Retained earnings 227,550 200,737
Less treasury stock, at cost (45,065) (26,446)
Accumulated other comprehensive income (loss) (1,485) 1,373
--------- ---------
Total stockholders' equity 305,614 271,772
--------- ---------
$ 354,447 $ 317,013
========= =========
See accompanying notes to the consolidated financial statements.
3
FAIR, ISAAC AND COMPANY, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the six months and three months ended March 31, 2002 and 2001
(in thousands, except share and per share data)
(Unaudited)
Six Months Ended Three Months Ended
March 31, March 31,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues $ 172,111 $ 158,454 $ 87,050 $ 81,331
Costs and expenses:
Cost of revenues 77,712 72,723 39,127 37,458
Research and development 14,778 14,678 7,301 7,363
Sales, general and administrative 36,661 39,059 18,719 18,913
Amortization of intangibles 1,134 1,050 609 525
------------ ------------ ------------ ------------
Total costs and expenses 130,285 127,510 65,756 64,259
------------ ------------ ------------ ------------
Income from operations 41,826 30,944 21,294 17,072
Other income, net 3,823 2,236 1,964 1,088
------------ ------------ ------------ ------------
Income before income taxes 45,649 33,180 23,258 18,160
Provision for income taxes 17,917 13,704 9,073 7,501
------------ ------------ ------------ ------------
Net income $ 27,732 $ 19,476 $ 14,185 $ 10,659
============ ============ ============ ============
Net Income $ 27,732 $ 19,476 $ 14,185 $ 10,659
Other comprehensive loss, net of tax:
Unrealized holding gains (losses) arising
during the period (1,709) (7) (2,394) 41
Less: Realized gains previously recognized
in other comprehensive income (974) -- (974) --
------------ ------------ ------------ ------------
Net unrealized gains (losses) (2,683) (7) (3,368) 41
Foreign currency translation adjustments (175) (87) (230) (211)
------------ ------------ ------------ ------------
Other comprehensive loss (2,858) (94) (3,598) (170)
------------ ------------ ------------ ------------
Comprehensive income $ 24,874 $ 19,382 $ 10,587 $ 10,489
============ ============ ============ ============
Earnings per share:
Diluted $ 1.15 $ 0.87 $ 0.59 $ 0.47
============ ============ ============ ============
Basic $ 1.21 $ 0.90 $ 0.62 $ 0.49
============ ============ ============ ============
Shares used in computing earnings per share:
Diluted 24,080,000 22,335,000 24,191,000 22,444,000
============ ============ ============ ============
Basic 22,906,000 21,674,000 23,021,000 21,544,000
============ ============ ============ ============
See accompanying notes to the consolidated financial statements.
4
FAIR, ISAAC AND COMPANY, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended March 31, 2002 and 2001
(in thousands)
(Unaudited)
Six Months Ended
March 31,
-----------------------
2002 2001
--------- ---------
Cash flows from operating activities
Net income $ 27,732 $ 19,476
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization 13,589 11,982
Gain on sales of investments (1,605) (46)
Share of equity loss and write-off on equity investments 1,071 510
Deferred compensation 499 499
Tax benefit from exercise of stock options 8,520 3,036
Loss on sale of fixed assets 118 38
Other 2 --
Changes in operating assets and liabilities:
Accounts receivable 1,457 (2,496)
Unbilled work in progress (6,201) (3,702)
Prepaid expenses and other assets 342 (8,393)
Accounts payable 7,884 543
Accrued compensation and employee benefits (1,554) 50
Other accrued liabilities and other liabilities (2,271) (637)
Billings in excess of earned revenues 268 (1,091)
--------- ---------
Net cash provided by operating activities 49,851 19,769
--------- ---------
Cash flows from investing activities
Purchases of property and equipment (11,200) (10,690)
Cash portion of Nykamp acquisition (2,593) --
Purchases of investments (49,407) (51,544)
Proceeds from maturities of investments 7,860 38,277
Proceeds from sales of investments 91,371 --
--------- ---------
Net cash provided by (used in) investing activities 36,031 (23,957)
--------- ---------
Cash flows from financing activities
Principal payments of capital lease obligations -- (223)
Proceeds from the exercise of stock options and
issuance of treasury stock 15,968 14,454
Dividends paid (919) (578)
Repurchase of company stock (19,439) (19,837)
--------- ---------
Net cash used in financing activities (4,390) (6,184)
--------- ---------
Increase (decrease) in cash and cash equivalents 81,492 (10,372)
Cash and cash equivalents, beginning of period 24,608 39,506
--------- ---------
Cash and cash equivalents, end of period $ 106,100 $ 29,134
========= =========
See accompanying notes to the consolidated financial statements.
5
FAIR, ISAAC AND COMPANY, INCORPORATED
Notes to Consolidated Financial Statements
Note 1 General
In management's opinion, the accompanying unaudited consolidated
financial statements for Fair, Isaac and Company, Incorporated (the "Company")
for the six months and three months ended March 31, 2002 and 2001 have been
prepared in accordance with generally accepted accounting principles for interim
financial statements and include all adjustments (consisting only of normal
recurring accruals unless otherwise stated) that the Company considers necessary
for a fair presentation of its financial position, results of operations, and
cash flows for such periods. However, the accompanying financial statements do
not contain all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. All such financial
statements presented herein are unaudited; however, the September 30, 2001
balance sheet has been derived from audited financial statements. This report
and the accompanying financial statements should be read in connection with the
Company's audited financial statements and notes thereto presented in its Annual
Report on Form 10-K for the fiscal year ended September 30, 2001. Notes that
would substantially duplicate the disclosures in the Company's audited financial
statements for the fiscal year ended September 30, 2001, contained in the 2001
Form 10-K, have been omitted. 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 full fiscal year ending September 30, 2002.
Certain amounts in the financial statements and note thereto have been
reclassified to conform to 2002 classifications.
Note 2 Earnings Per Share
The following reconciles the numerators and denominators of diluted and
basic earnings per share (EPS):
Six months ended Three months ended
March 31, March 31,
-------------------- --------------------
(in thousands, except per share data) 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
Numerator - Net income $ 27,732 $ 19,476 $ 14,185 $ 10,659
======== ======== ======== ========
Denominator - Shares:
Diluted weighted-average shares 24,080 22,335 24,191 22,444
Dilutive effect of:
Employee stock options (1,140) (661) (1,111) (900)
Restrictive securities issued in Nykamp
acquisition (34) (59)
-------- -------- -------- --------
Basic weighted-average shares 22,906 21,674 23,021 21,544
======== ======== ======== ========
Earnings per share:
Diluted $ 1.15 $ 0.87 $ 0.59 $ 0.47
======== ======== ======== ========
Basic $ 1.21 $ 0.90 $ 0.62 $ 0.49
======== ======== ======== ========
The computation of diluted EPS for the six months ended March 31, 2002
and 2001 excludes stock options to purchase 646,000 and 114,000 shares of common
stock, respectively. The computation of diluted EPS for the three months ended
March 31, 2002 and 2001 excludes stock options to purchase 863,000 and 105,000
shares of common stock, respectively. The shares were excluded because the
exercise prices for the options were greater than the respective average market
price of the common shares and their inclusion would be antidilutive.
