FAIR ISAAC CORP (FICO) FY 2024 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) includes the following: a business overview that provides a high-level summary of our strategies and initiatives, highlights from fiscal year 2024 and key performance metrics for our Software segment; a more detailed analysis of our results of operations; our capital resources and liquidity, which discusses key aspects of our statements of cash flows, changes in our balance sheets and our financial commitments; and a summary of our critical accounting estimates that involve a significant level of estimation uncertainty. Our MD&A should be read in conjunction with Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. The following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ from those referred to herein due to a number of factors, including but not limited to risks described in Item 1A, Risk Factors, in this Annual Report on Form 10-K.

Our MD&A focuses on discussion of year-over-year comparisons between fiscal 2024 and fiscal 2023. Discussion of fiscal 2022 results and year-over-year comparisons between fiscal 2023 and fiscal 2022 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended September 30, 2023.

BUSINESS OVERVIEW

Strategies and Initiatives

In fiscal 2024, our B2B scoring solutions, including the flagship FICO® Score, continued to be the standard measure of consumer credit risk in the U.S. The adoption of our most predictive scores, FICO® Score 10 and 10 T, gained increased traction for non-conforming mortgages and will be implemented for conforming mortgages based on the timeline set forth by the Federal Housing Finance Agency for enterprise credit scoring requirements. We continued the expansion of our financial inclusion initiatives through the FICO® Educational Analytics Challenge, a program created to help promote diversity in data science, engineering, and technology at Historically Black Colleges and Universities. Additionally, we host free Score A Better FutureTM financial education workshops for students and adults from traditionally underserved communities. Internationally, we launched a FICO Score based on Ukrainian Bureau of Credit Histories data, an innovative score to help Ukrainians gain credit access in Poland. We also remained committed to expanding usage of the FICO® Resilience Index, a complement to FICO Scores that more precisely predicts a borrower’s resilience to future economic disruptions, helping lenders manage latent risk. We continued to develop alternative data scores, including trended data cash flow attributes, to help lenders identify credit borrowers with positive financial profiles that extend beyond their traditional credit reports as well as offer credit score layering leveraging UltraFICO® Score and FICO® Score XD to help broaden accessibility and extend financial inclusion to borrowers with limited credit history.

During fiscal 2024, the strategy for our Software segment was to continue to advance and drive growth through our platform-first, cloud delivered products. A significant portion of our short-term opportunity remains in North America, where financial institutions are focused on digital transformation and understand the value of FICO® Platform. We have also expanded our FICO Platform reach both by geography and customer type in order to enable organizations to operationalize analytics, and to power customer connections and decision making at scale. We continue to innovate and bring new capabilities to FICO Platform, demonstrating its value with new customers and expanding use cases with existing customers.

We also continued to enhance stockholder value by returning cash to stockholders through our stock repurchase program. During fiscal 2024, we repurchased 0.6 million shares at a total repurchase price of $833.3 million.

Highlights from Fiscal 2024

•Total revenues were $1.7 billion during fiscal 2024, a 13% increase from fiscal 2023.

•Revenues for our Scores segment were $919.7 million during fiscal 2024, a 19% increase from fiscal 2023.

•Annual Recurring Revenue for our Software segment as of September 30, 2024 was $721.2 million, an 8% increase from September 30, 2023.

•Dollar-Based Net Retention Rate for our Software segment was 106% as of September 30, 2024.

•Operating income was $733.6 million during fiscal 2024, a 14% increase from fiscal 2023.

•Net income was $512.8 million during fiscal 2024, a 19% increase from fiscal 2023.

•Diluted EPS was $20.45 during fiscal 2024, a 21% increase from fiscal 2023.

•Cash flow from operating activities was $633.0 million during fiscal 2024, compared with $468.9 million during fiscal 2023.

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•Cash and cash equivalents were $150.7 million as of September 30, 2024, compared with $136.8 million as of September 30, 2023.

•Total debt balance was $2.2 billion as of September 30, 2024, compared with $1.9 billion as of September 30, 2023.

•Total share repurchases during fiscal 2024 were $833.3 million, compared with $407.3 million during fiscal 2023.

Key performance metrics for Software segment

Annual Contract Value Bookings (“ACV Bookings”)

Management regards ACV Bookings as an important indicator of future revenues, but it is not comparable to, nor is it a substitute for, an analysis of our revenues and other U.S. generally accepted accounting principles (“U.S. GAAP”) measures. We define ACV Bookings as the average annualized value of software contracts signed in the current reporting period that generate current and future on-premises and SaaS software revenue. We only include contracts with an initial term of at least 24 months and we exclude perpetual licenses and other software revenues that are non-recurring in nature. For renewals of existing software subscription contracts, we count only incremental annual revenue expected over the current contract as ACV Bookings.

