ITEM 1. BUSINESS
Development Of The Business
Fair, Isaac and Company, Incorporated (NYSE: FIC)("Fair, Isaac" or the "Company") is a leading developer of data management systems and services for the financial services, direct marketing and personal lines insurance industries. The Company employs various tools, such as database enhancement software, predictive modeling, adaptive control and systems automation to help its customers make "better decisions through data."
Established in 1956, Fair, Isaac pioneered the credit risk scoring technologies now employed by most major U.S. consumer credit grantors. Its rule-based decision management systems, originally developed to screen consumer credit applicants, are now routinely employed in all phases of the credit account cycle: direct mail solicitation (credit cards, lines of credit, etc.), application processing, card reissuance, on-line credit authorization and collection. Although direct comparisons are difficult, management believes Fair, Isaac ranks first or second in sales of every type of credit management product or service it markets, and that its total sales to the consumer credit market exceed those for similar products by any direct competitor.
Approximately 48 percent of fiscal 1998 revenues were derived from usage-priced products and services marketed through alliances with major credit bureaus and third-party credit card processors. Sales of decision management products and services directly to credit industry end-users accounted for approximately 25 percent of revenues.
In more recent years Fair, Isaac has expanded its product and service offerings, applying its proven risk/reward modeling capabilities to automobile and home insurance underwriting, small business and mortgage lending, telecommunications and most recently, healthcare. With the acquisition of DynaMark in December 1992, the Company made its first foray into marketing data processing and database management, an area it considers a prime target for diversification. Its strategy in this area is to develop and market an array of services combining DynaMark's strengths in warehousing and manipulating complex consumer databases with Fair, Isaac's expertise in predictive modeling and decision systems. DynaMark contributed $49.2 million or 20 percent of Fair, Isaac's fiscal 1998 revenues. The Company's Insurance business unit generated revenues in fiscal 1998 of $9.2 million or 4 percent of revenues. In fiscal l997, the Company recorded its first revenues from its new Healthcare Information business unit, and during fiscal 1998 derived revenues from providing analytical marketing services to a large pharmaceuticals manufacturer to help improve customer relationships and management of prescription compliance (i.e., a patient's fulfillment of prescriptions and taking them to completion).
In July 1997 the Company acquired Risk Management Technologies (RMT), a leading provider of enterprise-wide risk management and performance measurement solutions to major financial institutions around the world. This acquisition enables the Company to extend its franchise in providing data-driven decision support to the financial services industries beyond its current focus on individual customers. With RMT's products and services, the Company has positioned itself to support an institution's entire financial risk management operation, encompassing both the consumer and enterprise levels. RMT's revenues in fiscal l998 were $6.2 million, or 3 percent of the Company's revenues. The Company's historical financial statements for prior fiscal year periods have been restated to account for the Company's merger with RMT on a pooling-of-interests basis.
Fair, Isaac numbers hundreds of the world's leading credit card and travel card issuers, retail establishments and consumer lenders among its regular customers. It has enjoyed continuous client relationships with some of these companies for nearly 30 years. Through alliances with all three major U.S. credit bureaus, the Company also serves a large and growing number of middle-market credit grantors, primarily by providing direct mail solicitation screening, application scoring and account management services on a usage-fee basis. In addition, some of its newer end-user products, such as CreditDesk(R) application processing software and CrediTable(R) pooled-data scoring systems, are designed to meet the needs of relatively small users of scoring systems.
Approximately 17 percent of Fair, Isaac's fiscal 1998 revenues came from sales outside the United States. With its long-standing presence in Western Europe and Canada and the more recent establishment of operating bases in Great Britain, France, Germany, Japan, Mexico and South Africa, the Company is well positioned to benefit from the expected growth in global credit card issuance and usage through the balance of the 1990s. In September l997 the Company signed an agreement with Serasa Centralizaco de Servicos dos Banco, Brazil's largest credit reporting agency, which will result in the first bureau-based score delivery service in Brazil.
Since 1993, Fair, Isaac's revenues and diluted earnings per share have increased at a compound rate of 30 percent and 35 percent, respectively. The Company attributes this growth to rising market demand for credit scoring and account management services; success in increasing its share of the market; and a gradual shift in marketing and pricing strategy, from primary reliance on direct, end-user sales of customized analytical and software products to ongoing usage revenues from services provided through credit bureaus and bankcard processing agencies.
During the period since 1990, while the rate of account growth in the U.S. bankcard industry has been slowing and many of the Company's largest institutional clients have merged and consolidated, the Company has generated above-average growth in revenues--even after adjusting for the effect of acquisitions--from its bankcard-related scoring and account management businesses by deepening its penetration of large banks and other credit issuers. The Company believes much of its future growth prospects will rest on its ability to: (1) develop new, high-value products, (2) increase its penetration of established or emerging credit markets outside the U.S. and Canada and (3) expand--either directly or through further acquisitions--into relatively undeveloped or underdeveloped markets for its products and services, such as direct marketing, insurance, small business lending and healthcare information management.
Products and Services
The Company's principal products are statistically derived, rule-based analytic tools designed to help businesses make better decisions on their customers and prospective customers, and software systems and components to implement these analytic tools. In addition to sales of these products directly to end-users, the Company also makes these products available in service mode through arrangements with credit bureaus and third-party credit card processors. The Company's DynaMark subsidiary provides data processing and database management services to businesses engaged in direct marketing. Its RMT subsidiary provides management tools to larger, more sophisticated financial institutions for enterprise-wide, integrated financial risk and profitability management.
Products and services sold to the consumer credit industry have traditionally accounted for most of the Company's revenues. However, the Company is actively promoting its products and services to other segments of the credit industry, including mortgage and small business lending; and to non-credit industries, particularly personal lines insurance, direct marketing, telecommunications and healthcare. Consumer credit accounted for over 73 percent of the Company's revenues in each of the three years in the period ended September 30, 1998. Sales to customers in the direct marketing business, including the marketing arms of financial service businesses, accounted for 13 to 20 percent of revenues in each of the three years in the period ended September 30, 1998. Revenues from sales to the insurance industry accounted for 3 to 4 percent of revenues in each of the three years in the period ended September 30, 1998. In fiscal 1997 the Company's recorded the first revenues from its new Healthcare Information business unit, and during fiscal 1998 derived revenues from providing analytical marketing services to a large pharmaceuticals manufacturer to help improve customer relationships and management of prescription compliance (i.e., a patient's fulfillment of prescriptions and taking them to completion).
Analytic Products
The Company's primary analytic products are scoring algorithms (also called "scorecards") which can be used in screening lists of prospective customers, evaluating applicants for credit or insurance and managing existing credit accounts. Some of the most common types of scoring algorithms developed by the Company are described below. Scoring algorithms are developed by correlating information available at the time a particular decision is made with known performance at a later date. Scoring algorithms can be developed to predict the likelihood of
different kinds of performance (e.g., credit delinquency, response to a solicitation, and insurance claims frequency); they can be developed from different data sources (e.g., credit applications and credit bureau files); and they can be developed either for a particular user ("custom" scorecards) or for many users in a particular industry ("pooled data" or "generic" scorecards).
Credit Application Scoring Algorithms. First introduced in 1958, Credit Application Scoring Algorithms are tools that permit credit grantors to calculate the risk of lending to individual applicants. They are delivered in the form of a table of numbers, one for each possible answer to each of about ten to twelve selected predictive questions that are found on the form filled in by the applicant or on a credit report purchased by the credit grantor. The user "scores" an applicant by looking in the table for the number associated with the answers provided about the applicant and calculating their sum. The "score" thus obtained is compared to a "cutoff score" previously established by the credit grantor's management to determine whether or not to extend the requested credit. A significant proportion of revenues from Credit Application Scoring Algorithms is derived from sales of new or replacement algorithms to existing users.
Behavior Scoring Algorithms. The Company pioneered Behavior Scoring Algorithms with a research program in 1969. The first commercially successful products were introduced in 1978. In contrast to Credit Application Scoring Algorithms which deal with credit applicants, Behavior Scoring Algorithms permit management to define rules for the treatment of existing credit customers on an ongoing basis.
Although similar in statistical principle and manner of construction, Behavior Scoring Algorithms differ in several important respects from Credit Application Scoring Algorithms. First, rather than using an applicant's answers on a credit application or a credit report, the data used to determine a behavior score come from the customer's purchase and payment history with that credit grantor. Second, each customer is scored monthly, rather than only at application time, and an action is selected each time in response to the score. Third, the available actions are much more varied than simply granting or denying credit to an applicant. For example, if an account is delinquent, the actions available to a credit manager can include a simple message on a customer's bill calling attention to the delinquency, a dunning letter, a phone call, or a referral to a collection agency, with the action to be taken in any given case to be determined by the customer's behavior score.
Scores produced by specially designed Behavior Scoring Algorithms can be used to select actions for mailing promotional materials to customers, for changing the credit limits allowed, for authorizing individual credit card transactions, for taking various actions on delinquent accounts and for reissuing credit cards which are about to expire. Behavior Scoring Algorithms are also components of the Adaptive Control Systems described below.
Credit Bureau Scoring Services. The Company also provides scoring algorithms to each of the three major automated credit bureaus in the United States based solely on the information in their files. Customers of the credit bureau can use the scores derived from these algorithms to prescreen solicitation candidates, to evaluate applicants for new credit and to review existing accounts. Credit grantors using these services pay based on usage and the Company and the credit bureau share these usage revenues. The PreScore(R) service offered by the Company combines a license to use such algorithms for prescreening solicitation candidates along with tracking and consulting services provided by the Company and is priced on a time or usage basis.
ScoreNet(SM) Service. The ScoreNet Service, introduced in August 1991, allows credit grantors to obtain Fair, Isaac's credit bureau scores and related data on a regular basis and in a format convenient for use in their account management programs. In most cases the account management program is a Fair, Isaac Adaptive Control System or Adaptive Control service at a credit card processor. The Company obtains the data from the credit bureau(s) selected by each subscriber and delivers it to the subscriber in a format compatible with the subscriber's account management system.
Insurance Scoring Algorithms. The Company has also delivered scoring systems for insurance underwriters and marketers. Such systems use the same underlying statistical technology as credit scoring systems, but are designed to predict claim frequency or profitability of applicants for personal insurance such as automobile or homeowners'
coverage. During fiscal 1993, the Company introduced a Property Loss Score ("PLS") service in conjunction with Equifax, Inc., a leading provider of data to insurance underwriters. In 1994, the Company introduced a similar service in conjunction with Trans Union Corporation called "ASSIST" which is designed to predict automobile insurance risk. In 1995, with Equifax Inc., the Company introduced a risk prediction score for automobile insurance called Casualty Loss Score ("CLS") service. Equifax subsequently spun off its Insurance Unit, which is now Choicepoint. In 1996, with Acxiom, the Company introduced a risk prediction score for homeowners' and automobile insurance called InfoScore. PLS, ASSIST, CLS and InfoScore are similar to the credit bureau scoring services in that a purchaser of data from Choicepoint, Trans Union or Acxiom can use the scores to evaluate the risk posed by applicants for homeowners' or automobile insurance. The Company and Choicepoint, Trans Union or Acxiom, as the case may be, share the usage revenue produced by these services. Aspects of automated application processing systems and Adaptive Control Systems are also applicable to insurance underwriting decisions. The Company is actively marketing its products and services to the insurance industry.
Other Scoring Algorithms. The Company has developed scoring algorithms for other users, which include public utilities that require deposits from selected applicants before starting service, tax authorities that select returns to be audited, and mortgage lenders. The Company has also developed scoring algorithms for use in selecting life insurance salesmen, finance company managers, and prisoners suitable for early release, although to date these algorithms have not generated significant revenues.
Automated Strategic Application Processing Systems (ASAP)
The Company's Automated Strategic Application Processing systems (ASAP) automate the processing of credit applications, including the implementation of the Company's Credit Application Scoring Algorithms. The Company offers Mid-Range ASAPs which are stand-alone assemblies of hardware and software; Mainframe ASAP, SEARCH, StrategyWare,(R) and ScoreWare consisting of software for IBM and IBM-compatible mainframe computers; and CreditDesk which consists of software for personal computers. The Company does not expect significant sales of new Mid-Range ASAP systems but still derives maintenance and enhancement revenues from existing systems.
The tasks performed by ASAPs include: (i) checking for the completeness of the data initially given and printing an inquiry letter in the case of insufficient information; (ii) checking whether an applicant is a known perpetrator of fraud; (iii) electronically requesting, receiving, and interpreting a credit report when it is economic to do so; (iv) assigning a credit limit to the account, if acceptable, and printing a denial letter if not; and (v) forwarding the data necessary to originate billing records for accepted applicants.
Mid-Range ASAP is a minicomputer-based system which carries out the tasks listed above in a manner extensively "tailored" to each user's unique requirements. Mainframe ASAP is a software-only package designed to be executed on IBM or IBM-compatible mainframe computers. It is most useful for very large volume credit grantors who elect to enter application information from a number of separate locations. CreditDesk is designed for use on stand-alone or networked personal computers. Although its software functions are not tailored as extensively as the other versions of ASAP, CreditDesk features an easy-to-use graphics interface. The Company also sells software components for IBM or IBM-compatible mainframe computers under the tradenames "SEARCH" and "ScoreWare." SEARCH acquires and interprets credit bureau reports as a separate package. ScoreWare provides for easy installation of credit application scorecards and computes scores from such scorecards as part of the application processing sequence. StrategyWare combines the application processing features described "above with the "Champion/Challenger" strategy concept described below under "Adaptive Control Systems."
The Company's Mid-Range and Mainframe ASAP systems are currently being used in the United States, Canada, and Europe by banks, retailers, and other financial institutions. CreditDesk is being used by over 600 credit grantors in more than a dozen countries. To support these installations, the Company provides complete hardware and software maintenance, general software support in the form of consulting, and specific software support by producing enhancements, as well as other modifications at a user's request.
Adaptive Control Systems
The Company's most advanced product is the Adaptive Control System, now generally marketed under the tradename "TRIAD". An Adaptive Control System is a complex of behavior scoring algorithms, computer software, and account management strategy addressed to one or more aspects of the management of a consumer credit or similar portfolio. For example, the Company has developed an Adaptive Control System for use by an electric utility in the management of its customer accounts.
A principal feature of an Adaptive Control System is software for testing and evaluation of alternative management strategies, designated the "Champion and Challenger Strategy Software." The "Champion" strategy applied to any aspect of controlling a portfolio of accounts (such as determining collection messages or setting credit limits) is that set of rules considered by management to be the most effective at the time. A "Challenger" strategy is a different set of rules which is considered a viable candidate to outperform the Champion. The Company's Champion and Challenger Strategy software is tailored to the customer's billing system and is designed to permit the operation of both strategies at the same time and also to permit varying fractions of the accounts to go to each of the competing strategies. For example, if a Challenger is very different from the Champion, management may wish to test it on a very small fraction of the accounts, rather than to risk a large loss. Alternatively, if a Challenger appears to be outperforming a Champion, management can direct more and more of the account flow to it. There need not, in fact, be a limitation on the number of Challengers in place at any one time beyond the limits imposed by the ability of the Company and the user management to study the results.
A Champion/Challenger structure is based on one or more of the Company's component products, usually Behavior Scoring Algorithms, as well as Company-developed software that permits convenient allocation of accounts to strategies and convenient modification of the strategies themselves. Adaptive Control Systems can also consider information external to the particular creditor, particularly scores and other information obtained from credit bureaus, in the design of strategies. A specific goal of the Company's Adaptive Control System product is to make the account management functions of the user as independent as possible of the user's overall data processing systems development department.
For a Champion/Challenger structure to function effectively, new Challenger strategies must be developed continually as insight is gained, as external conditions change, and as management goals are modified. The Company often participates in the design and development of new Challenger strategies and in the evaluation of the results of Champion/Challenger competitions as they develop.
Contracts for Adaptive Control Systems for end-users generally include multi-year software maintenance, strategy design and evaluation, and consulting components. The Company also provides Adaptive Control services through First Data Resources, Inc. and Total System Services, Inc., the two largest third-party credit card processors in the United States. The Adaptive Control service is also available in the United Kingdom through First Data Resources, Ltd. and Bank of Scotland; in Buenos Aires, through Argencard S.A.; and in Frankfurt, through B+S Card Service Gmbh. Credit card issuers subscribing to these services pay monthly fees based on the number of accounts processed. During fiscal 1996, the Company introduced StrategyWare(R), which is an Adaptive Control System designed to apply Champion/Challenger principles to the processing of new credit accounts, rather than the management of existing accounts. The Company also believes that Adaptive Control Systems can operate in areas other than consumer credit; and, as noted above, has provided an Adaptive Control System to an electric utility company.
DynaMark
DynaMark provides a variety of data processing and database management services to companies and organizations in direct marketing. DynaMark offers several proprietary tools in connection with such services including "DynaLink" and "DynaMatch." DynaLink gives financial institutions and other users remote computer access to their "warehoused" customer account files or marketing databases. It allows them to perform on-line analyses ranging from profiling the history of a single customer purchase or credit usage to calling up print-outs of all files
having certain defined characteristics in common. DynaMatch uses a unique scoring system to identify matching or duplicate records that most standard "merge-purge" systems would overlook. Credit managers and direct marketers can use it to identify household relationships (accounts registered in different names, but sharing a common address and surname) and to eliminate costly duplicate mailings. Credit card issuers can use it to spot potentially fraudulent or overlimit credit card charges by individuals using two or more cards issued under slightly different names or addresses.
Risk Management Technologies
Risk Management Technologies (RMT) provides management tools to larger, more sophisticated financial institutions around the world for enterprise-wide, integrated financial risk and profitability management. Financial institutions must constantly evaluate the effect of interest rate changes and other factors on their entire operation including their loan, credit card and investment portfolios, to determine bottom line exposure and potential revenues. RMT's financial decision support software, the RADAR System, is a comprehensive enterprise management system that performs asset-liability management, transfer pricing, and performance measurement modeling. RMT's Genesis product is a graphical data integration management tool used to integrate data rapidly from multiple legacy systems and other sources into a consolidated, client/server data warehouse. Within this warehouse, data remain readily available for use in multiple decision-support applications.
Healthcare
The Company is currently providing analytical marketing services to a large pharmaceuticals manufacturer to help improve customer relationship and "compliance" management using a variety of techniques including internet communications. "Compliance" in this instance refers to whether prescriptions are actually filled and taken to completion. The Company has also introduced a receivables management system for hospitals and other healthcare providers. The first revenue-generating contract for this product was signed in October 1998.
Customer Service and Support
The Company provides service and support to its customers in a variety of ways. They include: (i) education of liaison teams appointed by buyers of scoring algorithms and software; ( ii) maintenance of an answering service that responds to inquiries on minor technical questions; (iii) proactive Company-initiated follow-up with purchasers of the Company's products and services; (iv) conducting seminars held several times a year in various parts of the United States and, less often, in other countries; (v) conducting annual conferences for clients in which user experience is exchanged and new products are introduced; (vi) delivery of special studies which are related to the use of the Company's products and services; and (vii) consulting and training services provided by the Company's subsidiary, Credit & Risk Management Associates, Inc. ("CRMA").