6
Note 3 Cash Flow Statement
Supplemental disclosure of cash flow information:
Six months ended
March 31,
-------------------
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
Income tax payments $ 1,312 $10,846
Interest paid 13 115
Non-cash investing and financing activities:
Issuance of treasury stock to ESOP and ESPP 1,521 1,040
Fair value of assets acquired from Nykamp 6,425 --
Liabilities acquired from Nykamp 787 --
Future installment share payments for acquisition
of Nykamp 2,818 --
Amortization of premium on investments 388 55
Note 4 New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting,
thereby eliminating use of the pooling-of-interest method. It also specifies the
types of acquired intangible assets that are to be recognized and reported
separately from goodwill. SFAS No. 142 requires that goodwill and certain
intangibles with indefinite lives are no longer amortized, but will instead be
tested for impairment at least annually or more frequently if impairment
circumstances arise. SFAS No. 142 is required to be applied starting with fiscal
years beginning after December 15, 2001, with early application permitted in
certain circumstances. The Company is currently evaluating the impact that the
adoption of SFAS No. 142 will have on its financial position, and results of its
operations. Amortization of intangibles was approximately $1,134,000 million and
$609,000 for the six months and three months ended March 31, 2002, respectively,
compared to $1,050,000 and $525,000 for the respective corresponding periods of
fiscal year 2001.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The standard applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development, and (or) normal use of the asset. SFAS
No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The fair value of the liability is added to
the carrying amount of the associated asset and this additional carrying amount
is depreciated over the life of the asset. The liability is accreted at the end
of each period through charges to operating expense. If the obligation is
settled for other than the carrying amount of the liability, the Company will
recognize a gain or loss on settlement. SFAS No. 143 is effective for fiscal
years beginning after June 15, 2002, and early application is encouraged. The
Company implemented SFAS No. 143 in its first quarter of fiscal year 2002. The
adoption of SFAS No. 143 did not have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of. SFAS No. 144 establishes the accounting model for
long-lived assets to be disposed of by sale and applies to all long-lived
assets, including discontinued operations. It replaces the provisions of APB
opinion No. 30, Reporting Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, for the disposal of segments of a business.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001,
and early adoption is encouraged. The Company adopted SFAS No. 144 in its first
quarter of fiscal year 2002. The adoption did not have a material impact on the
Company's consolidated financial position, results of operations or cash flows.
7
Note 5 Segment information
Effective October 1, 2001, the Company reorganized into four reportable
segments worldwide to align with the new internal management of its business
operations based on products. The reportable segments are Scoring, Strategy
Machine, Consulting, and Software & Maintenance.
The Scoring segment includes scoring services distributed through major
credit bureaus, ChoicePoint and Call Credit; the ScoreNet(R) service; the
PreScore(R) services; and insurance bureau scoring services sold through credit
bureaus and ChoicePoint. These products and services were previously reported in
the Global Data Repositories & Processors segment in fiscal year 2001.
The Strategy Machine segment includes the following Strategy
Machine(TM) Solutions: TRIAD(TM) credit account management services distributed
through third-party bankcard processors and Fair, Isaac MarketSmart Decision
System(R) (MarketSmart), LiquidCredit(R), TelAdaptive(TM), consumer services
available through myFICO.com, and Strategy Science products. Our TRIAD credit
account management services distributed through third-party bankcard processors
products were included under the Global Data Repositories & Processors segment
in fiscal year 2001, and the remaining products in this new segment were
included in either the Global Financial Services segment or the Other segment in
fiscal 2001.
The Consulting segment includes all consulting services and custom
analytics. In fiscal 2001, custom analytics were included in the Other segment
and most other consulting services were reported in the segment in which the
revenues from the related products and services were reported.
The Software & Maintenance segment principally includes TRIAD(TM)
end-user software, StrategyWare(R) and Decision System products. In fiscal 2001,
our TRIAD end-user software, StrategyWare and Decision System products were
included under the Global Financial Services and the Other segments.
The segment information for the six months and three months ended March
31, 2001 has been restated to conform to the fiscal year 2002 presentation.
The Company's Chief Executive and Operating Officers evaluate segment
financial performance based on segment revenues and operating income. Operating
income is calculated as revenue less expenses such as personnel, facilities,
consulting and travel. Unallocated other income consists mainly of interest
income and net gain on sale of investments. The Company does not evaluate the
financial performance of each segment based on its assets or capital
expenditures.
8
Strategy Software &
(in thousands) Scoring Machine Consulting Maintenance Total
- ------------------------------------------------------------------------------------------------------------------------------------
Six months ended March 31, 2002
Revenue $ 59,800 $ 67,330 $ 27,748 $ 17,233 $172,111
======== ======== ======== ======== ========
Operating income $ 28,736 $ 5,495 $ 1,529 $ 6,066 $ 41,826
Unallocated other income, net 3,823
--------
Income before income taxes $ 45,649
========
Depreciation and Amortization $ 3,486 $ 7,364 $ 1,705 $ 1,034 $ 13,589
======== ======== ======== ======== ========
Six months ended March 31, 2001
Revenue $ 56,136 $ 64,656 $ 18,641 $ 19,021 $158,454
======== ======== ======== ======== ========
Operating income $ 24,223 $ 1,867 $ 680 $ 4,174 $ 30,944
Unallocated other income, net 2,236
--------
Income before income taxes $ 33,180
========
Depreciation and Amortization $ 2,983 $ 6,760 $ 1,188 $ 1,051 $ 11,982
======== ======== ======== ======== ========
Three months ended March 31, 2002
Revenue $ 29,711 $ 32,985 $ 15,044 $ 9,310 $ 87,050
======== ======== ======== ======== ========
Operating income $ 14,559 $ 2,218 $ 907 $ 3,610 $ 21,294
Unallocated other income, net 1,964
--------
Income before income taxes $ 23,258
========
Depreciation and Amortization $ 1,762 $ 3,718 $ 862 $ 541 $ 6,883
======== ======== ======== ======== ========
Three months ended March 31, 2001
Revenue $ 29,079 $ 32,232 $ 9,412 $ 10,608 $ 81,331
======== ======== ======== ======== ========
Operating income $ 13,002 $ 374 $ 417 $ 3,279 $ 17,072
Unallocated other income, net 1,088
--------
Income before income taxes $ 18,160
========
Depreciation and Amortization $ 1,503 $ 3,413 $ 590 $ 540 $ 6,046
======== ======== ======== ======== ========
9
The Company's revenues and percentage of revenues by reportable market
segments are as follows:
Six Months Ended Six Months Ended
March 31, 2002 March 31, 2001
------------------------ ------------------------
Scoring $ 59,800 35% $ 56,136 35%
Strategy Machine 67,330 39% 64,656 41%
Consulting 27,748 16% 18,641 12%
Software & Maintenance 17,233 10% 19,021 12%
-------- -------- -------- --------
$172,111 100% $158,454 100%
======== ======== ======== ========
Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------------ ------------------------
Scoring $ 29,711 34% $ 29,079 36%
Strategy Machine 32,985 38% 32,232 39%
Consulting 15,044 17% 9,412 12%
Software & Maintenance 9,310 11% 10,608 13%
-------- -------- -------- --------
$ 87,050 100% $ 81,331 100%
======== ======== ======== ========
In addition, the Company's revenues and percentage of revenues on a
geographical basis are set out as follows:
Six Months Ended Six Months Ended
March 31, 2002 March 31, 2001
------------------------- -------------------------
United States $138,743 81% $127,684 81%
International 33,368 19% 30,770 19%
-------- -------- -------- --------
$172,111 100% $158,454 100%
======== ======== ======== ========
Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------------- -------------------------
United States $ 67,924 78% $ 64,379 79%
International 19,126 22% 16,952 21%
-------- -------- -------- --------
$ 87,050 100% $ 81,331 100%
======== ======== ======== ========
Note 6 Acquisition of Nykamp
On December 11, 2001, the Company announced that it was acquiring
substantially all of the assets of Nykamp Consulting Group, Inc. (Nykamp), a
privately-held company based in Chicago. Nykamp provided customer relationship
management strategy and implementation services. The agreement was signed on
December 10, 2001 and the acquisition was completed on December 17, 2001. The
assets acquired and liabilities assumed are recorded at estimated fair values as
determined by the Company's management based on information currently available
and on current assumptions as to future operations. Under the acquisition
agreement, the Company will pay total consideration valued at approximately $5.6
million, including cash and common stock over the next three years. As a result
of the acquisition, assets and liabilities are recorded as follows:
10
(in thousands)
--------------
Current assets acquired $ 2,144
Fixed and other assets acquired 327
Other intangible assets (including trade name, 1,359
non-compete agreement, and customer base,
amortizable between approximately 3 to 5 years)
Goodwill 2,595
-------
Fair value of assets acquired 6,425
Liabilities assumed (787)
-------
Net assets acquired $ 5,638
=======
Note 7 Investments
On June 1, 2000, the Company entered into a joint venture with
MarketSwitch Corporation (MKSW). The Company and MKSW each held a 50% voting
interest in the joint venture, OptiFI, Inc. The Company accounts for the
investment on an equity basis and records its equity share of the joint
venture's operating gain/loss each period. At September 30, 2001, the investment
was valued at $1,076,000 after the Company recorded its cumulative equity share
of the operating loss of the joint venture of $924,000 for fiscal years 2000 and
2001.