ACV Bookings is calculated by dividing the total expected contract value by the contract term in years. The expected contract value equals the fixed amount — including guaranteed minimums, if any — stated in the contract, plus estimates of future usage-based fees. We develop estimates from discussions with our customers and examinations of historical data from similar products and customer arrangements. Differences between estimates and actual results occur due to variability in the estimated usage. This variability can be the result of 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. For the periods presented, ACV Bookings related to estimates of future usage-based fees was approximately 30% of the total ACV Bookings amount on an annualized basis. Differences between the initial estimates of future usage-based fees and actual results historically have not been material and we do not currently expect that they will be materially different in the future.

We disclose estimated revenue expected to be recognized in the future related to remaining performance obligations in Note 9 to the accompanying consolidated financial statements. However, we believe ACV Bookings is a useful supplemental measure of our business as it includes estimated revenues and future billings excluded from Note 9, such as usage-based fees and guaranteed minimums derived from our on-premises software licenses, among others.

The following table summarizes our ACV Bookings during the periods indicated:

(*) We sold certain assets related to our Siron compliance business during the quarter ended December 31, 2022, and the amount above excludes this product line for the year ended September 30, 2023.

Annual Recurring Revenue (“ARR”)

Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, requires us to recognize a significant portion of revenue from our on-premises software subscriptions at the point in time when the software is first made available to the customer, or at the beginning of the subscription term, despite the fact that our contracts typically call for billing these amounts ratably over the life of the subscription. The remaining portion of our on-premises software subscription revenue including maintenance and usage-based fees are recognized over the life of the contract. This point-in-time recognition of a portion of our on-premises software subscription revenue creates significant variability in the revenue recognized period to period based on the timing of the subscription start date and the subscription term. Furthermore, this point-in-time revenue recognition can create a significant difference between the timing of our revenue recognition and the actual customer billing under the contract. We use ARR to measure the underlying performance of our subscription-based contracts and mitigate the impact of this variability. ARR is defined as the annualized revenue run-rate of on-premises and SaaS software agreements within a quarterly reporting period, and as such, is different from the timing and amount of revenue recognized. All components of our software licensing and subscription arrangements that are not expected to recur (primarily perpetual licenses) are excluded. We calculate ARR as the quarterly recurring revenue run-rate multiplied by four.

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The following table summarizes our ARR for on-premises and SaaS software exiting each of the dates presented:

(*) We sold certain assets related to our Siron compliance business during the quarter ended December 31, 2022, and the amounts and percentages above exclude this product line at December 31, 2022.

Dollar-Based Net Retention Rate (“DBNRR”)

We consider DBNRR to be an important measure of our success in retaining and growing revenue from our existing customers. To calculate DBNRR for any period, we compare the ARR at the end of the prior comparable quarter (“base ARR”) to the ARR from that same cohort of customers at the end of the current quarter (“retained ARR”); we then divide the retained ARR by the base ARR to arrive at the DBNRR. Our calculation includes the positive impact among this cohort of customers of selling additional products, price increases and increases in usage-based fees, and the negative impact of customer attrition, price decreases, and decreases in usage-based fees during the period. However, the calculation does not include the positive impact from sales to any new customers acquired during the period. Our DBNRR may increase or decrease from period to period as a result of various factors, including the timing of new sales and customer renewal rates.

The following table summarizes our DBNRR for on-premises and SaaS software exiting each of the dates presented:

(*) We sold certain assets related to our Siron compliance business during the quarter ended December 31, 2022, and the percentages above exclude this product line at December 31, 2022.

RESULTS OF OPERATIONS

We are organized into two reportable segments: Scores and Software. Although we sell solutions and services into a large number of end user product and industry markets, our reportable business segments reflect the primary method in which management organizes and evaluates internal financial information to make operating decisions and assess performance.

Segment revenues, operating income, and related financial information, including disaggregation of revenue, for the years ended September 30, 2024, 2023 and 2022 are set forth in Note 9 and Note 14 to the accompanying consolidated financial statements.