Scoring algorithms can diminish in effectiveness over time as the population of applicants or customers changes. Such changes take place for a variety of reasons, many of which are unknown or poorly understood, but some are a result of marketing strategy changes or shifts in the national or the local economy. It is to the user's advantage, therefore, to monitor the performance of its algorithms so that they can be replaced when it is economic to do so. In response to this need as well as the requirement of the Equal Credit Opportunity Act that scoring algorithms be periodically validated, the Company provides tracking services and software products which measure the continuing performance of its scoring algorithms while in use by customers.
Technology
The Company's personnel have a high degree of expertise in several separate disciplines: operations research, mathematical statistics, computer-based systems design, programming and data processing.
The fundamental principle of operations research is to direct attention to a class of management decisions, to make a mathematical model of the situation surrounding that class of decisions and to find rules for making the decisions which maximize achievement of the manager's goal. The Company's analytic products are classic
examples of this doctrine reduced to practice. The entire focus is on decision making using the best mathematical and computational techniques available.
The fundamental goal of mathematical statistics is to provide the method for deriving the maximum amount of useful information from an undigested body of data. The objective of the design of computer-based systems is to provide a mechanism for efficiently accepting input data from a source, storing that data in a cost-effective medium, operating on the data with reliable algorithms and decision rules and reporting results in readily comprehensible forms.
The Company's analytic products have a clear distinguishing characteristic in that they make management by rule possible in situations where the only alternative is reliance on a group of people whose actions can never be entirely consistent. Rules for selecting actions require computation of probabilities of results. But computing the probability of a particular result in the traditional mode, that is, by counting the number of occurrences of each possible result in all possible combinations of circumstances, clearly breaks down when the number of combinations becomes very large. When only a few thousand cases of results are available, more subtle mathematical methods must be used. The Company has been actively developing and using techniques of this kind for 42 years, as indicated by the development and continual enhancement of its proprietary suite of algorithms and computer programs used to develop scoring algorithms.
The Company's products must also interface successfully with systems already in place. For example, they must accept data in various forms and in various media such as handwritten applications, video display terminal input, and telecommunications messages from credit bureaus. They must also provide output in diverse forms and media, such as video displays, printed reports, transactions on magnetic tape and printed letters. The Company's response to this interface requirement has been to develop a staff which is expert in both logical design of information systems and the various computer languages used for coding.
Markets and Customers
The Company's products for use in the area of consumer credit are marketed to banks, retailers, finance companies, oil companies, credit unions and credit card companies. The Company has over 600 users of products sold directly by the Company to end-users. These include about 75 of the 100 largest banks in the United States; several of the largest banks in Canada; approximately 40 banks in the United Kingdom; more than 70 retailers; 7 oil companies; major travel and entertainment card companies; and more than 40 finance companies. Custom algorithms and systems have generally been sold to larger credit grantors. The scoring, application processing and adaptive control services offered through credit bureaus and third-party processors are intended, in part, to extend usage of the Company's technology to smaller credit issuers and the Company believes that users of its products and services distributed through third-parties number in the thousands. As noted above, the Company also sells its products to utilities, tax authorities, and telecommunications and insurance companies.
DynaMark markets its services to a wide variety of businesses engaged in direct marketing. These include banks and insurance companies, catalog merchandisers, fund-raisers and others. Most of DynaMark's revenues come from direct sales to the end user of its services, but in some cases DynaMark acts as a subcontractor to advertising agencies or others managing a particular project for the end user. RMT markets to large financial institutions throughout the world. Its clients are typically large financial institutions with a wide range of products, investments and operational units and a sophisticated balance sheet.
No single end-user customer accounted for more than 10% of the Company's revenues in fiscal 1998. Revenues generated through the Company's alliances with the three major credit bureaus in the United States, Equifax, Experian Information Solutions, Inc. (formerly known as TRW Information Systems & Services) and Trans Union, each accounted for approximately seven to ten percent of the Company's total revenues in fiscal 1998.
The percentage of revenues derived from customers outside the United States was approximately 17 percent in each of fiscal 1998, 1997, and 1996. RMT derives more than half of its revenues from clients outside the United States. DynaMark had virtually no non-U.S. revenues prior to fiscal 1997. The United Kingdom, Japan and Canada
are the largest international market segments. Mexico, South Africa, a number of countries in South America and almost all of the Western European countries are represented in the user base. The Company has delivered products to users in approximately 60 countries. The information set forth under the caption "Segment Information" in Note 12 to the Consolidated Financial Statements is incorporated herein by reference. The Company's foreign offices are primarily sales and customer service offices acting as agents on behalf of the U.S. production operations. Net identifiable assets, capital expenditures and depreciation associated with foreign offices are not material.
The Company has enjoyed good relations with the majority of its customers over extended periods of time, and a substantial portion of its revenue is derived from repeat customers. As noted above, the Company is actively pursuing new users, particularly in the marketing, insurance and healthcare fields as well as those potential users in the consumer credit area not yet using the Company's products.
Contracts and Backlog
The Company's practice is to enter into contracts with several different kinds of payment terms. Scoring algorithms have historically been sold through one-time, fixed-price contracts. The Company will continue to sell scoring algorithms on this basis but has also entered into longer term contractual arrangements with some of its largest customers for the delivery of multiple algorithms. PC-ASAP ("CreditDesk") customers have the option to enter into contracts that provide for a one-time license fee or volume-sensitive monthly lease payments. The one-time and usage-based contracts contain a provision requiring monthly maintenance payments. Mainframe ASAP contracts include a one-time fee for the basic software license, plus monthly fees for maintenance and enhancement services. The Company also realizes maintenance and enhancement revenues from users of its line of Mid-Range ASAP systems. PreScore contracts call for usage or periodic license fees and there is generally a minimum charge. Contracts for the delivery of complete Adaptive Control Systems typically contain both fixed and variable elements in recognition of the fact that they extend over multiple years and must be negotiated in the face of substantial uncertainties. As noted above, the Company is also providing scoring algorithms and application processing on a service basis through credit bureaus, and credit account management services through third-party bankcard processors. Subscribers pay for these services and for the ScoreNet service based on usage. DynaMark and RMT employ a combination of fixed fee and volume-or usage-based pricing for their services.
As of September 30, 1998, the Company's backlog, which includes only firm contracts, was approximately $68,517,000, as compared with approximately $70,168,000 as of September 30, 1997. Most usage-based revenues do not appear as part of the backlog. The Company believes that approximately 25 percent of the September 30, 1998 backlog will be delivered after the end of the current fiscal year ending September 30, 1999. Most DynaMark contracts include unit or usage charges, the total amount of which cannot be determined until the work is completed. DynaMark's and CRMA's backlog are not significant in amount, are not considered a significant indicator of future revenues, and are not included in the foregoing figures. RMT's backlog is included in the foregoing backlog figures.
Competition
The Company believes that its typical product development cycle, which in the past has extended as long as ten years, has tended to moderate the Company's growth rate. It also believes, however, that this long product development lead time provides a barrier to entry of competitive products. As credit scoring, automated application processing, and behavioral scoring algorithms, all of which were pioneered by the Company, have become standard tools for credit providers, competition has emerged from five sectors: scoring algorithm builders, providers of automated application processing services, data vendors, neural network developers and artificial intelligence system builders. It is likely that a number of new entrants will be attracted to the market, including both large and small companies. Many of the Company's present and potential competitors have substantially greater financial, managerial, marketing, and technological resources than the Company. The Company believes that none of its competitors offer the same mix of products as the Company. However certain competitors may have larger shares of particular geographic or product markets. In-house analytic and systems developers are also a significant source of competition for the Company.
The Company believes that the principal factors affecting competition for scoring algorithms are product performance and reliability; expertise and knowledge of the credit industry; ability to deliver algorithms in a timely manner; customer support, training and documentation; ongoing enhancement of products; and comprehensiveness of product applications. It competes with both outside suppliers and in-house groups for this business. The Company's primary competitor among outside suppliers of scoring algorithms is Experian, formerly known as, C.C.N. Systems Limited ("CCN") of Nottingham, England, a subsidiary of Great Universal Stores plc, a large British retailer. Scores sold by credit bureaus in conjunction with credit reports, including scores computed by algorithms developed by the Company, provide potential customers with the alternative of purchasing scores on a usage-priced basis.
The Company believes that the principal factors affecting competition in the market for automated application processing systems (such as ASAP) are the same as those affecting scoring algorithms, together with experience in developing computer software products. Competitors in this area include outside computer service providers and in-house computer systems departments. The Company believes that its primary competitor in this area is American Management Systems, Incorporated ("AMS"). AMS also offers credit scoring algorithms.
The Company competes with data vendors in the market for its credit bureau scoring services including PreScore and ScoreNet. In the past several years, data vendors have expanded their services to include evaluation of the raw data they provide. All of the major credit bureaus offer competing prescreening and credit bureau scoring services developed, in some cases, in conjunction with the Company's primary scoring algorithm competitor, CCN. In November 1996 it was announced that CCN had agreed to acquire Experian Information Solutions, Inc. (formerly known as TRW Information Systems & Services). CCN has since been renamed "Experian".
Both AMS and Experian offer products intended to perform some of the same functions as the Company's Adaptive Control Systems. The Company believes that customers using its Adaptive Control Systems, in both custom end-user form and through third-party processors, significantly outnumber users of the competing AMS and Experian products.
Another source of emerging competition comes from companies developing artificial intelligence systems including those known as "expert systems" and "neural networks." An expert system is computer software that replicates the decision-making process of the best available human "experts" in solving a particular class of problem, such as credit approval, charge card authorization, or insurance underwriting. Scoring technology differs from expert systems in that scoring technology is based upon a large database of results, from which rules and algorithms are developed, as compared to expert systems, which are typically based primarily on the "expert's" judgment and less so upon a significant database. The Company believes its technology is superior to expert system technology where sufficient performance data are available. Neural networks, on the other hand, are an alternative method of developing scoring algorithms from a database but using mathematical techniques quite different from those used by the Company. For example, HNC Software, Inc. has developed systems using neural network technology which compete with some of the Company's products and services. The Company believes that analytical skill and knowledge of the business environment in which an algorithm will be used are generally more important than the choice of techniques used to develop the algorithm; and, further, that the Company has an advantage in these areas with respect to its primary markets as compared with neural network developers.
There are a large number of companies providing data processing and database management services in competition with DynaMark, some of which are considerably larger than DynaMark. The Company believes the market for such services will continue to expand rapidly for the foreseeable future. Competition in this area is based on price, service, and, in some cases, ability of the processor to perform specialized tasks. DynaMark has concentrated on providing specialized types of data processing and database management services using proprietary tools which, it believes, give it an edge over its competition in these areas. RMT is a leading provider of enterprise-wide risk management and performance-measurement solutions to major financial institutions. There are a number of companies offering enterprise-wide "solutions", or serving sub-segments of this market (such as trading operations of financial institutions), in competition with RMT. The Company believes that no direct competitor currently offers the depth and scope of analytical functionality in products and services for financial risk management that RMT provides, which gives RMT an advantage in this market.
Product Protection
The Company relies upon the laws protecting trade secrets and upon contractual non-disclosure safeguards, including its employee non-disclosure agreements and restrictions on transferability that are incorporated into its customer agreements, to protect its software and proprietary interests in its product methodology and know-how. The Company currently has one patent application pending but does not otherwise have patent protection for any of its programs or algorithms, nor does it believe that the law of copyrights affords any significant protection for its proprietary software. The Company instead relies principally upon such factors as the knowledge, ability, and experience of its personnel, new products, frequent product enhancements, and name recognition for its success and growth. The Company retains title to and protects the suite of algorithms and software used to develop scoring algorithms as a trade secret and has never distributed its source code.
In spite of these precautions, it may be possible for competitors or users to copy or reproduce aspects of the Company's software or to obtain information that the Company regards as trade secrets. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. Due to recent changes in the case law and Patent and Trademark Office Guidelines with respect to the patentability of software, algorithms and "methods of doing business," the Company is currently reevaluating the possibility of obtaining patent protection for certain aspects of its technology.
Research and Development
Technological innovation and excellence have been goals of the Company since its founding. The Company has devoted, and intends to continue to devote, significant funds to research and development. The Company has ongoing projects for improving its fundamental knowledge in the area of algorithm design, its capabilities to produce algorithms efficiently, and its ability to specify and code algorithm executing software. The information set forth in the line entitled "Research and development" in the Consolidated Statement of Income and the information set forth under the caption "Software costs" in Note 1 to the Consolidated Financial Statements is incorporated herein by reference.
In addition to the projects formally designated as Research and Development, many of the Company's activities contain a component that produces new knowledge. For example, an Adaptive Control System, by its nature and purpose, must be designed to match its environment and learn as it operates. In the areas in which the Company's products are useful, the "laboratory" is necessarily the site of the user's operations.
Hardware Manufacturing
Hardware for the Company's Mid-Range ASAP systems consists primarily of a Motorola MC 68030-based central processing unit, one or more video display terminals, a disk storage unit, and various other input-output and peripheral devices. The Company's manufacturing process at its San Rafael, California facility involves assembly, testing, and quality assurance functions. Components and parts used in the Company's Mid-Range ASAP systems are purchased from outside vendors, and the Company generally seeks to use components and parts that are available in quantity from a number of distributors. The Company believes that, should any of these components become unavailable from current sources, alternative sources could be developed. Hardware manufacturing and enhancements account for less than one percent of total revenue.
Personnel
As of September 30, 1998, the Company employed approximately 1,487 persons. None of its employees is covered by a collective bargaining agreement and no work stoppages have been experienced.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal office is located in San Rafael, California, approximately 15 miles north of San Francisco. The Company leases approximately 270,000 square feet of office space in four buildings at that location under leases expiring in 2000 or later. It also leases approximately 5,884 square feet of warehouse space in San Rafael for its hardware operations and for storage under month-to-month leases. In May 1998 the Company entered into a synthetic lease agreement for an office complex with approximately 406,000 square feet in San Rafael, California with an expected initial occupancy date in the year 2001. DynaMark leases approximately 109,000 square feet of office and data processing space in three buildings in Arden Hills, Minnesota under leases which expire in 2012. DynaMark has entered into a lease for a fourth building with approximately 50,407 square feet at the same location, with an anticipated occupancy date of July 1999 and expiring in 2012. DynaMark also leases approximately 25,000 square feet of office and data processing space in New York City under a lease expiring in 2004 and approximately 14,800 square feet for offices in Brookings and Madison, South Dakota and Shoreview, Minnesota. RMT leases approximately 14,740 square feet of office space in Berkeley, California. The Company also leases a total of approximately 47,147 square feet of office space for offices in Baltimore, Maryland; New Castle, Delaware; Atlanta, Georgia; Chicago, Illinois; Toronto, Ontario; Birmingham, England; Tokyo, Japan; Paris, France; Mexico City, Mexico; Sao Paulo, Brazil; Milan, Italy; Johannesburg, South Africa; and Wiesbaden, Germany. See Notes 5 and 11 in the Consolidated Financial Statements for information regarding the Company's obligations under leases. The Company believes that suitable additional space will be available to accommodate future needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
No material legal proceedings are pending.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Name Positions Held Age ---- -------------- ---
Larry E. Rosenberger President and Chief Executive Officer 52 since March, 1991, Executive Vice President 1985-1991, Senior Vice President 1983-1985, Vice President 1977-1983. A Director since 1983. Joined the Company in 1974.
John D. Woldrich Appointed Chief Operating Officer 55 effective August 1, 1995. Executive Vice President since 1985, Senior Vice President 1983-1985, Vice President 1977-1983. A Director since 1983. Joined the Company in 1972.
Barrett B. Roach Executive Vice President since 58 joining the Company in August 1992. Chief Administrative and Financial Officer of Network Equipment Technologies, Inc. from 1986 to July 1990. Owned and operated a vineyard from July 1990 to August 1992.
Patrick G. Culhane Executive Vice President since August 44 1995; Senior Vice President 1992- 1995; Vice President 1990-1992; joined the Company in 1985.
H. Robert Heller Executive Vice President since 58 September 1996 and a Director since February 1994. President of International Payments Institute from December 1994 to September 1996; President and Chief Executive Officer of Visa U.S.A., Inc. 1991-1993, Executive Vice President of Visa International 1989-1991.
Jeffrey F. Robinson Senior Vice President since 1986, 49 Vice President 1980-1986. Treasurer 1981-1983. Joined the Company in 1975.
Kenneth M. Rapp Senior Vice President since August 52 1994, and President and Chief Operating Officer of DynaMark, Inc. since it was founded in 1985.
Peter L. McCorkell Senior Vice President since August 52 1995; Vice President, Secretary and General Counsel since joining the Company in 1987.
Patricia Cole Senior Vice President, Chief 49 Financial Officer and Treasurer since November 1996; Controller since joining the Company in September 1995. Vice President and Controller of Qwest Communications International Inc. 1993-1995; Controller of Los Angeles Cellular Telephone Company 1990-1992.
David M. LaCross President, Chief Executive Officer of 46 Risk Management Technologies since it was founded in 1989.
- ---------------------- The term of office for all officers is at the pleasure of the Board of Directors.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of May 6, 1996, the Company's common stock began trading on the New York Stock Exchange under the symbol: FIC. Prior to that date, it was traded over-the-counter on the NASDAQ Stock Market under the symbol: FICI. At December 7, 1998, Fair, Isaac had 340 holders of record of its common stock. The following table lists the high and low last transaction prices for the periods shown, as reported by the New York Stock Exchange and the NASDAQ Stock Market.
Stock Prices High Low - ------------------------------------------------------------ October 1 - December 31, 1996 39 3/8 33 5/8 January 1 - March 31, 1997 43 1/8 35 April 1 - June 30, 1997 44 7/8 30 1/4 July 1 - September 30, 1997 47 1/2 40 3/4 October 1 - December 31, 1997 46 30 1/4 January 1 - March 31, 1998 38 5/8 28 3/16 April 1 - June 30, 1998 40 9/16 31 1/2 July 1 - September 30, 1998 41 1/2 29 1/4
Dividends
On May 24, 1995, Fair, Isaac announced a 100 percent stock dividend (equivalent to a two-for-one stock split) and its intention to pay quarterly dividends of 2 cents per share or 8 cents per year subsequent to issuance of the stock dividend. Quarterly dividends of that amount were paid throughout the 1997 and 1998 fiscal years. There are no current plans to change the cash dividend or to issue any further stock dividend.
Recent Sales of Unregistered Securities
On July 21, 1997, the Company acquired all the outstanding stock of RMT, a privately held California corporation, pursuant to a merger of a wholly owned subsidiary of the Company and RMT in which RMT became a wholly-owned subsidiary of the Company (the "Merger"). The number of shares of the Company's common stock and option equivalents issued by the Company in connection with the Merger was 1,252,655.
At the time of the transaction, the issuance of the shares of the Company's common stock and the options to purchase the Company common stock to the former RMT security holders in the Merger was not registered under the Securities Act of 1933, as amended (the "1933 Act"), because the transaction involved a non-public offering exempt from registration under Section 4(2) of the 1933 Act and Regulation D promulgated thereunder.