During the quarter ended March 31, 2002, the joint venture wound down
its business operations, reverted certain rights in its intangible assets to
MKSW and the Company, and distributed its remaining assets among its creditors.
Pursuant to a separation agreement signed by MKSW, the Company and the joint
venture, in consideration for the rights assigned pursuant to the separation
agreement, the Company and MKSW agreed to pay to the joint venture the amount of
$5,000 each upon execution of the separation agreement. The Company has no
further obligation to fund the joint venture or to discharge any of its
remaining indebtednesses.
During the three and six months ended March 31, 2002 the Company
recorded its equity share of operating loss of the joint venture at
approximately $580,000 and $866,000, respectively, compared to $165,000 and
$314,000 in the respective periods of the prior fiscal year. For the three
months ended March 31, 2002, the Company recorded its equity share of operating
losses of $580,000 up until the date when the decision was made to wind down the
business operations of the joint venture, at which time, the Company wrote off
the remaining investment balance, valued at approximately $210,000. The Company
recorded its share of the equity loss of the joint venture and the investment
write-off under Other income, net.
Note 8 Commitments and Contingencies
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial condition.
Note 9 Subsequent Events
On April 22, 2002, the Company announced a three-for-two stock split of
its outstanding shares of common stock to be effected in the form of a stock
dividend. As a result of the stock split, stockholders of record at the close of
business on May 15, 2002 will receive an additional share of Fair, Isaac common
stock for every two shares owned. Additional shares resulting from the split
will be distributed on June 5, 2002, and the Company will pay cash in lieu of
fractional shares. The stock split will increase the number of shares
outstanding to approximately 35 million.
On April 29, 2002, the Company announced that it signed a merger
agreement with HNC Software Inc. (HNC), a provider of high-end analytic and
decision management software. The Company expects that the addition of HNC's
domain and technology expertise will allow the combined company to offer a more
complete set of solutions to core markets, including financial services, retail,
telecommunications, and
11
insurance, as well as gain new opportunities in government and healthcare. Under
the merger agreement, approved by both Boards of Directors, at the effective
time of the merger, the stockholders of HNC will receive 0.346 of a newly issued
Fair, Isaac share for each share of HNC. HNC stockholders will own approximately
35% of the total outstanding capital stock of the merged company. The overall
transaction is valued at approximately $810 million, based on the closing price
of Fair, Isaac stock on April 26, 2002. The transaction is expected to be
tax-free to stockholders of both companies for U.S. federal income tax purposes
and is expected to close in the Company's fourth quarter of fiscal year 2002,
subject to regulatory review, approval by both companies' stockholders and
certain other conditions.
12
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
Certain statements contained in this Report that are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the "Act"). In addition, certain
statements in our future filings with the Securities and Exchange Commission, 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 financial items; (ii) statements of our plans and objectives
by our management or Board of Directors, including those relating to products or
services; (iii) statements of future economic performance; (iv) statements
concerning our pending merger with HNC Software Inc., including the timing of
closing; and (v) statements of assumptions underlying such statements. Words
such as "believes," "anticipates," "expects," "intends," "targeted," 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 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 this Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations-Risk Factors, below. 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 the Company files from time to time with the Securities and
Exchange Commission, including our Reports on Forms 10-Q, 10-K and 8-K to be
filed by the Company in fiscal year 2002.
Overview
Fair, Isaac and Company, Incorporated (NYSE: FIC) (the "Company", which
may be referred to as we, us or our) is the leading provider of creative
analytics for predictive modeling and decisioning that unlock value for people,
businesses and industries. Our predictive modeling, decision analysis,
intelligence management and decision engine systems power more than 14 billion
decisions a year. Founded in 1956, we help thousands of companies in over 60
countries acquire customers more efficiently, increase customer value, reduce
risk and credit losses, lower operating expenses and enter new markets more
profitably. Most leading banks and credit card issuers rely on our analytic
solutions, as do many insurers, retailers, telecommunications providers and
other customer-oriented companies. Through the www.myFICO.com Web site,
consumers use our FICO(R) scores, the standard measure of credit risk, to
understand and manage their credit risk profile. Our home page on the Internet
is at www.fairisaac.com. You can learn more about us by visiting that site. The
information on these Web sites is not incorporated by reference into this
Report.
On April 29, 2002, we announced the signing of a merger agreement with
HNC Software Inc. (HNC), a provider of high-end analytic and decision management
software. Under the merger agreement, approved by both Boards of Directors, at
the effective time of the merger, the stockholders of HNC will receive 0.346 of
a newly issued Fair, Isaac share for each share of HNC. HNC stockholders will
own approximately 35% of the total outstanding capital stock of the merged
company. The overall transaction is valued at approximately $810 million, based
on the closing price of Fair, Isaac stock on April 26, 2002. The transaction is
expected to be tax-free to stockholders of both companies for U.S. federal
income tax purposes and is expected to close in the fourth quarter of our fiscal
year 2002, subject to regulatory review, approval by both companies'
stockholders and certain other conditions.
Our revenues for the three months ended March 31, 2002 reached $87.1
million, up 7% as compared to revenues of $81.3 million for the same period in
fiscal 2001. Net income for the three months ended March 31, 2002 increased 33%
to $14.2 million, or $0.59 per diluted share, compared with net income of $10.7
million, or $0.47 per diluted share, for the corresponding period of fiscal
2001.
Our revenues for the six months ended March 31, 2002 were $172.1
million, up 9% from $158.5 million for the same period last fiscal year. Net
income for the six months increased 42% to $27.7 million,
13
or $1.15 per diluted share, compared with $19.5 million, or $0.87 per diluted
share, for the same period in the prior fiscal year.