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Revenues

The following tables set forth certain summary information on a segment basis related to our revenues for fiscal 2024, 2023 and 2022:

Scores

Scores segment revenues increased $145.8 million in fiscal 2024 from 2023 due to an increase of $150.8 million in our business-to-business scores revenue, partially offset by a decrease of $5.0 million in our business-to-consumer revenue. The increase in business-to-business scores revenue was primarily attributable to a higher unit price, partially offset by a decrease in volume of mortgage originations. The decrease in business-to-consumer revenue was primarily attributable to a decrease in direct sales generated from the myFICO.com website.

Software

The following table provides information about disaggregated revenue for our Software segment by revenue types:

The following table provides information about disaggregated revenue for on-premises and SaaS software within our Software segment by timing of revenue recognition:

(1)Includes license portion of our on-premises subscription software and perpetual license, both of which are recognized when the software is made available to the customer, or at the start of the subscription.

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(2)Includes maintenance portion and usage-based fees of our on-premises subscription software, maintenance revenue on perpetual licenses, as well as SaaS revenue.

Software segment revenues increased $58.1 million in fiscal 2024 from 2023 due to a $71.2 million increase in on-premises and SaaS software revenue, partially offset by a $13.0 million decrease in services revenue. The increase in our on-premises and SaaS software revenue was primarily attributable to an increase in revenue recognized over time largely driven by SaaS growth for our Platform products. The decrease in professional services revenue was primarily attributable to our strategy to emphasize higher-margin software over professional services.

Operating Expenses and Other Income (Expense), Net

The following tables set forth certain summary information related to our consolidated statements of income and comprehensive income for fiscal 2024, 2023 and 2022:

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Cost of Revenues

Cost of revenues consists primarily of employee salaries, incentives, and benefits for personnel directly involved in delivering software products, operating SaaS infrastructure, and providing support, implementation and consulting services; 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 fiscal 2024 over 2023 increase in cost of revenues of $37.2 million was primarily attributable to an $18.1 million increase in infrastructure and facilities costs, a $12.4 million increase in personnel and labor costs, a $4.3 million increase in direct materials costs, and a $2.4 million increase in outside services costs. The increase in infrastructure and facilities costs was primarily attributable to an increase in third-party data center hosting costs, a prior year one-time reimbursement from a third-party data center provider for implementation costs previously incurred, and an increase in software royalty costs. The increase in personnel and labor costs was primarily attributable to increased market base-pay adjustments and increased share-based compensation expense. The increase in direct materials costs was primarily attributable to increased telecommunications expenses to support FICO® Customer Communications Services revenue. The increase in outside services costs was primarily attributable to increased consulting costs. Cost of revenues as a percentage of revenues decreased to 20% during fiscal 2024 from 21% during fiscal 2023, 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 Software products.

The fiscal 2024 over 2023 increase in research and development expenses of $12.0 million was primarily attributable to an $8.2 million increase in personnel and labor costs, as a result of increases in share-based compensation expense, headcount, and incentive expense, a $2.4 million increase in infrastructure and facilities costs primarily attributable to increased third-party data center hosting costs, and a $1.8 million increase in consulting costs. Research and development expenses as a percentage of revenues decreased to 10% during fiscal 2024 from 11% during fiscal 2023.

Selling, General and Administrative

Selling, general and administrative expenses consist principally of employee salaries, incentives, commissions and benefits; travel costs; overhead costs; advertising and other promotional expenses; corporate facilities expenses; legal expenses; and business development expenses.

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The fiscal 2024 over 2023 increase in selling, general and administrative expenses of $62.3 million was primarily attributable to a $38.6 million increase in personnel and labor costs, a $6.0 million increase in outside services costs, a $5.5 million increase in advertising and other promotional costs, a $4.9 million increase in non-income tax costs, a $3.7 million increase in travel costs, and a $2.6 million increase in infrastructure and facilities costs. The increase in personnel and labor costs was primarily attributable to increased share-based compensation expense, increased headcount, market base-pay adjustments, increased fringe benefit costs related to our supplemental retirement and savings plan, and increased incentive expense. The increase in outside services costs was primarily attributable to increased legal and consulting expenses. The increase in advertising and other promotional expenses was primarily attributable to increased costs for advertising campaigns and corporate events. The increase in non-income tax costs was primarily attributable to a tax law change related to transfer pricing effective in fiscal 2024 that impacted a non-U.S. subsidiary. The increase in travel costs was primarily attributable to promotional and corporate events. The increase in infrastructure and facilities costs was primarily attributable to the impact of a favorable adjustment in the prior year from the termination of an office lease. Selling, general and administrative expenses as a percentage of revenues increased to 27% during fiscal 2024 from 26% during fiscal 2023.