In July 1996, the Company purchased certain assets and liabilities of Printronic Corporation of America, Inc. (Printronic), a privately held direct mail computer processing company, and effective at the close of September 30, 1996, the Company acquired 100% of the stock of Credit & Risk Management Associates, Inc. (CRMA), a privately held consulting services company. Part of the consideration paid for Printronic and CRMA consisted of 84,735 Company shares of common stock. At the time of each of these transactions, the issuance of the shares of the Company's common stock was not registered under the 1933 Act, because the transaction involved a non-public offering exempt from registration under Section 4(2) of the 1933 Act and Regulation D promulgated thereunder.
The financial data for the fiscal years ended September 30, 1994 through 1996 have been restated to reflect the merger, effective July 1997, between Fair, Isaac and Company, Incorporated and Risk Management Technologies which has been accounted for under the pooling-of-interests method.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Fair, Isaac and Company, Incorporated, provides products and services designed to help a variety of businesses use data to make better decisions on their customers, prospective customers and existing portfolios. The Company's products include statistically derived, rule-based analytical tools, software designed to implement those analytical tools and consulting services to help clients use and track the performance of those tools. The Company also provides a range of credit scoring and credit account management services in conjunction with credit bureaus and credit card processing agencies. Its DynaMark subsidiary provides data processing and database management services to businesses engaged in direct marketing activities, many of which are in the credit and insurance industries. The Company's Risk Management Technologies subsidiary provides enterprise-wide risk management and performance measurement solutions to major financial institutions.
The Company is organized into business units that correspond to its principal markets: consumer credit, insurance, direct marketing (DynaMark), enterprise-wide financial risk management (RMT) and a new unit, Healthcare. Sales to the consumer credit industry have traditionally accounted for the bulk of the Company's revenues. Products developed specifically for a single user in this market are generally sold on a fixed-price basis. Such products include application and behavior scoring algorithms (also known as "analytic products" or "scorecards"), credit application processing systems (ASAP(TM) and CreditDesk(R)) and custom credit account management systems, including those marketed under the name TRIAD. Software systems usually also have a component of ongoing maintenance revenue, and CreditDesk systems have also been sold under time- or volume-based price arrangements. Credit scoring and credit account management services sold through credit bureaus and third-party credit card processors are generally priced based on usage. Products sold to the insurance industry are generally priced based on the number of policies in force, subject to contract minimums. DynaMark and RMT employ a combination of fixed-fee and usage-based pricing, and the Healthcare unit intends to employ a combination of fixed-fee and usage-based pricing for its products.
This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes. In addition to historical information, this report includes certain forward-looking statements regarding events and trends that may affect the Company's future results. Such statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially. Such factors include, but are not limited to, those described in this discussion and analysis.
RESULTS OF OPERATIONS
Revenues
Revenues from credit application scoring products increased by 22 percent in fiscal 1997 compared with fiscal 1996, and decreased by 12 percent in fiscal 1998 compared with fiscal 1997. The increase in fiscal 1997 was due primarily to the Company's sales of new products and increased sales of small business loan scoring products. The decrease in revenues in fiscal 1998 reflected the impact of bank consolidations. ASAP revenues increased by 47 percent in fiscal 1997 compared with fiscal 1996, and by 14 percent in fiscal 1998 compared with fiscal 1997, primarily due to increased sales of PC-based ASAP products (CreditDesk) and sales of the StrategyWare(R) decision support system.
Revenues from sales of credit account management systems (TRIAD) sold to end-users decreased by 5 percent from fiscal 1996 to fiscal 1997, and increased by 18 percent from fiscal l997 to fiscal l998. The major factor in the decline in revenues in fiscal l997 was a delay in the completion of the next major release of the software. The increase in fiscal 1998 was due primarily to the release of the next version of TRIAD (TRIAD 5.0) in November l997. The Company's high degree of success in penetrating the U.S. bankcard industry with these products has limited, and may continue to limit, the revenue growth in that market. However, the Company has added functionality for the existing base of TRIAD users and is actively marketing TRIAD for other types of credit products and in overseas markets.
The Company provides credit risk management consulting services primarily through CRMA, which it acquired in September 1996. CRMA completed its second year as part of the Credit business unit on September 30, l998. CRMA's revenues increased by 62 percent in fiscal l998 compared with fiscal 1997 and comprised approximately 4 percent of the Company's Credit revenues in fiscal 1998 as compared to 3 percent in fiscal l997.
Usage revenues are generated primarily by credit scoring services distributed through major credit bureaus and credit account management services distributed through third-party bankcard processors. Revenues from credit bureau-related services increased 22 percent in both fiscal l997 and fiscal 1998 and accounted for approximately 35 percent of revenues in fiscal 1997 and 1998. Revenues from services provided through bankcard processors also increased in each of these years, primarily due to increases in the number of accounts at each of the major processors.
Revenues derived from alliances with credit bureaus and credit card processors have accounted for much of the Company's revenue growth in the last three years. While the Company has been very successful in extending or renewing such agreements in the past, and believes it will generally be able to do so in the future, the loss of one or more such alliances or an adverse change in terms could have a significant impact on revenues and operating margin. Revenues generated through the Company's alliances with Equifax, Inc., Experian Information Solutions, Inc., (formerly TRW Information Systems & Services) and Trans Union Corporation each accounted for approximately 8 to 10 percent of the Company's total revenues in fiscal 1996 and 1997, and approximately 7 to 10 percent of the Company's total revenues in fiscal 1998.
In 1996 Experian was acquired by CCN Group Ltd., a subsidiary of Great Universal Stores, PLC. CCN is the Company's largest competitor, worldwide, in the area of credit scoring. TRW/Experian has offered scoring products developed by CCN in competition with those of the Company for several years. The acquisition had no apparent impact on the Company's revenues from Experian in fiscal 1997 and l998.
On September 30, 1997, amendments to the federal Fair Credit Reporting Act became effective. The Company believes these changes to the federal law regulating credit reporting will be favorable to the Company and its clients. Among other things, the new law expressly permits the use of credit bureau data to prescreen consumers for offers of credit and insurance and allows affiliated companies to share consumer information with each other subject to certain conditions. There is also a seven-year moratorium on new state legislation on certain issues. However, the states remain free to regulate the use of credit bureau data in connection with insurance underwriting.
The Company believes enacted or proposed state regulation of the insurance industry has had a negative impact on its efforts to sell insurance risk scores through credit reporting agencies.
DynaMark's revenues increased from $21.2 million in fiscal 1996 to $29.8 million in fiscal 1997 and to $49.2 million in fiscal 1998. The increases in DynaMark's revenues (excluding intercompany revenues) were due primarily to increased revenues from customers in the financial services industry. Gross margins for fiscal 1996, 1997 and 1998 were approximately 39, 42 and 51 percent, respectively. Since its acquisition, DynaMark has taken on an increasing share of the mainframe batch processing requirements of the Company's other business units. During each of fiscal 1996 and 1997, such intercompany revenue represented approximately 14 percent of DynaMark's total revenues, and in fiscal 1998 such revenue represented approximately 8 percent of DynaMark's total revenues. Accordingly, DynaMark's externally reported revenues may tend to understate DynaMark's growth and contribution to the Company as a whole.
RMT's revenues for fiscal l997 increased by 18 percent compared with fiscal l996, and in fiscal 1998 decreased by 26 percent compared with fiscal 1997, due primarily to the impact of bank consolidations.
Increases in insurance revenues for fiscal l998, compared with fiscal 1997, were due to strong growth in both insurance products sold to end-users and in the insurance scoring services offered through consumer reporting agencies. In fiscal 1997, the Company recorded its first revenues from its Healthcare business unit, and during fiscal 1998 derived revenues from providing analytical marketing services to a large pharmaceuticals manufacturer to help improve customer relationships and management of prescription compliance (i.e., a patient's fulfillment of prescriptions and taking them to completion).
The Company's revenues derived from clients outside the United States increased from $26.1 million in 1996 to $33.9 million in fiscal l997 and to $42.9 million in fiscal 1998. RMT contributed $4.3 million, $4.6 million and $3.7 million to the Company's non-U.S. revenues for fiscal years 1996, l997 and l998, respectively. DynaMark has not had significant non-U.S. revenues. Sales of software products, including TRIAD and CreditDesk, increased usage of credit bureau scores in Canada, and an increase in the number of accounts using the Company's account management services at credit card processors in Europe and Latin America accounted for most of the increase in international revenues in fiscal 1997 and 1998. Gains or losses due to fluctuations in currency exchange rates have not been significant to date but may become more important if, as expected, the proportion of the Company's revenues denominated in foreign currencies increases in the future.
Revenues from software maintenance and consulting services each accounted for less than 10 percent of revenues in each of the three years in the period ended September 30, 1998, and the Company does not expect revenues from either of these sources to exceed 10 percent of revenues in the foreseeable future.
During the period since 1990, while the rate of account growth in the U.S. bankcard industry has been slowing and many of the Company's largest institutional clients have merged and consolidated, the Company has generated above-average growth in revenues--even after adjusting for the effect of acquisitions--from its bankcard-related scoring and account management business by deepening its penetration of large banks and other credit issuers. The Company believes much of its future growth prospects will rest on its ability to: (a) develop new, high-value products, (b) increase its penetration of established or emerging credit markets outside the U.S. and Canada and (c) expand--either directly or through further acquisitions--into relatively undeveloped or underdeveloped markets for its products and services, such as direct marketing, insurance, small business lending and healthcare information
management. During fiscal 1998, the Company's backlog of orders for fixed-priced products declined slightly. This indicates that revenue growth in fiscal 1999 and later years may depend to a large extent on sales of newly developed products.
Over the long term, in addition to the factors discussed above, the Company's rate of revenue growth--excluding growth due to acquisitions--is limited by the rate at which it can recruit and absorb additional professional staff. Management believes this constraint will continue to exist indefinitely. On the other hand, despite the high penetration the Company has already achieved in certain markets, the opportunities for application of its core competencies are much greater than it can pursue. Thus, the Company believes it can continue to grow revenues, within the personnel constraint, for the foreseeable future. At times management may forego short-term revenue growth in order to devote limited resources to opportunities that it believes have exceptional long-term potential. This occurred in the period from 1988 through 1990, when the Company devoted significant resources to developing the usage-priced services distributed through credit bureaus and third-party processors.
Expenses
Cost of revenues
Cost of revenues consists primarily of personnel, travel and related overhead costs; costs of computer service bureaus; and the amounts paid by the Company to credit bureaus for scores and related information in connection with the ScoreNet(R) Service.
Cost of revenues, as a percentage of revenues, declined slightly in the periods from fiscal l996 to fiscal 1997 and from fiscal l997 to fiscal 1998. The decrease in both fiscal l997 and fiscal 1998 was due primarily to the reassignment to research and development activities of certain personnel whose primary assignment had been production and delivery.
Sales and marketing
Sales and marketing expenses consist principally of personnel, travel, overhead, advertising and other promotional expenses. As a percentage of revenues, sales and marketing expenses decreased in fiscal 1997 compared with fiscal 1996 due primarily to a reduction in media advertising and remained essentially unchanged from fiscal 1997 to fiscal 1998.
Research and development
Research and development expenses include the personnel and related overhead costs incurred in product development, researching mathematical and statistical algorithms and developing software tools that are aimed at improving productivity and management control. Research and development increased sharply from fiscal l996 to fiscal 1997 and from fiscal 1997 to fiscal 1998. After several years of concentrating on developing new markets--either geographically or by industry--for its existing technologies, in fiscal 1996 and fiscal l997 the Company renewed its historical emphasis on developing new technologies, especially in the area of software development.
In fiscal 1998, the Company continued to emphasize development of new technologies. Research and development expenditures in fiscal 1998 were primarily related to new bankruptcy scoring products for Visa (Integrated Solutions Concepts) and Trans Union, new fraud-detection software products, joint product development projects with Deluxe Financial Services, Inc., healthcare receivables management and Year 2000 compliance work.
General and administrative
General and administrative expenses consist mainly of compensation expenses for certain senior management, corporate facilities expenses, the costs of administering certain benefit plans, legal expenses, expenses associated with the exploration of new business opportunities and the costs of operating administrative functions, such as finance and computer information systems. As a percentage of revenues, general and administrative expenses were essentially unchanged for fiscal l996, l997 and l998.
Amortization of intangibles
The Company is amortizing the intangible assets arising from various acquisitions over periods ranging from 2 to 15 years. The level of amortization expense in future years will depend, in part, on the amount of additional payments to the former shareholders of CRMA, a privately held company acquired at the end of fiscal l996. See below, under "Capital Resources and Liquidity."
Other income (expense)
The table in Note 13 to the Consolidated Financial Statements presents the detail of other income and expenses. Interest income is derived from the investment of funds surplus to the Company's immediate operating requirements. At September 30, 1998, the Company had approximately $46.5 million invested in U.S. treasury securities and other interest-bearing instruments. Interest income increased in both fiscal 1997 and 1998 due to higher average cash balances in interest-bearing accounts and instruments.
The Company's share of operating losses in certain early-stage development companies that are accounted for using the equity method is charged to other expense. During the fiscal year ended September 30, l997, the Company wrote off non-marketable investments with an equity basis of $773,000, primarily related to an Italian start-up venture that was adversely affected by a new privacy law. In fiscal year ended September 30, 1998, the Company liquidated its share of this non-marketable security resulting in a gain of $165,000 and has no further financial commitments in connection with this investment. Note 4 to the Consolidated Financial Statements describes the Company's investment in such companies.
In fiscal 1998, the difference between the increase in operating income (7 percent) and the increase in net income (18 percent) was primarily due to the interest income derived from investments in U.S. treasury securities and other interest-bearing instruments, and the absence of losses from investments in start-ups.
Provision for income taxes
The Company's effective tax rate was 39.3, 41.8 and 42.2 percent in fiscal l996, 1997 and l998, respectively. The increase to 42.2 percent in fiscal 1998 was due primarily to the nondeductible nature of goodwill, deferred compensation and an increase in the effective state tax rate. The Company expects its effective tax rate in fiscal 1999 to be approximately 42 percent, barring any change in the tax laws.
Capital Resources and Liquidity
Working capital increased from $34,699,000 at September 30, 1996, to $47,727,000 at September 30, l997, and to $54,852,000 at September 30, 1998. The increase in fiscal 1997 was due primarily to increases in accounts receivable and unbilled work in progress, which more than offset the increase in accrued compensation and employee benefits and the decrease in prepaid expenses and other assets.
The increase in fiscal 1998 was due primarily to increases in short-term investments, unbilled work in progress and accounts receivable, which more than offset the increase in accounts payable and other accrued liabilities and accrued compensation and employee benefits.
The Company's exposure to collection risks is comprised of the sum of accounts receivable plus unbilled work in progress, less billings in excess of earned revenues. Changes in contract terms and product mix, along with variations in timing, may cause fluctuations in any or all of these items. During fiscal 1997, the increases in accounts receivable and billings in excess of earned revenues were proportional to the increase in revenues. The greater increase in unbilled work in progress was due primarily to changes in product mix and contract terms. During fiscal 1998, the increase in accounts receivable was proportionally much less than the increase in revenues due to improved collection efforts by the Company, and the increases in unbilled work in progress and billings in excess of earned revenues were proportional to the increase in revenues.
The Company capitalized $45,000 as goodwill relating to amounts due to the former stockholders of CRMA under the CRMA purchase agreement based upon its financial results in fiscal 1997, and has capitalized $263,000 based upon CRMA's financial results in fiscal 1998. An additional payment to the former stockholders of CRMA based upon CRMA's financial results in fiscal 1999 may also be required. That amount, which will be paid 55 percent in Company stock and 45 percent in cash, will not exceed $1,833,000.
In fiscal 1997, cash provided by operations resulted primarily from net income before depreciation and amortization, decreases in prepaid expenses and other assets and increases in accrued compensation and employee benefits, partially offset by the increase in accounts receivable and unbilled work in progress. Cash was used in investing activities primarily for additions to property and equipment and the purchase of interest-bearing investments, partially offset by the maturities of interest-bearing investments. Cash was used in financing activities for the payment of dividends, reduction of capital lease obligations and repurchase of Company stock, partially offset by cash generated by the exercise of stock options.
In fiscal 1998, cash provided by operations resulted primarily from net income before depreciation and amortization, and increases in accounts payable and other accrued liabilities and accrued compensation and employee benefits, partially offset by the increases in accounts receivable, other assets and unbilled work in progress. Cash was used in investing activities primarily for additions to property and equipment, and purchases of interest-bearing investments, partially offset by the maturities of interest-bearing investments. Cash was provided by financing activities primarily from the exercise of stock options, partially offset by cash used for the payment of dividends and the reduction of capital lease obligations.
Future cash flows will continue to be affected by operating results, contractual billing terms and collections, investment decisions and dividend payments, if any. At September 30, 1998, the Company had no significant capital commitments other than those obligations described in Notes 2, 5 and 11 of the Consolidated Financial Statements.
On December 1, 1997, the Company purchased undeveloped land in San Rafael, California, with the intention of constructing an office complex to accommodate future growth. Development has commenced, and on May 15, 1998, the Company entered into a synthetic lease arrangement, which will materially increase the Company's future operating lease expenses. Rental payments will commence upon completion of construction, which is expected to
occur in the second quarter of fiscal 2001. With this external financing, the Company believes that the cash and marketable securities on hand, along with cash expected to be generated by operations, will be adequate to meet its capital and liquidity needs for both the current year and the foreseeable future.
Year 2000
The Company is performing Year 2000 remediation work and compliance testing on its software products marketed to customers. The updated versions of most of its software products currently being shipped to customers are Year 2000 compliant. Certain international versions of the Company's software products are not yet Year 2000 compliant, but the Company expects to be prepared to ship upgrade "patches" for these products by the end of calendar 1998. Year 2000 remediation work, including compliance testing, for most earlier versions of the Company's software installed at customer sites will be performed as part of the Company's normal upgrade and maintenance process. Prior to the end of calendar 1999, the Company will discontinue support for some software products that have been replaced by other products, and Year 2000 upgrades for these products will not be available. Revenues from such products are not significant. There are no assurances that the Company's current products do not contain undetected errors or defects associated with Year 2000 date functions that may result in material costs to the Company. However, the Company currently does not expect significant disruption of its revenues or operations from the Year 2000 issues associated with its products. The Company has not made an assessment of the potential impact of failing to complete its own Year 2000 remediation work nor has it developed any contingency plans for such an event.
Additionally, the Company has substantially completed its Year 2000 inventory and assessment of internal information technology (IT) and non-IT systems and applications and expects all major internal systems to be fully compliant by the end of December 1998. The Company has determined that the majority of its internally developed systems are Year 2000 compliant. All applications supplied to Company by third parties are either Year 2000 compliant today or have "patches" currently available to bring them into compliance. Extensive compliance testing has commenced and will continue through most of the calendar year 1999. The most reasonably likely worst-case scenarios would include: (a) corruption of data contained in the Company's internal information systems, and (b) hardware/operating system failure. The Company is in the process of completing its contingency plans for business-critical IT and non-IT internal systems as an extension of its existing disaster recovery plan and expects to complete such planning by June 30, 1999.
The Company estimates that the costs of Year 2000 remediation (including compliance testing) for its products and internal systems will be in the range of $4 million to $5 million. Approximately two-thirds of these estimated costs have been expended as of September 30, 1998. These costs principally consist of both internal staff costs and expenses for external consultants, software and hardware, which have been or will be expensed by the Company during the period they are incurred. Expected costs for the Year 2000 remediation work (including compliance testing) and projected completion dates are based on the Company's management's estimates and assumptions and actual results may vary materially from those anticipated.