Effective October 1, 2001, the Company reorganized into four reportable
segments worldwide to align with the new internal management reporting of our
business operations based on products. These four reportable segments are
Scoring, Strategy Machine, Consulting, and Software and Maintenance, which are
further described below.
o Scoring. This segment includes our scoring services
distributed through major credit bureaus, including TransUnion
Corporation, Experian Information Solutions, Inc. and Equifax
Inc., ChoicePoint and Call Credit; our ScoreNet service sold
directly to credit grantors which allows credit grantors to
obtain our credit bureau scores and related data from the
credit bureaus on their existing accounts for use in their
account management system or for integration with the services
of a credit card processor; our PreScore services offered
through credit bureaus for large credit card issuers that
contract directly with us for scores to pre-screen prospects
for their mailing solicitations; and insurance bureau scores
sold through credit bureaus and ChoicePoint. These services
primarily generate usage revenues. Scoring segment products
were included under the Global Data Repositories & Processors
segment in fiscal year 2001.
o Strategy Machine. Our Strategy Machine Solutions can deliver a
complete solution, encompassing software, data, analytics and
operations, for a specific function for the customer. The
lines of products and services in this segment are our
TRIAD(TM) credit account management services distributed
through third-party bankcard processors who include First Data
Resources, Inc., Total System Services, Inc. and Electronic
Data Systems, Inc.; Fair, Isaac MarketSmart Decision System
(MarketSmart), LiquidCredit, TelAdaptive, consumer services
available through myFICO.com, and Strategy Science. These
products and services are generally sold on a usage basis. Our
TRIAD credit account management services distributed through
third-party bankcard processors products were included under
the Global Data Repositories & Processors segment in fiscal
2001, and the remaining products in this new segment were
included under either the Global Financial Services segment or
the Other segment.
o Consulting. This segment includes revenues from all consulting
services. Revenues in this segment are derived from analytics,
custom applications, data warehousing, integration, and risk
management consulting services. We undertake consulting
engagements primarily with companies that are users of our
analytics, software and netsourced solutions, and with
companies deemed to be attractive prospective clients for
those solutions. Consulting services include building custom
analytic models for clients, advising clients on how to
develop and implement sound analytic solutions, providing
expert analysis of model development and assisting with
successful implementation or repositioning of predictive
modeling within the business for greater effectiveness. These
services are generally offered on an hourly fee basis. In
fiscal 2001, custom analytics products were included in the
Other segment and most other consulting services revenues were
reported in the segment with the associated products and
services.
o Software and Maintenance. This segment is comprised of our
software products that are sold directly to the end user, who
is responsible for installing, operating and supporting them.
The principal software products in this segment are TRIAD(TM)
end-user software, StrategyWare and Decision System products.
These products are generally licensed to a single user on a
fixed-price basis. This segment also includes ongoing
maintenance revenue related to installed software systems. In
fiscal 2001, TRIAD end-user software, StrategyWare and
Decision System products were included under the Global
Financial Services and the Other segments.
Comparative segment revenues, operating income, and related financial
information for the six and three months ended March 31, 2002 and the
corresponding periods in fiscal 2001 are set forth in Note 5 to the Consolidated
Financial Statements.
14
RESULTS OF OPERATIONS
Revenues
The following table displays (a) the percentage of revenues represented
by each segment in the six and three months ended March 31, 2002 and (b) the
percentage change in the amount of revenues within each segment from the
corresponding periods in the prior fiscal year.
Six Months Three Months
Ended Percentage Ended Percentage
March 31, Change March 31, Change
------------------ ------ ----------------- ------
2002 2001 2002 2001
---- ---- ---- ----
Scoring 35% 35% 7% 34% 36% 2%
Strategy Machine 39% 41% 4% 38% 39% 2%
Consulting 16% 12% 49% 17% 12% 60%
Software & Maintenance 10% 12% (9%) 11% 13% (12%)
--- --- --- ---
Total 100% 100% 9% 100% 100% 7%
=== === === ===
The growth in Scoring segment revenues in the six months ended March
31, 2002, compared to the same period in the prior fiscal year, was primarily
due to increased revenues derived from risk and insurance scoring services at
the credit bureaus and the PreScore service. This growth was mainly attributable
to increased marketing efforts of credit card issuers and a strong market for
mortgage re-financings. These increases were partially offset by decreased
revenues derived from ScoreNet. Scoring segment revenues increased in the three
months ended March 31, 2002, compared to the same period in the prior fiscal
year, primarily due to increased revenues derived from insurance scoring
services at the credit bureaus and PreScore services, partially offset by a
slight decline in revenues derived from sales of risk and marketing scores.
The increases in revenues derived from our Strategy Machine segment in
the six and three months ended March 31, 2002, compared with the same periods in
the prior fiscal year, were due primarily to increased revenues from MarketSmart
and our newer products. Our first consumer service through myFICO.com was
introduced in March 2001 and our first Strategy Science offering was introduced
during the third quarter of fiscal 2001. These revenue increases were partly
offset by decreased revenues from sales of List Processing services.
Compared to the corresponding periods in the prior fiscal year,
consulting revenues grew in the six and three months ended March 31, 2002,
primarily due to revenues resulting from the acquisition of the Nykamp business
and increased revenues derived from consulting services related to MarketSmart,
Strategy Science, Decision System, and StrategyWare.
Revenues derived from our Software and Maintenance segment decreased in
the six and three months ended March 31, 2002, compared with corresponding
periods in the prior fiscal year, due primarily to decreases in revenues from
StrategyWare and maintenance support for retired products. These decreases were
partially offset by increased sales of our Decision System product.
In the first half of fiscal 2002, revenues generated from our
agreements with TransUnion, Equifax and Experian accounted for approximately 8%,
12% and 7% of revenues, respectively. In the first half of fiscal 2001,
TransUnion accounted for approximately 10% of our revenues; Equifax,
approximately 10%; and Experian, approximately 8%. For the first half of fiscal
2002, revenues produced through credit bureaus increased approximately 13%
compared to the same period in fiscal 2001 and accounted for approximately 36%
of revenues in the first half of fiscal 2002. Revenues from alliances with the
credit bureaus, including services distributed through such alliances, increased
14% in fiscal 2001 and 13% in fiscal 2000 as compared to the prior fiscal year,
and accounted for approximately 38% of revenues in fiscal 2001 and 37% in fiscal
2000. Revenues generated from processors accounted for approximately 11% of our
revenues in the first half of fiscal 2002 and in the corresponding period in the
prior fiscal year.
While we have been successful in extending or renewing our agreements
with credit bureaus and credit card processors in the past, and believe we will
likely be able to do so in the future, the loss of one or more
15
such alliances or an adverse change in terms could have a material adverse
effect on our revenues and operating margin.
Revenues derived from clients outside the United States represented
approximately 19% of total revenues in the six months ended March 31, 2002 and
the corresponding period of the prior fiscal year. During fiscal 2001 and 2000,
we derived approximately 18% and 19% of our revenues respectively, from business
outside the United States. Fluctuations in currency exchange rates have not had
a significant effect on revenues to date. In October 2001, we initiated a
hedging program by taking out forward foreign currency contracts normally of
less than a six-month period to reduce our exposure to fluctuations in certain
foreign currency translation rates resulting from holding net assets denominated
in foreign currencies. All gains and losses realized on the maturity of forward
foreign currency contracts are reflected in the reporting periods in which they
are realized. All open forward foreign currency contracts existing at the end of
the reporting period are revalued at the respective forward foreign currency
rates prevailing at the end of the reporting period to the maturity dates of the
open contracts. Unrealized revaluation gains/losses on such open contracts are
also reflected in the income statement of the current reporting period. In the
six months ended March 31, 2002, net realized and unrealized losses of $89,000
on foreign currency net assets and forward foreign currency contracts are
reported under Other income, net; and for the same period of fiscal 2001,
$292,000 net realized and unrealized losses were reported under cost of
revenues, and the remaining net losses of $106,000 were reported under Other
income, net. The Company believes that foreign exchange does not have a current
material impact to its consolidated financial results.