Amortization of Intangible Assets

Amortization of intangible assets consists of expense related to intangible assets recorded in connection with our acquisitions. Our finite-lived intangible assets, consisting primarily of completed technology and customer contracts and relationships, are amortized using the straight-line method over periods ranging from five to ten years.

Amortization expense was $0.9 million and $1.1 million for fiscal 2024 and 2023, respectively.

Gain on Product Line Asset Sale

The $1.9 million gain on product line asset sale during fiscal 2023 was attributable to the sale of certain assets related to our Siron compliance business.

Interest Expense, Net

Interest expense includes interest on the senior notes issued in December 2021, December 2019, and May 2018, as well as interest and credit agreement fees on the revolving line of credit and term loans. On our consolidated statements of income and comprehensive income, interest expense is netted with interest income, which is derived primarily from the investment of funds in excess of our immediate operating requirements.

The fiscal 2024 from 2023 increase in net interest expense of $10.1 million was primarily attributable to a higher average interest rate and higher average outstanding balance of borrowings under our credit agreement during fiscal 2024.

Other Income (Expense), Net

Other income (expense), net consists primarily of unrealized investment gains/losses and realized gains/losses on certain investments classified as trading securities, exchange rate gains/losses resulting from remeasurement of foreign-currency-denominated receivable and cash balances held by our various reporting entities 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 fiscal 2024 over 2023 increase in other income, net of $7.7 million was primarily attributable to an increase in net unrealized and realized gains on investments classified as trading securities in our supplemental retirement and savings plan and a decrease in foreign currency exchange losses.

Provision for Income Taxes

Our effective income tax rates were 20.1%, 22.4% and 20.7% in fiscal 2024, 2023 and 2022, respectively.

The decrease in our effective tax rate in fiscal 2024 compared to fiscal 2023 was due to an increase in excess tax benefits related to share-based compensation.

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Operating Income

The following tables set forth certain summary information on a segment basis related to our operating income for fiscal 2024, 2023 and 2022:

Scores

Software

The fiscal 2024 over 2023 increase in operating income of $90.8 million was primarily attributable to a $204.0 million increase in segment revenues, partially offset by a $55.3 million increase in segment operating expenses, a $30.5 million increase in corporate expenses, and a $25.6 million increase in share-based compensation cost.

At the segment level, the $118.1 million increase in segment operating income was the result of a $132.3 million increase in our Scores segment operating income and a $16.3 million increase in our Software segment operating income, partially offset by a $30.5 million increase in corporate expenses.

The $132.3 million increase in our Scores segment operating income was attributable to a $145.8 million increase in segment revenue, partially offset by a $13.5 million increase in segment operating expenses. Segment operating income as a percentage of segment revenue for Scores was 88%, consistent with fiscal 2023.

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The $16.3 million increase in our Software segment operating income was attributable to a $58.1 million increase in segment revenue, partially offset by a $41.8 million increase in segment operating expenses. Segment operating income as a percentage of segment revenue for Software decreased to 32% from 33%, primarily attributable to a prior year one-time reimbursement from a third-party data center provider for implementation costs previously incurred, partially offset by a decrease in sales of our lower-margin professional services.

CAPITAL RESOURCES AND LIQUIDITY

Outlook

As of September 30, 2024, we had $150.7 million in cash and cash equivalents, which included $124.4 million held by our foreign subsidiaries. We believe our cash and cash equivalents balances, including those held by our foreign subsidiaries, as well as available borrowings from our $600 million revolving line of credit and anticipated cash flows from operating activities, will be sufficient to fund our working and other capital requirements for at least the next 12 months and thereafter for the foreseeable future, including the $15.0 million principal payments on the $300 Million Term Loan (as defined below) due over the next 12 months. Under our current financing arrangements, we have no other significant debt obligations maturing over the next twelve months. For jurisdictions outside the U.S. where cash may be repatriated in the future, the Company expects the net impact of any repatriations to be immaterial to the Company’s overall tax liability.

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

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 totaled $633.0 million in fiscal 2024 compared to $468.9 million in fiscal 2023. The $164.1 million increase was attributable to an $83.4 million increase in net income, a $43.0 million increase that resulted from timing of receipts and payments in our ordinary course of business, and a $37.7 million increase in non-cash items.

