FAIR ISAAC CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD LOOKING STATEMENTS Statements contained in this report that are not statements of historical fact should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). In addition, certain statements in our future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the PSLRA. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, income or loss, expenses, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other statements concerning future financial performance; (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services, research and development, and the sufficiency of capital resources; (iii) statements of assumptions underlying such statements, including those related to economic conditions; (iv) statements regarding results of business combinations; (v) statements regarding business relationships with vendors, customers or collaborators, including the proportion of revenues generated from international as opposed to domestic customers; and (vi) statements regarding products, their characteristics, performance, sales potential or effect in the hands of customers. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “should,” “potential,” “goals,” “strategy,” “outlook,” “plan,” “estimated,” “will,” variations of these terms and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in Part II, Item 1A “ Risk Factors ” of this Quarterly Report on Form 10-Q (including the impact of COVID-19 on macroeconomic conditions and our business, operations and personnel). The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. OVERVIEW We use analytics to help businesses automate, improve and connect decisions across their enterprise — an approach we commonly refer to as decision management. Our predictive analytics, which includes the industry-standard FICO ® Score, and our decision management technologies leverage the use of data and mathematical algorithms to predict, categorize, and describe consumer behavior in order to power hundreds of billions of customer decisions each year. We help thousands of companies in over 100 countries use our decision management technology to target and acquire customers more efficiently, increase customer value, detect and reduce fraud and credit losses, measure and manage credit risk, maintain regulatory compliance, lower operating expenses, and enter new markets more profitably. Most leading banks and credit card issuers rely on our solutions, as do insurers, retailers, telecommunications providers, automotive companies, pharmaceutical companies, healthcare organizations, public agencies and organizations in other industries. We also serve consumers through online services that enable people to purchase and understand their FICO ® Scores, the standard measure of consumer credit risk in the U.S., and empower them to manage their financial health. Most of our solutions address customer engagement, including customer acquisition, customer onboarding, customer servicing and management, and customer protection. We also help businesses improve non-customer decisions such as streamlining transaction and claims processing, and optimizing logistics. Our solutions enable users to make decisions that are more precise, consistent and agile, and that systematically advance business goals. This helps our clients to reduce the cost of doing business, increase revenues and profitability, reduce losses from risks and fraud, and increase customer loyalty. 19 Table of Contents A significant portion of our revenues are derived from the sale of products and services within the banking (including consumer credit) industry, and 90% and 86% of our revenues were derived from within this industry during the quarters ended March 31, 2021 and 2020, respectively, and 87% and 85% of our revenues were derived from within this industry during the six months ended March 31, 2021 and 2020, respectively. In addition, we derive a significant share of revenues from transactional or unit-based software license fees, transactional fees derived under credit scoring and SaaS subscription services arrangements, and annual software maintenance fees. Arrangements with transactional or unit-based pricing accounted for 85% and 78% of our revenues during the quarters ended March 31, 2021 and 2020, respectively. Arrangements with transactional or unit-based pricing accounted for 83% and 76% of our revenues during the six months ended March 31, 2021 and 2020, respectively. We derive a significant portion of our revenues from clients outside the U.S. International revenues accounted for 29% and 32% of total consolidated revenues for the quarters ended March 31, 2021 and 2020, respectively, and 29% and 32% of total consolidated revenues for the six months ended March 31, 2021 and 2020, respectively. Revenue increased 8% to $331.4 million during the quarter ended March 31, 2021 from $308.0 million for the quarter ended March 31, 2020, and 6% to $643.8 million during the six months ended March 31, 2021 from $606.5 million during the six months ended March 31, 2020. We continue to drive growth in our Scores segment. Scores revenue increased 31% to $168.7 million during the quarter ended March 31, 2021 from $129.1 million during the quarter ended March 31, 2020, and 28% to $313.4 million during the six months ended March 31, 2021 from $244.3 million during the six months ended March 31, 2020. Scores operating income increased 29% to $146.5 million during the quarter ended March 31, 2021 from $113.5 million during the quarter ended March 31, 2020, and 28% to $269.6 million during the six months ended March 31, 2021 from $210.9 million during the six months ended March 31, 2020. For our Applications and Decision Management Software segments, revenue decreased 9% to $162.6 million during the quarter ended March 31, 2021 from $178.8 million during the quarter ended March 31, 2020, and 9% to $330.4 million during the six months ended March 31, 2021 from $362.2 million during the six months ended March 31, 2020. The decrease was largely attributable to the shift in the timing of revenue recognition on our term license subscription sales, as described below; as well as our recent strategic shift to emphasize software over services. During fiscal 2020, we changed our practice of selling term software licenses with separate license and maintenance components to a single software subscription contract with license and maintenance bundled. This transition was substantially completed by the end of the first quarter of our fiscal 2021. This transition has shifted the timing of our revenue recognition on these subscription sales, resulting in less revenue recognized upfront and more revenue recognized over the term of these subscriptions. As a result, we expect a negative impact to our revenue recognized from term software licenses throughout the rest of our fiscal 2021. This does not change total revenue recognized over the life of a contract. In addition, this change does not negatively impact our cash flows. Operating income increased 34% to $101.2 million during the quarter ended March 31, 2021 from $75.7 million during the quarter ended March 31, 2020, and net income increased 18% to $68.7 million during the quarter ended March 31, 2021 from $58.3 million during the quarter ended March 31, 2020. Operating income increased 54% to $195.9 million during the six months ended March 31, 2021 from $127.6 million during the six months ended March 31, 2020, and net income increased 37% to $155.2 million from $113.2 million, primarily driven by higher operating income during the six months ended March 31, 2021, partially offset by lower excess tax benefits related to stock-based compensation. We continued to advance our cloud-enabled, platform-based software strategy by exiting less strategic areas of our business in order to increase our focus on the FICO Decision Management Platform. In May 2021, we signed a definitive agreement to sell our Collections and Recovery (“C&R”) business. The transaction is expected to close in our current fiscal year, subject to customary closing conditions. We continue to enhance stockholder value by returning cash to stockholders through our stock repurchase program. During the quarter and six months ended March 31, 2021, we repurchased approximately 440,588 shares at a total repurchase price of $205.2 million and 541,738 shares at a total repurchase price of $255.2 million, respectively. As of March 31, 2021, we had $471.3 million remaining under our current stock repurchase program. We intend to include the C&R sale proceeds in a $200 million Accelerated Share Repurchase program following the close of the transaction. COVID-19 Update As the COVID-19 pandemic persists, our focus remains on promoting employee health and safety, serving our customers and ensuring business continuity. For a discussion of the variety of measures we have taken, as well as the impacts on and risks to our business from COVID-19, please refer to “COVID-19 Update” included in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020; certain risk factors included in Part II, Item 1A “Risk Factors” of this Quarterly Report; and the information presented below under “Results of Operations” in this Quarterly Report. 