Expenses
The following table sets forth for the fiscal periods indicated (a) the
percentage of revenues represented by certain line items in our Consolidated
Statements of Income and Comprehensive Income and (b) the percentage change in
the amount of each such line item from the corresponding periods in the prior
fiscal year.
Six Months Three Months
Ended Percentage Ended Percentage
March 31, Change March 31, Change
------------------ ------ ----------------- ------
2002 2001 2002 2001
---- ---- ---- ----
Revenues 100% 100% N/A 100% 100% N/A
Costs and expenses:
Cost of revenues 45% 45% 7% 45% 46% 4%
Research and development 9% 9% 1% 8% 9% (1%)
Sales, general and administrative 21% 25% (6%) 22% 23% (1%)
Amortization of intangibles 1% 1% 8% 1% 1% 16%
---- ---- ---- ----
Total costs and expenses 76% 80% 2% 76% 79% 2%
---- ---- ---- ----
Income from operations 24% 20% 35% 24% 21% 25%
Other income, net 2% 1% 71% 2% 1% 81%
---- ---- ---- ----
Income before income taxes 26% 21% 38% 26% 22% 28%
Provision for income taxes 10% 9% 31% 10% 9% 21%
---- ---- ---- ----
Net Income 16% 12% 42% 16% 13% 33%
==== ==== ==== ====
Costs and Expenses
Cost of revenues consists primarily of personnel directly involved in
creating, installing and supporting revenue products; travel and related
overhead costs; costs of computer service bureaus; and our payments made to
credit bureaus for scores and for related outside support in connection with the
ScoreNet service. As compared with the same periods a year earlier, the costs of
revenues, as a percentage of revenues, in the six and three months ended March
31, 2002, were substantially the same, but in absolute dollars increased
primarily due to transition costs associated with a new arrangement, implemented
in the fourth quarter of fiscal 2001, to outsource our mainframe operations to
International Business Machines Corp.
Research and development expenses include the personnel and related
overhead costs incurred in development, researching mathematical and statistical
models and developing software tools that are aimed at improving productivity,
profitability and management control. Research and development expenses in
16
the six months and three months ended March 31, 2002, as a percentage of
revenues, were consistent with the corresponding period of fiscal 2001.
Sales, general and administrative expenses consist principally of
employee salaries and benefits, travel, overhead, advertising and other
promotional expenses, corporate facilities expenses, the costs of administering
certain benefit plans, legal expenses, business development expenses, and the
cost of operating our computer systems. As a percentage of revenues, these
expenses for the six and three months ended March 31, 2002 decreased, as
compared to the corresponding periods of fiscal 2001, due primarily to lower
personnel and facility costs.
At March 31, 2002 we employed 1,486 persons worldwide compared with
1,476 employees at March 31, 2001. The increase in personnel is primarily due to
personnel hired in connection with the acquisition of assets from Nykamp, offset
by reductions in data center support staff.
We amortize the intangible assets arising from various acquisitions
over periods ranging from four to fifteen years. Amortization of goodwill and
other intangible assets was approximately $1.1 million and $0.6 million for the
six months and three months ended March 31, 2002, respectively, compared to $1.1
million and $0.5 for the respective corresponding periods of fiscal 2001.
Other income, net
Other income, net consists mainly of interest income from investments,
interest expense, exchange rate gains/losses from holding foreign currencies in
bank accounts, and other non-operating items. Other income, net increased in the
six and three months ended March 31, 2002 compared with the corresponding
periods a year earlier, primarily due to net gain on sales of investments of
approximately $1.6 million and $1.0 million in the six months and the three
months ended March 31, 2002, respectively.
Provision for income taxes
Our effective tax rate is 39.25% and 39% in the six months and three
months ended March 31, 2002, respectively, as compared to 41.3% for the
corresponding prior year periods. The decrease is primarily due to the
utilization of valuation allowance from capital gains, implementation of the
"extraterritorial income exclusion" regime, the availability of research and
development tax credits, and the revision to the state tax rate to reflect
activities in states with lower tax rates.
Financial Condition
Our working capital increased to approximately $173.9 million at March
31, 2002, from approximately $94.6 million at September 30, 2001 primarily due
to significant increases in cash inflows resulting from operating activities,
proceeds from sales of investments, and proceeds from the exercise of stock
options and issuance of treasury stock, partially offset by the acquisition of
assets from Nykamp and decreased proceeds from maturities of investments. See
Note 6 to the Consolidated Financial Statements for additional information on
the acquisition of Nykamp.
Cash and investments increased to approximately $181.8 million at March
31, 2002 from approximately $154.6 million at September 30, 2001. Our long-term
obligations are mainly related to employee incentive and benefit obligations.
In fiscal 1999, we initiated a stock repurchase program to purchase up
to 1.5 million shares of our common stock, to be funded by cash on hand. During
our second quarter of fiscal 2002, we purchased 323,000 shares of our
outstanding common stock for $19.4 million, completing this repurchase plan. On
April 23, 2002, our Board of Directors authorized a new common stock repurchase
program for up to 1.5 million shares (or 2.25 million shares, after giving
effect to the pending three-to-two stock split). Under the new program, we may
purchase shares from time to time in the open market or in privately negotiated
transactions. The timing and amount of any repurchase of shares will be
determined by the Company's management, based on its evaluation of market
conditions and other factors. As of May 10, 2002, we had purchased approximately
1.1 million shares of our outstanding common stock for $61.5 million under the
new program.
We believe that our current cash and cash equivalents, short-term cash
investments and cash expected to be generated from operations will be sufficient
to meet our working capital, capital expenditure, and investment needs for both
the current fiscal year and the foreseeable future.
17
Critical Accounting Policies and Estimates
We prepare our financial statements in conformity with U.S. generally
accepted accounting principles. These accounting principles require management
to make certain judgments and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
as of the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. We periodically evaluate our estimates
including those relating to revenue recognition, the allowance for doubtful
accounts, goodwill and other intangible assets, capitalized software development
costs, 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 impact the most
significant judgments and estimates used in the preparation of our consolidated
financial statements:
Revenue recognition
We recognize software revenue in accordance with the American Institute
of Certified Public Accountants' ("AICPA") Statement of Position 97-2 ("SOP
97-2"), "Software Revenue Recognition" as modified by SOP 98-4 and SOP 98-9, and
in certain instances in accordance with SOP 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts." We recognize other
non-software revenue in accordance with the guidance provided by Staff
Accounting Bulletin 101 issued by the Securities and Exchange Commission.
In most cases, we recognize software license revenue upon delivery,
provided all significant obligations have been met, persuasive evidence of an
arrangement exists, fees are fixed and determinable, collections are probable,
and we are not involved in significant production, customization, or
modification of the software or services that are essential to the functionality
of the software.
If the arrangement involves (1) development of custom scoring systems
or (2) significant production, customization, or modification of software or
service essential to the functionality of the software, the revenue is generally
recognized under the percentage-of-completion method contract accounting.
Progress toward completion is generally measured by achieving certain standards
and objectively verifiable milestones present in each project. In order to apply
the percentage of completion of method, management is required to estimate the
number of hours needed to complete a particular project. As a result, recognized
revenues and profits are subject to revisions as the contract progresses to
completion.