The Company has also initiated communications with third parties on which it is dependent for essential services and for the distribution of its significant services to determine how they are addressing Year 2000 issues and to evaluate any impact on the Company's operations. The Company is working with these third parties to resolve Year 2000 issues and information received to date indicates that these parties are in the process of implementing and/or testing remediation strategies to ensure Year 2000 compliance of systems, services and/or products. However, the lack of resolution of Year 2000 issues by these parties--especially the credit bureaus and credit card processors through which the Company distributes credit scoring and account management services--could have a material adverse impact on the Company's future business operations, financial condition and results of operations.
The Company anticipates that the most reasonably likely worst-case scenarios involving third-party Year 2000 issues would include: (a) failure of infrastructure services provided by government agencies and third parties (e.g., transportation, electricity, telephone, Internet services, etc.) and (b) failure of one or more of the credit bureaus or credit card processors through which the Company distributes its credit scoring and account management services to achieve timely and successful Year 2000 compliance. Contingency plans to address these most reasonably likely
worst-case scenarios are under development and are expected to be completed by June 30, 1999. At this time the Company cannot quantify the potential impact of third-party Year 2000 issues.
The foregoing information and statements regarding the Company's Year 2000 capabilities and readiness are "Year 2000 Information and Readiness Disclosures" in conformance with the Year 2000 Information and Readiness Disclosure Act of 1998 enacted on October 19, 1998.
European Economic and Monetary Union (EMU)
Under the European Union's plan for Economic and Monetary Union (EMU), the euro becomes the sole accounting currency of EMU countries on January 1, 2002. Its initial phase goes into effect on January 1, 1999, in 11 participating countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. In this initial phase the EMU mandates that key financial systems be able to triangulate conversion rates so that any amount booked will be logged and processed simultaneously in both the local currency and euros. The Company believes that its computer systems and programs are euro-compliant. Costs associated with compliance were not material and were expensed by the Company as they were incurred.
Quarterly Results
The table in Note 15 to the Consolidated Financial Statements presents unaudited quarterly operating results for the last eight fiscal quarters. Management believes that all the necessary adjustments have been included in the amounts stated to present fairly the selected quarterly information, when read in conjunction with the financial statements included elsewhere in this report. This information includes all normal recurring adjustments that the Company considers necessary for a fair presentation thereof, in accordance with generally accepted accounting principles.
Quarterly results may be affected by fluctuations in revenue associated with credit card solicitations, by the timing of orders for and deliveries of certain ASAP and TRIAD systems and by the seasonality of ScoreNet purchases. With the exception of the cost of ScoreNet data purchased by the Company, most of its 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. However, in recent years these fluctuations were generally offset by the strong growth in revenues from services delivered through credit bureaus and third-party bankcard processors.
Management believes that neither the quarterly variations in net revenues and net income nor the results of operations for any particular quarter are necessarily indicative of results of operations for full fiscal years. Accordingly, management believes that the Company's results should be evaluated on an annual basis.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Disclosures. The following discussion about the Company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. The Company does not use derivative financial instruments for speculative or trading purposes.
Interest Rate Sensitivity. The Company maintains a short-term investment portfolio consisting mainly of income securities with an average maturity of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at September 30, 1998, the fair value of the portfolio would decline by an immaterial amount. The Company has the ability to hold its fixed income investments until maturity, and therefore the Company would not expect its operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its securities portfolio. The Company believes foreign currency and equity risk is not material.
ITEM 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT AUDITORS
The Board of Directors Fair, Isaac and Company, Incorporated:
We have audited the accompanying consolidated balance sheets of Fair, Isaac and Company, Incorporated, and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fair, Isaac and Company, Incorporated, and subsidiaries as of September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1998, in conformity with generally accepted accounting principles.
San Francisco, California October 29, 1998
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Summary of Significant Accounting Policies
Nature of business
Fair, Isaac and Company, Incorporated, (the "Company") is incorporated under the laws of the State of Delaware. The Company offers a variety of technological tools to enable users to make better decisions through data. The Company is a world leader in developing predictive and risk assessment models for the financial services industry, including credit and insurance scoring algorithms. The Company also offers direct marketing and database management services, and enterprise-wide risk management and performance measurement solutions to major financial institutions through its wholly owned subsidiaries, DynaMark, Inc. (DynaMark) and Risk Management Technologies (RMT), respectively.
Basis of consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated from the consolidated financial statements.
Use of estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents consist of cash in banks and investments with an original maturity of 90 days or less at time of purchase.
Investments
Investments in U.S. government obligations and marketable equity securities are classified as "available-for-sale" and carried at market. Investments in 50% or less owned companies in which the Company has the ability to exercise significant influence are accounted for using the equity method and are classified as non-marketable securities. Other investments are carried at the lower of cost or net realizable method and are classified as non-marketable securities.
Investments classified as available-for-sale securities with remaining maturities over one year and non-marketable securities are classified as long-term investments.
Credit and market risk
The Company invests a portion of its excess cash in U.S. government obligations and has established guidelines relative to diversification and maturities that maintain safety and liquidity. In addition, an allowance for doubtful accounts is maintained at a level which management believes is sufficient to cover potential credit losses for accounts receivable. Actual losses have been within management's expectations.
Depreciation and amortization
Depreciation and amortization on property and equipment including leasehold improvements and capitalized leases are provided using the straight-line method over estimated useful lives ranging from three to ten years or the term of the respective leases.
Revenue recognition
Revenues from contracts for the development of credit scoring systems and custom software are recognized using the percentage-of-completion method of accounting based upon milestones that are defined using management's estimates of costs incurred at various stages of the project as compared to total estimated project costs. Revenues determined by the percentage-of-completion method in excess of contract billings are recorded as unbilled work in progress. Such amounts are generally billable upon reaching certain performance milestones that are defined by the individual contracts. Deposits billed and received in advance of performance under contracts are recorded as billings in excess of earned revenues.
Revenues from usage-priced products and services are recognized on receipt of usage reports from the third parties through which such products and services are delivered. Amounts due under such arrangements are recorded as unbilled work in progress until collected. Revenues from non-customized software licenses and shrink-wrapped products are recognized upon delivery of product and services, or license renewal. Revenues from products and services sold on time-based pricing, including maintenance of computer and software systems, are recognized ratably over the contract period.
Software costs
The Company follows one of two paths to develop software. One involves a detailed program design, which is used when introducing new technology; the other involves the creation of a working model for modification to existing technologies that has been supported by adequate testing. All costs incurred prior to the resolution of unproven functionality and features, including new technologies, are expensed as research and development. After the uncertainties have been tested and the development issues have been resolved, technological feasibility is achieved and subsequent costs such as coding, debugging and testing are capitalized.
When developing software using existing technology, the costs incurred prior to the completion of a working model are expensed. Once the product design is met, this typically concludes the software development process and is usually the point at which technological feasibility is established. Subsequent expenses, including coding and testing, if any, are capitalized. For the three-year period ending September 30, 1998, technological feasibility coincided with the completion process; thus, all design and development costs were expensed as research and development costs.
Purchased software costs are amortized over three to five years. For the years ended September 30, 1998, 1997 and 1996, amortization of capitalized software was $528,000, $808,000 and $248,000, respectively. At September 30, 1998 and 1997, unamortized purchased computer software costs were $6,508,000 and $1,221,000, respectively.
Intangibles
The intangible assets consisting of goodwill and non-compete agreements arose principally from business acquisitions and are amortized on a straight-line basis over the period of expected benefit, which ranges from 2 to 15 years. The Company assesses the recoverability of goodwill by evaluating the undiscounted projected results of operations over the remaining amortization period.
Income taxes
Income taxes are recognized during the year in which transactions enter into the determination of financial statement income, with deferred taxes being provided for temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws.
Foreign currency
The Company has determined that the functional currency of each foreign operation is the local currency. Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rate on the balance sheet date, while revenues and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are accumulated as a separate component of stockholders' equity.
Earnings per share
Diluted earnings per share are based on the weighted-average number of common shares outstanding and common stock equivalent shares. Common stock equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. Basic earnings per share is computed on the basis of the weighted average number of common stock shares outstanding.
Accounting pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 130, "Reporting Comprehensive Income." SFAS No. 130 established standards for reporting comprehensive income and its components in financial statements. This statement requires that all items which are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income is equal to net income plus the change in "other comprehensive income." SFAS No. 130 requires that an entity: (a) classify items of other comprehensive income by their nature in a financial statement, and (b) report the accumulated balance of other comprehensive income separately from common stock and retained earnings in the equity section of the balance sheet. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. Beginning with the first quarter of 1999, management intends to conform its consolidated financial statements to this pronouncement.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for publicly held entities to follow in reporting information about operating segments in annual financial statements and requires that those entities report selected information about operating segments in interim financial statements. This statement also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. Beginning with fiscal year 1999, management intends to conform its annual consolidated financial statements to this pronouncement.
In October 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The Company will be required to adopt SOP 97-2 for software transactions entered into beginning October 1, 1998, and retroactive application to years prior to adoption is prohibited. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements (e.g., software products, upgrades/enhancements, postcontract customer support, installation, training, etc.) to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence, which is specific to the vendor. The revenue allocated to software products (including specified upgrades/enhancements) generally is recognized upon delivery of the products. The revenue allocated to postcontract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements (such as training and installation) generally is recognized as the services are performed. If a vendor does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. The Company's management believes that the adoption of SOP 97-2 will not have a material impact on the Company's results of operations. Beginning with fiscal year 1999, management intends to conform its consolidated financial statements to this pronouncement.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits." The statement standardizes the disclosure requirements for pension and other
postretirement benefits. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the disclosure. Beginning with fiscal year 1999, management intends to conform its consolidated financial statements to this pronouncement.
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP requires that certain costs related to the development or purchase of internal-use software be capitalized and amortized over the estimated useful life of the software. The SOP also requires that costs related to the preliminary project stage and the post-implementation/operations stage of an internal-use computer software development project be expensed as incurred. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1998. Beginning with fiscal year 2000, management intends to conform its consolidated financial statements to this pronouncement.
Fair value of financial instruments
The fair values of cash and cash equivalents, accounts receivable and accounts payable are approximately equal to their carrying amounts because of the short-term maturity of these instruments. The fair values of the Company's investment securities are disclosed in Note 4.
2. Mergers and Acquisitions
In July 1997, the Company issued 1,252,665 shares of its common stock (including 544,218 shares underlying options assumed by the Company) in connection with the merger with RMT. The acquisition has been accounted for under the pooling-of-interests method. Accordingly, the consolidated financial statements have been restated for all prior periods to include RMT. Further, all common share and per share data have been restated for prior periods.
For the pre-merger periods indicated, revenues and net income of the Company and RMT are as follows:
Nine-months ended June 30, 1997 Year ended (dollars in thousands) Unaudited September 30, 1996 - --------------------------------------------------------------------------------
Revenues
Fair, Isaac and Company, Incorporated $137,031 $148,749 Risk Management Technologies 5,746 7,164 -------- -------- $142,777 $155,913 ======== ======== Net Income
Fair, Isaac and Company, Incorporated $ 13,732 $ 16,179 Risk Management Technologies 630 1,244 -------- -------- $ 14,362 $ 17,423 ======== ========
RMT previously used the fiscal year ended December 31 for its financial reporting. RMT's operating results for the year ended December 31, 1996, are included in the accompanying statement of income in the column headed September 30, 1996. The statement of income's comparative 1997 results reflect the operations of the Company and RMT for the year ended September 30, 1997. Accordingly, the duplication of RMT's net income, for the three months ended December 31, 1996, has been adjusted by a $214,000 charge to retained earnings in fiscal 1997.
In July 1996, the Company purchased certain assets and liabilities of Printronic Corporation of America, Inc. (Printronic), a privately held direct mail computer processing company, and effective at the close of September 30, 1996, the Company acquired 100% of the stock of Credit & Risk Management Associates, Inc. (CRMA), a privately held consulting services company.
The consideration paid for Printronic and CRMA consisted of 84,735 Company shares valued at $3,572,000 plus $1,697,000 in cash. Both acquisitions have been accounted for as purchases. The results of operations of Printronic have been included in the consolidated financial statements since the acquisition date; no results of operations for CRMA are included in the consolidated financial statements for the year ended September 30, 1996. The purchase price for each acquisition was allocated based on estimated fair values at the dates of acquisition. The excess of the purchase prices over the fair value of net assets or liabilities was $5,547,000 and has been recorded as goodwill, which will be amortized on a straight-line basis over 7 or 15 years.
The CRMA purchase agreement provides for additional contingent cash and Company stock payments to the former CRMA shareholders not to exceed $5,499,000 based on specified financial performance of CRMA through September 1999. For the years ended September 30, 1998 and 1997, an additional $265,000 and $45,000, respectively, were capitalized as goodwill relating to the additional contingent cash and Company stock payments.
Pro forma unaudited consolidated operating results of the Company, Printronic and CRMA for the years ended September 30, 1996, assuming the acquisitions had been made as of October 1, 1995, are summarized below.
Pro forma summary (unaudited) Year ended September 30, (dollars in thousands except per share data) 1996 - --------------------------------------------------------------------------------
Revenue $ 162,491 Net income $ 17,495 Earnings per share: Diluted $ 1.25 Basic $ 1.32
These pro forma results have been prepared for comparative purposes only and include certain adjustments such as additional amortization expense as a result of goodwill and other intangible assets. They do not purport to be indicative of the results of operations that actually would have resulted had the combinations been in effect on October 1, 1995, or of future results of operations of the consolidated entities.
3. Cash Flow Statement
4. Investments
The long-term U.S. government obligations mature in one to five years.
For the year ended September 30, 1997, a non-marketable investment with an equity basis of $773,000 in an overseas start-up venture, principally an Italian credit reporting agency, was written off due to the potential negative impact on the agency's operations from a new Italian privacy law. During the year ended September 30, 1998, the Company liquidated its share of this non-marketable security for a gain of $165,000. The Company does not have any further financial commitments with respect to this investment. The Company also recognized its equity share of losses from this Italian venture of $2,082,000 and $821,000 for the years ended September 30, 1997 and 1996, respectively.
For the year ended September 30, 1996, an investment of $1,535,000 in the non-marketable preferred stock of an early-stage enterprise was written off due to the deteriorating financial condition of the entity. The Company does not have any further financial commitments with respect to the investment.
5. Property and Equipment
Property and equipment at September 30, 1998 and 1997 valued at cost, consist of the following:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Data processing equipment $ 42,995 $ 34,248 Office furniture, vehicles and equipment 16,156 14,383 Leasehold improvements 13,777 12,003 Capitalized leases 2,841 2,841 Less accumulated depreciation and amortization (38,876) (28,989) -------- -------- Net property and equipment $ 36,893 $ 34,486 ======== ========
Depreciation and amortization charged to operations were $13,553,000, $10,479,000 and $7,194,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Capitalized leases consist primarily of one lease bearing an interest rate of 7% that matures in the year 2001. The following is a schedule, by years, of future minimum lease payments under capitalized leases, together with the present value of the net minimum lease payments, at September 30, 1998:
Years ended September 30, (dollars in thousands) - -------------------------------------------------------------------------------
1999 $ 487 2000 467 2001 375 ------- 1,329 Less: Amount representing interest (124) ------- Present value of net minimum lease payments $ 1,205 =======
6. Intangibles
Intangibles at September 30, 1998 and 1997, consist of the following:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Goodwill $ 13,430 $ 10,138 Other 2,470 2,270 Less accumulated amortization (5,442) (4,047) -------- -------- $ 10,458 $ 8,361 ======== ========
Amortization charged to operations was $1,395,000, $1,274,000 and $734,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
7. Income Taxes
The provision for income taxes consists of the following:
Years ended September 30, (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------
Current: Federal $ 17,380 $ 14,685 $ 9,026 State 3,967 2,863 1,901 Foreign 240 136 270 -------- -------- -------- 21,587 17,684 11,197 -------- -------- -------- Deferred: Federal (3,152) (2,400) 183 State (657) (424) (99) -------- -------- -------- (3,809) (2,824) 84 -------- -------- -------- $ 17,778 $ 14,860 $ 11,281 ======== ======== ========
Amounts for the current year are based upon estimates and assumptions as of the date of this report and could vary significantly from amounts shown on the tax returns as filed.
The tax effect of significant temporary differences resulting in deferred tax assets at September 30, 1998 and 1997, are as follows:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Deferred tax assets: Depreciation and amortization $ 2,350 $ 2,637 Customer advances 2,198 -- Employee benefit plans 1,594 280 Deferred compensation 1,489 2,042 Compensated absences 1,455 1,070 State taxes 1,388 1,007 Capital loss carryforward 1,245 1,530 Bad debt provision 464 283 Capital lease obligations 197 201 Warranty reserves 140 26 Other 630 103 -------- -------- 13,150 9,179 Less valuation allowance (1,245) (1,083) -------- -------- 11,905 8,096 Deferred tax liabilities: Tax on net unrealized gains on available-for-sale securities (491) (210) -------- -------- Deferred tax assets, net $ 11,414 $ 7,886 ======== ========
The valuation allowance for deferred tax assets at September 30, 1998 and 1997, was $1,245,000 and $1,083,000, respectively. The valuation allowance was needed to reduce the deferred tax assets since the Company does not meet the more-likely-than-not requirement for utilization of the capital loss carry forward.
8. Employee Benefit Plans
Pension plan
The plan assets consist primarily of U.S. government and marketable equity securities.
The projected benefit obligation includes an accumulated benefit obligation of $10,981,000 and $8,057,000 at September 30, 1998 and 1997, respectively. The projected benefit obligation exceeded the fair value of the pension plan assets for the years ended September 30, 1998 and 1997, respectively.
The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6.5% and 4.0%, respectively, at September 30, 1998, and 7.5% and 5.0%, respectively, at September 30, 1997. The expected long-term rate of return on assets was 8.5% at September 30, 1998 and 1997.
The net pension cost for the fiscal years ended September 30, 1998 and 1997, included the following components:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Service costs $ 1,516 $ 1,011 Interest cost on projected benefit obligation 943 745 Actual return on plan assets (840) (2,050) Net amortization and deferral 132 1,502 ------- ------- Net periodic pension plan cost $ 1,751 $ 1,208 ======= =======
Employee stock ownership plan
The Company has an Employee Stock Ownership Plan (ESOP) that covers eligible full-time employees. Contributions to the ESOP are determined annually by the Company's Board of Directors. In addition, the ESOP may purchase stock from the Company or its stockholders. Provisions for contributions to the ESOP were $1,803,000, $1,534,000 and $1,445,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
At September 30, 1998 and 1997, the ESOP held 835,693 and 970,566 shares of Company stock, respectively. The amount of dividends on ESOP shares were $75,212, $81,000 and $94,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Company stock held and paid for by the ESOP is allocated annually to participants based on employee compensation levels. While employed by the Company, participants vest in the allocated shares at rates ranging from 0% to 30% over a period of 1 to 7 years until fully vested, depending on the plan.