20 Table of Contents Bookings Management regards the volume of bookings achieved as an important indicator of future revenues, but they are not comparable to, nor a substitute for, an analysis of our revenues. Bookings represent contracts signed in the current reporting period that generate current and future revenue streams. While we disclose estimated revenue expected to be recognized in the future related to unsatisfied performance obligations in Note 11 to the accompanying condensed consolidated financial statements, we believe bookings amount is still a meaningful measure of our business as it includes estimated revenues omitted from Note 11, such as usage-based royalties derived from our software licenses, among others. We estimate bookings as of the end of the period in which a contract is signed, and initial booking estimates are not updated in future periods for changes between estimated and actual results. Our calculations have varying degrees of certainty depending on the revenue type and individual contract terms. They are subject to a number of risks and uncertainties concerning timing and contingencies affecting product delivery and performance, and estimates take into consideration contract terms, knowledge of the marketplace and experience with our customers, among other factors. Actual revenue and the timing thereof could differ materially from our initial estimates. Although many of our contracts contain non-cancelable terms, most of our bookings are transactional or service-related that depend upon certain estimates, such as volume of transactions, number of active accounts, or number of hours incurred. Since these estimates cannot be considered fixed or firm, we do not believe it is appropriate to characterize bookings as backlog. The following paragraphs discuss the key assumptions used to calculate bookings and the susceptibility of these assumptions to variability for each revenue type, as defined in Revenue Recognition in the Critical Accounting Policies and Estimates. Transactional and Maintenance Bookings We calculate transactional bookings as the total estimated volume of transactions or number of accounts under contract, multiplied by the contractual rate. Transactional contracts generally span multiple years and require estimates of future transaction volumes or number of active accounts. We develop estimates from discussions with our customers and examinations of historical data from similar products and customer arrangements. Differences between estimated bookings and actual results occur due to variability in the volume of transactions or number of active accounts estimated. This variability is primarily caused by the economic trends in our customers’ industries; individual performance of our customers relative to their competitors; and regulatory and other factors that affect the business environment in which our customers operate. We calculate maintenance bookings directly from the terms stated in the contract. Professional Services Bookings We calculate professional services bookings as the estimated number of hours to complete a project multiplied by the rate per hour. We estimate the number of hours based on our understanding of the project scope, conversations with customer personnel and our experience in estimating professional services projects. Estimated bookings may differ from actual results primarily due to differences in the actual number of hours incurred. License Bookings Licenses that are sold on a term or perpetual basis when bookings generally equal the fixed amount (including guaranteed minimums) stated in the contract. Bookings Trend Analysis Bookings Bookings Yield (1) Number of Bookings over $1 Million Weighted- Average Term (2) (In millions) (Months) Quarter Ended March 31, 2021 $ 84.0 10 % 13 34 Quarter Ended March 31, 2020 $ 84.1 14 % 15 35 Six Months Ended March 31, 2021 $ 152.1 17 % 24 NM (a) Six Months Ended March 31, 2020 $ 196.2 23 % 40 NM (a) (1) Bookings yield represents the percentage of revenue recognized from bookings for the periods indicated. (2) Weighted-average term of bookings measures the average term over which bookings are expected to be recognized as revenue. 21 Table of Contents (a) NM - Measure is not meaningful as our estimate of bookings is as of the end of the period in which a contract is signed, and we do not update our initial booking estimates in future periods for changes between estimated and actual results. Transactional and maintenance bookings were 58% and 44% of total bookings for the quarters ended March 31, 2021 and 2020, respectively. Professional services bookings were 26% and 40% of total bookings for the quarters ended March 31, 2021 and 2020, respectively. License bookings were 16% of total bookings for each of the quarters ended March 31, 2021 and 2020. Transactional and maintenance bookings were 62% and 40% of total bookings for the six months ended March 31, 2021 and 2020, respectively. Professional services bookings were 25% and 38% of total bookings for the six months ended March 31, 2021 and 2020, respectively. License bookings were 13% and 22% of total bookings for the six months ended March 31, 2021 and 2020, respectively. RESULTS OF OPERATIONS Revenues The following tables set forth certain summary information on a segment basis related to our revenues for the quarters and six-month periods ended March 31, 2021 and 2020: Quarter Ended March 31, Percentage of Revenues Period-to-Period Change Period-to-Period Percentage Change Segment 2021 2020 2021 2020 (In thousands) (In thousands) Applications $ 129,514 $ 140,279 39 % 46 % $ (10,765) (8) % Scores 168,719 129,148 51 % 42 % 39,571 31 % Decision Management Software 33,128 38,544 10 % 12 % (5,416) (14) % Total $ 331,361 $ 307,971 100 % 100 % 23,390 8 % Six Months Ended March 31, Percentage of Revenues Period-to-Period Change Period-to-Period Percentage Change Segment 2021 2020 2021 2020 (In thousands) (In thousands) Applications $ 264,875 $ 292,457 41 % 48 % $ (27,582) (9) % Scores 313,370 244,286 49 % 40 % 69,084 28 % Decision Management Software 65,530 69,732 10 % 12 % (4,202) (6) % Total $ 643,775 $ 606,475 100 % 100 % 37,300 6 % Quarter Ended March 31, 2021 Compared to Quarter Ended March 31, 2020 Applications Quarter Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 96,687 $ 97,789 $ (1,102) (1) % Professional services 27,627 35,134 (7,507) (21) % License 5,200 7,356 (2,156) (29) % Total $ 129,514 $ 140,279 (10,765) (8) % 22 Table of Contents Applications segment revenues decreased $10.8 million primarily due to a $7.5 million decrease in services revenue, a $2.2 million decrease in license revenue and a $1.1 million decrease in transactional and maintenance revenue. The decrease in services revenue was primarily due to our recent strategic shift to emphasize software over services. The decrease in license revenue was primarily attributable to the shift in the timing of revenue recognition on our term license subscription sales as a result of changing our practice of selling term licenses with separate license and maintenance components to a single software subscription contract with license and maintenance bundled. The decrease in transactional and maintenance revenue was primarily attributable to a decrease in our fraud solutions revenue, partially offset by an increase in our marketing and compliance solutions revenue. Scores Quarter Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 167,212 $ 127,610 $ 39,602 31 % Professional services 703 819 (116) (14) % License 804 719 85 12 % Total $ 168,719 $ 129,148 39,571 31 % Scores segment revenues increased $39.6 million due to an increase of $23.8 million in our business-to-business scores revenue and $15.8 million in our business-to-consumer services revenue. The increase in business-to-business scores revenue was primarily attributable to a higher unit price in insurance and auto resellers, as well as an increase in auto and mortgage volumes during the quarter ended March 31, 2021. The increase in business-to-consumer services revenue was attributable to an increase in both royalties derived from direct sales generated from the myFICO.com website and scores sold indirectly to consumers through credit reporting agencies. Revenues generated from our agreements with Experian, TransUnion, and Equifax accounted for 16%, 13% and 10%, respectively, of our total revenues for the quarter ended March 31, 2021. Revenues generated from our agreements with Experian, TransUnion, and Equifax accounted for 16%, 10% and 8%, respectively, of our total revenues for the quarter ended March 31, 2020. Revenues from these customers included amounts recorded in our other segments. Decision Management Software Quarter Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 17,020 $ 15,303 $ 1,717 11 % Professional services 9,464 11,952 (2,488) (21) % License 6,644 11,289 (4,645) (41) % Total $ 33,128 $ 38,544 (5,416) (14) % Decision Management Software segment revenues decreased $5.4 million primarily due to a $4.6 million decrease in license revenue and a $2.5 million decrease in services revenue, partially offset by a $1.7 million increase in transactional and maintenance revenue. The decrease in license revenue was primarily attributable to the shift in the timing of revenue recognition on our term license subscription sales as a result of changing our practice of selling term licenses with separate license and maintenance components to a single software subscription contract with license and maintenance bundled. The decrease in services revenue was primarily due to our recent strategic shift to emphasize software over services. The increase in transactional and maintenance revenue was primarily attributable to an increase in SaaS subscription revenue. 