Cash Flows from Investing Activities

Net cash used in investing activities totaled $28.0 million in fiscal 2024 compared to $16.0 million in fiscal 2023. The $12.0 million increase was attributable to a $16.7 million increase in capitalized internal-use software costs and a $4.6 million increase in purchases of property and equipment, partially offset by a $6.1 million decrease in cash transferred, net of proceeds, from a product line asset sale and a $3.2 million increase in proceeds from sales, net of purchases, of marketable securities.

Cash Flows from Financing Activities

Net cash used in financing activities totaled $592.9 million in fiscal 2024 compared to $455.0 million in fiscal 2023. The $137.9 million increase was primarily attributable to a $416.2 million increase in repurchases of common stock and a $62.5 million increase in taxes paid related to net share settlement of equity awards, partially offset by a $340.0 million increase in proceeds, net of payments, on our revolving line of credit and term loans.

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Repurchases of Common Stock

In January 2024, our Board of Directors approved a stock repurchase program (the “January 2024 program”), replacing our previously authorized October 2022 stock repurchase program, which was terminated prior to its expiration. The January 2024 program was open-ended and authorized repurchases of shares of our common stock from time to time up to an aggregate cost of $500.0 million in the open market or in negotiated transactions. In July 2024, our Board of Directors approved a new stock repurchase program (the “July 2024 program”), replacing the January 2024 program, which was terminated prior to its expiration and under which $29.6 million was remaining for repurchase at the time of termination. The July 2024 program is open-ended and authorizes repurchases of shares of our common stock from time to time up to an aggregate cost of $1.0 billion in the open market or in negotiated transactions. The July 2024 program remains in effect until the total authorized amount is expended or until further action by our Board of Directors. As of September 30, 2024, we had $760.5 million remaining under the July 2024 program. During fiscal 2024 and 2023, we expended $833.3 million and $407.3 million, respectively, under the July 2024 program and previously authorized stock repurchase programs, as applicable.

Revolving Line of Credit and Term Loans

We have a $600 million unsecured revolving line of credit and a $300 million unsecured term loan (the “$300 Million Term Loan”) with a syndicate of banks that mature on August 19, 2026. Borrowings under the revolving line of credit and the $300 Million Term Loan 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. The $300 Million Term Loan requires principal payments in consecutive quarterly installments of $3.75 million on the last business day of each quarter. Interest rates on amounts borrowed under the revolving line of credit and the $300 Million Term Loan are based on (i) an adjusted base rate, which is the greatest of (a) the prime rate, (b) the Federal Funds rate plus 0.5%, and (c) one-month adjusted term Secured Overnight Financing Rate (“SOFR”) plus 1%, plus, in each case, an applicable margin, or (ii) an adjusted term SOFR plus an applicable margin (or, if such rate is no longer available, a successor benchmark rate determined in accordance with the terms of the credit agreement). Adjusted term SOFR is defined as term SOFR for the relevant interest period plus a SOFR adjustment of 0.10% per annum. The applicable margin for base rate borrowings and for SOFR borrowings is determined based on our consolidated leverage ratio. The applicable margin for base rate borrowings ranges from 0% to 0.75% per annum and for SOFR borrowings ranges from 1% to 1.75% per annum. In addition, we must pay certain credit facility fees. The revolving line of credit and the $300 Million Term Loan contain certain restrictive covenants including a maximum consolidated leverage ratio of 3.5 to 1.0, subject to a step up to 4.0 to 1.0 following certain permitted acquisitions and subject to certain conditions, and a minimum interest coverage ratio of 3.0 to 1.0. The credit agreement also contains other covenants typical of unsecured credit facilities.

On June 13, 2024, we amended our credit agreement to provide for the issuance of a new $450 million unsecured term loan (the “$450 Million Term Loan”) with a syndicate of banks, increasing the total capacity of the credit agreement to $1.35 billion. The $450 Million Term Loan is subject to the same interest rate provisions and covenants as the revolving line of credit and the $300 Million Term Loan, and matures on August 19, 2026. We have no obligation to make scheduled principal payments on the $450 Million Term Loan prior to the maturity date, but may prepay the $450 Million Term Loan, without premium or penalty, in whole or in part.

As of September 30, 2024, we had $210.0 million in borrowings outstanding under the revolving line of credit at a weighted-average interest rate of 6.396%, $258.8 million in outstanding balance of the $300 Million Term Loan at an interest rate of 6.344%, and $450.0 million in outstanding balance of the $450 Million Term Loan at an interest rate of 6.281%. We were in compliance with all financial covenants under the credit agreement as of September 30, 2024.