Defined contribution plans
The Company offers 401(k) plans for eligible employees. Eligible employees may contribute up to 15% of compensation. The Company provides a matching contribution, which either vests immediately or over five years, depending on the plan. The Company contributions to 401(k) plans were $790,000, $673,000 and $470,000 for the years ended September 30, 1998, 1997 and 1996, respectively. In addition, the Company maintains a supplemental retirement and savings plan for certain officers and senior management employees. Company contributions to that plan were $247,000, $132,000 and $104,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Officers' incentive plan
The Company has an executive compensation plan for the benefit of officers. Benefits are payable based on the achievement of financial and performance objectives, which are set annually by the Board of Directors, and the market value of the Company's stock. Total expenses under the plan were $3,273,000, $3,842,000 and $3,560,000 for the years ended September 30, 1998, 1997 and 1996, respectively. The incentive earned each year is paid 50% currently, and the balance is payable over a four-year period, subject to certain adjustments, as defined in the plan, based on employment status and the market value of the Company's common stock. At September 30, 1998 and 1997, the long-term officers' incentive plan payable was $3,066,000 and $3,475,000, respectively.
Employee incentive plans
The Company has incentive plans for eligible employees not covered under the executive compensation plan. Awards under these plans are paid annually and are based on the achievement of certain financial and performance objectives. Total expenses under these plans were $5,537,000, $5,211,000 and $4,426,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
9. Stock
Common
A total of 35,000,000 shares of common stock, $.01 par value, are authorized, of which 13,992,126 shares (including 9,787 shares of treasury stock) were outstanding at September 30, 1998, and 13,474,382 shares (including 12,114 shares of treasury stock) were outstanding at September 30, 1997.
Preferred
A total of 1,000,000 shares of preferred stock, $.01 par value, are authorized; no preferred stock has been issued.
10. Stock Option Plans
The Company has two stock option plans, one of which is for the granting of stock options, stock appreciation rights, restricted stock and common stock that reserve shares of common stock for issuance to officers, key employees and non-employee directors. The Company has elected to continue to apply the provisions of APB No. 25, and provide the pro forma disclosures of SFAS No. 123, "Accounting for Stock-Based Compensation." Granted awards generally have a maximum term of ten years and vest over one to five years. Under this plan approved by the stockholders, a number of shares equal to 4% of the number of shares of the Company's common stock outstanding on the last day of the preceding fiscal year is added to the shares available under the plan each fiscal year, provided that the number of shares suitable for grants of incentive stock options for the remaining term of the plan shall not exceed 1,500,000 shares. The other plan is limited to the former employees of RMT, who, as of the merger date, held unexpired and unexercised stock option grants under the RMT stock option plans. Granted awards have a maximum term of ten years and vest over three years. The total number of issuable options under the plan is 650,800.
The fair value of options at the date of grant was estimated using the Black-Scholes model with the following weighted-average assumptions for the years ended September 30:
1998 1997 1996 - -------------------------------------------------------------------------------
Expected life (years) 5 5 5 Interest rate 5.5% 6.5% 6.2% Volatility 43% 45% 45% Dividend yield 0% 0% 0%
The weighted-average fair value of options granted for the years ended September 30, 1998, 1997 and 1996, was $17.30, $17.47 and $15.35, respectively.
Stock-based compensation under SFAS No. 123 would have had the following pro forma effects for the years ended September 30:
(in thousands, except per share data) 1998 1997 1996 - --------------------------------------------------------------------------------
Net income, as reported $ 24,327 $ 20,686 $ 17,423 ======== ======== ========== Pro forma net income $ 20,655 $ 18,091 $ 17,002 ======== ======== ========== Earnings per share, as reported: Diluted $ 1.68 $ 1.46 $ 1.25 ======== ======== ========== Basic $ 1.77 $ 1.55 $ 1.32 ======== ======== ========== Pro forma earnings per share: Diluted $ 1.43 $ 1.27 $ 1.22 ======== ======== ========== Basic $ 1.50 $ 1.35 $ 1.29 ======== ======== ==========
The pro forma effect on net income for each of the years ended September 30, 1998, 1997 and 1996, may not be representative of the effects on reported net income in future years.
11. Commitments and Contingencies
The Company conducts certain of its operations in facilities occupied under non-cancelable operating leases with lease terms in excess of one year. The leases generally provide for annual increases based upon the Consumer Price Index or fixed increments.
In May 1998, the Company entered into a synthetic lease agreement to lease land in San Rafael, California, and improvements comprising the first phase of an office complex facility to be constructed on the land. A synthetic lease is asset-based financing structured to be treated as a lease for accounting purposes but as a loan for tax purposes. The office complex facility is intended to accommodate the future growth of the Company.
The Company had an option (the "Option") to purchase the undeveloped land in December 1997, and the Option was assigned to the lessor in connection with the synthetic lease transaction. The lessor under the synthetic lease has committed to spend up to $55 million for the purchase of the land and construction of this first phase of the facility, and the Company will act as construction agent for the lessor. At September 30, 1998, the lessor's total accumulated cost for land and construction of the facility was $15.1 million. The lease term began in May 1998 and continues thereafter for five years for the land and, when they are constructed, will incorporate the buildings and other improvements that will comprise the first phase of the facility. Rental payments will commence on completion of construction, and at that time the rental payments will be based on the total construction costs for the facility and the one month LIBOR rate plus 0.75% or 1.00%. The completion of construction is expected to occur in January 2001.
With the approval of lessor, the Company may extend the lease term for up to three one-year periods or one three-year period. The Company has the option either to purchase the entire facility at a purchase price approximating lessor's then-accumulated total costs or only certain portions of the facility, at a pre-set price, at any time during the term or, at the expiration of the lease term to cause the facility to be sold to a third party.
The synthetic lease requires the Company to maintain specified financial covenants, all of which the Company was in compliance with at September 30, 1998. Future minimum lease payments under the synthetic lease are not included in the schedule below.
Minimum future rental commitments under operating leases are as follows:
Year ending September 30, (dollars in thousands) - -------------------------------------------------------------------------------
1999 $ 7,954 2000 8,198 2001 7,779 2002 7,544 2003 5,075 Thereafter 33,270 -------- $ 69,820 ========
Rent expense under operating leases, including month-to-month leases, was $8,298,000, $6,413,000 and $4,821,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
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.
12. Segment Information
The Company operates principally in the financial services industry. Operations in other industries are less than 10% of consolidated revenues. The Company's international operations consist primarily of sales, production and service offices. Foreign sales are primarily exports. The Company's revenues from customers outside the United States were $42,894,000, $33,879,000 and $26,142,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
13. Other Income (Expense)
Other income (expense) consists of the following:
Years ended September 30, (dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------
Interest income $ 2,403 $ 2,040 $ 1,748 Interest expense (803) (336) (223) Foreign currency loss (278) (677) (97) Equity loss in investments -- (2,082) (821) Investment write-off -- (773) (1,535) Acquisition expenses -- (558) -- Other 351 176 114 ------- ------- ------- $ 1,673 $(2,210) $ (814) ======= ======= =======
Earnings Per Share
Total options outstanding included 930,000, 474,000 and 59,000 options to purchase shares of common stock at prices ranging from $36.50 to $45.63, $38.25 to $45.63 and $40.00 to $41.88 at September 30, 1998, 1997 and 1996, respectively. These options were not included in the computation of diluted EPS because the exercise price for such options was greater than the average market price of the common shares for the years ended September 30, 1998, 1997 and 1996, respectively.
15. Supplementary Financial Data (Unaudited)
The financial data for the above quarterly information has been restated to reflect the merger, effective July 1997, between Fair, Isaac and Company, Incorporated, and Risk Management Technologies, which has been accounted for under the pooling-of-interests method.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The required information regarding Directors of the registrant is incorporated by reference from the information under the caption "Election of Directors - Nominees" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
The required information regarding Executive Officers of the registrant is contained in Part I of this Form 10-K.
The required information regarding compliance with Section 16(a) of the Securities Exchange Act is incorporated by reference from the information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the information under the captions "Compensation of Directors and Executive Officers," "Compensation Committee Interlocks and Insider Participation," and "Director Consulting Arrangements" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the information under the caption "Stock Ownership" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the information under the captions "Director Consulting Arrangements" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Reference Page Form 10-K (a) 1. Consolidated financial statements:
Report of Independent Auditors................................ 25
Consolidated statements of income for each of the years in the three-year period ended September 30, 1998........ 26
Consolidated balance sheets at September 30, 1998 and September 30, 1997....................................... 27
Consolidated statements of stockholders' equity for each of the years in the three-year period ended September 30, 1998....................................... 28
Consolidated statements of cash flows for each of the years in the three-year period ended September 30, 1998.. 29
Notes to consolidated financial statements.................... 30
2. Financial statement schedule:
Independent Auditor's Report on Financial Statement Schedule.... 52
II Valuation and qualifying accounts at September 30, 1998, 1997 and 1996............................................ 53
3. Exhibits:
2.1 Lease dated December 2, 1998, by and between DynaMark, Inc., and CSM Corporation.
2.2 Agreement and Plan of Reorganization, dated June 12, l997, among the Company, FIC Acquisition Corporation, Risk Management Technologies ("RMT"), and the shareholders and optionholders of RMT, filed as Exhibit 2.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference. Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules were omitted but will be furnished supplementally to the Commission on request.
2.3 Employment Agreement, dated July 21, l997, by and between the Company and David LaCross, filed as Exhibit 2.3 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
2.4 Amendment To Lease, dated December 2, 1998, by and between CSM Corporation (assignee) and DynaMark, Inc. amending lease dated May 1,1995 between DynaMark, Inc. and Control Data Systems Inc.
3.1 Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
3.2 Restated By-laws of the Company, filed as Exhibit 3.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
4.1 Registration Rights Agreement, dated June 23, l997, among the Company, David LaCross and Kathleen O. LaCross, Trustees U/D/T dated April 2, 1997, Jefferson Braswell, Software Alliance LLC, Robert Ferguson, James T. Fan and Leland Prussia, filed as Exhibit 4.1 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
4.2 Registration Rights Agreement, dated September 30, 1996, among the Company, Donald J. Sanders, Paul A. Makowski and Lawrence E. Dukes, filed as Exhibit 4.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.1 Certificate of Resolution Changing Officers' Incentive Plan, Exempt Employees Bonus Plan and other Company Plan Parameters.*
10.2 Company's 1987 Stock Option Plan, originally filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (Commission File No. 33-14491) (the "Registration Statement").*
10.3 Lease dated April 28, 1995, between CSM Investors, Inc., and DynaMark, Inc. filed as Exhibit 10.3 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.4 Fair, Isaac and Company, Inc. Officers' Incentive Plan (effective October 1, 1992), originally filed as Exhibit 10.4 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994.*
10.5 Lease, dated October 30, 1983, between S.R.P. Limited Partnership and the Company, as amended, originally filed as Exhibit 10.7 to the Registration Statement.
10.6 Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.8 to the Company's report on Form 10-K for the fiscal year ended September 30, 1988.*
10.7 Lease dated July 1, 1993, between The Joseph and Eda Pell Revocable Trust and the Company and the First through Fifth Addenda thereto filed as Exhibit 10.7 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.8 First Amendment to the Company's 1987 Stock Option Plan, originally filed as Exhibit 10.11 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.*
10.9 First Amendment to the Company's Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.*
10.10 Amendment No.1 to the Company's 1992 Long-Term Incentive Plan (as amended and restated effective November 21, 1995), filed as Exhibit 10.10 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997 and incorporated herein by reference.*
10.11 Addendum Number Seven to lease between S.R.P. Limited Partnership and the Company, originally filed as Exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1990.
10.12 Addenda Numbers Eight and Nine to lease between SRP Limited Partnership and the Company filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.13 Lease, dated September 5, 1991, between 111 Partners, a California general partnership, and the Company originally filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.14 Construction Loan Agreement, dated September 5, 1991, between 111 Partners and the Company originally filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.15 Amendment No.2 to the Company's 1992 Long-Term Incentive Plan (as amended and restated effective November 21, 1995) filed as exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
10.16 The Company's 1992 Long-Term Incentive Plan as amended and restated effective November 21, 1995, filed as Exhibit 10.16 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.*
10.17 Amendment No.3 to the Company's Stock Option Plan for Non-Employee Directors, filed as Exhibit 10.17 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
10.18 Lease dated May 1, 1995, between Control Data Corporation and DynaMark, Inc. filed as Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.19 Lease dated April 10, 1994, between Leed Properties and DynaMark, Inc., filed as Exhibit 10.19 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994, and incorporated herein by reference.
10.20 Fair, Isaac Supplemental Retirement and Savings Plan and Trust Agreement effective November 1, 1994, filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994, and incorporated herein by reference.*
10.21 Lease dated July 10, 1993, between the Joseph and Eda Pell Revocable Trust and the Company filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.22 Lease dated October 11, 1993, between the Joseph and Eda Pell Revocable Trust and the Company and the First through Fourth Addenda thereto filed as Exhibit 10.22 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.23 Second Amendment to Lease dated December 2, 1998, between CSM Corporation and DynaMark, Inc. amending lease between the parties dated March 11, 1997.
10.24 Exchange Agreement and Plan of Reorganization, dated July 19, 1996, among DynaMark, Inc., Printronic Corporation of America, Inc., Leo R. Yochim, and Susan Keenan, filed as Exhibit 10.24 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.25 Agreement and Plan of Merger and Reorganization, dated September 30, 1996, among the Company, FIC Acquisition Corporation, Credit & Risk Management Associates, Inc., Donald J. Sanders, Paul A. Makowski and Lawrence E. Dukes, filed as Exhibit 10.25 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.26 Contract between the Company and Dr. Robert M. Oliver, dated April 2, 1996, filed as Exhibit 10.26 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.*
10.27 Letter of Intent dated July 15, 1996, between the Company and Village Properties, and the First Amendment thereto dated July 18, 1996, filed as Exhibit 10.27 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.28 Office Building Lease, dated November 14, 1996, between the Company and Regency Center, filed as Exhibit 10.28 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.29 Sixth and Seventh Addenda to the Lease, dated July 1, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.29 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.30 First and Second Addenda to the Lease dated July 10, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.30 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.31 Fifth Addendum to the Lease, dated October 11, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.31 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.32 First Addendum to Lease, dated August 13, l997, by and between the Company and Regency Center, filed as Exhibit 10.32 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.33 Option Agreement, dated November 26, l997, by and between the Company and Village Builders, L.P., filed as Exhibit 10.33 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.34 Leasehold Improvements Agreement, dated November 26, l997, by and between the Company and Village Builders, L.P., filed as Exhibit 10.34 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.35 Lease, dated March 11, l997, by and between DynaMark, Inc. and CSM, filed as Exhibit 10.35 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.36 First Amendment to Lease, dated September 24, l997, by and between DynaMark, Inc. and CSM, filed as Exhibit 10.36 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.37 Chase Database Agreement, dated October 29, l997, by and among DynaMark, Inc. and Chase Manhattan Bank USA, National Association, filed as Exhibit 10.37 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference. Confidential treatment has been requested for certain portions of this document. Such portions have been omitted from the filing and have been filed separately with the Commission.
10.38 Participation Agreement, dated May 15, 1998, between Company, Lease Plan North America, Inc., ABN Amro Bank N.V. and other participants named therein.
10.39 Lease Agreement, Construction Deed of Trust with Assignment of Rents, Security Agreement and Fixture Filing, dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.40 Purchase Agreement dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.41 Third Amendment to Lease Dated December 2, 1998, by and between CSM Corporation and DynaMark, Inc. amending lease between the parties dated April 28, 1995.
21.1 Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP (see page 54 of this Form 10-K).
24.1 Power of Attorney (see page 51 of this Form 10-K).
27 Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed with the Securities and Exchange Commission during the fiscal quarter ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, 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: December 28, 1998 By /s/ Peter L. McCorkell ----------------------------------- Peter L. McCorkell Senior Vice President, Secretary and General Counsel
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints PETER L. McCORKELL his attorney-in-fact, with full power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
The Board of Directors Fair, Isaac and Company, Incorporated:
Under date of October 29, 1998, we reported on the consolidated balance sheets of Fair, Isaac and Company, Incorporated and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1998, which are included in the 1998 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule in the 1998 annual report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
San Francisco, California October 29, 1998
Consent of Independent Auditors
The Board of Directors Fair, Isaac and Company, Incorporated:
We consent to incorporation by reference in the registration statement (No. 33-20349) on Form S-8, the registration statement (No. 33-26659) on Form S-8, the registration statement (No. 33-63428) on Form S-8, the registration statement (No. 333-02121) on Form S-8, the registration statement (No. 333-32309) on Form S-8, the registration statement (No. 333-20537) on Form S-3, the registration statement (No. 333-42473) on Form S-3 of Fair, Isaac and Company, Incorporated and subsidiaries of our reports dated October 29, 1998, relating to the consolidated balance sheets of Fair, Isaac and Company, Incorporated and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows and related financial statement schedule for each of the years in the three-year period ended September 30, 1998, which reports appear in the September 30, 1998 annual report on Form 10-K of Fair, Isaac and Company, Incorporated, and subsidiaries.
San Francisco, California December 28, 1998
EXHIBIT INDEX TO FAIR, ISAAC AND COMPANY, INCORPORATED REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
Exhibit No. Exhibit - ----------- ------- 2.1 Lease dated December 2, 1998, by and between DynaMark, Inc. and CSM Corporation.
2.4 Amendment To Lease, dated December 2, 1998, by and between CSM Corporation (assignee) and DynaMark, Inc. amending lease dated May 1,1995 between DynaMark, Inc. and Control Data Systems Inc.
10.1 Certificate of Resolution Changing Officers' Incentive Plan, Exempt Employees Bonus Plan and other Company Plan Parameters.
10.2 Company's 1987 Stock Option Plan, originally filed as Exhibit 10.2 to the Registration Statement.
10.5 Lease, dated October 30, 1983, between S.R.P. Limited Partnership and the Company, as amended, originally filed as Exhibit 10.7 to the Registration Statement.
10.6 Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.8 to the Company's report on Form 10-K for the fiscal year ended September 30, 1988.
10.8 First Amendment to the Company's 1987 Stock Option Plan, originally filed as Exhibit 10.11 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.
10.9 First Amendment to the Company's Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.
10.11 Addendum Number Seven to lease between S.R.P. Limited Partnership and the Company, originally filed as Exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1990.
10.13 Lease, dated September 5, 1991, between 111 Partners, a California general partnership, and the Company originally filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.14 Construction Loan Agreement, dated September 5, 1991, between 111 Partners and the Company originally filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.23 Second Amendment to Lease dated December 2, 1998 between CSM Corporation and DynaMark, Inc. amending lease between the parties dated March 11, 1997.
10.38 Participation Agreement, dated May 15, 1998, between Company, Lease Plan North America, Inc., ABN Amro Bank N.V. and other participants named therein.
10.39 Lease Agreement, Construction Deed of Trust with Assignment of Rents, Security Agreement and Fixture Filing, dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.40 Purchase Agreement dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.41 Third Amendment To Lease, dated December 2, 1998, by and between CSM Corporation and DynaMark, Inc. amending lease between the parties dated April 28, 1995.
21.1 Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP (see page 54 of this Form 10-K).