23 Table of Contents Six Months Ended March 31, 2021 Compared to Six Months Ended March 31, 2020 Applications Six Months Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 194,418 $ 196,626 $ (2,208) (1) % Professional services 58,232 69,157 (10,925) (16) % License 12,225 26,674 (14,449) (54) % Total $ 264,875 $ 292,457 (27,582) (9) % Applications segment revenues decreased $27.6 million primarily due to a $14.4 million decrease in license revenue, a $10.9 million decrease in services revenue, and a $2.2 million decrease in transactional and maintenance revenue. The decrease in license revenue was primarily attributable to the shift in the timing of revenue recognition on our term license subscription sales as a result of changing our practice of selling term licenses with separate license and maintenance components to a single software subscription contract with license and maintenance bundled, as well as a decrease in the number and size of term license deals signed or renewed during the six months ended March 31, 2021, mainly in our fraud solutions. The decrease in services revenue was primarily due to our recent strategic shift to emphasize software over services. The decrease in transactional and maintenance revenue was primarily attributable to a decrease in our fraud solutions, partially offset by an increase in our compliance and marketing solutions. Scores Six Months Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 305,802 $ 235,056 $ 70,746 30 % Professional services 820 1,083 (263) (24) % License 6,748 8,147 (1,399) (17) % Total $ 313,370 $ 244,286 69,084 28 % Scores segment revenues increased $69.1 million due to an increase of $40.6 million in our business-to-business scores revenue and $28.5 million in our business-to-consumer services revenue. The increase in business-to-business scores revenue was primarily attributable to a higher unit price in auto, unsecured originations and insurance, and an increase in mortgage and auto volumes, partially offset by a decrease in unsecured originations volume. The increase in business-to-consumer services revenue was attributable to an increase in both royalties derived from scores sold indirectly to consumers through credit reporting agencies and direct sales generated from the myFICO.com website. Revenues generated from our agreements with Experian, TransUnion, and Equifax accounted for 15%, 12% and 10%, respectively, of our total revenues for the six months ended March 31, 2021. Revenues generated from our agreements with Experian, TransUnion, and Equifax accounted for 14%, 10% and 7%, respectively, of our total revenues for the six months ended March 31, 2020. Revenues from these customers included amounts recorded in our other segments. Decision Management Software Six Months Ended March 31, Period-to-Period Change Period-to-Period Percentage Change 2021 2020 (In thousands) (In thousands) Transactional and maintenance $ 32,849 $ 29,394 $ 3,455 12 % Professional services 20,167 21,690 (1,523) (7) % License 12,514 18,648 (6,134) (33) % Total $ 65,530 $ 69,732 (4,202) (6) % 24 Table of Contents Decision Management Software segment revenues decreased $4.2 million primarily due to a $6.1 million decrease in license revenue, and a $1.5 million decrease in services revenue, partially offset by a $3.5 million increase in transactional and maintenance revenue. The decrease in license revenue was primarily attributable to the shift in the timing of revenue recognition on our term license subscription sales as a result of changing our practice of selling term licenses with separate license and maintenance components to a single software subscription contract with license and maintenance bundled. The decrease in services revenue was primarily due to our recent strategic shift to emphasize software over services. The increase in transactional and maintenance revenue was primarily attributable to an increase in SaaS subscription revenue. Operating Expenses and Other Income / Expenses The following tables set forth certain summary information related to our condensed consolidated statements of income and comprehensive income for the quarters and six-month periods ended March 31, 2021 and 2020: Quarter Ended March 31, Percentage of Revenues Period-to-Period Change Period-to- Period Percentage Change 2021 2020 2021 2020 (In thousands, except employees) (In thousands, except employees) Revenues $ 331,361 $ 307,971 100 % 100 % $ 23,390 8 % Operating expenses: Cost of revenues 88,333 88,139 27 % 29 % 194 — % Research and development 43,612 39,439 13 % 13 % 4,173 11 % Selling, general and administrative 97,272 103,465 29 % 33 % (6,193) (6) % Amortization of intangible assets 945 1,202 — % — % (257) (21) % Total operating expenses 230,162 232,245 69 % 75 % (2,083) (1) % Operating income 101,199 75,726 31 % 25 % 25,473 34 % Interest expense, net (9,943) (11,254) (3) % (4) % 1,311 (12) % Other income (expense), net 568 (2,008) — % (1) % 2,576 (128) % Income before income taxes 91,824 62,464 28 % 20 % 29,360 47 % Income tax provision 23,150 4,176 7 % 1 % 18,974 454 % Net income $ 68,674 $ 58,288 21 % 19 % 10,386 18 % Number of employees at quarter end 3,953 4,029 (76) (2) % 25 Table of Contents Six Months Ended March 31, Percentage of Revenues Period-to-Period Change Period-to- Period Percentage Change 2021 2020 2021 2020 (In thousands) (In thousands) Revenues $ 643,775 $ 606,475 100 % 100 % $ 37,300 6 % Operating expenses: Cost of revenues 177,861 178,897 28 % 29 % (1,036) (1) % Research and development 84,263 78,382 13 % 13 % 5,881 8 % Selling, general and administrative 191,183 215,486 30 % 36 % (24,303) (11) % Amortization of intangible assets 1,882 2,998 — % — % (1,116) (37) % Restructuring and impairment charges — 3,104 — % 1 % (3,104) (100) % Gain on sale of product line assets (7,334) — (1) % — % (7,334) — % Total operating expenses 447,855 478,867 70 % 79 % (31,012) (6) % Operating income 195,920 127,608 30 % 21 % 68,312 54 % Interest expense, net (19,584) (21,022) (3) % (3) % 1,438 (7) % Other income (expense), net 3,448 (2,227) 1 % — % 5,675 (255) % Income before income taxes 179,784 104,359 28 % 18 % 75,425 72 % Income tax provision (benefit) 24,618 (8,850) 4 % (1) % 33,468 (378) % Net income $ 155,166 $ 113,209 24 % 19 % 41,957 37 % Cost of Revenues Cost of revenues consists primarily of employee salaries and benefits for personnel directly involved in delivering software products, operating SaaS infrastructure, and providing support, implementation and consulting services; allocated overhead, facilities and data center costs; software royalty fees; credit bureau data and processing services; third-party hosting fees related to our SaaS services; travel costs; and outside services. The quarter-over-prior year quarter increase in cost of revenues of $0.2 million was primarily attributable to a $1.6 million increase in direct materials primarily driven by increased third-party data costs related to increased Scores revenue, partially offset by a $1.5 million decrease in travel activity due to COVID-19. Cost of revenues as a percentage of revenues decreased to 27% during the quarter ended March 31, 2021 from 29% during the quarter ended March 31, 2020 primarily due to increased sales of our higher-margin Scores products. The year-to-date period over period decrease in cost of revenues of $1.0 million was primarily attributable to a $3.6 million decrease in travel activity due to COVID-19, partially offset by a $2.9 million increase in direct materials primarily driven by increased third-party data costs related to increased Scores revenue. Cost of revenues as a percentage of revenues decreased to 28% during the six months ended March 31, 2021 from 29% during the six months ended March 31, 2020, primarily due to increased sales of our higher-margin Scores products. Research and Development Research and development expenses include personnel and related overhead costs incurred in the development of new products and services, including research of mathematical and statistical models and development of new versions of Applications and Decision Management Software products. The quarter-over-prior year quarter increase in research and development expenses of $4.2 million was primarily attributable to an increase in labor and personnel costs as a result of increased headcount and increased fringe benefit costs related to our supplemental retirement and savings plan. Research and development expenses as a percentage of revenues was 13% during each of the quarters ended March 31, 2021 and March 31, 2020. 