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”). The 2019 Senior Notes require interest payments semi-annually at a rate of 4.00% per annum and will mature on June 15, 2028. On December 17, 2021, we issued $550 million of additional senior notes of the same class as the 2019 Senior Notes in a private offering to qualified institutional investors (the “2021 Senior Notes,” and collectively with the 2018 Senior Notes and the 2019 Senior Notes, the “Senior Notes”). The 2021 Senior Notes require interest payments semi-annually at a rate of 4.00% per annum and will mature on June 15, 2028, the same date as the 2019 Senior Notes. The indentures for the Senior Notes contain certain covenants typical of unsecured obligations. As of September 30, 2024, the carrying value of the Senior Notes was $1.3 billion and we were in compliance with all financial covenants under these obligations.

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Contractual Obligations

The following table presents a summary of our contractual obligations at September 30, 2024:

(1)Represents the unpaid principal payments due under the Senior Notes, revolving line of credit, and term loans.

(2)Represents purchase obligations primarily consisting of commitments to purchase certain services. For services that have been delivered under these arrangements as of September 30, 2024, we recorded related liabilities within accounts payable or other accrued liabilities on our consolidated balance sheet, which are excluded from the purchase obligations amount.

(3)Represents unrecognized tax benefits related to uncertain tax positions. As we are not able to reasonably estimate the timing of the payments or the amount by which the liability will increase or decrease over time, the related balances have not been reflected in the section of the table showing payment by fiscal year.

CRITICAL ACCOUNTING ESTIMATES

We prepare our consolidated financial statements in conformity with U.S. GAAP. 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 resulting from business combinations and other long-lived assets – impairment assessment, 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 and such differences could be material to our financial condition and results of operations. Critical accounting estimates are those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations.

While our significant accounting policies are more fully described in Note 1 and Note 9 to our consolidated financial statements included elsewhere in this report, we believe the following accounting policies require the most critical accounting estimates, which involve significant subjectivity and judgment, and changes to such estimates or assumptions could have a material impact on our financial condition or operating results. Therefore, we consider an understanding of the variability and judgment required in making these estimates and assumptions to be critical in fully understanding and evaluating our reported financial results.

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Revenue Recognition

For our SaaS subscriptions, 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. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue recognized under the contract will not occur. Variable consideration is estimated based on either the expected value or the most likely amount method depending on which method we expect to better predict the amount of consideration to which we will be entitled. Our estimates of variable consideration are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us at contract inception and require judgment. For the periods presented, we have not experienced significant changes to our estimates and judgments related to variable consideration in our contracts.

For our professional services, 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. For the periods presented, we have not experienced significant changes to our estimates and judgments related to the timing of satisfaction of our professional services.

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. For the periods presented, we have not experienced significant changes to our estimates and judgments related to the identification of performance obligations for our contracts.

We determine the standalone selling prices (“SSP”) 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. For the periods presented, we have not experienced significant changes to our estimates and judgments related to the determination of our SSPs.

Goodwill 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.

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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 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. Alternatively, we may bypass the qualitative assessment described above for any reporting unit in any period and proceed directly to performing step one of the goodwill impairment test.

Our 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 projected 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 other long-lived assets could occur.

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 and other long-lived assets. For the periods presented, we have not experienced significant changes to our estimates and judgments related to our goodwill or other long-lived 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 share-based compensation cost at the grant date based on the fair value of the award and recognize it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the stock award (generally three to four years). We use the Black-Scholes valuation model to determine the fair value of our stock options and a Monte Carlo valuation model to determine the fair value of our market share units. Our valuation models and generally accepted valuation techniques require us to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, expected dividend yield, employee turnover rates and employee stock option exercise behaviors. For the periods presented, we have not experienced significant changes to our estimates and judgments related to the fair value of our awards. See Note 12 to the accompanying consolidated financial statements for further discussion of our share-based employee benefit plans.

Income Taxes

We estimate our income taxes based on the various jurisdictions where we conduct business, which involves significant judgment in determining our income tax provision. We estimate our current tax liability using currently enacted tax rates and laws and assess temporary differences that result from differing treatments of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities recorded on our 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.

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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.

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. For the periods presented, we have not experienced significant changes to our estimates and judgments related to the assessment of likelihood and in the determination of a range of potential losses.

New Accounting Pronouncements

For information about recent accounting pronouncements recently adopted and not yet adopted and the impact on our consolidated financial statements, refer to Part II, Item 8, Financial Statements and Supplementary Data, Note 1, Nature of Business and Summary of Significant Accounting Policies, in our accompanying Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.