24.1 Power of Attorney (see page 51 of this Form 10-K).
27 Financial Data Schedule.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Fair, Isaac and Company, Incorporated, provides products and services designed to help a variety of businesses use data to make better decisions on their customers, prospective customers and existing portfolios. The Company's products include statistically derived, rule-based analytical tools, software designed to implement those analytical tools and consulting services to help clients use and track the performance of those tools. The Company also provides a range of credit scoring and credit account management services in conjunction with credit bureaus and credit card processing agencies. Its DynaMark subsidiary provides data processing and database management services to businesses engaged in direct marketing activities, many of which are in the credit and insurance industries. The Company's Risk Management Technologies subsidiary provides enterprise-wide risk management and performance measurement solutions to major financial institutions.
The Company is organized into business units that correspond to its principal markets: consumer credit, insurance, direct marketing (DynaMark), enterprise-wide financial risk management (RMT) and a new unit, Healthcare. Sales to the consumer credit industry have traditionally accounted for the bulk of the Company's revenues. Products developed specifically for a single user in this market are generally sold on a fixed-price basis. Such products include application and behavior scoring algorithms (also known as "analytic products" or "scorecards"), credit application processing systems (ASAP(TM) and CreditDesk(R)) and custom credit account management systems, including those marketed under the name TRIAD. Software systems usually also have a component of ongoing maintenance revenue, and CreditDesk systems have also been sold under time- or volume-based price arrangements. Credit scoring and credit account management services sold through credit bureaus and third-party credit card processors are generally priced based on usage. Products sold to the insurance industry are generally priced based on the number of policies in force, subject to contract minimums. DynaMark and RMT employ a combination of fixed-fee and usage-based pricing, and the Healthcare unit intends to employ a combination of fixed-fee and usage-based pricing for its products.
This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes. In addition to historical information, this report includes certain forward-looking statements regarding events and trends that may affect the Company's future results. Such statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially. Such factors include, but are not limited to, those described in this discussion and analysis.
RESULTS OF OPERATIONS
Revenues
Revenues from credit application scoring products increased by 22 percent in fiscal 1997 compared with fiscal 1996, and decreased by 12 percent in fiscal 1998 compared with fiscal 1997. The increase in fiscal 1997 was due primarily to the Company's sales of new products and increased sales of small business loan scoring products. The decrease in revenues in fiscal 1998 reflected the impact of bank consolidations. ASAP revenues increased by 47 percent in fiscal 1997 compared with fiscal 1996, and by 14 percent in fiscal 1998 compared with fiscal 1997, primarily due to increased sales of PC-based ASAP products (CreditDesk) and sales of the StrategyWare(R) decision support system.
Revenues from sales of credit account management systems (TRIAD) sold to end-users decreased by 5 percent from fiscal 1996 to fiscal 1997, and increased by 18 percent from fiscal l997 to fiscal l998. The major factor in the decline in revenues in fiscal l997 was a delay in the completion of the next major release of the software. The increase in fiscal 1998 was due primarily to the release of the next version of TRIAD (TRIAD 5.0) in November l997. The Company's high degree of success in penetrating the U.S. bankcard industry with these products has limited, and may continue to limit, the revenue growth in that market. However, the Company has added functionality for the existing base of TRIAD users and is actively marketing TRIAD for other types of credit products and in overseas markets.
The Company provides credit risk management consulting services primarily through CRMA, which it acquired in September 1996. CRMA completed its second year as part of the Credit business unit on September 30, l998. CRMA's revenues increased by 62 percent in fiscal l998 compared with fiscal 1997 and comprised approximately 4 percent of the Company's Credit revenues in fiscal 1998 as compared to 3 percent in fiscal l997.
Usage revenues are generated primarily by credit scoring services distributed through major credit bureaus and credit account management services distributed through third-party bankcard processors. Revenues from credit bureau-related services increased 22 percent in both fiscal l997 and fiscal 1998 and accounted for approximately 35 percent of revenues in fiscal 1997 and 1998. Revenues from services provided through bankcard processors also increased in each of these years, primarily due to increases in the number of accounts at each of the major processors.
Revenues derived from alliances with credit bureaus and credit card processors have accounted for much of the Company's revenue growth in the last three years. While the Company has been very successful in extending or renewing such agreements in the past, and believes it will generally be able to do so in the future, the loss of one or more such alliances or an adverse change in terms could have a significant impact on revenues and operating margin. Revenues generated through the Company's alliances with Equifax, Inc., Experian Information Solutions, Inc., (formerly TRW Information Systems & Services) and Trans Union Corporation each accounted for approximately 8 to 10 percent of the Company's total revenues in fiscal 1996 and 1997, and approximately 7 to 10 percent of the Company's total revenues in fiscal 1998.
In 1996 Experian was acquired by CCN Group Ltd., a subsidiary of Great Universal Stores, PLC. CCN is the Company's largest competitor, worldwide, in the area of credit scoring. TRW/Experian has offered scoring products developed by CCN in competition with those of the Company for several years. The acquisition had no apparent impact on the Company's revenues from Experian in fiscal 1997 and l998.
On September 30, 1997, amendments to the federal Fair Credit Reporting Act became effective. The Company believes these changes to the federal law regulating credit reporting will be favorable to the Company and its clients. Among other things, the new law expressly permits the use of credit bureau data to prescreen consumers for offers of credit and insurance and allows affiliated companies to share consumer information with each other subject to certain conditions. There is also a seven-year moratorium on new state legislation on certain issues. However, the states remain free to regulate the use of credit bureau data in connection with insurance underwriting.
The Company believes enacted or proposed state regulation of the insurance industry has had a negative impact on its efforts to sell insurance risk scores through credit reporting agencies.
DynaMark's revenues increased from $21.2 million in fiscal 1996 to $29.8 million in fiscal 1997 and to $49.2 million in fiscal 1998. The increases in DynaMark's revenues (excluding intercompany revenues) were due primarily to increased revenues from customers in the financial services industry. Gross margins for fiscal 1996, 1997 and 1998 were approximately 39, 42 and 51 percent, respectively. Since its acquisition, DynaMark has taken on an increasing share of the mainframe batch processing requirements of the Company's other business units. During each of fiscal 1996 and 1997, such intercompany revenue represented approximately 14 percent of DynaMark's total revenues, and in fiscal 1998 such revenue represented approximately 8 percent of DynaMark's total revenues. Accordingly, DynaMark's externally reported revenues may tend to understate DynaMark's growth and contribution to the Company as a whole.
RMT's revenues for fiscal l997 increased by 18 percent compared with fiscal l996, and in fiscal 1998 decreased by 26 percent compared with fiscal 1997, due primarily to the impact of bank consolidations.
Increases in insurance revenues for fiscal l998, compared with fiscal 1997, were due to strong growth in both insurance products sold to end-users and in the insurance scoring services offered through consumer reporting agencies. In fiscal 1997, the Company recorded its first revenues from its Healthcare business unit, and during fiscal 1998 derived revenues from providing analytical marketing services to a large pharmaceuticals manufacturer to help improve customer relationships and management of prescription compliance (i.e., a patient's fulfillment of prescriptions and taking them to completion).
The Company's revenues derived from clients outside the United States increased from $26.1 million in 1996 to $33.9 million in fiscal l997 and to $42.9 million in fiscal 1998. RMT contributed $4.3 million, $4.6 million and $3.7 million to the Company's non-U.S. revenues for fiscal years 1996, l997 and l998, respectively. DynaMark has not had significant non-U.S. revenues. Sales of software products, including TRIAD and CreditDesk, increased usage of credit bureau scores in Canada, and an increase in the number of accounts using the Company's account management services at credit card processors in Europe and Latin America accounted for most of the increase in international revenues in fiscal 1997 and 1998. Gains or losses due to fluctuations in currency exchange rates have not been significant to date but may become more important if, as expected, the proportion of the Company's revenues denominated in foreign currencies increases in the future.
Revenues from software maintenance and consulting services each accounted for less than 10 percent of revenues in each of the three years in the period ended September 30, 1998, and the Company does not expect revenues from either of these sources to exceed 10 percent of revenues in the foreseeable future.
During the period since 1990, while the rate of account growth in the U.S. bankcard industry has been slowing and many of the Company's largest institutional clients have merged and consolidated, the Company has generated above-average growth in revenues--even after adjusting for the effect of acquisitions--from its bankcard-related scoring and account management business by deepening its penetration of large banks and other credit issuers. The Company believes much of its future growth prospects will rest on its ability to: (a) develop new, high-value products, (b) increase its penetration of established or emerging credit markets outside the U.S. and Canada and (c) expand--either directly or through further acquisitions--into relatively undeveloped or underdeveloped markets for its products and services, such as direct marketing, insurance, small business lending and healthcare information
management. During fiscal 1998, the Company's backlog of orders for fixed-priced products declined slightly. This indicates that revenue growth in fiscal 1999 and later years may depend to a large extent on sales of newly developed products.
Over the long term, in addition to the factors discussed above, the Company's rate of revenue growth--excluding growth due to acquisitions--is limited by the rate at which it can recruit and absorb additional professional staff. Management believes this constraint will continue to exist indefinitely. On the other hand, despite the high penetration the Company has already achieved in certain markets, the opportunities for application of its core competencies are much greater than it can pursue. Thus, the Company believes it can continue to grow revenues, within the personnel constraint, for the foreseeable future. At times management may forego short-term revenue growth in order to devote limited resources to opportunities that it believes have exceptional long-term potential. This occurred in the period from 1988 through 1990, when the Company devoted significant resources to developing the usage-priced services distributed through credit bureaus and third-party processors.
Expenses
Cost of revenues
Cost of revenues consists primarily of personnel, travel and related overhead costs; costs of computer service bureaus; and the amounts paid by the Company to credit bureaus for scores and related information in connection with the ScoreNet(R) Service.
Cost of revenues, as a percentage of revenues, declined slightly in the periods from fiscal l996 to fiscal 1997 and from fiscal l997 to fiscal 1998. The decrease in both fiscal l997 and fiscal 1998 was due primarily to the reassignment to research and development activities of certain personnel whose primary assignment had been production and delivery.
Sales and marketing
Sales and marketing expenses consist principally of personnel, travel, overhead, advertising and other promotional expenses. As a percentage of revenues, sales and marketing expenses decreased in fiscal 1997 compared with fiscal 1996 due primarily to a reduction in media advertising and remained essentially unchanged from fiscal 1997 to fiscal 1998.
Research and development
Research and development expenses include the personnel and related overhead costs incurred in product development, researching mathematical and statistical algorithms and developing software tools that are aimed at improving productivity and management control. Research and development increased sharply from fiscal l996 to fiscal 1997 and from fiscal 1997 to fiscal 1998. After several years of concentrating on developing new markets--either geographically or by industry--for its existing technologies, in fiscal 1996 and fiscal l997 the Company renewed its historical emphasis on developing new technologies, especially in the area of software development.
In fiscal 1998, the Company continued to emphasize development of new technologies. Research and development expenditures in fiscal 1998 were primarily related to new bankruptcy scoring products for Visa (Integrated Solutions Concepts) and Trans Union, new fraud-detection software products, joint product development projects with Deluxe Financial Services, Inc., healthcare receivables management and Year 2000 compliance work.
General and administrative
General and administrative expenses consist mainly of compensation expenses for certain senior management, corporate facilities expenses, the costs of administering certain benefit plans, legal expenses, expenses associated with the exploration of new business opportunities and the costs of operating administrative functions, such as finance and computer information systems. As a percentage of revenues, general and administrative expenses were essentially unchanged for fiscal l996, l997 and l998.
Amortization of intangibles
The Company is amortizing the intangible assets arising from various acquisitions over periods ranging from 2 to 15 years. The level of amortization expense in future years will depend, in part, on the amount of additional payments to the former shareholders of CRMA, a privately held company acquired at the end of fiscal l996. See below, under "Capital Resources and Liquidity."
Other income (expense)
The table in Note 13 to the Consolidated Financial Statements presents the detail of other income and expenses. Interest income is derived from the investment of funds surplus to the Company's immediate operating requirements. At September 30, 1998, the Company had approximately $46.5 million invested in U.S. treasury securities and other interest-bearing instruments. Interest income increased in both fiscal 1997 and 1998 due to higher average cash balances in interest-bearing accounts and instruments.
The Company's share of operating losses in certain early-stage development companies that are accounted for using the equity method is charged to other expense. During the fiscal year ended September 30, l997, the Company wrote off non-marketable investments with an equity basis of $773,000, primarily related to an Italian start-up venture that was adversely affected by a new privacy law. In fiscal year ended September 30, 1998, the Company liquidated its share of this non-marketable security resulting in a gain of $165,000 and has no further financial commitments in connection with this investment. Note 4 to the Consolidated Financial Statements describes the Company's investment in such companies.
In fiscal 1998, the difference between the increase in operating income (7 percent) and the increase in net income (18 percent) was primarily due to the interest income derived from investments in U.S. treasury securities and other interest-bearing instruments, and the absence of losses from investments in start-ups.
Provision for income taxes
The Company's effective tax rate was 39.3, 41.8 and 42.2 percent in fiscal l996, 1997 and l998, respectively. The increase to 42.2 percent in fiscal 1998 was due primarily to the nondeductible nature of goodwill, deferred compensation and an increase in the effective state tax rate. The Company expects its effective tax rate in fiscal 1999 to be approximately 42 percent, barring any change in the tax laws.
Capital Resources and Liquidity
Working capital increased from $34,699,000 at September 30, 1996, to $47,727,000 at September 30, l997, and to $54,852,000 at September 30, 1998. The increase in fiscal 1997 was due primarily to increases in accounts receivable and unbilled work in progress, which more than offset the increase in accrued compensation and employee benefits and the decrease in prepaid expenses and other assets.
The increase in fiscal 1998 was due primarily to increases in short-term investments, unbilled work in progress and accounts receivable, which more than offset the increase in accounts payable and other accrued liabilities and accrued compensation and employee benefits.
The Company's exposure to collection risks is comprised of the sum of accounts receivable plus unbilled work in progress, less billings in excess of earned revenues. Changes in contract terms and product mix, along with variations in timing, may cause fluctuations in any or all of these items. During fiscal 1997, the increases in accounts receivable and billings in excess of earned revenues were proportional to the increase in revenues. The greater increase in unbilled work in progress was due primarily to changes in product mix and contract terms. During fiscal 1998, the increase in accounts receivable was proportionally much less than the increase in revenues due to improved collection efforts by the Company, and the increases in unbilled work in progress and billings in excess of earned revenues were proportional to the increase in revenues.
The Company capitalized $45,000 as goodwill relating to amounts due to the former stockholders of CRMA under the CRMA purchase agreement based upon its financial results in fiscal 1997, and has capitalized $263,000 based upon CRMA's financial results in fiscal 1998. An additional payment to the former stockholders of CRMA based upon CRMA's financial results in fiscal 1999 may also be required. That amount, which will be paid 55 percent in Company stock and 45 percent in cash, will not exceed $1,833,000.
In fiscal 1997, cash provided by operations resulted primarily from net income before depreciation and amortization, decreases in prepaid expenses and other assets and increases in accrued compensation and employee benefits, partially offset by the increase in accounts receivable and unbilled work in progress. Cash was used in investing activities primarily for additions to property and equipment and the purchase of interest-bearing investments, partially offset by the maturities of interest-bearing investments. Cash was used in financing activities for the payment of dividends, reduction of capital lease obligations and repurchase of Company stock, partially offset by cash generated by the exercise of stock options.
In fiscal 1998, cash provided by operations resulted primarily from net income before depreciation and amortization, and increases in accounts payable and other accrued liabilities and accrued compensation and employee benefits, partially offset by the increases in accounts receivable, other assets and unbilled work in progress. Cash was used in investing activities primarily for additions to property and equipment, and purchases of interest-bearing investments, partially offset by the maturities of interest-bearing investments. Cash was provided by financing activities primarily from the exercise of stock options, partially offset by cash used for the payment of dividends and the reduction of capital lease obligations.
Future cash flows will continue to be affected by operating results, contractual billing terms and collections, investment decisions and dividend payments, if any. At September 30, 1998, the Company had no significant capital commitments other than those obligations described in Notes 2, 5 and 11 of the Consolidated Financial Statements.
On December 1, 1997, the Company purchased undeveloped land in San Rafael, California, with the intention of constructing an office complex to accommodate future growth. Development has commenced, and on May 15, 1998, the Company entered into a synthetic lease arrangement, which will materially increase the Company's future operating lease expenses. Rental payments will commence upon completion of construction, which is expected to
occur in the second quarter of fiscal 2001. With this external financing, the Company believes that the cash and marketable securities on hand, along with cash expected to be generated by operations, will be adequate to meet its capital and liquidity needs for both the current year and the foreseeable future.
Year 2000
The Company is performing Year 2000 remediation work and compliance testing on its software products marketed to customers. The updated versions of most of its software products currently being shipped to customers are Year 2000 compliant. Certain international versions of the Company's software products are not yet Year 2000 compliant, but the Company expects to be prepared to ship upgrade "patches" for these products by the end of calendar 1998. Year 2000 remediation work, including compliance testing, for most earlier versions of the Company's software installed at customer sites will be performed as part of the Company's normal upgrade and maintenance process. Prior to the end of calendar 1999, the Company will discontinue support for some software products that have been replaced by other products, and Year 2000 upgrades for these products will not be available. Revenues from such products are not significant. There are no assurances that the Company's current products do not contain undetected errors or defects associated with Year 2000 date functions that may result in material costs to the Company. However, the Company currently does not expect significant disruption of its revenues or operations from the Year 2000 issues associated with its products. The Company has not made an assessment of the potential impact of failing to complete its own Year 2000 remediation work nor has it developed any contingency plans for such an event.
Additionally, the Company has substantially completed its Year 2000 inventory and assessment of internal information technology (IT) and non-IT systems and applications and expects all major internal systems to be fully compliant by the end of December 1998. The Company has determined that the majority of its internally developed systems are Year 2000 compliant. All applications supplied to Company by third parties are either Year 2000 compliant today or have "patches" currently available to bring them into compliance. Extensive compliance testing has commenced and will continue through most of the calendar year 1999. The most reasonably likely worst-case scenarios would include: (a) corruption of data contained in the Company's internal information systems, and (b) hardware/operating system failure. The Company is in the process of completing its contingency plans for business-critical IT and non-IT internal systems as an extension of its existing disaster recovery plan and expects to complete such planning by June 30, 1999.
The Company estimates that the costs of Year 2000 remediation (including compliance testing) for its products and internal systems will be in the range of $4 million to $5 million. Approximately two-thirds of these estimated costs have been expended as of September 30, 1998. These costs principally consist of both internal staff costs and expenses for external consultants, software and hardware, which have been or will be expensed by the Company during the period they are incurred. Expected costs for the Year 2000 remediation work (including compliance testing) and projected completion dates are based on the Company's management's estimates and assumptions and actual results may vary materially from those anticipated.
The Company has also initiated communications with third parties on which it is dependent for essential services and for the distribution of its significant services to determine how they are addressing Year 2000 issues and to evaluate any impact on the Company's operations. The Company is working with these third parties to resolve Year 2000 issues and information received to date indicates that these parties are in the process of implementing and/or testing remediation strategies to ensure Year 2000 compliance of systems, services and/or products. However, the lack of resolution of Year 2000 issues by these parties--especially the credit bureaus and credit card processors through which the Company distributes credit scoring and account management services--could have a material adverse impact on the Company's future business operations, financial condition and results of operations.