26 Table of Contents The year-to-date period over period increase in research and development expenses of $5.9 million was primarily attributable to an increase in labor and personnel costs as a result of increased headcount and increased fringe benefit costs related to our supplemental retirement and savings plan. Research and development expenses as a percentage of revenues was 13% during each of the six months ended March 31, 2021 and March 31, 2020. Selling, General and Administrative Selling, general and administrative expenses consist principally of employee salaries, commissions and benefits; travel costs; overhead costs; advertising and other promotional expenses; corporate facilities expenses; legal expenses; business development expenses; and the cost of operating computer systems. The quarter-over-prior year quarter decrease in selling, general and administrative expenses of $6.2 million was primarily attributable to a $2.7 million decrease in travel activity, a $2.1 million decrease in non-capitalizable commission cost, and a $2.1 million decrease in bad debt expense attributable to estimated losses for customers and industries most impacted by COVID-19 during the second quarter of our fiscal 2020. Selling, general and administrative expenses as a percentage of revenues decreased to 29% during the quarter ended March 31, 2021 from 33% during the quarter ended March 31, 2020. The year-to-date period over period decrease in selling, general and administrative expenses of $24.3 million was primarily attributable to a $7.6 million decrease in travel activity, a $4.5 million decrease in marketing costs primarily driven by a company-wide marketing event held during the first quarter of our fiscal 2020, a $4.7 million decrease in non-capitalizable commission cost, and a $2.1 million decrease in bad debt expense attributable to estimated losses for customers and industries most impacted by COVID-19 during the second quarter of our fiscal 2020. Selling, general and administrative expenses as a percentage of revenues decreased to 30% during the six months ended March 31, 2021 from 36% during the six months ended March 31, 2020. Amortization of Intangible Assets Amortization of intangible assets consists of amortization expense related to intangible assets recorded in connection with acquisitions accounted for by the acquisition method of accounting. Our finite-lived intangible assets, consisting primarily of completed technology and customer contracts and relationships, are being amortized using the straight-line method over periods ranging from four to fifteen years. Amortization expense was $0.9 million during the quarter ended March 31, 2021 compared to $1.2 million during the quarter ended March 31, 2020. Amortization expense was $1.9 million during the six months ended March 31, 2021 compared to $3.0 million during the six months ended March 31, 2020. The decrease was primarily attributable to certain assets associated with our Tonbeller acquisition becoming fully amortized in January 2020. Restructuring and Impairment Charges There were no restructuring expenses during the quarter and six months ended March 31, 2021. There were no restructuring expenses during the quarter ended March 31, 2020. During the six months ended March 31, 2020, we incurred employee separation costs of $3.1 million due to the elimination of 69 positions throughout the Company. Cash payments for all the employee separation costs were paid during fiscal 2020. Gain on Sale of Product Line Assets The $7.3 million gain on the sale of product line assets during the six months ended March 31, 2021 was attributable to the sale of all assets related to our cyber risk score operations in October 2020; and the sale of certain assets related to our Applications and Decision Management Software operations to an affiliated joint venture in China in December 2020. 27 Table of Contents Interest Expense, Net Interest expense includes interest on the senior notes issued in December 2019, May 2018, and July 2010 (which July 2010 senior notes were paid in full at maturity in July 2020), as well as interest and credit facility fees on the revolving line of credit. Our condensed consolidated statements of income and comprehensive income include interest expense netted with interest income, which is derived primarily from the investment of funds in excess of our immediate operating requirements. The quarter-over-prior year quarter decrease in interest expense of $1.3 million was primarily attributable to a lower average outstanding debt balance during the quarter ended March 31, 2021. The year-to-date period over period decrease in interest expense of $1.4 million was primarily attributable to a lower average outstanding debt balance during the six months ended March 31, 2021. Other Income (Expense), Net Other income (expense), net consists primarily of realized investment gains/losses, exchange rate gains/losses resulting from remeasurement of foreign-currency-denominated receivable and cash balances into their respective functional currencies at period-end market rates, net of the impact of offsetting foreign currency forward contracts and other non-operating items. The quarter-over-prior year quarter increase in other income (expense), net of $2.6 million was primarily attributable to an increase in net unrealized gains on our supplemental retirement and savings plan, partially offset by an increase in foreign currency exchange losses. The year-to-date period over period increase in other income (expense), net of $5.7 million was primarily attributable to an increase in net unrealized gains on our supplemental retirement and savings plan during the six months ended March 31, 2021. Income Tax Provision (Benefit) The effective income tax rates were 25.2% and 6.7% during the quarters ended March 31, 2021 and 2020, respectively, and 13.7% and (8.5)% during the six months ended March 31, 2021 and 2020, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the full fiscal year. The effective tax rate in any quarter can also be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution. The effective tax rates for the six months ended March 31, 2021 and 2020 were both impacted by the recording of excess tax benefits relating to stock awards. In addition, stock exercises during the quarter and six months ended March 31, 2020 resulted in an additional increase in excess benefits. 28 Table of Contents Operating Income The following tables set forth certain summary information on a segment basis related to our operating income (loss) for the quarters and six-month periods ended March 31, 2021 and 2020: Quarter Ended March 31, Period-to-Period Change Period-to-Period Percentage Change Segment 2021 2020 (In thousands) (In thousands) Applications $ 27,372 $ 28,823 $ (1,451) (5) % Scores 146,542 113,488 33,054 29 % Decision Management Software (10,172) (8,810) (1,362) 15 % Corporate expenses (33,392) (33,785) 393 (1) % Total segment operating income 130,350 99,716 30,634 31 % Unallocated share-based compensation (28,206) (22,788) (5,418) 24 % Unallocated amortization expense (945) (1,202) 257 (21) % Operating income $ 101,199 $ 75,726 25,473 34 % Six Months Ended March 31, Period-to-Period Change Period-to-Period Percentage Change Segment 2021 2020 (In thousands) (In thousands) Applications $ 62,874 $ 64,991 $ (2,117) (3) % Scores 269,567 210,914 58,653 28 % Decision Management Software (24,990) (28,267) 3,277 (12) % Corporate expenses (63,645) (67,995) 4,350 (6) % Total segment operating income 243,806 179,643 64,163 36 % Unallocated share-based compensation (53,338) (45,933) (7,405) 16 % Unallocated amortization expense (1,882) (2,998) 1,116 (37) % Unallocated restructuring and impairment charges — (3,104) 3,104 (100) % Unallocated gain on sale of product line assets 7,334 — 7,334 — % Operating income $ 195,920 $ 127,608 68,312 54 % Applications Quarter