Fair Isaac Corporation (FICO) — Form 10-Q
Business context and period: FICO provides analytics, software, data management and credit-scoring solutions. This fiscal third-quarter report covers the quarter and nine months ended June 30, 2011; comparisons are with the same periods in 2010. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and liquidity
| Metric | Quarter ended June 30, 2011 | Prior-year quarter | Nine months ended June 30, 2011 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $150.7 | $155.3 | $459.4 | $450.5 |
| Operating income | $37.4 | $31.1 | $86.2 | $85.8 |
| Operating margin | 24.8% | 20.0% | 18.8% | 19.0% |
| Net income | $23.2 | $17.9 | $46.9 | $48.6 |
| Diluted EPS | $0.58 | $0.40 | $1.16 | $1.04 |
Quarterly revenue declined 3%, while operating income rose 20% and net income rose 29%. For the nine-month period, revenue increased 2%, operating income was nearly flat, and net income declined 3%. Nine-month diluted EPS rose despite lower net income, alongside fewer weighted-average shares. Net margin, calculated from reported figures, was 15.4% for the quarter and 10.2% year to date.
- Revenue mix and segments: Quarterly Applications revenue grew 1% to $92.1 million; Scores fell 10% to $41.8 million; Tools fell 3% to $16.8 million. For nine months, Applications rose 5% to $285.6 million, Scores declined 5% to $123.6 million, and Tools rose 3% to $50.2 million. Applications growth reflected fraud and origination solutions; Scores weakness included lower bureau-channel volumes and the absence of a prior-year royalty-fee true-up.
- Cash flow: Nine-month operating cash flow was $105.1 million, up from $84.0 million. Investing activities used $57.7 million, mainly reflecting net purchases of marketable securities; financing activities used $54.9 million, including $53.8 million of share repurchases and $8.0 million of debt repayment. Cash and equivalents declined $5.3 million to $140.9 million.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $263.4 million at June 30. Senior notes were $512.0 million in total, including $8.0 million current maturities; no borrowings were outstanding on the $200 million revolving facility. The facility was due to expire October 20, 2011. Management said available liquidity, the facility and expected operating cash flows should cover working capital, capital needs and scheduled debt repayments over the next 12 months. Current assets were $376.4 million and current liabilities $134.7 million.
- Capital returns: FICO repurchased 1.86 million shares for $52.7 million in the nine months, with $122.1 million remaining under its authorization at June 30. The quarterly dividend was $0.02 per share; management expected to continue the current rate, subject to Board review.
Material changes and management commentary
- Quarterly operating improvement reflected lower operating expenses, particularly R&D, SG&A and amortization; operating expenses fell 9% despite revenue declining 3%. Year-to-date operating income was affected by $12.4 million of restructuring charges, absent in the prior-year period.
- Restructuring charges arose from a reengineering initiative: $8.2 million for reductions of 177 positions and $3.3 million for excess leased space, plus $0.9 million of facility-related charges in the prior quarter. Most severance payments had been made by the end of the third quarter; facility obligations are expected to be paid over several years.
- Bookings were $50.0 million for the quarter versus $63.5 million a year earlier; bookings yield was 24% versus 29%, and weighted-average term was 19 months versus 28 months. Nine-month bookings rose to $191.6 million from $177.7 million. The company cautions that bookings rely on estimates and are not backlog.
- Management described economic conditions as stabilized with gradual improvement, but noted persistent U.S. unemployment and housing-market weakness and a modest expected global recovery. It planned continued expense management and investment in Decision Management and core operations. It expected cost of revenue as a percentage of revenue to remain consistent or rise slightly; R&D and SG&A ratios to be slightly higher; amortization slightly lower; and interest expense consistent with the June-quarter level. No specific revenue or EPS guidance was provided in the supplied filing text.
Risks, contingencies and unusual items
- Banking and insurance generated 79% of quarterly revenue and 78% of nine-month revenue. FICO also reported that the three major credit bureaus collectively accounted for approximately 19% of quarterly revenue and 18% year to date, including revenue recorded in other segments. Changes in bureau relationships or distribution could materially affect results.
- Management identified ongoing economic, customer-transaction-volume, competitive, regulatory, data-access, cybersecurity and international risks. It warned that a weaker-than-expected recovery could reduce Applications reporting-unit value and potentially trigger goodwill impairment. At the July 2010 test, Applications fair value was 110% of carrying value; specified adverse changes in cash flow or discount rate could have caused the unit to fail the first impairment test step.
- The $200 million revolving credit facility expired in October 2011 and contained leverage and fixed-charge covenants. FICO reported compliance at June 30 and no outstanding borrowings; renewal or replacement terms are not provided in the supplied text.
- Unrecognized tax benefits were estimated at $13.5 million, with $1.7 million of accrued interest. Customer disputes, former-employee claims and other ordinary-course legal matters were disclosed; management did not expect them to have a material adverse effect, but potential loss amounts could not be determined with certainty.
- FICO’s appeal in litigation involving Experian and VantageScore was awaiting an Eighth Circuit ruling expected later in 2011. Separately, the Braun-related IPO class-action settlement required no FICO contribution but remained subject to appeal.
- Foreign-exchange forwards were used to offset currency exposures, were short-term and had zero fair value at period end. The company reported no material off-balance-sheet arrangements and said disclosure controls were effective.
Important facts for investors to verify
- Whether the credit facility was renewed or replaced before its October 2011 expiration, and the resulting borrowing capacity and covenant terms.
- Subsequent bureau-channel transaction volumes, major credit-bureau contract developments and concentration of revenue among key customers.
- Bookings conversion and term, particularly given lower quarterly bookings and yield; bookings are estimates, not committed backlog.
- Progress and cash costs of restructuring, and whether planned cost reductions and investment support margins and revenue growth.
- Applications goodwill impairment headroom under updated forecasts and market assumptions.
- Developments in the Experian/VantageScore appeal, tax positions and other disclosed legal or customer contingencies.