Revenues from multiple element arrangements are allocated to each
element based on the relative fair values of the elements. The determination of
fair value is based on objective evidence that is specific to our business. If
such evidence of fair value for each element of the arrangement does not exist,
all revenue from the arrangement is deferred until such time that evidence of
fair value for each element does exist or until all elements of the arrangement
are delivered. If in a multiple element arrangement, fair value does not exist
for one or more of the delivered elements in the arrangement, but fair value
does exist for all of the undelivered elements, then the residual method of
accounting is applied. 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.
Revenue determined by the percentage-of-completion method in excess of
contract billings is recorded as unbilled work in progress. Such amounts are
generally billable upon reaching certain performance milestones as defined by
individual contracts. Billings received in advance of performance under
contracts are recorded as billings in excess of earned revenues.
Revenues recognized from our credit scoring, data processing, data
management, internet delivery services and consulting are generally recognized
as these services are performed, provided all significant obligations have been
met, persuasive evidence of an arrangement exists, fees are fixed and
determinable, and collections are probable.
18
Revenues from post-contract customer support, such as maintenance, are
recognized on a straight-line basis over the term of the contract.
Allowance for doubtful accounts
We make estimates regarding the collectibility of our accounts
receivables. When we evaluate the adequacy of our allowance for doubtful
accounts, we closely analyze specific accounts receivable balances, historical
bad debts, customer creditworthiness, current economic trends and changes in our
customer payments terms. Material differences may result in the amount and
timing of expense for any period if we were to make different judgments or
utilize different estimates. If the financial condition of our customers
deteriorates resulting in an impairment of their ability to make payments, or if
payments from customers are significantly delayed, additional allowances might
be required.
Goodwill and other intangible assets
Under current accounting standards, that are to be modified at the
start of our next fiscal year, we make judgments about the remaining useful
lives of goodwill, purchased intangible assets and other long-lived assets
whenever events or changes in circumstances indicate an other than temporary
impairment in the carrying value of the assets recorded on our balance sheet. In
order to judge the remaining useful life of an asset, we make various
assumptions about the value of the asset in the future. This may include
assumptions about future prospects for the business that the asset relates to
and typically involves computations of the estimated future cash flows to be
generated by these businesses. Based on these judgments and assumptions, we
determine whether we need to take an impairment charge to reduce the value of
the asset stated on our balance sheet to reflect its actual fair value.
Judgments and assumptions about future values and remaining useful
lives are complex and often subjective. They can be affected by a variety of
factors, including external factors such as industry and economic trends, and
internal factors such as changes in our business strategy and our internal
forecasts. Although we believe the judgments and assumptions we have made in the
past have been reasonable and appropriate, different judgments and assumptions
could materially impact our reported financial results. Different assumptions of
the anticipated future benefits from these businesses would result in greater or
lesser impairment charges, which would affect net income and result in different
amounts on our balance sheet. Beginning next fiscal year, the method for
assessing potential impairments of intangibles will change based on new
accounting rules issued by the FASB and related implementation guidance.
Capitalized software development costs
We capitalize certain software development costs after establishment of
a product's technological feasibility. Such costs are then amortized over the
estimated life of the related product. Periodically, we compare a product's
unamortized capitalized cost to the product's net realizable value. To the
extent unamortized capitalized costs exceed net realizable value based on the
product's estimated future gross revenues, reduced by the estimated future costs
of completing and disposing of the product, the excess is written off. This
analysis requires us to estimate future gross revenues associated with certain
products, and the future costs of completing and disposing of certain products.
If these estimates change, write-offs of capitalized software costs could
result.
Income taxes
We use the asset and liability approach to account for income taxes.
This methodology recognizes deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax base of assets and liabilities. We then record a valuation allowance
to reduce deferred tax assets to an amount that likely will be realized. We
consider future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance. If we determine
during any period that we could realize a larger net deferred tax asset than the
recorded amount, we would adjust the deferred tax asset to increase income for
the period. Conversely, if we determine that we would be unable to realize a
portion of our recorded deferred tax asset, we would adjust the deferred tax
asset to record a charge to income for the period.
19
Contingencies and litigation
We are subject to various proceedings, lawsuits and claims relating to
product, 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. The amount of loss accrual, if any, is
determined after careful analysis of each matter, and is subject to adjustment
if warranted by new developments or revised strategies.
Risk Factors
We face numerous risks in connection with the proposed merger with HNC. These
risks may adversely affect our results of operations whether or not the merger
is completed.
We are subject to the risk that the merger may not be completed on a
timely basis or at all. These risks include the following:
o If the merger is not completed, the price of our common stock
may decline to the extent that its current market price
reflects a market assumption that the merger will be
completed.
o Our business may be adversely affected to the extent that the
prospect of the proposed merger harms our relationships with
customers and employees. Customers may delay or defer
purchasing decisions because of uncertainty about the
direction of the combined company's product offerings.
Employees may be uncertain about their future role with the
combined company until integration plans are finalized, which
could adversely effect our ability to attract or retain key
employees.
o The completion of the merger depends on regulatory approval
which, even if granted, may result in unfavorable restrictions
or conditions. Any delay in the completion of the merger could
diminish the anticipated benefits of the merger or result in
additional transaction costs, loss of revenue or other effects
associated with uncertainty about the transaction, including a
decline in the price of our common stock.
o We will be required to pay significant costs incurred in
connection with the merger, including legal, accounting and a
portion of the financial advisory fees and certain filing
fees, whether or not the merger is completed.
Even if the merger is completed, the combined company may not realize
the expected benefits of the merger because of integration and other challenges.
These risks include the following:
o The failure of the combined company to meet the complex
challenges involved in integrating the products, technology,
personnel and other operations of the Company and HNC
successfully or otherwise to realize any of the anticipated
benefits of the merger, including anticipated cost savings,
could seriously harm the results of operations of the combined
company.
o Managing the implementation of the integration plan will
divert management attention from ongoing business concerns,
which could harm future operating results.
o The combined company must retain and motivate key employees,
which will be more difficult in light of uncertainty regarding
the merger, and failure to do so could seriously harm the
combined company. Motivating employees and keeping them
focused on the strategies and goals of the combined company
may be particularly difficult due to the potential
distractions of the merger and morale challenges posed by
workforce reductions of the combined company anticipated in
connection with the merger.
o Charges to earnings resulting from the application of the
purchase method of accounting may adversely affect the market
value of our common stock following the merger. Under the
purchase method of accounting, the combined company will
allocate the total estimated purchase price to HNC's net
tangible assets, amortizable intangible assets, intangible
assets with indefinite lives and in-process research and
development based on their fair values as of the date of
completion of the merger, and record the excess of the
purchase price over those fair values as goodwill. The portion
of the estimated purchase price allocated to in-process
research and development will be expensed by the combined
company in the quarter in which the merger is completed. That
amount has not yet been determined, but may be material. The
combined company will incur additional depreciation and
amortization expense over the useful lives of certain of the
net tangible and intangible assets acquired in connection with
the merger. In addition, to the extent the value of goodwill
or intangible assets with indefinite lives becomes impaired,
the combined company may
20
be required to incur material charges relating to the
impairment of those assets. The combined company will also
incur liabilities and restructuring charges associated with
integration planning, including costs associated with employee
severance and facilities closures, which are currently unknown
but may be material.
The foregoing risks will be described in more detail in the joint proxy
statement/prospectus related to the merger which we will file with the SEC as a
registration statement on Form S-4.
Our revenues are dependent, to a great extent, upon general economic conditions
and more particularly, upon conditions in the consumer credit and the financial
services industries.