Ended March 31, Percentage of Revenues Six Months Ended March 31, Percentage of Revenues 2021 2020 2021 2020 2021 2020 2021 2020 (In thousands) (In thousands) Segment revenues $ 129,514 $ 140,279 100 % 100 % $ 264,875 $ 292,457 100 % 100 % Segment operating expense (102,142) (111,456) (79) % (79) % (202,001) (227,466) (76) % (78) % Segment operating income $ 27,372 $ 28,823 21 % 21 % $ 62,874 $ 64,991 24 % 22 % 29 Table of Contents Scores Quarter Ended March 31, Percentage of Revenues Six Months Ended March 31, Percentage of Revenues 2021 2020 2021 2020 2021 2020 2021 2020 (In thousands) (In thousands) Segment revenues $ 168,719 $ 129,148 100 % 100 % $ 313,370 $ 244,286 100 % 100 % Segment operating expense (22,177) (15,660) (13) % (12) % (43,803) (33,372) (14) % (14) % Segment operating income $ 146,542 $ 113,488 87 % 88 % $ 269,567 $ 210,914 86 % 86 % Decision Management Software Quarter Ended March 31, Percentage of Revenues Six Months Ended March 31, Percentage of Revenues 2021 2020 2021 2020 2021 2020 2021 2020 (In thousands) (In thousands) Segment revenues $ 33,128 $ 38,544 100 % 100 % $ 65,530 $ 69,732 100 % 100 % Segment operating expense (43,300) (47,354) (131) % (123) % (90,520) (97,999) (138) % (141) % Segment operating loss $ (10,172) $ (8,810) (31) % (23) % $ (24,990) $ (28,267) (38) % (41) % The quarter-over-prior year quarter $25.5 million increase in operating income was primarily attributable to a $23.4 million increase in segment revenues, a $6.8 million decrease in segment operating expenses, and a $0.4 million decrease in corporate expenses, partially offset by a $5.4 million increase in share-based compensation cost. At the segment level, the quarter-over-prior year quarter $30.6 million increase in segment operating income was the result of a $33.1 million increase in our Scores segment operating income and a $0.4 million decrease in corporate expenses, partially offset by a $1.5 million decrease in our Applications segment operating income and $1.4 million increase in our Decision Management Software segment operating loss. The quarter-over-prior year quarter $1.5 million decrease in Applications segment operating income was due to a $10.8 million decrease in segment revenue, partially offset by a $9.3 million decrease in segment operating expenses. Segment operating margin for Applications during the quarter ended March 31, 2021 was 21%, consistent with the quarter ended March 31, 2020. The quarter-over-prior year quarter $33.1 million increase in Scores segment operating income was due to a $39.6 million increase in segment revenue, partially offset by a $6.5 million increase in segment operating expenses. Segment operating margin for Scores during the quarter ended March 31, 2021 was 87%, consistent with the quarter ended March 31, 2020. The quarter-over-prior year quarter $1.4 million increase in Decision Management Software segment operating loss was due to a $5.4 million decrease in segment revenue, partially offset by a $4.0 million decrease in segment operating expenses. Segment operating margin for Decision Management Software decreased to negative 31% from negative 23%, mainly due to a decrease in sales of our higher-margin software products. The year-to-date period over period increase of $68.3 million in operating income was primarily attributable to a $37.3 million increase in segment revenues, a $22.6 million decrease in segment operating expenses, a $7.3 million gain on sale of product line assets, a $4.3 million decrease in corporate expenses, and a $3.1 million decrease in restructuring and impairment charges, partially offset by a $7.4 million increase in share-based compensation cost. At the segment level, the year-to-date period over period increase of $64.2 million in segment operating income was the result of a $58.7 million increase in our Scores segment operating income, a $4.3 million decrease in corporate expenses, a $3.3 million decrease in our Decision Management Software segment operating loss, partially offset by a $2.1 million decrease in our Applications segment operating income. 30 Table of Contents The year-to-date period over period $2.1 million decrease in Applications segment operating income was due to a $27.6 million decrease in segment revenue, partially offset by a $25.5 million decrease in segment operating expenses. Segment operating income as a percentage of segment revenue for Applications increased to 24% from 22%, primarily attributable to a decrease in travel activity due to COVID-19, as well as our strategic cost initiative implemented in September 2020 in which we reduced our workforce, consolidated office space and abandoned certain property and equipment. The year-to-date period over period $58.7 million increase in Scores segment operating income was attributable to a $69.1 million increase in segment revenue, partially offset by a $10.4 million increase in segment operating expenses. Segment operating margin for Scores during the six months ended March 31, 2021 was 86%, consistent with the six months ended March 31, 2020. The year-to-date period over period $3.3 million decrease in Decision Management Software segment operating loss was attributable to a $7.5 million decrease in segment operating expenses, partially offset by a $4.2 million decrease in segment revenue. Segment operating margin for Decision Management Software improved to negative 38% from negative 41%, primarily attributable to a decrease in travel activity due to COVID-19, as well as our strategic cost initiative implemented in September 2020 through which we reduced our workforce, consolidated office space and abandoned certain property and equipment. CAPITAL RESOURCES AND LIQUIDITY Outlook As of March 31, 2021, we had $197.8 million in cash and cash equivalents, which included $124.8 million held by our foreign subsidiaries. Our cash position could be affected by various risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic and other risks detailed in Part II, Item 1A titled “Risk Factors” of this Quarterly Report on Form 10-Q. However, based on our current business plan and revenue prospects, we believe our cash and cash equivalents balances, as well as available borrowings from our $400 million revolving line of credit and anticipated cash flows from operating activities, will be sufficient to fund our working and other capital requirements. Under our current financing arrangements, we have no significant debt obligations maturing over the next twelve months. Our undistributed earnings outside the U.S. are deemed to be permanently reinvested in foreign jurisdictions. We currently do not foresee a need to repatriate cash and cash equivalents held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue for state income or foreign withholding taxes on the distributed foreign earnings, which we expect to be immaterial. In the normal course of business, we evaluate the merits of acquiring technology or businesses, or establishing strategic relationships with or investing in these businesses. We may elect to use available cash and cash equivalents to fund such activities in the future. In the event additional needs for cash arise, or if we refinance our existing debt, we may raise additional funds from a combination of sources, including the potential issuance of debt or equity securities. Additional financing might not be available on terms favorable to us, or at all. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited. Summary of Cash Flows Six Months Ended March 31, Period-to-Period Change 2021 2020 (In thousands) Cash provided by (used in): Operating activities $ 231,470 $ 121,859 $ 109,611 Investing activities 1,746 (14,958) 16,704 Financing activities (196,795) (100,344) (96,451) Effect of exchange rate changes on cash 4,021 (4,017) 8,038 Increase in cash and cash equivalents $ 40,442 $ 2,540 37,902 31 Table of Contents Cash Flows from Operating Activities Our primary method for funding operations and growth has been through cash flows generated from operating activities. Net cash provided by operating activities increased to $231.5 million during the six months ended March 31, 2021 from $121.9 million during the six months ended March 31, 2020. The $109.6 million increase was attributable to a $77.8 million increase that resulted from timing of receipts and payments in our ordinary course of business and a $42.0 million increase in net income, partially offset by a $10.2 million decrease in non-cash items, including a $7.3 million gain on the sale of product line assets. Cash Flows from Investing Activities Net cash provided by investing activities was $1.7 million for the six months ended March 31, 2021 as compared to net cash used of $15.0 million for the six months ended March 31, 2020. The $16.7 million change was primarily attributable to an $8.9 million decrease in purchases of property and