The Company anticipates that the most reasonably likely worst-case scenarios involving third-party Year 2000 issues would include: (a) failure of infrastructure services provided by government agencies and third parties (e.g., transportation, electricity, telephone, Internet services, etc.) and (b) failure of one or more of the credit bureaus or credit card processors through which the Company distributes its credit scoring and account management services to achieve timely and successful Year 2000 compliance. Contingency plans to address these most reasonably likely
worst-case scenarios are under development and are expected to be completed by June 30, 1999. At this time the Company cannot quantify the potential impact of third-party Year 2000 issues.
The foregoing information and statements regarding the Company's Year 2000 capabilities and readiness are "Year 2000 Information and Readiness Disclosures" in conformance with the Year 2000 Information and Readiness Disclosure Act of 1998 enacted on October 19, 1998.
European Economic and Monetary Union (EMU)
Under the European Union's plan for Economic and Monetary Union (EMU), the euro becomes the sole accounting currency of EMU countries on January 1, 2002. Its initial phase goes into effect on January 1, 1999, in 11 participating countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. In this initial phase the EMU mandates that key financial systems be able to triangulate conversion rates so that any amount booked will be logged and processed simultaneously in both the local currency and euros. The Company believes that its computer systems and programs are euro-compliant. Costs associated with compliance were not material and were expensed by the Company as they were incurred.
Quarterly Results
The table in Note 15 to the Consolidated Financial Statements presents unaudited quarterly operating results for the last eight fiscal quarters. Management believes that all the necessary adjustments have been included in the amounts stated to present fairly the selected quarterly information, when read in conjunction with the financial statements included elsewhere in this report. This information includes all normal recurring adjustments that the Company considers necessary for a fair presentation thereof, in accordance with generally accepted accounting principles.
Quarterly results may be affected by fluctuations in revenue associated with credit card solicitations, by the timing of orders for and deliveries of certain ASAP and TRIAD systems and by the seasonality of ScoreNet purchases. With the exception of the cost of ScoreNet data purchased by the Company, most of its 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. However, in recent years these fluctuations were generally offset by the strong growth in revenues from services delivered through credit bureaus and third-party bankcard processors.
Management believes that neither the quarterly variations in net revenues and net income nor the results of operations for any particular quarter are necessarily indicative of results of operations for full fiscal years. Accordingly, management believes that the Company's results should be evaluated on an annual basis.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Disclosures. The following discussion about the Company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. The Company does not use derivative financial instruments for speculative or trading purposes.
Interest Rate Sensitivity. The Company maintains a short-term investment portfolio consisting mainly of income securities with an average maturity of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at September 30, 1998, the fair value of the portfolio would decline by an immaterial amount. The Company has the ability to hold its fixed income investments until maturity, and therefore the Company would not expect its operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its securities portfolio. The Company believes foreign currency and equity risk is not material.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT AUDITORS
The Board of Directors Fair, Isaac and Company, Incorporated:
We have audited the accompanying consolidated balance sheets of Fair, Isaac and Company, Incorporated, and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fair, Isaac and Company, Incorporated, and subsidiaries as of September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1998, in conformity with generally accepted accounting principles.
San Francisco, California October 29, 1998
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Summary of Significant Accounting Policies
Nature of business
Fair, Isaac and Company, Incorporated, (the "Company") is incorporated under the laws of the State of Delaware. The Company offers a variety of technological tools to enable users to make better decisions through data. The Company is a world leader in developing predictive and risk assessment models for the financial services industry, including credit and insurance scoring algorithms. The Company also offers direct marketing and database management services, and enterprise-wide risk management and performance measurement solutions to major financial institutions through its wholly owned subsidiaries, DynaMark, Inc. (DynaMark) and Risk Management Technologies (RMT), respectively.
Basis of consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated from the consolidated financial statements.
Use of estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents consist of cash in banks and investments with an original maturity of 90 days or less at time of purchase.
Investments
Investments in U.S. government obligations and marketable equity securities are classified as "available-for-sale" and carried at market. Investments in 50% or less owned companies in which the Company has the ability to exercise significant influence are accounted for using the equity method and are classified as non-marketable securities. Other investments are carried at the lower of cost or net realizable method and are classified as non-marketable securities.
Investments classified as available-for-sale securities with remaining maturities over one year and non-marketable securities are classified as long-term investments.
Credit and market risk
The Company invests a portion of its excess cash in U.S. government obligations and has established guidelines relative to diversification and maturities that maintain safety and liquidity. In addition, an allowance for doubtful accounts is maintained at a level which management believes is sufficient to cover potential credit losses for accounts receivable. Actual losses have been within management's expectations.
Depreciation and amortization
Depreciation and amortization on property and equipment including leasehold improvements and capitalized leases are provided using the straight-line method over estimated useful lives ranging from three to ten years or the term of the respective leases.
Revenue recognition
Revenues from contracts for the development of credit scoring systems and custom software are recognized using the percentage-of-completion method of accounting based upon milestones that are defined using management's estimates of costs incurred at various stages of the project as compared to total estimated project costs. Revenues determined by the percentage-of-completion method in excess of contract billings are recorded as unbilled work in progress. Such amounts are generally billable upon reaching certain performance milestones that are defined by the individual contracts. Deposits billed and received in advance of performance under contracts are recorded as billings in excess of earned revenues.
Revenues from usage-priced products and services are recognized on receipt of usage reports from the third parties through which such products and services are delivered. Amounts due under such arrangements are recorded as unbilled work in progress until collected. Revenues from non-customized software licenses and shrink-wrapped products are recognized upon delivery of product and services, or license renewal. Revenues from products and services sold on time-based pricing, including maintenance of computer and software systems, are recognized ratably over the contract period.
Software costs
The Company follows one of two paths to develop software. One involves a detailed program design, which is used when introducing new technology; the other involves the creation of a working model for modification to existing technologies that has been supported by adequate testing. All costs incurred prior to the resolution of unproven functionality and features, including new technologies, are expensed as research and development. After the uncertainties have been tested and the development issues have been resolved, technological feasibility is achieved and subsequent costs such as coding, debugging and testing are capitalized.
When developing software using existing technology, the costs incurred prior to the completion of a working model are expensed. Once the product design is met, this typically concludes the software development process and is usually the point at which technological feasibility is established. Subsequent expenses, including coding and testing, if any, are capitalized. For the three-year period ending September 30, 1998, technological feasibility coincided with the completion process; thus, all design and development costs were expensed as research and development costs.
Purchased software costs are amortized over three to five years. For the years ended September 30, 1998, 1997 and 1996, amortization of capitalized software was $528,000, $808,000 and $248,000, respectively. At September 30, 1998 and 1997, unamortized purchased computer software costs were $6,508,000 and $1,221,000, respectively.
Intangibles
The intangible assets consisting of goodwill and non-compete agreements arose principally from business acquisitions and are amortized on a straight-line basis over the period of expected benefit, which ranges from 2 to 15 years. The Company assesses the recoverability of goodwill by evaluating the undiscounted projected results of operations over the remaining amortization period.
Income taxes
Income taxes are recognized during the year in which transactions enter into the determination of financial statement income, with deferred taxes being provided for temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws.
Foreign currency
The Company has determined that the functional currency of each foreign operation is the local currency. Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rate on the balance sheet date, while revenues and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are accumulated as a separate component of stockholders' equity.
Earnings per share
Diluted earnings per share are based on the weighted-average number of common shares outstanding and common stock equivalent shares. Common stock equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. Basic earnings per share is computed on the basis of the weighted average number of common stock shares outstanding.
Accounting pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 130, "Reporting Comprehensive Income." SFAS No. 130 established standards for reporting comprehensive income and its components in financial statements. This statement requires that all items which are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income is equal to net income plus the change in "other comprehensive income." SFAS No. 130 requires that an entity: (a) classify items of other comprehensive income by their nature in a financial statement, and (b) report the accumulated balance of other comprehensive income separately from common stock and retained earnings in the equity section of the balance sheet. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. Beginning with the first quarter of 1999, management intends to conform its consolidated financial statements to this pronouncement.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for publicly held entities to follow in reporting information about operating segments in annual financial statements and requires that those entities report selected information about operating segments in interim financial statements. This statement also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. Beginning with fiscal year 1999, management intends to conform its annual consolidated financial statements to this pronouncement.
In October 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The Company will be required to adopt SOP 97-2 for software transactions entered into beginning October 1, 1998, and retroactive application to years prior to adoption is prohibited. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements (e.g., software products, upgrades/enhancements, postcontract customer support, installation, training, etc.) to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence, which is specific to the vendor. The revenue allocated to software products (including specified upgrades/enhancements) generally is recognized upon delivery of the products. The revenue allocated to postcontract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements (such as training and installation) generally is recognized as the services are performed. If a vendor does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. The Company's management believes that the adoption of SOP 97-2 will not have a material impact on the Company's results of operations. Beginning with fiscal year 1999, management intends to conform its consolidated financial statements to this pronouncement.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits." The statement standardizes the disclosure requirements for pension and other
postretirement benefits. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the disclosure. Beginning with fiscal year 1999, management intends to conform its consolidated financial statements to this pronouncement.
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP requires that certain costs related to the development or purchase of internal-use software be capitalized and amortized over the estimated useful life of the software. The SOP also requires that costs related to the preliminary project stage and the post-implementation/operations stage of an internal-use computer software development project be expensed as incurred. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1998. Beginning with fiscal year 2000, management intends to conform its consolidated financial statements to this pronouncement.
Fair value of financial instruments
The fair values of cash and cash equivalents, accounts receivable and accounts payable are approximately equal to their carrying amounts because of the short-term maturity of these instruments. The fair values of the Company's investment securities are disclosed in Note 4.
2. Mergers and Acquisitions
In July 1997, the Company issued 1,252,665 shares of its common stock (including 544,218 shares underlying options assumed by the Company) in connection with the merger with RMT. The acquisition has been accounted for under the pooling-of-interests method. Accordingly, the consolidated financial statements have been restated for all prior periods to include RMT. Further, all common share and per share data have been restated for prior periods.
For the pre-merger periods indicated, revenues and net income of the Company and RMT are as follows:
Nine-months ended June 30, 1997 Year ended (dollars in thousands) Unaudited September 30, 1996 - --------------------------------------------------------------------------------
Revenues
Fair, Isaac and Company, Incorporated $137,031 $148,749 Risk Management Technologies 5,746 7,164 -------- -------- $142,777 $155,913 ======== ======== Net Income
Fair, Isaac and Company, Incorporated $ 13,732 $ 16,179 Risk Management Technologies 630 1,244 -------- -------- $ 14,362 $ 17,423 ======== ========
RMT previously used the fiscal year ended December 31 for its financial reporting. RMT's operating results for the year ended December 31, 1996, are included in the accompanying statement of income in the column headed September 30, 1996. The statement of income's comparative 1997 results reflect the operations of the Company and RMT for the year ended September 30, 1997. Accordingly, the duplication of RMT's net income, for the three months ended December 31, 1996, has been adjusted by a $214,000 charge to retained earnings in fiscal 1997.
In July 1996, the Company purchased certain assets and liabilities of Printronic Corporation of America, Inc. (Printronic), a privately held direct mail computer processing company, and effective at the close of September 30, 1996, the Company acquired 100% of the stock of Credit & Risk Management Associates, Inc. (CRMA), a privately held consulting services company.
The consideration paid for Printronic and CRMA consisted of 84,735 Company shares valued at $3,572,000 plus $1,697,000 in cash. Both acquisitions have been accounted for as purchases. The results of operations of Printronic have been included in the consolidated financial statements since the acquisition date; no results of operations for CRMA are included in the consolidated financial statements for the year ended September 30, 1996. The purchase price for each acquisition was allocated based on estimated fair values at the dates of acquisition. The excess of the purchase prices over the fair value of net assets or liabilities was $5,547,000 and has been recorded as goodwill, which will be amortized on a straight-line basis over 7 or 15 years.
The CRMA purchase agreement provides for additional contingent cash and Company stock payments to the former CRMA shareholders not to exceed $5,499,000 based on specified financial performance of CRMA through September 1999. For the years ended September 30, 1998 and 1997, an additional $265,000 and $45,000, respectively, were capitalized as goodwill relating to the additional contingent cash and Company stock payments.
Pro forma unaudited consolidated operating results of the Company, Printronic and CRMA for the years ended September 30, 1996, assuming the acquisitions had been made as of October 1, 1995, are summarized below.
Pro forma summary (unaudited) Year ended September 30, (dollars in thousands except per share data) 1996 - --------------------------------------------------------------------------------
Revenue $ 162,491 Net income $ 17,495 Earnings per share: Diluted $ 1.25 Basic $ 1.32
These pro forma results have been prepared for comparative purposes only and include certain adjustments such as additional amortization expense as a result of goodwill and other intangible assets. They do not purport to be indicative of the results of operations that actually would have resulted had the combinations been in effect on October 1, 1995, or of future results of operations of the consolidated entities.
3. Cash Flow Statement
4. Investments
The long-term U.S. government obligations mature in one to five years.
For the year ended September 30, 1997, a non-marketable investment with an equity basis of $773,000 in an overseas start-up venture, principally an Italian credit reporting agency, was written off due to the potential negative impact on the agency's operations from a new Italian privacy law. During the year ended September 30, 1998, the Company liquidated its share of this non-marketable security for a gain of $165,000. The Company does not have any further financial commitments with respect to this investment. The Company also recognized its equity share of losses from this Italian venture of $2,082,000 and $821,000 for the years ended September 30, 1997 and 1996, respectively.
For the year ended September 30, 1996, an investment of $1,535,000 in the non-marketable preferred stock of an early-stage enterprise was written off due to the deteriorating financial condition of the entity. The Company does not have any further financial commitments with respect to the investment.
5. Property and Equipment
Property and equipment at September 30, 1998 and 1997 valued at cost, consist of the following:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Data processing equipment $ 42,995 $ 34,248 Office furniture, vehicles and equipment 16,156 14,383 Leasehold improvements 13,777 12,003 Capitalized leases 2,841 2,841 Less accumulated depreciation and amortization (38,876) (28,989) -------- -------- Net property and equipment $ 36,893 $ 34,486 ======== ========
Depreciation and amortization charged to operations were $13,553,000, $10,479,000 and $7,194,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Capitalized leases consist primarily of one lease bearing an interest rate of 7% that matures in the year 2001. The following is a schedule, by years, of future minimum lease payments under capitalized leases, together with the present value of the net minimum lease payments, at September 30, 1998:
Years ended September 30, (dollars in thousands) - -------------------------------------------------------------------------------
1999 $ 487 2000 467 2001 375 ------- 1,329 Less: Amount representing interest (124) ------- Present value of net minimum lease payments $ 1,205 =======
6. Intangibles
Intangibles at September 30, 1998 and 1997, consist of the following:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Goodwill $ 13,430 $ 10,138 Other 2,470 2,270 Less accumulated amortization (5,442) (4,047) -------- -------- $ 10,458 $ 8,361 ======== ========
Amortization charged to operations was $1,395,000, $1,274,000 and $734,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
7. Income Taxes
The provision for income taxes consists of the following:
Years ended September 30, (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------
Current: Federal $ 17,380 $ 14,685 $ 9,026 State 3,967 2,863 1,901 Foreign 240 136 270 -------- -------- -------- 21,587 17,684 11,197 -------- -------- -------- Deferred: Federal (3,152) (2,400) 183 State (657) (424) (99) -------- -------- -------- (3,809) (2,824) 84 -------- -------- -------- $ 17,778 $ 14,860 $ 11,281 ======== ======== ========
Amounts for the current year are based upon estimates and assumptions as of the date of this report and could vary significantly from amounts shown on the tax returns as filed.
The tax effect of significant temporary differences resulting in deferred tax assets at September 30, 1998 and 1997, are as follows:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Deferred tax assets: Depreciation and amortization $ 2,350 $ 2,637 Customer advances 2,198 -- Employee benefit plans 1,594 280 Deferred compensation 1,489 2,042 Compensated absences 1,455 1,070 State taxes 1,388 1,007 Capital loss carryforward 1,245 1,530 Bad debt provision 464 283 Capital lease obligations 197 201 Warranty reserves 140 26 Other 630 103 -------- -------- 13,150 9,179 Less valuation allowance (1,245) (1,083) -------- -------- 11,905 8,096 Deferred tax liabilities: Tax on net unrealized gains on available-for-sale securities (491) (210) -------- -------- Deferred tax assets, net $ 11,414 $ 7,886 ======== ========
The valuation allowance for deferred tax assets at September 30, 1998 and 1997, was $1,245,000 and $1,083,000, respectively. The valuation allowance was needed to reduce the deferred tax assets since the Company does not meet the more-likely-than-not requirement for utilization of the capital loss carry forward.
8. Employee Benefit Plans
Pension plan
The plan assets consist primarily of U.S. government and marketable equity securities.
The projected benefit obligation includes an accumulated benefit obligation of $10,981,000 and $8,057,000 at September 30, 1998 and 1997, respectively. The projected benefit obligation exceeded the fair value of the pension plan assets for the years ended September 30, 1998 and 1997, respectively.
The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6.5% and 4.0%, respectively, at September 30, 1998, and 7.5% and 5.0%, respectively, at September 30, 1997. The expected long-term rate of return on assets was 8.5% at September 30, 1998 and 1997.
The net pension cost for the fiscal years ended September 30, 1998 and 1997, included the following components:
(dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------
Service costs $ 1,516 $ 1,011 Interest cost on projected benefit obligation 943 745 Actual return on plan assets (840) (2,050) Net amortization and deferral 132 1,502 ------- ------- Net periodic pension plan cost $ 1,751 $ 1,208 ======= =======
Employee stock ownership plan
The Company has an Employee Stock Ownership Plan (ESOP) that covers eligible full-time employees. Contributions to the ESOP are determined annually by the Company's Board of Directors. In addition, the ESOP may purchase stock from the Company or its stockholders. Provisions for contributions to the ESOP were $1,803,000, $1,534,000 and $1,445,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
At September 30, 1998 and 1997, the ESOP held 835,693 and 970,566 shares of Company stock, respectively. The amount of dividends on ESOP shares were $75,212, $81,000 and $94,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Company stock held and paid for by the ESOP is allocated annually to participants based on employee compensation levels. While employed by the Company, participants vest in the allocated shares at rates ranging from 0% to 30% over a period of 1 to 7 years until fully vested, depending on the plan.
Defined contribution plans
The Company offers 401(k) plans for eligible employees. Eligible employees may contribute up to 15% of compensation. The Company provides a matching contribution, which either vests immediately or over five years, depending on the plan. The Company contributions to 401(k) plans were $790,000, $673,000 and $470,000 for the years ended September 30, 1998, 1997 and 1996, respectively. In addition, the Company maintains a supplemental retirement and savings plan for certain officers and senior management employees. Company contributions to that plan were $247,000, $132,000 and $104,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Officers' incentive plan
The Company has an executive compensation plan for the benefit of officers. Benefits are payable based on the achievement of financial and performance objectives, which are set annually by the Board of Directors, and the market value of the Company's stock. Total expenses under the plan were $3,273,000, $3,842,000 and $3,560,000 for the years ended September 30, 1998, 1997 and 1996, respectively. The incentive earned each year is paid 50% currently, and the balance is payable over a four-year period, subject to certain adjustments, as defined in the plan, based on employment status and the market value of the Company's common stock. At September 30, 1998 and 1997, the long-term officers' incentive plan payable was $3,066,000 and $3,475,000, respectively.