Approximately 82% of our revenues are derived from sales of products
and services to the consumer credit and financial services industry in the first
half of both fiscal 2002 and 2001. A downturn in the consumer credit industry or
the financial services industry caused by increases in interest rates or a
tightening of credit, among other factors, could harm our results of operations.
The revenue growth and profitability of our business depends on the overall
demand for our existing and new products. A softening of demand for our
decisioning solutions caused by a weakening of the economy generally may result
in decreased revenues or lower growth rates. There can be no assurance that we
will be able to effectively promote future revenue growth in our business. Since
1990, while the rate of account growth in the U.S. bankcard industry has been
slowing and many of our largest institutional clients have merged and
consolidated, we have generated most of our revenue growth from our
bankcard-related scoring and account management business by cross-selling our
products and services to large banks and other credit issuers. As this industry
continues to consolidate, we may have fewer opportunities for revenue growth.
For example, consolidation in the financial services industry could change the
demand for our products and services that support our clients' customer
acquisitions programs. There can be no assurance that we will be able to
effectively promote future revenue growth in our business. In addition, recent
terrorist attacks upon the U.S. have added (or exacerbated) economic, political
and other uncertainties, which could adversely affect the Company's revenue
growth.
Quarterly revenues and operating results have varied significantly in the past
and this unpredictability will likely continue in the future.
Our revenues and operating results have varied significantly in the
past. We expect fluctuations in our operating results to continue for the
foreseeable future. Consequently, we believe that period-to-period comparisons
of our financial results should not be relied upon as an indication of future
performance. It is possible that in some future periods our operating results
may fall below the expectations of market analysts and investors, and in this
event the market price of our common stock would likely fall. In addition, with
the exception of the cost of ScoreNet service data purchased by us, most of our
operating expenses are not affected by short-term fluctuations in revenues;
thus, short-term fluctuations in revenues may have a significant impact on
operating results. Factors that affect our revenues and operating results
include the following:
o Variability in demand from our existing customers,
particularly within our Strategy Machine and Scoring segments;
o The lengthy sales cycle of many of our products;
o Consumer dissatisfaction with, or problems caused by, the
performance of our personal credit management products;
o Our ability to successfully and timely develop, introduce and
market new products and product enhancements;
o The timing of our new product announcements and introductions
in comparison with our competitors;
o The level of our operating expenses;
o Changes in competitive conditions in the consumer credit and
financial services industries;
o Fluctuations in domestic and international economic
conditions;
o Acquisition-related expenses and charges;
o Timing of orders for and deliveries of certain software
systems; and
o Other factors unique to our product lines.
21
Our ability to increase our revenues is highly dependent upon the introduction
of new products and services and if our products and services are not accepted
by the marketplace, our business may be harmed.
We have a significant share of the available market for our traditional
products and services, such as the products and services included in our Scoring
and Strategy Machine segment (specifically, account management services at
credit card processors). To increase our revenues, we must enhance and improve
existing products and continue to introduce new products and new versions of
existing products that keep pace with technological developments, satisfy
increasingly sophisticated customer requirements and achieve market acceptance.
We believe much of our future growth prospects will rest on our ability to
continue to expand into newer markets for our products and services, such as
direct marketing, insurance, small business lending, retail, telecommunications
and our newest market, personal credit management. If our current or potential
customers are not willing to switch to or adopt our new products and services,
our revenues will be harmed.
There are significant risks associated with the introduction of new products.
Significant undetected errors or delays in new products or new versions
of a product, especially in the area of customer relationship management, may
affect market acceptance of our products and could harm our business, results of
operations or financial position. If we were to experience delays in the
commercialization and introduction of new or enhanced products, if customers
were to experience significant problems with the implementation and installation
of products, or if customers were dissatisfied with product functionality or
performance, our business, results of operations or financial position could be
harmed.
There can be no assurance that our new products will achieve
significant market acceptance or will generate significant revenue. Products
that we plan to directly or indirectly market in the future are in various
stages of development. We are expanding our technology into a number of new
business areas to foster long-term growth, including consumer services and the
design of business strategies using our new Strategy Science technology. These
areas are relatively new to our product development and sales and marketing
personnel. There is no assurance that we will compete effectively or will
generate significant revenues in these new areas.
Failure to obtain data from our clients to update and re-develop or to create
new models could harm our business.
Updates of models and development of new and enhanced models depend to
a significant extent on availability of statistically relevant data. Such data
is usually obtained under agreements with our clients. Refusals by clients to
provide such data or to obtain permission of their customers to provide such
data, and privacy and data protection restrictions, could result in loss of
access to the required data. Any interruption of our supply of data could have a
material adverse effect on our business, financial condition or results of
operations.
Our business and the business of our clients are subject to government
regulation and changes in regulation.
Legislation and governmental regulation inform how our business is
conducted. Both our core businesses and our newer consumer initiatives are
affected by regulation. In both arenas, significant regulatory areas include:
federal and state regulation of consumer report data and consumer reporting
agencies, like the Fair Credit Reporting Act (the "FCRA"); regulation designed
to insure that lending practices are fair and non-discriminatory, like the Equal
Credit Opportunity Act; and privacy law, like provisions of the Financial
Services Modernization Act of 1999. A variety of other consumer protection laws
affect our business such as federal and state statutes governing the use of the
Internet and telemarketing. In addition, many foreign jurisdictions relevant to
our business have regulation in one or more of these general areas. For example,
in the European Union (EU) the Privacy Directive (Directive 95/46/EC) creates
minimum standards for the protection of personal data. In addition, some EU
member states have enacted protections which go beyond the requirements of the
Privacy Directive.
In connection with our core business-to-business activities, these
statutes govern our operations directly to some degree. For example, the
Financial Services Modernization Act's restrictions on the use
22
and transmittal of nonpublic personal information govern some of our activities.
However, governmental regulation has a significant indirect effect on such
activities because such regulation influences our clients' expectations and
needs vis-a-vis our products and services. Our current and prospective clients'
activities are closely governed by the regulations outlined above and by other
regulations. For example, our clients include credit bureaus, credit card
processors, state and federally chartered banks, savings and loan associations,
credit unions, consumer finance companies, and other consumer lenders and
insurers, all of which are subject to extensive and complex federal and state
regulations, and often international regulations. The products and services we
sell to such clients must be appropriately designed to function in these
regulated industries. Moreover, industries we may target in the future may also
be subject to extensive regulations.
In connection with our consumer services, many of the same regulations
are pertinent. In this arena, however, our activities are more directly affected
by regulation. For example, the Fair Credit Reporting Act, or FCRA, governs when
and how we may deliver credit score explanation services to consumers. The
Financial Services Modernization Act of 1999 requires us to make certain
disclosure to consumers regarding our collection and use of personal information
and grants consumers certain opt out rights. This type of regulation creates
risk associated with compliance, such as possible regulatory enforcement action.
Changes to existing regulation or legislation, new regulation or
legislation, or more restrictive interpretation of existing regulation by
enforcement agencies, could harm our business, results of operations and
financial condition. Examples of possible regulatory developments that could
affect our business include new restrictions on the sharing of information by
affiliated entities, narrowing of the permitted uses of consumer report data,
and mandates to provide credit scores to consumers. The permitted uses of
consumer report data in connection with certain customer acquisition efforts are
governed primarily by the FCRA. The relevant federal preemption provisions
effectively sunset in 2004. Unless extended, the sunset of preemption could lead
to greater state regulation, increasing the cost of customer acquisition
activity. Such state legislation could cause financial institutions to pursue
new strategies, negatively affecting the demand for our existing offerings.
Our operations outside the United States subject us to unique risks that may
harm our results of operations.