equipment and $8.3 million in cash proceeds from the sale of product line assets for the six months ended March 31, 2021. Cash Flows from Financing Activities Net cash used in financing activities increased to $196.8 million for the six months ended March 31, 2021 from $100.3 million for the six months ended March 31, 2020. The $96.5 million increase was primarily attributable to a $350.0 million decrease in proceeds from issuance of senior notes and a $102.3 million increase in repurchases of common stock, partially offset by a $256.0 million decrease in payments on our revolving line of credit and a $95.0 million increase in proceeds from our revolving line of credit. Repurchases of Common Stock In July 2020, our Board of Directors approved a stock repurchase program following the completion of our previous program. This program was open-ended and authorized repurchases of shares of our common stock up to an aggregate cost of $250.0 million in the open market or in negotiated transactions. In March 2021, our Board of Directors approved a new stock repurchase program following the completion of the July 2020 program. This new program is open-ended and authorizes repurchases of shares of our common stock up to an aggregate cost of $500.0 million in the open market or in negotiated transactions. Pursuant to the July 2020 and March 2021 programs, we repurchased approximately 440,588 shares of our common stock at a total repurchase price of $205.2 million and 541,738 shares of our common stock at a total repurchase price of $255.2 million during the quarter and six months ended March 31, 2021, respectively. Revolving Line of Credit We have a $400 million unsecured revolving line of credit with a syndicate of banks that expires on May 8, 2023. Proceeds from the credit facility can be used for working capital and general corporate purposes and may also be used for the refinancing of existing debt, acquisitions, and the repurchase of our common stock. Interest on amounts borrowed under the credit facility is based on (i) a base rate, which is the greater of (a) the prime rate, (b) the Federal Funds rate plus 0.500% and (c) the one-month LIBOR rate plus 1.000%, plus, in each case, an applicable margin, or (ii) an adjusted LIBOR rate plus an applicable margin. The applicable margin for base rate borrowings ranges from 0% to 0.875% and for LIBOR borrowings ranges from 1.000% to 1.875%, and is determined based on our consolidated leverage ratio. In addition, we must pay credit facility fees. The credit facility contains certain restrictive covenants including: maintaining a maximum consolidated leverage ratio of 3.25 on an average trailing four-quarter basis, subject to a step up to 3.75 following certain permitted acquisitions; and a minimum interest coverage ratio of 3.00. The credit agreement also contains other covenants typical of unsecured facilities. As of March 31, 2021, we had $225.0 million in borrowings outstanding at a weighted-average interest rate of 1.236% and we were in compliance with all financial covenants under this credit facility, and do not believe we are at material risk of not meeting these covenants due to COVID-19. 32 Table of Contents Senior Notes On May 8, 2018, we issued $400 million of senior notes in a private offering to qualified institutional investors (the “2018 Senior Notes”). The 2018 Senior Notes require interest payments semi-annually at a rate of 5.25% per annum and will mature on May 15, 2026. On December 6, 2019, we issued $350 million of senior notes in a private offering to qualified institutional investors (the “2019 Senior Notes,” and with the 2018 Senior Notes, the “Senior Notes”). The 2019 Senior Notes require interest payments semi-annually at a rate of 4.00% per annum and will mature on June 15, 2028. The indentures for the Senior Notes contain certain covenants typical of unsecured obligations. As of March 31, 2021, the carrying value of the Senior Notes was $750.0 million and we were in compliance with all financial covenants under these obligations, and do not believe we are at material risk of not meeting these covenants due to COVID-19. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. CRITICAL ACCOUNTING POLICIES AND ESTIMATES We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. These accounting principles require management to make certain judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We periodically evaluate our estimates including those relating to revenue recognition, goodwill and other intangible assets resulting from business acquisitions, share-based compensation, income taxes and contingencies and litigation. We base our estimates on historical experience and various other assumptions that we believe to be reasonable based on the specific circumstances, the results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements: Revenue Recognition Contracts with Customers Our revenue is primarily derived from term-based or perpetual licensing of software and scoring products and solutions, and associated maintenance; SaaS subscription services; scoring and credit monitoring services for consumers; and professional services. For contracts with customers that contain various combinations of products and services, we evaluate whether the products or services are distinct—distinct products or services will be accounted for as separate performance obligations, while non-distinct products or services are combined with others to form a single performance obligation. For contracts with multiple performance obligations, the transaction price is allocated to each performance obligation on a relative standalone selling price (“SSP”) basis. Revenue is recognized when control of the promised goods or services is transferred to our customers. License revenue is derived from contracts in which we grant our direct customers or distributors the right to deploy or resell our software and scoring products and solutions on-premises. Our software offerings often include a term-based or perpetual license and post-contract support or maintenance, both of which generally represent distinct performance obligations and are accounted for separately. For term-based licenses, the transaction price is either in the form of a fixed consideration—a single subscription with license and maintenance bundled, or a usage-based royalty—sometimes subject to a guaranteed minimum—for the license and maintenance bundle. For perpetual licenses, the transaction price is generally a fixed consideration with separately stated prices for license and maintenance. When the amount is in the form of a fixed consideration, including the guaranteed minimum in usage-based royalty, license revenue from distinct on-premises licenses is recognized at the point in time when the software or scoring solution is made available to the customer or distributor. Any royalties not subject to the guaranteed minimum or earned in excess of the minimum amount are recognized as transactional revenue when the subsequent sales or usage occurs. Revenue allocated to maintenance is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits. 33 Table of Contents In addition to usage-based royalty on our software and scoring products, transactional revenue is also derived from SaaS contracts in which we provide customers with access to and standard support for our software application either in the FICO ® Analytic Cloud or AWS, our primary cloud infrastructure provider, on a subscription basis. The transaction price typically includes a fixed consideration in the form of a guaranteed minimum that allows up to a certain level of usage and a variable consideration in the form of usage or transaction-based fees in excess of the minimum threshold; or usage or transaction-based variable amount not subject to a minimum threshold. We determined the nature of our SaaS arrangements is to provide continuous access to our hosted application in the cloud, i.e., a stand-ready obligation that comprises a series of distinct service periods (e.g., a series of distinct daily, monthly or annual periods of service). We estimate the total variable consideration at contract inception—subject to any constraints that may apply—and update the estimates as new information becomes available and recognize the amount ratably over the SaaS service period, unless we determine it is appropriate to allocate the variable amount to each distinct service period and recognize revenue as each distinct service period is performed. We also derive transactional revenue from credit scoring and monitoring services that provide consumers access to their credit reports and enable them to monitor their credit. These are provided as either a one-time or ongoing subscription service renewed monthly or annually, all with a fixed consideration. We determined the nature of the subscription service is a stand-ready