Employee incentive plans
The Company has incentive plans for eligible employees not covered under the executive compensation plan. Awards under these plans are paid annually and are based on the achievement of certain financial and performance objectives. Total expenses under these plans were $5,537,000, $5,211,000 and $4,426,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
9. Stock
Common
A total of 35,000,000 shares of common stock, $.01 par value, are authorized, of which 13,992,126 shares (including 9,787 shares of treasury stock) were outstanding at September 30, 1998, and 13,474,382 shares (including 12,114 shares of treasury stock) were outstanding at September 30, 1997.
Preferred
A total of 1,000,000 shares of preferred stock, $.01 par value, are authorized; no preferred stock has been issued.
10. Stock Option Plans
The Company has two stock option plans, one of which is for the granting of stock options, stock appreciation rights, restricted stock and common stock that reserve shares of common stock for issuance to officers, key employees and non-employee directors. The Company has elected to continue to apply the provisions of APB No. 25, and provide the pro forma disclosures of SFAS No. 123, "Accounting for Stock-Based Compensation." Granted awards generally have a maximum term of ten years and vest over one to five years. Under this plan approved by the stockholders, a number of shares equal to 4% of the number of shares of the Company's common stock outstanding on the last day of the preceding fiscal year is added to the shares available under the plan each fiscal year, provided that the number of shares suitable for grants of incentive stock options for the remaining term of the plan shall not exceed 1,500,000 shares. The other plan is limited to the former employees of RMT, who, as of the merger date, held unexpired and unexercised stock option grants under the RMT stock option plans. Granted awards have a maximum term of ten years and vest over three years. The total number of issuable options under the plan is 650,800.
The fair value of options at the date of grant was estimated using the Black-Scholes model with the following weighted-average assumptions for the years ended September 30:
1998 1997 1996 - -------------------------------------------------------------------------------
Expected life (years) 5 5 5 Interest rate 5.5% 6.5% 6.2% Volatility 43% 45% 45% Dividend yield 0% 0% 0%
The weighted-average fair value of options granted for the years ended September 30, 1998, 1997 and 1996, was $17.30, $17.47 and $15.35, respectively.
Stock-based compensation under SFAS No. 123 would have had the following pro forma effects for the years ended September 30:
(in thousands, except per share data) 1998 1997 1996 - --------------------------------------------------------------------------------
Net income, as reported $ 24,327 $ 20,686 $ 17,423 ======== ======== ========== Pro forma net income $ 20,655 $ 18,091 $ 17,002 ======== ======== ========== Earnings per share, as reported: Diluted $ 1.68 $ 1.46 $ 1.25 ======== ======== ========== Basic $ 1.77 $ 1.55 $ 1.32 ======== ======== ========== Pro forma earnings per share: Diluted $ 1.43 $ 1.27 $ 1.22 ======== ======== ========== Basic $ 1.50 $ 1.35 $ 1.29 ======== ======== ==========
The pro forma effect on net income for each of the years ended September 30, 1998, 1997 and 1996, may not be representative of the effects on reported net income in future years.
11. Commitments and Contingencies
The Company conducts certain of its operations in facilities occupied under non-cancelable operating leases with lease terms in excess of one year. The leases generally provide for annual increases based upon the Consumer Price Index or fixed increments.
In May 1998, the Company entered into a synthetic lease agreement to lease land in San Rafael, California, and improvements comprising the first phase of an office complex facility to be constructed on the land. A synthetic lease is asset-based financing structured to be treated as a lease for accounting purposes but as a loan for tax purposes. The office complex facility is intended to accommodate the future growth of the Company.
The Company had an option (the "Option") to purchase the undeveloped land in December 1997, and the Option was assigned to the lessor in connection with the synthetic lease transaction. The lessor under the synthetic lease has committed to spend up to $55 million for the purchase of the land and construction of this first phase of the facility, and the Company will act as construction agent for the lessor. At September 30, 1998, the lessor's total accumulated cost for land and construction of the facility was $15.1 million. The lease term began in May 1998 and continues thereafter for five years for the land and, when they are constructed, will incorporate the buildings and other improvements that will comprise the first phase of the facility. Rental payments will commence on completion of construction, and at that time the rental payments will be based on the total construction costs for the facility and the one month LIBOR rate plus 0.75% or 1.00%. The completion of construction is expected to occur in January 2001.
With the approval of lessor, the Company may extend the lease term for up to three one-year periods or one three-year period. The Company has the option either to purchase the entire facility at a purchase price approximating lessor's then-accumulated total costs or only certain portions of the facility, at a pre-set price, at any time during the term or, at the expiration of the lease term to cause the facility to be sold to a third party.
The synthetic lease requires the Company to maintain specified financial covenants, all of which the Company was in compliance with at September 30, 1998. Future minimum lease payments under the synthetic lease are not included in the schedule below.
Minimum future rental commitments under operating leases are as follows:
Year ending September 30, (dollars in thousands) - -------------------------------------------------------------------------------
1999 $ 7,954 2000 8,198 2001 7,779 2002 7,544 2003 5,075 Thereafter 33,270 -------- $ 69,820 ========
Rent expense under operating leases, including month-to-month leases, was $8,298,000, $6,413,000 and $4,821,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
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.
12. Segment Information
The Company operates principally in the financial services industry. Operations in other industries are less than 10% of consolidated revenues. The Company's international operations consist primarily of sales, production and service offices. Foreign sales are primarily exports. The Company's revenues from customers outside the United States were $42,894,000, $33,879,000 and $26,142,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
13. Other Income (Expense)
Other income (expense) consists of the following:
Years ended September 30, (dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------
Interest income $ 2,403 $ 2,040 $ 1,748 Interest expense (803) (336) (223) Foreign currency loss (278) (677) (97) Equity loss in investments -- (2,082) (821) Investment write-off -- (773) (1,535) Acquisition expenses -- (558) -- Other 351 176 114 ------- ------- ------- $ 1,673 $(2,210) $ (814) ======= ======= =======
Earnings Per Share
Total options outstanding included 930,000, 474,000 and 59,000 options to purchase shares of common stock at prices ranging from $36.50 to $45.63, $38.25 to $45.63 and $40.00 to $41.88 at September 30, 1998, 1997 and 1996, respectively. These options were not included in the computation of diluted EPS because the exercise price for such options was greater than the average market price of the common shares for the years ended September 30, 1998, 1997 and 1996, respectively.
15. Supplementary Financial Data (Unaudited)
The financial data for the above quarterly information has been restated to reflect the merger, effective July 1997, between Fair, Isaac and Company, Incorporated, and Risk Management Technologies, which has been accounted for under the pooling-of-interests method.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The required information regarding Directors of the registrant is incorporated by reference from the information under the caption "Election of Directors - Nominees" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
The required information regarding Executive Officers of the registrant is contained in Part I of this Form 10-K.
The required information regarding compliance with Section 16(a) of the Securities Exchange Act is incorporated by reference from the information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the information under the captions "Compensation of Directors and Executive Officers," "Compensation Committee Interlocks and Insider Participation," and "Director Consulting Arrangements" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the information under the caption "Stock Ownership" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the information under the captions "Director Consulting Arrangements" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 1999.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Reference Page Form 10-K (a) 1. Consolidated financial statements:
Report of Independent Auditors................................ 25
Consolidated statements of income for each of the years in the three-year period ended September 30, 1998........ 26
Consolidated balance sheets at September 30, 1998 and September 30, 1997....................................... 27
Consolidated statements of stockholders' equity for each of the years in the three-year period ended September 30, 1998....................................... 28
Consolidated statements of cash flows for each of the years in the three-year period ended September 30, 1998.. 29
Notes to consolidated financial statements.................... 30
2. Financial statement schedule:
Independent Auditor's Report on Financial Statement Schedule.... 52
II Valuation and qualifying accounts at September 30, 1998, 1997 and 1996............................................ 53
3. Exhibits:
2.1 Lease dated December 2, 1998, by and between DynaMark, Inc., and CSM Corporation.
2.2 Agreement and Plan of Reorganization, dated June 12, l997, among the Company, FIC Acquisition Corporation, Risk Management Technologies ("RMT"), and the shareholders and optionholders of RMT, filed as Exhibit 2.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference. Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules were omitted but will be furnished supplementally to the Commission on request.
2.3 Employment Agreement, dated July 21, l997, by and between the Company and David LaCross, filed as Exhibit 2.3 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
2.4 Amendment To Lease, dated December 2, 1998, by and between CSM Corporation (assignee) and DynaMark, Inc. amending lease dated May 1,1995 between DynaMark, Inc. and Control Data Systems Inc.
3.1 Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
3.2 Restated By-laws of the Company, filed as Exhibit 3.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
4.1 Registration Rights Agreement, dated June 23, l997, among the Company, David LaCross and Kathleen O. LaCross, Trustees U/D/T dated April 2, 1997, Jefferson Braswell, Software Alliance LLC, Robert Ferguson, James T. Fan and Leland Prussia, filed as Exhibit 4.1 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
4.2 Registration Rights Agreement, dated September 30, 1996, among the Company, Donald J. Sanders, Paul A. Makowski and Lawrence E. Dukes, filed as Exhibit 4.2 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.1 Certificate of Resolution Changing Officers' Incentive Plan, Exempt Employees Bonus Plan and other Company Plan Parameters.*
10.2 Company's 1987 Stock Option Plan, originally filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (Commission File No. 33-14491) (the "Registration Statement").*
10.3 Lease dated April 28, 1995, between CSM Investors, Inc., and DynaMark, Inc. filed as Exhibit 10.3 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.4 Fair, Isaac and Company, Inc. Officers' Incentive Plan (effective October 1, 1992), originally filed as Exhibit 10.4 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994.*
10.5 Lease, dated October 30, 1983, between S.R.P. Limited Partnership and the Company, as amended, originally filed as Exhibit 10.7 to the Registration Statement.
10.6 Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.8 to the Company's report on Form 10-K for the fiscal year ended September 30, 1988.*
10.7 Lease dated July 1, 1993, between The Joseph and Eda Pell Revocable Trust and the Company and the First through Fifth Addenda thereto filed as Exhibit 10.7 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.8 First Amendment to the Company's 1987 Stock Option Plan, originally filed as Exhibit 10.11 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.*
10.9 First Amendment to the Company's Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.*
10.10 Amendment No.1 to the Company's 1992 Long-Term Incentive Plan (as amended and restated effective November 21, 1995), filed as Exhibit 10.10 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997 and incorporated herein by reference.*
10.11 Addendum Number Seven to lease between S.R.P. Limited Partnership and the Company, originally filed as Exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1990.
10.12 Addenda Numbers Eight and Nine to lease between SRP Limited Partnership and the Company filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.13 Lease, dated September 5, 1991, between 111 Partners, a California general partnership, and the Company originally filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.14 Construction Loan Agreement, dated September 5, 1991, between 111 Partners and the Company originally filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.15 Amendment No.2 to the Company's 1992 Long-Term Incentive Plan (as amended and restated effective November 21, 1995) filed as exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
10.16 The Company's 1992 Long-Term Incentive Plan as amended and restated effective November 21, 1995, filed as Exhibit 10.16 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.*
10.17 Amendment No.3 to the Company's Stock Option Plan for Non-Employee Directors, filed as Exhibit 10.17 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.*
10.18 Lease dated May 1, 1995, between Control Data Corporation and DynaMark, Inc. filed as Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.19 Lease dated April 10, 1994, between Leed Properties and DynaMark, Inc., filed as Exhibit 10.19 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994, and incorporated herein by reference.
10.20 Fair, Isaac Supplemental Retirement and Savings Plan and Trust Agreement effective November 1, 1994, filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1994, and incorporated herein by reference.*
10.21 Lease dated July 10, 1993, between the Joseph and Eda Pell Revocable Trust and the Company filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.22 Lease dated October 11, 1993, between the Joseph and Eda Pell Revocable Trust and the Company and the First through Fourth Addenda thereto filed as Exhibit 10.22 to the Company's report on Form 10-K for the fiscal year ended September 30, 1995, and incorporated herein by reference.
10.23 Second Amendment to Lease dated December 2, 1998, between CSM Corporation and DynaMark, Inc. amending lease between the parties dated March 11, 1997.
10.24 Exchange Agreement and Plan of Reorganization, dated July 19, 1996, among DynaMark, Inc., Printronic Corporation of America, Inc., Leo R. Yochim, and Susan Keenan, filed as Exhibit 10.24 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.25 Agreement and Plan of Merger and Reorganization, dated September 30, 1996, among the Company, FIC Acquisition Corporation, Credit & Risk Management Associates, Inc., Donald J. Sanders, Paul A. Makowski and Lawrence E. Dukes, filed as Exhibit 10.25 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.26 Contract between the Company and Dr. Robert M. Oliver, dated April 2, 1996, filed as Exhibit 10.26 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.*
10.27 Letter of Intent dated July 15, 1996, between the Company and Village Properties, and the First Amendment thereto dated July 18, 1996, filed as Exhibit 10.27 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.28 Office Building Lease, dated November 14, 1996, between the Company and Regency Center, filed as Exhibit 10.28 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.29 Sixth and Seventh Addenda to the Lease, dated July 1, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.29 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.30 First and Second Addenda to the Lease dated July 10, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.30 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.31 Fifth Addendum to the Lease, dated October 11, 1993, between the Company and the Joseph and Eda Pell Revocable Trust, filed as Exhibit 10.31 to the Company's report on Form 10-K for the fiscal year ended September 30, 1996, and incorporated herein by reference.
10.32 First Addendum to Lease, dated August 13, l997, by and between the Company and Regency Center, filed as Exhibit 10.32 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.33 Option Agreement, dated November 26, l997, by and between the Company and Village Builders, L.P., filed as Exhibit 10.33 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.34 Leasehold Improvements Agreement, dated November 26, l997, by and between the Company and Village Builders, L.P., filed as Exhibit 10.34 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.35 Lease, dated March 11, l997, by and between DynaMark, Inc. and CSM, filed as Exhibit 10.35 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.36 First Amendment to Lease, dated September 24, l997, by and between DynaMark, Inc. and CSM, filed as Exhibit 10.36 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference.
10.37 Chase Database Agreement, dated October 29, l997, by and among DynaMark, Inc. and Chase Manhattan Bank USA, National Association, filed as Exhibit 10.37 to the Company's report on Form 10-K for the fiscal year ended September 30, 1997, and incorporated herein by reference. Confidential treatment has been requested for certain portions of this document. Such portions have been omitted from the filing and have been filed separately with the Commission.
10.38 Participation Agreement, dated May 15, 1998, between Company, Lease Plan North America, Inc., ABN Amro Bank N.V. and other participants named therein.
10.39 Lease Agreement, Construction Deed of Trust with Assignment of Rents, Security Agreement and Fixture Filing, dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.40 Purchase Agreement dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.41 Third Amendment to Lease Dated December 2, 1998, by and between CSM Corporation and DynaMark, Inc. amending lease between the parties dated April 28, 1995.
21.1 Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP (see page 54 of this Form 10-K).
24.1 Power of Attorney (see page 51 of this Form 10-K).
27 Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed with the Securities and Exchange Commission during the fiscal quarter ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, 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: December 28, 1998 By /s/ Peter L. McCorkell ----------------------------------- Peter L. McCorkell Senior Vice President, Secretary and General Counsel
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints PETER L. McCORKELL his attorney-in-fact, with full power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
The Board of Directors Fair, Isaac and Company, Incorporated:
Under date of October 29, 1998, we reported on the consolidated balance sheets of Fair, Isaac and Company, Incorporated and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1998, which are included in the 1998 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule in the 1998 annual report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
San Francisco, California October 29, 1998
Consent of Independent Auditors
The Board of Directors Fair, Isaac and Company, Incorporated:
We consent to incorporation by reference in the registration statement (No. 33-20349) on Form S-8, the registration statement (No. 33-26659) on Form S-8, the registration statement (No. 33-63428) on Form S-8, the registration statement (No. 333-02121) on Form S-8, the registration statement (No. 333-32309) on Form S-8, the registration statement (No. 333-20537) on Form S-3, the registration statement (No. 333-42473) on Form S-3 of Fair, Isaac and Company, Incorporated and subsidiaries of our reports dated October 29, 1998, relating to the consolidated balance sheets of Fair, Isaac and Company, Incorporated and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows and related financial statement schedule for each of the years in the three-year period ended September 30, 1998, which reports appear in the September 30, 1998 annual report on Form 10-K of Fair, Isaac and Company, Incorporated, and subsidiaries.
San Francisco, California December 28, 1998
EXHIBIT INDEX TO FAIR, ISAAC AND COMPANY, INCORPORATED REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
Exhibit No. Exhibit - ----------- ------- 2.1 Lease dated December 2, 1998, by and between DynaMark, Inc. and CSM Corporation.
2.4 Amendment To Lease, dated December 2, 1998, by and between CSM Corporation (assignee) and DynaMark, Inc. amending lease dated May 1,1995 between DynaMark, Inc. and Control Data Systems Inc.
10.1 Certificate of Resolution Changing Officers' Incentive Plan, Exempt Employees Bonus Plan and other Company Plan Parameters.
10.2 Company's 1987 Stock Option Plan, originally filed as Exhibit 10.2 to the Registration Statement.
10.5 Lease, dated October 30, 1983, between S.R.P. Limited Partnership and the Company, as amended, originally filed as Exhibit 10.7 to the Registration Statement.
10.6 Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.8 to the Company's report on Form 10-K for the fiscal year ended September 30, 1988.
10.8 First Amendment to the Company's 1987 Stock Option Plan, originally filed as Exhibit 10.11 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.
10.9 First Amendment to the Company's Stock Option Plan for Non-Employee Directors, originally filed as Exhibit 10.12 to the Company's report on Form 10-K for the fiscal year ended September 30, 1989.
10.11 Addendum Number Seven to lease between S.R.P. Limited Partnership and the Company, originally filed as Exhibit 10.15 to the Company's report on Form 10-K for the fiscal year ended September 30, 1990.
10.13 Lease, dated September 5, 1991, between 111 Partners, a California general partnership, and the Company originally filed as Exhibit 10.20 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.14 Construction Loan Agreement, dated September 5, 1991, between 111 Partners and the Company originally filed as Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended September 30, 1991.
10.23 Second Amendment to Lease dated December 2, 1998 between CSM Corporation and DynaMark, Inc. amending lease between the parties dated March 11, 1997.
10.38 Participation Agreement, dated May 15, 1998, between Company, Lease Plan North America, Inc., ABN Amro Bank N.V. and other participants named therein.
10.39 Lease Agreement, Construction Deed of Trust with Assignment of Rents, Security Agreement and Fixture Filing, dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.40 Purchase Agreement dated May 15, 1998, between Company and Lease Plan North America, Inc.
10.41 Third Amendment To Lease, dated December 2, 1998, by and between CSM Corporation and DynaMark, Inc. amending lease between the parties dated April 28, 1995.
21.1 Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP (see page 54 of this Form 10-K).
24.1 Power of Attorney (see page 51 of this Form 10-K).
27 Financial Data Schedule.