A growing portion of our revenues is derived from international sales.
During the six months ended March 31, 2002, approximately 19% of our revenues
was derived from business outside the United States and approximately 18% and
19% in fiscal 2001 and 2000 respectively. As part of our growth strategy, we
plan to continue to pursue opportunities outside the United States. Accordingly,
our future operating results could be negatively affected by a variety of
factors arising out of international commerce, some of which are beyond our
control. These factors include:
o The general economic and political conditions in countries
where we sell our products and services;
o Incongruent tax structures;
o Difficulty in staffing and managing our organization's
operations in various countries;
o The effects of a variety of foreign laws and regulations;
o Import and export licensing requirements;
o Longer payment cycles;
o Currency fluctuations and changes in tariffs and other trade
barriers; and
o Difficulties and delays in translating products and related
documentation into foreign languages.
There can be no assurance that we will be able to successfully address
each of these challenges in the near term. Some of our business is conducted in
currencies other than the U.S. dollar. Foreign currency transaction gains and
losses are not currently material to our financial position, results of
operations or cash flows. Foreign currency transaction losses were $89,000, and
$398,000 for the first half of fiscal 2002 and 2001, respectively. An increase
in our foreign revenues could subject us to increased foreign currency
transaction risks in the future.
23
If we do not recruit and retain qualified personnel, our business could be
harmed.
Our continued growth and success depend, to a significant extent, on
the continued service of our senior management and other highly qualified key
research, development, sales and marketing personnel and the hiring of new
qualified personnel. Competition for highly skilled business, product
development, technical and other personnel is intense. There can be no assurance
that we will be successful in continually recruiting new personnel and in
retaining existing personnel. In general, we do not have long-term employment or
non-competition agreements with our employees. The loss of one or more key
employees or our inability to attract additional qualified employees or retain
other employees could harm our revenues and results of operations.
We rely upon our proprietary technology rights and if we are unable to protect
them, our business could be harmed.
Because the protection of our proprietary technology is limited, our
proprietary technology could be used by others without our consent. Our success
depends, in part, upon our proprietary technology and other intellectual
property rights. To date, we have relied primarily on a combination of
copyright, patent, trade secret, and trademark laws, and nondisclosure and other
contractual restrictions on copying and distribution to protect our proprietary
technology. We cannot assure you that our means of protecting our intellectual
property rights in the United States or abroad will be adequate or that others,
including our competitors, will not use our proprietary technology without our
consent. Furthermore, litigation may be necessary to enforce our intellectual
property rights, to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others, or to defend against claims of
infringement or invalidity. Such litigation could result in substantial costs
and diversion of resources and could harm our business, operating results and
financial condition.
We may be subject to possible infringement claims that could harm our business.
With recent developments in the law that permit patenting of business
methods, we expect that products in the industry segments in which we compete
will increasingly be subject to claims of patent infringement as the number of
products and competitors in our industry segments grow and the functionality of
products overlaps. Similarly, we expect more software products will be subject
to patent infringement claims in light of recent developments in the law that
extend the ability to patent software. Regardless of the merits, responding to
any such claim made against us could be time-consuming, result in costly
litigation and require us to enter into royalty and licensing agreements on
terms unfavorable to us. If a successful claim is made against us and we fail to
develop or license a substitute technology, our business, results of operations
or financial position could be harmed.
Security is important to our business, and breaches of security, or the
perception that e-commerce is not secure could harm our business.
Internet-based, business-to-business electronic commerce requires the
secure transmission of confidential information over public networks. Several of
our products, including our new consumer services, are accessed through the
Internet. Consumers using the Internet to access their personal information will
demand the secure transmission of such data. Security breaches in connection
with the delivery of our products and services, including our netsourced
products and consumer services, or well-publicized security breaches affecting
the Internet in general, could significantly harm our business, operating
results and financial condition. We cannot be certain that advances in computer
capabilities, new discoveries in the field of cryptography, or other
developments will not result in a compromise or breach of the technology we use
to protect content and transactions on the networks on which the netsourced
products and the proprietary information in our databases are accessed or on
which the consumer services is made available. Anyone who is able to circumvent
our security measures or the security measures of our business partners could
misappropriate proprietary, confidential customer information or cause
interruptions to our operations. We may be required to incur significant costs
to protect against security breaches or to alleviate problems caused by such
breaches. Further, a well-publicized compromise of security could deter people
and businesses from using the Internet to conduct transactions that involve
transmitting confidential information.
24
We are dependent upon major contracts with credit bureaus.
A substantial portion of our revenues is derived from contracts with
the three major credit bureaus. These contracts, which normally have a term of
five years or less, accounted for approximately 38%, and 37% of our revenues in
fiscal 2001 and 2000, respectively. If we are unable to renew any of these
contracts on the same or similar terms, our revenues and results of operations
would be harmed.
We may incur risks related to acquisitions or significant investment in
businesses.
As part of our business strategy, we have made in the past, and may
make in the future, acquisitions of, or significant investments in, businesses
that offer complementary products, services and technologies, such as the
planned merger with HNC that we recently announced. Any acquisitions or
investments will be accompanied by the risks commonly encountered in
acquisitions of businesses. Such risks include, among other things, the
possibility that we will pay more than the acquired company or assets are worth,
the difficulty of assimilating the operations and personnel of the acquired
businesses, the potential product liability associated with the sale of the
acquired company's products, the potential disruption of our ongoing business,
the distraction of management from our business, and the impairment of
relationships with employees and clients as a result of any integration of new
management personnel. These factors could harm our business, results of
operations or financial position, particularly in the case of a larger
acquisition. Consideration paid for future acquisitions, if any, could be in the
form of cash, stock, and rights to purchase stock or a combination thereof.
Dilution to existing stockholders and to earnings per share may result in
connection with any such future acquisitions.
Backlog orders may be cancelled or delayed.
There is no assurance that backlog will result in revenues. We believe
that increased revenue growth in fiscal 2002 and later years will continue to
depend on sales of newly developed products.
25
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Disclosures
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risk
related to changes in interest rates, foreign currency exchange rates and equity
security price risk. We do not use derivative financial instruments for
speculative or trading purposes.
Interest Rate Sensitivity
We maintain an investment portfolio consisting mainly of income
securities with an average maturity of less than five years. These
available-for-sale securities are subject to interest rate risk and will fall in
value if market interest rates increase. We have the ability to hold our fixed
income investments until maturity, and therefore we would not expect our
operating results or cash flows to be affected to any significant degree by the
effect of a sudden change in market interest rates on our securities portfolio.
We believe that our foreign currency and equity risks are not material.
The following table presents the principal amounts and related
weighted-average yields for our fixed rate investment portfolio at March 31,
2002 and September 30, 2001:
March 31, 2002 September 30, 2001
--------------------------- ----------------------------
Book/Market Average Book/Market Average
(in thousands) Value Yield Value Yield
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ 95,504 1.75% $ 16,918 2.87%
Short-term investments 7,728 2.11% 13,800 2.57%
Long-term investments 64,135 3.94% 110,709 3.78%
-------- --------
$167,367 2.61% $141,427 3.55%
======== ========
26
ITEM 6. Exhibits and Reports on Form 8-K.
(b) Reports on Form 8-K:
No report on Form 8-K was filed during the quarter ended March 31,
2002.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FAIR, ISAAC AND COMPANY, INCORPORATED
DATE: May 14, 2002
By /s/ Henk J. Evenhuis
---------------------------------------
Henk J. Evenhuis
Vice President and Chief
Financial Officer
28