obligation to generate credit reports, provide credit monitoring and other services for our customers, which comprises a series of distinct service periods (e.g., a series of distinct daily, monthly or annual periods of service). Revenue from one-time or monthly subscription services is recognized during the period when service is performed. Revenue from annual subscription services is recognized ratably over the subscription period. Professional services include software or SaaS implementation, consulting, model development, training services and premium cloud support. They are sold either standalone, or together with other products or services and generally represent distinct performance obligations. The transaction price can be a fixed amount or on a time and materials basis. Revenue on fixed-price services is recognized using an input method based on labor hours expended which we believe provides a faithful depiction of the transfer of services. Revenue on services provided on a time and materials basis is recognized applying the “right-to-invoice” practical expedient as the amount to which we have a right to invoice the customer corresponds directly with the value of our performance to the customer. In addition, we sell premium cloud support on a subscription basis for a fixed amount, and revenue is recognized ratably over the contract term. Significant Judgments Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct and should be accounted for separately may require significant judgment. Specifically, when implementation service is included in the original software or SaaS offerings, judgment is required to determine if the implementation service significantly modifies or customizes the software or SaaS service in such a way that the risks of providing it and the customization service are inseparable. In rare instances, contracts may include significant modification or customization of the software of SaaS service and will result in the combination of software or SaaS service and implementation service as one performance obligation. We determine the SSPs using data from our historical standalone sales, or, in instances where such information is not available (such as when we do not sell the product or service separately), we consider factors such as the stated contract prices, our overall pricing practices and objectives, go-to-market strategy, size and type of the transactions, and effects of the geographic area on pricing, among others. When the selling price of a product or service is highly variable, we may use the residual approach to determine the SSP of that product or service. Significant judgment may be required to determine the SSP for each distinct performance obligation when it involves the consideration of many market conditions and entity-specific factors discussed above. Significant judgment may be required to determine the timing of satisfaction of a performance obligation in certain professional services contracts with a fixed consideration, in which we measure progress using an input method based on labor hours expended. In order to estimate the total hours of the project, we make assumptions about labor utilization, efficiency of processes, the customer’s specification and IT environment, among others. For certain complex projects, due to the risks and uncertainties inherent with the estimation process and factors relating to the assumptions, actual progress may differ due to the change in estimated total hours. Adjustments to estimates are made in the period in which the facts requiring such revisions become known and, accordingly, recognized revenues are subject to revisions as the contract progresses to completion. 34 Table of Contents Capitalized Commission Costs We capitalize incremental commission fees paid as a result of obtaining customer contracts. Capitalized commission costs are amortized on a straight-line basis over ten years — determined using a portfolio approach — based on the transfer of goods or services to which the assets relate, taking into consideration both the initial and future contracts as we do not typically pay a commission on a contract renewal. The amortization costs are included in selling, general, and administrative expenses of our condensed consolidated statements of income and comprehensive income. We apply a practical expedient to recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that we otherwise would have recognized is one year or less. These costs are recorded within selling, general, and administrative expenses. Business Combinations Accounting for our acquisitions requires us to recognize, separately from goodwill, the assets acquired and the liabilities assumed at their acquisition-date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred and the net of the acquisition-date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of income and comprehensive income. Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date, including our estimates for intangible assets, contractual obligations assumed, pre-acquisition contingencies and contingent consideration, where applicable. If we cannot reasonably determine the fair value of a pre-acquisition contingency (non-income tax related) by the end of the measurement period, we will recognize an asset or a liability for such pre-acquisition contingency if: (i) it is probable that an asset existed or a liability had been incurred at the acquisition date and (ii) the amount of the asset or liability can be reasonably estimated. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Subsequent to the measurement period, changes in our estimates of such contingencies will affect earnings and could have a material effect on our consolidated results of operations and financial position. Examples of critical estimates in valuing certain of the intangible assets we have acquired include but are not limited to: (i) future expected cash flows from software license sales, support agreements, consulting contracts, other customer contracts and acquired developed technologies and patents; (ii) expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; and (iii) the acquired company’s brand and competitive position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. Historically, there have been no significant changes in our estimates or assumptions. To the extent a significant acquisition is made during a fiscal year, as appropriate we will expand the discussion to include specific assumptions and inputs used to determine the fair value of our acquired intangible assets. In addition, uncertain tax positions and tax-related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly based upon facts and circumstances that existed as of the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill provided that we are within the measurement period. Subsequent to the measurement period or our final determination of the tax allowance’s or contingency’s estimated value, whichever comes first, changes to these uncertain tax positions and tax-related valuation allowances will affect our provision for income taxes in our consolidated statements of income and comprehensive income and could have a material impact on our consolidated results of operations and financial position. Historically, there have been no significant changes in our valuation allowances or uncertain tax positions as it relates to business combinations. We do not believe there is a reasonable likelihood there will be a material change in the future estimates. 35 Table of Contents Goodwill, Acquisition Intangibles and Other Long-Lived Assets - Impairment Assessment Goodwill represents the excess of cost over the fair value of identifiable assets acquired and liabilities assumed in business combinations. We assess goodwill for impairment for each of our reporting units on an annual basis during our fourth fiscal quarter using a July 1 measurement date unless circumstances require a more frequent measurement. We have determined that our reporting units are the same as our reportable segments. When evaluating goodwill for impairment, we may first perform an assessment qualitatively whether it is more likely than not that a reporting unit's carrying amount exceeds its fair value, referred to as a “step zero” approach. If, based on the review of the qualitative factors, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, we would bypass the two-step impairment test. Events and circumstances we consider in performing the “step zero” qualitative assessment include macro-economic conditions, market and industry conditions, internal cost factors, share price fluctuations, and the operational stability and the overall financial performance of the reporting units. If we conclude that it is more likely than not that a reporting unit's fair value is less than its carrying amount, we would perform the first step (“step one”) of the two-step impairment test and calculate the estimated fair value of the reporting unit by using discounted cash flow valuation models and by comparing our reporting units to guideline publicly-traded companies. These methods require estimates of our future revenues, profits, capital expenditures, working capital, and other relevant factors, as well as selecting appropriate guideline publicly-traded companies for each reporting unit. We estimate these amounts by evaluating historical trends, current budgets, operating plans, industry data, and other relevant factors. Using assumptions that are different from those used in our estimates, but in each case reasonable, could produce significantly different results and materially affect the determination of fair value and/or goodwill impairment for each reporting unit. For example, if the economic environment impacts our forecasts beyond what we have anticipated, it could cause the fair value of a reporting unit to fall below its respective carrying value. For fiscal 2017, we elected to proceed directly to the step one quantitative analysis for all of our reporting units. There was a substantial excess of fair value over carrying value for each of our reporting units and we determined goodwill was not impaired for any of our reporting units for fiscal 2017. For fiscal 2018, 2019 and 2020, we performed a step zero qualitative analysis for our annual assessment of goodwill impairment. After evaluating and weighing all relevant events and circumstances, we concluded that it is not more likely than not that the fair value of any of our reporting units was less their carrying amounts. Consequently, we did not perform a step one quantitative analysis and determined goodwill was not impaired for any of our reporting units for fiscal 2018, 2019 and 2020. Our intangible assets that have finite useful lives and other long-lived assets are assessed for potential impairment when there is evidence that events and circumstances related to our financial performance and economic environment indicate the carrying amount of the assets may not be recoverable. When impairment indicators are identified, we test for impairment using undiscounted cash flows. If such tests indicate impairment, then we measure and record the impairment as the difference between the carrying value of the asset and the fair value of the asset. Significant management judgment is required in forecasting future operating results used in the preparation of the projected cash flows. Should different conditions prevail, material write downs of our intangible assets or other long-lived assets could occur. We review the estimated remaining useful lives of our acquired intangible assets at each reporting period. A reduction in our estimate of remaining useful lives, if any, could result in increased annual amortization expense in future periods. As discussed above, while we believe that the assumptions and estimates utilized were appropriate based on the information available to management, different assumptions, judgments and estimates could materially affect our impairment assessments for our goodwill, acquired intangibles with finite lives and other long-lived assets. Historically, there have been no significant changes in our estimates or assumptions that would have had a material impact for our goodwill or intangible assets impairment assessment. We believe our projected operating results and cash flows would need to be significantly less favorable to have a material impact on our impairment assessment. However, based upon our historical experience with operations, we do not believe there is a reasonable likelihood of a significant change in our projections. Share-Based Compensation We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the stock award (generally three to four years). We use the Black-Scholes valuation model to determine the fair value of our stock options and the Monte Carlo valuation model to determine the fair value of our market share units. Our valuation models and generally accepted valuation techniques require us to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, expected dividend yield, employee turnover rates and employee stock option exercise behaviors. Historically, there have been no material changes in our estimates or assumptions. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions. 36 Table of Contents Income Taxes We estimate our income taxes based on the various jurisdictions where we conduct business, which involves significant judgment in determining our income tax provision. We estimate our current tax liability using currently enacted tax rates and laws and assess temporary differences that result from differing treatments of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities recorded on our condensed consolidated balance sheets using the currently enacted tax rates and laws that will apply to taxable income for the years in which those tax assets are expected to be realized or settled. We then assess the likelihood our deferred tax assets will be realized and to the extent we believe realization is not more likely than not, we establish a valuation allowance. When we establish a valuation allowance or increase this allowance in an accounting period, we record a corresponding income tax expense in our consolidated statements of income and comprehensive income. In assessing the need for the valuation allowance, we consider future taxable income in the jurisdictions we operate; our ability to carry back tax attributes to prior years; an analysis of our deferred tax assets and the periods over which they will be realizable; and ongoing prudent and feasible tax planning strategies. An increase in the valuation allowance would have an adverse impact, which could be material, on our income tax provision and net income in the period in which we record the increase. We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the technical merits of the tax position indicate it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions more likely than not of being sustained upon audit, the second step is to measure the tax benefit as the largest amount more than 50% likely of being realized upon settlement. Significant judgment is required to evaluate uncertain tax positions and they are evaluated on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results. A description of our accounting policies associated with tax-related contingencies and valuation allowances assumed as part of a business combination is provided under “Business Combinations” above. Contingencies and Litigation We are subject to various proceedings, lawsuits and claims relating to products and services, technology, labor, stockholder and other matters. We are required to assess the likelihood of any adverse outcomes and the potential range of probable losses in these matters. If the potential loss is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. If the potential loss is considered less than probable or the amount cannot be reasonably estimated, disclosure of the matter is considered. The amount of loss accrual or disclosure, if any, is determined after analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies. Due to uncertainties related to these matters, accruals or disclosures are based on the best information available at the time. Significant judgment is required in both the assessment of likelihood and in the determination of a range of potential losses. Revisions in the estimates of the potential liabilities could have a material impact on our consolidated financial position or consolidated results of operations. Historically, there have been no material changes in our estimates or assumptions. We do not believe there is a reasonable likelihood there will be a material change in the future estimates. New Accounting Pronouncements Recently Adopted Accounting Pronouncements In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-15, Intangibles—Goodwill and Other (Topic 350): Internal-Use Software (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. We adopted ASU 2018-15 in the first quarter of our fiscal 2021 and the adoption did not have a significant impact on our condensed consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequent amendments to the initial guidance: ASU 2018-19, ASU 2019-04, ASU 2019-05 and ASU 2019-11 (collectively, “Topic 326”). Topic 326 requires measurement and recognition of expected credit losses for financial assets held. We adopted Topic 326 in the first quarter of our fiscal 2021 and the adoption did not have a significant impact on our condensed consolidated financial statements. 37 Table of Contents Recent Accounting Pronouncements Not Yet Adopted We do not expect that any recently issued accounting pronouncements will have a significant effect on our financial statements.